##### Table of Contents

---




UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, DC 20549





---




FORM 10-Q





|x |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ----------------------------------------------------------------------------------------




For the quarterly period ended March 31, 2002.





| ̈ |  | 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 0-31275





LARGE SCALE BIOLOGY CORPORATION


(Exact name of registrant as specified in its charter)





Delaware

77-0154648(State or other jurisdiction of

(I.R.S. employerincorporation or organization)

identification number)





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 May 8, 2002:





Class

Number of Shares OutstandingCommon Stock $0.001 par value

24,949,144





---



---

##### Table of Contents

Some of the statements contained in this report constitute forward-looking statements that involve substantial risks and
uncertainties. In some cases, you can identify these statements by forward-looking words such as may, will, should, expect, plan, anticipate, believe,
estimate or continue and variations of these words or comparable words. In addition, any statements which refer to expectations, projections or other characterizations of future events or circumstances are forward-looking
statements. Our Managements Discussion and Analysis of Financial Condition and Results of Operations contain many such forward-looking statements. These forward-looking statements involve known and unknown risks, uncertainties and situations
that may cause our or our industrys actual results, level of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these statements.
The risk factors contained in this report, under the heading Factors That May Affect Our Business, as well as any other cautionary language in this report, provide examples of risks, uncertainties and events that may cause our actual results to
differ from the expectations described or implied in our forward-looking statements.





Although we believe that the
expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. You should not place undue reliance on these forward-looking statements, which apply only
as of the date of this report. Except as required by law, we do not undertake to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.





Large Scale Biology Corporation, LSBC, our logo, GENEWARE, PLURIGEN, ProGEx and other product names are trademarks of or registered trademarks of
Large Scale Biology Corporation in the United States and/or other countries. References in this report to the Company, our, we and us refer collectively to Large Scale Biology Corporation, a Delaware
corporation, and its predecessors and subsidiaries.




i




---

##### Table of Contents

LARGE SCALE BIOLOGY CORPORATION


FORM 10-Q


FOR THE QUARTER ENDED MARCH 31, 2002





TABLE OF CONTENTS





PagePART IFINANCIAL INFORMATIONItem 1.

Financial StatementsCondensed Consolidated Balance Sheets as of March 31, 2002 and December 31, 2001 (Unaudited)

1Condensed Consolidated Statements of Operations for the three months ended March 31, 2002 and 2001 (Unaudited)

2Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2002 and 2001 (Unaudited)

3Notes to Condensed Consolidated Financial Statements (Unaudited)

4Item 2.

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

5PART IIOTHER INFORMATIONItem 2.

Changes in Securities and Use of Proceeds

18Item 6.

Exhibits and Reports on Form 8-K

18




ii




---

##### Table of Contents

PART IFINANCIAL INFORMATION








Item 1.Financial Statements








LARGE SCALE BIOLOGY CORPORATION





CONDENSED CONSOLIDATED BALANCE SHEETS


(Unaudited)





March 31, 2002


December 31, 2001ASSETSCurrent assets:Cash and cash equivalents

$
16,350,000


$
24,055,000Marketable securities


24,811,000



24,724,000Prepaid expenses and other current assets


1,619,000



1,662,000Total current assets


42,780,000



50,441,000Property, plant, and equipment, net


18,059,000



18,882,000Intangible assets, net


4,055,000



4,207,000Other assets


3,189,000



3,382,000$
68,083,000


$
76,912,000LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable

$
2,104,000


$
1,816,000Accrued expenses


927,000



1,105,000Current portion of long-term debt


103,000



107,000Deferred revenue and customer advances


350,000



278,000Total current liabilities


3,484,000



3,306,000Long-term debt


241,000



249,000Long-term deferred revenue and customer advances


169,000



320,000Total liabilities


3,894,000



3,875,000Stockholders equity:Common stock, issued and outstanding:March 31, 200224,954,300 shares;December 31, 200124,892,989 shares


191,930,000



191,901,000Stockholders notes receivable


(47,000
)


(50,000
)Deferred compensation


(2,427,000
)


(3,093,000
)Accumulated deficit


(125,267,000
)


(115,721,000
)Total stockholders equity


64,189,000



73,037,000$
68,083,000


$
76,912,000





See accompanying notes to condensed consolidated financial statements.




