UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549


                                    FORM 10-Q

 (Mark One)

[X]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
     SECURITIES EXCHANGE ACT OF 1934

                  For the Quarterly Period Ended June 30, 2001

                                       OR

[_]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
     SECURITIES EXCHANGE 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 200
                           Brisbane, 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 [ ]

The issuer has one class of common stock with 14,177,605  shares  outstanding as
of July 31, 2001.


<PAGE>

                                  VaxGen, Inc.

                                    Form 10-Q

                       For the Quarter Ended June 30, 2001

                                Table of Contents


Part I.  Financial Information                                              Page

Item 1.  Financial Statements:
          Condensed Balance Sheets......................................       1
          Condensed Statements of Operations............................       2
          Condensed Statements of Cash Flows............................       3
          Notes to Condensed Financial Statements.......................       4

Item 2.  Management's Discussion and Analysis of Financial Condition
         and Results of Operations:
          Overview......................................................       9
          Results of Operations.........................................      11
          Liquidity and Capital Resources...............................      13
          Risk Factors..................................................      16

Item 3.  Quantitative and Qualitative Disclosure about Market Risk......      27

Part II. Other Information

Item 2.  Changes in Securities and Use of Proceeds......................      28
Item 4.  Submission of Matters to a Vote of Security Holders............      29
Item 6.  Exhibits and Reports on Form 8-K...............................      30
         Signature......................................................      31


<PAGE>

                          PART I - FINANCIAL INFORMATION


                                   VaxGen, Inc.
                         (A Development Stage Enterprise)

                                  BALANCE SHEETS
                                   (Unaudited)
Item 1. Financial Statements

                                      ASSETS

<TABLE>
<CAPTION>
                                                           June 30,       December 31,
                                                             2001            2000
                                                        -------------    -------------
<S>                                                     <C>              <C>
Current assets:
Cash and cash equivalents                               $  13,284,000    $   5,426,000
Investment securities                                      43,979,000       43,098,000
Interest receivable                                           676,000          733,000
Prepaid expenses and other current assets                   2,265,000        4,114,000
                                                        -------------    -------------
Total current assets                                       60,204,000       53,371,000

Property and equipment, net                                 2,937,000        3,202,000
Other assets                                                  125,000          224,000
                                                        -------------    -------------

Total assets                                            $  63,266,000    $  56,797,000
                                                        =============    =============

<CAPTION>
                       LIABILITIES AND STOCKHOLDERS' EQUITY
<S>                                                     <C>              <C>
Current liabilities:
Payable to Genentech                                    $     337,000    $   2,071,000
Accounts payable                                              149,000          315,000
Accrued liabilities                                         2,825,000        2,941,000
Dividends payable                                             127,000             --
Current portion of long-term obligations                       31,000           31,000
                                                        -------------    -------------
Total current liabilities                                   3,469,000        5,358,000

Long-term obligations                                         195,000          367,000

Commitments and contingencies

Redeemable convertible preferred stock, $0.01
par value, 20,500 shares authorized:

     Series A 6% cumulative convertible stock, $0.01
     par value, 20,000 shares issued and outstanding
     at June 30, 2001                                      15,040,000             --

Stockholders' equity:
Preferred stock, $0.01 par value, 20,000,000 shares
  authorized; none issued or outstanding                         --               --
Common stock, $0.01 par value, 40,000,000 shares
  authorized; 14,170,105 and 14,045,656 shares issued
  and outstanding at June 30, 2001 and
  December 31, 2000, respectively                             141,000          140,000
Additional paid-in capital                                126,150,000      121,717,000
Deferred stock compensation                                (1,028,000)      (1,667,000)
Accumulated other comprehensive income -
  unrealized gain on investment securities                    556,000          354,000
Deficit accumulated during the development stage          (81,257,000)     (69,472,000)
                                                        -------------    -------------
Total stockholders' equity                                 44,562,000       51,072,000

                                                        -------------    -------------

Total liabilities and stockholders' equity              $  63,266,000    $  56,797,000
                                                        =============    =============
</TABLE>



            See accompanying notes to condensed financial statements.


                                       1

<PAGE>

                                  VaxGen, Inc.
                        (A Development Stage Enterprise)
                            STATEMENTS OF OPERATIONS
                                   (Unaudited)

<TABLE>
<CAPTION>
                                                                                                                     Period from
                                                          Three Months Ended                Six Months Ended          Inception
                                                               June 30,                        June 30,          (November 27, 1995)
                                                      ---------------------------   ----------------------------       through
                                                         2001            2000           2001            2000        June 30, 2001
                                                      -----------    ------------   ------------    ------------     ------------
<S>                                                   <C>            <C>            <C>             <C>              <C>
Revenue:

Contract revenue                                      $   346,000    $       --     $    421,000    $       --       $    696,000

Operating expenses:

Research and development:
Genentech charges                                         107,000         410,000        502,000         660,000        9,858,000
Other                                                   3,634,000       4,394,000      7,748,000       8,196,000       46,571,000
                                                      -----------    ------------   ------------    ------------     ------------
Total research and development                          3,741,000       4,804,000      8,250,000       8,856,000       56,429,000

General and administrative expenses                     3,375,000       1,771,000      5,717,000       3,365,000       35,204,000
                                                      -----------    ------------   ------------    ------------     ------------

Loss from operations                                   (6,770,000)     (6,575,000)   (13,546,000)    (12,221,000)     (90,937,000)

Other income (expense) :
Investment income, net                                    923,000       1,007,000      1,775,000       2,041,000        9,763,000
Interest expense                                           (7,000)         (2,000)       (14,000)         (6,000)         (83,000)
                                                      -----------    ------------   ------------    ------------     ------------
Total other income, net                                   916,000       1,005,000      1,761,000       2,035,000        9,680,000

Net loss                                               (5,854,000)     (5,570,000)   (11,785,000)    (10,186,000)     (81,257,000)
                                                      ===========    ============   ============    ============     ============

Charges attributed to convertible preferred stock:
     Dividends                                           (127,000)           --         (127,000)           --
     Accretion of redemption value                       (142,000)                      (142,000)
     Beneficial conversion charge                        (734,000)           --         (734,000)           --
                                                      -----------    ------------   ------------    ------------
Net loss applicable to common shareholders            $(6,857,000)   $ (5,570,000)  $(12,788,000)   $(10,186,000)
                                                      ===========    ============   ============    ============

Net loss per share applicable to common
     shareholders, basic and diluted                  $     (0.49)   $      (0.41)  $      (0.91)   $      (0.75)

Weighted average shares used in computing basic
and diluted loss per share                             14,100,000      13,564,000     14,081,000      13,552,000
                                                      ===========    ============   ============    ============
</TABLE>


            See accompanying notes to condensed financial statements.


                                        2
<PAGE>

                                  VaxGen, Inc.
                        (A Development Stage Enterprise)
                            STATEMENTS OF CASH FLOWS
                                   (Unaudited)


<TABLE>
<CAPTION>
                                                                                                                     Period from
                                                                                            Six Months Ended          Inception
                                                                                                June 30,          November 27, 1995)
                                                                                      ---------------------------      through
                                                                                          2001           2000       June 30, 2001
                                                                                      ------------   ------------   -------------
<S>                                                                                   <C>            <C>           <C>
Cash flows from operating activities:

Net loss                                                                              $(11,785,000)  $(10,186,000) $ (81,257,000)

Adjustments to reconcile net loss to net cash used in operating activities:
  Depreciation and amortization                                                            452,000        363,000      1,819,000
  Amortization of premiums and discounts on investment securities                           14,000        143,000       (505,000)
  Stock compensation expense                                                               868,000        449,000     14,158,000
  Warrants issued to consultants                                                           114,000           --          114,000
  Changes in assets and liabilities:
    Interest receivable                                                                     57,000       (284,000)      (676,000)
    Prepaid expenses and other current assets                                            1,849,000       (145,000)    (2,265,000)
    Other assets                                                                            99,000          1,000        (14,000)
    Payable to Genentech                                                                (1,734,000)      (767,000)       337,000
    Accounts payable, accrued liabilities and other long-term obligations                 (510,000)      (223,000)     3,058,000
                                                                                      ------------   ------------  -------------

