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UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, DC 20549





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FORM 10-Q





(MARK ONE)





| | x |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------




| |  ̈ |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM
                     TO                     .
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------




Commission File Number 000-31275





LARGE SCALE BIOLOGY CORPORATION


(Exact name of registrant as specified in its
charter)





Delaware

77-0154648(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)





3333 Vaca Valley Parkway, Suite 1000, Vacaville, CA 95688


(Address of principal executive offices and zip code)





(707) 446-5501


(Registrants telephone number, including area code)





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





The number of shares outstanding of registrants common stock, as of October 31,
2001:





CLASS

NUMBER OF SHARES OUTSTANDINGCommon Stock $0.001 par value

24,582,489





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LARGE SCALE BIOLOGY CORPORATION


FORM 10-Q


FOR THE QUARTER ENDED SEPTEMBER 30, 2001





TABLE OF CONTENTS





PagePART I  FINANCIAL INFORMATIONItem 1.

Financial StatementsCondensed Consolidated Balance Sheets as of September 30, 2001 (Unaudited) and December 31, 2000

1Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2001 and 2000 (Unaudited)

2Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2001 and 2000 (Unaudited)

3Notes to Condensed Consolidated Financial Statements

4Item 2.

Managements Discussion and Analysis of Financial Condition and Results of Operations

6PART II  OTHER INFORMATIONItem 2.

Changes in Securities and Use of Proceeds

19Item 6.

Exhibits and Reports on Form 8-K

19





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PART IFINANCIAL INFORMATION





Item 1.Financial Statements





LARGE SCALE BIOLOGY CORPORATION





CONDENSED CONSOLIDATED BALANCE SHEETS





September 30, 2001

December 31, 2000(Unaudited)ASSETSCurrent assets:Cash and cash equivalents


$   27,002,000




$   40,030,000Marketable securities


31,145,000




44,971,000Prepaid expenses and other current assets


4,796,000




1,923,000Total
current assets


62,943,000




86,924,000Property, plant, and equipment, net


19,138,000




13,270,000Intangible assets, net


4,323,000




5,015,000Other assets


863,000




1,734,000$   87,267,000




$106,943,000LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable


$      3,237,000




$     4,534,000Accrued expenses


1,299,000




803,000Current portion of long-term debt


285,000




2,048,000Deferred revenue and customer advances


588,000




8,686,000Total
current liabilities


5,409,000




16,071,000Long-term debt


321,000




423,000Long-term deferred revenue


297,000




657,000Total
liabilities


6,027,000




17,151,000Stockholders equity:Common stock, issued and outstanding:September 30, 200124,582,489
shares; December 31, 200024,446,325 shares


190,647,000




190,097,000Stockholders notes receivable


(50,000
)



(65,000
)Deferred compensation


(3,255,000
)



(5,208,000
)Accumulated deficit


(106,102,000
)



(95,032,000
)Total
stockholders equity


81,240,000




89,792,000$   87,267,000




$106,943,000











See accompanying notes to condensed consolidated financial statements.




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LARGE SCALE BIOLOGY CORPORATION





CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS


(Unaudited)





Three months ended September 30,

Nine months ended September 30,2001

2000

2001

2000Revenues

$   5,129,000


$   6,338,000


$17,053,000


$17,572,000Costs and expenses:Development agreements

681,000


2,561,000


3,216,000


6,405,000Research and development

5,794,000


3,913,000


16,376,000


11,648,000General, administrative and marketing

3,781,000


2,235,000


10,266,000


5,432,000Stock compensation bonus




7,268,000





7,268,000Amortization of goodwill and
               purchased intangibles

325,000


325,000


975,000


872,000Total
costs and expenses

10,581,000


16,302,000


30,833,000


31,625,000Loss from operations

(5,452,000
)

(9,964,000
)

(13,780,000
)

(14,053,000
)Other income (expense):Interest income

660,000


757,000


2,793,000


1,101,000Interest expense

(9,000
)

(91,000
)

(83,000
)

(276,000
)Change in fair value of warrant




(1,365,000
)




(811,000
)Total
other income (expense)

651,000


(699,000
)

2,710,000


14,000Net loss

$  (4,801,000
)

$(10,663,000
)

$(11,070,000
)

$(14,039,000
)Net loss per sharebasic and diluted

$             (0.20
)

$              (0.60
)

$              (0.45
)

$              (1.15
)Weighted average shares outstanding      basic and diluted

24,573,282


17,749,193


24,536,891


12,186,960











See accompanying notes to condensed consolidated financial statements.




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LARGE SCALE BIOLOGY CORPORATION





CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


(Unaudited)





Nine months ended September 30,2001

2000Cash flows from operating activities:Net loss

$(11,070,000
)

$(14,039,000
)Adjustments to reconcile net loss to net cash flows used in operating activities:Depreciation of property, plant and equipment

2,968,000


2,539,000Amortization of intangible assets

1,138,000


1,097,000Accrued interest and amortized discount on marketable
securities

568,000


(136,000
)Issuance of common stock for services

7,000


Stock compensation expense

1,953,000


9,216,000Change in fair value of warrant




811,000Changes in assets and liabilities:Prepaid expenses and other current
assets

(2,873,000
)

(1,805,000
)Other assets

348,000


(480,000
)Accounts payable

1,201,000


(93,000
)Accrued expenses

885,000


(18,000
)Deferred revenue and customer advances

(8,458,000
)

(7,060,000
)Net cash
used in operating activities

(13,333,000
)

(9,968,000
)Cash flows from investing activities:Purchase of marketable securities

(49,955,000
)

(37,861,000
)Proceeds from matured marketable securities


63,213,000


11,053,000Capital expenditures

(11,334,000
)

(2,152,000
)Increase in intangible assets

(446,000
)

(1,151,000
)Net cash
provided by (used in) investing activities

1,478,000


(30,111,000
)Cash flows from financing activities:Proceeds from issuance of common stock

154,000


90,227,000Proceeds from issuance of long-term debt




745,000Proceeds from stock note payments

15,000


8,000Change in restricted cash

523,000


408,000Principal payments on long-term debt

(1,865,000
)

(1,609,000
)Net cash
provided by (used in) financing activities

(1,173,000
)

89,779,000Net increase (decrease) in cash and cash equivalents

(13,028,000
)

49,700,000Cash and cash equivalents at beginning of period

40,030,000


6,975,000Cash and cash equivalents at end of period

$27,002,000


$56,675,000








See accompanying notes to
condensed consolidated financial statements.




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LARGE SCALE BIOLOGY CORPORATION





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)





1.    The Company and Summary of Significant Accounting Policies





Large Scale Biology Corporation and its subsidiaries (collectively the
Company) applies its proprietary proteomics and functional genomics technologies to develop products and establish commercial collaborations with pharmaceutical, biotechnology, agricultural, chemical and other life science companies. The
Company maintains its headquarters and a research facility in Vacaville, California, a processing facility in Owensboro, Kentucky and an additional research facility in Germantown, Maryland.





