|UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549


FORM 10-Q


(Mark One)


|X| QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934


For the Quarterly
Period Ended September 30, 2003


OR


|_| TRANSITION REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934


Commission File
Number 0-26483


VaxGen, Inc.


(Exact name of
Registrant as Specified in its Charter)


Delaware(State or
other jurisdiction of incorporation or organization)


94-3236309(I.R.S. Employer
Identification Number)


1000 Marina Blvd.,
Suite 200Brisbane, California 94005(Address of Principal
Administrative Offices) (Zip Code)


(650) 624-1000(Registrants Telephone
Number, Including Area Code)


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


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


The issuer has one class of common
stock with 20,828,777 shares outstanding as of November 1, 2003.
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|VaxGen, Inc.


Form 10-Q


For the Quarter Ended
September 30, 2003


Table of Contents
|---------------------------------------------------------------------------------------

|        |  |                                                                
|------- |  | ---------------------------------------------------------------
|Part I  |  | Financial Information                                          
|        |  | Recent Accounting and Financial Developments                   
|Item 1  |  | Financial Statements (unaudited):                              
|        |  | Condensed Consolidated Balance Sheets                          
|        |  | 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:                                         
|        |  | Overview                                                       
|        |  | Results of Operations                                          
|        |  | Liquidity and Capital Resources                                
|        |  | Risk Factors                                                   
|Item 3  |  | Quantitative and Qualitative Disclosures About Market Risk     
|Item 4  |  | Controls and Procedures                                        
|Part II |  | Other Information                                              
|Item 1  |  | Legal Proceedings                                              
|Item 6  |  | Exhibits and Reports on Form 8-K                               
|        |  | Signature                                                      
|        |  | Certifications                                                 

|
|

|Recent Accounting and
Financial Developments


In October 2003, the
Company discovered an error related to the classification and valuation of
warrants issued in connection with the Companys Series A Redeemable
Convertible Preferred Stock. In addition, in the second quarter of 2003, the
Company properly reflected $606,000 of costs incurred for validation procedures from operating
expenses to property and equipment. As a result of the restatement, the net loss
applicable to common stockholders increased by $270,000 for the nine months
ended September 30, 2002. As a result, the financial statements for the fiscal
year 2002 and for the second, third and fourth fiscal quarters of 2001 were
restated in the Companys Form 10-K/A filed on November 19, 2003.
Financial statements for the first and second fiscal quarters of 2003 and 2002
were restated on the Companys Forms 10-Q/A also filed on November 19,
2003. Restated financial statements reflect adjustments primarily related to the
recognition, classification and valuation of warrants and beneficial conversion
features relating to the Companys Series A Redeemable Convertible
Preferred Stock financing, which closed in May 2001. These warrants provide for
cash redemption by the warrant holders upon the occurrence of certain events
outside the control of the Company. As such, the Company has reclassified these
warrants from equity to a liability.
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | For the nine months ended September 30, 2002, the net loss applicable to common
stockholders increased to $23,894,000 from $23,624,000 and basic and diluted loss per
share applicable to common stockholders increased to $(1.66) from $(1.64), each as
compared to the amounts previously reported by VaxGen on its Form 10-Q filed on November
14, 2002.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|The restated financial statements
reflect the following adjustments during the past two fiscal years and the first and
second quarters of the current fiscal year:
|------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | In 2001, the Company reclassified $3,507,000, the initial value assigned to warrants
issued in connection with the Companys Series A Redeemable Convertible Preferred
Stock financing, from stockholders equity to current liabilities.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Beginning on June 30, 2001 and in each subsequent quarter the restated financial
statements reflect a non-cash expense or credit based on the fair market value of the
warrants measured as of the end of each quarter, and a corresponding change in the current
liability representing the value assigned to the warrants noted above.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The value of beneficial conversion features totaling $12,688,000, originally recorded as
immediate deemed dividends to preferred stockholders of $734,000 in 2001, $11,061,000 in
2002 and $893,000 in the second quarter of 2003 has been reclassified to Series A
Redeemable Convertible Preferred Stock and is now amortized over the period ending on the
redemption date, May 23, 2004. Upon conversions of Series A Redeemable Convertible
Preferred Stock prior to the redemption date, of which two occurred in 2002 and three more
occurred in the second quarter of 2003, the related unamortized value of beneficial
conversion features and the unamortized value of the warrants have been recorded as a
beneficial conversion charge of $10,686,000 in 2002, $2,188,000 in the second
quarter of 2003 and $249,000 in the third quarter of 2003.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | In the second quarter of 2003, the Company properly reflected $606,000 of costs incurred for
validation procedures relating to the VCI manufacturing facility from operating expenses
to property and equipment.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|
|

|PART I  FINANCIAL
INFORMATION


Item 1. Financial
Statements



VaxGen, Inc.
(A Development Stage Enterprise)
CONDENSED CONDSOLIDATED BALANCE SHEETS
(Unaudited)
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                                    | September
      30,
      2003 |  | December
      31,
      2002(As Restated) |             
|------------------------------------------------------------------- | ------------------------------ |  | ------------------------------------------ | ------------
|ASSETS                                                              |                                |  |                                            |             
|Current
      assets:                                               |                                | 
|Cash
      and cash equivalents                                     |                                |  | $                                          | 683,000     
|Investment
      securities                                         |                                |  |                                            | 6,145,000   
|Accounts
      receivable                                           |                                |  |                                            | 3,274,000   
|Accounts
      receivable - related party                           |                                |  |                                            | 140,000     
|Deferred
      costs                                                |                                |  |                                            | 1,693,000   
|Prepaid
      expenses and other current assets                     |                                |  |                                            | 4,067,000   
|                                                                    |                                |  |                                            |             
|Total
      current assets                                          |                                |  |                                            | 16,002,000  
|Property
      and equipment, net                                   |                                |  |                                            | 17,808,000  
|Restricted
      cash                                               |                                |  |                                            | 1,088,000   
|Investment
      in affiliate                                       |                                |  |                                            |            
|Employee
      loans receivable                                     |                                |  |                                            | 95,000      
|Other
      assets                                                  |                                |  |                                            | 343,000     
|                                                                    |                                |  |                                            |             
|Total
      assets                                                  |                                |  | $                                          | 35,336,000  
|                                                                    |                                |  |                                            |             
|                                                                    |                                | 
|LIABILITIES
        AND STOCKHOLDERS EQUITY                        |                                |  |                                            |             
|Current
      liabilities:                                          |                                |  |                                            |             
|Payable
      to Genentech                                          |                                |  | $                                          | 1,860,000   
|Accounts
      payable                                              |                                |  |                                            | 4,909,000   
|Accrued
      clinical trial expenses                               |                                |  |                                            |            
|Accrued
      liabilities                                           |                                |  |                                            | 2,760,000   
|Deferred
      revenues                                             |                                |  |                                            | 5,729,000   
|Deferred
      rent - current                                       |                                |  |                                            | 50,000      
|Warrant
      valuation obligation                                  |                                |  |                                            | 4,709,000   
|Current
      portion of long-term obligations                      |                                |  |                                            | 5,000       
|                                                                    |                                |  |                                            |             
|Total
      current liabilities                                     |                                |  |                                            | 20,022,000  
|Minority
      interest of subsidiary                               |                                |  |                                            | 6,050,000   
|Deferred
      rent                                                 |                                |  |                                            | 517,000     
|Redeemable
      convertible preferred stock, $0.01 par             |                                | 
|value,
      20,500 shares authorized:                              |                                | 
|Series
      A 6% cumulative, $0.01 par value,                      |                                | 
|zero
      and 3,800 shares issued and outstanding at September 30, |                                | 
|2003
      and December 31, 2002, respectively (liquidation         |                                | 
|preference
      of $0 and $3,800,000 at September 30,              |                                | 
|2003
      and December 31, 2002, respectively)                     |                                |  |                                            |            
|Commitments
      and contingencies                                 |                                | 
|Stockholders
      equity:                                         |                                | 
|Preferred
      stock, $0.01 par value, 19,979,500 shares           |                                | 
|authorized;
      none issued or outstanding                        |                                |  |                                            |            
|Common
      stock, $0.01 par value, 40,000,000 shares authorized;  |                                | 
|20,807,611
      and 15,777,064 shares issued and outstanding       |                                | 
|at
      September 30, 2003 and December 31, 2002, respectively     |                                |  |                                            | 208,000     
|Additional
      paid-in capital                                    |                                |  |                                            | 171,725,000 
|Deferred
      stock compensation                                   |                                |  |                                            | (15,000     
|Accumulated
      other comprehensive income -                      |                                | 
|unrealized
      gain on investment securities                      |                                |  |                                            | 31,000      
|Deficit
      accumulated during the development stage              |                                |  |                                            | (163,202,000
|                                                                    |                                |  |                                            |             
|Total
      stockholders equity                                    |                                |  |                                            | 8,747,000   
|                                                                    |                                |  |                                            |             
|Total
      liabilities and stockholders equity                    |                                |  | $                                          | 35,336,000  
|                                                                    |                                |  |                                            |             

|See accompanying notes
to condensed consolidated financial statements.


2
|--------------------------------------------------------------------------

|VaxGen, Inc.(A Development
Stage Enterprise)CONDENSED CONSOLIDATED
STATEMENTS OF OPERATIONS(Unaudited)
|------------------------------------------------------------------------------------------------------

|                                            | Three months
      ended
      September 30, | Nine months
      ended
      September 30, | Period from
      Inception
      (November 27, 1995)
      through September 30,
|------------------------------------------- | -------------------------------------------- | ------------------------------------------- | ---------------------------------------------------------------------------------
|
|
|Revenue:                                    |                                              |                                             |                                                                                  
|Research
      grant and contract
  revenue |                                              |                                             | $                                                                                
|Related party
      services revenue        |                                              |                                             |                                                                                  
|                                            |                                              |                                             |                                                                                  
|Total revenues                              |                                              |                                             |                                                                                  
|Operating
      expenses:                   |                                              |                                            
|Research
      and development:             |                                              |                                            
|Genentech
      charges                     |                                              |                                             |                                                                                  
|Other                                       |                                              |                                             |                                                                                  
|                                            |                                              |                                             |                                                                                  
|Total research
      and development        |                                              |                                             |                                                                                  
|General and
      administrative
  expenses |                                              |                                             |                                                                                  
|                                            |                                              |                                             |                                                                                  
|Loss from
      operations                  |                                              |                                             |                                                                                  
|Other income
      (expense):               |                                              |                                            
|Investment
      income                     |                                              |                                             |                                                                                  
|Interest
      expense                      |                                              |                                             |                                                                                  
|Equity in
      loss of affiliate           |                                              |                                             |                                                                                  
|Warrant valuation
      adjustment          |                                              |                                             |                                                                                  
|                                            |                                              |                                             |                                                                                  
|Total other
      (expense) income, net     |                                              |                                             |                                                                                  
|                                            |                                              |                                             |                                                                                  
|Net loss
      before minority interest     |                                              |                                             |                                                                                  
|Minority
      interest in                  |                                              |                                            
|subsidiary
      losses                     |                                              |                                             |                                                                                  
|                                            |                                              |                                             |                                                                                  
|Net loss                                    |                                              |                                             |                                                                                  
|Charges related
      to convertible        |                                              |                                            
|preferred
      stock:                      |                                              |                                            
|Dividends                                   |                                              |                                             |                                                                                  
|Accretion
      to redemption value         |                                              |                                             |                                                                                  
|Beneficial
      conversion charge          |                                              |                                             |                                                                                  
|                                            |                                              |                                             |                                                                                  
|Net loss
      applicable to common         |                                              |                                            
|stockholders                                |                                              |                                             | $                                                                                
|                                            |                                              |                                             |                                                                                  
|Basic and
      diluted loss per share      |                                              |                                            
|applicable
      to common                  |                                              |                                            
|stockholders                                |                                              |                                             | $                                                                                
|Weighted
      average shares used in       |                                              |                                            
|computing
      basic and diluted           |                                              |                                            
|loss
      per share                        |                                              |                                             |                                                                                  

|See accompanying notes
to condensed consolidated financial statements.


3
|--------------------------------------------------------------------------

|VaxGen, Inc.(A Development Stage
Enterprise)CONDENSED CONSOLIDATED
STATEMENTS OF CASH FLOWS(Unaudited)
|------------------------------------------------------------------------------------------------------

|                                                                  | Nine months
      ended
September 30, | Period
      Inception
      (November 27,
|----------------------------------------------------------------- | ------------------------------------- | ------------------------------------------
|
|
|Net loss                                                          |                                       |                                           
|Adjustments
      to reconcile net loss to net                    |                                       |                                           
|cash used
      in operating activities:                          |                                       |                                           
|Minority
      interest in subsidiary losses                      |                                       |                                           
|Depreciation
      and amortization                               |                                       |                                           
|Amortization
      of premiums and                                |                                       |                                           
|discounts
      on investment securities                          |                                       |                                           
|Stock compensation
      expense                                  |                                       |                                           
|Bad debt
      reserve                                            |                                       |                                           
|Warrants
      issued to consultants                              |                                       |                                           
|Equity in
      loss of affiliate                                 |                                       |                                           
|Non-cash
      warrant valuation adjustments                      |                                       |                                           
|Changes
      in assets and liabilities:                          |                                       |                                           
|Accounts
      receivable                                         |                                       |                                           
|Deferred
      costs                                              |                                       |                                           
|Prepaid
      expenses and other current assets                   |                                       |                                           
|Restricted
      cash                                             |                                       |                                           
|Employee
      loans receivable                                   |                                       |                                           
|Other
      assets                                                |                                       |                                           
|Payable
      to Genentech                                        |                                       |                                           
|Deferred
      revenues                                           |                                       |                                           
|Deferred
      rent                                               |                                       |                                           
|Accounts
      payable, accrued liabilities                       |                                       |                                           
|and
      other long-term obligations                             |                                       |                                           
|                                                                  |                                       |                                           
|Net
      cash used in operating activities:                      |                                       |                                           
|Cash flows
      from investing activities:                       |                                       |                                           
|Purchase
      of investment securities                           |                                       |                                           
|Proceeds
      from sale and maturities of                        |                                       |                                           
|investment
      securities                                       |                                       |                                           
|Purchase
      of property and equipment                          |                                       |                                           
|Long-term
      lease deposits                                    |                                       |                                           
|Acquisition
      of affiliate, net of cash acquired              |                                       |                                           
|                                                                  |                                       |                                           
|Net
      cash provided by (used in) investing activities         |                                       |                                           
|Cash
      flows from financing activities:                       |                                       |                                           
|Proceeds
      from issuance of preferred stock                   |                                       |                                           
|Payments
      under capital lease obligations                    |                                       |                                           
|Proceeds
      from issuance of common stock, net of issuance     |                                       |                                           
|costs                                                             |                                       |                                           
|Return of
      capital on redeemable convertible preferred stock |                                       |                                           
|Exercise
      of employee stock options                          |                                       |                                           
|Employee
      stock purchase plan                                |                                       |                                           
|Loans from
      Genentech                                        |                                       |                                           
|Cash payment
      of dividends                                   |                                       |                                           
|                                                                  |                                       |                                           
|Net
      cash provided by financing activities:                  |                                       |                                           

|See
        accompanying notes to condensed consolidated financial statements.
      