Net cash used in operating activities                                                  (10,576,000)   (10,649,000)   (65,231,000)
                                                                                      ------------   ------------  -------------
Cash flows from investing activities:

Purchase of investment securities                                                      (16,152,000)   (11,512,000)  (156,599,000)
Proceeds form sale and maturities of investment securities                              15,459,000     24,041,000    113,681,000
Purchase of property and equipment                                                        (187,000)      (590,000)    (4,609,000)
Long-term lease deposits                                                                      --             --         (120,000)
                                                                                      ------------   ------------  -------------

Net cash provided by (used in) investing activities                                       (880,000)    11,939,000    (47,647,000)
                                                                                      ------------   ------------  -------------


Cash flows from financing activities:

Payments under capital lease obligations                                                   (16,000)       (12,000)       (68,000)
Proceeds from issuance of preferred stock                                               18,406,000           --       18,406,000
Stock issued to Genentech                                                                     --             --        1,025,000
Stock issued to other founders                                                                --             --           20,000
Stock issued in private placements                                                            --             --       65,164,000
Stock issued in initial public offering                                                       --             --       46,345,000
Issuance costs of private placements                                                          --             --       (4,208,000)
Issuance costs of initial public offering                                                     --             --       (4,386,000)
Exercise of employee stock options                                                         924,000        692,000      2,864,000
Loans from Genentech                                                                          --             --        1,000,000
                                                                                      ------------   ------------  -------------

Net cash provided by financing activities                                               19,314,000        680,000    126,162,000
                                                                                      ------------   ------------  -------------


Increase in cash and cash equivalents                                                    7,858,000      1,970,000     13,284,000

Cash and cash equivalents at beginning of period                                         5,426,000     16,063,000           --
                                                                                      ------------   ------------  -------------


Cash and cash equivalents at end of period                                            $ 13,284,000   $ 18,033,000  $  13,284,000
                                                                                      ============   ============  =============


Supplemental schedule of non cash investing and financing activities:

Dividends payable to redeemable convertible preferred stockholders                    $    127,000   $       --    $     127,000
Accretion of redemption value of redeemable convertible preferred stock                    142,000           --          142,000
Recognition of beneficial conversion feature of redeemable convertible preferred stock     734,000           --          734,000
Equipment acquired through capital leases                                                     --             --          138,000
Issuance of common stock through conversion of Genentech note payable                         --             --        1,000,000
</TABLE>


            See accompanying notes to condensed financial statements.

                                        3
<PAGE>

                                  VaxGen, Inc.
                        (A Development Stage Enterprise)

                     Notes to Condensed Financial Statements
                                  June 30, 2001
                                   (Unaudited)


1.   Basis of Presentation

The unaudited  condensed  financial  statements of VaxGen,  Inc. (the "Company")
included  herein have been  prepared  by the  Company  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 the  management  of the Company,  the  accompanying  unaudited
condensed  financial  statements  contain all  adjustments,  consisting  only of
normal  recurring  adjustments,   necessary  to  present  fairly  the  financial
information included herein. While the Company believes that the disclosures are
adequate to make the  information  not  misleading,  it is suggested  that these
financial  statements  should be read in conjunction with the Company's  audited
financial  statements  contained in its Annual  Report on Form 10-K for the year
ended December 31, 2000.

2.   Non-Cash Compensation

On April 1, 1999, the  stockholders  of the Company  approved an increase in the
number of shares  reserved for grant under the Company's  1996 Stock Option Plan
to 1,750,000  shares.  This  represents the  measurement  date for stock options
granted to employees  earlier in 1999 and in 1998, which were granted subject to
stockholder  approval of the plan amendment.  As a result,  the Company recorded
deferred  compensation in the amount of $3,223,000,  representing  the excess of
fair market value of the common shares on April 1, 1999,  $13.00 per share, over
the exercise price of the options on the date stockholder approval was obtained.
The Company has recorded  charges to non-cash  compensation  expense of $379,000
for the portion of the vesting  period  lapsed for the six months ended June 30,
2001. The balance of deferred  compensation  is being  amortized to expense over
the remaining vesting period of the options. Total non-cash compensation for the
six months  ended June 30, 2001 was  $868,000  as  compared to $449,000  for the
comparable period in 2000.

3.   Loss per Share

Basic loss per share is computed as net loss  applicable to common  stockholders
divided by the weighted  average  number of common  shares  outstanding  for the
period.  Diluted loss per share reflects the potential dilution that could occur
from  common  shares to be issued  through  stock  options,  warrants  and other
convertible securities. The potential



                                       4
<PAGE>

                                  VaxGen, Inc.
                        (A Development Stage Enterprise)

               Notes to Condensed Financial Statements (continued)
                                  June 30, 2001
                                   (Unaudited)


dilutive  effects of  1,758,082  shares of common stock  subject to  outstanding
stock options,  714,265  shares of common stock subject to outstanding  warrants
and 861,383  shares of common  stock  reserved  for  conversion  of the Series A
Preferred Stock are excluded from the diluted earnings per share calculation for
the period ended June 30, 2001, and 1,467,589  shares of common stock subject to
outstanding  stock  options  and  494,613  shares of  common  stock  subject  to
outstanding  warrants are excluded  from the diluted  earnings per share for the
period ended June 30, 2000, because the representative share increments would be
antidilutive.


4.   New Accounting Pronouncements

In June 1998, the Financial  Accounting  Standards Board (FASB) issued SFAS 133,
"Accounting  for  Derivative  Instruments  and  Hedging  Activities".  SFAS  133
establishes  accounting  and  reporting  standards for  derivative  instruments,
including derivative  instruments  embedded in other contracts,  and for hedging
activities.  SFAS 133,  as  amended  by SFAS 138,  is  effective  for all fiscal
quarters of fiscal years beginning after June 15, 2000. The adoption of SFAS 133
on  January  1,  2001  did  not  have  any  impact  on the  Company's  financial
statements.


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 6%
Cumulative  Convertible  Preferred Stock ("Preferred Stock") and the issuance of
Common  Stock  Purchase  Warrants  described  below.  Expenses  relating  to the
transaction  were  approximately  $1,600,000,   resulting  in  net  proceeds  of
approximately $18,400,000.  These proceeds will be used to prepare the Company's
HIV/AIDS vaccine, AIDSVAX(R) ("AIDSVAX"), for commercial-scale  manufacturing if
it proves  effective,  the  potential  development  of new adjuvants and general
corporate purposes.




                                       5
<PAGE>

                                  VaxGen, Inc.
                        (A Development Stage Enterprise)

               Notes to Condensed Financial Statements (continued)
                                  June 30, 2001
                                   (Unaudited)


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

Conversion

Each share of  Preferred  Stock can be  converted at the option of the holder at
any time after issuance  according to a conversion ratio,  subject to adjustment
for dilution or certain  equity  adjustments.  The initial  conversion  ratio is
determined  by dividing  the  liquidation  value  ($1,000 per share plus accrued
dividends) by the original  conversion  price of $23.2185 then multiplied by the
number of shares to be converted.  The Company may also force  conversion of the
Preferred  Stock into  common  stock,  if, at any time after May 23,  2002,  the
weighted  average  price  of  the  Company's  stock  for at  least  20 out of 30
consecutive trading days equals or exceeds 175% of the conversion price (175% of
$23.2185 or $40.63).

Redemption

In the event that there is no earlier  conversion,  the Company  must 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.  There is also a provision for
an early  redemption of the Preferred  Stock. An early redemption would occur if
the November 2001 interim analysis results in anything other than (i) permission
to terminate the trial and apply for regulatory approval,  or (ii) permission to
proceed to the  scheduled  endpoint  of the trial at the end of 2002,  or if the
interim  analysis is not  completed  by December 31, 2001 or the Data and Safety
Monitoring  Board's  determination  is not announced  prior to January 31, 2002.
Each holder of the Preferred  Stock may require the Company to redeem any or all
of such  holder's  Preferred  Stock as of a date six months  after the  negative
event at a redemption  price per preferred  share equal to $1,000 per share plus
all accrued and unpaid dividends. The Company may, within certain limits, pay up
to 50% of such redemption price in shares of the Company's common stock.