1




---

##### Table of Contents

LARGE SCALE BIOLOGY CORPORATION





CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS


(Unaudited)





Three months ended March 31,2002


2001Revenues

$
425,000


$
5,981,000Costs and expenses:Development agreements


127,000



1,435,000Research and development


6,325,000



4,808,000General, administrative and marketing


3,588,000



3,003,000Amortization


156,000



325,000Total costs and expenses


10,196,000



9,571,000Loss from operations


(9,771,000
)


(3,590,000
)Other income (expense):Interest income


229,000



1,245,000Interest expense


(4,000
)


(47,000
)Total other income


225,000



1,198,000Net loss

$
(9,546,000
)

$
(2,392,000
)Net loss per sharebasic and diluted

$
(0.38
)

$
(0.10
)Weighted average shares outstandingbasic and diluted


24,933,122



24,500,550








See accompanying notes to condensed consolidated
financial statements.




2




---

##### Table of Contents

LARGE SCALE BIOLOGY CORPORATION





CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


(Unaudited)





Three months ended March 31,2002


2001Cash flows from operating activities:Net loss

$
(9,546,000
)

$
(2,392,000
)Adjustments to reconcile net loss to net cash used in operating activities:Depreciation of property, plant and equipment


1,042,000



861,000Amortization of intangible and other assets


412,000



380,000Stock compensation expense


598,000



651,000Accrued interest and amortized discount on marketable securities


(3,000
)


247,000Common stock issued for services






5,000Changes in assets and liabilities:Prepaid expenses and other current assets


43,000



(280,000
)Other assets


60,000



141,000Accounts payable


288,000



(189,000
)Accrued expenses


(82,000
)


529,000Deferred revenue and customer advances


(79,000
)


(3,159,000
)Net cash used in operating activities


(7,267,000
)


(3,206,000
)Cash flows from investing activities:Purchases of marketable securities


(9,013,000
)


(27,308,000
)Proceeds from matured marketable securities


8,929,000



28,951,000Capital expenditures


(219,000
)


(5,875,000
)Increase in intangible assets


(127,000
)


(86,000
)Net cash used in investing activities


(430,000
)


(4,318,000
)Cash flows from financing activities:Proceeds from issuance of common stock


1,000



103,000Proceeds from stockholder loan payments


3,000



13,000Change in restricted cash






169,000Principal payments on long-term debt


(12,000
)


(587,000
)Net cash used in financing activities


(8,000
)


(302,000
)Net decrease in cash and cash equivalents


(7,705,000
)


(7,826,000
)Cash and cash equivalents at beginning of period


24,055,000



40,030,000Cash and cash equivalents at end of period

$
16,350,000


$
32,204,000





See accompanying notes to condensed consolidated financial statements.




3




---

##### Table of Contents

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, functional genomics and bioprocessing technologies to develop and manufacture personalized drugs, vaccines and diagnostics for rapid
identification and effective treatment of disease. The Companys headquarters and a research facility are located in Vacaville, California, a bioprocessing facility is located in Owensboro, Kentucky, and a proteomics research facility is
located in Germantown, Maryland.





Basis of PresentationThe unaudited condensed consolidated financial statements
have been prepared by the Company in accordance with the rules and regulations of the Securities and Exchange Commission (SEC) regarding interim financial information. Accordingly, these financial statements and notes thereto do not
include certain disclosures normally associated with financial statements prepared in accordance with accounting principles generally accepted in the United States of America. This interim financial information should be read in conjunction with the
audited consolidated financial statements and notes thereto for the year ended December 31, 2001, included in the Companys Annual Report on Form 10-K.