      4
|---------------------------------------------------------------------------------------------

|VaxGen, Inc.(A Development
Stage Enterprise)


CONDENSED CONSOLIDATED
STATEMENTS OF CASH FLOWS(continued)
|---------------------------------------------------------------------------------------------------------

|                                                                            | Nine months endedSeptember 30, | Period fromInception(November 27,
|--------------------------------------------------------------------------- | ------------------------------ | ---------------------------------
|
|Increase (decrease) in cash and cash equivalents                            |                                |                                  
|Cash and cash equivalents at beginning of period                            |                                |                                  
|                                                                            |                                |                                  
|Cash and cash equivalents at end of period                                  |                                |                                  
|                                                                            |                                |                                  
|Supplemental schedule of non cash
      investing and financing activities: |                                |                                  
|Dividends paid/accrued to redeemable convertible preferred                  |                                |                                  
|stockholders through the issuance of common stock                           |                                |                                  
|Accretion of redemption value of redeemable                                 |                                |                                  
|convertible preferred stock                                                 |                                |                                  
|Recognition of beneficial conversion feature                                |                                |                                  
|of redeemable convertible preferred stock                                   |                                |                                  
|Recognition of fair value of common stock warrants issued                   |                                |                                  
|with redeemable convertible preferred stock                                 |                                |                                  
|Recognition of valuation adjustment to fair value of common                 |                                |                                  
|stock warrants issued with redeemable convertible                           |                                |                                  
|preferred stock                                                             |                                |                                  
|Conversion of redeemable convertible preferred stock                        |                                |                                  
|into common stock                                                           |                                |                                  
|Reclassification of unaccreted portion of financing costs                   |                                |                                  
|from preferred stock to equity upon conversion                              |                                |                                  
|Equipment acquired through capital leases                                   |                                |                                  
|Issuance of stock through conversion of                                     |                                |                                  
|Genentech note payable                                                      |                                |                                  
|Note receivable partially settled by                                        |                                |                                  
|severance obligation                                                        |                                |                                  
|Prepaid insurance premiums in accounts payable                              |                                |                                  

|See
        accompanying notes to condensed consolidated financial statements.
      
      5
|---------------------------------------------------------------------------------------------

|VaxGen, Inc.(A Development
Stage Enterprise)Notes to Condensed Consolidated Financial StatementsSeptember 30, 2003(Unaudited)


1. Basis of Presentation


The unaudited condensed consolidated
financial statements of VaxGen, Inc. and subsidiary (a development stage enterprise)
(VaxGen, we, or the Company) included herein have been
prepared by VaxGen pursuant to the rules and regulations of the Securities and Exchange
Commission. Certain information or footnote disclosure normally included in financial
statements prepared in accordance with accounting principles generally accepted in the
United States of America have been condensed or omitted pursuant to such rules and
regulations. In the opinion of VaxGens management, the accompanying unaudited
condensed consolidated financial statements contain all adjustments, consisting only of
normal recurring adjustments, necessary to present fairly the condensed consolidated
financial information included herein. While VaxGen believes that the disclosures are
adequate to make the information not misleading these condensed consolidated financial
statements should be read in conjunction with VaxGens audited financial statements
contained in its amended Annual Report on Form 10-K/A for the year ended December 31,
2002 filed on November 19, 2003. The results of operations for the three and nine month periods ended September 30,
2003, are not necessarily indicative of the operating results for the full year.


The condensed consolidated financial
statements include the accounts of VaxGen and, in 2003, its consolidated subsidiary,
VaxGen-Celltrion, Inc (VCI), (see Note 7). VaxGen owns less than 100% of VCI;
therefore VaxGen records minority interest in the condensed consolidated financial
statements to account for the ownership interest of the minority owner. All significant
intercompany accounts and transactions have been eliminated in consolidation.


We have presented the condensed
consolidated financial statements on the basis of a going concern, which contemplates the
realization of assets and the satisfaction of liabilities in the normal course of
business. However, we may not be able to continue our operations because we have
experienced significant operating losses, which we expect will continue, and have
insufficient sources of funding for our operations. In order for us to remain a going
concern we will require significant additional funding in the near term. We are exploring
opportunities to raise capital through equity offerings, strategic alliances and other
financing vehicles. However, there can be no assurance that any such additional financing
will be available to us on the terms that we deem acceptable, if at all. The condensed
consolidated financial statements do not include any adjustments relating to the
recoverability and classification of liabilities that might be necessary should we be
unable to continue as a going concern. We expect the cash and cash equivalents at
September 30, 2003 along with expected cash receipts to be generated from our contractual
arrangements with the National Institutes of Health (NIH) will be sufficient
to fund operations according to our current plan through the first quarter of 2004.
External cash requirements are expected to be lower during the last quarter of 2003
because of anticipated revenues from our contract related to the development of an anthrax
vaccine and other revenue sources. Should managements plan not develop as
anticipated, we will restrict additional planned activities and operations, as necessary,
to sustain operations and conserve cash resources.


Use of estimates


The preparation of financial
statements requires management to make estimates, assumptions and judgments that affect
the reported amounts of assets, liabilities, revenues and expenses, and related
disclosures of contingent assets and liabilities. On an on-going basis, management
evaluates its estimates, including those related to investments; bad debts; grant revenue
arrangements; and litigation and other contingencies. VaxGen bases its estimates on
historical experience and on various other assumptions that are believed to be reasonable
under the circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from other
sources. Actual results may differ from those estimates under different assumptions or
conditions.


6
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Accounting for Asset
Retirement Obligations


On January 1, 2003, we adopted
Statement of Financial Accounting Standards No. 143, Accounting for Asset Retirement
Obligations (SFAS No. 143), which addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived assets and
the associated asset retirement costs. The standard applies to legal obligations
associated with the retirement of long-lived assets that result from the acquisition,
construction, development and/or normal use of the assets. SFAS No. 143 requires that the
fair value of a liability for an asset retirement obligation be recognized in the period
in which it is incurred if a reasonable estimate of fair value can be made. The fair value
of the liability is added to the carrying amount of the associated asset and this
additional carrying amount is depreciated over the life of the asset. The adoption of SFAS
No. 143 did not have an effect on our financial condition or results of
operations.


New accounting
pronouncements


In May 2003 the Financial Accounting
Standards Board released Statement of Financial Accounting Standards No. 150,
Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity (SFAS No. 150). This statement establishes
standards for how companies classify and measure certain financial instruments. SFAS No.
150 requires that companies classify financial instruments that fall within the scope of
the statement as liabilities. We adopted SFAS No. 150 in the third quarter of 2003. As all
our redeemable convertible preferred stock was converted to common stock prior to
September 30, 2003, the adoption of SFAS No. 150 did not have a material effect on our
financial condition or results of operations.




2. Restatement


In October 2003, the
Company discovered an error related to the classification and valuation of
warrants issued in connection with the Companys Series A Redeemable
Convertible Preferred Stock. In addition, in the second quarter of 2003, the
Company properly reflected $606,000 of costs incurred for validation procedures
from operating expenses to property and equipment. As a result of the
restatement, the net loss applicable to common stockholders increased by
$270,000 for the nine months ended September 30, 2002. As a result, the
financial statements for the fiscal year 2002 and for the second, third and
fourth fiscal quarters of 2001 were restated in the Companys
Form 10-K/A filed on November 19, 2003. Financial statements for the first
and second fiscal quarters of 2003 and 2002 were restated on the Companys
Forms 10-Q/A also filed on November 19, 2003. Restated financial statements
reflect adjustments primarily relating to the recognition, classification and
valuation of warrants and beneficial conversion features relating to the
Companys Series A Redeemable Convertible Preferred Stock financing, which
closed in May 2001. These warrants provide for cash redemption by the warrant
holder upon the occurrence of certain events outside the control of the Company.
As such, the Company has reclassified these warrants from equity to a liability.
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | For the three months ended September 30, 2003, the net loss applicable to common
stockholders increased to $9,531,000 from $8,526,000 and basic and diluted loss per
share applicable to common stockholders increased to $(0.66) from $(0.59), each as
compared to the amounts previously reported by VaxGen on its Form 10-Q filed on November
14, 2002.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | For the nine months ended September 30, 2002, the net loss applicable to common
stockholders increased to $23,894,000 from $23,624,000 and basic and diluted loss per
share applicable to common stockholders increased to $(1.66) from $(1.64), each as
compared to the amounts previously reported by VaxGen on its Form 10-Q filed on November
14, 2002.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|The restated financial statements
reflect the following adjustments during the past two fiscal years and the first and
second quarters of the current fiscal year:
|------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | In 2001, the Company reclassified $3,507,000, the initial value assigned to warrants
issued in connection with the Companys Series A Redeemable Convertible Preferred
Stock financing, from stockholders equity to current liabilities.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Beginning on June 30, 2001 and in each subsequent quarter the restated financial
statements reflect a non-cash expense or credit based on the fair market value of the
warrants measured as of the end of each quarter, and a corresponding change in the current
liability representing the value assigned to the warrants noted above.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The value of beneficial conversion features totaling $12,688,000, originally recorded as
immediate deemed dividends to preferred stockholders of $734,000 in 2001, $11,061,000 in
2002 and $893,000 in the second quarter of 2003 has been reclassified to Series A
Redeemable Convertible Preferred Stock and is now amortized over the period ending on the
redemption date, May 23, 2004. Upon conversions of Series A Redeemable Convertible
Preferred Stock prior to the redemption date, of which two occurred in 2002 and two more
occurred in the second quarter of 2003, the related unamortized value of beneficial
conversion features and the unamortized value of the warrants have been recorded as a beneficial feature conversion charge
of $10,686,000 in 2002, $2,188,000 in the second
quarter of 2003 and $249,000 in the third quarter of 2003.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | In the second quarter of 2003, the Company properly reflected $606,000 of costs incurred for
validation procedures relating to the VCI manufacturing facility from operating expenses
to property and equipment.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The principal effects of these adjustments
or the accompanying financial statements are set forth below:

|                                        | CONDENSED
      STATEMENTS OF OPERATIONS                  | 
|--------------------------------------- | --------------------------------------------------------- | 
|                                        | For
      the Three Months Ended
      September 30, 2002 | 
|                                        |                                                           | 
|                                        |                                                           | 
|                                        |                                                           | 
|Warrant
      valuation adjustment      |                                                           | 
|Total
      other income (expense), net |                                                           | 
|Net
      loss                          |                                                           | 
|Beneficial
      conversion charges     |                                                           | 
|Net
      loss applicable to common     |                                                           | 
|stockholders                            |                                                           | 
|Basic
      and diluted loss per share  |                                                           | 
|applicable
      to common              |                                                           | 
|stockholders                            |                                                           | 
|Weighted
      average shares used in   |                                                           | 
|computed
      basic and diluted        |                                                           | 
|loss
      per share                    |                                                           | 

|CONDENSED STATEMENTS
OF CASH FLOWS
|----------------------------------

|                                                           |  |  | For the
      Nine Months Ended 
      September 30, |            
|---------------------------------------------------------- |  |  | ---------------------------------------------------- | -----------
|
|
|
|
|
|Net
      loss                                             |  |  | $                                                    | (21,474,000
|Non-cash
      warrant valuation adjustments               |  |  |                                                      | 86,000     
|Supplemental
      schedule of non-cash                    |  | 
|investing
      and financing activities:                  |  | 
|Recognition
      of valuation adjustment to fair value of |  | 
|common
      stock warrants issued with redeemable         |  | 
|convertible
      preferred stock                          |  |  |                                                      | 86,000     

|3. Stock-Based
Compensation


We account for stock-based
compensation based on the provisions of Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees (APB No. 25), which
states that, for fixed plans, no compensation expense is recorded for stock options or
other stock-based awards to employees that are granted with an exercise price equal to or
above the estimated fair value per share of our common stock on the grant date. In the
event that stock options are granted with an exercise price below the estimated fair value
of our common stock at the grant date, the difference between the fair value of our common
stock and the exercise price of the stock option is recorded as deferred compensation.
Deferred compensation is amortized to compensation expense over the vesting period of the
stock option. We have adopted the disclosure requirements of Statement of Financial
Accounting Standards No. 123, Accounting for Stock-Based Compensation
(SFAS No. 123) and Statement of Financial Accounting Standards No. 148,
Accounting for Stock Based CompensationTransition and Disclosurean
Amendment of FASB Statement No. 123 (SFAS No. 148), which require
compensation expense to be disclosed based on the fair value of the options granted at the
date of the grant. If we had accounted for our stock-based compensation plans using a
fair-value-based method in accordance with SFAS No. 123, our net loss and net loss per
share would approximate the pro forma amounts indicated in the following table:


7
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                            | Three months endedSeptember 30, | Nine months endedSeptember 30, |  
|----------------------------------------------------------- | ------------------------------- | ------------------------------ | -
|
|Net
      loss applicable to common                         |                                 |                                |  
|stockholders
       as reported                            |                                 |                                | $
|Add:
      Stock-based employee compensation expense        |                                 |                               
|included
      in reported net loss, net                    |                                 |                               
|of
      related tax effects                                |                                 |                                |  
|Less:
      Total stock-based employee compensation expense |                                 |                               
|determined
      under fair value based method for all      |                                 |                               
|awards,
      net of related tax effects                    |                                 |                                |  
|                                                            |                                 |                                |  
|Net
      loss applicable to common                         |                                 |                               
|stockholders
      - pro forma                              |                                 |                                | $
|                                                            |                                 |                                |  
|Loss
      per share  basic and diluted, as reported       |                                 |                                | $
|Loss
      per share  basic and diluted, pro forma         |                                 |                                | $

|4. Loss
        per Share


Basic loss per share is computed as
net loss applicable to common stockholders divided by the weighted average number of
shares of common stock outstanding for the period. Potential shares of common stock
include dilutive shares issuable upon the exercise of outstanding options to purchase
shares of common stock, warrants to purchase shares of common stock, and shares of our
Series A redeemable convertible preferred stock (in 2002 only), which are listed below
assuming that the shares of the Series A redeemable convertible preferred stock converted
into shares of our common stock. For all periods presented, such potential shares of
common stock were excluded from the computation of diluted net loss per share, as their
effect is antidilutive.


Potentially dilutive securities
include:
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                        | September 30, | 
|--------------------------------------- | ------------- | 
|
|Options to purchase common stock        |               | 
|Warrants to purchase common stock       |               | 
|Redeemable convertible preferred  stock |               | 
|                                        |               | 
|Total                                   |               | 
|                                        |               | 

|Weighted average exercise prices for
excluded options and warrants were $10.70 and $11.68 at September 30, 2003 and 2002,
respectively.


5. Redeemable
Convertible Preferred Stock Financing


The Company entered into a Securities
Purchase Agreement dated as of May 23, 2001 with four investors, whereby the Company
received approximately $20,000,000 in consideration for the sale of 20,000 shares of the
Companys Series A Redeemable Convertible Preferred Stock (Preferred
Stock) and the issuance of Common Stock Purchase Warrants described below. Expenses
relating to the transaction were approximately $1,700,000, resulting in net proceeds of
approximately $18,300,000. These proceeds were used to prepare the Companys HIV/AIDS
vaccine, if proven successful, for commercial-scale manufacturing as well as for the
development of new adjuvants and for general corporate purposes. As of September 30, 2003,
there were no outstanding shares of Preferred Stock as all such shares had been converted
into common stock.


8
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|A summary of the significant terms of
the Preferred Stock financing are as follows:


Conversion


During the third quarter of 2003, two investors
converted 585 shares in the aggregate of Preferred Stock in exchange for 205,845 shares of
common stock, which included shares issued for accrued but unpaid dividends. At September
30, 2003 there was no Preferred Stock outstanding.


Redemption


In the event that there had been no
earlier conversion, the Company would have had to redeem the Preferred Stock for cash on
May 23, 2004, at a redemption price equal to $1,000 per share plus all accrued and unpaid
dividends.


The Company accounted for the
difference between the carrying amount of Preferred Stock and the redemption amount by
increasing the carrying amount for periodic accretion, so that the carrying amount would
equal the redemption amount at the scheduled redemption date. The accretion of the
redemption value of the Preferred Stock for the nine months ended September 30, 2003 and
2002 was $169,000 and $1,333,000, respectively. Included in the accretion were amounts
related to Preferred Stock issuance cost and discounts originated by beneficial conversion
options and warrants. As all the Preferred Stock has been converted into common stock,
there will be no further accretion in future periods.


Dividends


Prior to conversion, each share of
Preferred Stock was entitled to receive annual dividends of 6% payable on June 30 and
December 31, beginning on December 31, 2001. If not paid within five days of either such
date, the dividend would accumulate and compound. Payment could be made in cash or in
shares of common stock at the Companys option. Payment on December 31, 2001 was made
in 65,253 shares of common stock. During 2002, payment was made in 114,300 shares of
common stock, along with an additional 26,182 shares of common stock that were paid upon
conversion for accrued but unpaid dividends. During the first nine months of 2003, payment
was made in cash for $18,000 along with 31,561 shares of common stock that were paid upon
conversion for accrued but unpaid dividends. Net loss applicable to common stockholders
for the nine months ended September 30, 2003 and 2002 included non-cash charges of $91,000
and $903,000, respectively, for Preferred Stock dividends.