The Company was founded in 1987 to develop the GENEWARE ® system, a viral-based gene expression technology in plants that enables the discovery, development and production of new
biopharmaceuticals and gene-based agricultural products. The Companys proprietary systems are supported by patents, patent applications and exclusive technology licenses.





The Company acquired 92.5% of Large Scale Proteomics Corporation (Proteomics) in February 1999 and the remaining 7.5% in March
2000. Proteomics automated, high-throughput ProGEX  system provides a snapshot of the protein composition, or
proteome, of cells and tissues, and is being used to rapidly identify changes in proteins that are associated with important biological conditions such as diseases or with a therapeutic or toxic effect of a drug.





In August 2000, the Company sold shares of common stock in its initial public
offering.





Basis of PresentationThe accompanying
unaudited Condensed Consolidated Financial Statements have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form
10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the
opinion of the Companys management, all adjustments (consisting of only normal recurring adjustments) considered necessary for a fair presentation have been included. The interim financial information is not necessarily an indication of the
results that may be expected for the entire year.





The unaudited
Condensed Consolidated Financial Statements include the accounts of Large Scale Biology Corporation and its subsidiaries. All intercompany balances and transactions have been eliminated. The interim financial information should be read in
conjunction with the Audited Consolidated Financial Statements and Notes thereto for the year ended December 31, 2000, included in the Companys annual report on Form 10-K which was filed with the Securities and Exchange Commission on April 2,
2001.





Use of EstimatesThe preparation of financial
statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent
assets and liabilities at the date of the financial statements and the reported revenues and expenses during the period. Actual results could differ from those estimates.





Revenue RecognitionRevenues are derived from development agreements consisting of research funding, technology access fees,
milestone payments and government grants. Research funding revenue is recognized as services are performed and expenses are incurred. The Companys development agreements generally provide for continued access by its partners to technologies
developed under such agreements over the life of the development agreement. As a result, technology access fees and milestone payments received are deferred because their receipt does not represent the culmination of the earnings process. Revenue
from technology access fees is recognized on a straight-line basis over the life of the development agreement. Revenue related to




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milestone payments is recognized on a straight-line basis from the date of completion of the specified milestone over the remaining life of the development agreement. The life of a development
agreement is based on the terms of the agreement and does not include renewal periods, unless renewal is assured. Grant revenue is recognized as expenses are incurred and billed, except that revenue received for equipment purchases is deferred and
recognized as revenue over the life of the related equipment.





Net Loss Per ShareBasic net loss per share is computed by dividing the net loss for the period by the weighted average number of common shares outstanding during the
period. Diluted net loss per share is computed by dividing the net loss for the period by the weighted average number of common shares and any dilutive potential common shares that were outstanding during the period. The weighted average numbers of
shares for potentially dilutive securities are 327,689 and 7,938,471 for the three months ended September 30, 2001 and 2000, respectively, and 523,972 and 11,168,632 for the nine months ended September 30, 2001 and 2000, respectively, and are
composed of incremental common shares issuable upon the exercise of stock options and warrants, and, during 2000, common shares issuable on conversion of convertible preferred stock. These shares were excluded from diluted loss per share because of
their anti-dilutive effect. Therefore, diluted net loss per share is the same as basic net loss per share.





2.    Dow Agreement and Related Warrant





The Company entered into a Collaboration and License Agreement (the Dow Agreement) with The Dow Chemical Company and its subsidiary Dow AgroSciences LLC (collectively
Dow) in September 1998. The research collaboration under the Dow Agreement terminated on August 31, 2001. The Dow Agreement provided funding for sponsored genomics research, technology access fees and payments for the achievement of
certain research milestones. The Company is entitled to all funding received regardless of the results of the research. Accordingly, no obligation to repay or repurchase technology has been recorded. The Dow Agreement also provides for royalty
payments from Dow if and when Dow sells products that result from the research collaboration. Revenues from Dow represented 90% and 89% of total revenues during the three months ended September 30, 2001 and 2000, respectively, and 89% and 87% of
total revenues during the nine months ended September 30, 2001 and 2000, respectively. During 1998, the Company received a cash payment of $10,000,000 from Dow in exchange for access to the Companys technologies and a warrant granted to Dow to
purchase 1,848,091 shares of the Companys common stock subject to certain vesting provisions. The Company allocated $1,392,000 of that payment to the warrant and $8,608,000 to deferred revenue based on the estimated fair market value of the
warrant. The access fees were amortized to revenue over the three-year term of the research collaboration under the Dow Agreement, and each research milestone payment was amortized over the remaining term of the research collaboration under the Dow
Agreement from the date each milestone was achieved. As of September 30, 2001, other current assets included $3,395,000 owed to the Company by Dow which was paid in October 2001. The Company purchased from Dow certain intellectual property rights
and other rights accruing to Dow under the research collaboration for $2,150,000 in October 2001.





3.    Stockholders Equity





In April 2001, the Company adopted a stockholder rights plan. Under the plan, rights were distributed as a dividend at a rate of one right for each share of common stock held by
stockholders of record as of the close of business on May 4, 2001, and subject to specified exceptions and limitations set forth in the rights plan, for any share of common stock that becomes outstanding thereafter. The rights plan was not adopted
in response to any specific attempt to acquire the Company or its common stock. The rights will expire on April 27, 2011.





4.    Collaboration with Biosite Diagnostics Incorporated





In January 2001, the Company entered into a collaboration with Biosite Diagnostics Incorporated (Biosite) to generate the antibody and protein target components required to produce
the first generation of commercial protein biochips. In response to a lawsuit between Biosite and a third party over the use of certain technologies, the Company suspended work under this collaboration in September 2001, pending further evaluation
by the Company of the issues raised in that lawsuit. The Company is not a party to that lawsuit and still plans to pursue a commercial biochip business, using alternative technology, if necessary.




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Item 2.Managements Discussion and Analysis of Financial Condition and Results of Operations





You should read the following discussion and analysis by our management of our financial condition and results of operations in
conjunction with our unaudited condensed consolidated financial statements and the accompanying notes included elsewhere in this report and the 2000 audited consolidated financial statements and the accompanying notes included in our annual report
on Form 10-K filed with the Securities and Exchange Commission on April 2, 2001. This Managements Discussion and Analysis of Financial Condition and Results of Operations and other parts of this report contain forward-looking statements that
involve risks and uncertainties, including statements regarding managements expectations concerning future revenues and expense levels, capital expenditures and interest income, and other expectations regarding future operating results. Our
actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, the factors discussed under the heading Factors That May
Affect Our Business below.





Overview





Large Scale Biology uses its proprietary proteomics and functional genomics technologies to develop products and establish commercial
collaborations with pharmaceutical, biotechnology, agricultural, chemical and other life sciences companies, to enable the transformation of proteomic and genomic information into multiple product opportunities, such as drug targets, therapeutics
and diagnostics for drug effectiveness and toxicity.