The  Company  accounts  for  the  difference  between  the  carrying  amount  of
redeemable  preferred stock and the redemption amount by increasing the carrying
amount for periodic  accretion using the interest  method,  so that the carrying
amount will equal the redemption amount at the scheduled redemption date.



                                       6
<PAGE>

                                  VaxGen, Inc.
                        (A Development Stage Enterprise)

               Notes to Condensed Financial Statements (continued)
                                  June 30, 2001
                                   (Unaudited)

Dividends

Each share of  Preferred  Stock is entitled to receive a 6% dividend  each year,
paid 3% on each June 30 and  December 31. If not paid within five days of either
such date, the dividend will accumulate and compound. The first dividend payment
date is  December  31,  2001.  On that date,  each share will be  entitled  to a
dividend of $37.00 per preferred share. Payment may be made in cash or in shares
of  common  stock  at the  Company's  option.  Net  loss  applicable  to  common
shareholders  for the  second  quarter of 2001  includes  a  non-cash  charge of
approximately $127,000 for Preferred Stock dividends.

Voting

Each share of Preferred  Stock has voting  rights equal to the common stock into
which it is convertible on the record date of the vote.

Liquidation

In the event of  liquidation,  dissolution or winding up of the Company,  either
voluntary  or  involuntary,  each  holder of shares of  Preferred  Stock will be
entitled to receive, out of the assets of the Company available for distribution
to stockholders and prior to any distribution to holders of common stock, $1,000
per preferred share plus accrued dividends.

Common Stock Purchase Warrants

In connection  with the Preferred  Stock  financing,  the Company  issued Common
Stock  Purchase  Warrants  ("Warrants")  for the  purchase of 297,177  shares of
common stock to the Preferred Stock investors. The warrants, which expire on May
23, 2006, have an exercise price of $25.2375 per share. However, effective as of
May 23, 2002,  the  exercise  price shall be  automatically  adjusted to a price
equal to the lesser of (a) the original  exercise  price of $25.2375 and (b) the
average of the closing bid prices for the  Company's  common stock on The Nasdaq
Stock Market(R) during the twenty consecutive trading days immediately preceding
May 23,  2002,  provided  that the  exercise  price  shall not be adjusted to an
amount less than $14.133.

The Company has valued the  warrants  at $11.80 per share  resulting  in a total
value of approximately $3,500,000.  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 additional  paid-in-capital.  The charge
is being amortized over five years,



                                       7
<PAGE>

                                  VaxGen, Inc.
                        (A Development Stage Enterprise)

               Notes to Condensed Financial Statements (continued)
                                  June 30, 2001
                                   (Unaudited)


and accordingly net loss to common  stockholders  for the second quarter of 2001
reflects  a  non-cash  charge of  approximately  $97,000.  The fair value of the
warrants was calculated using the Black-Scholes method.

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  an
in-substance  dividend to the preferred  stockholders,  which  increases the net
loss applicable to common stockholders.


                                       8
<PAGE>

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
financial  statements  and related  notes  thereto  appearing  in Item 1 of this
report.   In  addition  to   historical   information,   this  report   contains
"forward-looking  statements" that are within the safe harbor  provisions of the
Private  Securities  Litigation  Reform  Act of 1995,  and that are  subject  to
certain  risks and  uncertainties  that  could  cause  actual  results to differ
materially  from  those  projected.  The words  "believe",  "expect",  "intend",
"anticipate",  and  similar  expressions  are used to  identify  forward-looking
statements,  but  their  absence  does  not  mean  that  such  statement  is not
forward-looking. Factors that might cause such a difference include, but are not
limited  to,  uncertainties  related to the  progress,  costs and results of the
Company's Phase III clinical trials, the progress of other internal research and
development  projects,  the  establishment  of collaborative  arrangements  with
governmental agencies,  the availability of manufacturing  capacity, the receipt
of research grants and the timing of certain expenses.  Reference should be made
to VaxGen's  Annual  Report on Form 10-K for the year ended  December  31, 2000,
filed with the Securities and Exchange Commission, under the heading "Business,"
and  to  the  heading  "Risk  Factors"  included  herein,  for a  more  detailed
description  of such  factors.  These risk factors,  among  others,  could cause
results to differ  materially from those  presently  anticipated by the Company.
Readers  are  cautioned  not to place undue  reliance  on these  forward-looking
statements,  which  speak  only  as of the  date  of this  report.  The  Company
undertakes  no  obligation  to publicly  release the results of any revisions to
these  forward-looking  statements  that  may  be  made  to  reflect  events  or
circumstances  after the date of this  report or to reflect  the  occurrence  of
anticipated events.

Overview

In November 1995, VaxGen was formed to continue  development of AIDSVAX. At that
time, Genentech,  Inc. ("Genentech") licensed to us the technology necessary for
completing  development and commercialization of AIDSVAX.  Currently,  Genentech
owns approximately 11% of VaxGen common stock.

Since our formation,  we have focused on developing and testing AIDSVAX. We have
developed  formulations  of AIDSVAX that 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
commenced two Phase III clinical trials, one in North America and Europe and one
in Thailand to determine the efficacy of AIDSVAX.  In October 1999, we completed
the enrollment of over 5,400 trial  volunteers  for the North  American/European
Phase III clinical trial,  which is being conducted in 59 clinical  centers.  In
August 2000, we completed the  enrollment of over 2,500  volunteers for the Thai
Phase III clinical  trial,  which is being  conducted in 17 clinical  centers in
Bangkok.


                                       9
<PAGE>


To date,  we have  generated  $696,000 in revenue  from grants from the National
Institutes of Health ("NIH") for research and  development of HIV vaccines along
with funds received through a collaborative agreement with BBI Biotech, which is
funded by the National Institute of Allergy and Infectious  Diseases  ("NIAID"),
to obtain and store clinical  specimens from our North  American/European  Phase
III clinical trial.  We anticipate only modest revenues from other  governmental
agencies or other grants or from  collaborations  with other  entities  over the
next three to four years. We have incurred losses since inception as a result of
research and development and general and  administrative  expenses in support of
our  operations.  As of June 30, 2001, we had a deficit  accumulated  during the
development stage of $81,257,000.  We anticipate  incurring  substantial  losses
over at least the next three to four years as we complete our  clinical  trials,
apply for  regulatory  approvals,  continue  development  of our  technology and
expand our operations.

For  the  North  American/European  clinical  trial,  we  will  have  our  first
opportunity in November 2001 to find out how well AIDSVAX works.  If the results
of the interim analysis demonstrate 30% or greater efficacy,  at 97% confidence,
we believe that the Data and Safety Monitoring Board, the independent  committee
that oversees our trials, will recommend that we terminate the trial and proceed
with seeking  regulatory  approval for AIDSVAX.  A confidence level of 97% means
that if the clinical  trial were  repeated,  97 times out of 100 we would see at
least a 30% greater  reduction in HIV infections  among  volunteers who received
AIDSVAX  compared with volunteers who received a placebo.  To achieve this level
of statistical  significance at the interim  analysis,  the vaccine must have an
actual  efficacy rate of over 60%. This higher  required  efficacy  level at the
interim analysis is due to several  factors,  including the number of volunteers
ultimately retained in the study, the rate of HIV infection in the placebo group
and the length of time associated with the clinical  observation  period. If the
results of the interim  analysis were to  demonstrate  such  efficacy,  we would
begin the process of applying  for  regulatory  approval.  If the results of the
interim analysis are inconclusive,  we will proceed for another 12 months to the
scheduled  conclusion of the trial at the end of 2002. During this time, we will
gather  additional  information  that will improve our ability to determine  the
vaccine's effectiveness.  The confidence interval would drop to 95% at the final
analysis. An interim analysis for the Thai clinical trial is anticipated to take
place during the fourth quarter of 2002.