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. In the opinion of the Companys management, the unaudited condensed consolidated financial statements include all adjustments (consisting of only normal recurring adjustments) and disclosures considered necessary for a fair
presentation of the results of the interim periods presented. This interim financial information is not necessarily indicative of the results of any future interim periods or for the Companys full year ending December 31, 2002.





Marketable SecuritiesMarketable securities at March 31, 2002 and 2001 consist of commercial paper, corporate and U.S. government
agency notes, and bank certificates of deposit all maturing within one year and are classified as held-to-maturity. The amortized cost of marketable securities at March 31, 2002 and 2001 approximates fair value. There were no significant holding
gains or losses for any of the periods shown.





Revenue RecognitionRevenues are derived from research and
collaboration agreements and government grants that consist of one or more revenue sources including research funding, technology access fees, and milestone payments. Revenue from research funding is recognized as services are performed and expenses
are incurred. The Companys collaboration agreements generally provide for continued access by the partners to technologies developed under such agreements for the life of the agreements. Accordingly, 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 term of the applicable agreement. Revenue from
milestone payments is recognized on a straight-line basis from the date of completion of the milestone to the end of the applicable agreement. The life of a collaboration agreement is based on the original term of the agreement, not including
renewal periods unless renewal is assured. Revenue from government grants 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 grant.





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 outstanding during the period, plus the potential dilutive
effect of common shares issuable upon exercise or conversion of outstanding stock options and warrants during the period. The weighted average number of potentially dilutive common shares are 167,373 and 1,435,371 for the three months ended March
31, 2002 and 2001, respectively. These shares were excluded from diluted net loss per share because of their anti-dilutive effect.




4




---

##### Table of Contents




Recently Issued Accounting StandardsIn June 2001, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standard No. 142 (SFAS 142), Goodwill and Other Intangible Assets. SFAS 142 addresses the recognition and measurement of goodwill and other intangible assets subsequent
to their acquisition. The Company adopted SFAS 142 on January 1, 2002. Adoption of SFAS 142 eliminates future amortization of goodwill and certain purchased intangible assets. As a result, amortization expense decreased to $156,000 in the three
months ended March 31, 2002 compared to $325,000 in prior year period. We expect amortization expense for subsequent quarters to be consistent with the quarter ended March 31, 2002. SFAS 142 also requires that goodwill and certain purchased
intangible assets be evaluated for impairment within six months of adoption and no less frequently than annually thereafter.








2.    Dow Contract





The Company entered into a Collaboration and
License Agreement with The Dow Chemical Company and its subsidiary, Dow AgroSciences LLC (collectively, Dow) on September 1, 1998. The collaboration portion of the agreement (Dow Collaboration) had a three-year term ending in
August 2001. Under the Dow Collaboration, the Company received funding for sponsored genomics research and payments for technology access fees and milestone achievements. The research funding was not contingent on achievement of certain results.
Accordingly, no obligation to repay any funded amounts or repurchase technology has been recorded. Revenues from the Dow Collaboration represented 87% of total revenues for the three months ended March 31, 2001. The Dow Collaboration ended in August
2001, although the Company retains royalty rights.








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





The following discussion of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and related notes included in this Report and our audited
consolidated financial statements and related notes for the year ended December 31, 2001 included in our Annual Report on Form 10-K. This discussion includes forward-looking statements, such as our projections about future results of operations that
are inherently uncertain. Our actual results could differ materially from those anticipated in our forward-looking statements as a result of many factors including, but not limited to, those discussed in Factors That May Affect Our
Business in this item.








Overview





We are a biotechnology company founded in 1987. Our primary goal is to develop therapeutic products using our proprietary technology and expertise in proteins. In addition, we are
marketing our technologies to collaborators and commercial customers. We have technological expertise in three areas: (1) proteomics, which is the study of proteins and how they change in disease and in response to drugs; (2) functional genomics,
which is the study of each proteins function; and (3) the production of proteins for commercial applications.





Our
strategy is threefold: (1) commercialize products and technologies in the field of human and animal healthcare, using proprietary methods to identify and analyze genes and proteins associated with disease; (2) provide quick and cost-effective
manufacturing of therapeutic proteins; and (3) capitalize on our leadership position with plant viral vector technology for product discovery applications in agriculture and forestry.