Before
February 1999, we were primarily engaged in the development and commercialization of genomics technologies. In February 1999, we acquired 92.5% of the outstanding common stock of Large Scale Proteomics Corporation, or Proteomics, a company primarily
engaged in the development of proteomics technologies. In March 2000, we acquired the remaining 7.5% of Proteomics common stock. We used the purchase method of accounting to record this acquisition.





In September 1998, we entered into a research collaboration and license agreement, or the Dow Agreement,
with The Dow Chemical Company and its subsidiary Dow AgroSciences LLC, or collectively, Dow. Under the Dow Agreement, we received funding for sponsored genomics research, technology access fees and payments when we reached specific research
milestones. We are entitled to royalties if and when Dow sells products that result from this collaboration. Revenues from the Dow Agreement represented 90% and 89% of our revenues during the three months ended September 30, 2001 and 2000,
respectively, and 89% and 87% of our revenues during the nine months ended September 30, 2001 and 2000, respectively.





On August 31, 2001, our research collaboration with Dow concluded. Consequently, we expect no future revenues relating to the research collaboration. We purchased from Dow certain
intellectual property rights and other rights accruing to Dow under the research collaboration for $2,150,000 in October 2001. While we are eligible to receive royalty payments from Dow in the future under the Dow Agreement, we do not expect to
receive revenues from Dow in the foreseeable future. We have reallocated research personnel who were working on the Dow research collaboration to internally funded projects. Therefore, we do not expect our research and development expenses to
decrease significantly as a result of the expiration of the research collaboration, except for direct costs of materials. Dows rights to the use of our proprietary GENEWARE ® technology in agricultural applications are now non-exclusive. Consequently, we are free to pursue business arrangements in this
field on an unrestricted basis. Until we enter into new collaboration agreements, future revenues and operating margins will be significantly lower than those we have reported for prior periods.





As a result of our investment in our technologies, we have incurred significant losses in each year
since our inception in 1987. As of September 30, 2001, we had an accumulated deficit of $106.1 million. We expect additional losses as we expand our research and development efforts, make investments in strategic collaborations and enhance our
technologies.




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In January 2001, we entered into a
collaboration with Biosite Diagnostics Incorporated, or Biosite, to generate the antibody and protein target components required to produce the first generation of commercial protein biochips. In response to a lawsuit between Biosite and a third
party over the use of certain technologies, we suspended work under this collaboration in September 2001, pending further evaluation by us of the issues raised in that lawsuit. We are not a party to that lawsuit and still plan to pursue a commercial
biochip business, using alternative technology, if necessary.





The
Company announced on September 14, 2001 the possible repurchase of up to 1 million shares of its common stock for cash in open market, negotiated or block transactions from time to time at market prices and as market conditions warrant. This was a
limited share repurchase plan authorized solely in connection with the resumption of trading following September 11. No shares were purchased under this plan which has subsequently expired.





Our Phase I clinical trial of the GENEWARE produced non-Hodgkins lymphoma vaccines has completed
enrollment and we are now awaiting completion of the study. In our search for proteins linked to various diseases, we have entered into new research collaborations to expand our Molecular Anatomy and Pathology database, a portfolio of
disease-associated human proteins that may be useful as drug targets and/or diagnostic markers. We believe our investments in these and other projects will enhance the value of our technologies and our future revenue opportunities, but will result
in continuing losses through at least 2003.





Results of Operations





| | Comparison of the Three and Nine Months Ended September 30, 2001 and 2000
| | -------------------------------------------------------------------------




Revenues.Revenues for the three months ended September 30, 2001 were $5.1
million, a decrease of $1.2 million, or 19%, from the three months ended September 30, 2000. Revenues for the nine months ended September 30, 2001 were $17.1 million, a decrease of $0.5 million, or 3%, from the nine months ended September 30, 2000.
For the three and nine months, revenues earned under the Dow Agreement were $4.6 and $15.1 million during 2001 and $5.6 and $15.3 million during 2000, respectively. Increases in revenues of $0.9 million for the three months and $3.3 million for the
nine months from the amortization of milestone payments were offset by decreases in revenues of $1.9 million for the three months and $3.5 million for the nine months from Dow research and development. The research collaboration under the Dow
Agreement terminated on August 31, 2001. Therefore, revenues from the Dow Agreement in 2001 will be less than in 2000. We expect revenues for the fourth quarter of 2001 and beyond to decrease significantly until we are able to secure new
collaboration agreements that generate substantial revenues.





Development agreement expenses.Development agreement expenses for the three and nine months ended September 30, 2001 were $0.7 and $3.2 million, a
decrease of $1.9 and $3.2 million, or 73% and 50%, respectively, from the corresponding 2000 periods. These decreases are attributable to a reduced level of research activity under the Dow Agreement. Research activities under the Dow Agreement
accounted for $0.4 million for the three months and $2.4 million for the nine months during 2001, and $2.2 million for the three months and $5.3 million for the nine months during 2000. We expect that development agreement expenses will continue to
decrease until we establish significant new collaborations.





Research and development expenses.Research and development expenses for the three and nine months ended September 30, 2001 were $5.8 and $16.4
million, an increase of $1.9 and $4.7 million, or 48% and 41%, respectively, over the corresponding 2000 periods. For the three and nine months, respectively, these increases are primarily the result of $0.7 and $1.8 million used for expanded
operations and new personnel at Proteomics and $0.3 and $1.0 million for new personnel and wage rate increases at our Vacaville and Owensboro facilities. The remainder of these increases is largely the result of the reassignment of research
personnel who were working on the Dow Research collaboration to internally funded projects.




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We expect that this reassignment
of research personnel will increase unreimbursed research and development expenses for the fourth quarter of 2001, and increase quarterly research and development expenses for 2002 in comparison to 2001. However, because of cost control measures
that we have recently implemented, including a freeze on new hires, we expect that unreimbursed research and development expenses will increase at a more moderate rate than in the past from the fourth quarter of 2001 throughout 2002. We expect to
reevaluate our resource allocation plans when new collaborations or other contracts are signed.





General, administrative and marketing expenses.General, administrative and marketing expenses for the three and nine months ended September 30, 2001
were $3.8 and $10.3 million, an increase of $1.5 and $4.8 million, or 69% and 89%, respectively, over the corresponding 2000 periods. For the three and nine months, respectively, these increases are primarily the result of $0.5 and $1.6 million of
salaries for new business development, finance and legal personnel and wage rate increases in Vacaville, $0.5 and $0.6 million of increased spending on developing our patent portfolio, $0.2 and $1.1 million of increased costs associated with our
operating as a public company and $0.1 and $0.9 million of increased spending for expanded operations and new administrative personnel at Proteomics. We expect general, administrative and marketing expenses to be significantly higher for the fourth
quarter of 2001 as compared to the corresponding quarter of 2000. However, because of cost control measures that we have recently implemented, including a freeze on new hires, we expect that quarterly general, administrative and marketing expenses
will increase at a more moderate rate than in the past from the fourth quarter of 2001 throughout 2002.





