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


FORM 10-Q/A


(Mark One)


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


For the Quarterly
Period Ended June 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 20,479,472 shares outstanding as of August 1, 2003.
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|VaxGen, Inc.


Form 10-Q/A


For the Quarter
Ended June 30, 2003


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

|Part
      I  |  | Financial
      Information                                           |  | Page
|------------- |  | --------------------------------------------------------------------- |  | ----
|              |  | Recent
      Accounting and Financial Developments                    |  | 1   
|Item
      1  |  | Financial
      Statements (unaudited):                               |  |     
|              |  | Condensed
      Consolidated Balance Sheets                           |  | 2   
|              |  | Condensed
      Consolidated Statements of Operations                 |  | 3   
|              |  | Condensed
      Consolidated Statements of Cash Flows                 |  | 4   
|              |  | Notes
      to Condensed Consolidated Financial Statements            |  | 6   
|Item
      2  |  | Managements
      Discussion and Analysis of Financial Condition and |  |     
|              |  | Results
      of Operations:                                          |  |     
|              |  | Overview                                                              |  | 12  
|              |  | Results
      of Operations                                           |  | 17  
|              |  | Liquidity
      and Capital Resources                                 |  | 20  
|              |  | Risk
      Factors                                                    |  | 22  
|Item
      3  |  | Quantitative
      and Qualitative Disclosures About Market Risk      |  | 32  
|Item
      4  |  | Controls
      and Procedures                                         |  | 32  
|Part
      II |  | Other
      Information                                               |  | 33  
|Item
      1  |  | Legal
      Proceedings                                               |  | 33  
|Item
      6  |  | Exhibits
      and Reports on Form 8-K                                |  | 34  
|              |  | Signature                                                             |  | 36  
|              |  | 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, 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 second fiscal quarter of 2003 and 2002 are
restated on this Form 10-Q/A. Restated financial statements 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. As a result
of the restatement, the net loss applicable to common stockholders decreased by
$2,624,000 and $735,000 for the six months ended June 30, 2003 and 2002,
respectively.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | For the six months ended June 30, 2003, the net loss applicable to common stockholders
decreased to $11,692,000 from $14,316,000 and basic and diluted loss per share applicable
to common stockholders decreased to $(0.70) from $(0.86), each as compared to the amounts
previously reported by VaxGen on its Form 10-Q filed on August 18, 2003.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | For the six months ended June 30, 2002, the net loss applicable to common stockholders
decreased to $14,363,000 from $15,098,000 and basic and diluted loss per share applicable
to common stockholders decreased to $(1.00) from $(1.05), each as compared to the amounts
previously reported by VaxGen on its Form 10-Q filed on August 18, 2003.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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
conversion feature charge of $10,686,000 in 2002 and $2,188,000 in the second
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 CONSOLIDATED BALANCE SHEETS(Unaudited)
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                             | June 30,2003(As Restated) |  | December 31,2002(As Restated) |             
|------------------------------------------------------------ | ------------------------- |  | ----------------------------- | ------------
|ASSETS                                                       |                          
|Current assets:                                              |                           | 
|Cash and cash equivalents                                    |                           |  | $                             | 7,894,000   
|Investment securities                                        |                           |  |                               | 6,705,000   
|Accounts receivable                                          |                           |  |                               | 516,000     
|Accounts receivable  related party                          |                           |  |                               | 392,000     
|Deferred costs                                               |                           |  |                               | 946,000     
|Prepaid expenses and other current assets                    |                           |  |                               | 494,000     
|                                                             |                           |  |                               |             
|Total current assets                                         |                           |  |                               | 16,947,000  
|Property and equipment, net                                  |                           |  |                               | 14,147,000  
|Restricted cash                                              |                           |  |                               | 1,039,000   
|Investment in affiliate                                      |                           |  |                               |            
|Employee loans receivable                                    |                           |  |                               | 135,000     
|Other assets                                                 |                           |  |                               | 400,000     
|                                                             |                           |  |                               |             
|Total assets                                                 |                           |  | $                             | 32,668,000  
|                                                             |                           |  |                               |             
|                                                            
|LIABILITIES AND STOCKHOLDERS EQUITY                         |                          
|Current liabilities:                                         |                           | 
|Payable to Genentech                                         |                           |  | $                             | 1,670,000   
|Accounts payable                                             |                           |  |                               | 1,598,000   
|Accrued clinical trial expenses                              |                           |  |                               |            
|Accrued liabilities                                          |                           |  |                               | 1,855,000   
|Deferred revenues                                            |                           |  |                               | 3,348,000   
|Warrant valuation obligation                                 |                           |  |                               | 1,729,000   
|Current portion of long-term obligations                     |                           |  |                               | 7,000       
|                                                             |                           |  |                               |             
|Total current liabilities                                    |                           |  |                               | 10,207,000  
|Minority interest of subsidiary                              |                           |  |                               | 6,084,000   
|Deferred rent                                                |                           |  |                               | 572,000     
|Redeemable convertible preferred stock, $0.01 par            |                           | 
|value, 20,500 shares authorized:                             |                           | 
|Series A 6% cumulative, $0.01 par value,                     |                           | 
|585 and 3,800 shares issued and outstanding at June 30,      |                           | 
|2003 and December 31, 2002, respectively (liquidation        |                           | 
|preference of $585,000 and $3,800,000 at June 30,            |                           | 
|2003 and December 31, 2002, respectively)                    |                           |  |                               | 254,000     
|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; |                           | 
|20,479,472 and 15,777,064 shares issued and outstanding      |                           | 
|at June 30, 2003 and December 31, 2002, respectively         |                           |  |                               | 204,000     
|                                                            
|Additional paid-in capital                                   |                           |  |                               | 170,817,000 
|Deferred stock compensation                                  |                           |  |                               | (29,000     
|Accumulated other comprehensive income                      |                           | 
|unrealized gain on investment securities                     |                           |  |                               | 52,000      
|Deficit accumulated during the development stage             |                           |  |                               | (155,493,000
|                                                             |                           |  |                               |             
|Total stockholders equity                                   |                           |  |                               | 15,551,000  
|                                                             |                           |  |                               |             
|Total liabilities and stockholders equity                   |                           |  | $                             | 32,668,000  
|                                                             |                           |  |                               |             

|See accompanying notes to condensed consolidated financial statements.