In recent years, the Companys revenues have been primarily derived from collaborations with others whereby we jointly attempt to develop commercial products by combining specific
technologies of each company. Between September 1998 and August 2001, we were engaged in a research collaboration with The Dow Chemical Company and its subsidiary Dow AgroSciences LLC, or collectively, Dow. Under our agreement with Dow, the Company
received funding for sponsored genomics research and payments for technology access fees and milestone achievements. We earned over $52 million in revenue from this collaboration, representing approximately 86% of our total revenues between
September 1998 and August 2001.




5




---

##### Table of Contents




The Companys recent operating results and financial position are summarized as follows:





| |  |  | The Company has incurred significant operating and net losses in each year since inception in 1987. As of March 31, 2002, the Companys accumulated deficit equaled $125.3
million.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | The Companys research collaboration with Dow, which accounted for 85% of total revenues in the year ended December 31, 2001, was completed in August 2001.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | The Company incurred negative operating cash flows of $7.3 million in the three months ended March 31, 2002 and $18.9 million and $13.0 million in the years ended December
31, 2001 and 2000, respectively.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




For the Company to generate positive earnings and operating cash flows in
2002, we must realize significant revenues and cash receipts from product sales or new collaboration agreements. Without positive operating cash flows in 2002, we will continue to consume our existing cash balance to fund internal research and
development and general and administrative activities. If that happens, we will conserve working capital by forcing significant reductions in operating expenses and reducing the rate of investment or scope of product development activities.
Additionally, we are evaluating each of our core technologies (proteomics, functional genomics, and bioprocessing), our internal research projects and our product development initiatives to emphasize near-term opportunities to generate revenue and
cash flows. The internal financial reviews of our technologies, research projects and products under development may result in the Companys decision to exit or sell one or more of our lines of business or cancel or delay one or more current
projects or products under development.








Results of Operations





Revenues.    Revenues decreased $5.6 million in the three
months ended March 31, 2002 compared to the prior year period. This decrease is primarily attributable to the completion of our research collaboration with Dow in August 2001. Revenues from Dow equaled $5.2 million in the three months ended
March 31, 2001. No revenues from Dow were realized subsequent to August 2001.





In the quarter ended March 31, 2002, we entered
into new collaborations with ApoImmune, Inc. and Weyerhauser Company. We also launched PLURIGEN  CM, our new stem
and progenitor cell growth factor formulation, which we believe exemplifies the successful application of our integrated core technologies to the development of innovative products. While these new collaborations and the product launch will not
replace the revenues from the Dow research collaboration, we believe that our investments in core technologies and product development initiatives will generate revenue opportunities for the Company in the near future.





Development agreement costs.    Development agreement costs consist mainly of personnel expenses and research materials
related to activities performed under revenue generating collaboration agreements. Development agreement costs decreased $1.3 million in the three months ended March 31, 2002 compared to the prior year period. This decrease is primarily
attributable to the completion of our research collaboration with Dow in August 2001. Development agreement costs related to the Dow research collaboration equaled $1.1 million in the three months ended March 31, 2001. We expect future
development agreement costs to fluctuate consistently with increases or decreases in revenues earned from any new collaboration agreements we may enter into during 2002.





Research and development expenses.    The largest component of research and development expenses is internal personnel. Other significant components include
consulting and outside research services and materials related to research activities. Research and development expenses increased $1.5 million, or 32%, in the three months ended March 31, 2002 compared to the prior year period. This increase
is primarily attributable to the reallocation of resources from activities associated with the Dow research collaboration to internally funded research projects. For reporting purposes, this reallocation of resources resulted in increased research
and development expenses and decreased development agreement costs (as noted above). The increase in 2002 is also due to amortization expense of intellectual property licenses purchased in 2001 and increased consumption of research materials,
primarily for our full-length cDNA project. We currently expect research and development expenses in subsequent quarters to be materially consistent with the quarter ended March 31, 2002. However, we may have to




6




---

##### Table of Contents

significantly reduce these expenses if the Company continues to experience negative operating cash flows.