Common Stock Purchase
Warrants


In connection with the Preferred
Stock financing, the Company issued Common Stock Purchase Warrants (the
Warrants) initially for the purchase of 297,177 shares of common stock to the
Preferred Stock investors. The Warrants, which expire on May 23, 2006, originally had an
exercise price of $25.2375 per share; however, effective as of June 5, 2003, the exercise
price was adjusted to $12.324 per share and the number of shares issuable on exercise of
the warrants increased to 608,568, in accordance with the terms of the Warrants. These
warrants provide for cash redemption by the warrant holders upon the occurrence of certain events
outside the control of the Company.


The Company valued the Warrants at
$11.80 per share, resulting in a total value of approximately $3,500,000 at issuance. The
fair value of the Warrants was calculated using the Black-Scholes model with the following
inputs; exercise price of $19.51 five year expected life, risk-free interest rate of 4.96%, dividend yield of zero,
volatililty of 75% and a marketability discount of 10%. This amount was accounted for
as a reduction in the carrying value of the Preferred Stock until the scheduled redemption
of the Preferred Stock, and an increase to current liabilities. The discount is being
amortized over three years, and accordingly, net loss to common stockholders for the nine
months ended September 30, 2003 and 2002 reflected non-cash charges of $169,000 and
$1,333,000, respectively. As a result of the conversions of Preferred Stock in the third
quarter of 2003, the Company recorded the pro-rata share of the unaccreted portion of the
fair value assigned to the Warrants as a deemed dividend to common stockholders of
$20,000 in the third quarter of 2003.


9
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|The valuation of the warrants and the
corresponding current liability is re-measured quarterly and the condensed consolidated
financial statements reflect a non-cash expense or credit based on the change in the fair
market value of the warrants as measured at the end of each fiscal quarter. Accordingly,
the condensed consolidated financial statements for the three months ended September 30,
2003 and 2002 reflected non-cash expenses of $2,980,000 and $944,000, respectively,
relating to the periodic revaluation of the warrant liability. For the nine months ended
September 30, 2003 and 2002 the non-cash charges relating to the periodic revaluation of
the warrant liability were a credit of $1,071,000 and an expense of $86,000, respectively.


Effect of Beneficial
Conversion Feature


The Companys Preferred Stock
was issued with a beneficial conversion feature, which was valued at $734,000. The
beneficial conversion amount has been accounted for as an increase in additional paid-in
capital and as a discount to the preferred stockholders. The beneficial conversion feature
discount is being accreted over the stated redemption date in accordance with EITF No.
00-27, Application of Issue No. 98-5 to Certain Convertible Instruments (EITF
00-27).


In 2002, one of the holders of
Preferred Stock exercised a warrant, which had the effect, under the anti-dilution
provisions applicable to the Preferred Stock, of reducing the conversion price of the
Preferred Stock to $14.133. The reduction in conversion price resulted in an additional
553,044 shares of common stock issuable upon conversion. The incremental shares issuable
upon conversion were accounted for as a contingent beneficial conversion feature in
accordance with EITF 00-27. The contingent beneficial conversion feature was measured
by multiplying the incremental shares by the fair value of the Companys common stock
on the commitment date of May 23, 2001. The fair value of the Companys common stock
on the commitment date was $20.00 per share. Accordingly, the Company recorded a
contingent beneficial conversion feature in the amount of $11,061,000, which was recorded
as additional paid in capital and as a discount to the Preferred Stock. The contingent beneficial conversion
feature discount is also being accreted to the stated redemption date, May 23, 2004.


In connection with a private
placement financing which closed in the second quarter of 2003 the conversion price of the
Preferred Stock was further reduced, from $14.133 to $2.87. This further reduction in
conversion price resulted in an additional 1,055,298 shares of common stock issuable upon
conversion. The incremental shares issuable upon conversion were accounted for as a
contingent beneficial conversion feature as described above. Accordingly, the Company
recorded a contingent beneficial conversion feature in the amount of $893,000 in the
second quarter of 2003, which was recorded as additional paid in capital and as a discount to the Preferred
Stock. This contingent beneficial conversion feature discount is also being accreted to
the stated redemption date, May 23, 2004.


As noted above, two investors
converted their Preferred Stock into common stock during the third quarter of 2003. The
unamortized discount relating to the shares
converted was recorded as a beneficial conversion charge of $229,000.


10
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|6. Anthrax Contract


In September 2002, the Company was
awarded a contract from the National Institute of Allergy and Infectious Diseases
(NIAID) to develop a new anthrax vaccine candidate and to create a feasibility
plan to manufacture an emergency stockpile of 25 million doses of the vaccine. The current
period of performance of the contract is from September 30, 2002 through December 31,
2003. Under the initial phase of the NIAID contract, the Company expects to be awarded,
upon satisfaction of certain milestones, approximately $20,867,000. The total amount to be
awarded under this contract was originally $13,636,000, and NIAID has authorized
additional funding totaling $7,231,000 for the contract. During the nine months ended
September 30, 2003, the Company recognized a total of $7,618,000 in revenue related to the
completion of the first, second and third contractual milestones. The Company will
recognize revenue based on the completion of future milestones, which have been specified
by NIAID. Revenues and direct costs (not to exceed revenues) associated with milestones which
have not been substantiated through objective evidence of completion from NIAID, will be
deferred on the balance sheet. At September 30, 2003, the Company had $1,693,000 of
deferred costs and $5,729,000 of deferred revenues related to this contract.


NIAID has elected to extend the
contract and, in September 2003, we were awarded an $80,300,000 contract for the advanced
development of our anthrax vaccine candidate, to conduct a large-scale Phase II clinical
trial and to manufacture 3 million doses of anthrax vaccine under an Investigational New
Drug Application (IND).


7. Celltrion Joint
Venture


In February 2002, the Company and Nexol
Biotech Co., Ltd., Nexol Co., Ltd., Korea Tobacco and Ginseng Corporation and J. Stephen
& Company Ventures Ltd. (the South Korean investors) formed a joint
venture, named Celltrion, to build and operate a mammalian cell culture biomanufacturing
facility in Incheon, South Korea, and to provide partial funding of the construction of an
intermediate scale manufacturing facility in South San Francisco. Under the terms of the
Celltrion joint venture agreement, dated February 25, 2002, between the Company and the
South Korean investors, the total capitalization of Celltrion during the start-up phase
will be between $80,000,000 and $120,000,000, subject to adjustment with the consent of
the shareholders of Celltrion.


As a result of the in-kind investment
of mammalian cell culture technology and manufacturing know-how valued at $30,000,000, the
Company currently has a 47.8% interest in Celltrion, although if funding is completed as
intended, the Companys interest will be approximately 44%. As of September 30, 2003,
the South Korean investors had contributed approximately $43,750,000 in cash to Celltrion
of the $52,000,000 in cash that the Celltrion joint venture agreement requires to have
been funded by the end of August 2002, and secured a $40,000,000 loan with a Korean bank.
There is a remaining balance of $6,300,000 to be funded, of which J. Stephen & Co.
Ventures was obligated to fund $3,800,000 in June 2003, and Nexol Biotech was obligated to
fund $2,500,000 in December 2002. The Company does not expect J. Stephen & Co.
Ventures, Nexol Biotech, or any of the other South Korean investors to invest additional
funds in Celltrion in the near future, if at all. Celltrion currently has no commitments
for the investment of additional funds. The Incheon facility is expected to engage in
mammalian cell culture biomanufacturing, which is used to make many of the pharmaceutical
products developed by the biotechnology industry, including monoclonal antibodies and
therapeutic proteins. The Company accounts for its investment in Celltrion using the
equity method of accounting. The Company does not own a majority of the voting its nor
will it be the primary beneficiary of the joint venture.


Under the terms of the joint venture
agreement, Celltrion has invested $7,000,000 to capitalize a new corporation,
VaxGen-Celltrion, Inc. (VCI) to design and construct the intermediate scale
manufacturing facility adjacent to the Companys research facility in South San
Francisco. On June 7, 2002, the Company entered into a joint venture agreement with
Celltrion to specify the terms governing the management and operation of VCI. The Company
is responsible for all staffing and operational costs and expenses of the facility, as
well as all capital costs in excess of the initial $7,000,000 investment by Celltrion.
Under the terms of the VCI joint venture agreement, at the end of each calendar quarter,
VCI will issue one share of its common stock to the Company for every dollar the Company
spends in connection with capital expenditures, validation, operation and licensure of the
South San Francisco facility.


11
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|The South San Francisco manufacturing
facility was originally contemplated to be used to facilitate the transfer of cell culture
manufacturing technology to Celltrion, (including AIDSVAX manufacturing technology, if the
Company pursues licensure) to conduct on-site training of Celltrion personnel, and to
expedite commercial licensure and launch of AIDSVAX. Under the terms of the VCI joint
venture agreement, the Company has the right to use the facility, at the Companys
expense, for the development and licensure of new products, and the Company plans to use
the South San Francisco facility to manufacture its anthrax vaccine candidate and to
manufacture an emergency stockpile of anthrax vaccine if the Company is awarded the U.S.
Government contract to produce the stockpile.


Through the first quarter of 2003,
the Company accounted for its investment in VCI using the equity method of accounting. As
a result of the Companys ongoing investment in VCI, its direct
ownership percentage of VCI increased to approximately 45% as of June 30, 2003 and 55% as
of September 30, 2003. During the quarter ended June 30, 2003, the Company, as a result of
its increasing direct ownership interest in the equity of VCI, combined with its primary
beneficiary status, determined that the financial position and results of operations of
VCI are required to be consolidated with the financial statements of the Company.
Accordingly, the condensed consolidated financial statements as of and for the three and
nine months ended September 30, 2003 reflect the consolidated results of VaxGen and VCI,
effective from January 1, 2003 going forward. All material intercompany balances and
transactions have been eliminated in consolidation.


8. Related Party
Transactions


As of September 30, 2003, the Company
had loans outstanding to two executive officers in the amount of $95,000. In May 2002, an
executive received a non-interest bearing loan in the amount of $80,000. Per the
executives employment agreement the loan is to be forgiven at the rate of 25% per
year for each of the first four full years of the executives employment with the
Company. At September 30, 2003 this loan balance was $40,000 reflecting loan forgiveness
relating to the executives first two full years of employment with the Company. In
August 2000, an executive received a non-interest bearing loan in the amount of $55,000.
This loan was settled by a cash payment in November 2003. Both loans were made to assist
in the purchase of residences in connection with employment-related relocations.


9. Comprehensive Loss
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                             | Three months endedSeptember 30, | Nine months endedSeptember 30,
|------------------------------------------------------------ | ------------------------------- | ------------------------------
|
|Net loss                                                     |                                 |                               
|Net unrealized gains (losses) on
      investment securities |                                 |                               
|                                                             |                                 |                               
|Comprehensive loss                                           |                                 |                               
|                                                             |                                 |                               

|12
|--

|ITEM 2. | MANAGEMENTS
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------

|This discussion and analysis should
be read in conjunction with our condensed consolidated financial statements and related
notes thereto appearing in Item 1 of this report. In addition to historical information,
this report contains forward-looking statements within the meaning of the
federal securities laws. These forward-looking statements include without limitation
projections as to the timing or amount of future revenues or expenses, statements
regarding our expectations and beliefs about our ability to raise additional capital to
finance our operations, forecasts regarding the length of time current cash resources will
enable us to continue our operations in the absence of additional financing, the timing
and progress of completion of our anthrax, smallpox or HIV/AIDS vaccine candidates, the
timing and amount of any government awards relating to an anthrax vaccine, our ability to
obtain additional financing from private sources, from governmental agencies or from
philanthropic organizations to continue to develop AIDSVAX and Celltrions ability to
complete construction of its manufacturing facilities and its ability to manufacture
biopharmaceutical products. Reference should be made to the section of this report
entitled Risk Factors, and to our amended Annual Report on Form 10-K/A, filed
with the Securities and Exchange Commission on November 19, 2003 under the heading
Business, for a more detailed description of such factors. Readers are
cautioned not to place undue reliance on these forward-looking statements, which speak
only as of the date of this report. We do not undertake and specifically decline any
obligation to update or to publicly announce the results of any revisions to these
forward-looking statements to reflect future events or developments.


CRITICAL ACCOUNTING
POLICIES AND ESTIMATES


Our discussion and analysis of our
operating results and financial condition are based upon our condensed consolidated
financial statements, which have been prepared in accordance with accounting principles
generally accepted in the United States of America. The preparation of the financial
statements requires us to make estimates, judgments, and assumptions that affect the
reported amounts of assets, liabilities, revenues and expenses. While we believe our
estimates, judgments, and assumptions are reasonable, the inherent nature of estimates is
that actual results will likely be different from the estimates made.


We believe the following critical
accounting policy affects the most significant judgments and estimates used in the
preparation of our consolidated financial statements.


Revenue Recognition


We recognize revenue when all of the
following conditions have occurred:
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Persuasive
evidence of an arrangement exists;
| | - | ---------------------------------------------

| |  | Delivery
has occurred or services have been rendered;
| | - | -----------------------------------------------------

| |  | The
price is fixed and determinable; and
| | - | ----------------------------------------

| |  | Collectibility
is reasonably assured.
| | - | -------------------------------------

|Our fees are typically considered to
be fixed or determinable at the inception of an arrangement and are negotiated at the
outset of an arrangement and are generally based on specific services or products to be
delivered. In the event payment terms are provided that differ significantly from our
standard business practices and collectibility is not reasonably assured, the fees are
deemed to not be fixed or determinable and revenue is recognized as the fees are paid.


13
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|In addition, we adopted the guidance
provided by the SEC, which addresses the proper recognition of service revenue based upon
output measures. We believe that this is the appropriate treatment of our contract with
the NIH to develop a new anthrax vaccine. Under this arrangement we deferred revenues and
expenses on our balance sheet until we are able to provide objective evidence that we have
attained the specified milestones established by the NIH. Costs are deferred only to the
extent of expected revenues. At September 30, 2003, we had $1,693,000 of deferred costs
and $5,729,000 of deferred revenues related to this agreement.


Investment in Celltrion
and VCI


We account for our investment in
Celltrion using the equity method of accounting. We do not own a majority of the voting
stock nor will we be the primary beneficiary of the joint venture. Since the historical
cost of the non-monetary assets that we contributed is zero, there is no investment in
Celltrion recorded on our balance sheet. Additionally, because we have no further funding
obligation to Celltrion, we will not pick up equity in earnings (loss) of Celltrion until
such time that losses previously not recognized have been recovered.


Through the first quarter of 2003, we
accounted for our investment in VCI using the equity method of accounting. As a result of
our ongoing investment in VCI, our ownership percentage of VCI increased to approximately
55% as of September 30, 2003. During the quarter ended June 30, 2003, the Company, as a
result of its increasing direct ownership interest in the equity of VCI,
combined with its primary beneficiary status, determined that the financial position and
results of operations of VCI should be consolidated with the financial
statements of the Company. Accordingly, the condensed consolidated financial statements as
of and for the three and nine months ended September 30, 2003 reflect the consolidated
results of VaxGen and VCI, effective from January 1, 2003 going forward. All material
intercompany balances and transactions have been eliminated in consolidation.


Valuation of Long-Lived
Assets


The carrying value of long-lived
assets is reviewed on a regular basis for the existence of facts or circumstances both
internally and externally that may suggest impairment. Specific potential indicators of
impairment include:
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a
significant decrease in the fair value of an asset;
| | - | -----------------------------------------------------

| |  | a
significant change in the extent or manner in which an asset is used or a significant
physical change in an asset;
| | - | --------------------------------------------------------------------------------------------------------------------

| |  | a
significant adverse change in legal factors or in the business climate that affects the
value of an asset;
| | - | ------------------------------------------------------------------------------------------------------------

| |  | an
adverse action or assessment by the U.S. Food and Drug Administration or another
regulator; and
| | - | --------------------------------------------------------------------------------------------------

| |  | an
accumulation of costs significantly in excess of the amount originally expected to
acquire or construct an asset.
| | - | --------------------------------------------------------------------------------------------------------------------

|When we determine that the carrying
value of intangible assets or long-lived assets are not recoverable based upon the
existence of one or more of the above indicators of impairment, we may be required to
record impairment charges for these assets that have not been previously recorded.


