**U.S. SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON,D.C.  20594**

 

**FORM 10-K**

** **
| **ý****  ANNUAL REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
|----------------------------------------------------------------------------------------------------------------------------|
| **dated March 14, 2005 for the fiscal  year ended December 31, 2004**                                            |

 

**CommissionFile No.  333-12570**

 

**STRESSGEN BIOTECHNOLOGIESCORPORATION**

(Exact Name of Registrant asSpecified in its Charter)

 
| **Yukon  Territory, Canada**                                    | ** ** | **N/A**                            |
|-----------------------------------------------------------------|------------|------------------------------------|
| (State or  Other Jurisdiction of Incorporation or Organization) |       | (IRS  Employer Identification No.) |
| ** **                                                      | ** ** | ** **                         |
| **350-4243  Glanford Avenue**                                   | ** ** | ** **                         |
| **Victoria,  British Columbia V8Z 4B9**                         | ** ** | ** **                         |
|                                                            | ** ** | ** **                         |
| **Parent of Stressgen Biotechnologies, Inc.**              | ** ** | ** **                         |
| **6055 Lusk Boulevard,****San Diego,  California**              | ** ** | **92121**                          |
| (Address of  Principal Executive Offices)                       |       | (Zip Code)                         |

 

| Registrant’s Telephone Number, including  area code: | **(250)  744-2811** |
|-----------------------------------------------------------|---------------------|
| ** **                                                | **(858) 202-4900**  |

 

Securities Registered pursuantto Section 12(b) of the Act:  **None**

Securities Registered pursuantto Section 12(g) of the Act:  **None**

 

Indicate by check mark whether the Registrant: (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months and (2) has beensubject to such filing requirements for the past 90 days.  Yes  ý  No  o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item405 of Regulation S-K is not contained herein, and will not be contained, tothe best of the Registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-K orany amendment to this Form 10-K.  ý

 

Indicateby check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2of the Act). Yes  ý

 

As of June 30, 2004 and March 8, 2005, the aggregate marketvalues of common shares held by non-affiliates of the Registrant were approximatelyCdn. $59,455,250 and $25,739,773, respectively. These amounts represented approximately U.S. $44,356,349 (based on the June 30,2004 closing price of Cdn. $0.82 per common share, as reported on The TorontoStock Exchange, and 72,506,403 outstanding common shares and a U.S.-Canadian exchangerate of 1.3404) and U.S. $21,151,921 (based on the March 8, 2005 closingprice of Cdn. $0.36 per common shares as reported on The Toronto StockExchange, 72,506,403 outstanding common shares and an U.S.-Canadian exchangerate of 1.2169).  These numbers areprovided only for the purposes of this report and do not represent an admissionby either the Registrant or any non-affiliate as to the status of any person.

 

The Company’s accounts are maintained in Canadian dollars.  In this Annual Report on Form 10-K, alldollar amounts are stated in Canadian dollars except where otherwise indicated.

 

Documents incorporated by reference: None.

 

 

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**TABLE OFCONTENTS**

 
| Item 1.  BUSINESS                                                                                                                                                                                      |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                                                                                        |   |
| Item 2.  PROPERTIES                                                                                                                                                                                    |   |
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| Item 3.  LEGAL PROCEEDINGS                                                                                                                                                                             |   |
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| Item 4.  SUBMISSION OF MATTERS  TO A VOTE OF SECURITY HOLDERS                                                                                                                                          |   |
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| Item 5.  MARKET FOR REGISTRANT’S  COMMON EQUITY AND RELATED STOCKHOLDER MATTERS                                                                                                                   |   |
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| Items 6, 7 and 7A.  SELECTED  FINANCIAL DATA; MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION  AND RESULTS OF OPERATIONS; QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT  MARKET RISK |   |
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| Item 8.  FINANCIAL STATEMENTS  AND SUPPLEMENTARY DATA                                                                                                                                                  |   |
|                                                                                                                                                                                                        |   |
| Item 9.  CHANGES IN AND  DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE                                                                                                         |   |
|                                                                                                                                                                                                        |   |
| Item 9A.       CONTROLS AND PROCEDURES                                                                                                                                        |   |
|                                                                                                                                                                                                        |   |
| Item 9B.       OTHER INFORMATION                                                                                                                                              |   |
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| Item 10.  OUR DIRECTORS,  EXECUTIVE OFFICERS AND KEY EMPLOYEES                                                                                                                                         |   |
|                                                                                                                                                                                                        |   |
| Item 11.  COMPENSATION OF  DIRECTORS AND EXECUTIVE OFFICERS                                                                                                                                            |   |
|                                                                                                                                                                                                        |   |
| Item 12.  SECURITY OWNERSHIP OF  CERTAIN BENEFICIAL OWNERS AND MANAGEMENT                                                                                                                              |   |
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| Item 13.  CERTAIN RELATIONSHIPS  AND RELATED TRANSACTIONS                                                                                                                                              |   |
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| Item 14.  PRINCIPAL ACCOUNTING FEES AND SERVICES                                                                                                                                                       |   |
|                                                                                                                                                                                                        |   |
| Item 15.  EXHIBITS, FINANCIAL  STATEMENT SCHEDULES                                                                                                                                                     |   |

 

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This report contains text in addition to the requirements for an AnnualReport on Form 10-K to fulfill the requirements of a Canadian AnnualInformation Form as set forth in National Instrument 51-102 and relatedpolicies of the Canadian Securities Administrators.

 

**PART I**

 

**FORWARD-LOOKING STATEMENTS**

** **

**This Report contains forward-lookingstatements that involve risks and uncertainties. Our forward-lookingstatements, which are typically indicated by words such as “intend,” “plan,” “anticipate”and “expect,” include statements regarding the results of on-going research,development efforts and the scope of future operations. Such statements areonly predictions.  Actual results maydiffer materially from those implied by our forward-looking statements, due tofactors including our need for additional capital, the risk that HspE7 does notdemonstrate statistically significant results in future clinical trials, ourdependence upon collaborative partners and the risk that we will not obtainapproval to market our products.  Theseand other risks are discussed in this Annual Report, including under thecaption “Factors that May Affect Future Performance.” We disclaim anyobligation to update forward-looking statements as circumstances change.**

 

# **Item 1**. BUSINESS

 

**Overview**

** **

We are a biopharmaceutical company that discovers, develops and seeks tocommercialize therapeutic vaccines for the treatment of infectious diseases andcancers.  Unlike traditional preventativevaccines that need to be administered before an individual becomes infected,therapeutic vaccines are designed to stimulate the human immune system to fightexisting infectious diseases and cancers.

 

Our lead therapeutic vaccine candidate isHspE7.  HspE7 is a broad-spectrumtherapeutic vaccine candidate in development for diseases caused by the humanpapilloma virus (“HPV”), a virus which has over 100 types.  HPV infection can result indiseases including internal and external genital warts and precancerousconditions, such as cervical and anal dysplasia.  Precancerous HPV-related conditions canprogress into life-threatening diseases, including cervical, anal and head andneck cancers.  HPV is the most commonsexually transmitted disease in the U.S. Approximately 5.5 million new sexually transmitted HPV infections arereported in the U.S. each year.  At least20 million people in the U.S. are already infected.  Existingestimates of annual U.S. healthcare costs associated with HPV include US$1.6billion in direct costs and up to US$6 billion in screening for cervicalcancer, making it the second most costly sexually transmitted disease after HIVinfection.

 

We initially plan to seek approval of HspE7 for the treatment ofpatients suffering from an HPV-related disease called recurrent respiratorypapillomatosis (“RRP”). In RRP the papillomas, commonly known as warts, grow inthe upper airways of patients.  They caninterfere with the breathing of pediatric patients and occasionally befatal.  Over 2,300 new cases of pediatricRRP and over 3,600 new cases of adult RRP were diagnosed in a 12-month periodaccording to the

 

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most recent reported survey of U.S. otolaryngologists andbronchoesophagologists; the survey estimated that there were over 5,970 casesof active pediatric RRP in which surgery was required in the previous threeyears, and over 9,000 cases of active adult RRP in the U.S.

 

In February 2004 we announced the results of an open-label, singlearm, multicenter RRP phase II trial in 27 patients ranging in age from two to18 years who required frequent surgical procedures to reduce the obstructioncaused by the warts. In the trial the patients experienced an aggregate of 87fewer surgeries during the first year after treatment with HspE7.  The time between post-treatment surgeriesincreased by a mean of 95% compared to the pre-treatment period. The mean ofthe first post-treatment interval after surgery increased to 106 days from anaverage of 55 days between surgeries before treatment with HspE7.  We plan to commence a pivotal phase III clinicaltrial in RRP in mid-2005.  The U.S. Foodand Drug Administration (“FDA”) has agreed to review the protocol for the trialunder a Special Protocol Assessment (“SPA”), has granted HspE7 orphan drugstatus for the treatment of RRP and has designated HspE7 for the treatment ofRRP as a fast track product development program.

 

In November 2004 weannounced the results of a trial of HspE7 in 21 high grade cervical dysplasiapatients that was sponsored by the Norris Comprehensive Cancer Center of theUniversity of Southern California (USC) in Los Angeles, California.  Patients in the trial received HspE7, thenwere scheduled to undergo a surgical procedure known as LEEP (loopelectrosurgical excision procedure) two months following the last dose. In thetrial, 40% of the patients were considered responders at the time of thescheduled surgery, based upon a downgrading of disease from high grade to lowgrade or no dysplasia. After vaccination 64% (nine of fourteen) of patientstested developed a specific immune response to viral antigens related to thecause of the disease. This result is an early response rate for HspE7, sinceLEEP was performed only two months following the last dose of the drug.

 

We plan to expand the application for HspE7 to other HPV indications,so that it can be indicated for a broad range of HPV-related diseases.  In addition to RRP, we are initiallytargeting niche patient populations for which there are serious unmet medicalneeds, including HIV-positive patients with HPV-associated diseases andpatients with high-grade cervical dysplasia for whom the standard treatment,LEEP, has been unsuccessful. We have astrategic collaboration with F. Hoffmann-La Roche Ltd. and Hoffmann-LaRoche Inc. (together, “Roche”) that couldlead to further development of HspE7.

 

HspE7 is derived from our proprietary platform technology that enablesus to covalently fuse stress proteins to antigens that invoke immune systemresponses.  Stress proteins, also knownas heat shock proteins (“Hsp”), naturally occur in the human body.  Hsp play important roles in the immunesystem, including transporting substances within cells and activating cells ofthe immune system.  By covalently fusingHsp and disease-associated antigens, we believe that we can create a proprietaryportfolio of CoValTM fusion products designed to stimulate the immune system toidentify, target and eliminate virus-infected and cancerous cells.

 

In addition to our drug development efforts, we currently produce andsell Hsp, antibodies, bioreagents and other products for research use.  We plan to sell our bioreagents business in2005 to fund our drug development program.