The Companys major research and development projects have included our initiatives in the areas of therapeutic vaccines, endothelial cell-derived growth factor, protein and
vaccine manufacturing, protein biochips, marker and target discovery, and plant functional genomics. We cannot estimate with reasonable certainty the project completion dates or cost to complete these projects. If we are to generate significant cash
flows in the future, we believe that one or more of these projects must develop into a commercially successful product or service. Although we believe that all of our projects are important, business developments such as new collaborations with our
partners may dictate the relative emphasis and resources we place on any given project which will affect the costs and completion dates of our other projects. Alternative technologies may supersede our technologies or make them non-competitive, in
which case we would shift our resources away from projects related to these obsolete technologies. In addition, if we are unable to generate significant cash flows in the near future, we may have to delay, reduce the scope of, or eliminate one or
more of our research and development projects. Any delay in the completion of any one of our research and development projects would jeopardize the success of the product or service we expect to commercialize from that
project.





General, administrative and marketing
expenses.    General, administrative and marketing expenses largely consist of non-research personnel. General, administrative and marketing expenses increased $585,000, or 19%, in the three months ended March 31, 2002
compared to the prior year period. This increase was primarily attributable to patent filings for the Companys products and technologies including: Human full-length gene collection; PLURIGEN  CM; the Companys proteomics technology; and other products under late-stage development. We currently expect general,
administrative and marketing expenses in subsequent quarters to be consistent with, or less than the quarter ended March 31, 2002. However, we may have to significantly reduce these expenses if the Company continues to experience negative operating
cash flows.





Amortization.    Amortization expense relates to the Companys purchase of Large
Scale Proteomics Corporation in 1999. Amortization expense decreased $169,000, or 52%, in the three months ended March 31, 2002 compared to the prior year period. This decrease is attributable to the discontinuance of amortizing goodwill and certain
purchased intangibles effective January 1, 2002 in accordance with SFAS 142. We expect amortization expense for subsequent quarters to be consistent with the quarter ended March 31, 2002.





Interest income.    Interest income decreased $1.0 million, or 82%, in the three months ended March 31, 2002 compared to the prior year period. This decrease
is attributable to the Companys declining cash balances available for investment and the significant reduction in interest yields throughout 2001. Unless the Companys cash position improves, we expect interest income to continue to
decline in subsequent quarters.








Liquidity and Capital Resources





March 31, 2002


December 31, 2001Cash and marketable securities

$
41,161,000


$
48,779,000Working capital


39,296,000



47,135,000Three Months Ended March 31,2002


2002Net cash used in operating activities

$
(7,267,000
)

$
(3,206,000
)Cash used in investing activities, excluding marketable securities activity


(346,000
)


(5,961,000
)Net cash used in financing activities


(8,000
)


(302,000
)





Working capital.    Working
capital represents the Companys current assets (including cash and marketable securities) less current liabilities. We have historically funded our working capital needs through payments received from collaboration agreements and issuances of
preferred and common stock including our initial public offering of common stock in the third quarter of 2000. We utilized proceeds from the IPO to support our working capital needs in the first quarter of 2002. The rate of utilization of IPO
proceeds for the remainder of




7




---

##### Table of Contents

2002 depends on the Companys ability to generate positive cash flows from product sales or from new collaboration agreements. Based upon our current level
of operating cash flows, we expect that our cash and marketable securities balance at March 31, 2002 is sufficient to meet our working capital and capital expenditure needs through at least December 31, 2002. However, if the Company continues to
experience significant negative operating cash flows in subsequent quarters of 2002, we may need to sell additional equity or debt securities, obtain credit financing, or sell all or a portion of certain assets or technologies in order to fund our
operating activities in 2003 and beyond. Given the Companys financial position, credit financing may not be available to the Company or on terms acceptable to the Company. Also, the sale of additional equity or convertible debt securities may
result in significant dilution to our current stockholders.