Stock compensation bonus.The stock compensation bonus of $7.3 million for 2000 was a noncash charge incurred for stock options that we issued to
certain key officers and employees in December 1999 which vested upon the completion of our IPO.





Amortization of goodwill and purchased intangibles.The amortization of goodwill and purchased intangibles of $0.3 million for each of the three
months ended September 30, 2001 and 2000 and $1.0 and $0.9 million for the nine months ended September 30, 2001 and 2000, respectively, relate to our purchase of Proteomics. We expect amortization charges for goodwill and purchased intangibles to be
approximately $0.3 million for the fourth quarter of 2001.





Interest income (expense).Interest income decreased to $0.7 million for the three months ended September 30, 2001, from $0.8 million for the
corresponding 2000 period, primarily due to lower interest rates. Interest income increased to $2.8 million for the nine months ended September 30, 2001, from $1.1 million for the corresponding 2000 period, due to the investment of the proceeds from
our initial public offering of common stock, or IPO, in the third quarter of 2000. We expect interest income in 2001 to be more than interest income in 2000 as the proceeds from our IPO are invested over an entire year. However, we anticipate that
quarterly interest income for the fourth quarter of 2001 and during 2002 will decrease from each preceding quarter due to planned expenditures and the current trend of decreasing interest rates.





Change in fair value of warrant.The noncash charge of $1.4 and $0.8
million for the three and nine months ended September 30, 2000, respectively, relates to the increase in the fair value of a warrant we issued to Dow in connection with the Dow Agreement. This warrant had a put option that would have
required us to repurchase common stock issued to Dow upon exercise of the warrant. This put option expired upon the effective date of our IPO. Consequently, the warrant liability was reclassified to permanent equity and no subsequent
gains or charges will be incurred.





Liquidity and Capital Resources





From our inception through September 30, 2001, we funded our operations primarily through payments from
our collaborative agreements, private sales of our equity securities, debt and warrant financing and our IPO.





At September 30, 2001, we had cash and cash equivalents of $27.0 million and marketable securities of $31.1 million. Net cash used in operating activities of $13.3 million in the
nine months ended September 30,




8


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2001 was principally due to $21.9 million paid to our suppliers and employees, partially offset by $3.3 million of research funding received under the Dow Agreement, $3.3 million from interest
from our investments and $2.0 million from other agreements. In the future, for us to achieve positive net cash flow from operating activities, we believe we must enter into new revenue generating collaboration agreements and carefully manage the
level of internally funded research and development activities.





Net cash provided by investing activities of $1.5 million in the nine months ended September 30, 2001 was principally due to $13.3 million of net proceeds from the purchase and
sale of marketable securities, partially offset by $11.3 million for purchases of property, plant and equipment and $0.4 million for increases in intangible assets. Our total planned expenditures for property, plant and equipment during 2001 are
approximately $13.2 million. We anticipate that capital expenditures will be substantially less in 2002 than in 2001. However, we may require additional capital expenditures upon signing new collaborations or other contracts. We will continue to
consider using a portion of our cash to acquire or invest in complementary businesses, products or technologies, or to obtain the right to use such complementary technologies.





Net cash used in financing activities of $1.2 million in the nine months ended September 30, 2001 was primarily the result of $1.3 million
of net principal payments on long-term debt, partially offset by $0.2 million received from the exercise of stock options.





In the future, our liquidity and capital resources will depend upon, among other things, the level of our research and development activities, clinical, regulatory and marketing
expenses and funding from collaborations. We believe that our cash and cash equivalents and our marketable securities, together with revenues from our collaborations and other sources will be adequate to fund our anticipated cash and working capital
requirements at least through December 31, 2002. During or after this period, if our capital resources are insufficient to meet our future capital requirements and expenses, we may need to sell additional equity or debt securities or obtain
additional credit arrangements. Additional financing may not be available on terms acceptable to us or at all. The sale of additional equity or convertible debt securities may result in dilution to our stockholders.





Recently Issued Accounting Standards





In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 141, or SFAS No. 141, Business Combinations and
Statement of Financial Accounting Standard No. 142, or SFAS No. 142, Goodwill and Other Intangible Assets.SFAS No. 141 addresses the initial recognition and measurement of goodwill and other intangible assets acquired in a business
combination and SFAS No. 142 addresses the initial recognition and measurement of intangible assets acquired outside of a business combination whether acquired individually or with a group of other assets. SFAS No. 142 also addresses the recognition
and measurement of goodwill and other intangible assets subsequent to their acquisition. SFAS No. 141 is applicable to business combinations beginning July 1, 2001. We are required to adopt SFAS No. 142 on January 1, 2002. We expect that the
adoption of these statements will not have a material effect on our financial position, results of operations and cash flows.





In October 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standard No. 144, or SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets. SFAS No. 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets. We are required to adopt SFAS No. 144 on January 1, 2002. We have not yet evaluated the effects of the adoption of this
statement on our financial position, results of operations and cash flows.





Factors That May Affect Our Business





We operate in a rapidly changing environment that involves a
number of risks, some of which are beyond our control. The following discussion highlights some of these risks and others are discussed elsewhere in this Report.







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This Report on Form 10-Q contains forward-looking statements within the meaning of
the federal securities laws, which involve risks and uncertainties. These forward-looking statements are not historical facts but rather are based on current expectations, estimates and projections about our business and industry, beliefs and
assumptions. We use words such as anticipates, expects, intends, plans, believes, seeks, estimates and variations of these words and similar expressions to identify
forward-looking statements. These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, some of which are beyond our control, are difficult to predict and could cause actual results to differ
materially from those expressed or forecasted in the forward-looking statements. These risks and uncertainties include those described below and elsewhere in this Report. You should not place undue reliance on these forward-looking statements, which
reflect our managements view only as of the date of this Report. Except as required by law, we undertake no obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise.





Risks Related To Our Business





| | We have a history of losses and cannot predict when we will become profitable, if at all
| | ----------------------------------------------------------------------------------------




We have had net losses in each year since our inception in 1987. We sustained a net loss of $11.1
million in the nine months ended September 30, 2001 and had an accumulated deficit of $106.1 million as of September 30, 2001. The research collaboration under the Dow Agreement terminated on August 31, 2001 and we expect no additional revenues
under the Dow Agreement for several years. We have not yet entered into any new collaborations that could make up for the decrease in cash flow resulting from the termination of the Dow collaboration. We expect to continue to spend significant
amounts to develop products, fund research and development, and to enhance our core technologies. As a result we will need to generate significant additional revenues from collaborations and the commercialization of our products and technologies to
achieve profitability. We expect to incur substantial losses in the foreseeable future. If we are unable to enter into new collaborations, control our operating expenses and successfully commercialize our products and technologies, we may never
become profitable.





| | We are at an early stage of development, and we may not be able to successfully develop and commercialize our products and technologies
| | ---------------------------------------------------------------------------------------------------------------------------------------




We are in an early stage of development as an operating
company, and we are subject to all the risks inherent in the development of a business enterprise, including the need for substantial capital to support the development of our products and technologies. We have had limited revenue from contract
research and development services and collaborations.