 

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We have incurred significant losses since our inception and expect toincur substantial losses for the foreseeable future as we invest in ourresearch and product development programs, including manufacturing,pre-clinical studies and clinical trials, and regulatory activities.  At December 31, 2004 our accumulateddeficit was $212,349,000. Historically, we have depended principally on equity financings, cashflows from our bioreagent business and funding from research collaborations tofund our business activities.  We have aplan to sell our bioreagent business during 2005.  While this will provide proceeds from thesale it will reduce our near term revenues. We intend to pursue additional equity financings, markets permitting,and to seek additional research collaborations to fund our business activities.

 

Our success will depend upon

 

•                  our ability to raise sufficient capital tofurther the development of HspE7

 

•                  the safety and efficacy of ourimmunotherapeutic products in pre-clinical studies and clinical trials, and

 

•                  obtaining regulatory approvals necessary tomarket our products.

 

The marketability of our products will be influenced by competitionfrom alternative therapies and the degree of protection our intellectualproperty provides. We believe there will be significant markets for ourtherapeutic products should these products prove to be effective in humanclinical trials.

 

**Business Strategy**

 

Our goal is to develop and commercialize a variety of therapeuticvaccines for the treatment of virally-induced human diseases and cancers.  Key elements to our strategy include:

 

•                  *Complete the development and obtain regulatory approval for HspE7 totreat RRP*.  We intend to bringHspE7 to market as rapidly as possible by seeking U.S. regulatory approval tomarket it for RRP. The FDA has granted fast track and orphan drug status toHspE7 for RRP patients and has agreed to review a protocol for this trial undera SPA.  We plan to commence a phase IIItrial for this indication in mid-2005.

 

•                  *Expand the label for HspE7 to other indications*.  We plan to expand the list of conditions forwhich HspE7 is indicated by initially targeting other patient populations withhigh risk forms of HPV disease, including HIV-positive patients and patientswith cervical intraepithelial neoplasia (“CIN”) for whom LEEP has not beensuccessful.  In the longer term, we planto target larger market opportunities for HPV-related diseases such as genitalwarts and high-risk dysplasias.

 

•                  *Build a U*.*S*. *sales force*.  We planto establish our own U.S. commercialization team to help us generate sales forHspE7 and subsequent products. We believe that this initiative will require arelatively small commercial sales and marketing team for the indications thatwe are currently targeting.

 

•                  *Build a broad portfolio of product candidates*.  Using our proprietary platform technology, weplan to develop additional CoValTM fusion product candidates totreat other viral infections and cancers. We also plan to strengthen our pipeline by in-licensing complementaryproduct candidates.

 

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•                  *Collaborate with established pharmaceutical and biotechnology companies*.   We intend to partner and collaborate withestablished pharmaceutical and biotechnology companies, including Roche, tospeed development of our product candidates and to provide us access to globalregulatory, sales and marketing infrastructures.

 

**Background of HPV**

 

HPV infection is extremely common, with an estimated 80% of sexuallyactive people contracting it at some point in their lives.  At least 20 million people in the U.S. arealready infected with sexually transmitted HPV infections.  Although HPV can remain latent or regressspontaneously in some people, it can also manifest itself physically as warts,dysplasias and cancers.  More than 30 ofthe over 100 different types of HPV infect genital tissue.  Some types also infect head, neck and analepithelial cells.  Relatively benigntypes of HPV cause plantar and common warts.

 

Warts, dysplasias and cancers result from excessive cell growth.  In HPV infections, uncontrolled cell growthcan be caused by proteins expressed by HPV, such as E7, which interfere withnormal cell functions that usually limit cell growth.  HPV infects epithelial cells, which do notpresent antigens efficiently for detection by the immune system.  The immune system does not always recognizeor eradicate HPV-infected cells which allows for warts, dysplasias and cancersto develop.

 

Serious HPV-related diseases include:

 

*Recurrent Respiratory Papillomatosis*

 

RRP is usually caused by HPV types 6 and 11 that also cause the betterknown condition of genital warts.  Ratherthan infecting genital tissue, the papillomas in RRP occur in the epithelialtissue located in the larynx and airways. They can interfere with the breathing of pediatric patients andoccasionally be fatal.  Death can occurfrom airway obstruction, cancerous transformation, the overwhelming spread ofthe disease or complications from surgical treatments. There are two groups ofRRP patients.  Juvenile-onset RRP canoccur in children born to mothers infected with HPV.  Adult-onset RRP may arise from birth or oralsexual activity.  Over 2,300 new cases ofpediatric RRP and over 3,600 new cases of adult RRP were diagnosed in a 12month period according to the most recent reported survey of U.S.otolaryngologists and bronchoesophagologists. The survey estimated that there were over 5,970 cases of activepediatric RRP in which surgery was required in the previous three years, andover 9,000 cases of active adult RRP in the U.S.  Approximately 75% of diagnosed juvenile-onsetcases become evident before the age of five years. No drugs are approved forRRP in the U.S.  Instead, patients aretypically treated with surgery using a microdebrider or a laser.  Surgery is not a cure and recurrence is frequent.  The average pediatric patient hasapproximately five surgeries per year, with some patients undergoing more than20 procedures annually.  Each surgery cancost thousands of dollars and result in complications, including the formationof scar tissue, decreased functioning of the larynx and hoarseness.

 

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*Genital Warts*

 

Genital warts are soft, fleshy raised growths that can appear ininternal and external genital areas. They are also usually caused by HPV types 6 and 11.  The incidence of genital warts is anestimated one million new cases in the U.S. each year.  Despite a common misperception, genital wartscan be spread even when condoms are used. Although warts are generally benign, they can cause psychologicaldistress by making patients feel ashamed and less attractive.  There is no approved cure for genital warts;however, a variety of therapies are available. The choice of treatment depends on the extent and location of diseaseand the preferences of the physician and patient.  External genital warts can be treated withtopical medications.  Published sustainedclearance rate estimates for topical treatments range from 20% to 44%; however,the duration of follow-up in most studies is very brief.  We believe that the rate of long termclearance is much lower.  When topicalmedications are not appropriate or effective, ablative therapies are typicallyused.  These therapies, which requireoffice visits, include the application of trichloroacetic acid, cryotherapy(freezing with liquid nitrogen), laser surgery, electrosurgery (burning) and,particularly for internal warts, surgical excision.  Recurrence is common even after treatment.

 

*Cervical Intraepithelial Neoplasia**and Failures of LEEP*

 

CIN, also known as cervical dysplasia, is characterized by the presencein the cervix of abnormal cells that can precede and develop into cervicalcancer.  The primary cause of suchabnormalities is infection with HPV types 16 and 18.  Experts recommend screening all sexuallyactive women for HPV.  In the U.S. Papscreens, which are used to help detect HPV, are estimated to cost up to US$6billion per year.  An estimated 1.2million women each year are diagnosed with low-grade cervical dysplasia in theU.S.  Another estimated 200,000 to300,000 women are diagnosed with high-grade cervical dysplasia in the U.S. eachyear.  There are no FDA-approved drugtherapies for CIN.  Typically, high-gradeCIN is treated with a type of surgery called LEEP, estimated to cost fromUS$400 to US$1,450 per treatment.  Theincidence of residual disease after LEEP varies from 20% to 30%. Potentialcomplications include bleeding and the excessive removal of healthy tissue.  LEEP is not recommended for lesions that aretoo deep to view with medical instruments. In those cases, widely used treatments include surgery, the cost ofwhich varies depending upon the site of the lesion, or cold-knife cone biopsy,estimated to cost US$3,700 per treatment. None of the treatments are alwayseffective in removing all abnormal cells. The recurrence rates of CIN have been estimated at 19% of patientstreated with cryotherapy and 13% of patients treated with laser surgery orLEEP.  In addition, the availabletreatments do not treat the underlying HPV infection.

 

*HPV Infection in Immunocompromised Patients*

 

Patients develop compromised immune systems for reasons including HIVinfection, chemotherapy and the use of immunosuppressants following an organtransplant.  Patients with compromisedimmune systems are particularly prone to HPV infection, including themanifestations described above and anal intraepithelial neoplasia (“AIN”), acondition similar to CIN but occurring in the anal epithelial tissue. Mosttreatments for HPV used in the general patient population are also used inimmunocompromised patients.  Recurrenceof HPV-associated diseases after treatment is especially common in HIV-infectedHPV patients. For example, 39% to 62% of HIV-positive women have recurrences ofCIN, compared with 9% to 18% of HIV-negative women.  Patients that receive highly activeantiretroviral therapy (“HAART”) for HIV have better response rates than HIVpatients that do not receive HAART.

 

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However, they still experience more frequent and persistent HPVinfections than people without compromised immune systems.

 

*Cervical Cancer*

 

Almost all cervical cancers can be attributed to four HPV types: 16,18, 45 and 31.  American Cancer Societyestimates for 2003 predicted that approximately 12,200 women in the U.S. wouldbe diagnosed with invasive cervical cancer and that about 4,100 patients woulddie from the disease.  Globally, anestimated 400,000 new cases of cervical cancer are identified each year.Although death rates from cervical cancer have declined in developed countries,invasive cervical cancer continues to be associated with extrememorbidity.  Because of the mortalityrates, the World Health Organization has called cervical cancer the second mostimportant cancer threat in women after breast cancer. There are no FDA-approveddrug therapies. Patients with cancer are typically treated with surgery andradiation.  If the cancer spreads,chemotherapy can be used to treat the cancer in other areas of the body.

 

*Head and Neck Cancer*

 

Cancers of the oral cavity, pharynx and larynx constitute a serious andincreasing public health problem worldwide. In the U.S an estimated 40,000 new head and neck squamous cellcarcinomas occur annually. Worldwide, there are an estimated 600,000 head andneck cancers in men and 270,000 cases in women annually.  In studies HPV DNA has been found in anaverage of 35% of head and neck tumors.  The specific percentages of cancers attributable to HPV can increasedepending upon the location of the cancer. Fifty percent to 70% of oropharyngeal cancers and 60% of tonsillarcarcinomas are estimated to be HPV-associated in developed Westerncountries.  No FDA approved therapies orcures exist for HPV-related head and neck cancers.  Instead, these cancers are treated withsurgery and with primary radiation therapy. However, most oropharyngeal cancers are detected at a late stage, wherethe five-year survival rate is 50% or less, despite expensive treatments.  Other complications include infections, pain,loss of taste and eating problems.

 

**The Stressgen Solution**

 

We are developing HspE7 as a broad-spectrum therapeutic vaccine forHPV-related conditions.  HspE7 is one ofour proprietary CoValTM fusion proteins. It is made using recombinant DNAtechnology to covalently fuse an Hsp to a HPV E7 viral protein to form onetherapeutic protein.  The E7 viralprotein is often poorly recognized by the immune system.  By combining Hsp with E7, an E7-specificimmune response can be achieved.  HspE7works by efficiently targeting the E7 antigen to dendritic cells, which have anatural affinity for Hsp. Dendritic cells are known to be the most potent cellsin the body for triggering immune responses.