Recent Accounting
and Financial Developments


In October 2003, we discovered an error related to the classification and
valuation of warrants issued in connection with our Series A Redeemable
Convertible Preferred Stock. We have corrected this error by restating our
financial statements for fiscal years 2002 and 2001, on our Form 10-K/A filed
November 19, 2003 and for the first and second quarters of fiscal 2003 on our
Forms 10-Q/A, which we also filed on November 19, 2003. Our restated financial
statements reflect adjustments primarily relating to the recognition,
classification and valuation of warrants and beneficial conversion features
relating to our Series A Redeemable Convertible Preferred Stock financing, which
closed in May 2001.


The restated financial statements include adjustments to reclassify $3,507,000,
the initial value assigned to warrants issued in connection with our Series A
Redeemable Convertible Preferred Stock, from stockholders' equity to current
liabilities, and to record subsequent non-cash expenses or credits based on the
fair market value of the warrants. The restated financial statements also
include reclassifications of charges previously recorded as deemed dividends to
Series A Redeemable Convertible Preferred Stock and subsequent amortization of
those amounts over the period ending upon the redemption date, May 23, 2004.
Upon conversions of Series A Redeemable Convertible Preferred Stock we have
recorded the unamortized value of beneficial conversion features as well as the
unamortized value of the warrants as deemed dividends to preferred stockholders.
We also reclassified $606,000 of costs incurred in the second quarter of fiscal
2003 for validation procedures relating to the VCI manufacturing facility from
operating expenses to property and equipment.




OVERVIEW


In November 1995, VaxGen was formed
to continue development of AIDSVAX, a preventive vaccine candidate against HIV/AIDS. At
that time, Genentech, Inc. (Genentech) licensed to us the technology necessary
for completing development and commercialization of AIDSVAX under a license agreement. As
of November 1, 2003, Genentech owned approximately 7% of our outstanding common stock.


14
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Until 2002, our work was focused on
developing and testing AIDSVAX. We have since broadened our operations with the formation
of Celltrion and the initiation of programs to develop preventive vaccines against anthrax
and smallpox.


We have developed two formulations of
AIDSVAX, which focus on the predominant HIV subtype in North America, Europe, the
Caribbean, and Australia (subtype B) and the predominant HIV subtype in Southeast Asia and
East Asia (subtype E). We have completed two Phase III clinical trials, one in North
America and Europe to determine the efficacy AIDSVAX B/B and one in Thailand, to determine
the efficacy of AIDSVAX B/E.


In October 1999, we completed the
initial inoculation and enrollment of over 5,400 trial volunteers for the North
American/European Phase III clinical trial, which was conducted in 59 clinical centers and
completed the clinical trial as planned in December 2002. On February 24, 2003, we
announced that the study did not show a statistically significant reduction of HIV within
the study population as a whole, which was the primary endpoint of the trial.


In August 2000, we completed the
initial inoculation and enrollment of over 2,500 volunteers for the Thai Phase III
clinical trial, which was conducted in 17 clinical centers in Bangkok. We completed the
fieldwork for this trial during the second quarter of 2003. On November 12, 2003, we
announced that the vaccine candidate, AIDSVAX B/E, did not show efficacy for either the
primary or secondary endpoints. The primary endpoint for the trial was the prevention of
infection by HIV, whereas the secondary endpoints concerned whether vaccination slowed
the progression of disease among those who receive the vaccine but later became infected
with HIV. These were the same endpoints tested for in the North American/European Phase
III clinical trial. The Thai trial was conducted in accordance with international good
clinical practices and showed that the vaccine was well tolerated with no serious adverse
events related to the vaccine and marked reductions in behaviors which may prevent HIV
infection.


Although we intend to continue
analyzing data from these trials, any additional development of AIDSVAX will depend on
whether we obtain funding from sources such as governmental agencies and philanthropic
organizations. Beginning in April 2003, NIAID and the Centers for Disease Control and
Prevention (CDC) have been supporting a series of meetings with us to examine
data from the trial to independently determine if any further government supported
research and development are warranted. We cannot be certain whether or when we will
obtain additional funding to continue to develop AIDSVAX.


In February 2002, we and a group of
South Korean investors announced the formation of a joint venture, called Celltrion, to
build and operate a manufacturing facility in Incheon, South Korea. As our part of the
investment in the joint venture, we are providing mammalian cell culture technology and
biologics production expertise. Under the terms of the joint venture agreement, Celltrion
invested $7,000,000 to capitalize a new corporation, VaxGen-Celltrion, Inc.
(VCI) to design and construct the intermediate scale manufacturing facility
adjacent to the Companys research facility in South San Francisco. On June 7, 2002,
the Company entered into a joint venture agreement with Celltrion to specify the terms
governing the management and operation of VCI. The Company is responsible for all staffing
and operational costs and expenses of the facility, as well as all capital costs in excess
of the initial $7,000,000 investment by Celltrion. Under the terms of the VCI joint
venture agreement, at the end of each calendar quarter, VCI will issue one share of its
common stock to the Company for every dollar the Company spends in connection with capital
expenditures, validation, operation and licensure of the South San Francisco facility.


The South San Francisco
manufacturing facility was originally contemplated to be used to facilitate the
transfer of cell culture manufacturing technology to Celltrion, (including
AIDSVAX manufacturing technology, if the Company pursues licensure) to conduct
on-site training of Celltrion personnel, and to expedite commercial licensure
and launch of AIDSVAX. Under the terms of the VCI joint venture agreement, the
Company has the right to use the facility, at the Companys expense, for
the development and licensure of new products, and the Company plans to use the
South San Francisco facility to manufacture its anthrax vaccine candidate and to
manufacture an emergency stockpile of anthrax vaccine if the Company is awarded
the U.S. Government contract to produce the stockpile. To date, our investment
in VCI is $8,468,000. The condensed consolidated financial statements as of and
for the three and nine months ended September 30, 2003 reflect the consolidated
results of VaxGen and VCI, effective from January 1, 2003 going forward.


15
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|In September 2002, we were awarded a
contract from NIAID to develop a new anthrax vaccine candidate and to create a feasibility
plan to manufacture an emergency stockpile of 25 million doses of the vaccine. The current
period of performance of the contract is from September 30, 2002 through December 31,
2003. The goal of the government contract is to develop a modern vaccine that proves to be
safe in humans, efficacious in animal challenge studies and requires no more than three
injections. Under the initial phase of the NIAID contract, we expect to be awarded, upon
satisfaction of certain milestones, approximately $20,900,000 to advance the development
of a vaccine candidate initially developed by the USAMRIID. At September 30, 2003 we had
recognized $7,618,000 in revenue relating to this contract. NIAID has elected to extend
the contract and, in September 2003, we were awarded an $80,300,000 contract for the
advanced development of our anthrax vaccine candidate, to conduct a large-scale Phase II
clinical trial and to manufacture 3 million doses of anthrax vaccine under an
Investigational New Drug Application (IND).


Also in September 2002, we were
awarded a $1.0 million task order to provide AIDSVAX under a supply contract to develop
HIV vaccines for a forthcoming Phase III trial in Thailand funded by the NIH and conducted
by the Walter Reed Army Institute of Research (WRAIR). The majority of the
contract award will be earned in 2003. There were two government options that, when
exercised, would increase the contract award to a total of $3.3 million. In February 2003,
NIAID exercised the first option to take delivery of the first two-thirds of the vaccine
supply. In April 2003, NIAID exercised its second option for the remaining balance. WRAIR
began enrolling volunteers during the fourth quarter of 2003 and will combine our AIDSVAX
B/E vaccine with ALVAC, an HIV vaccine candidate being developed by Aventis Pasteur.


In December 2002, we announced that
we and Chemo-Sero-Therapeutic Research Institute (Kaketsuken) of Kumamoto,
Japan, entered into initial agreement that allows us to begin development of
Kaketsukens attenuated smallpox vaccine, LC16-Kaketsuken, for use in the United
States, subject to approval by the FDA. We believe that the vaccine, which was licensed in
Japan in 1980, will have a better safety profile, yet be equally effective, compared to
smallpox vaccines available in the United States or elsewhere. We are currently in
negotiations with Kaketsuken to define the specific commercial terms of our relationship
and our rights to sell any commercialized vaccine.


Since inception, our research and
development expenses have been applied to two product development projects: AIDSVAX B/B
and AIDSVAX B/E, our HIV vaccine candidates, and a program to develop a new anthrax
vaccine for the United States government.


As of September 30, 2003 we have
incurred total costs of $85,173,000 in research and development of AIDSVAX since we began
operations in late 1995. For the nine months ended September 30, 2003, we incurred costs
of $3,339,000 towards the research and development of AIDSVAX. The most significant
research and development costs incurred for the development of AIDSVAX include: the costs
to conduct the Phase III clinical trials, the cost of the clinical materials, the costs
associated with the laboratory activities required to support the trials, the advanced
development of our manufacturing process, the establishment of a regulatory and quality
systems group to support the possible licensure of the products, and the costs to refine
the manufacturing process of the vaccine. In 2003, we expect the development cost for
AIDSVAX will be approximately $3,900,000. The costs are primarily associated with the
conclusion of the Thai Phase III clinical trial.


The anthrax vaccine project began
during the fourth quarter of 2002 when the NIH awarded us a cost reimbursement contract to
develop a new vaccine to prevent anthrax infection. As of September 30, 2003, we have
incurred total costs of $6,844,000 towards this project, of which $1,693,000 has been
deferred along with the related revenue until the milestones that are required have been
met. We expect to incur additional costs related to this project of approximately $520,000
during 2003, of which we expect to receive reimbursement for all our direct expenses,
coverage for a certain part of our overhead and general and administrative expenses and a
fixed profit amount.


16
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|In February 2003, we received
official notification from NIAID indicating that we met the program requirements
stipulated under the first milestone of the anthrax vaccine development contract.
Milestone 1 required us to produce the pilot lot of the anthrax vaccine clinical material
among other associated activities. In June 2003, we received official notification from
NIAID indicating that we met the program requirements stipulated under the second
milestone of the anthrax vaccine development contract. We received
official notification from NIAID indicating that we met the program requirements
stipulated under the third milestone of the anthrax vaccine development contract,
effective July 2003. Along with Milestones 1, 2 and 3, we continue to perform, in
parallel, against the other milestones required under the contract with NIAID. To date, we
have performed within budget and on schedule. However, we cannot guarantee that we will
continue to do so.


We cannot reasonably estimate the
nature, timing and the ultimate cost of completing product development projects due to the
numerous risks and uncertainties associated with developing vaccines, including:
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | intense
and changing governmental regulation, both foreign and domestic, and social and political
considerations with respect to drug development, particularly bio-terrorism and AIDS
research;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
fact that the anthrax and smallpox vaccine projects are in the very early stages of
development and that we have only limited experience in developing vaccines and products
other than AIDSVAX;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
uncertainty of future pre-clinical and clinical study results and the uncertainty of the
timing of enrolling volunteers in vaccine trials, particularly in large scale clinical
vaccine trials enrolling numerous volunteers in multiple cities and in various countries;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
possibility of delays in the collection of clinical trial data;
| | - | -------------------------------------------------------------------

| |  | the
uncertainty related to VCIs manufacturing facilities, which are either in an early
stage of construction or have not yet been validated; and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------

| |  | various
risks related to our reliance on third parties, including Genentech, Celltrion and
government entities.
| | - | ---------------------------------------------------------------------------------------------------------------

|See the section entitled Risk
Factors for a more detailed discussion of these risks and uncertainties.



RESULTS OF OPERATIONS


Since inception, we have generated
$11,514,000 in research grant and contract revenue from a contract from NIAID to develop a
new anthrax vaccine, grants from the NIH for research and development of HIV vaccines,
funds received through a collaborative agreement with BBI Biotech Research Laboratories,
Inc. and from service agreement fees from Celltrion.


17
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Nine months ended
September 30, 2003 compared to the nine months ended September 30, 2002


Revenue


Research grant and contract revenue
increased from $370,000 for the nine months ended September 30, 2002 to $9,289,000 for the
nine months ended September 30, 2003. The revenue for the nine months ended September 30,
2003 primarily consisted of contract revenue with NIAID related to the completion of the
first, second and third milestones in the development of a new anthrax vaccine which
amounted to approximately $7,618,000; funds received as reimbursements under a
collaborative agreement with BBI Biotech which amounted to approximately $24,000; two
Small Business Innovation Research (SBIR) grants that are funded by NIAID
which amounted to approximately $924,000; and revenue related to WRAIR which amounted to
approximately $323,000. Related party service fee revenue of $439,000 was earned as part
of a service agreement with Celltrion. Revenue earned in one period is not indicative of
revenue to be earned in future periods. We expect research grant and contract revenue to
increase in the foreseeable future if we are successful in pursuing our current and
anticipated future contracts. We expect related party service revenue to remain at
approximately current levels for the foreseeable future.


Research and development
expenses


Research and development expenses
increased approximately 10%, from $13,898,000 for the nine months ended September 30, 2002 to
$15,238,000 for the nine months ended September 30, 2003. The net increase was due
primarily to supplies and subcontractor costs relating to the anthrax contract.
These costs were approximately $7,100,000 higher for the nine months ended September 30,
2003 than for the same period in 2002. Also, personnel costs rose in the first nine months
of 2003 by $2,600,000 reflecting expenses required to staff a regulatory and quality
systems organization as well as the staffing necessary to develop, validate and operate a
manufacturing facility. These increased expenses were partially offset by allocation
of approximately $3,400,000 in costs for validating the VCI manufacturing facility, by the
deferral of approximately $2,600,000 in costs relating to anthrax contract milestones not
yet met and by a reduction in clinical trial expenses of approximately $2,800,000 due to
the completion of the AIDSVAX clinical trials. We expect research
and development expenses to increase for the foreseeable future if we are able to advance
the product candidates we have under development and if we are able to raise necessary
funds to support such programs.


General and
administrative expenses


General and administrative expenses
increased approximately 33%, from $9,677,000 for the nine months ended September 30, 2002 to $12,828,000
for the nine months ended September 30, 2003. Of this increase, approximately $1,500,000
was due to expenses relating to the operation of the South San Francisco manufacturing
facility with most of the remaining increase due to higher spending for occupancy and
insurance costs. During the third quarter of 2002, we entered into a sublease agreement to
occupy an additional 50,000 square feet of space to establish a manufacturing facility and
the laboratory facilities needed to support a manufacturing operation. In addition,
insurance premium costs, mainly in the product liability and directors and officers
liability programs, increased due to current market conditions in the insurance industry.
We expect general and administrative expenses will be maintained at similar levels but
will be adjusted according to the level of our research and development activity and
planned operations.


Total other income, net


Other income, net, decreased approximately 13%,
from $1,731,000 for the nine months ended September 30, 2002 to $1,499,000 for the nine
months ended September 30, 2003. This decrease is primarily due to the effect of
mark-to-market adjustments relating to the valuation of warrants issued in our 2001 Series
A Redeemable Convertible Preferred Stock financing. Also, there was a decrease in
investment income primarily attributable to the effect of lower average balances of cash,
cash equivalents and investment securities, along with lower yields.


18
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|Minority interest in
subsidiary losses


Minority interest in subsidiary
losses was $625,000 for the nine months ended September 30, 2003 reflecting
Celltrions share of the net loss of VCI during that period.


Three months ended
September 30, 2003 compared to the three months ended September 30, 2002


Revenue


Research grant and contract revenue increased
from $132,000 for the three months ended September 30, 2002 to $5,612,000 for the three
months ended September 30, 2003. The revenue for the three months ended September 30, 2003
primarily consisted of contract revenue with NIAID related to the completion of the third
milestone in the development of a new anthrax vaccine of approximately $5,059,000;
two SBIR grants that are funded by NIAID which amounted to approximately $268,000; and
revenue related to WRAIR which amounted to approximately $285,000. Related party service
fee revenue of $132,000 was earned as part of a service agreement with the Celltrion joint
venture. Revenue earned in one period is not indicative of revenue to be earned in future
periods. We expect research grant and contract revenue to increase in the foreseeable
future if we are successful in pursuing our current and anticipated future contracts. We
expect related party service revenue to remain at approximately current levels for the
foreseeable future.