Net cash used in operating activities.    Net cash used in operating activities increased $4.1 million in the three months ended March 31, 2002 compared to the prior year period. This increase in cash usage is
primarily attributable to reductions of $2.0 million and $1.3 million in cash received from collaboration agreements (primarily from Dow) and interest from cash investments, respectively. Additionally, cash operating expenses increased $470,000 in
the first quarter of 2002 as compared to the first quarter of 2001, reflecting increased investment in internal research and development projects and increased general and administrative expenses.





Cash used in investing activities, excluding marketable securities activities.    Capital expenditures decreased $5.7 million
in the three months ended March 31, 2002 compared to the prior year period. In the first quarter of 2001, the Company invested $5.1 million for capital expenditures, primarily leasehold improvements, at our proteomics research facility in
Germantown, Maryland. The Companys planned capital expenditures for 2002 are less than $2 million. This planned amount may change based upon the requirements of any new collaboration agreements we may enter into during 2002.





Net cash used in financing activities.    The decrease in net cash used in financing activities for the three
months ended March 31, 2002 compared to the prior year period is primarily attributable to lower debt repayment requirements.





Commitments





The Company leases facilities in Vacaville, California and Germantown, Maryland under operating leases. Additionally, the
Company has research sponsorship agreements with major universities, government institutions and other companies whereby we fund specific projects of interest to the Company.





The Companys non-cancelable commitments to make minimum payments under contractual obligations as of March 31, 2002 are as follows:





Apr-Dec 2002

2003

2004

2005

2006

After 5 YearsLong-term debt

$
95,000

$
49,000

$
52,000

$
54,000

$
57,000

$
37,000Operating leases


1,281,000


1,758,000


948,000


806,000


830,000


3,578,000Research agreements


417,000














Clinical trial services


434,000


154,000


134,000


162,000


169,000


License agreements


225,000














Total

$
2,452,000

$
1,961,000

$
1,134,000

$
1,022,000

$
1,056,000

$
3,615,000





In addition to the future non-cancelable minimum payments above, certain of our
research agreements require future aggregate payments of $2,350,000 if the agreements are not cancelled.





In March 2002, the
Company entered into an agreement with an organization having expertise and knowledge in clinical trials coordination and data management. This agreement will support the Phase II/III clinical trials of our Non-Hodgkins Lymphoma vaccine. The
agreement will terminate upon the earlier of (1) the completion of the Phase II/III clinical trials, or (2) February 27, 2007. The agreement requires the Company to pay a fixed amount of $1,053,000 over the term of the agreement and a variable
amount of $2,950 per patient that participates in the clinical trials. At this time, we cannot estimate with certainty the number of patients expected to participate in the Phase II/III clinical trials.





In June 2001, the Company entered into a patent license agreement that that requires the Company to pay $600,000 in the first year of the agreement for
a two-year worldwide exclusive right to specified technologies. As of March 31, 2002, $400,000 has been paid. The agreement provides extension options for exclusive or non-exclusive rights beginning in year three. Additionally, the agreement
provides the licensor an option, through June 2004, to require the Company to fund research of a laboratory associated with the licensor. If such option is exercised, the required research funding will be at least $200,000 per year.





In January 2001, the Company entered into an agreement with Biosite Inc. whereby the Company originally committed to
pay $6,760,000 over 14 months for the purchase of antibodies. Later in 2001, Biosite and Xoma Ltd. (and certain Xoma affiliates) sued each other over intellectual property issues. That litigation impacted work Biosite had agreed to do for the
Company under the agreement. Because of this litigation, the Company voided the agreement in January 2002. We have not paid and do not expect to pay any amounts to Biosite under the terms of the voided agreement.





The Company does not have any unconsolidated entities or any other arrangements with third parties that provide financing, liquidity or capital
resources to the Company.





Critical Accounting Policies





The Companys accounting policies are explained in Note 1 to the audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2001. We consider the
following accounting policies to be critical given they involve estimates and judgments made by management and are important for our investors understanding of our operating results and financial condition.