 

Dendritic cells are a type of white blood cell that educate other whiteblood cells, called T cells, to seek out and destroy diseased cells in the bodyinfected by viruses or that are cancerous. Dendritic cells work by binding,engulfing and processing proteins called antigens that are expressed by virusesand cancer cells into small fragments. The dendritic cells then present thesefragments on their surface to program T cells to recognize these fragments asforeign and harmful. Once T cells identify the fragments as foreign, they rapidlymultiply and roam the body

 

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to target and kill infected cells that express the antigens. Thesetypes of T cells are called killer T cells.

 

Coupling E7 to Hsp takes advantage of the Hsp receptors that dendriticcells express on their surface to introduce E7, as part of a larger fusionprotein, into the dendritic cells.   Theintroduction of the fusion protein appears to allow the dendritic cells toprocess E7 and produce specific antigens to promote a killer T cell responseagainst infected cells that express the E7 protein.  In preclinical studies conducted using atumor animal model, administration of HspE7 has been shown to prevent thegrowth of and cause the destruction of tumors that express the HPV E7 protein.Only the fusion protein induces significant tumor regression and long-termsurvival in these studies.  According toour research, neither the E7 antigen nor the Hsp alone, nor a mixture of thetwo, is effective.

 

We believe our HspE7 product candidate offers a number of advantages asa therapy for HPV because, based on our research to date, it:

 

•                  treats a broad spectrum of HPV-diseases;

 

•                  utilizesthe body’s own immune system;

 

•                  actssystemically to reach HPV infections throughout the body;

 

•                  iswell tolerated (based on 400 patients to date);

 

•                  ismuch less invasive than surgery; and

 

•                  isadministered by a short series of injections, assuring patient compliance.

 

**Our Clinical Development Programs**

 

Our technology platform supports our building a portfolio of CoValTMfusion candidates. Our lead candidate is HspE7, which we are currentlydeveloping to treat RRP. External collaborators are also investigating HspE7 asa treatment for HPV-related conditions in HIV-positive patients, LEEP failuresin CIN patients and genital warts.

 

In trials involving over 400 patients to date, HspE7 has been welltolerated.  The predominant adverseexperience noted from HspE7 treatment at various doses and schedules has beeninjection site reaction, mild to moderate in severity, clearing in hours todays without treatment.  Mild to moderateflu-like symptoms also have been observed in some patients.

 

*Recurrent Respiratory Papillomatosis*

 

In February 2004 we reported results from an open-label, singlearm, multicenter RRP phase II trial in 27 patients ages two to 18 years oldrequiring frequent surgical debulking. The dosing regimen was 500 mgHspE7 subcutaneously three doses over 60 days. Patients were followed for up to 60 weeks from the first dose to assessthe frequency of required surgeries and the safety and tolerance of HspE7.  The trial met its targeted primary endpointof lengthening the time between surgeries following treatment with HspE7.  The time between post-treatment surgeries,measured as the median post-treatment interval, increased by a mean of 95%compared to the pre-treatment period. The mean of the first post-treatment interval after surgery increased to106 days from an average of 55 days between surgeries before treatment withHspE7 (p<0.02).  The

 

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average annual surgery rate after treatment with HspE7 decreased fromapproximately 8.7 to 6.5 (p<0.003). Of the 27 patients in the study, two patients required no surgery in the48 week follow-period compared to a pre-treatment median of 63 days and 101days respectively. The median interval of all surgeries reported followingtreatment suggests that the 27-child patient population experienced anaggregate of 87 fewer surgeries during the first year after treatment.  Overall, these results were internallyconsistent and statistically significant.

 

We held an end-of-phase II meeting with the FDA in June 2004 todiscuss the design of our planned pivotal phase III clinical trial.  We plan to submit a clinical trial protocolfor review by the FDA under a Special Protocol Assessment, an agreement that istypically binding on the FDA regarding the protocol design for a clinical trialto support a biologics license application (“BLA”).  We intend to begin accruing patients in ourpivotal phase III trial by mid-2005. Depending on the clinical and other results, we anticipate being able tosubmit a BLA for HspE7 to treat RRP in mid-2007. We plan to apply for priorityreview when we file the BLA.  The FDA hasgranted HspE7 orphan drug status and designated it as a fast track developmentprogram for the treatment of RRP.

 

*Dysplasiasin HIV+ Patients*

 

The U.S. National Cancer Institute (“NCI”) is sponsoring a phase I/IItrial with HspE7 to treat AIN in 15 HIV-positive patients.  The trial will evaluate clinical andimmunological response of escalating doses of HspE7 and viral load at sixmonths.  The NCI plans to sponsor a phaseII CIN trial in HIV-positive patients. We have conducted preclinical studies that demonstrate Hsp fusionsinduce killer T cell responses in animals that are deficient in CD4+ T helpercells, which are regulatory cells in the immune system that are best known fortheir ability to promote antibody production. In HIV-positive patients the number and function of T helper cells issubstantially impaired. Because HspE7 activity apparently does not require Thelper cells, we believe it has the potential to treat patients immunocompromisedby HIV infection.

 

*Cervical Intraepithelial Neoplasia / LEEPFailures*

 

The NCI and a research collaborator have sponsored or are sponsoringthree separate phase II CIN trials using different dosing regimens.  These studies, which target the accrual of249 patients in the aggregate, include:

 

•                  aninitial single arm trial in 21 HIV-negative females with high-grade CIN toassess pathological and clinical response, HPV status and immunologicalmarkers, followed by a single arm trial in an expected 12 additional patients;

 

•                  asingle arm, open-label trial in up to 66 HIV-negative females with high-gradeCIN; and

 

•                  arandomized, double-blind placebo controlled trial in 150 HIV-negative femaleswith low-grade CIN to assess pathological and clinical response, HPV status andimmunological markers.

 

In November 2004 we announced the results of a trial of HspE7 in21 high grade cervical dysplasia patients that was sponsored by the NorrisComprehensive Cancer Center of USC in Los Angeles, California.  Patients in the trial received HspE7, thenwere scheduled to undergo

 

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LEEP two months following the last dose. In the trial, 40% of thepatients were considered responders at the time of the scheduled surgery, basedupon a downgrading of disease from high grade to low grade or no dysplasia.After vaccination 64% (nine of fourteen) of patients tested developed aspecific immune response to viral antigens related to the cause of the disease.This result is an early response rate for HspE7, since LEEP was performed onlytwo months following the last dose of the drug.

 

*Genital Warts*

 

We have completed a six month phase II, multicenter, randomized,double-blind, parallel-group, placebo-controlled study in 54 male and femalepatients with anogenital (external genital or perianal) warts.  The dosing regimen was 500 mgHspE7 administered subcutaneously three doses over 60 days. The primaryobjective of the study was to determine whether this regimen was more effectivethan placebo in reducing the total area of anogenital warts. A secondaryobjective of the study was to compare the safety of HspE7 to placebo in thesepatients.  Results from this trial showedthat, at six months, genital warts decreased in size by a median of 53%compared to a median of 16% in patients treated with placebo.  At six months, 35% of patients treated withHspE7 had complete clearance of warts compared with 25% of patients treatedwith placebo.  The complete response ratefor patients with genital warts varied depending on the gender of the patientand location of the warts.  The treatmentmet expectations, but the variance in size reduction was much greater thanexpected. As a result, we concluded that the study did not include sufficientpatients for the trial results to be statistically significant.

 

During a study of AIN patients who received 500 mgof HspE7 administered subcutaneously three doses over 60 days, one of ourinvestigators identified an improvement in genital warts.  In a retrospective review of the data, 23patients were identified for continuing follow-up for up to 24 months.  Within the cohort, 11 of 23 patients reachingthe 12 month evaluation point, 11 of 17 patients reaching the 18 monthevaluation point and eight of ten patients reaching the 24 month evaluation pointhad complete clearance of internal and external warts.

 

In December 2004we announced the completion of enrollment in a phase II clinical trial of HspE7in 30 patients with internal genital warts, conducted by our collaborator,Stephen E. Goldstone, M.D of The Mount Sinai School of Medicine in New YorkCity.  The primary endpoint of the singlearm pilot study will be complete response, measured by complete clearance ofbaseline internal warts. We anticipate that twelve-month data from the trialwill be available at the end of 2005.

 

*Anal Intraepithelial Neoplasia*

 

In February 2004 we reported the results of a randomized,double-blind, placebo-controlled, multicenter non-pivotal phase III trial inAIN in 133 patients, 110 of whom continued into a blinded cross-overstudy.  The original HspE7 dosing regimenwas 500 mg HspE7administered subcutaneously three doses over 60 days.  In the cross-over study, patients whoreceived placebo were given HspE7. Patients that had received HspE7 were given one booster from six to 12months after the initial dose.  The phaseIII trial did not meet its primary endpoint of demonstrating that the patients’dysplasia downgraded from high grade to low grade or no dysplasia at sixmonths.  The results are difficult tointerpret due in part to a high level of

 

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disagreement among the pathologists as to whether the samples should beclassified as high-grade, low-grade or no dysplasia.  In addition, the placebo effect that we had anticipatedbased on a previous phase II trial and studies of the natural history of thedisease doubled from the estimate used to power the study.  Certain secondary endpoints, such asdowngrades assessed through the physician’s observations of manifestations ofthe disease, did achieve statistical significance at certain observational timepoints.

 

In an earlier open-label phase II trial in 82 patients using three 500 mgsubcutaneous doses of HspE7, 82.9% of previously untreated patients withhigh-grade AIN demonstrated a partial response 24 weeks after receiving HspE7,compared with a placebo response rate estimated from an earlier trial to be18.6%.  That trial supported thepossibility that HspE7 is effective. Based on the data in AIN in the aggregate and taking into account thenormal variability in the reading of biopsies, we believe that HspE7 may beactive in AIN.

 

*HPV-Related Cancers*

 

In 2001 we suspended a study in Brazil in patients with advanced cancerafter only seven of 23 projected patients received the planned five doses ofHspE7, based on investigator feedback that the patients’ carcinoma was soadvanced that a meaningful clinical response could not reasonably be expectedin a population of the targeted size. The treatment regimen itself was judged to be well tolerated in thedosed patients.

 

Preclinical studies conducted in animal models have provided someevidence to suggest that HspE7 may stimulate cell-mediated immunity to fightcervical cancer.  In vivo studies oftumor implantation and rejection in a murine model of cervical cancer (TC-1tumor cells) showed:

 

•                  treatmentwith HspE7 promotes regression of established TC-1 tumors;

 

•                  treatmentwith HspE7 that leads to tumor regression also provides protection against asubsequent challenge with TC-1 tumor cells; and

 

•                  treatmentwith E7 alone or an admixture of Hsp and E7 does not cause regression of TC-1 tumors.