Research and development
expenses


Research and development expenses
increased approximately 19%, from $4,942,000 for the three months ended September 30, 2002 to $5,877,000
for the three months ended September 30, 2003. The increase was due primarily to
supplies and subcontractor costs relating to the anthrax contract. These costs were
approximately $3,300,000 higher for the three months ended September 30, 2003 than in the
same period in 2002. Also, personnel costs rose in the three months ended September 30,
2003 by $737,000 due to consultancy, salary and benefits expenses required to staff a
regulatory and quality systems organization and to develop, validate and operate a
manufacturing facility. These increased expenses were partially offset by allocation
of approximately $1,677,000 in costs for validating the VCI manufacturing facility, by the
deferral of approximately $748,000 in costs relating to anthrax contract milestones not
yet met and by a reduction in clinical trial expenses of approximately $721,000 due to the
completion of the AIDSVAX clinical trials. We expect research and
development expenses to increase for the foreseeable future if we are able to advance the
product candidates we have under development and if we are able to raise necessary funds
to support such programs.


General and
administrative expenses


General and administrative expenses
increased approximately 21%, from $3,608,000 for the three months ended September 30, 2002 to $4,363,000
for the three months ended September 30, 2003. The increase was due primarily to higher
professional fees for public relations, legal and accounting services totaling
approximately $535,000, higher spending for occupancy and insurance costs totaling
approximately $483,000 and expenses relating to the operation of the South San Francisco
manufacturing facility of approximately $74,000. The increase in professional fees was
largely due to costs of AIDSVAX related public relations activities. Occupancy expenses
have increased due to costs relating to our new manufacturing facility and expanded
laboratory facilities needed to support a manufacturing operation. In addition, insurance
premium cost, mainly in the product liability and directors and officers liability
programs, increased due to current market conditions in the insurance industry. The
overall increase in general and administrative expenses was partially offset by reduced
compensation costs of approximately $300,000 reflecting revisions of estimates relating to our bonus programs. We expect general and
administrative expenses will be maintained at similar levels but will be adjusted
according to the level of our research and development activity and planned operations.


19
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|Total other expense, net


Other expense, net, increased approximately 925%,
from $286,000 for the three months ended September 30, 2002 to $2,931,000 for the three
months ended September 30, 2003. This increase is primarily due to the effect of
mark-to-market adjustments relating to the valuation of warrants issued in our 2001 Series
A Redeemable Convertible Preferred Stock financing. In addition, there was a decrease in
investment income primarily attributable to the effect of lower average balances of cash,
cash equivalents and investment securities, along with lower yields.


Minority interest in
subsidiary losses


Minority interest in subsidiary
losses was $41,000 for the three months ended September 30, 2003 reflecting
Celltrions share of the net loss of VCI during that period.



LIQUIDITY AND CAPITAL
RESOURCES


Our primary financing requirements
are for (i) capital equipment expenditures related to the manufacturing facility in South
San Francisco, California; (ii) funding our day-to-day working capital requirements; and
(iii) research and development costs.


Cash, cash equivalents and investment
securities were $6,828,000 and our working capital position was $(4,020,000) at September
30, 2003. The negative working capital position at September 30, 2003 was principally due
to deferred revenue of $5,729,000, representing invoicing activities not yet recognized as
revenue and the warrant obligation of $4,709,000, representing the fair value of warrants
issued in connection with our Series A Redeemable Convertible Preferred stock financing.
We have financed our operations since inception primarily through capital provided by
Genentech, sales of our common stock, an issuance of convertible preferred stock, research
grant and contract revenues and related party services revenues. Genentech has no
obligation to provide us future funding.


We completed our initial public
offering in July 1999, in which we sold 3,565,000 shares of common stock resulting in net
proceeds to us of approximately $41,959,000. Since our initial public offering, we have
raised aggregate net proceeds of $35,784,500 through sales of common stock, including net
proceeds of $24,100,000 through the private placement of 2,174,000 shares of common stock
to Vulcan Ventures, Inc. in December 1999, net proceeds of $5,000,000 through the sale of
1,742,160 shares of common stock to a single institutional investor in May 2003 at $2.87
per share and net proceeds of $6,684,500 through the sale of 1,591,307 shares of common
stock to a single institutional investor in June 2003 at $4.3989 per share. In addition,
on May 23, 2001, we completed a preferred stock financing through which four investors
paid us an aggregate of approximately $20,000,000 in consideration for 20,000 shares of
our Series A Redeemable Convertible Preferred Stock at a price of $1,000 per share,
convertible into shares of our common stock, at an initial conversion price of $23.2185
per share. At September 30, 2003 all 20,000 shares of Series A Redeemable Convertible
Preferred Stock had been converted to common stock. Expenses relating to the transaction
were approximately $1,700,000, resulting in net proceeds to us of approximately
$18,300,000. The proceeds from the Series A Redeemable Convertible Preferred Stock
financing were used to prepare the Companys HIV/AIDS vaccine, if proven successful,
for commercial-scale manufacturing as well as for the development of new adjuvants and for
general corporate purposes.


In connection with the Series A
Redeemable Convertible Preferred Stock financing, we issued warrants for the purchase of
297,177 shares of our common stock to our preferred stock investors. The warrants, which
expire on May 23, 2006, originally had an exercise price of $25.2375 per share; however
effective as of June 5, 2003, the exercise price was automatically adjusted to $12.324 per
share and the number of shares issuable on exercise of the warrants increased to 608,568,
in accordance to the terms of the warrants.


20
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|Since our inception,
        investing activities, other than purchases and sales of investment securities,
        have consisted entirely of equipment acquisitions and leasehold improvements.
        From inception through September 30, 2003, our gross investment in equipment
        and leasehold improvements was $11,045,000. The increase in equipment
        and leasehold improvements has been primarily due to the development of
        our research and development laboratories, our manufacturing facility
        and in the establishment of office facilities. Net cash used in operating
        activities for the nine months ended September 30, 2003 was $15,654,000,
        primarily representing expenditures for research and development costs
        and general and administrative expenses in excess of revenues from grants
        and contracts as compared to $21,224,000 for the nine months ended September
        30, 2002.


In 2001, we finalized a collaborative
agreement with BBI Biotech, which is being funded by NIAID, to obtain and store clinical
specimens from our North American/European Phase III clinical trial of AIDSVAX. The
project is being funded under a contract, which NIAID awarded BBI Biotech for seven years.
Under a subcontract with BBI Biotech, we anticipated receiving approximately $1,730,000 to
support the sample collection. We recognized $424,000 and $0 from this collaborative
agreement for the nine months ended September 30, 2003 and 2002, respectively. We have
completed this project and we do not anticipate further revenue recognition relating to
this collaborative agreement.


Also in 2001, we were awarded an SBIR
grant from the NIH to continue the development of a vaccine designed to prevent infection
by HIV subtype C, the most widespread form of the virus, which is predominantly found in
Africa, China and India. The SBIR Fast Track grant provides up to $1,131,000 for the
development program. We recognized revenue relating to this grant of approximately
$199,000 and 238,000 for the nine months ended September 30, 2003 and 2002, respectively.
The NIH grant will allow us to create and conduct laboratory tests of a subtype C vaccine
that could be used alone in Southern Africa and India, or it could be combined with a
vaccine against the B and E subtypes for other regions of the world, such as China, where
all three subtypes are in circulation. We have completed this project and we do not
anticipate further revenue recognition relating to this grant.


In February 2002, we and a group of
South Korean investors formed a joint venture, named Celltrion, which intends to raise up
to approximately $122,000,000, consisting of up to approximately $92,000,000 in cash and
an in-kind investment of mammalian cell culture technology and know-how valued at
$30,000,000, to build and operate a manufacturing facility in Incheon, South Korea. The
joint venture also funded a capital contribution of $7,000,000 towards construction of a
smaller manufacturing facility in South San Francisco. Both facilities will be designed
for commercial manufacture of biopharmaceutical products, including AIDSVAX if eventually
licensed, our anthrax vaccine candidate, or other products for third parties made through
mammalian-cell fermentation.


As part of our investment in the
joint venture, we provided mammalian cell culture technology and biologics production
expertise. We currently are Celltrions single-largest stockholder. Although we have
no further funding obligation to Celltrion, we are responsible for any additional capital
equipment costs in excess of $7,000,000 and certain costs related to capital expenditures,
validation, operation and licensure of VCIs manufacturing facility in South San
Francisco, California. The South Korean investors will provide the funding necessary to
design and construct both facilities and to validate and operate the Incheon facility.
After all planned rounds of financing are completed, our fully diluted ownership of
Celltrion will be approximately 44%. As of September 30, 2003, the South Korean investors
had contributed to Celltrion approximately $43,750,000 of the $52,000,000 in cash required
under joint venture agreement between us and Celltrion, and secured a $40,000,000 loan
with a Korean bank. As a result, we currently have a 47.8% interest in the joint venture.


      Under the initial phase of
        the NIAID contract to develop a new anthrax vaccine, we expect an award,
        upon satisfaction of certain milestones, of approximately $20,900,000
        to advance the development of a vaccine candidate initially developed
        by the USAMRIID. During the first quarter of 2003, we recognized a total
        of $667,000 in revenue related to the completion of the first contractual
        milestone. In the second quarter of 2003, we recognized a total of $1,892,000
        in revenue related to the completion of the second contractual milestone.
        In the third quarter of 2003, we recognized a total of $5,059,000 in revenue
        related to the completion of the third contractual milestone. We will recognize revenue
        based on the completion of future milestones, which have been specified
        by NIAID. Revenues and direct costs (not to exceed revenues) associated with
        milestones which have not been substantiated through objective evidence
        from NAID, will be deferred on our balance sheet. As of October 2003,
        we had received payments of approximately $13,364,000 from NIAID
        since the award date for this contract.


21
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--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|In September 2002, we were awarded a
$1,000,000 task order to supply AIDSVAX B/E under an existing general contract to
develop HIV vaccines for a forthcoming Phase III trial in Thailand funded by NIAID and
conducted by WRAIR. There were two contract options that, when exercised, would increase
the total contract award to $3,300,000. In February 2003, NIAID exercised the first
option to take delivery of the first two-thirds of the vaccine supply. In April 2003,
NIAID exercised their second option for the remaining balance. The majority of the
contract award will be earned in the fourth quarter of 2003 when the supply is transferred
to WRAIR.


In October 2002, the NIH awarded us
an SBIR grant to characterize the sequences of the viruses responsible for recent HIV
infections. The viruses are being sequenced from blood specimens obtained from volunteers
who became infected during their participation in our North American/European Phase III
clinical trial and is intended to help identify Subtype B virus variants that should be
included in future vaccine formulations. The grant award for the first phase of the grant
was $210,000. We recognized approximately $108,000 in grant revenue relating to the first
phase of the award for the nine months ended September 30, 2003. We were awarded a grant
for the second phase of the grant in June 2003, for a total of $2,003,000. We recognized
approximately $534,000 in grant revenue relating to the second phase of the award for the
nine months ended September 30, 2003.


In September, 2003 NIAID elected to
extend the anthrax vaccine contract and we were awarded an $80,300,000 contract for the
advanced development of our anthrax vaccine candidate, to conduct a large-scale Phase II
clinical trial and to manufacture 3 million doses of anthrax vaccine under an
Investigational New Drug Application (IND).


We believe that our existing cash and
cash equivalents and investment securities, together with investment income, the funds
from our existing government contracts and grants, will enable us to meet our forecasted
expenditures through the first quarter of 2004. However, we will need to raise additional
funds to support our product development programs, other business opportunities and our
general operations. Our future capital requirements are also dependent on several other
factors, including:
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
progress of other internal research and development projects;
| | - | -----------------------------------------------------------------

| |  | the
timing and ability to negotiate government contracts or grants, particularly our ability
to win additional contracts to develop our anthrax vaccine candidate;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
ability to attract and negotiate business development opportunities;
| | - | ------------------------------------------------------------------------

| |  | the
timing of collection of accounts receivable from our government contracts and grants; and
| | - | ---------------------------------------------------------------------------------------------

| |  | the
timing of revenue, from our vaccine candidates.
| | - | ---------------------------------------------------

|We cannot assure you that we will be
able to raise funds when needed, or that such funds will be available on satisfactory
terms. If we are unable to raise additional capital, we will have to curtail or cease
operations. We will restrict additional planned activities and operations, as necessary,
to sustain operations and conserve cash resources.


22
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|RISK FACTORS


You should carefully consider the
following risk factors, in addition to the other information set forth in this Quarterly
Report on Form 10-Q, before making any investment decisions regarding our common stock.
Each of these risk factors could adversely affect our business, operating results and
stock price.


Risks Relating to Our
Business


We will need to raise additional
capital, and any inability to raise required funds could harm our business.


As of September 30, 2003, we had $6.8
million of cash, cash equivalents and investment securities. In their report, dated
February 7, 2003, except as to note 2 which is as of November 19, 2003, relating to our December 31, 2002 audited financial statements, our
independent accountants expressed substantial doubt as to our ability to continue as a
going concern. We will require additional funds to continue operations and may attempt to
raise these funds through equity or debt financings, collaborative arrangements with
corporate partners or from other sources. Any equity financings will be dilutive to
existing stockholders and any debt financings will likely involve covenants restricting
our business activities. We cannot guarantee you that additional funds will be available
on acceptable terms, or at all. If we are unable to raise additional capital when
necessary, we may be required to relinquish our rights to certain key technologies, drug
candidates or marketing territories under the terms of certain of our collaborative
agreements.


We may fail to obtain contracts to
provide emergency stockpiles of anthrax and smallpox vaccines to the U.S. government, and
we may be unable to commercialize our vaccine candidates.


The U.S. government has undertaken
commitments to help secure improved countermeasures against bioterrorism, including the
stockpiling of vaccines for anthrax and smallpox. On September 30, 2003, VaxGen and Avecia
Limited were awarded cost-reimbursement contracts to advance development of their
respective anthrax vaccines and to each supply an inventory of three million doses of
their anthrax vaccines to the U.S. government. These contracts have estimated values of
$80.3 million and $71.3 million, respectively. Under the current version of Project
BioShield, the U.S. government expects to purchase a total of 60 million doses of an rPA
anthrax vaccine over a 10-year period. The process of obtaining government contracts is
lengthy and uncertain and we must compete for each contract. Moreover, the award of one
government contract does not necessarily secure the award of future contracts covering the
same vaccine. Accordingly, we cannot be certain that we will be awarded any future
contracts to supply a government stockpile of anthrax vaccine. It is possible that future
awards to provide the U.S. government with emergency stockpiles of anthrax vaccine will be
granted solely to Avecia or another supplier. If the U.S. government makes significant
future contract awards for the supply of its emergency stockpile to our competitors, such
as Avecia, our business will be harmed and it is unlikely that we will be able to
ultimately commercialize that particular vaccine.


In addition, the determination of
when and whether a product is ready for large scale purchase and potential use will be
made by the government through consultation with a number of governmental agencies,
including the FDA, the NIH, the CDC, and the Department of Homeland Security. President
Bush has proposed and Congress is considering measures to accelerate the facilitation of
bioterrorism countermeasure product development by the NIH, the review process by the FDA
and the final government procurement contracting authority. While this may help speed the
approval of our vaccine candidates, it may also encourage competitors to develop their own
vaccine candidates. If competitive vaccine candidates gain approval, we could face severe
competition, which could harm our business. Furthermore, while Project BioShield was
passed by the House of Representatives, we cannot be certain that this legislation will be
enacted into law or, if it is enacted into law, predict the timing of its enactment or the
amount of funds which will be allocated, nor can we predict the decisions that will be
made in the future by various government agencies.


23
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|If the U.S. government fails to
continue funding our anthrax vaccine candidate development efforts or fails to purchase
sufficient quantities of any future biodefense vaccine candidate, we may be unable to
generate sufficient revenues to continue operations.


We have received funding from the
U.S. government for the development of our anthrax vaccine candidate. Changes in
government budgets and agendas may result in future funding being decreased and
de-prioritized, and government contracts typically contain provisions that permit
cancellation in the event that funds are unavailable to the governmental agency.
Furthermore, we cannot be certain of the timing of any future funding and substantial
delays or cancellations of funding could result from protests or challenges from third
parties. If the U.S. government fails to continue to adequately fund our research and
development programs, we may be unable to generate sufficient revenues to continue
operations. Similarly, if we develop an anthrax vaccine candidate that is approved by the
FDA, but the U.S. government does not place sufficient orders for this product, our future
business will be harmed.