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

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

|                                    | Three months endedJune 30, |  | Six months endedJune 30, |            | Period fromInception(November 27, 1995)through June 30, |  
|----------------------------------- | -------------------------- |  | ------------------------ | ---------- | ------------------------------------------------------- | -
|
|Revenue:                            |                            |  |                          |            |                                                         |  
|Research grant
and contract revenue |                            |  | $                        | 2,565,000  |                                                         | $
|Related party
services revenue      |                            |  |                          | 206,000    |                                                         |  
|                                    |                            |  |                          |            |                                                         |  
|Total revenues                      |                            |  |                          | 2,771,000  |                                                         |  
|Operating expenses:                 |                            | 
|Research and
development:           |                            | 
|Genentech charges                   |                            |  |                          | 692,000    |                                                         |  
|Other                               |                            |  |                          | 4,644,000  |                                                         |  
|                                    |                            |  |                          |            |                                                         |  
|Total research
and development      |                            |  |                          | 5,336,000  |                                                         |  
|General and
administrative expenses |                            |  |                          | 4,010,000  |                                                         |  
|                                    |                            |  |                          |            |                                                         |  
|Loss from operations                |                            |  |                          | (6,575,000 | )                                                       |  
|Other income
(expense):             |                            | 
|Investment
income                   |                            |  |                          | 176,000    |                                                         |  
|Interest expense                    |                            |  |                          |           |                                                         |  
|Equity in loss
of affiliate         |                            |  |                          |           |                                                         |  
|Warrant valuation
adjustment        |                            |  |                          | (1,024,000 | )                                                       |  
|                                    |                            |  |                          |            |                                                         |  
|Total other
(expense) income, net   |                            |  |                          | (848,000   | )                                                       |  
|                                    |                            |  |                          |            |                                                         |  
|Net loss before
minority interest   |                            |  |                          | (7,423,000 | )                                                       |  
|Minority interest
in                |                            | 
|subsidiary
losses                   |                            |  |                          | 168,000    |                                                         |  
|                                    |                            |  |                          |            |                                                         |  
|Net loss                            |                            |  |                          | (7,255,000 | )                                                       |  
|Charges related
to convertible      |                            | 
|preferred
stock:                    |                            | 
|Dividends                           |                            |  |                          | (46,000    | )                                                       |  
|Accretion to
redemption value       |                            |  |                          | (222,000   | )                                                       |  
|Beneficial
conversion charge        |                            |  |                          | (2,132,000 | )                                                       |  
|                                    |                            |  |                          |            |                                                         |  
|Net loss applicable
to common       |                            | 
|stockholders                        |                            |  | $                        | (9,655,000 | )                                                       | $
|                                    |                            |  |                          |            |                                                         |  
|Basic and diluted
loss per share    |                            | 
|applicable
to common                |                            | 
|stockholders                        |                            |  | $                        | (0.56      | )                                                       | $
|Weighted average
shares used in     |                            | 
|computing
basic and diluted         |                            | 
|loss
per share                      |                            |  |                          | 17,358,000 |                                                         |  

|See accompanying notes to condensed consolidated financial statements.

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

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

|                                                                  | Six months
      ended |  | Period
      from
      Inception
      (November 27,
      1995) through
      June 30, |           
|----------------------------------------------------------------- | ---------------------- |  | ---------------------------------------------------------------------------------------- | ----------
|
|Net
      loss                                                    |                        |  | $                                                                                        | (8,828,000
|Adjustments
      to reconcile net loss to net                    |                        | 
|cash
      used in operating activities:                          |                        | 
|Minority
      interest in subsidiary losses                      |                        |  |                                                                                          | (584,000  
|Depreciation
      and amortization                               |                        |  |                                                                                          | 593,000   
|Amortization
      of premiums and                                |                        | 
|discounts
      on investment securities                          |                        |  |                                                                                          | (51,000   
|Stock
      compensation expense                                  |                        |  |                                                                                          | 281,000   
|Bad debt
      reserve                                            |                        |  |                                                                                          |          
|Warrants
      issued to consultants                              |                        |  |                                                                                          |          
|Equity
      in loss of affiliate                                 |                        |  |                                                                                          |          
|Non-cash
      warrant valuation adjustments                      |                        |  |                                                                                          | (4,051,000
|Changes
      in assets and liabilities:                          |                        | 
|Accounts
      receivable                                         |                        |  |                                                                                          | 834,000   
|Deferred
      costs                                              |                        |  |                                                                                          | 433,000   
|Prepaid
      expenses and other current assets                   |                        |  |                                                                                          | 1,271,000 
|Restricted
      cash                                             |                        |  |                                                                                          | (6,000    
|Employee
      loans receivable                                   |                        |  |                                                                                          |          
|Other
      assets                                                |                        |  |                                                                                          | (15,000   
|Payable
      to Genentech                                        |                        |  |                                                                                          | (230,000  
|Deferred
      revenues                                           |                        |  |                                                                                          | 2,431,000 
|Deferred
      rent                                               |                        |  |                                                                                          | (34,000   
|Accounts
      payable, accrued liabilities                       |                        | 
|and
      other long-term obligations                             |                        |  |                                                                                          | (3,551,000
|                                                                  |                        |  |                                                                                          |           
|Net
      cash used in operating activities:                      |                        |  |                                                                                          | 11,507,000
|Cash
      flows from investing activities:                       |                        | 
|Purchase
      of investment securities                           |                        |  |                                                                                          | (4,614,000
|Proceeds
      from sale and maturities of                        |                        | 
|investment
      securities                                       |                        |  |                                                                                          | 11,286,000
|Purchase
      of property and equipment                          |                        |  |                                                                                          | (699,000  
|Long-term
      lease deposits                                    |                        |  |                                                                                          |          
|Acquisition
      of affiliate, net of cash acquired              |                        |  |                                                                                          | (3,548,000
|                                                                  |                        |  |                                                                                          |           
|Net
      cash provided by (used in) investing activities         |                        |  |                                                                                          | 2,425,000 
|Cash
      flows from financing activities:                       |                        | 
|Proceeds
      from issuance of preferred stock                   |                        |  |                                                                                          |          
|Payments
      under capital lease obligations                    |                        |  |                                                                                          | (8,000    
|Proceeds
      from issuance of common stock, net of issuance     |                        | 
|costs                                                             |                        |  |                                                                                          | 11,685,000
|Return
      of capital on redeemable convertible preferred stock |                        |  |                                                                                          |          
|Exercise
      of employee stock options                          |                        |  |                                                                                          | 633,000   
|Employee
      stock purchase plan                                |                        |  |                                                                                          | 235,000   
|Loans
      from Genentech                                        |                        |  |                                                                                          |          
|Cash
      payment of dividends                                   |                        |  |                                                                                          | (18,000   
|                                                                  |                        |  |                                                                                          |           
|Net
      cash provided by financing activities                   |                        |  |                                                                                          | 12,527,000

|4
|-

|VaxGen,
Inc.(A Development Stage Enterprise)


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

|                                                                  | Six months
      ended |  | Period
      from
      Inception
      (November 27,
      1995) through
      June 30, |           
|----------------------------------------------------------------- | ---------------------- |  | ---------------------------------------------------------------------------------------- | ----------
|
|Increase
      (decrease) in cash and cash equivalents            |                        |  |                                                                                          | 3,445,000 
|Cash
      and cash equivalents at beginning of period            |                        |  |                                                                                          | 4,449,000 
|                                                                  |                        |  |                                                                                          |           
|Cash
      and cash equivalents at end of period                  |                        |  | $                                                                                        | 7,894,000 
|                                                                  |                        |  |                                                                                          |           
|Supplemental
      schedule of non cash                           |                        | 
|investing
      and financing activities:                         |                        | 
|Dividends
      paid/accrued to redeemable convertible preferred  |                        | 
|stockholders
      through the issuance of common stock           |                        |  | $                                                                                        | 85,000    
|Accretion
      of redemption value of redeemable                 |                        | 
|convertible
      preferred stock                                 |                        |  |                                                                                          | 302,000   
|Recognition
      of beneficial conversion feature                |                        | 
|of
      redeemable convertible preferred stock                   |                        |  |                                                                                          | 2,459,000 
|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                                             |                        |  |                                                                                          | (4,051,000
|Conversion
      of redeemable convertible preferred stock        |                        | 
|into
      common stock                                           |                        |  |                                                                                          | 3,299,000 
|Reclassification
      of unaccreted portion of financing costs   |                        | 
|from preferred stock to equity upon conversion                    |                        |  |                                                                                          | 104,000   
|Equipment
      acquired through capital leases                   |                        |  |                                                                                          |          
|Issuance
      of stock through conversion of                     |                        | 
|Genentech
      note payable                                      |                        |  |                                                                                          |          
|Note
      receivable partially settled by                        |                        | 
|severance
      obligation                                        |                        |  |                                                                                          |          

|See accompanying notes to condensed consolidated financial statements.