 

The NCI plans to sponsor a clinical trial with HspE7 in cervical cancerpending the availability of additional clinical supplies.

 

**Follow-on CoValTM Fusion Products**

 

We have been researching other fusion proteins which, like HspE7, aremade using our proprietary technology based on covalently bonding Hsp toantigens expressed by viruses or cancers. As in HspE7 the heat shock protein portion of the fusion may stimulatedendritic cells to process disease-specific antigens to enable the immunesystem to recognize and destroy cells presenting the antigen.  We need substantial additional resources,either through raising capital or collaborations, to further the development ofour follow-on products.

 

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*Hepatitis B*

 

We have compiled preclinical data tosupport an Investigative New Drug (“IND”) application for a fusion of an Hspand a selected hepatitis B virus (“HBV”) antigen.  In mice our HBV fusions have been shown toelicit killer T cells that recognize the HBV antigen, suggesting such killer Tcells would be capable of eliminating HBV-infected cells.  The killer T cells have also been shown toproduce the cytokine interferon gamma, which is known to have anti-viralactivity.  We expect that the results ofthese preclinical studies would support a filing for an IND for the Hsp-HBVantigen fusion protein in approximately 18 months after initiation ofdevelopment activities.

 

Chronic hepatitis B is a disease of theliver caused by the hepatitis B virus. Infection with HBV is characterized by jaundice, fatigue, abdominal painand other symptoms, with many patients developing liver cirrhosis andcancer.  There are estimated to be1,000,000 to 1,250,000 cases of chronic hepatitis B in the U.S., according tothe Centers for Disease Control and Prevention. In addition, there are between 140,000 and 320,000 new cases ofhepatitis B in the U.S. each year, resulting in 4,000 to 5,000 deaths accordingto the American Social Health Association. Worldwide, about 1,000,000 deaths are attributable to HBV infection andits complications annually, according to the World Health Organization. Due tothe large infected population and small percentage of the public beingvaccinated for the disease, the need for therapies for chronic hepatitis Bvirus infection remains, even though safe and effective preventative vaccinesexist.

 

*Herpes Simplex*

 

We are collaborating with a university to perform preclinical studieson heat shock fusion proteins to treat genital herpes caused by herpes simplexvirus type 2 (HSV-2). The university is testing a number of HSV-2 proteins inHsp fusions as therapeutic vaccines in animal models of human genital herpes.We intend to dedicate additional effort to this project when resources permit.

 

An estimated 45 million Americans are already infected with genitalherpes, and there are an additional estimated 500,000 to 1,000,000 new caseseach year.  Since HSV remains dormant ininfected persons for their lifetime, genital herpes is a recurrent disease.Some episodes of reactivation are associated with skin blistering in thegenital region, causing physical and psychological discomfort.  Most episodes of the infection areasymptomatic, which results in people unknowingly transmitting the virus.  Except in newborns, genital herpes is notlife-threatening.  Nonetheless, it isdistressing and can contribute to the spread of other sexually transmitteddiseases.

 

*Hepatitis C*

 

We believe our technology also offers promise for producing atherapeutic vaccine for hepatitis C. Hepatitis C causes symptoms similar to those of hepatitis B, but iscaused by the hepatitis C virus. No currently available therapy can eradicatethe virus or do more than delay the progression of the disease.  No vaccine is available. Chronic hepatitis Ccan cause cirrhosis, liver failure, and liver cancer. HCV is spread through contactwith blood and other bodily fluids. Currently, there are six known hepatitis Cgenotypes, and more than 50 subtypes. The relative 

 

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prevalence of different genotypes differs by geographic region.  It is estimated that 3.9 million people inthe U.S. (1.8% of the population) have been infected with HCV and that 2.7million are chronically infected. Worldwide there is an estimated 200 million cases.  In the U.S. 8,000 to 10,000 deaths each yearare currently attributed to HCV. Although about 80% of patients are currently asymptomatic, researcherspredict that over the next 10 to 20 years chronic hepatitis C will become amajor burden on the health care system as patients progress to end-stage liverdisease.

 

**Strategic Relationships**

 

*Roche Collaboration Agreement*

 

In December 2003, we announced a restructuring of our June 2002collaboration agreement with Roche providing for the development andcommercialization of HspE7.  Under therestructured terms we granted Roche an option to license the first generationHspE7 product, a license to develop a second generation HspE7 product, andnon-exclusive options to negotiate rights to CoValTM fusion productcandidates for the treatment of cancers related to or stemming from HPV andhepatitis C.   Roche can pay fees to makethese options exclusive until January 1, 2007.

 

In connection with the first generation of HspE7, the restructuredagreement gives us the right to develop and commercialize the product forindications other than genital warts, including control of regulatory matterssuch as IND applications.  In theoriginal agreement we were responsible for clinical expenses only for thedevelopment of RRP.  In the current agreementwe are responsible for the manufacturing and other costs of all indicationsthat we develop.  If Roche exercises itsrights to the first generation product, it will fund all prospectivedevelopment costs.  Roche can exerciseits rights to the first generation of HspE7 by paying a fee, in which case itwould also become responsible for event-driven milestones that could result inaggregate payments to us of up to US$138,000,000. Under that scenario, we wouldreceive the revenue from all first generation HspE7 product sales in the U.S.and Canada for three years following approval of a BLA with the FDA and wouldreceive sales-based payments (similar to royalties) of approximately 35% of netsales in the U.S. and Canada thereafter. We would receive sales-based payments of 20% of net sales in countriesother than the U.S. and Canada.

 

By paying additional fees, Roche can exclusively develop the secondgeneration HspE7 product.  In such case Roche would be required topay the costs of development, manufacturing and commercialization of theproduct and to make payments to us upon the achievement of defined milestones.We would also receive tiered, progressive sales-based payments that we believeare competitive with other agreements of this stage and type.  Commercialsuccess payments of up to approximately US$85,000,000 become payable dependingupon the aggregate net sales of either or both generations of the HspE7products. The restructured collaboration agreement gives us the right todiscuss, negotiate and execute an alternative agreement with a third-party forthe development and commercialization of HspE7 through a license, partnership,joint venture or similar transaction. After March 31, 2005 and through the end of the option period Rochecan terminate this right by paying us a fee, which would be eitherUS$10,000,000 or US$15,000,000 depending on the stage of development of theproduct.  We cannot determine if or when this option will be exercised.

 

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*Other Research and Development Collaborations*

 

In 1999 we entered into a collaboration and signed a clinical trialsagreement with the NCI’s Division of Cancer Treatment and Diagnosis to sponsortrials of HspE7 for the treatment of cancers caused by HPV.  In June 2002 we signed a secondagreement with the NCI’s Division of Cancer Prevention to sponsor additionalclinical trials for the prevention of cancers caused by HPV.

 

Our clinical trials agreements allow the NCI to develop a general planfor clinical development of HspE7 for cancer-related indications, solicitclinical research protocols from independent investigators and cooperativeresearch groups, and sponsor and fund their studies.  We are expected to provide clinical gradeHspE7 for the investigators to use in their studies but not to providefunding.  We will receive access to datafrom the trials in return for providing HspE7.

 

We have a number of other collaborative or sponsored researchagreements that could provide us with important sources of research data andlead to technology development opportunities. We have entered into an agreement with the U.S. National Institute ofAllergy and Infectious Diseases to test our hepatitis B product candidate inpreclinical models.  We have sponsoredacademic institutions to evaluate our hepatitis B product candidate in animalmodels and to perform research with our CoValTM fusion proteincandidates made with herpes simplex antigens.

 

**Intellectual Property**

 

Our intellectual property protection policy involves filing andprosecuting patent applications relevant to the inventions that we considermeaningful to our business.  We also relyupon unpatented trade secrets, know-how and continuing technological innovationto develop and maintain a competitive position. We have devoted substantial management attention and resources to maintainingpatents and licenses and conducting an assertive patent prosecution strategy.

 

We have aworldwide exclusive license agreement with the Whitehead Institute for our corefusion technology, giving us rights to various patents, pending applications,continuation-in-part applications and their foreign counterparts.  Pursuant to the license agreement we fund theprosecution of the patent applications, which currently include applications inthe U.S., Canada, Europe and Japan.  TwoU.S. patents, which will expire in 2019, and a European patent, which willexpire in 2014, have been granted based on these Whitehead applications.  We are vigorously defending challenges tothese patents, which cover Hsp fusions with viral or cancer-associated antigensand their use as immunotherapeutics, and to our European patent directed to Hspfusions with HPV viral antigens, including HPV E6 and E7, and their use asimmunotherapeutics.  We also hold issuedU.S. patents related to Hsp fusions with HPV viral antigens, including HPV E6and E7 and to the detection of elevated levels of Hsp expression.  Interpretation and evaluation ofbiopharmaceutical or biotechnology patent claims present complex and oftennovel legal and factual questions.  Wecannot be sure that:

 

•                  ourpending applications will result in issued patents;

 

•                  theissued patents will be held valid and enforceable if challenged; or

 

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•                  acompetitor will not be able to circumvent an issued patent by the developmentor adoption of a competitive non-infringing product or process.

 

Our bioreagents business requires intellectual property licenses tosell many of our products.  However,because our bioreagents sales are spread over more than 400 products, we do notbelieve that any individual patent or license is material to the business.  We have a plan to sell our bioreagentsbusiness in 2005.  See disclosure in Note 12to our financial statements.

 

**Manufacturing**

 

We are currently working with a contract manufacturer, Avecia Limited (“Avecia”),to develop a quality controlled and quality assured process for producingHspE7.  Avecia has experience usingstandard operating procedures, analytical methods and specifications that allowbiologics such as HspE7 to be manufactured in commercial quantities inaccordance with current good manufacturing practices (“GMP”) and otherregulations.  Under the agreement Aveciawill perform process development, scale-up and manufacturing of bulk activeingredient for the production of commercial-grade clinical supplies needed forour clinical trials with HspE7. We anticipate that clinical-grade supplies willbe available in mid-2005.  We expect thescope of services covered by the existing agreement to extend through the BLAprocess.  If we terminate our currentservices agreement with Avecia, we may be required to pay a cancellation fee,which could have been up to $441,000, depending on Avecia’s ability to reschedule usageof their facility.  We may also haveAvecia manufacture commercial drug substance under a separate agreement.  A separate contractor will perform the filland finish operations to produce the vialed product.  We expect that our dependence on contractorssuch as Avecia for the process development and manufacture of heat shockprotein fusions will continue for the foreseeable future.