We may not be able to obtain and
maintain proprietary rights necessary for the development and commercialization of our
smallpox vaccine candidate.


Our current business strategy focuses
primarily on the development and commercialization of vaccine candidates for anthrax and
smallpox. Kaketsuken of Japan holds exclusive commercial rights to our smallpox vaccine
candidate. We have entered into an agreement with Kaketsuken that grants us limited
development rights for the smallpox vaccine; however, Kaketsuken has not yet granted us
further development or commercialization rights. Although we have entered into a
non-binding letter of intent that provides that Kaketsuken will negotiate with us on an
exclusive basis to grant us these rights, we cannot guarantee you that we will be able to
enter into a definitive agreement pursuant to which Kaketsuken would grant us further
development and commercialization rights. If we are unable to obtain further development
and commercializing rights from Kaketsuken, we will be unable to sell this smallpox
vaccine even if we are successful in developing it.


     U.S. government agencies have special contracting requirements, which create
          additional risks.


We have entered into contracts with
the NIAID, a division of NIH, and a license agreement with USAMRIID, which are U.S.
government agencies. Substantially all of our revenue is derived from government contracts
and grants. In contracting with government agencies, we are subject to various U.S.
government agency contract requirements. Future sales to U.S. government agencies will
depend, in part, on our ability to meet U.S. government agency contract requirements,
certain of which we may not be able to satisfy.


     U.S. government contracts typically contain unfavorable termination provisions and
          are subject to audit and modification by the government at its sole discretion,
          which subjects us to additional risks. These risks include the ability of the
          U.S. government to unilaterally:
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | suspend
or prevent us for a set period of time from receiving new contracts or extending existing
contracts based on violations or suspected violations of laws or regulations;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | terminate
our existing contracts;
| | - | ---------------------------------

| |  | reduce
the scope and value of our existing contracts;
| | - | -----------------------------------------------------

| |  | audit
and object to our contract-related costs and fees, including allocated indirect costs;
| | - | --------------------------------------------------------------------------------------------

| |  | control
and potentially prohibit the export of our products; and
| | - | ----------------------------------------------------------------

| |  | change
certain terms and conditions in our contracts.
| | - | -----------------------------------------------------

|The U.S. government may terminate any
of its contracts with us either for its convenience or if we default by failing to perform
in accordance with the contract schedule and terms. Termination for convenience provisions
generally enable us to recover only our costs incurred or committed, and settlement
expenses and profit on the work completed prior to termination. Termination for default
provisions do not permit these recoveries and make us liable for excess costs incurred by
the U.S. government in procuring undelivered items from another source.


24
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|As a U.S. government contractor, we
are subject to periodic audits and reviews. Based on the results of its audits, the U.S.
government may adjust our contract-related costs and fees, including allocated indirect
costs. Although adjustments arising from government audits and reviews have not seriously
harmed our business in the past, future audits and reviews could cause adverse effects. In
addition, under U.S. government purchasing regulations, some of our costs, including most
financing costs, amortization of intangible assets, portions of our research and
development costs, and some marketing expenses, may not be reimbursable or allowed under
our contracts. Further, as a U.S. government contractor, we are subject to an increased
risk of investigations, criminal prosecution, civil fraud, whistleblower lawsuits and
other legal actions and liabilities to which purely private sector companies are not.


In addition, the license agreement
provides that USAMRIID reserves the right to require us and our affiliates to grant a
nonexclusive, partially exclusive, or exclusive license in any field of use to a
responsible applicant, upon terms that are reasonable under the circumstances and under
applicable law, to fulfill public health or safety needs.


We have only a limited operating
history and we expect to continue to generate losses.


To date, we have engaged primarily in
research, development and clinical testing. Since our inception in 1995, we have not been
profitable, and we cannot be certain that we will ever achieve or sustain profitability.
At September 30, 2003, we had an accumulated deficit of approximately $163.2 million.
Developing our product candidates will require significant additional research and
development, including non-clinical testing and clinical trials, as well as regulatory
approval. We expect these activities, together with our general and administrative
expenses, to result in operating losses for the foreseeable future. Our ability to achieve
profitability will depend, in part, on our ability to procure future contracts to supply
the anthrax and smallpox vaccines to the U.S. government, to successfully complete
development of our proposed products, to obtain required regulatory approvals and to
manufacture and market our products directly or through business partners. We cannot
assure you that we will be able to accomplish any of these objectives.


Vaccine development is a long,
expensive and uncertain process, and delay or failure can occur at any stage of our
clinical trials.


To develop vaccine candidates, we
must provide the FDA and foreign regulatory authorities with clinical data that
demonstrate safety and immune response. Because humans are not normally exposed to anthrax
or smallpox, statistically significant efficacy of our biodefense product candidates
cannot be demonstrated in humans, but instead must be demonstrated, in part, by utilizing
animal models before they can be approved for commercial sale. Vaccine development to show
adequate evidence of efficacy in animal models and safety and immune response in humans is
a long, expensive and uncertain process, and delay or failure can occur at any stage of
our animal studies or clinical trials. Any delay or significant adverse clinical events
arising during any of our clinical trials could force us to abandon a vaccine candidate
altogether or to conduct additional clinical trials in order to obtain approval from the
FDA. These development efforts and clinical trials are lengthy and expensive, and the
outcome is uncertain. If we are unable to successfully develop our vaccine candidates, our
revenues will suffer, and our stock price is likely to decline.


Delays in successfully completing
our clinical trials could jeopardize our ability to obtain regulatory approval or market
our vaccine candidates on a timely basis.


Our business prospects will depend on
our ability to complete patient enrollment in clinical trials, to obtain satisfactory
results, to obtain required regulatory approvals and to successfully commercialize our
vaccine candidates. Completion of our clinical trials, announcement of results of the
trials and our ability to obtain regulatory approvals could be delayed for a variety of
reasons, including:


25
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | slower-than-anticipated
enrollment of volunteers in the trials;
| | - | ---------------------------------------------------------------

| |  | lower-than-anticipated
recruitment or retention rate of volunteers in the trials;
| | - | ---------------------------------------------------------------------------------

| |  | serious
adverse events related to the vaccine candidates;
| | - | ---------------------------------------------------------

| |  | unsatisfactory
results of any clinical trial;
| | - | ---------------------------------------------

| |  | the
failure of our principal third-party investigators to perform our clinical trials on our
anticipated schedules; or
| | - | ----------------------------------------------------------------------------------------------------------------------

| |  | different
interpretations of our pre-clinical and clinical data, which could initially lead to
inconclusive results.
| | - | --------------------------------------------------------------------------------------------------------------------

|Our development costs will increase
if we have material delays in any clinical trial or if we need to perform more or larger
clinical trials than planned. If the delays are significant, or if any of our vaccine
candidates do not prove to be safe or effective or do not receive required regulatory
approvals, our financial results and the commercial prospects for our product candidates
will be harmed. Furthermore, our inability to complete our clinical trials in a timely
manner could jeopardize our ability to obtain regulatory approval.


The independent clinical
investigators that we rely upon to conduct our clinical trials may not be diligent,
careful or timely, and may make mistakes, in the conduct of our clinical trials.


We depend on independent clinical
investigators to conduct our clinical trials. The investigators are not our employees, and
we cannot control the amount or timing of resources that they devote to our vaccine
development programs. If independent investigators fail to devote sufficient time and
resources to our vaccine development programs, or if the their performance is substandard,
it may delay FDA approval of our vaccine candidates. These independent investigators may
also have relationships with other commercial entities, some of which may compete with us.
If these independent investigators assist our competitors at our expense, it could harm
our competitive position.


The approval requirements for
vaccines used to fight bioterrorism are still evolving, and we cannot be certain that any
vaccines we develop, if effective, would meet these requirements.


We are developing product candidates
based upon current governmental policies regulating these vaccines. For instance, we
intend to pursue FDA approval of our anthrax and smallpox vaccine candidates under
requirements published by the FDA in 2002 that allow the FDA to approve certain vaccines
used to reduce or prevent the toxicity of chemical, biological, radiological or nuclear
substances based on human clinical data to demonstrate safety and immune response, and
evidence of effectiveness derived from appropriate animal studies and any additional
supporting data. Our business is subject to substantial risk because these policies may
change suddenly and unpredictably and in ways that could impair our ability to obtain
regulatory approval of these products, and we cannot guarantee that the FDA will approve
our anthrax and smallpox vaccines.


If we fail to comply with
extensive regulations enforced by domestic and foreign regulatory authorities, the
commercialization of our product candidates could be prevented or delayed.


Vaccine candidates are subject to
extensive government regulations related to development, testing, manufacturing and
commercialization in the United States and other countries. Our vaccine candidates are in
the pre-clinical and clinical stages of development and have not received required
regulatory approval from the FDA or foreign regulatory bodies to be commercially marketed
and sold. The process of obtaining and complying with FDA, other governmental and foreign
regulatory approvals and regulations is costly, time consuming, uncertain and subject to
unanticipated delays. Despite the time and expense exerted, regulatory approval is never
guaranteed. We also are subject to the following risks and obligations, among others:


26
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The
FDA or foreign regulators may refuse to approve an application if they believe that
applicable regulatory criteria are not satisfied.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------

| |  | The
FDA or foreign regulators may require additional testing for safety and efficacy.
| | - | -------------------------------------------------------------------------------------

| |  | The
FDA or foreign regulators may interpret data from pre-clinical testing and clinical
trials in different ways than we interpret them.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------

| |  | If
regulatory approval of a product is granted, the approval may be limited to specific
indications or limited with respect to its distribution.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The
FDA or foreign regulators may not approve our manufacturing processes or manufacturing
facilities.
| | - | ------------------------------------------------------------------------------------------------------

| |  | The
FDA or foreign regulators may change their approval policies or adopt new regulations.
| | - | ------------------------------------------------------------------------------------------

| |  | Even
if United States regulatory approval for any product is obtained, the marketing license
will be subject to continual review, and newly discovered or developed safety or efficacy
data may result in revocation of the marketing license.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | If
regulatory approval of the vaccine candidate is granted, the marketing of that vaccine
would be subject to adverse event reporting requirements and the FDAs general
prohibition against promoting products for unapproved or off-label uses.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | We
will be subject to continual regulatory review and periodic inspection and approval of
manufacturing modifications, including compliance with the FDAs cGMP, regulations.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Failure to comply with these or other
regulatory requirements of the FDA and other applicable foreign regulatory bodies may
subject us to administrative or judicially imposed sanctions, including:
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | warning
letters;
| | - | ----------------

| |  | civil
penalties;
| | - | ----------------

| |  | criminal
penalties;
| | - | -------------------

| |  | injunctions;
| | - | ------------

| |  | product
seizure or detention;
| | - | -----------------------------

| |  | product
recalls; and
| | - | --------------------

| |  | total
or partial suspension of production.
| | - | ------------------------------------------

|Our product development efforts
may not yield marketable products due to results of studies or trials, failure to achieve
regulatory approvals or market acceptance, proprietary rights of others or manufacturing
issues.


Our success depends on our ability to
successfully develop and obtain regulatory approval to market new biopharmaceutical
products. We expect that a significant portion of the research that we will conduct will
involve new and unproven technologies. Development of a product requires substantial
technical, financial and human resources even if the product is not successfully
completed.


Our potential products may appear to
be promising at various stages of development yet fail to reach the market for a number of
reasons, including the:
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | lack
of sufficient prevention benefit or unacceptable safety during pre-clinical studies or
clinical trials;
| | - | ------------------------------------------------------------------------------------------------------------

| |  | failure
to receive necessary regulatory approvals;
| | - | --------------------------------------------------

| |  | existence
of proprietary rights of third parties; or
| | - | ----------------------------------------------------

| |  | inability
to develop manufacturing methods that are efficient, cost-effective and capable of
meeting stringent regulatory standards.
| | - | ------------------------------------------------------------------------------------------------------------------------------------

|27
|--

|Political or social factors may
delay or impair our ability to market our vaccine products.


Products developed to treat diseases
caused by or combat the threat of bioterrorism will be subject to changing political and
social environments. The political and social responses to bioterrorism have been highly
charged and unpredictable. Political or social pressures may delay or cause resistance to
bringing our products to market or limit pricing of our products, which would harm our
business.


We may fail to protect our
intellectual property or may infringe on the intellectual property rights of others,
either of which could harm our business.


If we are unable to protect our
intellectual property, we may be unable to prevent other companies from using our
technology in competitive products. If we infringe on the intellectual property rights of
others, we may be prevented from developing or marketing our product candidates. We rely
on patent and other intellectual property protection to prevent our competitors from
manufacturing and marketing our product candidates. Our technology, including technology
licensed from Genentech and USAMRIID, or that we may license in the future, if any, will
be protected from unauthorized use by others only to the extent that it is covered by
valid and enforceable patents or effectively maintained as trade secrets. The patent
positions of pharmaceutical and biotechnology companies can be highly uncertain and
involve complex legal and factual questions. No consistent policy regarding the breadth of
claims allowed in biotechnology patents has emerged to date. Accordingly, we cannot
predict the scope and breadth of patent claims that may be afforded to other
companies patents. In addition, we could incur substantial costs in litigation if we
are required to defend against patent suits brought by third parties, or if we initiate
these suits.


The degree of future protection for
our proprietary rights is uncertain, and we cannot ensure that:
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | others
will not independently develop similar or alternative technologies or duplicate any of
our technologies;
| | - | ---------------------------------------------------------------------------------------------------------------

| |  | any
patents issued to us or licensed from Genentech and USAMRIID, or that we may license in
the future, if any, will provide a basis for commercially viable products or will provide
us with any competitive advantages or will not be challenged by third parties;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | we
or any of our current or future licensors will adequately protect trade secrets;
| | - | -----------------------------------------------------------------------------------

| |  | we
will develop additional proprietary technologies that are patentable; or
| | - | ---------------------------------------------------------------------------

| |  | the
patents of others will not have a material adverse effect on our business.
| | - | ------------------------------------------------------------------------------

|We cannot be certain that patents
issued to us in the future, if any, or patents that we have licensed from Genentech and
USAMRIID, or that we may license in the future, if any, will be enforceable and afford
protection against competitors. In this regard, the U.S. government has the right to use,
for or on behalf of the U.S. government, any technologies developed by us under our U.S.
government contracts and we cannot prohibit third parties, including our competitors, from
using those technologies in providing products and services to the U.S. government.
Accordingly, under our license agreement with USAMRIID granting us an exclusive license to
commercialize the anthrax vaccine, the U.S. government retains a license for any federal
government agency to practice and have practiced USAMRIIDs anthrax-related
inventions, by or on behalf of the government, thereby allowing the use of the inventions
in support of government contracts with other parties, including our competitors. In
addition, we cannot assure you that our operations or technology will not infringe
intellectual property rights of others. If we infringe the intellectual property of
others, there can be no assurance that we would be able to obtain licenses to use the
technology on commercially reasonable terms or at all.


Our South Korean
manufacturing joint venture may not be successful.


Celltrion has not yet completed its
full capitalization and we have not completed the transfer of our technology to Celltrion.
Two of the existing investors in Celltrion have failed to meet a total of $6.3 million in
funding obligations. Celltrion will be unable to validate and operate the manufacturing
facility in South Korea if Celltrion is unable to secure or raise the necessary funding or
does not receive the necessary technology for the manufacture of mammalian cell culture or
other biopharmaceutical products.


28
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Even if Celltrion successfully
completes the construction of its South Korean manufacturing facility, we cannot be
certain that the facility will pass domestic or foreign regulatory approvals or be able to
manufacture mammalian cell culture products in commercial quantities on a cost-effective
basis or at all. In addition, as of the date of this report, Celltrion has not secured any
agreements under which products would be produced at this facility and it is uncertain
whether there will be sufficient demand for mammalian cell culture biomanufacturing to
make this facility profitable.