Our
anticipated products, including a novel vaccine for the treatment of non-Hodgkins lymphoma, or NHL, and our initiative to be a protein and antibody content provider for biochips, most likely will require that we enter into new collaborations
before we can manufacture and market them. Vaccines are also subject to the governmental regulatory process. Because we are in new and developing fields, and our research focuses on new and unproven technologies, our therapeutic vaccines, drugs and
proteins that we develop may not be effective in humans, or may not meet regulatory requirements for safety and efficacy. In addition, even if we successfully develop a product, there may not be a substantial commercial market for that product.





| | We are in new and developing fields and there may not be a market for our products and technologies
| | ---------------------------------------------------------------------------------------------------




Our research is fundamentally unique and we cannot assure the acceptance of its scientific merit or the
benefits of products produced by it, or that the public will react favorably to it. Protein-based gene expression products and technologies, including our plant-derived proteins and our ProGEx system and GENEWARE technology, have limited commercial
precedent. The usefulness of the information and products generated by our proteomics and functional genomics technologies is unproven, and our collaborators and potential collaborators may determine that they are not useful or cost-effective. In
addition, we must develop these new products and technologies in time to meet market demand, if any. If we fail to do so, it is likely that other technologies and companies will predominate and we will not be able to earn a sufficient return on our
investment.




10


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| | We may require additional capital
| | ---------------------------------




In order for us to remain competitive so we can develop profitable and cash-positive operations, we must generate revenue from our products under development
and our technologies, including our ProGEx and GENEWARE systems. Changes in our business may occur that would consume available capital resources significantly sooner than we expect. In addition, the risks inherent in developing innovative products,
such as a protein biochip or the NHL vaccine, make it difficult to forecast with certainty the capital required to commercialize our products. If our capital resources are insufficient to meet future capital requirements and expenses, we will have
to raise additional funds. If we raise additional funds by issuing equity securities, our existing stockholders may be diluted. We may raise this capital through public or private financings or additional collaborations, strategic partnerships or
licensing arrangements. While we cannot predict our need for additional capital in the future, the amount required may be substantial. If we are unable to raise sufficient additional capital, we will have to curtail or cease operations.





| | Alternative technologies may supersede our technologies or make them non-competitive
| | ------------------------------------------------------------------------------------




Genomics, proteomics and biomanufacturing fields are intensely competitive. They are characterized by
extensive research efforts, which result in rapid technological progress. If our competitors succeed in developing products or technologies that are more effective than ours or that render our products or technologies obsolete or noncompetitive, our
business will suffer. Many universities, public agencies and established pharmaceutical, biotechnology, chemical and other life sciences companies with substantially greater resources than we have are developing and using technologies and are
actively engaging in the development of products similar to or competitive with our products and technologies. Like us, our competitors are using proteomics and genomics technologies to identify potential drug targets, therapeutic proteins and
diagnostic marker proteins. In addition, our competitors have developed databases containing gene sequence, gene expression, genetic variation or other genomic information and are marketing or plan to market their data to pharmaceutical,
biotechnology, chemical and other life sciences companies. To remain competitive, we must continue to invest in new and existing technologies, expand our databases and improve our bioinformatics software, including proprietary software used with our
ProGEx system.





Our competitors may devise faster, more complete or
more accurate methods to obtain proteomic and functional genomic information than our ProGEx and GENEWARE systems. There has been and continues to be substantial academic and commercial research effort devoted to the development of such methods. If
a successful competitive method is developed, it could undermine the commercial basis for the products and technologies we intend to provide.





| | We may not be able to enter into collaborations necessary to fully develop and commercialize our products and technologies, and we will be dependent on our
collaborators if we do
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




We intend to
independently pursue some therapeutic product applications into the development stage. However, we expect to develop and commercialize most of our future products in collaboration with pharmaceutical, biotechnology, agricultural, chemical and other
life sciences companies. Our success will depend in large part on our ability to enter into future collaborations with other companies for the research and development, pre-clinical and clinical testing and the regulatory approval and
commercialization of our products. Our reliance upon these companies for these capabilities will reduce our control over such activities and could make us dependent upon them. To date, we have entered into only a limited number of collaborations.
Generally, the scope of these collaborations has been to demonstrate the function of plant genes and the feasibility of using viral vectors to create proteins in plants and to identify marker proteins for drug development and diagnostics. Our
existing agreements generally provide us with rights to participate financially in the commercial development of products resulting from the use of our technologies. We may be unable to obtain such rights in future collaborations. In addition,
unforeseen delays or complications could arise and result in the breach of our contractual obligations with our collaborators and others, or render our technologies unable to perform at the quality and capacity levels required for success.




11


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| | Conflicts with our collaborators or licensees could harm our business
| | ---------------------------------------------------------------------




Conflicts with our collaborators could have a negative impact on our relationships with them, including on our revenues to be derived
from certain of these relationships, and impair our ability to enter into future collaborations, either of which could adversely affect our business. Collaborators could develop competing products, preclude us from entering into collaborations with
their competitors or terminate their agreements with us prematurely. Moreover, disagreements could arise with collaborators or licensees over rights to our intellectual property, our rights to share in any of the future revenues from products or
technologies resulting from use of our technologies, our rights to payments for achievement of milestones or our performance of research and development activities on behalf of collaborators, or our activities in separate fields may conflict with
other business plans of our collaborators or licensees.





| | We must enter into agreements with third parties to provide sales and marketing services, or develop these capabilities on our own, if we are to successfully
commercialize our products and technologies
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




Although we plan to enter into sales and marketing arrangements with third parties, we may not be able to enter into these arrangements on favorable terms, if at all. If we cannot
enter into these arrangements, we must develop a sales and marketing force with sufficient technical expertise to generate demand for our products and technologies. Our inability to develop or contract for effective sales and marketing capabilities
would significantly impair our ability to develop and commercialize our products.





| | We may not be able to successfully manufacture products in commercial quantities or at acceptable costs
| | -------------------------------------------------------------------------------------------------------




We have only produced proteins on a small, test scale. The failure of our
technologies to provide safe, effective, useful or commercially viable approaches to the discovery and development of drug targets and proteins which can be used as therapeutics would significantly limit our business plan and future growth.





| | We may be unable to recruit and retain senior management and other key scientific personnel on whom we are dependent
| | --------------------------------------------------------------------------------------------------------------------




The loss of one or more of our senior management or other key scientific personnel
could have a material adverse effect on our business and could inhibit our research and development and commercialization efforts. Although we have entered into employment agreements with some of our key personnel, these employment agreements are
for a limited period of time and most of our key personnel are not subject to employment agreements. There is currently a shortage of skilled senior management in the biotechnology industry, which is likely to continue and intensify. In addition, we
face competition for research scientists and technical staff from other companies, academic institutions, government entities, nonprofit laboratories and other organizations. Failure to recruit and retain senior management and scientific personnel
on acceptable terms would prevent us from achieving our business objectives.





| | Concentration of ownership among our existing executive officers, directors and principal stockholders enables them to collectively control all significant
corporate decisions
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




Our directors, our
executive officers and entities affiliated with our directors and our executive officers beneficially own, in the aggregate, approximately 43% of our outstanding common stock as of September 30, 2001. These stockholders as a group will most likely
be able to elect our directors and officers, control our management and affairs and be able to control most matters requiring the approval of our stockholders, including any merger, consolidation or sale of all or substantially all of our assets and
any other significant corporate transaction. The concentration of ownership will also prevent a change of control of our Company at a premium price if these stockholders oppose it, and may discourage third parties from making a proposal to cause a
change of control in the first instance.