## ** **

## **Government Regulation and Product Approval Process**

## ** **

We must navigate a complex regulatory process to obtain approval tomarket our products.  In the U.S. the FDAregulates drugs and biological products. The Health Products and Food Branch (“HPFB”) Inspectorate enforces theCanadian rules and regulations governing the production and manufacturingof our products and research and development activities.  In these and other jurisdictions, applicabledrug licensing laws require:

 

•                  carefullycontrolled research and testing of products;

 

•                  governmentalreview and approval of results prior to marketing therapeutic products;

 

•                  licensureof manufacturing facilities; and

 

•                  adherenceto GMP during production.

 

Pre-clinical studies must be conducted to test chemistry, pharmacologyand efficacy.  Successful pre-clinicalresults, which entail achieving potentially valuable pharmacological activitycombined with an acceptably low level of toxicity, enable the manufacturer ofthe new drug to file an IND application to begin clinical trials involvinghumans.  An IND application must be filedwith and accepted by the FDA or HPFB, as applicable, before human clinicaltrials may begin.

 

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Clinical trials typically include at least three phases.  Phase I clinical trials consist of testing aproduct in a small number of humans for its safety (toxicity), dose toleranceand pharmacokinetic properties including absorption, distribution, metabolismand elimination.  Phase II clinicaltrials usually involve a larger patient population than is required for phase Itrials.  The phase II trials are conductedto evaluate the effectiveness of a product in patients having the disease ormedical condition for which the product is indicated.  These trials also serve to identify possiblecommon short-term side effects and risks in a larger group of patients.  Potential dosing regimens may also beevaluated during phase II trials. Phase III clinical trials involve conductingtests in an expanded patient population at geographically dispersed sites toestablish clinical safety and effectiveness. These trials usually involve comparison to a standard treatment or to notreatment.  They also generateinformation from which the overall benefit-risk relationship relating to thedrug can be determined to provide a basis for drug labeling.

 

Two key factors influencing the rate of progression of clinical trialsare the rate at which patients can be accrued to participate in the researchprogram and whether effective treatments are currently available for thedisease the drug is intended to treat. Patient accrual can depend upon the incidence and severity of thedisease and the alternative treatments available.

 

Upon completion of all clinical studies, the results of these studiesare submitted to the U.S. FDA as part of a biologics license application or toCanada’s HPFB as part of a new drug submission, to obtain approval to commencemarketing the product.  The entity thatwill manufacture the product must submit an establishment license applicationfor approval by the FDA or HPFB.

 

Before a product can receive approval for marketing in the U.S. orCanada the applicant must show:

 

•                  developmentof a well-controlled process of manufacturing;

 

•                  preclinicalstudies of safety and pharmacology; and

 

•                  studiesof safety and efficacy in humans.

 

Even after a marketing approval is obtained, further studies, includingphase IV post-market studies, may be required to provide additional data onsafety and efficacy necessary to gain approval for the use of a product as atreatment for clinical indications other than those for which the product wasinitially tested.  The FDA or HPFB mayrequire post-market surveillance programs to monitor a product’s side effects.

 

In addition to obtaining pre-licensing approval, manufacturingfacilities must conform on an ongoing basis with GMP.  After the establishment is licensed for themanufacture of any product, manufacturers are subject to periodic inspectionsby regulatory authorities.

 

Whether or not FDA or HPFB approval has been obtained, approval of aproduct by comparable regulatory authorities in Europe and other jurisdictionswill be necessary prior to commencement of marketing the product in suchcountries.  Each country may impose itsown requirements and may refuse to grant, or may require additional data beforegranting, an approval even though the relevant product has been approved byanother authority.

 

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In addition to the need to meet regulatory requirements before ourproducts can be sold, the nature of our business requires compliance withnumerous federal, provincial, state, local and international laws, regulationsand recommendations.  For example, we aresubject to regulations covering:

 

•                  themaintenance of safe working conditions;

 

•                  laboratorymanufacturing practices; and

 

•                  theuse and disposal of hazardous or potentially hazardous substances, includingradioactive compounds and infectious disease agents used in connection with ourresearch work.

 

## **Competition**

## ** **

The diseases we are targeting are currently managed through a varietyof therapeutic and surgical approaches. For example, genital warts can be treated by topical creams andointments, cryosurgery, freezing, electro-surgery and laser treatment.  Some papillomas and cancers caused by HPV canbe treated surgically.

 

We are subject to competition from products that use differentapproaches or means of accomplishing a similar therapeutic effect as our CoValTMfusion products.  Many pharmaceutical andbiotechnology companies also focus their research and product developmentprograms on the treatment of the same therapeutic indications as ours, includingHPV-related diseases, HBV and cancer. For example, Merck & Co., Inc. and GlaxoSmithKline arecurrently conducting large phase III trials for preventative vaccines againstspecific types of HPV.

 

Potential competitors that are developing products to treat HPVindications use approaches including therapeutic vaccines, immunotherapies,immunomodulators, topical therapies and small molecule drugs. As examples,Transgene S.A. and Zycos Inc., recently acquired by MGI Pharma, Inc., areconducting clinical trials with different formulations of HPV antigens astherapeutic vaccines; Medigene AG is developing a topical treatment.

 

Other potential competitors are performing research and developingtherapeutic products based on the intrinsic nature of stress proteins to assistthe body in fighting infection and related cancers.  Our technology focuses on Hsp covalentlyfused to antigens; however, there are other ways to potentially use Hsp tomodulate immune responses.  Companiesincluding Antigenics Inc. are using stress protein-related approaches tostimulate or modulate the body’s immune system in therapeuticapplications.  Other companies such asConforma Therapeutics and Vernalis plc are developing small molecule drugs tomodulate Hsp expression in cells as another approach for cancer therapy.

 

Competition in our industry may increase over time due to rapid andsubstantial changes in technology and other critical inputs required forproduct development and commercialization. Many of our competitors have greater human and financial resourcesdedicated to product development and human clinical testing than we do.  Our competitors may have more substantialmarketing and financial resources. Acquisitions of or investments in competing pharmaceutical andbiotechnology companies by other firms could increase their financial,marketing and other

 

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resources.  Technologicaldevelopments could render our proposed products or technologiesnon-competitive.

 

In the bioreagent market there are numerous suppliers.  Direct competition is more limited in thestress protein area in which we specialize. A few companies have a broad line of competing products, such asAffinity Bioreagents Inc.  Several largercompanies have introduced a limited range of products similar to ours.  Many of our bioreagent product licenses arenon-exclusive.  As a result competitionfrom other suppliers could increase in the future.

 

## **Human Resources**

## ** **

As of March 8, 2005 we employed 103 personnel, ofwhich over 50 were engaged in, directly or indirectly, research and developmentefforts.  Twenty-five of those employeesare employed by the bioreagents business that we are planning to sell and thatwe decided to report as a discontinued operation at December 31,2004.  Of the scientific personsemployed, two hold an M.D., twelve hold Ph.D.s, and the balance hold eitherM.Sc. or B.Sc. degrees or other diplomas. Our employees are not covered by any collective bargainingagreement.  All employees are required toexecute confidentiality and assignment of invention agreements as a conditionof their employment.

 

**Availability of Information**

 

Our annual report on Form 10-K and quarterly reports on Form 10-Qare available on our website, www.stressgen.com, free of charge, as soon asreasonably practicable after such material is filed with the U.S. and Canadiansecurities regulatory authorities.  Ourwebsite also provides links for users to find our filings on the websitesmaintained by the U.S. and Canadian securities regulatory authorities,www.sec.gov and www.sedar.com.  Weconsider those sites to be the appropriate sources for reports that are filedwith the securities regulatory authorities of only the U.S. or only Canada, ratherthan with both countries.  We includeinformation regarding directors’ and officers’ remuneration, principal holdersof our securities and securities authorized for issuance under our equitycompensation plans in our annual information circulars for our general meetingsof shareholders involving the election of directors.  Our annual financial information is providedin our financial statements and Management’s Discussion and Analysis,incorporated in this document.  Papercopies of our most recent filings are available from our Investor Relationsdepartment free of charge upon request.

 

Our transfer agent is Computershare Trust Company of Canada, Toronto,Ontario.

 

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**FACTORS THAT MAY AFFECT FUTUREPERFORMANCE**

 

**Before investing in our common stock youshould carefully consider the following risk factors, the other informationincluded herein and the information included in our other reports andfilings.  Our business, financialcondition, and the trading price of our common stock could be adverselyaffected by these and other risks.**

 

**We require additional financing to executeour business plan**

 

We expect to needUS$50,000,000 to operate the company, commercialize HspE7 and retain a prudentamount of cash on hand.  This estimateassumes that:

 

•                  we will not enter into a collaborationagreement that will cover the costs of the services still required for theHspE7 program;

 

•                  our previously issued warrants are exercised;and

 

•                  we obtain the proceeds expected from a saleof our bioreagents business.

 

If we receive less capitalthan we require, the amount of proceeds allocated to the development andcommercialization of HspE7 will be reduced. This will likely result in delays in our manufacturing, clinical and regulatorytimelines and may require us to change our long-term business strategy. Even ifwe raise US$50,000,000 we may need additional funds to:

 

•                  pursue further research and development;

 

•                  conduct clinical trials;

 

•                  obtain regulatory approvals;

 

•                  file, prosecute, defend and enforce our intellectualproperty rights;  and

 

•                  market our products.

 

We may seek additional funds through public or private equity or debtfinancing, strategic transactions and/or from other sources.  If we fund our programs through equityfinancings and if the price of the shares ultimately sold in that offering isless than the net tangible book value of your common shares, you will sufferdilution.  Depending upon the amount ofcapital we raise through the sale of equity, the dilution may besubstantial.  We could enter intocollaborative arrangements for the development of particular products thatwould lead to our relinquishing some or all rights to the related technology orproducts.

 

There are no assurances that future funding will be available onfavorable terms or at all.  If adequatefunding is not obtained, we will need to reduce, defer or cancel developmentprograms, planned initiatives or overhead expenditures, to the extentnecessary.  The failure to fund ourcapital requirements would have a material adverse effect on our business,financial condition and results of operations.

 

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**Weare an early stage development company**

 

Our biotechnology business is still at an early stage ofdevelopment.  Significant additionalresearch and development and clinical trials must be completed before ourtechnology can be commercialized.  Wehave not completed the development of any therapeutic products and, therefore,have not begun to market or generate revenues from the commercialization of anytherapeutic products.  We have undertakenonly limited human clinical trials for HspE7 and cannot assure you thatsubsequent trials will generate favourable results, that the results obtained fromlaboratory or research studies for our other products will be replicated inhuman studies, that our human studies will demonstrate efficacy or that ourstudies and trials will not identify undesirable side effects of ourproducts.  There are no assurances thatany of our therapeutic products will:

 

•                  meet applicable health regulatory standards;

 

•                  obtain required regulatory approvals orclearances;

 

•                  be produced in commercial quantities atreasonable costs;

 

•                  be successfully marketed; or

 

•                  be profitable enough that we will recoup theinvestment made in such product candidates.