5
|-------------------------------------------------------------------------

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


1. Basis
of Presentation


The unaudited condensed
consolidated financial statements of VaxGen, Inc. (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 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 six month
periods ended June 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 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 June 30, 2003, 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 half of 2003 because of anticipated
revenues from our contract with the National Institutes of Health
(NIH) 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
and reclassifications


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; restructuring; 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
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|VaxGen, prior to filing
its financial statements on Form 10-Q, publicly releases an unaudited condensed
consolidated balance sheet and statement of operations. Between the date of
VaxGens earnings release and the filing of its Form 10-Q,
reclassifications and adjustments may be required. The condensed consolidated
statements of operations for the three and six month periods ended June 30, 2003
reflect adjustments to other income, net, minority interest in subsidiary
losses, and charges attributable to redeemable convertible preferred stock made
subsequent to the earnings release. The cumulative effect of these adjustments
was a decrease in net loss applicable to common stockholders, basic and diluted,
for the three and six month periods ended June 30, 2003 of $11,000 and $120,000
respectively. The effect of these adjustments upon basic and diluted loss per
share applicable to common stockholders for the three and six month periods
ended June 30, 2003 was $0.00 and $0.01 respectively.


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 a material 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 plan to adopt SFAS No. 150 in the third  quarter of
2003 and we  anticipate  that, as a result of our adoption of SFAS No. 150, we will
classify our redeemable convertible preferred stock as a liability.


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. 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 second fiscal quarter of 2003 and 2002 are restated in this form 10-Q/A
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. 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 decreased by $2,624,000 and $735,000 for the six months ended June 30, 2003 and 2002, respectively.
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | For the six months ended June 30, 2003, the net loss applicable to common stockholders
decreased to $11,692,000 from $14,316,000 and basic and diluted loss per share applicable
to common stockholders decreased to $(0.70) from $(0.86), each as compared to the amounts
previously reported by VaxGen on its Form 10-Q filed on August 18, 2003.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|7
|-

| |  | For the six months ended June 30, 2002, the net loss applicable to common stockholders
decreased to $14,363,000 from $15,098,000 and basic and diluted loss per share applicable
to common stockholders decreased to $(1.00) from $(1.05), each as compared to the amounts
previously reported by VaxGen on its Form 10-Q filed on August 18, 2003.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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 feature charge of $10,686,000 in 2002 and $2,188,000 in the second
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 on the accompanying financial statements are set forth below:

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

|CONDENSED
CONSOLIDATED BALANCE SHEETS(Unaudited)June 30, 2003
|-------------------------------------------------------------

|                                                 | (AsRestated) |  | (AsPreviouslyReported) |             
|------------------------------------------------ | ------------ |  | ---------------------- | ------------
|Property and equipment, net                      |              |  | $                      | 14,147,000  
|Total assets                                     |              |  |                        | 32,668,000  
|Warrant valuation obligation                     |              |  |                        | 1,729,000   
|Total current liabilities                        |              |  |                        | 10,207,000  
|Minority interest of subsidiary                  |              |  |                        | 6,084,000   
|Redeemable convertible preferred stock           |              |  |                        | 254,000     
|Additional paid-in capital                       |              |  |                        | 170,817,000 
|Deficit accumulated during the development stage |              |  |                        | (155,493,000
|Total stockholders equity                       |              |  |                        | 15,551,000  
|Total liabilities and stockholders equity       |              |  |                        | 32,668,000  

|CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS(Unaudited)
|----------------------------------------------------------

|                                       | Three months endedJune 30, 2003 |  | Three months endedJune 30, 2002 |           
|-------------------------------------- | ------------------------------- |  | ------------------------------- | ----------
|
|                                       |                                 |  |                                 |           
|General and administrative expenses    |                                 |  | $                               | 4,010,000 
|Loss from operations                   |                                 |  |                                 | (6,575,000
|Warrant valuation adjustment           |                                 |  |                                 | (1,024,000
|Total other (expense) income, net      |                                 |  |                                 | (848,000  
|Net loss before minority interest      |                                 |  |                                 | (7,423,000
|Minority interest in subsidiary losses |                                 |  |                                 | 168,000   
|Net loss                               |                                 |  |                                 | (7,255,000
|Accretion
      to redemption value    |                                 |  |                                 | (222,000  
|Beneficial conversion charge           |                                 |  |                                 | (2,132,000
|Net loss applicable to common          |                                 | 
|stockholders                           |                                 |  | $                               | (9,655,000
|Basic and diluted loss per share       |                                 | 
|applicable to common                   |                                 | 
|stockholders                           |                                 |  | $                               | (0.56     
|Weighted average shares used in        |                                 | 
|computing basic and diluted            |                                 | 
|loss per share                         |                                 |  |                                 | 17,358,000

|9
|-

|                                       | Six months endedJune 30, 2003 |  | Six months endedJune 30, 2002 |            
|-------------------------------------- | ----------------------------- |  | ----------------------------- | -----------
|
|                                       |                               |  |                               |            
|General and administrative expenses    |                               |  | $                             | 8,465,000  
|Loss from operations                   |                               |  |                               | (13,842,000
|Warrant valuation adjustment           |                               |  |                               | 4,051,000  
|Total other income, net                |                               |  |                               | 4,430,000  
|Net loss before minority interest      |                               |  |                               | (9,412,000 
|Minority interest in subsidiary losses |                               |  |                               | 584,000    
|Net loss                               |                               |  |                               | (8,828,000 
|Accretion
      to redemption value    |                               |  |                               | (302,000   
|Beneficial conversion charge           |                               |  |                               | (2,459,000 
|Net loss applicable to common          |                               | 
|stockholders                           |                               |  | $                             | (11,692,000
|Basic and diluted loss per share       |                               | 
|applicable to common                   |                               | 
|stockholders                           |                               |  | $                             | (0.70      
|Weighted average shares used in        |                               | 
|computing basic and diluted            |                               | 
|loss per share                         |                               |  |                               | 16,606,000 

|                                       | For the period from Inception(November 27, 1995) throughJune 30, 2003 | 
|-------------------------------------- | --------------------------------------------------------------------- | 
|
|                                       |                                                                       | 
|General and administrative expenses    |                                                                       | 
|Loss from operations                   |                                                                       | 
|Warrant valuation adjustment           |                                                                       | 
|Total other income (expense), net      |                                                                       | 
|Net loss before minority interest      |                                                                       | 
|Minority interest in subsidiary losses |                                                                       | 
|Net loss                               |                                                                       | 
|Accretion
      to redemption value    |                                                                       | 
|Beneficial conversion charges          |                                                                       | 
|Net loss applicable to common          |                                                                       | 
|stockholders                           |                                                                       | 