Our  strategy is to develop,  test and obtain  regulatory  approval  for various
formulations of AIDSVAX.  We intend to use Genentech  and/or other third parties
as our partners for  manufacturing  and  distribution.  Genentech  has exclusive
options to  manufacture  and market  AIDSVAX  products.  If  Genentech  does not
exercise its options, we have the right to pursue third party arrangements, with
Genentech  obligated  to  provide  the  transfer  of  technology  necessary  for
manufacturing the vaccine.


                                       10
<PAGE>

Results of Operations

Six months ended June 30, 2001 compared to the six months ended June 30, 2000

Contract Revenue

Contract  revenue  increased  to $421,000 for the six months ended June 30, 2001
from $0 for the six  months  ended June 30,  2000.  Contract  revenue  primarily
consisted of funds received as  reimbursements  under a collaborative  agreement
with BBI Biotech that is funded by NIAID.  Research  contract  revenue earned in
one period is not indicative of research contract revenue to be earned in future
periods.

Research and Development Expenses

Research and  development  expenses  decreased 7%, from  $8,856,000  for the six
months ended June 30, 2000 to $8,250,000 for the six months ended June 30, 2001.
The  decrease is due to a reduction  in  expenses  related to the ongoing  North
American/European  and Thai  clinical  trials  offset by an increase in expenses
associated  with  development  of  additional   AIDSVAX  vaccines  (see  further
discussion  in  "Liquidity  and Capital  Resources").  The reduction in clinical
trial expenses was due to fewer scheduled  volunteer visits  consistent with the
clinical trial protocol.  Research and  development  expenses for the six months
ended June 30, 2001 included costs for additional personnel along with operating
our research laboratory facility.

General and Administrative Expenses

General and  administrative  expenses increased 70%, from $3,365,000 for the six
months ended June 30, 2000 to $5,717,000 for the six months ended June 30, 2001.
The increase was  primarily  due to  additional  personnel  hired to support our
growing  infrastructure,  non-cash compensation expense related to an employment
matter and an increase in outside professional service fees.

Other Income, Net

Other income, net, consisting  primarily of investment income,  decreased by 13%
from $2,035,000 for the six months ended June 30, 2000 to $1,761,000 for the six
months ended June 30, 2001. This was primarily due to lower average  balances of
cash, cash equivalents and investment securities.


                                       11
<PAGE>


Three  months  ended June 30, 2001  compared to the three  months ended June 30,
2000

Contract Revenue

Contract revenue  increased to $346,000 for the three months ended June 30, 2001
from $0 for the three months ended June 30, 2000.  Contract revenue consisted of
funds  received  as  reimbursements  under a  collaborative  agreement  with BBI
Biotech that is funded by NIAID.  Research contract revenue earned in one period
is not indicative of research contract revenue to be earned in future periods.

Research and Development Expenses

Research and development  expenses  decreased 22%, from $4,804,000 for the three
months  ended June 30, 2000 to  $3,741,000  for the three  months ended June 30,
2001.  The  decrease  is due to a reduction  in expenses  related to the ongoing
North  American/European  and Thai  clinical  trials  offset by an  increase  in
expenses associated with development of additional AIDSVAX vaccines (see further
discussion  in  "Liquidity  and Capital  Resources").  The reduction in clinical
trial expenses was due to fewer scheduled  volunteer visits  consistent with the
clinical trial protocol.  Research and development expenses for the three months
ended June 30, 2001 included costs for additional personnel along with operating
our research laboratory facility.

General and Administrative Expenses

General and administrative expenses increased 91%, from $1,771,000 for the three
months  ended June 30, 2000 to  $3,375,000  for the three  months ended June 30,
2001.  The increase was primarily due to additional  personnel  hired to support
our  growing  infrastructure,   non-cash  compensation  expense  related  to  an
employment matter and an increase in outside professional service fees.

Other Income, Net

Other income,  net, consisting  primarily of investment income,  decreased by 9%
from  $1,005,000  for the three  months  ended June 30, 2000 to $916,000 for the
three  months  ended June 30,  2001.  This was  primarily  due to lower  average
balances of cash, cash equivalents and investment securities.


                                       12
<PAGE>


Liquidity and Capital Resources

Cash, cash  equivalents and investment  securities were  $57,263,000 at June 30,
2001. We have financed our operations since inception through private placements
of common stock and preferred  stock,  our initial public  offering  ("IPO") and
capital  provided by Genentech.  Genentech last funded VaxGen in 1997 and has no
obligation to provide future funding to the Company.

We completed our IPO in July 1999, in which we issued and sold 3,565,000  shares
of common stock for aggregate  proceeds to us in the amount of  $46,400,000.  Of
the aggregate proceeds received in the IPO, approximately $4,400,000 was used to
pay  costs  and  expenses  related  to the IPO,  resulting  in net  proceeds  of
approximately $42,000,000.

In December  1999,  we  completed a private  placement of common stock to Vulcan
Ventures, Inc., the investment organization of Paul G. Allen. The funds from the
private  placement  will support our ongoing  operations  along with our current
clinical  trials.  This  private  placement  has  also  enabled  us to  commence
development of a formulation  of AIDSVAX,  that focuses on the  predominant  HIV
type found in Sub-Saharan  Africa,  China,  India and South America (subtype C).
Currently,  we  have  developed  formulations  of  AIDSVAX  that  focus  on  the
predominant  HIV type in North  America,  Europe,  the  Caribbean  and Australia
(subtype  B) and the  predominant  HIV subtype in  Southeast  Asia and East Asia
(subtype E). The private placement  consisted of approximately  2,174,000 shares
of  common  stock,  which  resulted  in  proceeds,  net  of  expenses,  to us of
approximately $24,000,000.

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 Cumulative Convertible Preferred Stock ("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. In the event that
there is no earlier  conversion,  we must 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.  Expenses  relating to the transaction were  approximately
$1,600,000,  resulting in net proceeds of  $18,400,000.  These proceeds from the
preferred stock financing will be used to prepare our HIV/AIDS vaccine, AIDSVAX,
for  commercial-scale  manufacturing  if  it  proves  effective,  the  potential
development of new adjuvants and general corporate purposes.

In connection  with the 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,  have an exercise price of $25.2375
per share,  subject to a


                                       13
<PAGE>

one-time possible downward adjustment on May 23, 2002, but not below $14.133 per
share.

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  June  30,  2001,  our  gross
investment in equipment and leasehold improvements was $4,609,000.  The increase
in  equipment  and  leasehold   improvements  has  been  primarily  due  to  the
development of our research and development  laboratory and the establishment of
larger  office  facilities.  Net cash used in operating  activities  for the six
months  ended  June 30,  2001 was  $10,576,000,  representing  expenditures  for
research and development costs and general and administrative expenses.

In October 1999, we entered into a  collaboration  with the federal  Centers for
Disease  Control  and  Prevention  ("CDC") to support  research at six of the 54
clinics in the United States  currently  conducting Phase III clinical trials of
our AIDSVAX  vaccine.  The CDC selected  the six sites in the fourth  quarter of
1999. Contractual arrangements between the CDC and the clinics were completed in
the second quarter of 2000. The  participating  sites will continue to implement
our  Phase  III  protocol,  as  well  as  conduct  epidemiological,  social  and
behavioral research,  which will be shared by the Company and the CDC. The sites
will be compensated directly by the CDC for the clinical costs, which would have
been incurred by the Company,  and for conducting the additional  research.  The
CDC has agreed to contribute approximately $8,000,000 to the participating sites
over a four-year period.