In addition, the political, social
and economic situation in South Korea, and the stability of the Korean peninsula as a
whole, may not provide an environment in which Celltrion would be able to manufacture
products cost-efficiently or at all. The South Korean government may impose regulations or
restrictions that would make it difficult, impractical or impossible, whether
economically, legally or otherwise, for Celltrion to conduct its business there.
Celltrions manufacturing operations may expose our business to numerous risks
inherent in international operations including:
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | foreign
currency controls;
| | - | --------------------------

| |  | currency
fluctuations;
| | - | ----------------------

| |  | trade
restrictions or changes in tariffs;
| | - | -----------------------------------------

| |  | the
difficulties associated with staffing and managing international operations;
| | - | --------------------------------------------------------------------------------

| |  | generally
longer receivables collection periods;
| | - | ------------------------------------------------

| |  | potentially
limited protection for intellectual property rights;
| | - | ----------------------------------------------------------------

| |  | potentially
adverse taxes; and
| | - | ------------------------------

| |  | international
conflict and war.
| | - | -------------------------------

|If Celltrion is unable to manufacture
mammalian cell culture products, or if it becomes commercially impractical for Celltrion
to manufacture such products, we may not gain financial or other benefit from the joint
venture.


We face competition from several
companies with greater financial, personnel and research and development resources than
ours.


Our competitors are developing
vaccine candidates for anthrax and smallpox, which would compete with the vaccine
candidates we are developing. Our commercial opportunities will be reduced or eliminated
if our competitors develop and market products for any of the diseases that we target
that:
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | are
more effective;
| | - | -------------------

| |  | have
fewer or less severe adverse side effects;
| | - | -----------------------------------------------

| |  | are
better tolerated;
| | - | ---------------------

| |  | are
more adaptable to various modes of dosing;
| | - | ----------------------------------------------

| |  | are
easier to administer; or
| | - | ----------------------------

| |  | are
less expensive than the products or product candidates we are developing.
| | - | -----------------------------------------------------------------------------

|Even if we are successful in
developing effective vaccine products, and obtain FDA and other regulatory approvals
necessary for commercializing them, our products may not compete effectively with other
successful products. Researchers are continually learning more about diseases, which may
lead to new technologies for treatment. Our competitors may succeed in developing and
marketing products either that are more effective than those that we may develop, alone or
with our collaborators, or that are marketed before any products we develop are marketed.


Our competitors include fully
integrated pharmaceutical companies and biotechnology companies that currently have drug
and target discovery efforts, as well as universities and public and private research
institutions. For instance, Avecia Limited, in collaboration with Baxter Healthcare
Corporation and the United Kingdoms Defense Science and Technology Laboratory, was
recently awarded a $71.3 million cost-reimbursement contract by NIAID to make three
million doses of an anthrax vaccine for the U.S. government. Many of the organizations
competing with us, including Avecia, have substantially greater capital resources, larger
research and development staffs and facilities, greater experience in drug development and
in obtaining regulatory approvals, and greater marketing capabilities than we do.


29
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Difficulties we may encounter
managing growth and our changing business focus could adversely affect the results of our
operations.


We have experienced a period of rapid
change in our business as a result of increased emphasis on biodefense opportunities. In
addition, we expect to experience growth in manufacturing, clinical and regulatory
functions associated with our biodefense business. If such growth and change continues, it
will continue to place a strain on our administrative and operational infrastructure. If
we are unable to manage this growth effectively, our business, results of operations or
financial condition may be materially adversely affected.


Natural disasters,
including earthquakes, may damage our facilities.


Our corporate and manufacturing
facilities are primarily located in the San Francisco Bay area. In addition to our office
and research facilities, through our ownership position in both Celltrion and VCI, we have
a significant investment in VCIs biomanufacturing facilities in South San Francisco,
which contain sensitive and expensive bioreactor equipment. The San Francisco Bay area is
in close proximity to known earthquake fault zones. As a result, our corporate, research
and manufacturing facilities are susceptible to damage from earthquakes and other natural
disasters, such as fires, floods and similar events. Although we maintain general business
insurance against fires and some general business interruptions, there can be no assurance
that the amount of coverage will be adequate in any particular case.


If we fail to manage successfully
any company or product acquisitions, joint ventures or in-licensed product candidates, we
may be limited in our ability to develop our product candidates and to continue to expand
our product candidate pipeline.


Our current vaccine product
development programs were initiated through in-licensing or collaborative arrangements.
These collaborations include licensing proprietary technology from, and other
relationships with, biotechnology companies and government research institutes and
organizations. As part of our business strategy, we intend to continue to expand our
product pipeline and capabilities through company or product acquisitions, in-licensing or
joint venture arrangements. Any such activities will be accompanied by certain risks
including:
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | exposure
to unknown liabilities of acquired companies;
| | - | ------------------------------------------------------

| |  | higher
than anticipated acquisition costs and expenses;
| | - | -------------------------------------------------------

| |  | the
difficulty and expense of integrating operations and personnel of acquired companies;
| | - | -----------------------------------------------------------------------------------------

| |  | disruption
of our ongoing business;
| | - | -----------------------------------

| |  | diversion
of managements time and attention; and
| | - | -------------------------------------------------

| |  | possible
dilution to stockholders.
| | - | ----------------------------------

|If our competitors successfully enter
into partnering or license agreements with these groups, or we are unable to reach
agreement on license or partnering agreements on terms acceptable to us, we may then be
precluded from pursuing those specific opportunities. Since each of these opportunities is
unique, we may not be able to find a substitute. In addition, if we are unable to manage
successfully any acquisitions, joint ventures and other collaboration opportunities, we
may be limited in our ability to develop new products and therefore to continue to expand
our product pipeline.


30
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Our use of hazardous materials,
chemicals and viruses require us to comply with regulatory requirements and exposes us to
potential liabilities.


Our research and development involves
the controlled use of hazardous materials, chemicals and viruses. We are subject to
federal, state and local laws governing the use, manufacture, storage, handling and
disposal of such materials. Although we believe that our safety procedures for the use,
manufacture, storage, handling and disposal of such materials comply with the standards
prescribed by federal, state and local regulations, we cannot eliminate the risk of
accidental contamination or injury from these materials. In the event of such an accident,
we could be held liable for significant damages or fines. These damages could exceed our
resources and any applicable insurance coverage. In addition, we may be required to incur
significant costs to comply with regulatory requirements in the future.


We may become subject to product
liability claims, which could reduce demand for our product candidates or result in
damages that exceed our insurance coverage.


We face an inherent risk of exposure
to product liability suits in connection with vaccines being tested in human clinical
trials or sold commercially. We may become subject to a product liability suit if any
vaccine we develop causes injury, or if vaccinated individuals subsequently become
infected or otherwise suffer adverse effects from our vaccines or products. Regardless of
merit or eventual outcome, product liability claims may result in decreased demand for a
vaccine or product, injury to our reputation, withdrawal of clinical trial volunteers and
loss of revenues. If a product liability claim is brought against us, the cost of
defending the claim would be significant and any adverse determination may result in
liabilities in excess of our insurance coverage. We currently have product liability
insurance in the amount of $25.0 million for our anthrax program including the supply of
three million doses of anthrax vaccine to NIAID, as well as separate clinical trials
coverage for our smallpox and AIDSVAX programs. However, we cannot be certain that our
current insurance can be maintained, or that additional insurance coverage could be
obtained, on acceptable terms, if at all.


Legislation limiting or
restricting liability for medical products used to fight bioterrorism is evolving, and we
cannot be certain that any such protections will apply to our vaccines or products.


Legislation relating to medical
products used to fight bioterrorism is evolving, and may enable the United States
government to release and use certain medical products prior to such products obtaining
FDA or other regulatory approval. According to the terms of one proposed bill, upon a
declaration of emergency, the U.S. government may authorize the introduction and use of a
qualified medical product prior to such medical product obtaining FDA regulatory approval.
Further, such proposed legislation provides that the United States government may elect to
purchase and stockpile quantities of vaccines or products prior to receipt of regulatory
approval to fight bioterrorism. Legislation limiting or restricting liability for the use
of such vaccines is evolving, and we cannot be certain that any such protections will
apply to the vaccines or products developed by us. If the legislation does not provide
sufficient protection, and we are not able to obtain these protections by contract, we may
become subject to product liability suits and other third party claims if vaccines or
products developed by us cause injury, or if vaccinated individuals subsequently become
infected or otherwise suffer adverse effects from such vaccines or products.


We may be subject to claims that
we or our employees have wrongfully used or disclosed alleged trade secrets of their
former employers.


As is commonplace in the
biotechnology industry, we employ individuals who were previously employed at other
biotechnology or pharmaceutical companies, including our competitors or potential
competitors. Although no claims against us are currently pending, we may be subject to
claims that these employees or we have inadvertently or otherwise used or disclosed trade
secrets or other proprietary information of their former employers. Litigation may be
necessary to defend against these claims. Even if we are successful in defending against
these claims, litigation could result in substantial costs and be a distraction to
management.


31
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Failure to hire and retain key
management employees could adversely affect our ability to obtain financing, develop our
products, conduct clinical trials or execute our business strategy.


We are highly dependent on our senior
management and scientific staff. These individuals have played a critical role in raising
capital, negotiating business development opportunities, developing the vaccine
candidates, conducting clinical trials and manufacturing products. If we lose the services
of any key members of senior management or scientific staff and we are unable to recruit
qualified replacements where we deem it necessary, we may be unable to achieve our
business objectives.


Risks Relating to Our
Relationship with Genentech and Our Relationships with Other Third Parties


We license AIDSVAX from Genentech
and our license agreement may be terminated under certain circumstances.


Since inception, we have been focused
on research and development of AIDSVAX, which we licensed from Genentech. This license
agreement, as amended effective as of May 1, 2002, permits Genentech to terminate the
agreement, or terminate the exclusivity of our license, if we:
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | fail
to use due diligence in developing, seeking regulatory approval for, marketing or
commercializing products covered by the agreement;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------

| |  | fail
to file a Biologics License Application for AIDSVAX with the FDA prior to May 1, 2004;
provided, that this date may be extended to May 1, 2006 if our Phase III clinical trials
do not meet their primary endpoints; or
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | breach
the license agreement and fail to cure the breach within the time period provided in the
agreement.
| | - | ----------------------------------------------------------------------------------------------------------

|If Genentech were to terminate our
license agreement, we would not be able to develop or market AIDSVAX.


Under the Genentech license
agreement, Genentech has retained title to the licensed patents and patent applications
and other licensed technology previously owned by Genentech, while we will retain title to
any improvements developed by us.


We currently do not have an internal
marketing and sales force and may rely on third parties for the sales or marketing of some
or all of our vaccines if they are successfully developed. Our dependence on third parties
may delay or impair our ability to generate revenues, or adversely affect our
profitability.


We lack any sales or marketing
history, and as of present do not have plans on developing internally such capability,
other than for sales directly to the U.S. government. We intend to rely on third parties
for the sales and marketing of our products. Our lack of sales and marketing personnel and
distribution relationships may impair our ability to generate revenues.


Risks Related to the
Issuance of Series A 6% Cumulative Redeemable Convertible Preferred Stock (Series A
Preferred Stock) and Warrants


We may be obligated to
redeem the common stock issued on exercise of the warrants and/or the warrants at a
premium to the purchase or exercise price.


On May 23, 2001, we completed a
private placement in which we issued 20,000 shares of our Series A Preferred Stock and
warrants, or the Series A Warrants, to purchase common stock for aggregate proceeds of
$20,000,000. As of September 30, 2003, there were no shares of Series A Preferred Stock
outstanding; however, there remain Series A Warrants to purchase 608,568 shares of
common stock outstanding. As of September 30, 2003, only one share of common stock had
been issued upon the exercise of Series A Warrants. The terms of the Series A Warrants
give the holders a contractual right to require us to redeem all of the common stock
issued upon exercise of the Series A Warrants and/or the Series A Warrants at a 20%
premium under certain circumstances including:


32
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | if
we breach certain of our obligations under the purchase agreements between us and the
holders;
| | - | -------------------------------------------------------------------------------------------------

| |  | if
our stock is delisted  or not quoted on an approved  stock  exchange or the Nasdaq
 National  Market or Small Cap Market          for five consecutive days; or
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | if
we are insolvent or certain actions are taken as part of a bankruptcy proceeding.
| | - | ------------------------------------------------------------------------------------

|If any of these circumstances were to
occur, our redemption of the common stock issued on exercise of the Series A Warrants,
and/or the Series A Warrants, would require the expenditure of a significant amount of
cash that could substantially exceed the proceeds that we received in the private
placement, and, consequently, could harm our business.


If our warrant holders elect to
have their warrants assumed by a potential acquirer of VaxGen, the acquirer could be
deterred from completing the acquisition.


Holders of the Series A Warrants can
elect to have their Series A Warrants remain outstanding after an acquisition of VaxGen
and to have the acquirer assume all of our obligations to the holder. The ability of the
holders of the Series A Warrants to force an acquirer to assume the Series A Warrants
could deter a potential acquirer from completing an acquisition of VaxGen.


Other Risks




      If
        we are unable to maintain our Nasdaq National Market listing, it could
        have a material adverse impact on our stock price, the market for our
        stock and our ability to raise capital


Our common stock trades on The Nasdaq
National Market. In order to continue trading on The Nasdaq National Market, we must
satisfy the continued listing requirements for that market. While we are presently in
compliance with the continued listing requirements, we may not be able to maintain
compliance with them.


Under The Nasdaq National Market
continued listing requirements, the minimum net tangible asset requirement was replaced
with a minimum stockholders equity requirement of $10,000,000. If we fail to comply with this or the other
applicable continued listing requirements our
common stock may be delisted from The Nasdaq National Market.


At September 30, 2003, our
stockholders equity was $8,747,000 and our closing stock price on November 17, 2003
was $9.30. A delisting of our common stock from The Nasdaq National Market would
materially reduce the liquidity of our common stock and result in a corresponding material
reduction in the price of our common stock. In addition, any such delisting would
materially adversely affect our ability to raise capital through alternative financing
sources on terms acceptable to us, or at all, which could materially harm our business.


If we are delisted from the Nasdaq
National Market, we will also face a variety of legal consequences that will likely
negatively affect our business including, without limitation, the following:
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | we may lose our exemption from the provisions of Section 2115 of the California
Corporations Code, which imposes aspects of California corporate law on certain
non-California corporations operating within California. As a result, (1) our stockholders
would be entitled to cumulative voting, and (2) we would be subject to more stringent
stockholder approval requirements and more stockholder-favorable dissenters rights
in connection with certain strategic transactions;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the state securities law exemptions available to us would be more limited and, as a
result, future issuances of our securities may require time-consuming and costly
registration statements and qualifications; and
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | due to the application of different securities law exemptions and provisions, we may be
required to amend our stock option and stock purchase plans and comply with time-consuming
and costly administrative procedures.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Our stock price may be volatile,
and your investment in our stock could decline in value.


The trading price of our common stock
has been and is likely to continue to be extremely volatile. Our stock price could be
subject to wide fluctuations in response to a variety of factors, including the following:
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | adverse
results or delays in clinical trials;
| | - | ---------------------------------------------

| |  | delays
in our product development efforts;
| | - | ------------------------------------------

| |  | failure
to win future government contracts for anthrax or smallpox;
| | - | -------------------------------------------------------------------

| |  | real
or perceived safety issues with any of our vaccine candidates;
| | - | -------------------------------------------------------------------

| |  | delays
in completion of our manufacturing facilities in South Korea and the U.S.;
| | - | ---------------------------------------------------------------------------------

| |  | changes
in financial estimates by securities analysts;
| | - | ------------------------------------------------------

| |  | rumors
about our business prospects, product development efforts or clinical trials;
| | - | ------------------------------------------------------------------------------------

| |  | new
 products or services  offered by us or our  competitors  or  announcements  relating  to
product  developments  by our          competitors;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------

| |  | issuances
of debt or equity securities;
| | - | ---------------------------------------

| |  | sales by our stockholders of substantial amounts of our common stock, including shares
issued upon exercise of outstanding options and warrants and conversion of the Series A
Preferred Stock; and
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | other
events or factors, many of which are beyond our control.
| | - | --------------------------------------------------------------

|In addition, the stock market in
general, and The Nasdaq National Market and biotechnology companies in particular, have
experienced extreme price and volume fluctuations that have often been unrelated or
disproportionate to the operating performance of these companies. Broad market and
industry factors may negatively affect the market price of our common stock, regardless of
actual operating performance. In the past, following periods of volatility in the market
price of a companys securities, securities class action litigation has often been
instituted against companies. This type of litigation, if instituted, could result in
substantial costs and a diversion of managements attention and resources, which
would harm our business.