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

|                                                        |  | 
|------------------------------------------------------- |  | 
|
|
|                                                        |  | 
|Net
      loss                                          |  | 
|Minority
      interest in subsidiary losses            |  | 
|Non-cash
      warrant valuation adjustments            |  | 
|Net cash
      used in operating activities             |  | 
|Acquisition
      of affiliate, net of cash acquired    |  | 
|Net cash
      provided by (used in) investing          |  | 
|activities                                              |  | 
|                                                        |  | 
|Supplemental
      schedule of non-cash                 |  | 
|investing
      and financing activities:               |  | 
|                                                        |  | 
|Accretion
      of redemption value of redeemable       |  | 
|convertible
      preferred stock                       |  | 
|Recognition
      of beneficial conversion feature      |  | 
|of
      redeemable convertible preferred stock         |  | 
|Recognition
      of valuation adjustment to fair value |  | 
|of
      common stock warrants issued with              |  | 
|redeemable
      convertible preferred stock            |  | 
|Reclassification
      of unaccreted portion of         |  | 
|financing
      costs from preferred stock to           |  | 
|equity
      upon conversion                            |  | 

|10
|--

|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:
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                      | Three months endedJune 30, |  | Six months endedJune 30, |            
|----------------------------------------------------- | -------------------------- |  | ------------------------ | -----------
|                                                      |                            |  |                          |            
|
|                                                      |                            |  |                          |            
|Net loss applicable to common stockholders            |                            |  | $                        | (9,655,000 
|Add: Stock-based employee compensation                |                            | 
|expense included in reported net loss,                |                            | 
|net of related tax effects                            |                            |  |                          | 143,000    
|Less: Total stock-based employee compensation         |                            | 
|expense determined under fair value based             |                            | 
|method for all awards, net of related tax
    effects |                            |  |                          | (1,582,000 
|                                                      |                            |  |                          |            
|Net loss applicable to common                         |                            | 
|stockholders  pro forma                              |                            |  | $                        | (11,094,000
|                                                      |                            |  |                          |            
|                                                     
|Loss per share  basic and diluted                    |                            |  | $                        | (0.56      
|                                                     
|Loss per share  basic and diluted, pro forma         |                            |  | $                        | (0.64      

|11
|--

|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, which are listed below assuming that the shares of the
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:
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                       | June 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 $11.54 and $12.45 at June 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, AIDSVAX, for commercial-scale manufacturing as well as for the
development of new adjuvants and for general corporate purposes. As of June 30,
2003, 585 shares of Preferred Stock were outstanding, which are convertible into
203,833 shares of common stock.


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


Conversion


Each share of Preferred
Stock can be converted into common stock 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 per share then
multiplied by the number of shares to be converted. During the fourth quarter of
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. During the
fourth quarter of 2002, two investors converted a total of 16,200 shares of
Preferred Stock in exchange for 1,172,436 shares of common stock, which included
shares issued for accrued but unpaid dividends. In the second quarter of 2003,
the Company sold 1,742,160 newly issued shares of VaxGens common stock to
a single institutional investor at a price of $2.87 per share. This transaction
had the effect, under the anti-dilution provisions applicable to the Preferred
Stock, of reducing the conversion price of the Preferred Stock to $2.87. During
the second quarter of 2003, three investors converted 3,215 shares in the
aggregate of Preferred Stock in exchange for 1,149,758 shares of common stock,
which included shares issued for accrued but unpaid dividends.

12
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|The Company may also
force conversion of the Preferred Stock into common stock if the weighted
average price per share of our stock for at least 20 out of 30 consecutive
trading days equals or exceeds $24.73.


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. 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 convertible preferred
stock and the redemption amount by increasing the carrying amount for periodic
accretion, so that the carrying amount will equal the redemption amount at the
scheduled redemption date. The accretion of the redemption value of the
Preferred Stock for the six months ended June 30, 2003 and 2002 was $2,761,000
and $990,000, respectively. Included in the accretion were amounts related to
Preferred Stock issuance costs and discounts originated by beneficial conversion
options and warrants.


Dividends


Each share of Preferred
Stock is 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 will accumulate and compound. Payment may 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 six months of 2003, payment was made in cash
for $18,000 along with 29,549 shares of common stock that were paid upon
conversion for accrued but unpaid dividends. Net loss applicable to common
stockholders for the six months ended June 30, 2003 and 2002 included non-cash
charges of $85,000 and $603,000, respectively, for Preferred Stock dividends.


Voting


Each share of Preferred
Stock has voting rights equal to the number of shares of common stock into which
it is convertible on the record date of the vote, provided that, for voting
purposes, in no event shall the conversion price be deemed to be less than
$19.824 per share.


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 share plus accrued 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.

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

|The Company valued the
Warrants at $11.80 per share, resulting in a total value of approximately
$3,500,000 at issuance. 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 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 six months ended June 30, 2003 and 2002
reflected non-cash charges of $91,000 and $585,000 respectively. As a result of
the conversions of Preferred Stock in the second 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. The deemed dividend
amounted to $142,000.


The valuation of the
Warrants and the corresponding current liability is re-measured quarterly and
the restated financial statements reflect non-cash charges and credits based on
changes in the fair market value of the warrants as measured at the end of each
fiscal quarter. Accordingly, the restated financial statements reflect non-cash
charges/(credits) of $1,024,000 and $(790,000) for the three months ended June
30, 2003 and 2002, respectively. For the six months ended June 30, 2003 the
non-cash charges/(credits) were $(4,051,000) and $(858,000), 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
Stock. The beneficial conversion feature 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).


As noted above, one of
the holders of Preferred Stock exercised a warrant in 2002, 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 No. 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 in the fourth quarter of 2002, which was recorded
additional paid in capital or 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 during the fourth quarter
of 2002 and three investors converted Preferred Stock into common during the
second quarter of 2003. The unamortized discount relating to the shares
converted in 2002 and 2003 was recorded as beneficial conversion charges of $10,686,000 in 2002
and $2,188,000 in the second fiscal quarter of 2003.


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 an additional discount to the Preferred
Stock. This contingent beneficial conversion feature discount is also being
accreted to the stated redemption date, May 23, 2004.

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

|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 $16,200,000. During the six
months ended June 30, 2003, the Company recognized a total of $2,558,000 in
revenue related to the completion of the first and second 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 June 30, 2003, the Company had $946,000 of deferred costs and
$3,348,000 of deferred revenues related to this contract.


7.
Celltrion Joint Venture


In February 2002, the Company
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.