Revenue Recognition.    Revenues are derived from research and collaboration agreements and government grants that consist of
one or more revenue sources including research funding, technology access fees and milestone payments. Revenue from research funding is recognized as services are performed and expenses are incurred. The Companys collaboration agreements
generally provide for continued access by the partners to technologies developed under such agreements for the life of the agreements. Accordingly, 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 term of the applicable agreement. Revenue from milestone payments is recognized on a straight-line basis from the
date of completion of the milestone to the end of the applicable agreement. The life of a collaboration agreement is based on the original term of the agreement, not including renewal periods unless renewal is assured. Revenue from government grants
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 grant.





Intangible and Long Lived Assets.    The Companys intangible and long-lived assets include goodwill and other intangibles related to the Companys
acquisition of Large Scale Proteomics Corporation, capitalized costs of filing patent applications that relate to commercially viable technologies, capitalized license fees for rights to specified technologies, and property and equipment related to
our bioprocessing facility in Kentucky. We evaluate our intangible and long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. If such assets are
considered to be impaired, the impairment to be recognized is measured as the amount by which the carrying amount of the assets exceeds the fair value of the assets.





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 other risks are discussed elsewhere in this Report.





Risks Related To Our Business





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





We are in an early stage of
commercialization, 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 our novel vaccines 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/or 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, proteins and other therapeutics under development 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




8




---

##### Table of Contents

Protein-based gene expression products and technologies, including our plant-derived proteins, plant-based protein bioprocessing, our
ProGEx system and GENEWARE technology, have limited commercial precedent. Much of 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. The usefulness of the information and products generated by our proteomics, functional genomics and bioinformatics technologies is unproven, and our collaborators and potential collaborators may determine that they are not
useful or cost-effective. We generate large amounts of data from our research with genes and proteins and we may not be able to timely mine or integrate this data, or turn it into commercially viable information. In addition, we must complete
development of our 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.





In an environment of diminished revenue, we must take steps to preserve working capital and extend the viability of the
Company





Because we are experiencing diminished revenue and cash flow, we are internally funding virtually all of our
product development initiatives. At the same time, because our cash flow is substantially reduced compared to the last three years, we are experiencing increasing pressure to curtail spending and otherwise reduce costs. If we cannot increase our
cash flow in the very near term, we will likely be required to take one or more of the following actions: reorganize our operations; delay, reduce the scope of, or eliminate one or more of our research and development programs; significantly reduce
patent-related expenses, effectively foregoing our rights to future technologies or products; obtain funds through arrangements with collaborative partners or others that may require us to relinquish rights to certain of our technologies, product
candidates or products that we would otherwise seek to develop or commercialize on our own; or sell or license the rights to certain of our products or technologies on terms that may not be favorable to us.








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 $9.5 million in the three months ended March 31,
2002, and had an accumulated deficit of $125.3 million as of March 31, 2002. From September 1998 through August 2001, almost all of our revenues came from our research collaboration with Dow. The research collaboration with Dow ended on August 31,
2001 and we expect no additional revenues under our contract with Dow for several years. We have not yet entered into any new collaborations that could make up for the decrease in cash flow and revenues resulting from the completion of our research
collaboration with Dow. We expect to continue to spend significant amounts to develop products and to fund our operations. 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 may require additional capital





In order for us to develop profitable and cash-positive operations, we must generate revenue from our products under
development and our technologies. We have never generated enough cash during any period since our inception to cover our expenses and we expect to continue to spend substantial funds to continue our product development programs. 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 NHL vaccines, 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. We may be unsuccessful in entering into any new collaboration that results in significant revenues or cash flow. If we are unable to raise sufficient additional capital, we will have to
curtail or cease operations.