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| | Our stockholder rights plan and provisions of our charter documents and Delaware law may inhibit a takeover, which could adversely affect our stock price
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------




We have adopted a stockholder rights plan
and declared a dividend distribution of one right for each outstanding share of common stock to stockholders of record as of May 4, 2001. Subject to certain specified exceptions and limitations under the rights plan, we will continue to issue one
right for each share of common stock that becomes outstanding after May 4, 2001. Each right entitles the holder to purchase one unit consisting of one one-hundredth of a share of our Series A Junior Participating Preferred Stock for $45 per unit.
Under certain circumstances, if a person or group acquires 15% or more of our outstanding shares of common stock, holders of the rights (other than the person or group causing their exercisability) will be able to purchase, in exchange for the $45
exercise price, shares of our common stock or of any company into which we are merged having a value of $90. In addition, the board of directors has the option, under certain circumstances, to exchange each right (other than rights held by the
person or group triggering the board of directors option) for a share of common stock for no additional consideration on the part of the holder of the right. The rights expire on April 27, 2011. Our rights plan could make it more difficult for
a third party to acquire us (or a significant percentage of our outstanding capital stock) by causing substantial dilution of the stock ownership of a person or group attempting to acquire control of us. Our rights plan may have the effect of
discouraging these attempts because a potential acquirer would have to negotiate with our board of directors to avoid suffering dilution.





Provisions in our charter and bylaws and applicable provisions of the Delaware General Corporation Law may also make it more difficult for a third party to
acquire control of us without the approval of our board of directors. These provisions may make it more difficult or expensive for a third party to acquire a majority of our common stock or delay, prevent or deter a merger, acquisition, tender offer
or proxy contest, which may adversely affect our stock price.





Risks Related to Our Industry





| | If companies in the pharmaceutical, biotechnology, agricultural, chemical and life sciences industries do not succeed or their demand for our products and
technologies decreases, then our revenues could be reduced
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




We expect to derive our revenues primarily from products and technologies provided to the pharmaceutical, biotechnology, agricultural, chemical and life sciences industries.
Accordingly, our success will depend directly on the success of companies in these industries and their demand for our products, services and technologies. Our operating results may fluctuate substantially due to reductions and delays in research
and development expenditures by companies in those industries, or their unwillingness or inability to use our products and technologies. These reductions and delays may result from factors which are not within our control, such as:





| |  |  | changes in economic conditions generally
| | - |  | ----------------------------------------




| |  |  | the extent to which companies in these industries conduct research and development involving proteomics and functional genomics in-house or through industry consortia;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | the extent to which genomic information is or is not made publicly available;
| | - |  | -----------------------------------------------------------------------------




| |  |  | consolidation within one or more of these industries;
| | - |  | -----------------------------------------------------




| |  |  | changes in the regulatory environment affecting these industries;
| | - |  | -----------------------------------------------------------------




| |  |  | pricing pressures
| | - |  | -----------------




| |  |  | market-driven pressures on companies to consolidate and reduce costs; and/or
| | - |  | ----------------------------------------------------------------------------




| |  |  | other factors affecting research and development spending in these industries.
| | - |  | ------------------------------------------------------------------------------




| | If competitive products are better than our products, then our business may fail
| | --------------------------------------------------------------------------------




The markets for protein development and production, including human and veterinary therapeutics and
vaccines like the ones we are developing, are highly competitive. Virtually all of the genes in the human genome




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have been sequenced and have been substantially identified. We face significant competition in our protein product development and production efforts from entities using alternative, and in some
cases higher volume and larger scale, approaches for the same purpose. Competitors with substantially greater resources are actively developing products similar to or competitive with our products and potential products. Our competitors may succeed
in developing products or obtaining regulatory approval before we do or in developing products that are more effective than those we develop or propose to develop. A large number of universities and other not-for-profit institutions, many of which
are funded by the U.S. and foreign governments, are also conducting research to discover genes and their functions. Any one or more of these entities may discover and establish a patent position in one or more of the genes or proteins that we wish
to commercialize.





In addition, several pharmaceutical,
biotechnology, chemical and other life sciences companies engage in research and development in the use of unique gene expression systems to produce therapeutic proteins. These competitors may develop products earlier or obtain regulatory approvals
faster than we may be able to, or develop products that are more effective than ours. At least one of our major competitors, Oxford Glycosciences, Plc., is located in Europe, and our ability to use our patent rights to prevent competition in the
creation and use of proteomics-driven products and technologies is more limited outside of the United States. New developments are expected to continue, and discoveries by others may render our products and technologies noncompetitive, which could
lead to the failure of our business.





| | We may not have access to sufficiently complete, accurate or defect-free data from outside sources, including genome sequence data, which would increase our
costs and could affect our product development efforts
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




The efforts of the Human Genome Project and private companies to create a complete catalog of the human genome may not enable us to fully integrate that data with our proprietary
protein databases. In addition, we obtain our data from other sources, including our academic collaborators and our sources of cell and tissue samples. This data could contain errors or other defects which could corrupt our databases or increase our
costs by requiring us to use alternative methods or sources to obtain such data. In addition, these data sources may have acquired this information in a manner that violates various applicable legal requirements.





| | We and our collaborators may not obtain FDA and other approvals for our products in a timely manner, or at all
| | --------------------------------------------------------------------------------------------------------------




Drugs and diagnostic products are subject to an extensive and uncertain regulatory
approval process by the FDA and comparable agencies in other countries. The regulation of new products is extensive, and the required process of laboratory testing and human studies is lengthy, expensive and uncertain. The burden of these
regulations will fall on us to the extent we are developing proprietary products on our own. We may not be able to obtain the clearances and approvals necessary for the clinical testing, field-testing, manufacturing or marketing of our products. If
the products are the result of a collaborative effort, these burdens may fall on our collaborators or we may share these burdens with them. We may not obtain FDA or other approvals for those products in a timely manner, or at all. We may encounter
significant delays or excessive costs in our efforts to secure necessary approvals or licenses. Even if we obtain FDA regulatory approvals, the FDA extensively regulates manufacturing, labeling, marketing, promotion and advertising after product
approval. Further, once a manufacturer obtains regulatory approval, a marketed product and its manufacturer are subject to continual review, and discovery of previously unknown problems with a product or manufacturer may result in restrictions on
the product, manufacturer or manufacturing facility, including withdrawal of the product from the market. In some countries, regulatory agencies also set or approve the sale prices for drug products. Additionally, several of our product development
areas may involve relatively new technology that has not been the subject of extensive product testing in humans. The regulatory requirements governing these products and related clinical procedures remain uncertain and the products themselves may
be subject to substantial review by the FDA and foreign governmental regulatory authorities that could prevent or delay approval. Regulatory requirements ultimately imposed on our products could limit our ability to test, manufacture and
commercialize our products.