We are currently involved in
litigation concerning the results of our AIDSVAX clinical trial.


Since the announcement of the results
of the North American/European Phase III clinical trial for AIDSVAX, we have been named in
several securities class action lawsuits and a shareholder derivative lawsuit relating to
how those results were disclosed. We are currently engaged in defending against these
actions, which, if decided against us, could adversely affect our financial position.
Furthermore, these actions are not likely to be resolved in less than a year. The costs of
defending these lawsuits could be significant and may not be covered by our insurance
policies. The defense of these lawsuits could also result in continued diversion of our
managements time and attention away from business operations, which could harm our
business.


Our stockholders could experience
substantial dilution as result of the issuance of additional preferred stock.


Our board of directors has the
authority to establish the designation of 19,979,500 additional shares of preferred stock
that are convertible into common stock without any action by our stockholders, and to fix
the rights, preferences, privileges and restrictions, including voting rights, of such
shares. The issuance and conversion of any such preferred stock would further dilute the
percentage ownership of our stockholders.


Our stock price may be volatile,
and an investment in our stock could decline in value.


The trading price of our common stock
has been and is likely to continue to be extremely volatile. Our stock price could be
subject to wide fluctuations in response to a variety of factors, including the following:
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | failure
to win future government contracts for anthrax or smallpox vaccines;
| | - | ----------------------------------------------------------------------------

| |  | adverse
results or delays in clinical trials;
| | - | ---------------------------------------------

| |  | delays
in our product development efforts;
| | - | ------------------------------------------

| |  | real
or perceived safety issues with any of our vaccine candidates;
| | - | -------------------------------------------------------------------

| |  | delays
in completion and/or validation of our manufacturing facilities in South Korea and the
United States;
| | - | ------------------------------------------------------------------------------------------------------------

|33
|--

| |  | changes
in financial estimates by securities analysts;
| | - | ------------------------------------------------------

| |  | rumors
about our business prospects, product development efforts or clinical trials;
| | - | ------------------------------------------------------------------------------------

| |  | new
 products or services  offered by us or our  competitors  or  announcements  relating  to
product  developments  by our          competitors;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------

| |  | issuances
of debt or equity securities;
| | - | ---------------------------------------

| |  | sales
by our  stockholders  of  substantial  amounts  of our  common  stock,  including  shares
 issued  upon  exercise  of          outstanding options and warrants; and
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | other
events or factors, many of which are beyond our control.
| | - | --------------------------------------------------------------

|In addition, the stock market in
general, and the Nasdaq National Market and biotechnology companies in particular, have
experienced extreme price and volume fluctuations that have often been unrelated or
disproportionate to the operating performance of these companies. Broad market and
industry factors may negatively affect the market price of our common stock, regardless of
actual operating performance. In the past, following periods of volatility in the market
price of a companys securities, securities class action litigation has often been
instituted against companies.



ITEM 3. QUANTITATIVE AND
QUALITATIVE DISCLOSURES ABOUT MARKET RISK


Our exposure to market rate changes
is related primarily to our debt securities included in our investment portfolio. We do
not have any derivative financial instruments. By policy, we invest in debt instruments of
the U.S. government, federal agencies and high-quality corporate issuers, limit the amount
of credit exposure to any one issuer, limit duration by restricting the term, and hold
investments to maturity except under rare circumstances. Investments in both fixed rate
and floating rate instruments carry a degree of interest rate risk. Fixed rate securities
may have their fair market value adversely impacted due to a rise in interest rates, while
floating rate securities may produce less income than expected if interest rates fall. Due
in part to these factors, our future investment income may decrease due to changes in
interest rates or due to losses we may suffer when securities decline in market value. At
September 30, 2003, we held government debt instruments and corporate obligations in the
principal amount of $3,274,000. If market interest rates were to increase immediately and
uniformly by 10% from levels at September 30, 2003, the fair value of our portfolio would
decline by an immaterial amount. Our exposure to losses as a result of interest rate
changes is managed through investing primarily in securities that mature in a period of
one year or less.


We have exposure to foreign exchange
rate risk primarily related to our conducting clinical trials in Thailand. Thailand is
currently considered an emerging economy. A material increase in the value of
Thailands currency against the U.S. Dollar could cause an increase in our expenses.
The majority of our contracts associated with conducting clinical trials in Thailand are
priced in Baht. For the nine months ended September 30, 2003, we have incurred no foreign
exchange gains or losses.



ITEM 4. CONTROLS AND
PROCEDURES


Our chief executive officer and
principal financial officer are responsible for establishing and maintaining disclosure
controls and procedures, as such term is defined under Rule 13a-15(e) and 15d-15(e)
promulgated under the Securities Exchange Act of 1934, as amended (the Exchange
Act). Based on their evaluation of the effectiveness of the Companys
disclosure controls and procedures, our chief executive officer and principal financial
officer concluded that our disclosure controls and procedures were effective, as of the
end of the period covered by this report.


34
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|PART II  OTHER
INFORMATION



ITEM 1. LEGAL PROCEEDINGS


On March 17, 2003 a civil complaint
for violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 was filed
in the United States District Court for the Northern District of California, entitled
Janice Whitkens v. VaxGen, Inc., et al., Civil Action No. C03-1129 JSW. Named, as
defendants are VaxGen, Inc., Chief Executive Officer Lance K. Gordon and President Donald
P. Francis, M.D. The plaintiff seeks to represent a class of persons who purchased the
Companys securities between August 6, 2002 and February 26, 2003, and alleges that
the defendants misled investors about the progress of certain clinical trials and the
Companys future manufacturing and marketing plans. Management believes the Company
has strong defenses and intends to defend the action vigorously.


Following the filing of the Whitkens
complaint, several additional class action complaints were filed in the same court, each
making identical or similar allegations against the same defendants. These cases have been
consolidated with the Whitkens case into a single action. Management believes the Company
has strong defenses and intends to defend the action vigorously.


On or about March 21, 2003, two
separate but virtually identical shareholder derivative actions were filed in California
Superior Court for San Mateo County entitled Rhodes v. Allen, et al. Civil Action No. CIV
430087, and MacDonald v. Allen, et al., Civil Action No. CIV 430088. These cases have been
consolidated into a single action. Named as defendants in the consolidated action are
Company directors Lance K. Gordon, Donald P. Francis, M.D., Phillip W. Berman, David W.
Beier, Randall L-W. Caudill, Stephen C. Francis and William D. Young. Also named as
defendants are Paul Allen and Vulcan Ventures, Inc. The allegations of the consolidated
complaint mirror those contained in the class action, and plaintiffs allege as well that
Mr. Allen and Vulcan Ventures sold shares of the Companys stock while in possession
of material non-public information about the Company. Plaintiffs, purportedly suing on
behalf of the Company, assert claims against all defendants for breach of fiduciary duty,
abuse of control, mismanagement, waste and unjust enrichment, and against Mr. Allen and
Vulcan Ventures for breach of fiduciary duty and insider trading. Management believes the
Company has strong defenses and intends to defend the action vigorously.


35
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|ITEM 4. SUBMISSION OF
MATTERS TO A VOTE OF SECURITY HOLDERS


On July 18, 2003, at the 2003 Annual
Meeting of Stockholders, the stockholders of VaxGen, Inc. (the Company) were
asked to vote on the following five items:
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1. | To
elect eight directors, Lance K. Gordon, Donald P. Francis, Phillip W. Berman,
                    David W. Beier, Randall L-W. Caudill, Stephen C. Francis, Michel
Greco and                     William D. Young to serve until the Companys 2004
Annual Meeting of                     Stockholders or until their earlier retirement,
resignation or removal;
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | To
approve the amendment to the Companys 2001 Employee Stock Purchase Plan
                    (the Plan), to increase the aggregate number of shares of
Common                     Stock authorized for issuance under the Plan by 300,000
shares;
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | To
consider and vote on the potential issuance of additional shares of the
                    Companys Common Stock to certain investors on conversion of the
                    Companys outstanding Series A Preferred Stock and on exercise
of                     outstanding warrants to purchase the Companys Common Stock
that were                     issued in connection with a private placement in May 2001,
to the extent that                     such stock issuances would require stockholder
approval under the rules of the                     Nasdaq National Market;
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4. | To
ratify the form of Indemnification Agreement entered into between the Company
                    and its officers and directors; and
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------

| | 5. | To
ratify the appointment of KPMG LLP as the Companys independent auditors
                    for the fiscal year ending December 31, 2003.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------

|The results of the matters presented
at the annual meeting, were as follows:
|----------------------------------------------------------------------------

| | 1. | Lance
K. Gordon, Donald P. Francis, Phillip W. Berman, David W. Beier, Randall
                    L-W. Caudill, Stephen C. Francis, Michel Greco and William D. Young
were elected                     as directors of the Company to serve until the 2004
Annual Meeting of                     Stockholders as follows:
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | For                        |  | Withheld  
| | -------------------------- |  | ----------
| | Lance
      K. Gordon      |  | 16,271,932
| | Donald
      P. Francis    |  | 16,203,101
| | Phillip
      W. Berman    |  | 16,293,152
| | David
      W. Beier       |  | 16,269,301
| | Randall
      L-W. Caudill |  | 16,270,401
| | Stephen
      C. Francis   |  | 16,269,190
| | Michel
      Greco         |  | 16,293,142
| | William
      D. Young     |  | 16,271,101

| | 2. | The
approval of the amendment to the Plan, to increase the aggregate number of
                    shares of Common Stock authorized for issuance under the Plan by
300,000 shares                     was approved as follows:
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | For        | Against | Abstain
| | ---------- | ------- | -------
| | 16,214,043 |         | 161,944

|36
|--

| | 3. | The
approval of the potential issuance of additional shares of the                     Companys
Common Stock to certain investors on conversion of the                     Companys
outstanding Series A Preferred Stock and on exercise of                     outstanding
warrants to purchase the Companys Common Stock that were                     issued
in connection with a private placement in May 2001, to the extent that
                    such stock issuances would require stockholder approval under the
rules of the                     Nasdaq National Market was approved as follows:
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | For       | Against | Abstain
| | --------- | ------- | -------
| | 1,750,956 |         | 201,606

| | 4. | The
ratification of the form of Indemnification Agreement entered into between
                    the Company and its officers and directors was approved as follows:
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | For        | Against | Abstain
| | ---------- | ------- | -------
| | 16,212,526 |         | 144,532

| | 5. | The
ratification of KPMG LLP as the Companys independent auditors for the
2003 fiscal year was approved as follows:
| | -- | --------------------------------------------------------------------------------------------------------------------

| | For        | Against | Abstain
| | ---------- | ------- | -------
| | 16,358,983 |         | 21,654 

|ITEM 5. OTHER INFORMATION


Contract for Advanced
Development of Anthrax Vaccine Candidate


On October 2, 2003 the Company
announced that it had been awarded an $80.3 million contract from the NIAID for the advanced development of its anthrax
vaccine candidate, rPA102. The three-year contract is intended to fund many of the steps
required for commercial licensure of the vaccine candidate.


The new NIAID contract is intended to
fund animal studies, Phase II clinical trials, the scale up and validation of the vaccine
manufacturing process and production of 3 million doses of finished product. The
vaccines efficacy will be determined through animal testing, based on the FDAs two-animal rule model, instead of large Phase III studies
in humans.


VaxGen plans to manufacture the
protein antigen used in rPA102 in VCIs manufacturing facility in South San Francisco,
Calif. VaxGen believes the facility, as currently equipped, has the capacity to produce
approximately 100 million doses of rPA102 bulk vaccine per year. Filling, packaging and
labeling of the vaccine will be done at contract manufacturing sites.


The contract has been funded in whole
with Federal funds from the National Institute of Allergy and Infectious Diseases,
National Institutes of Health, under Contract No. N01-AI-30053.


37
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|ITEM 6. EXHIBITS AND
REPORTS ON FORM 8-K


(a)    
Exhibits required by Item 601 of Regulation S-K:


The following exhibits are filed as
part of this report:
|--------------------------------------------------------------------------------------------------------------------------------------------------------------

|       |  |                                                 | Incorporated by Reference |    
|------ |  | ----------------------------------------------- | ------------------------- | ---
|
|3.1    |  | Amended and Restated Certificate of             |                           | S-8
|       |  | Incorporation.                                  |                          
|       |  |                                                 |                           |    
|3.2    |  | Amendment to the Amended and                    |                           | S-8
|       |  | Restated Certificate of Incorporation.          |                          
|       |  |                                                 |                           |    
|3.3    |  | Amended and Restated Bylaws                     |                           | S-1
|       |  |                                                 |                           |    
|4.1    |  | Reference is made to Exhibits 3.1, 3.2 and 3.3. |                          
|       |  |                                                 |                           |    
|4.2    |  | Certificate of Designations, Rights             |                           | S-8
|       |  | and Preferences of Series A 6% Cumulative       |                          
|       |  | Convertible Preferred Stock.                    |                          
|       |  |                                                 |                           |    
|4.3    |  | Securities Purchase Agreement by                |                           | 8-K
|       |  | and among Registrant and Certain                |                          
|       |  | Stockholders.                                   |                          
|       |  |                                                 |                           |    
|4.4    |  | Registrant Rights Agreement by and              |                           | 8-K
|       |  | among Registrant and Certain                    |                          
|       |  | Stockholders.                                   |                          
|       |  |                                                 |                           |    
|4.5    |  | Form of Common Stock Purchase                   |                           | 8-K
|       |  | Warrant.                                        |                          
|       |  |                                                 |                           |    
|10.47* |  | Contract between VaxGen and the National        |                          
|       |  | Institute of Allergy and Infectious             |                          
|       |  | Diseases, National Institues of Health,         |                          
|       |  | Under Contract No. N01-AI-30053                 |                          
|       |  | dated September 30, 2003                        |                           |    
|       |  |                                                 |                           |    
|31.1   |  | Certification Required by Rule 13a-14(a)        |                           |    
|       |  | or Rule 15d-14(a)                               |                          
|       |  |                                                 |                           |    
|31.2   |  | Certification Required by Rule 13a-14(a) or     |                           |    
|       |  | Rule 15d-14(a)                                  |                          
|       |  |                                                 |                           |    
|32.1   |  | Certifications Required by Rule 13a-14(b)       |                           |    
|       |  | or Rule 15d-14(b) and Section 1350 of           |                          
|       |  | Chapter 63 of Title 18 of the United States     |                          
|       |  | Code (18 U.S.C. 1350)                           |                          

|*Confidential treatment
requested. The redacted portions have been separately filed with the SEC as required by
Rule 406 of Regulation C.


38
|----------------------------------------------------------------------------------------------------------------------------------------------

|The certifications attached as
Exhibit 32.1 accompany this Quarterly Report on Form 10-Q are not deemed filed with the
Securities and Exchange Commission and are not to be incorporated by reference into any of
the Registrants filings under the Securities Act of 1933 or the Securities Exchange Act of
1934, whether made before or after the date of the Form 10-Q, irrespective of any general
incorporation language contained in such filing.


(b)    Reports on Form 8-K:


A current report on Form 8-K, dated
July 7, 2003, was filed with the Securities and Exchange Commission, reporting under Item
5 that we had announced that the Company intended to complete its Phase III trial in
Thailand.


A current report on Form 8-K, dated
July 22 2003, was filed with the Securities and Exchange Commission, reporting under Item
5 the results of matters presented at the Companys annual meeting held on July 18,
2003.


A current report on Form 8-K, dated
August 5, 2003, was filed with the Securities and Exchange Commission, reporting under
Item 12 the press release announcing the Companys second quarter ended June 30, 2003
financial results.


A current report on Form 8-K, dated
September 4, 2003, was filed with the Securities and Exchange Commission, reporting under
Item 5 that the Company had signed a binding letter of intent with the Health Protection
Agency for England and Wales to negotiate terms under which VaxGen would license U.K.
rights to, and transfer technology for, its recombinant anthrax vaccine candidate.


39
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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 thereunto duly authorized.
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                         |  | VaxGen, Inc.                                                                                                    
|------------------------ |  | ----------------------------------------------------------------------------------------------------------------
|Dated: November 19, 2003 |  | By: /s/ Carter A. Lee Carter A. Lee
Senior Vice President
Finance & Administration
(Principal Financial Officer)

|40
|--