On March 23,  2001,  we  finalized a  collaborative  agreement  with BBI Biotech
Research  Laboratories,  Inc.  ("BBI  Biotech"),  which is being  funded  by the
National  Institute  of Allergy and  Infectious  Diseases  ("NIAID"),  an agency
within the National Institutes of Health, to obtain and store clinical specimens
from our North  American/European Phase III clinical trial. The project is being
funded  under a contract,  which NIAID  awarded to BBI Biotech for seven  years.
Under a subcontract with BBI Biotech, we will receive approximately  $489,000 to
support the collection of human tissue and cell samples. We received $346,000 in
the second  quarter  ended June 30, 2001.  If AIDSVAX  proves  successful in our
Phase III clinical trials,  the samples will be used to determine if the vaccine
induced a cellular  immune  response in the  volunteers  who received the active
vaccine.

We  believe  that  our  existing  cash  and  cash   equivalents  and  investment
securities,  together  with  investment  income  along  with  funds  from  other
potential  collaborative  arrangements,  will  enable us to meet our  forecasted
expenditures through the anticipated  completion of our North  American/European
Phase III clinical  trial.  However,  we may need to raise  additional  funds to
complete the Thai Phase III clinical trial and we would need to raise additional
funds to support the  necessary  manufacturing  and  development  programs if we
apply for regulatory approval of the vaccine.


                                       14
<PAGE>


We will also need to raise  additional  capital if the Phase III clinical trials
are delayed or more costly than currently anticipated, or to continue operations
if the Phase III clinical trials are not successful,  or if commercialization is
delayed for any other reason. Our future capital requirements are also dependent
on several other factors, including:

     o    the progress of other internal research and development projects;

     o    the need for leasehold  improvements to facilities and the purchase of
          additional capital equipment;

     o    the   ability   to  attract   and   negotiate   business   development
          opportunities; and

     o    the timing of revenue, if any, from AIDSVAX.

We cannot  assure you that we will be able to raise funds when  needed,  or that
such funds will be available on  satisfactory  terms,  or at all. We expect that
our ability to raise  additional  capital  will be  affected by whether  AIDSVAX
achieves clinical success at either the interim or final analysis.  However,  if
clinical  success is  achieved  at either  point of  analysis,  we do not expect
difficulty in raising additional capital.


                                       15
<PAGE>

                                  Risk Factors

                         Risks Relating to Our Business

If we are unable to commercialize our sole product candidate,  AIDSVAX,  we will
not have revenues to continue operations.

AIDSVAX is our only  product  candidate.  We do not know  whether the current or
planned  formulations  of AIDSVAX will be effective in preventing HIV infection.
The overall  scientific  knowledge of HIV is limited.  Although our research has
indicated  that  AIDSVAX  contains a protein  that is critical in the  infection
process,  other  proteins  and elements may be necessary to develop an effective
vaccine.

Our success will depend  entirely on the success of AIDSVAX.  In particular,  we
must be able to:

     o    establish  the  safety,  purity,  potency  and  efficacy of AIDSVAX in
          humans;

     o    obtain  regulatory  approvals  for  AIDSVAX,  including a  preapproval
          inspection of a manufacturing facility; and

     o    successfully     commercialize     AIDSVAX    through    collaborative
          relationships.

If we are unable to  commercialize  AIDSVAX,  we do not have other products from
which to derive revenue.

We may not be able to obtain regulatory approval to market AIDSVAX in the United
States or abroad on a timely basis, or at all.

Clinical testing is a long,  expensive and uncertain  process.  We cannot assure
you that the data  collected  from our  clinical  trials will be  sufficient  to
support  approval of AIDSVAX by the FDA or any foreign  regulatory  authorities,
that the clinical  trials will be completed on schedule or, even if the clinical
trials are successfully  completed and on schedule,  that the FDA or any foreign
regulatory authorities will ultimately approve AIDSVAX for commercial sale.

To gain  regulatory  approval for the sale of AIDSVAX in the United  States,  we
believe,  based on  discussions  with the FDA and the  vote of its  Vaccine  and
Related  Biological  Products  Advisory  Committee,  that  the  requirement  for
regulatory  approval  will be a 30%  greater  reduction  in HIV  infections,  at
statistical  significance,  among  volunteers who received AIDSVAX compared with
volunteers who received a placebo. These discussions and the vote of the Vaccine
and Related Biological Products Advisory Committee,  however, are not binding on
the FDA. In the context of our North


                                       16
<PAGE>

American/European  clinical  trial,  which  represents a small sampling from the
entire population,  this means that to establish 30% efficacy at a statistically
significant  level  there  must be an  actual  efficacy  rate of over 60% at the
interim  analysis,  meaning that the trial results would need to  demonstrate at
least a 60% greater  reduction  in HIV  infections  among  volunteers  receiving
AIDSVAX  compared  with the  placebo  group.  We  anticipate  that the  efficacy
required to obtain  regulatory  approval to market AIDSVAX in foreign  countries
will vary from one  country to another  and may differ  significantly  from that
required by the FDA. We cannot assure you that the data collected from our North
American/European  or Thai clinical  studies will demonstrate the required level
of efficacy to permit the  commercialization of AIDSVAX in the Unites States, in
Thailand or in any other foreign country.

Delay in completing our clinical  trials could  jeopardize our ability to obtain
regulatory approval to market AIDSVAX in the United States or abroad on a timely
basis.

Our clinical trials could be delayed for a variety of reasons, including:

     o    lower-than-anticipated retention rate of volunteers in the trial;

     o    serious adverse events related to the vaccine; or

     o    different  interpretations of our preclinical and clinical data, which
          can lead initially to inconclusive results.

Our  inability  to  complete  our  clinical  trials  in a  timely  manner  could
jeopardize our ability to obtain domestic or foreign regulatory approval.

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

AIDSVAX is subject to extensive  government  regulations related to development,
clinical trials,  manufacturing and commercialization.  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.  It also  subjects  us to the  following  risks and  obligations,  among
others.

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

     o    The FDA or foreign  regulators  may  require  additional  testing  for
          safety and efficacy.


                                       17
<PAGE>

     o    If  regulatory  approval of a product is granted,  the approval may be
          limited  to  specific  indications  or  limited  with  respect  to its
          distribution;  for example,  the FDA may approve the licenses for only
          high-risk populations.

     o    The  FDA  or  foreign   regulators   may  not   approve   the  AIDSVAX
          manufacturing  processes or manufacturing  facilities,  or may require
          additional  clinical  studies  to  establish  the  safety,  purity and
          potency of AIDSVAX.

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

     o    If  regulatory  approval of the vaccine is granted,  the  marketing of
          AIDSVAX would be subject to adverse event reporting  requirements  and
          the  FDA's  general   prohibition   against  promoting   products  for
          unapproved or "off-label" uses.

     o    We will  be  subject  to  continual  regulatory  review  and  periodic
          inspection  and  approval of  manufacturing  modifications,  including
          compliance with the FDA's Good Manufacturing Practices regulations.

In addition, the FDA stringently applies regulatory standards for manufacturing.
Failure to comply with any of these post-approval  requirements can, among other
things,  have resulted in warning letters,  product  seizures,  recalls,  fines,
injunctions,   suspensions  or  revocations  of  marketing  licenses,  operating
restrictions and criminal prosecutions.

There can be no  assurance  that we will avoid  incurring  significant  costs to
comply  with  such  laws and  regulations  in the  future,  or that such laws or
regulations will not have a material adverse effect on us.

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.  At June 30, 2001, we had an accumulated deficit of approximately $81.3
million.  We sustained net losses of  approximately  $2.1 million in 1996,  $3.1
million in 1997, $9.2 million in 1998,  $23.3 million in 1999,  $31.8 million in
2000 and $11.8  million  for the six months  ended June 30,  2001.  We expect to
incur substantial losses for at least an additional three to four years.

If we need  additional  funds,  and are unable to raise  them,  we would have to
curtail or cease operations.