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| | If new rules issued by the USDA adversely affect us or our collaborators ability to commercialize genetically modified products, then our ability to sell
certain products and technologies will be severely impaired
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




We must comply with USDA regulations for outdoor releases of genetically engineered organisms as well as other products designed for use on or with agricultural products. The USDA
has released regulations that prohibit the inclusion of genetically modified ingredients in products labeled as organic. The USDA regulations also prohibit the use of genetically modified fibers in clothing labeled as organic. These new regulations
ultimately could make any products that may be developed with our collaborators, including Dow, unattractive to or too expensive for consumers, or could cause the government to prohibit their sale or use. In addition, the USDA prohibits growing and
transporting genetically modified plants except pursuant to an exemption or under special permits. We may use genetically modified plants as screening or production hosts. Changes in USDA policy regarding the movement or field release of genetically
modified plant hosts could adversely affect our business by increasing the cost of our products and technologies or decreasing consumer demand for those products and technologies or causing the government to prohibit their sale or use.





| | Future legal and regulatory requirements may limit or discourage the use of certain genetically engineered organisms and products, which could reduce our
revenues
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------




The FDA currently applies the same
regulatory standards to foods developed through genetic engineering as it applies to foods developed through traditional plant breeding. However, genetically engineered food products will be subject to pre-market review if these products raise
safety questions or if the FDA considers these products to be food additives. Our products and the products of our collaborators that contain genes that we identify or determine to have a particular function may be subject to lengthy FDA reviews and
unfavorable FDA determinations if the FDA considers them to be food additives or if the FDA changes its policy. Also, we believe the FDAs policy is that it will not require that genetically engineered agricultural products be labeled as such,
provided that these products are as safe and have the same nutritional characteristics as conventionally developed products. The FDA may reconsider or change its labeling policies, or local or state authorities may enact labeling requirements. Any
such labeling requirements could reduce the demand for genetically engineered products. In those products where production must be performed outdoors, the USDA prohibits manufacturers from growing and transporting genetically engineered plants
except pursuant to an exemption or a permit under strict controls. If our future products are not exempted or covered by permits by the USDA, it may be impossible to sell such products.





| | If there is negative public reaction to the use of genetically engineered products and technologies, then the market for certain products and technologies we
develop will be adversely affected
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




Future
commercial success of some of our products and of the products of some of our collaborators, will depend in part on public acceptance of the use of genetically engineered products including drugs, plants and plant products. Claims that genetically
engineered products are unsafe for consumption or pose a danger to the environment may influence public attitudes. Negative public reaction to genetically modified organisms and products could result in greater government regulation of genetic
research and resultant products, including stricter labeling requirements, and could cause a decrease in the demand for our products.





| | We may be sued for product liability and our product liability insurance may not be adequate
| | --------------------------------------------------------------------------------------------




The testing, marketing and sale of our and our collaborators products will entail a risk of
allegations of product liability, and third parties may assert substantial product liability claims against us. While we have limited product liability insurance to protect against this risk, adequate insurance coverage may not be available at an
acceptable cost, if at all, in the future and a product liability claim or product recall could materially and adversely affect our business. Inability to obtain sufficient insurance coverage at an acceptable cost or otherwise to protect against
potential product liability claims could prevent or inhibit the commercialization of the products we or our collaborators develop. If we are sued for any injury allegedly caused by our products or our collaborators products, our liability
could exceed our total assets and our ability to pay the liability.




15


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| | If we use hazardous materials in our business in a manner that causes injury or violates laws, we may be liable for substantial damages
| | ---------------------------------------------------------------------------------------------------------------------------------------




Our research and development processes involve the use of
hazardous materials, including chemicals and radioactive and biological materials. Our operations also produce hazardous waste products. The chemicals we use include, but are not limited to, flammable solvents such as methanol and ethanol, ethidium
dye which is a commonly used fluorescent dye for visualizing DNA, and buffer solutions used in the purification of DNA. We also use several radioisotopes including phosphorous-32, carbon-14, sulfur-35, phosphorous-33, iodine-125 and hydrogen-3. We
cannot eliminate the risk of accidental contamination or discharge and any resultant injury from these materials. Federal, state and local laws and regulations govern the use, manufacture, storage, handling and disposal of these materials. We could
be subject to civil damages and criminal penalties in the event of an improper or unauthorized release of, or exposure of individuals to, hazardous materials. Further, it is possible that the materials we use could contaminate another partys
property. In addition, claimants may sue us for injury or contamination that results from our use or the use by third parties of these materials, and our liability may exceed our total assets and our ability to pay the liability. In addition,
compliance with environmental laws and regulations is expensive, and current or future environmental regulations may impair our research and development and production efforts. Although we have general liability insurance, these policies do not
cover claims arising from pollution from chemical or radioactive materials. Our collaborators are working with various types of hazardous materials in connection with our collaborations. In the event of a lawsuit or investigation, we could be held
responsible for any injury we or our collaborators cause to persons or property by exposure to, or release of, any hazardous materials.





| | Healthcare reform and restrictions on reimbursements may limit the financial returns from our products
| | ------------------------------------------------------------------------------------------------------




Our ability and that of our collaborators to commercialize therapeutics and
diagnostic products may depend in part on the extent to which government health administration authorities, private health insurers and other organizations will pay the cost of these products. These third parties are increasingly challenging both
the need for and the price of new medical products and services. Significant uncertainty exists as to the reimbursement status of newly approved therapeutics and diagnostics, and adequate third party reimbursement may not be available for any
product to enable us to maintain price levels sufficient to realize an appropriate return on our investment in research and product development.





Risks Related to Our Intellectual Property





| | Patent protection in the biotechnology industry is uncertain, which may result in a decrease in the value of our products and technologies
| | ------------------------------------------------------------------------------------------------------------------------------------------




We are involved in overlapping and rapidly evolving areas of
biotechnology, pharmaceutical development and basic research involving viral vectors, plant transgenics, proteomics, functional genomics and immunotherapy. Each of these areas has been the subject of intense research and patenting activity
throughout the world by our commercial competitors, actual and potential collaborators, academic institutions and government researchers. We cannot determine whether or not there are patents currently pending which, if issued, would prevent us from
practicing our core technologies, commercializing them or developing commercially viable products based upon them.