General economic conditions result in uncertainty with
respect to other companies and entities collaborating with us or otherwise dealing with us, and this can have an adverse effect on our revenues and cash flows





To a large extent, decisions by businesses and other entities to collaborate or otherwise do business with us are discretionary, and the decision making process typically takes many
months to complete. We believe that the prolonged slowdown in the U.S. economy and economies overseas has caused, and may continue to cause such potential collaborators and customers to defer decisions to work with us or access our technologies. As
a result, we expect that revenues and cash flow will be uncertain for the remainder of 2002. Therefore, it is difficult to accurately assess and predict the future demand for our products, technologies and services. If these general economic
considerations continue, such conditions will likely have a continuing, adverse effect on our revenues and operating results.




9




---

##### Table of Contents




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





Genomics, proteomics, bioprocessing and bioinformatics are fields that are intensely competitive. They are characterized by
extensive research efforts, which result in rapid technological progress which can render existing technologies obsolete or economically noncompetitive. 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.





Our competitors may devise faster, more complete or more accurate methods to obtain proteomic
and functional genomic information than our technologies and systems, including 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 would 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. We cannot guarantee that such collaborative arrangements will be available to us on
acceptable terms, or at all. 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.








Conflicts with collaborators or licensees could harm our business




10




---

##### Table of Contents

Conflicts with 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 40% of our outstanding common stock as of March 31, 2002. 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
if these stockholders oppose it, and may discourage third parties from making a proposal to cause a change of control in the first instance.








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




11




---

##### Table of Contents

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 takeover 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 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




12




---

##### Table of Contents

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, such as our vaccines for the treatment of non-Hodgkins lymphoma. 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.








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




13




---

##### Table of Contents

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 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 negatively impact 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.








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




14




---

##### Table of Contents

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 may also be 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, protein microarrays, functional genomics, protein transformation, 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 the patentable scope of genomic sequence data. 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 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




15




---

##### Table of Contents

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 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:




16




---

##### Table of Contents

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



17




---

##### Table of Contents

PART IIOTHER INFORMATION








Item 2.Changes in Securities and Use of Proceeds





Effective December 1, 2001, four executive
officers elected to take a portion of their salary, normally paid in cash, in shares of common stock. The amount of stock compensation that each individual elected to take in lieu of cash ranged from $20,000$30,000 annually and is payable in
quarterly installments beginning February 28, 2002. On February 28, 2002, the Company issued a total of 4,902 unregistered shares of common stock among the four individuals.





The issuance of the above unregistered securities were made in reliance upon Section 4(2) of the Securities Act of 1933 and were made without general solicitation or advertising. The
applicable individuals are sophisticated investors and have access to all relevant information to evaluate their investment and represented to us that the shares were being acquired for personal investment.





During the third quarter of 2000, the Company received net proceeds of approximately $89 million from an initial public offering of the Companys
common stock. Provided below is a reasonable estimate of the amount of IPO net proceeds used in each of the following categories, through March 31, 2002:





Construction of plant, building and facilities

$
2,009,000Purchase and installation of machinery and equipment


7,272,000Construction of leasehold improvements


5,993,000Repayment of indebtedness


3,630,000Purchase of intellectual property licenses


2,650,000Capitalized patent costs


1,380,000Working capital


24,661,000Cash and investments


41,161,000





The use of proceeds for working capital includes expenses for research and
development and general and administrative activities. Cash and investments consist of money market funds, commercial paper, corporate and U.S. government agency notes, and bank certificates of deposit.





None of the IPO net proceeds were paid directly or indirectly to directors, officers, or their associates, persons owning 10 percent (10%) or more of
any class of our equity securities, or our affiliates. The use of IPO net proceeds set forth above does not represent a material change from the anticipated use of proceeds described in the prospectus contained in our Registration Statement on Form
S-1 (SEC Registration No. 333-34198), declared effective on August 9, 2000.








Item
6.Exhibits and Reports on Form 8-K





(a)  List of Exhibits:





None.





(b)  Reports on Form 8-K:





No reports on Form 8-K were filed during the period covered by
this Report.




18




---

##### Table of Contents

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.





Dated:  May 15, 2002



LARGE SCALE BIOLOGY CORPORATIONBy:

/s/    RONALD J. ARTALERonald J. Artale Chief Financial Officer Senior Vice President, Finance










19