 

None of our therapeutic product candidates are expected to becommercially available for several years. It is possible that we will not successfully develop any therapeuticproducts.

 

**We have a history of operating losses and maynever become profitable**

 

We have not recorded any revenues from the sale of therapeutic productsand have accumulated substantial net losses. We expect we will continue to incur losses for at least the next severalyears while our primary activities are research, development and clinicaltrials.  If we sell our bioreagentsbusiness, we would exchange a source of on-going revenue for immediatecash.  Once the proceeds from the salehave been exhausted, we could incur larger operating losses in future fiscalperiods than we incurred during comparable periods in 2003 or 2004.  To become profitable we, either alone or withone or more partners, must develop, manufacture and successfully markettherapeutic product candidates.

 

**Our success depends on collaborativepartners, licensees and other third parties over whom we have limited control**

 

Due to the complexity of the process of developing therapeutics, ourcore business depends on arrangements with pharmaceutical companies, corporateand academic collaborators, licensors, licensees and others for the research,development, clinical testing, technology rights, manufacturing, marketing andcommercialization of our products. We have various research collaborations andoutsource many other business functions, including clinical trials andmanufacturing.  Our license agreementscould obligate us to diligently bring potential products to market, makemilestone payments and royalties that, in some instances, could be substantial,and incur the costs of filing and prosecuting patent applications.  There are no assurances that we will

 

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be able to establish or maintain collaborations that are important toour business on favorable terms, or at all.

 

A number of risks arise from our dependence on collaborative agreementswith third parties.  Product developmentand commercialization efforts could be adversely affected if key collaborativepartners:

 

•                  terminate or suspend their agreements withus;

 

•                  cause delays;

 

•                  fail to timely develop or manufacture inadequate quantities a substance needed in order to conduct clinical trials;

 

•                  fail to adequately perform clinical trials;

 

•                  determine not to develop, manufacture orcommercialize a product to which they have rights; or

 

•                  otherwise fail to meet their contractualobligations.

 

Also, our collaborative partners could pursue other technologies ordevelop alternative products that could compete with the products we aredeveloping.

 

**The profitability of our products will dependin part on our ability to protect proprietary rights and operate withoutinfringing the proprietary rights of others**

 

The profitability of our products will depend in part on our ability toobtain and maintain patents and licenses and preserve trade secrets, and theperiod our intellectual property remains exclusive.  We must also operate without infringing theproprietary rights of third parties and without third parties circumventing ourrights. The patent positions of pharmaceutical and biotechnology enterprises,including ours, are uncertain and involve complex legal and factual questionsfor which important legal principles are largely unresolved.  For example, no consistent policy has emergedregarding the breadth of biotechnology patent claims that are granted by theU.S. Patent and Trademark Office or enforced by the U.S. federal courts.  In addition, the scope of the originallyclaimed subject matter in a patent application can be significantly reducedbefore a patent is issued.  Thebiotechnology patent situation outside the U.S. is even more uncertain, iscurrently undergoing review and revision in many countries, and may not protectour intellectual property rights to the same extent as the laws of the U.S.  Because patent applications are maintained insecrecy in some cases, we cannot be certain that we or our licensors are thefirst creators of inventions described in our pending patent applications orpatents or the first to file patent applications for such inventions.

 

Other companies may independently develop similar products and designaround any patented products we develop. We cannot assure you that:

 

•                  any of our patent applications will result inthe issuance of patents;

 

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•                  we will develop additional patentableproducts;

 

•                  the patents we have been issued will provideus with any competitive advantages;

 

•                  the patents of others will not impede ourability to do business; or

 

•                  third parties will not be able to circumvent ourpatents.

 

On October 22, 2002 Antigenics Inc. announced that it had filed anopposition in the European Patent Office (“EPO”) to a European patent andrequests for re-examination in the U.S. Patent and Trademark Office of two U.S.patents we licensed in connection with our platform technology.  In October 2003 Antigenics filed anopposition in the European Patent Office to an additional, product specific,European patent.  The EPO may hold anoral hearing as early as this fall if the parties do not request a change inthe date.  We do not know when we willobtain results from these proceedings. Until we receive final results from the opposition and re-examinationprocesses, we will not be able to assure investors of the success of ourplanned vigorous defense of the patents.

 

A number of pharmaceutical, biotechnology, research and academiccompanies and institutions have developed technologies, filed patentapplications or received patents on technologies that may relate to ourbusiness.  If these technologies,applications or patents conflict with ours, the scope of our current or futurepatents could be limited or our patent applications could be denied.  Our business may be adversely affected ifcompetitors independently develop competing technologies, especially if we donot obtain, or obtain only narrow, patent protection.  If patents that cover our activities areissued to other companies, we may not be able to: obtain licenses at areasonable cost, or at all; develop our technology; or introduce, manufactureor sell the products we have planned.

 

Patent litigation is becoming widespread in the biotechnologyindustry.  Such litigation may affect ourefforts to form collaborations, to conduct research or development, to conductclinical testing or to manufacture or market any products underdevelopment.  There are no assurancesthat our patents would be held valid or enforceable by a court or that acompetitor’s technology or product would be found to infringe our patents inthe event of patent litigation.  Ourbusiness could be materially affected by an adverse outcome to suchlitigation.  Similarly, we may need toparticipate in interference proceedings declared by the U.S. Patent andTrademark Office or equivalent international authorities to determine priorityof invention.  We could incur substantialcosts and devote significant management resources to defend our patent positionor to seek a declaration that another company’s patents are invalid.

 

Much of our know-how and technology may not be patentable, though itmay constitute trade secrets. There are no assurances that we will be able tomeaningfully protect our trade secrets. We cannot assure you that any of our existing confidentiality agreementswith employees, consultants, advisors or collaborators will provide meaningfulprotection for our trade secrets, know-how or other proprietary information inthe event of any unauthorized use or disclosure.  Collaborators, advisors or consultants maydispute the ownership of proprietary rights to our technology, for example byasserting that they developed the technology independently.

 

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**We may encounter difficulties inmanufacturing our products**

 

Our manufacturing experience in bioreagents is not directly applicableto the manufacture of therapeutic products. We have not yet introduced any therapeutic products and have noexperience manufacturing therapeutic vaccines ourselves.  Before our products can be profitable, theymust be produced in commercial quantities in a cost-effective manufacturingprocess that complies with regulatory requirements, including goodmanufacturing practices (“GMP”), production and quality controlregulations.  Because we do not havefacilities for the production of therapeutic products such as HspE7, wecontract with third parties for process development, the scale-up ofmanufacturing our products from the laboratory bench to commercial quantities,manufacturing of bulk materials, product characterization, filling the product intovials, packaging and related processes. If there are delays or difficulties in developing a commercialmanufacturing process, performing manufacturing or transferring HspE7 betweencontractors performing different aspects of the manufacturing process, we maynot be able to conduct clinical trials, obtain regulatory approval or meetdemand for our products.

 

Production of future products could require raw materials which arescarce or which can be obtained only from a limited number of sources.  If our manufacturers were unable to obtainadequate supplies of such raw materials, the development, regulatory approvaland marketing of our products could be delayed.

 

**We could need additional clinical trials ortake more time to complete our clinical trials than we have planned**

 

Clinical trials vary in design by factors including dosage, end points,length, controls, and numbers and types of patients enrolled.  We may need to conduct a series of trials todemonstrate the safety and efficacy of our products.  The results of these trials may notdemonstrate safety or efficacy sufficiently for regulatory authorities toapprove our products.

 

Regulatory authorities may require us to determine whether our productsdelay or prevent disease recurrence. Clinical trials to show that a disease does not recur take longer tocomplete than clinical trials that end when patients stop having specificsymptoms.  The actual schedules for ourclinical trials could vary dramatically from the forecasted schedules due tofactors including changes in trial design, conflicts with the schedules ofparticipating clinicians and clinical institutions, delayed patient accrual andchanges affecting product supplies for clinical trials.

 

We rely on collaborators, including academic institutions, governmentalagencies and clinical research organizations, to conduct, supervise, monitorand design some or all aspects of clinical trials involving our products.  The U.S. National Cancer Institute issponsoring some HspE7 clinical trials. Since these trials depend on governmental participation and funding, wehave less control over their timing and design than trials we sponsor.  Delays in or failure to commence or completeany planned clinical trials could delay the ultimate timelines for product release.

 

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**We may not be able to obtain the regulatoryapprovals or clearances that are necessary to commercialize our products**

 

The U.S., Canada and other countries impose significant statutory andregulatory obligations upon the manufacture and sale of human therapeuticproducts.  Each regulatory authoritytypically has a lengthy approval process in which it examines pre-clinical andclinical data and the facilities in which the product is manufactured.  Regulatory submissions must meet complexcriteria to demonstrate the safety and efficacy of the ultimate products.  Addressing these criteria requiresconsiderable data collection, verification and analysis.  We may spend time and money preparingregulatory submissions or applications without assurances as to whether theywill be approved on a timely basis or at all.

 

Our product candidates, some of which are currently in the early stagesof development, will require significant additional development and pre-clinicaland clinical testing prior to their commercialization. These steps and theprocess of obtaining required approvals and clearances can be costly andtime-consuming.  If our potentialproducts are not successfully developed, cannot be proven to be safe andeffective through clinical trials, or do not receive applicable regulatoryapprovals and clearances, or if there are delays in the process:

 

•                  thecommercialization of our products could be adversely affected;

 

•                  anycompetitive advantages of the products could be diminished; and

 

•                  revenuesor collaborative milestones from the products could be reduced or delayed.

 

Governmental and regulatory authorities may approve a product candidatefor fewer indications or narrower circumstances than requested or may conditionapproval on the performance of post-marketing studies for a productcandidate.  Similarly, phase IV clinicaltrials could be a condition to regulatory approval.  Even if a product receives regulatoryapproval and clearance, it may later exhibit adverse side effects that limit orprevent its widespread use or that force us to withdraw the product from themarket.

 

Any marketed product and its manufacturer will continue to be subjectto strict regulation after approval. Results of post-marketing programs may limit or expand the furthermarketing of products.  Unforeseenproblems with an approved product or any violation of regulations could resultin restrictions on the product, including its withdrawal from the market andpossible civil actions.

 

The manufacturers of our products will be required to comply withapplicable GMP regulations, which include requirements relating to qualitycontrol and quality assurance, as well as the maintenance of records anddocumentation.  If the manufacturerscannot comply with regulatory requirements, including applicable GMPrequirements, we may not be allowed to develop or market the productcandidates.  If we or our manufacturersfail to comply with applicable regulatory requirements at any stage during theregulatory process, we may be subject to sanctions, including fines, productrecalls, product seizures, injunctions, refusal of regulatory agencies toreview pending market approval applications or supplements to approveapplications,

 

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total or partial suspension of production, civil penalties, withdrawalsof previously approved marketing applications and criminal prosecution.