The patent positions of biotechnology firms generally are highly uncertain and involve complex legal and factual questions that will determine who has the right to develop a
particular product. No clear policy has emerged regarding the breadth of claims covered in biotechnology patents in general and those relating to gene sequences in particular. In addition, recently there has been public debate questioning whether
genomic sequence data should be patentable. The biotechnology patent situation outside the United States is even more uncertain and is currently undergoing review and revision in many countries. Changes in, or different interpretations of, patent
laws in the United States and other countries might allow others to use our discoveries or to develop and




16


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commercialize products and technologies similar to our products and technologies without any compensation to us. Our potential collaborators or customers may conclude that uncertainties about
patent protection decrease the value of our databases, products and services.





Throughout the world there are numerous issued patents, as well as published foreign patent applications which may issue as patents, many of which relate to our current operations,
our anticipated future operations and the products we are likely to develop. The scope of these patents is a matter of legal interpretation and is subject to uncertainty. We have not obtained, but we may in the future obtain, opinions from our
patent counsel that we have freedom to conduct our commercial activities free of claims of patent infringement from third parties. For example, we are aware of one company, Enzon, Inc., that through its subsidiary, SCA Ventures, Inc., owns or has
licensed a broad portfolio of patents to single-chain antigen binding proteins. Enzon, in a letter mailed to numerous companies including us, has stated that it would like to discuss providing a license under these patents. In addition, Dow owns or
controls certain patent rights in the field of viral vectors covering the infection of plant cells and the expression of foreign genes in plant cells, and has informed us that it believes that some of our plant viral activities may fall within the
scope of its patents. Two patents issued to us in October, 2001, reference the Dow-controlled patents and conclude that they do not constitute prior art. If we are unable to resolve this matter, and are found to have infringed upon Dows
rights, our product development and research activities related to plant viruses which fall within the scope of Dows patents may be delayed or terminated. These kinds of disagreements could result in costly and time-consuming litigation and
divert our financial and managerial resources.





| | Our patent applications may not result in issued patents that are enforceable
| | -----------------------------------------------------------------------------




Our disclosures in our patent applications may not be sufficient to meet the statutory requirements for
patentability in all cases. As a result, we do not know which of our patent applications will result in enforceable patents. Our patent applications may not issue as patents, and any patents that are issued to us may not provide commercially
meaningful protection against competitors. Any issued patent may not provide us with competitive advantages. Others may challenge our patents or independently develop similar products which could result in an interference proceeding in the U.S.
Patent and Trademark Office. Others may be able to design around our issued patents or develop products similar to our products. In addition, others may discover uses for genes or proteins other than those uses covered in our patents, and these
other uses may be separately patentable.





| | Public disclosure and patents relating to genes and gene sequences held by others may limit our proprietary rights
| | ------------------------------------------------------------------------------------------------------------------




The Human Genome Project and many companies and institutions have identified genes
and deposited those sequences in public databases and are continuing to do so. These public disclosures might limit the scope of our claims or make unpatentable subsequent patent applications on full-length gene sequences. We are aware of issued
patents and patent applications containing subject matter such that we or our licensees or collaborators may require a license or rights in order to research, develop or commercialize some of our products and technologies. We may find that licenses
relating to such subject matter will not be available on acceptable terms, or at all.





| | Patent infringement or enforcement litigation or interference proceedings could be costly and disrupt our business and may prevent us from commercializing our
products
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------




The technology that we use to
develop our products and key resources, and those that we incorporate in our products and technologies, may be subject to claims by third parties, including our collaborators, that they infringe the patents or proprietary rights of others.
Technologies of our collaborators may also be subject to infringement or similar claims which could impair our collaborative product development and commercialization efforts. We also may need to enforce our patent rights in actions against others,
which could be expensive. The risk of such events occurring will tend to increase as the fields of proteomics, genomics and the biotechnology




17


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industry expand, more patents are issued and other companies attempt to discover genes and proteins and engage in other proteomics, genomics and biotechnology-related businesses. With respect to
identifying proteins uniquely associated with disease states or as targets for drug therapy, we are aware that companies have published patent applications relating to nucleic acids encoding specific proteins. If the U.S. Patent and Trademark Office
issues patents to these companies, their patents may limit our ability and the ability of our collaborators to practice under any patents that may be issued to us. Also, even if the U.S. Patent and Trademark office issues us a patent, the scope of
coverage or protection afforded to the patent may be limited.





| | We may not be able to protect our know-how and trade secrets
| | ------------------------------------------------------------




We generally control the disclosure and use of our know-how and trade secrets using confidentiality agreements. It is possible, however,
that:





| |  |  | Some or all confidentiality agreements will not be honored;
| | - |  | -----------------------------------------------------------




| |  |  | Third parties will independently develop equivalent technology;
| | - |  | ---------------------------------------------------------------




| |  |  | Disputes will arise with our consultants, collaborators or others concerning the ownership of intellectual property; and/or
| | - |  | ---------------------------------------------------------------------------------------------------------------------------




| |  |  | Unauthorized disclosure of our know-how or trade secrets will occur.
| | - |  | --------------------------------------------------------------------



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PART IIOTHER INFORMATION





Item 2.Changes in Securities and Use of Proceeds





The effective date of our Registration Statement on Form S-1, as amended (Registration No. 333-34198) was August 9, 2000. The estimated use of proceeds from our IPO for working
capital set forth below includes operating expenses for research and development and for general and administrative activities. Provided below is a reasonable estimate of the amount of our net offering proceeds used in each of the following
categories, through September 30, 2001:





Construction of plant, building and facilities

$   8,877,000Purchase and installation of machinery and equipment

5,231,000Purchases of real estate

Acquisition of other businesses

Repayment of indebtedness

3,368,000Capitalized patent costs

987,000Working capital

14,832,000Temporary investments

55,461,000





There are no other
uses of net offering proceeds over $100,000. Moreover, none of the net offering proceeds were paid directly or indirectly to directors, officers, or their associates, persons owning 10% or more of any class of our equity securities, or our
affiliates.





Item 6.Exhibits and Reports on Form 8-K





(a)  List of Exhibits:





Exhibit No.

Description3.1

Amended and Restated Bylaws, as amended on July 20, 2001





(b)  Reports on Form 8-K:





| | None.
| | -----



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SIGNATURES





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





| | La | rge Scale Biology Corporation
| | -- | -----------------------------




| | /s/    MICHAEL D. CENTRON
| | -------------------------

| | By | :
| | -- | -

| | Michael D. Centron
| | ------------------

| | Treasurer and Vice President
| | ----------------------------




|Da | ted: November 13, 2001
|-- | ----------------------



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Exhibit Index





Exhibit No.

Description3.1

Amended and Restated Bylaws, as amended on July 20, 2001




21