As of June 30, 2003, the
South Korean investors had contributed approximately $43,750,000 in cash to
Celltrion of the $50,000,000 in cash that the joint venture agreement between
Celltrion and the Company requires to have been funded by the end of August
2002, and secured a $40,000,000 loan with a Korean bank. As a result of the
in-kind investment of mammalian cell culture technology and know-how, the
Company currently has a 47.8% interest in Celltrion, although if funding is
completed as intended, our interest will be approximately 44%. In the event that
AIDSVAX is ultimately licensed for commercial use and the Incheon facility is
validated and licensed to produce AIDSVAX, Celltrion would produce bulk material
that will be sold to the Company. Celltrion may also be used to manufacture
other products that VaxGen may develop in the future or products from third
parties. 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 is obligated to invest $7,000,000 to
capitalize a new corporation, VaxGen-Celltrion, Inc. (VCI), and
Celltrion will initially be the sole shareholder of VCI, receiving seven million
shares of common stock in exchange for its $7,000,000 capital contribution. The
funding of the $7,000,000 capital contribution was completed in December 2002.
The capitalization of VCI has been used to design and construct the
manufacturing facility adjacent to VaxGens research facility in South San
Francisco, California. The Company plans to use this facility to manufacture its
anthrax vaccine if it is awarded a U.S. Government contract to produce an
emergency stockpile of the vaccine. The Company will supervise the design and
construction of this manufacturing facility and is responsible for all costs
relating to capital expenditures, validation, operation and licensure of the
facility in excess of the original $7,000,000 contribution by Celltrion. For
every dollar expended by the Company in connection with capital expenditures,
validation, operation and licensure of the facility in excess of the original
$7,000,000 contribution by Celltrion, VCI will issue to the Company one share of
VCI common stock.


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. 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 six months ended June 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.

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

|8. Related
Party Transactions


As of June 30, 2003, the
Company had loans outstanding to two executive officers in the amount of
$135,000. In May 2002, an executive received a non-interest bearing loan in the
amount of $80,000. The loan per the executives employment agreement will
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. In August 2000, an executive
received a non-interest bearing loan in the amount of $55,000. Both loans were
made to assist in the purchase of residences in connection with
employment-related relocations.


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

|                                 | Three months endedJune 30, |  | Six months endedJune 30, |           
|-------------------------------- | -------------------------- |  | ------------------------ | ----------
|
|                                 |                            |  |                          |           
|Net loss                         |                            |  | $                        | (9,655,000
|Net unrealized gains (losses) on |                            | 
|investment securities            |                            |  |                          | (134,000  
|                                 |                            |  |                          |           
|Comprehensive loss               |                            |  | $                        | (9,789,000
|                                 |                            |  |                          |           

|16
|--

|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.


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, the financial
statements for the fiscal year 2002 and for the second, third and fourth fiscal
quarters of 2001 were restated on our Form 10-K/A filed on November 19,
2003. Financial statements for the second fiscal quarter of 2003 and 2002 are
restated in this Form 10-Q/A. Restated financial statements reflect adjustments
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. The
warrants provide for cash redemption by the warrant holders upon occurrence of
certain events outside the control of the Company. As such, the Company has
reclassified the warrants from equity to a liability.


The following discussion
should be read in conjunction with the accompanying restated financial
statements as of and for the three and six month periods ended June 30, 2003 and
2002. For additional information on the restatement, refer to note 2 to the
Financial Statements.


CRITICAL
ACCOUNTING POLICIES AND ESTIMATES


Our discussion and
analysis of our operating results and financial condition is 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:

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

| |  | 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.


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 June 30, 2003, we had $946,000 of deferred costs
and $3,348,000 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 45% as of June 30, 2003. During the
quarter ended June 30, 2003, the Company, as a result of its increasing direct
and indirect 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 six months ended June 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;
| | - | --------------------------------------------------------------------------------------------------------------------

|18
|--

| |  | 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.




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 August 1, 2003, Genentech owned
approximately 7% of our outstanding common stock.


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 commenced 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. Although we intend to
continue analyzing data from this trial and to complete a second Phase III trial
in Thailand, 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 August 2000, we
completed the initial inoculation and enrollment of over 2,500 volunteers for
the Thai Phase III clinical trial, which is being conducted in 17 clinical
centers in Bangkok. We completed the fieldwork for this trial during the second
quarter of 2003 and expect to announce clinical results during the fourth
quarter of 2003. We will not know the results from the clinical trial until we
unblind the data immediately prior to public announcement. As occurred with our
North American/European trial, the Thai trial may fail to achieve its primary
endpoint. If the trial fails to achieve its primary endpoint, we may discontinue
developing AIDSVAX. The U.S. Food and Drug Administration (FDA) has
designated our HIV/AIDS vaccine candidates Fast Track Products for the
prevention of HIV infection. The Fast Track designation could enable more rapid
regulatory review of AIDSVAX if and when we submit a Biologics License
Application (BLA). We are required under our license with Genentech
to submit a BLA for AIDSVAX by May 2006. If we fail to do so or otherwise are
unable to extend this date, Genentech may terminate our license agreement or
convert the license to a non-exclusive license.

19
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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.
Celltrion contributed funds to a joint venture, VCI for the purpose of funding
the first $7,000,000 of construction cost for a smaller manufacturing facility
adjacent to our research facility in South San Francisco, California. This
smaller facility was originally intended to support the licensure and commercial
launch of AIDSVAX, if the North American and European clinical trial was
successful, but is also designed to support the manufacture of other
biopharmaceutical products, including our anthrax vaccine candidate or products
from third parties. In the event that AIDSVAX is proven successful and the
Incheon facility is validated and licensed to produce AIDSVAX, Celltrion would
produce bulk material that will be sold to us. However, in the event that we
abandon the development of AIDSVAX, we believe the Incheon facility could be
used to manufacture other biopharmaceutical products, in which we would share in
the profits based on our percentage ownership. After all rounds of financing are
complete, our fully-diluted ownership of Celltrion will be approximately 44%.
Although we have no further funding obligation to Celltrion, we are responsible
for certain future costs related to capital expenditures, validation, operation
and licensure of VCIs manufacturing facility in South San Francisco,
California in excess of Celltrions original $7,000,000 investment. At the
end of each calendar year, VCI will issue to us one share of VCI common stock
for every dollar expended by us in connection with capital expenditures,
validation, operation and licensure of the facility in excess of the original
$7,000,000 contribution by Celltrion. To date, our investment in VCI is
$5,662,000.


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 $16,200,000 to
advance the development of a vaccine candidate initially developed by the
USAMRIID. If results from the Phase I clinical trial are positive, NIAID may
elect, at least 60 days prior to December 31, 2003, to extend the contract. If
the contract were to be extended, we would be eligible for an additional
contract award of approximately $15,000,000 beginning in late 2003 and running
through 2007 as a continuation of the current contract to support a Phase II
clinical trial. Performance under the current contract may position us to be
awarded additional contracts expected to be awarded in 2003 to advance the
product development of an anthrax vaccine; conduct a large-scale Phase II
clinical trial; and manufacture an emergency stockpile of anthrax vaccine under
an Investigational New Drug Application (IND). Our current business
plan is highly dependent on our ability to win these additional contracts, and
we cannot be certain whether we will be awarded any additional contracts or the
timing of any such awards. If we fail to obtain the next contract to advance the
development of our vaccine, we may be unable to raise additional funds to
continue development of our other product candidates and fund operations.


Also in September 2002,
we were awarded a $1,000,000 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 $3,300,000. 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
start date of the clinical trial has been delayed due to matters outside of our
control, but is now currently scheduled to begin 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.

20
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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 June 30, 2003 we
have incurred total costs of $84,655,000 in research and development of AIDSVAX
since we began operations in late 1995. For the six months ended June 30, 2003,
we incurred costs of $2,821,000 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 June 30, 2003, we have incurred total costs of $3,191,000 towards this
project, of which $946,000 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 $4,200,000 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.


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 amongst 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. Along with Milestones 1 and 2, 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;
| | - | -------------------------------------------------------------------

|21
|--

| |  | the
uncertainty related to our 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 $5,902,000 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.