 

**Competitors may develop and market drugs thatare less expensive, more effective or safer, making our products obsolete oruncompetitive**

 

Many competitors and potential competitors have substantially greaterproduct development capabilities and financial, scientific, marketing andstaffing resources than we do. Technological competition from pharmaceutical companies andbiotechnology companies is intense and is expected to increase.  Other companies have developed technologiesthat could be the basis for competitive products.  Some of these products have an entirelydifferent approach or means of accomplishing the desired therapeutic effectthan products we are developing. Alternative products may be developed that are more effective, workfaster and are less costly than our products. Competitors may succeed in developing products earlier than us,obtaining approvals and clearances for such products more rapidly than us, ordeveloping products that are more effective than ours.  In addition, other forms of medicaltreatment, such as surgery, are competitive with our products. Over time, ourtechnology or products may become obsolete or uncompetitive.  See “Business of the Corporation -Competition.”

 

**Our products may not gain market acceptance**

 

Products such as HspE7, our lead therapeutic vaccine candidate, may notgain market acceptance among physicians, patients, healthcare payors and themedical community.  The degree of marketacceptance of any product depends on a number of factors, includingestablishment and demonstration of clinical efficacy and safety,cost-effectiveness, clinical advantages over alternative products, andmarketing and distribution support for the products.  Limited information regarding these factorsis available in connection with our products or products that may compete withours.

 

Our sales experience islimited to the sale of bioreagents.  Wedo not have experience selling therapeutics such as HspE7.  To directly market and distribute anypharmaceutical products, we or our collaborators will need a marketing andsales force with appropriate technical expertise and supporting distributioncapabilities.  We may not be able toestablish sales, marketing and distribution capabilities or enter intoarrangements with third parties on acceptable terms.  If we or our partners cannot successfullymarket and sell our products, our ability to generate revenue will be limited.

 

**Our operations and the use of our productscould subject us to damages relating to injuries or accidental contamination**

 

The human clinical trials we conduct, including trials in children, mayhave unforeseen long-term health implications. We have only limited amounts of product liability insurance for ourclinical trials.  We may not correctlyanticipate or be able to maintain on acceptable terms the level of insurancecoverage that would adequately cover potential liabilities from proposedclinical trials and eventual commercial sales. Product liability insurance is expensive, difficult to obtain and maynot be available in the future.  If wecannot obtain sufficient insurance coverage or other protection againstpotential product liability claims, the commercialization of our 

 

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products may become financially infeasible.  If any liabilities from a claim exceed thelimit of insurance coverage, we may not have the resources to pay them.

 

Our research and development processes involve the controlled use ofhazardous and radioactive materials.  Weare subject to federal, state, provincial and local laws and regulationsgoverning the use, manufacture, storage, handling and disposal of suchmaterials and waste products.  The riskof accidental contamination or injury from handling and disposing of suchmaterials cannot be completely eliminated. In the event of an accidentinvolving hazardous or radioactive materials, we could be held liable forresulting damages.  We are not insuredwith respect to this liability. Such liability could exceed our resources.  In the future we could incur significantcosts to comply with environmental laws and regulations.

 

**Our success depends on attracting andretaining qualified personnel**

 

We depend on a core management and scientific team.  The loss of one or more of these individualscould cause delays or prevent us from achieving our business objective ofcommercializing our product candidates. Our future success will depend in large part on our continued ability toattract and retain other highly qualified scientific, technical and managementpersonnel, as well as personnel with expertise in clinical testing andgovernment regulation.  We facecompetition for personnel from other companies, universities, public andprivate research institutions, government entities and otherorganizations.  If our recruitment andretention efforts are unsuccessful, our business operations could suffer.

 

**Our revenues will depend upon theavailability of reimbursement from third-party payors that are increasinglychallenging the price and examining the cost effectiveness of medical productsand services**

 

Sales of therapeutic products depend in part upon the availability ofreimbursement from third-party payors, including government healthadministration authorities, managed care providers, private health insurers andother organizations.  These third-partypayors increasingly attempt to contain costs by challenging the price ofproducts and services and limiting the coverage and level of reimbursement forpharmaceutical products.  Third partyreimbursement for our products may be inadequate to enable us to maintainprices that provide a return on our product development investment.  Governments continue to propose and passlegislation designed to reduce healthcare costs.  This legislation could further limitreimbursement.  If government andthird-party payors do not adequately reimburse patients for the costs of ourproducts, the market for our products may be limited.

 

**Our share price has been and is likely tocontinue to be highly volatile**

 

Our share price has been highly volatile inthe past and is likely to continue to be volatile. The price of our sharescould be materially affected by factors including:

 

•                  the announcement of clinical trials resultsby us or our competitors;

 

•                  regulatory actions;

 

•                  safety issues;

 

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•                  changes affecting patents or exclusivelicenses;

 

•                  future issuances of shares;

 

•                  the announcement of technologicalinnovations;

 

•                  the release of technical, financial, researchand other publications;

 

•                  the development of new commercial products;

 

•                  changes in regulations;

 

•                  the release of financial results;

 

•                  public concerns over risks relating tobiotechnology;

 

•                  sales of shares by existing shareholders; and

 

•                  changes in analyst recommendations.

 

# **Item 2**. PROPERTIES 

# ** **

We do not own any real property.  Our principal research facilities are inVictoria, British Columbia, as are the operations of Stressgen BioreagentsLimited Partnership, a British Columbia limited partnership.  The two Victoria businesses shareapproximately 25,000 square feet of office, research and manufacturing spaceunder a lease that expires at the end of 2005.

 

The office address of StressgenBiotechnologies Corporation is 350-4243 Glanford Avenue, Victoria, BritishColumbia V8Z 4B9.  It is a corporationcontinued under the laws of the Yukon Territory, with a registered officeaddress of Lackowicz & Shier, Suite 300, 204 Black Street,Whitehorse, YT Y1A 2M9 Canada.

 

Stressgen Biotechnologies Corporation holdsall the common stock of three subsidiaries:

 

•                  StressgenBiotechnologies, Inc., a Delaware corporation

 

•                  StressgenDevelopment Corporation, a Barbados corporation and

 

•                  StressgenHoldings Corporation, a corporation continued under the laws of the YukonTerritory (the general partner of Stressgen Bioreagents Limited Partnership).

 

Executive, clinical research, regulatory affairs and financialfunctions are provided by Stressgen Biotechnologies, Inc., which leasesspace in San Diego, California and Collegeville, Pennsylvania.

 

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# **Item 3**.  LEGALPROCEEDINGS

# ** **

As of the datehereof, we are not a party to any material legal proceedings.  From time to time we are involved in disputesarising out of our normal course of business.

 

# **Item 4**.  SUBMISSION OFMATTERS TO A VOTE OF SECURITY HOLDERS 

# ** **

We did not submit any matters to a vote of security holders, throughthe solicitation of proxies or otherwise, during the quarter ended December 31,2004.

 

**PART II**

 

# **Item 5**.  MARKET FORREGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS 

# ** **

**CommonShare Information**

 

Our common shares are listed andposted for trading in Canada on The Toronto Stock Exchange under the symbol “SSB.”  The following table sets forth, for theperiods indicated, the high and low sales prices of the common shares, asreported on the Toronto Stock Exchange. All amounts following are expressed in Canadian dollars unless otherwiseindicated.

 
| ** **          | ** ** | **Price Per Share** | ** ** | ** ** | ** ** |
|---------------------|------------|---------------------|------------|------------|------------|
| **Calendar Period** | ** ** | **High**            | ** ** | **Low**    | ** ** | ** ** | ** ** |
| ** **          | ** ** | **$**               | ** ** | **$**      | ** ** | ** ** | ** ** |
| **2003**            |       |                |       |       |       |   |   |   |
| First  Quarter      |       | 2.12                |       | 1.31       |       |   |   |   |
| Second  Quarter     |       | 2.78                |       | 1.40       |       |   |   |   |
| Third  Quarter      |       | 2.43                |       | 1.44       |       |   |   |   |
| Fourth  Quarter     |       | 2.23                |       | 1.56       |       |   |   |   |
|                |       |                |       |       |       |   |   |   |
| ** **          | ** ** | ** **          | ** ** | ** ** | ** ** | **Volume** | ** ** |
| **2004**            |       |                |       |       |       |   |   |
| January             |       | 1.84                |       | 1.56       |       | 6,490,759 |   |
| February            |       | 2.06                |       | 1.22       |       | 10,192,148 |   |
| March               |       | 1.30                |       | 1.00       |       | 6,511,349 |   |
| April               |       | 1.17                |       | 0.96       |       | 4,333,870 |   |
| May                 |       | 1.07                |       | 0.75       |       | 2,610,429 |   |
| June                |       | 1.08                |       | 0.76       |       | 2,620,304 |   |
| July                |       | 0.94                |       | 0.76       |       | 1,709,158 |   |
| August              |       | 0.82                |       | 0.63       |       | 1,171,672 |   |
| September           |       | 0.82                |       | 0.65       |       | 3,594,035 |   |
| October             |       | 0.75                |       | 0.51       |       | 2,671,592 |   |
| November            |       | 0.55                |       | 0.37       |       | 3,117,827 |   |
| December            |       | 0.47                |       | 0.36       |       | 3,582,417 |   |

 

On March 8, 2005, the closing priceof our common shares as reported by The Toronto Stock Exchange was $0.36 pershare.  We had 142 registered holders, 20of whom were residents of the

 

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U.S. Of the approximately 72,506,000 common shares outstanding, the portionheld by registered holders in the U.S. was approximately 6,554,000 or 9%.

 

There were approximately 16,000 holdersof our common shares as of the most recent annual general meeting ofshareholders on May 12, 2004.

 

**DividendPolicy**

 

We have not declared or paid anydividends on our common shares since inception. We have no plans to pay dividends in the foreseeable future.

 

**Exchange Controls and Other LimitationsAffecting Holders of Common Shares**

 

There is no law, governmental decree or regulation inCanada that restricts the export or import of capital, or which would affectour remittance of dividends or other payments to non-resident holders of ourcommon shares, other than withholding tax requirements.

 

There is no limitation imposed by Canadian law or the charter or otherconstituent documents of Stressgen on the right of non-residents to hold orvote our common shares, other than those imposed by the *InvestmentCanada Act*(Canada), or the ICA.

 

The ICA requires each individual, government or agency thereof,corporation, partnership, trust or joint venture that is not a “Canadian” asdefined in the ICA who commences a new business activity in Canada or acquirescontrol of an existing Canadian business, where the establishment oracquisition of control is not a reviewable transaction, to file a notificationwith Industry Canada. The ICA generally prohibits implementation of areviewable transaction by a non-Canadian unless after review the ministerresponsible for the ICA is satisfied that the investment is likely to be of netbenefit to Canada. An investment in our common shares by a non-Canadian wouldbe reviewable under the ICA if it were an investment to acquire control ofStressgen and the value of our assets of was $5 million or more. Higher limitsapply for acquisitions by or from World Trade Organization member countryinvestors.