We cannot be certain  that our existing  capital  resources,  together  with the
funding from the Centers for Disease Control and Prevention and the funding from
the National Institute of Allergy and Infectious Diseases, will be sufficient to
support our current and planned operations through commercialization of AIDSVAX.
We do not expect


                                       18
<PAGE>


AIDSVAX to be commercially  available until at least the fourth quarter of 2004.
If taken to completion,  the North American/European Phase III clinical trial is
anticipated  to be  completed in the fourth  quarter of 2002.  Once the trial is
completed,  we will need to analyze  the data and,  if  favorable,  prepare  our
Biologics  License  Application for submission to the FDA, which typically takes
between six and 12 months to be accomplished.  The FDA review process could take
at least an additional six months. We anticipate that it would take at least six
months after obtaining  regulatory approval for Genentech or another third party
to begin commercialization of AIDSVAX.

     We may need to raise additional funds if:

     o    AIDSVAX is not sufficiently  safe, pure and potent to commercialize in
          its current formulation;

     o    our Phase III clinical  trials are delayed,  are not successful or are
          more costly than currently estimated;

     o    commercialization   of  AIDSVAX  is  delayed  for  any  other  reason,
          including  the need to locate a  third-party  manufacturer  other than
          Genentech;

     o    we need to manufacture AIDSVAX ourselves using our own facilities; or

     o    additional trials are required.

We  cannot  assure  you  that we will be able to raise  sufficient  funds in the
future.  If we fail to raise sufficient funds, we would have to curtail or cease
operations.  We  believe  that  our  existing  cash  and  cash  equivalents  and
investment   securities,   together  with  investment   income  and  funds  from
collaborative  arrangements,  will enable us to meet our forecasted expenditures
through the  anticipated  completion  of our North  American/European  Phase III
clinical trial.  However,  we may need to raise additional funds to complete the
Thai Phase III  clinical  trial,  and we may need to raise  additional  funds to
support the necessary  manufacturing and development programs required to obtain
regulatory approval.

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

The goal of developing an HIV vaccine is an area of interest to competitors, and
several companies with substantially  greater financial,  personnel and research
and  development  resources  than ours have  announced  that they are  trying to
develop an HIV vaccine and are planning, conducting or have completed Phase I or
Phase II clinical  trials.  Although  our research  has  indicated  that AIDSVAX
contains a protein that is critical in the infection process, other proteins and
elements may be necessary  to develop an effective  vaccine,  and several of our
competitors are working to develop vaccines that activate a different arm of the
immune system. In addition,  several of these companies are developing new "drug
cocktails"  and other  treatments  that may  mitigate the impact of the


                                       19
<PAGE>

disease. Even if we complete our Phase III clinical trials, obtain FDA and other
required  regulatory  approvals and commercialize  AIDSVAX,  our competitors may
develop vaccines or treatments that are as or more effective, or less complex or
less expensive to produce, than AIDSVAX.

Adverse publicity regarding the safety or side effects of AIDSVAX could harm our
business and cause our stock price to fall.

Despite the  favorable  safety  tests that have been  completed  with respect to
AIDSVAX and our clinical  trials,  there still may be potential  side effects or
safety  concerns  that  have  not yet come to  light.  If our  studies  or other
researchers'  studies were to raise or substantiate  concerns over the safety or
side effects of AIDSVAX or vaccine development efforts generally, our reputation
and public support for our clinical trials could be harmed, which would harm our
business and could cause our stock price to fall.

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

We  are  highly  dependent  on  our  senior  management  and  scientific  staff,
particularly  Donald Francis,  M.D.,  D.Sc., our President,  and Phillip Berman,
Ph.D., our Senior Vice President, Research & Development. These individuals have
played  a  critical  role in  raising  financing,  developing  the  vaccine  and
conducting  clinical  trials.  Dr.  Francis is currently  serving as our interim
chief  executive  officer  while we  conduct  a  search  for a  permanent  chief
executive  officer.  The loss of the  services  of any of these key  members  of
senior  management  and  scientific  staff or our  inability to hire a permanent
chief executive officer, may prevent us from achieving our business objectives.

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 the  intellectual  property rights of others,  we may be prevented from
developing or marketing AIDSVAX.

We rely on patent and other  intellectual  property  protection  to prevent  our
competitors from manufacturing and marketing AIDSVAX. Our technology,  including
technology  licensed from Genentech,  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. As a result, our success depends on our
ability, and Genentech's ability, to:

     o    obtain patents;

     o    protect trade secrets;

     o    operate without infringing upon the proprietary rights of others; and

     o    prevent others from infringing on our proprietary rights.


                                       20
<PAGE>

We cannot be certain that our patents or patents that we license from  Genentech
will be enforceable and afford protection against competitors.  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.

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

We face an inherent  risk of exposure to product  liability  suits in connection
with AIDSVAX  vaccines being tested in human  clinical  trials and products that
may be sold  commercially.  We may become subject to a product liability suit if
AIDSVAX causes injury, or if vaccinated individuals subsequently become infected
with HIV. Regardless of merit or eventual outcome,  product liability claims may
result in decreased demand for a vaccine,  injury to our reputation,  withdrawal
of clinical trial volunteers and loss of revenues.

Political  or social  factors  may  delay or  reduce  revenues  by  delaying  or
impairing our ability to market AIDSVAX.

Products  developed for use in addressing  the HIV/AIDS  epidemic have been, and
will  continue to be,  subject to competing  and changing  political  and social
pressures.  The political and social response to the HIV/AIDS  epidemic has been
highly  charged and  unpredictable.  Political or social  pressures may delay or
cause  resistance  to  bringing  our  product to market or limit  pricing of our
product.

                Risks Relating to Our Relationship with Genentech

We  rely  on  Genentech  for  the  manufacture  of  AIDSVAX.  Our  inability  to
manufacture  AIDSVAX,  and our dependence on Genentech,  may delay or impair our
ability to generate revenues, or adversely affect our profitability.

We have no manufacturing  facilities. We are entirely dependent on third parties
to produce  AIDSVAX.  To date,  we have relied on  Genentech  for this  purpose.
Genentech currently has an exclusive option to manufacture  AIDSVAX. Our license
agreement  with  Genentech does not specify the price we will be required to pay
Genentech  to  manufacture  AIDSVAX.  Genentech is not able to assure us that it
will  have  adequate  manufacturing  capacity  to  produce  AIDSVAX  for us on a
commercial scale.

We are working with Genentech to investigate alternative means of addressing our
potential  future  manufacturing  needs.  Our  efforts to  identify  alternative
manufacturing solutions will require us to address the following risks.

     o    We  may  be  unable  to  locate  another   manufacturer   because  the
          availability  and  capacity  of  manufacturing  facilities  capable of
          producing  biological  drug  products


                                       21
<PAGE>

          using  mammalian cell culture  fermentation in large scale is in short
          supply and high demand on a worldwide basis.

     o    Any third-party  manufacturer would have to prove to us, Genentech and
          the FDA, and to other regulatory  authorities,  that its manufacturing
          processes,   facilities,   procedures,   and  personnel   comply  with
          government  regulations and that it could consistently produce AIDSVAX
          in accordance with regulatory standards.

     o    If we use a third-party  manufacturer,  or if we alter the formulation
          of AIDSVAX,  we may have to conduct additional clinical trials to show
          the  therapeutic  equivalence of the product made by the other company
          to the Genentech product.

     o    We may be  unable  to  enter  into a  manufacturing  agreement  with a
          third-party on reasonable terms, if at all.

     o    We have no way to  determine  the  price  we  would  be  charged  by a
          third-party to manufacture AIDSVAX.

     o    If we are unable to locate a suitable third-party manufacturer, we may
          need to  manufacture  AIDSVAX  ourselves  or through a joint  venture,
          which, if even possible, could require significant capital investment.

The cost and time to establish  or locate  manufacturing  facilities  to produce
AIDSVAX,  other than  through  Genentech  would be  substantial  and could delay
bringing  AIDSVAX to market.  This delay  could  require us to raise  additional
funds, may delay or impair our ability to generate  revenues or adversely affect
our profitability.

We  intend  to rely on  Genentech  and/or  other  third  parties  for the  sale,
marketing  and  commercialization  of AIDSVAX.  Our lack of sales and  marketing
personnel  and  distribution  relationships  may impair our  ability to generate
revenues.