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

|Six months ended
June  30, 2003 compared to the six months ended June 30, 2002


Revenue


Research grant and
contract revenue increased from $238,000 for the six months ended June 30, 2002
to $3,677,000 for the six months ended June 30, 2003. The revenue for the six
months ended June 30, 2003 primarily consisted of contract revenue with NIAID
related to the completion of the first and second milestones in the development
of a new anthrax vaccine which amounted to approximately $2,559,000; funds
received as reimbursements under a collaborative agreement with BBI Biotech
which amounted to approximately $424,000; two Small Business Innovation Research
(SBIR) grants that are funded by NIAID which amounted to
approximately $656,000; and revenue related to WRAIR which amounted to
approximately $39,000. Related party service fee revenue of $307,000 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 5%, from $8,956,000 for the six months ended June 30, 2002 to
$9,361,000 for the six months ended June 30, 2003. The net increase was due
primarily to personnel costs which rose in the first six months of 2003 by
$1,900,000 reflecting expenses required to staff a regulatory and quality
services organization as well as the staffing necessary to develop, validate and
operate a manufacturing facility. In addition, expenses relating to the anthrax
vaccine project, principally for subcontractor costs, increased in the first six
months of 2003 by $854,000. These increased expenses were partially offset by a
reduction in clinical trial expenses of $2,100,000 for the first six months of
2003 due to the completion of the North American and European AIDSVAX trial. 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 39%, from $6,069,000 for the six months ended
June 30, 2002 to $8,465,000 for the six months ended June 30, 2003. Of this
increase, approximately $853,000 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 (expense) income, net


Other (expense) income,
net, increased 120%, from $2,017,000 for the six months ended June 30, 2002 to
$4,430,000 for the six months ended June 30, 2003. The increase is primarily due
to the effect of mark-to-market adjustments relating to the valuation of
warrants issued in our 2001 Redeemable Convertible Preferred Stock financing. In
addition, there was an offsetting decrease in investment income of $780,000 in
the first six months of 2003 that was primarily attributable to lower average
balances of cash, cash equivalents and investment securities, along with lower
yields.

23
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|Minority
interest in subsidiary losses


Minority interest in
subsidiary losses was $584,000 for the six months ended June 30, 2003 reflecting
Celltrions share of the net loss of VCI during that period.


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


Revenue


Research grant and
contract revenue increased from $220,000 for the three months ended June 30,
2002 to $2,565,000 for the three months ended June 30, 2003. The revenue for the
three months ended June 30, 2003 primarily consisted of contract revenue with
NIAID related to the completion of the second milestone in the development of a
new anthrax vaccine which amounted to approximately $1,892,000; funds received
as reimbursements under a collaborative agreement with BBI Biotech which
amounted to approximately $202,000; two SBIR grants that are funded by NIAID
which amounted to approximately $447,000; and revenue related to WRAIR which
amounted to approximately $24,000. Related party service fee revenue of $206,000
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 24%, from $4,299,000 for the three months ended June 30, 2002
to $5,336,000 for the three months ended June 30, 2003. The net increase was due
primarily to personnel costs which rose in the three months ended June 30, 2003
by $865,000 due to salary and benefits expenses required to staff a regulatory
and quality services organization expenses for staffing necessary to develop,
validate and operate a manufacturing facility. Expenses for the anthrax vaccine
project, principally for subcontractor costs, increased by $1,162,000 in the
three months ended June 30, 2003. These increased expenses were partially offset
by a reduction in clinical trial expenses of $754,000 for the three months ended
June 30, 2003 due to the completion of the North American and European AIDSVAX
trial. 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 28%, from $3,141,000 for the three months
ended June 30, 2002 to $4,010,000 for the three months ended June 30, 2003. Of
this increase, approximately $307,000 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, personnel 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. Compensation costs increased due to the hiring of additional staff
required to support the expanding infrastructure of our operations. 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. 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 (expense) income, net


Other (expense) income,
net, changed from $1,347,000 for the three months ended June 30, 2002, to
$(848,000) for the three months ended June 30, 2003. The decrease is primarily
due to the effect of mark-to-market adjustments relating to the valuation of
warrants issued in our 2001 Redeemable Convertible Preferred Stock financing.
Also, investment income decreased $381,000, primarily attributable to lower
average balances of cash, cash equivalents and investment securities, along with
lower yields.

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

|Minority
interest in subsidiary losses


Minority interest in
subsidiary losses was $168,000 for the three months ended June 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 $14,599,000 and our working capital position was
$6,740,000 at June 30, 2003. We have financed our operations since inception
primarily through capital provided by Genentech, sales of our common stock, an
issuance of redeemable 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 sale 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. In the event
that there is no earlier conversion, we must redeem the Series A Redeemable
Convertible Preferred Stock for cash on May 23, 2004, at a redemption price
equal to $1,000 per share plus all accrued and unpaid dividends. We may within
certain limits, pay up to 50% of such redemption price in shares of our 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, AIDSVAX, for commercial-scale
manufacturing as well as for the development of new adjuvants and for general
corporate purposes. As of June 30, 2003, 585 shares of Series A Redeemable
Convertible Preferred Stock remained outstanding, which are convertible into
203,833 shares of common stock.


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, 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. Any future
financing at a price below $2.87 would cause a further adjustment in the number
of shares issuable upon exercise and the exercise price.


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, 2003, our gross investment in equipment and
leasehold improvements was $7,120,000. 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 six months
ended June 30, 2003 was $11,507,000, primarily representing expenditures for
research and development costs and general and administrative expenses in excess
of revenues from grants and contracts as compared to $12,161,000 for the six
months ended June 30, 2002.

25
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|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 six months ended June 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 six
months ended June 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 June 30, 2003, the South
Korean investors had contributed to Celltrion approximately $43,750,000 of the
$50,000,000 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 Celltrion.


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 $16,200,000 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. We will recognize revenue based on the
completion of future milestones, which have been specified by NIAID. Revenues
and 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 July 2003, we had received payments of approximately
$6,639,000 from NIAID since the award date for this contract.

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

|Also 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 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 six months ended June 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 $348,000 in grant revenue relating to
the second phase of the award for the six months ended June 30, 2003.


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.




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/A, 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 June 30, 2003, we
had $14,599,000 of cash and cash equivalents and investment securities. We
believe that our existing cash and cash equivalents and investment securities,
together with investment income and funds primarily from existing government
contracts and grants, will enable us to meet our forecasted expenditures through
the first quarter of 2004, but our existing capital resources will not be
sufficient to commercialize AIDSVAX. In addition, we have based this estimate on
assumptions that may prove to be wrong. In addition, our independent accountants
have expressed doubt about our ability to continue as a going concern. Even if
we are technically able to successfully develop AIDSVAX in light of our recent
clinical trials, we expect additional development efforts and clinical trials
will add several years to the development timeline and result in substantial
additional expense. We are unable to fund these efforts with our current
financial resources. In addition, unless we receive the next government contract
to advance development of our anthrax vaccine, we will need to obtain additional
funding to support our vaccine candidates as well as to continue operations past
the first quarter of 2004. We do not know if additional financing will be
available, at all or on acceptable terms. Any additional equity financing will
be dilutive to existing stockholders, and debt financing, if available, may
involve restrictive covenants. Collaborative arrangements will require us to
relinquish our rights to certain technologies drug candidates or marketing
territories. If we fail to raise sufficient funds, we would have to curtail or
cease operations.

27
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|We depend on the
award of government contracts, which involve the coordination of several
government agencies, for the development of our anthrax vaccine. The process of
procuring government contracts is lengthy and uncertain. If we fail to obtain
future contracts to pursue advanced development of our anthrax vaccine, or
provide an emergency stockpile, we may not be able to commercialize the product
and we may be unable to raise additional funds to continue operations.


We have entered into a
contract with the NIH to develop an anthrax vaccine. The contract requires us to
provide a plan for how we could manufacture an emergency stockpile of at least
25 million doses. However, the contracts for advanced development and the
emergency stockpile are each subject to separate awards, which we must compete
for. The process of obtaining government contracts is lengthy and uncertain, and
we cannot be certain that we would be awarded these contracts. Our current
business plan is highly dependent on obtaining these additional contracts. If we
fail to win these awards, we may be unable to raise additional funds to continue
our operations beyond the first quarter of 2004.


In addition, the federal
government has undertaken multiple commitments to help secure improved
countermeasures against bio-terrorism, including those, which might arise from
the illegal use of smallpox and anthrax. The determination of when and whether a
product is ready for use and large scale purchase will be made by a combination
of authoritative organizations, including the FDA, the NIH, the CDC, and the
Department of Homeland Security. In addition, President Bush has proposed and
Congress is actively considering measures to speed up the review of
countermeasure products by the NIH, the review process by the FDA and the final
government procurement contracting authority. Although project BioShield was
passed by the House of Representatives in July 2003 by a vote of 421 to 2, we
cannot predict the timing of enactment of pending legislation nor can we predict
the decisions that will be made in the future by various government agencies.


Clinical
development is a long, expensive and uncertain process, and delay or failure can
occur at any stage of our clinical trials. We may not succeed in our efforts to
develop AIDSVAX based on our preliminary results and not meeting the primary
endpoint of the Phase III clinical trial.


We must provide the FDA
and foreign regulatory authorities with clinical data that demonstrate the
safety and statistically significant efficacy of our product candidates before
they can be approved for commercial sale. Clinical development is a long,
expensive and uncertain process, and delay or failure can occur at any stage of
our clinical trials. AIDSVAX is our most advanced product candidate. Earlier
this year we announced data from the first of two Phase III clinical trials for
AIDSVAX, in which we failed to meet the primary endpoint of the trial, but did
observe some evidence of efficacy in certain racial subgroups. We will need to
modify the vaccine in order to continue developing it for use in a broad
population. In addition, we believe that we will have to conduct additional
clinical trials of AIDSVAX in order to obtain approval from the FDA either in a
broad patient population or in any particular subgroups. These development
efforts and subsequent clinical trials are lengthy and expensive, and the
outcome is uncertain. Even with modifications, we may discover that AIDSVAX
fails to protect individuals from contracting HIV. If we are unable to
successfully develop AIDSVAX, we will be unable to generate revenue from this
product opportunity, and our stock price is likely to decline.

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

|We have limited
experience in developing other types of vaccines and products, such as smallpox
and anthrax vaccines, and may be unable to develop other vaccines and products,
which could adversely affect our ability to execute our business strategy, our
business and our financial condition.


Part of our business
strategy is to develop biologic products for the prevention and treatment of
human infectious diseases. In September 2002, we were awarded a contract from
NIAID to develop a new anthrax vaccine and to create a feasibility plan to
manufacture an emergency stockpile of 25 million doses. In December 2002, we
entered into agreements with Kaketsuken to initiate development of
Kaketsukens attenuated smallpox vaccine for use in the United States. We
have only limited experience in developing other types of vaccines and products,
so we may not be able to develop either an effective anthrax vaccine or a
smallpox vaccine for use in the United States or receive the appropriate
regulatory approvals to distribute either vaccine candidate in the U.S. If these
development efforts fail, it could adversely affect our ability to execute our
business strategy, our business and our financial condition.


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


Completion of our
clinical trials, and announcement of results of the trials could be delayed for
a variety of reasons, including:
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

| |  | our principal third-party investigators may not perform our clinical trials on our
anticipated schedules or consistent with our clinical trial protocols, or
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------

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

|Our development costs
will increase if we have material delays in our clinical trial or if we need to
perform more or larger clinical trials than planned. If the delays are
significant, our financial results and the commercial prospects for our products
and product candidates will be harmed, and our prospects for profitability will
be impaired. Furthermore, our inability to complete our clinical trials in a
timely manner could jeopardize our ability to obtain regulatory approval.


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, 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.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 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.
| | - | -------------------------------------------------------------------------------------

|29
|--

| |  | 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.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The FDA or foreign regulators may not approve our manufacturing processes or manufacturing
facilities, or may require additional clinical studies to establish the safety, purity and
potency of our product candidates.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Even if United States regulatory approval for any product 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.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 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 cGMPs regulations.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|If the government
fails to continue funding or purchasing products we manufacture, our business
will be harmed.


We have received funding from the U.S.
government for the development of an anthrax vaccine. Changes in government budgets and agendas may
result in future funding to be decreased and de-prioritized. Furthermore, we cannot be certain of
the timing of any future funding. The failure of the U.S. government to continue to fund our
research and development programs would harm our business. Similarly, if we develop any anthrax
vaccine candidate that is approved by the FDA, the U.S. government is likely to be our largest
customer for this product. The failure of the U.S. government to place sufficient orders for this
product or to place orders on a timely basis would be harmful to our future business. Even if the
U.S. government were to become a customer, we would be subject to additional governmental contract
requirements, and future sales would depend, in part, on our ability to meet those requirements,
certain of which may be onerous or even impossible for us to satisfy


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


The approval requirements
of vaccines used to fight bio-terrorism are still evolving, and we cannot be
certain that any vaccines we develop, if effective, would meet the approval
requirements of regulatory authorities. We are developing products based upon
current policies regulating these vaccines. Our business is subject to
substantial risk because these policies may change quickly and unpredictably and
in ways that could impair our ability to obtain regulatory approval of these
products.


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. 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:

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

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

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

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

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

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


Several of our
competitors 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.
In addition, several of these companies are developing new drug therapies and
other treatments that may mitigate the impact of the disease. Our competitors
are also 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 easier to administer; or
| | - | ----------------------------

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

|Even if we are successful
in developing effective drugs, obtaining FDA and other required regulatory
approvals and commercializing them, our products may not compete effectively
with these products or 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. Many of the organizations competing
with us 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.


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, 2003, we
had an accumulated deficit of approximately $155,493,000. We expect to incur
substantial losses in the future.


Our South Korean
manufacturing joint venture may not be successful.


In February 2002, we
entered into a joint venture, Celltrion, with a group of South Korean investors
for the purpose of building and operating a manufacturing facility in Incheon,
South Korea, and a smaller manufacturing facility in South San Francisco. We
have not yet completed the full capitalization of, or the transfer of all
technology to, Celltrion. Celltrion will be unable to complete its
capitalization and unable to build a 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 AIDSVAX or other
biopharmaceutical products.

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

|Even if Celltrion
successfully builds its manufacturing facilities, we cannot be certain that the
facilities will pass domestic or foreign regulatory approvals or be able to
manufacture the vaccine candidates we are developing or third parties
products in commercial quantities, on a cost-effective basis or at all.