We have no sales, marketing or commercialization capability. Genentech currently
has an  exclusive  option  to  market  and  distribute  AIDSVAX.  We may rely on
Genentech  to  provide an  established  distribution  system and sales  force to
market AIDSVAX. If Genentech does not elect to exercise its option to market and
distribute the product,  we will need to identify and engage another  partner to
market and commercialize  AIDSVAX. We cannot assure you that we would be able to
establish  marketing or  commercialization  arrangements with third parties in a
timely manner or on favorable terms, or at all.

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

Our  license  agreement  with  Genentech  permits  Genentech  to  terminate  the
agreement, or terminate the exclusivity of our license, if we:


                                       22
<PAGE>

     o    fail to use due diligence in developing,  seeking regulatory  approval
          for,  marketing or  commercializing  products covered by the Genentech
          license agreement;

     o    fail to file the first market  approval  application  for AIDSVAX with
          the FDA prior to May 2002,  subject to potential  extension  for up to
          two years in certain circumstances,  with any other extension being at
          Genentech's sole decision;

     o    breach the license  agreement  and fail to cure the breach  within the
          time period provided in the agreement; and

     o    fail to maintain a tangible net worth of at least $1 million.


     Risks Related to the Issuance of Series A Preferred Stock and Warrants

We may be  obligated  to redeem the Series A Preferred  Stock,  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 6%  Cumulative  Convertible  Preferred  Stock and common
stock purchase  warrants for aggregate  proceeds of $20.0 million.  The terms of
our Series A preferred  stock, and the warrants,  give the selling  stockholders
the right to require us to redeem all of the Series A  preferred  stock,  common
stock issued on exercise of the  warrants,  and/or the  warrants,  under certain
circumstances, including:

     o    on May 23, 2004, with respect to the Series A preferred stock;

     o    upon a change of control, at a 15% premium to the purchase price, plus
          accrued dividends, with respect to the Series A preferred stock;

     o    if  (i)   the   November   2001   interim   analysis   of  the   North
          American/European  Phase  III  clinical  trial  does not  result  in a
          recommendation  by the  Data and  Safety  Monitoring  Board,  which is
          overseeing  our  North  American/European  clinical  trial,  either to
          terminate  the  trial  early so that we can seek FDA  approval,  or to
          continue  the  trial to the  scheduled  conclusion,  (ii) the  interim
          analysis is not  completed by December 31, 2001,  or (iii) the results
          of the interim analysis are not announced by January 31, 2002, in each
          case with respect to the Series A preferred stock;

     o    a 20% premium, if:

          |X|  the selling  stockholders  are unable to sell common  stock under
               the  registration  statement  after  the  expiration  of the time
               periods described in the registration rights agreement;


                                       23
<PAGE>

          |X|  our stock is delisted or not quoted on an approved stock exchange
               or on the  Nasdaq  National  Market  or Small  Cap  Market  for 5
               consecutive trading days;

          |X|  we do not have a  sufficient  number of  shares  of common  stock
               authorized  to satisfy our  obligations  in  connection  with the
               conversion  of the Series A  preferred  stock or  exercise of the
               warrants;

          |X|  we  commit a  material  breach  under,  or  otherwise  materially
               violate the terms of, the transaction  documents  entered into in
               connection  with the issuance of the Series A preferred stock and
               the warrants; or

          |X|  we are  insolvent or take other  actions,  or allow actions to be
               taken, as part of a bankruptcy proceeding.

Our  redemption  of the  Series  A  preferred  stock,  common  stock  issued  on
conversion  of the Series A  preferred  stock or on  exercise  of the  warrants,
and/or the warrants,  would require the  expenditure of a significant  amount of
cash that  would  substantially  exceed the  proceeds  that we  received  in the
private  placement  and could  exceed our ability to make such  payment or raise
additional capital.

We cannot issue common stock to a selling stockholder,  whether as a dividend or
in redemption  of  securities,  if after such issuance such selling  stockholder
would be deemed the beneficial owner of more than 9.9% of our common stock.

Under the terms of the agreements  between us and the selling  stockholders,  we
are, under limited  circumstances,  permitted to satisfy dividend and redemption
obligations  through  the  issuance of common  stock  rather than the payment of
cash.  We are not  permitted to issue common stock to a selling  stockholder  if
after such  issuance  such selling  stockholder  would be deemed the  beneficial
owner of more than 9.9% of our common  stock.  If we are unable to issue  common
stock to satisfy our dividend and redemption  obligations,  we would be required
to use cash to  satisfy  our  obligations,  which  could  adversely  affect  our
business and operating results.

Our stockholders could experience substantial dilution as result of the terms of
our Series A preferred stock and warrants issued in the private placement to the
selling stockholders or our ability to issue additional preferred stock.

The  20,000  outstanding  shares  of  Series A  preferred  stock  are  initially
convertible  into  approximately  861,383  shares of common  stock,  obtained by
dividing $20 million by $23.2185,  which represents a 15% premium to the closing
price of $20.19, calculated for purposes of the private placement that closed on
May 23, 2001. The  outstanding  warrants are initially  exercisable  for 297,177
shares of common stock. The number of


                                       24
<PAGE>

shares of common stock issuable by us upon  conversion of the Series A preferred
stock and exercise of the warrants can increase substantially in certain events,
including our issuance of common stock at prices less than the conversion  price
of the Series A  preferred  stock or the  exercise  price of the  warrants.  For
example, the exercise price of the warrants initially is $25.2375 per share, but
the  exercise  price is subject to  downward  adjustment  on May 23, 2002 if the
average of the  closing  bid prices for our common  stock  during the 20 trading
days prior to May 23, 2002 is less than $25.2375, to such average price, but not
below  $14.133 per share.  If the exercise  price of the  warrants  adjusts to a
price  below the  conversion  price of the Series A  preferred  stock,  which is
currently $23.2185 per share, and if a warrant is exercised, then the conversion
price of the  Series A  preferred  stock  will  automatically  be reduced to the
exercise price of the warrants,  but not to a price less than $14.133 per share.
Any such exercise or conversion price adjustment could result in the issuance of
up to approximately 790,000 additional shares,  assuming exercise and conversion
prices of $14.133 per share.

In addition,  we are permitted under limited  circumstances  to satisfy dividend
and redemption obligations on the preferred stock through the issuance of common
stock rather than through the expenditure of cash. Any increase in the number of
shares of common stock issuable  pursuant to the terms of the Series A preferred
stock  and  the  warrants,  or our  issuance  of  common  stock  to the  selling
stockholders to satisfy our dividend and redemption obligations, may result in a
decrease in the value of the outstanding shares of our common 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.

The  perceived  risk of dilution or any actual  dilution  occasioned by Series A
preferred  stock,  the  warrant  or  additional  preferred  stock  may cause our
stockholders  to sell their  shares,  which  would  contribute  to the  downward
movement  in stock  price of the common  stock.  In  addition,  the  significant
downward  pressure on the  trading  price of the common  stock  could  encourage
investors to engage in short sales, which would further contribute to a downward
pricing of the common stock.

If the holders of the Series A preferred  stock and the  warrants  elect to have
the Series A preferred stock and the warrants assumed by a potential acquirer of
VaxGen,  or redeemed by VaxGen,  the acquirer could be deterred from  completing
the acquisition.

The Series A  preferred  stock and the  warrants  permit the holders to elect to
have  their  shares  of  Series  A  preferred  stock  and  the  warrants  remain
outstanding after an acquisition of VaxGen,  and to have the acquirer assume all
of our obligations to the holder.  The Series A preferred stock also permits the
holders of Series A  preferred  stock to require us to  repurchase  the Series A
preferred stock, at a premium, in connection with



                                       25
<PAGE>

an  acquisition.  The  ability  to force an  acquirer  to  assume  the  Series A
preferred stock and the warrants,  and the ability to force us to repurchase the
Series A preferred  stock at a premium,  in the event of a merger  could deter a
potential acquirer from completing an acquisition of VaxGen.

Among our obligations that an acquirer might be forced to assume which would act
as a deterrent are:

     o    the price adjustment provisions, which could have an adverse effect on
          the market value of the acquirer's outstanding securities;

     o    the  obligation  to register the resale of the common  stock  issuable
          upon  conversion  of the Series A  preferred  stock and the  warrants,
          which could  result in the sale of a  substantial  number of shares in
          the market;

     o    the obligation to pay dividends on the Series A preferred stock;

     o    the  obligation  to redeem the  Series A  preferred  stock,  including
          redemption at a premium to the purchase  price,  on the  occurrence of
          certain events or on May 23, 2004;

     o    the  obligation  to pay the  holders of Series A  preferred  stock the
          amount invested plus accrued  dividends  before any other  stockholder
          receives any payment if we are liquidated; and

     o    the  obligation  to seek the  consent  of the  holders of the Series A
          preferred  stock before we can take  certain  actions,  including  the
          issuance of securities  that have senior or equal rights as the Series
          A preferred  stock or incurring  unsecured  indebtedness  for borrowed
          money,  or take other  actions  with respect to the Series A preferred
          stock or securities that have fewer rights than the Series A preferred
          stock.

We may be  required  to obtain the  consent of the holders of Series A preferred
stock before taking corporate actions, which could harm our business.

Our  certificate  of  incorporation  requires  us to obtain  the  consent of the
holders of the Series A preferred stock before we may issue securities that have
senior  or equal  rights  as the  Series A  preferred  stock or incur  unsecured
indebtedness  for  borrowed  money,  or take other  actions  with respect to the
Series A preferred  stock or securities that have fewer rights than the Series A
preferred  stock.  We are also  required to obtain the consent of the holders of
the  Series A  preferred  stock  before we amend or modify  our  certificate  of
incorporation  or bylaws to change any of the  rights of the Series A  preferred
stockholders.  While  these  obligations  may deter a  potential  acquirer  from
completing a transaction with us, they may also prevent us from taking corporate
actions that would be beneficial to us and our stockholders.


                                       26
<PAGE>


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 hold 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  interest  earning  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 June  30,  2001,  we held  government  debt  instruments  and
corporate obligations in the principal amount of $43,200,000. If market interest
rates were to increase  immediately and uniformly by 10% from levels at June 30,
2001, 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
and holding them until maturity.

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. At the time these  contracts were written,  the Thailand  exchange rate
was 37.5 Baht per one U. S. Dollar. As of June 30, 2001, we have incurred $2,000
in foreign exchange losses.


                                       27
<PAGE>


                           Part II - Other Information


Item 2. Changes in Securities and Use of Proceeds

The Company's  Registration Statement under the Securities Act of 1933 (File No.
333-78065)  was declared  effective  June 29, 1999.  Offering  proceeds,  net of
aggregate expenses of approximately $4,400,000,  were approximately $42,000,000.
All of the expenses related to the offering were direct or indirect  payments to
others and not payments to our directors or officers (or their associates) or to
our  affiliates  or 10%  shareholders.  As of June 30,  2001,  the  Company  has
utilized approximately  $29,700,000 of net proceeds of the offering ($28,700,000
for working  capital and $1,000,000 for leasehold  improvements  and equipment).
The Company has invested the  remainder of the net proceeds from the offering in
short-term  investments  such as  high-quality  corporate  issues and government
obligations.

Please see the description of our sale of redeemable convertible preferred stock
and  warrants to Halifax  Fund,  L.P.,  Societe  Generale,  Velocity  Investment
Partners, Ltd. and SDS Merchant Fund, L.P. in May 2001 provided above in Part I,
Item  1  -   Financial   Statements,   under   Notes  to   Condensed   Financial
Statements--Redeemable  Convertible  Preferred Stock  Financing,  and in Part I,
Item 2 - Management's Discussion and Analysis of Financial Condition and Results
of   Operations--Liquidity   and  Capital  Resources,   which  descriptions  are
incorporated  herein  by this  reference.  These  sales  were  made in a private
transaction pursuant to the exemption from registration provided by Section 4(2)
of the  Securities  Act of  1933,  as  amended,  and Rule  506 of  Regulation  D
promulgated  thereunder.  On July 20, 2001, a registration statement on Form S-3
that registered for resale certain shares of common stock issuable on conversion
of such shares of redeemable  convertible  preferred stock, and upon exercise of
such warrants, was declared effective by the Securities and Exchange Commission.



                                       28
<PAGE>


Item 4. Submission of Matters to a Vote of Security Holders

At our Annual Meeting of  Stockholders,  held on May 30, 2001, four matters were
voted upon. A description of each matter and tabulation of votes follows:

     1.   Election of Directors

                                                   Votes
                                  --------------------------------------
            Nominee                     For                  Withheld
-------------------------------   -----------------      ---------------
Donald P. Francis                    12,370,683               89,880
Phillip W. Berman                    12,435,931               24,632
Randall L-W. Caudill                 12,444,731               15,832
Stephen C. Francis                   12,396,009               64,554
Ruth B. Kunath                       12,443,665               16,898
William D. Young                     12,445,081               15,482

There were no abstentions or broker non-votes.

     2.   Ratification  of KPMG  LLP as our  independent  auditors  for the 2001
          fiscal year ending December 31, 2001:

                                    Votes
--------------------------------------------------------------------------------
         For                         Against                    Abstain
---------------------------    --------------------    -------------------------
      12,385,796                     56,351                      18,416

There were no broker non-votes.

3.       To approve the Company's 2001 Employee Stock Option Plan:

                                    Votes
--------------------------------------------------------------------------------
         For                         Against                    Abstain
---------------------------    --------------------    -------------------------
      12,210,112                     214,088                     36,363

There were no broker non-votes.

4.   To approve the increase in the number of authorized  shares of Common Stock
     by 20,000,000 shares:

                                    Votes
--------------------------------------------------------------------------------
         For                         Against                    Abstain
---------------------------    --------------------    -------------------------
      12,124,058                     286,823                     49,682

There were no broker non-votes.


                                       29
<PAGE>


Item 6. Exhibits and Reports on Form 8-K

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

The following exhibits are filed as part of this report:

<TABLE>
<CAPTION>
-------------- ------------------------------------------------------ ------------------------------------------------
                                                                                 Incorporated by Reference
-------------- ------------------------------------------------------ --------- -------------- ----------- -----------
                                                                                                 Filing      Exhibit
 Exhibit No.                          Exhibit                           Form      File No.        Date         No.
-------------- ------------------------------------------------------ --------- -------------- ----------- -----------
<S>                                                                     <C>       <C>           <C>           <C>
     3.1       Certificate of Designations, Rights and Preferences      8-K       000-26483     5-24-01       3.1
               of Series A 6% Cumulative Convertible Preferred Stock
-------------- ------------------------------------------------------ --------- -------------- ----------- -----------
    10.1       Securities Purchase Agreement by and among the           8-K       000-26483     5-24-01       10.1
               Company and Certain Stockholders
-------------- ------------------------------------------------------ --------- -------------- ----------- -----------
    10.2       Registration Rights Agreement by and among the           8-K       000-26483     5-24-01       10.2
               Company and Certain Stockholders
-------------- ------------------------------------------------------ --------- -------------- ----------- -----------
     4.1       Form of Common Stock Purchase Warrant                    8-K       000-26483     5-24-01       4.1
-------------- ------------------------------------------------------ --------- -------------- ----------- -----------
</TABLE>


(b)  Reports on Form 8-K:

     A current  report  on Form 8-K,  dated  May 24,  2001,  was filed  with the
     Securities and Exchange Commission, reporting under Item 5 that the Company
     raised $20 million  through a private  placement of  convertible  preferred
     stock.


                                       30
<PAGE>


                                   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:   August 13, 2001                    By:/s/ Carter A. Lee
                                               ---------------------------------
                                               Carter A. Lee
                                               Senior Vice President
                                               Finance & Administration
                                               (Principal Financial Officer)