In addition, the
political, social and economic situation of South Korea, and the stability of
the Korean peninsula as a whole, may not continue to provide an environment in
which we would be able to manufacture the vaccine candidates we are developing
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 us to conduct our 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 AIDSVAX or other vaccines or products, or if it becomes commercially
impractical for Celltrion to manufacture those products, we may not recoup the
cost of our investment, and our business and results of operations will suffer.


Our use of
hazardous materials, chemicals and viruses exposes us to potential liabilities.


Our research and development
involves the controlled use of hazardous materials, chemicals, and viruses.
Although we believe that our safety procedures for handling and disposing of
such materials comply with the standards prescribed by state and federal
regulations, we cannot completely 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.


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


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 $25,000,000. 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.

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

|Legislation
limiting or restricting liability for medical products used to fight
bio-terrorism 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 bio-terrorism 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 United States
government may authorize the introduction and use of a qualified medical product
(possibly the anthrax vaccine, currently under development with government
funding, and the smallpox vaccine) prior to either 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
bio-terrorism. 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 currently have product liability
insurance in the amount of $25,000,000. However, we cannot be certain that our
current insurance will cover such claims, or that adequate insurance coverage
can be obtained.


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


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. Similarly
products developed to treat or combat the threat of bio-terrorism will be
subject to changing political and social environments. The political and social
responses to the HIV/AIDS epidemic and to bio-terrorism 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.


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


We are highly dependent
on our senior management and scientific staff, particularly Lance Gordon, Ph.D.,
our Chief Executive Officer, 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, negotiating
business development opportunities, developing the vaccine and conducting
clinical trials. If we lose the services of any key members of senior management
and scientific staff and we are unable to recruit replacements where we deem it
necessary, we may be unable to achieve our business objectives.


Failure to protect
our intellectual property or infringing on the intellectual property rights of
others could harm our business and cause our stock price to fall.


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 or other products. We rely on patent and other intellectual
property protection to prevent our competitors from manufacturing and marketing
AIDSVAX and other products. 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:

33
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | obtain patents;
| | - | ---------------

| |  | protect
trade secrets;
| | - | ----------------------

| |  | operate without infringing upon the proprietary rights of others; and
| | - | ---------------------------------------------------------------------

| |  | prevent
others from infringing on our proprietary rights.
| | - | ---------------------------------------------------------

|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.


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


We intend to rely
on third parties for the production, sales or marketing 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.


Since inception we have
been primarily focused on research and development of AIDSVAX. We lack any sales
or marketing history, and as of present do not have plans on developing
internally such capability. 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. We are
also 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, although they have consented to our participation
in Celltrion, our South Korean manufacturing joint venture. 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.


Our license agreement
with Genentech, 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 the first market approval 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 all of 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.

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

|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 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
Preferred Stock and warrants to purchase common stock for aggregate proceeds of
$20,000,000. As of June 30, 2003, there were 585 shares of Series A Preferred
Stock and warrants to purchase 608,658 shares of common stock outstanding. The
terms of our Series A Preferred Stock, and the warrants, give the holders the
right to require us to redeem all of the outstanding Series A Preferred Stock,
common stock issued on exercise of the warrants, and/or the warrants, under
certain circumstances, including:
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | on May 23, 2004, with respect to the Series A Preferred Stock;
| | - | --------------------------------------------------------------

| |  | at
a 15% premium upon a change of control; and
| | - | ----------------------------------------------

| |  | at a 20% premium if we breach certain of our obligations under the purchase agreements, if
our stock is delisted or not quoted on an approved stock exchange or the Nasdaq National
Market or Small Cap Market for 5 consecutive days or if we are insolvent or certain
actions are 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, if any of
these circumstances were to happen they would require the expenditure of a
significant amount of cash that could substantially exceed the proceeds that we
received in the private placement.


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.


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 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.


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.

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

|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 June 30, 2003, our
stockholders equity was $15,551,000 and our closing stock price on August
1, 2003 was $4.24. 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;
| | - | -------------------------------------------------------------------

|36
|--

| |  | 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.




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 June 30, 2003, we held
government debt instruments and corporate obligations in the principal amount of
$6,705,000. If market interest rates were to increase immediately and uniformly
by 10% from levels at June 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 six months
ended June 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.

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

|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.

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

|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                                           
|     |                           | Incorporation.                                                                
|     |                          
|3.2  |                           | Amendment to
the Amended and Restated Certificate of Incorporation.           
|     |                           |                                                                               
|3.3  |                           | Amended and
Restated Bylaws                                                   
|     |                          
|4.1  |                           | Reference is
made to Exhibits 3.1, 3.2                                        
|     |                           | and 3.3.                                                                      
|     |                          
|4.2  |                           | Certificate
of Designations, Rights and                                       
|     |                           | Preferences
of Series A 6% Cumulative                                         
|     |                           | Convertible
Preferred Stock.                                                  
|     |                          
|4.3  |                           | Securities
Purchase Agreement by andamong Registrant and Certain Stockholders.
|     |                           |                                                                               
|4.4  |                           | Registrant
Rights Agreement by andamong Registrant and Certain Stockholders.  
|     |                           |                                                                               
|     |                          
|4.5  |                           | Form of Common
Stock Purchase Warrant.                                        
|     |                          
|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)             

|(b) Reports
on Form 8-K:


A current report on Form
8-K, dated May 13, 2003, was filed with the Securities and Exchange Commission,
reporting under Item 7 the press release announcing our first quarter financial
results.


A current report on Form
8-K, dated May 20, 2003, was filed with the Securities and Exchange Commission,
reporting under Item 5 that on May 19, 2003, we commenced the offering of
1,742,160 shares of our common stock at $2.87 per share pursuant to our Form S-3
shelf registration statement and that on May 20, 2003, we issued a press release
announcing that we had raised $5,000,000, through the sale of 1,742,160 shares
of our common stock to a single institutional investor.

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

|A current report on Form
8-K, dated May 28, 2003, was filed with the Securities and Exchange Commission,
reporting under Item 5 that we announced the U.S. Food and Drug Administration
has cleared the Investigational New Drug application for our anthrax vaccine
candidate.


A current report on Form
8-K, dated June 6, 2003, was filed with the Securities and Exchange Commission,
reporting under Item 5 that we commenced the offering of 1,591,307 shares of our
common stock at $4.3989 per share pursuant to our Form S-3 shelf registration
statement.


A current report on Form
8-K, dated June 9, 2003, was filed with the Securities and Exchange Commission,
reporting under Item 5 that we raised $7,000,000 through the sale of 1,591,307
newly issued shares of common stock to a single institutional investor.


A current report on Form
8-K, dated June 11, 2003, was filed with the Securities and Exchange Commission,
reporting under Item 5 that we were awarded a phase 2 Small Business Innovation
Research grant from the National Institute of Allergy and Infectious Diseases, a
part of the U.S. National Institutes of Health, to identify novel antigens for
potential use in future HIV vaccine candidates.


A current report on Form
8-K, dated June 24, 2003, was filed with the Securities and Exchange Commission,
reporting under Item 5 that we opened our new biopharmaceutical manufacturing
facility in South San Francisco, California.

40
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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)
|------------------------ |  | ---------------------------------------------------------------------------------------------------------------------------------

|41
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