 

The acquisition of a majority of the voting interests of an entity orof a majority of the undivided ownership interests in the voting shares of anentity that is a corporation is deemed to be acquisition of control of thatentity.  The acquisition of less than amajority but one-third or more of the voting shares of a corporation or of anequivalent undivided ownership interest in the voting shares of the corporationis presumed to be acquisition of control of that corporation unless it can beestablished that, upon the acquisition, the corporation is not controlled infact by the acquiror through the ownership of voting shares. The acquisition ofless than one-third of the voting shares of a corporation or of an equivalentundivided ownership interest in the voting shares of the corporation is deemednot to be acquisition of control of that corporation. Certain transactions inrelation to our common shares would be exempt from review from the ICA,including an:

 

•                  acquisitionof common shares by a person in the ordinary course of that person’s businessas a trader or dealer in securities;

 

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•                  acquisitionof control of Stressgen in connection with the realization of security grantedfor a loan or other financial assistance and not for any purpose related to theprovisions of the Investment Act; and

 

•                  acquisitionof control of Stressgen by reason of an amalgamation, merger, consolidation orcorporate reorganization following which the ultimate direct or indirectcontrol in fact of Stressgen, through the ownership of voting interests,remains unchanged.

 

The ICA was amended with the *Act to Implement theAgreement Establishing the World Trade Organization*(Canada) toprovide for special review thresholds for World Trade Organization membercountry investors. Under the ICA, as amended, an investment in our commonshares by an investor from a country which is a member of the WTO would bereviewable only if it were an investment to acquire control of the company andthe value of the assets of the company was equal to or greater than a specifiedamount, which increases in stages. As at December 31, 2004, the reviewthreshold was Cdn. $237,000,000. This amount is subject to an annual adjustmenton the basis of a prescribed formula in the ICA to reflect inflation and realgrowth within Canada.

 

**Certain Canadian Federal Income TaxInformation for United States Residents**

 

The following is a summary of certain Canadian federal income tax considerationsgenerally applicable to holders of common shares who, for purposes of theIncome Tax Act (Canada) (the “Canadian Tax Act”), deal at arm’s length and arenot affiliated with Stressgen, hold such shares as capital property, do not useor hold, and are not deemed to use or hold, the common shares in connectionwith a trade or business carried on, or deemed to be carried on, in Canada atany time, have not been at any time residents of Canada for purposes of theCanadian Tax Act and are residents of the United States of America (“U.S.Residents”) under the Canada-U.S. Income Tax Convention (1980) (the “Convention”).  The common shares will generally beconsidered to be capital property of holders unless such shares are held in thecourse of carrying on a business, or in an adventure or concern in the natureof trade.  Furthermore, this summary doesnot apply to any holder which carries on an insurance business in Canada andelsewhere, in respect of the common shares that are effectively connected withthe holder’s Canadian insurance business or that are “designated insuranceproperty” as defined in the Canadian Tax Act.

 

This summary is of a general nature only and is not intended to be, andshould not be construed to be, legal, business or tax advice to any holder ofcommon shares or prospective holder of common shares and no opinion orrepresentation with respect to any tax consequences, including, but not limitedto, Canadian federal, Canadian provincial or U.S. tax consequences, is made toany particular holder of common shares or prospective holder of common shares.Accordingly, holders of common shares and prospective holders of common sharesshould consult with their own tax advisers for advice with respect to the taxconsequences to them having regard to their own particular circumstances,including any consequences of purchasing, owning or disposing of common sharesarising under Canadian federal, Canadian provincial, U.S. Federal, U.S. stateor local tax laws or tax laws of jurisdictions outside the U.S. or Canada. 

 

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No advance income tax ruling has been requested or obtained from theCanada Customs and Revenue Agency to confirm the tax consequences of any of thetransactions described herein.

 

This summary is based on the current provisions of the Canadian Tax Actand the regulations thereunder (the “Regulations”), proposed amendments to theCanadian Tax Act and/or Regulations publicly announced by the Minister ofFinance (Canada) prior to the date hereof (the “Proposed Amendments”), and theprovisions of the Convention as in effect on the date hereof.  No assurance can be given that the ProposedAmendments will be entered into law in the manner proposed, or at all.

 

This summary is not exhaustive of all possible Canadian federal incometax consequences for U.S. Residents and does not take into account oranticipate any changes in law, whether by legislative, administrative,governmental or judicial decision or action, nor does it take into accountCanadian provincial, U.S. or foreign tax considerations which may differsignificantly from those discussed herein. No assurances can be given thatsubsequent changes in law or administrative policy will not affect or modifythe opinions expressed herein.

 

A holder will not be subject to tax under the Canadian Tax Act inrespect of any capital gain on a disposition or deemed disposition of commonshares (including the death of the holder) unless at the time of suchdisposition such shares constitute taxable Canadian property of the holder forpurposes of the Canadian Tax Act and such holder is not entitled to reliefunder an applicable tax treaty.  Thecommon shares will generally not constitute taxable Canadian property of aholder at the time of a disposition of such shares provided (1) suchshares are listed on a prescribed stock exchange (which includes the TorontoStock Exchange and would currently include the American Stock Exchange orNASDAQ), (2) the holder does not use or hold or is not deemed to use orhold, such shares in connection with carrying on a business in Canada, and (3) theholder, persons with whom such holder does not deal at arm’s length, or theholder and such persons, has not owned 25% or more of the issued shares of anyclass or series of our share capital at any time within the 5 years precedingthe date of disposition.  In any event,under the Convention, gains derived by a holder who is a resident of the U.S.(within the meaning of the Convention) from the disposition of common shareswill generally not be taxable in Canada unless the value of the common sharesis derived principally from real property situated in Canada.  If the common shares held by a holder do notconstitute taxable Canadian property or if a capital gain in respect of thecommon shares would because of a tax treaty be exempt from tax under theCanadian Tax Act, any capital loss arising upon the disposition of the commonshares will not be available to be used to offset a capital gain realized inrespect of another property, which may be subject to tax under the Canadian TaxAct.  To the extent the common sharesdisposed of constitute taxable Canadian property; the holder will be requiredto file a Canadian tax return, even if the gain arising from such a dispositionis exempt from tax because of a tax treaty.

 

Amounts in respect of common shares paid or credited or deemed to bepaid or credited as, on account or in lieu of payment of, or in satisfactionof, dividends to a U.S. Resident will generally be subject to Canadiannon-resident withholding tax at the rate of 25%. Currently, under theConvention the rate of Canadian non-resident withholding tax will generally bereduced to: (i) 5% of the gross amount of dividends if the beneficialowner is a company (other than a limited liability company) that is resident inthe U.S. and that owns at least 10% of our voting stock; or

 

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(ii) 15% of the gross amount of dividends if the beneficial owneris a resident of the U.S. (and is not a limited liability company) but does notqualify for the 5% withholding rate.

 

**United States Federal Income TaxConsiderations**

 

The following summary is a general description of the material UnitedStates federal income tax consequences of the purchase, ownership anddisposition of common shares by U.S. Holders (as defined below). This summarydoes not address all potentially relevant U.S. federal income tax matters. Thisdescription is intended for general information purposes only and does notconstitute an opinion regarding tax consequences.  It is based on the U.S. Internal Revenue Codeof 1986, as amended (the “Code”), Treasury regulations promulgated thereunder,and judicial and administrative interpretations thereof, all as in effect onthe date hereof and all of which are subject to change, prospectively orretroactively.

 

The tax treatment of a holder of common shares may vary depending uponhis particular situation. Certain holders (including, but not limited to,persons that are not U.S. Holders, banks, insurance companies, tax-exemptorganizations, financial institutions, persons subject to the alternativeminimum tax, real estate investment trusts, regulated investment companies,persons or entities that have a “functional currency” other than the U.S.dollar, shareholders who acquired their stock through the exercise of employerstock options, and broker-dealers) may be subject to special rules notdiscussed below. The following summary is limited to U.S. Holders who will holdthe common shares as “capital assets” within the meaning of Section 1221of the Code, and do not actually or constructively own 10% or more of ourvoting stock. The discussion below does not address the effect of any state,local or foreign tax law on a holder of the common shares.

 

Prospective investors should consult their own tax advisors about thefederal, state, local, and foreign tax consequences of purchasing, owning anddisposing of common shares.

 

As used herein, the term “U.S. Holder” means (i) an individual whois a citizen or resident of the U.S., (ii) a partnership, corporation orother entity organized in or under (or treated for federal income tax purposesas organized in or under) the laws of the U.S. or any state thereof, (iii) anestate subject to U.S. federal income taxation without regard to the source ofits income, and (iv) a trust if (a) a U.S. court is able to exerciseprimary supervision over the trust’s administration and (b) one or moreU.S. fiduciaries have the authority to control all of the trust’s substantialdecisions. The term “Non-U.S. Holder” shall mean the beneficial owner of commonshares other than a U.S. Holder.

 

***Dividend Income***

 

Subject to the discussion of the “passive foreign investment company” rules below,for United States federal income tax purposes, the gross amount of adistribution with respect to common shares will include the amount of anyCanadian federal income tax withheld, and will be treated as a taxable dividendto the extent of our current and accumulated earnings and profits.

 

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To the extent that distributions exceed our current or accumulatedearnings and profits, they will be treated first as a return of capital up tothe U.S. Holder’s adjusted basis in the common shares and thereafter as gainfrom the sale or exchange of the common shares.

 

If a dividend distribution is paid in Canadian dollars, the amountsincludable in income will be the U.S. dollar value, on the date of receipt, ofthe Canadian dollar amount distributed. Any subsequent gain or loss in respectof such Canadian dollars arising from exchange rate fluctuations will beordinary income or loss.

 

U.S. Holders who are individuals are currently subject to a maximumfederal income tax rate of 15% on dividends received from foreign corporationsthat are “qualified foreign corporations”, as defined by the Code.  We believe that the Company is a qualifiedforeign corporation.

 

Subject to the limitations set forth in the Code, as modified by theU.S.-Canada income tax treaty, U.S. Holders may elect to claim a credit againsttheir U.S. federal income tax liability for Canadian income tax withheld fromdividends received in respect of common shares. For purposes of calculating thecredit for the Canadian taxes paid against the U.S. taxes imposed, the dividendshould be foreign source income.  The rules relatingto the determination of the foreign tax credit are complex. U.S. Holders shouldconsult their personal tax advisors to determine whether and to what extentthey would be entitled to such credit. U.S. Holders that do not elect to claimforeign tax credits may instead claim a deduction for Canadian income taxwithheld.

 

***Sale of Common Stock***

 

Subject to the discussion of the “passive foreign investment company” rules below,the sale of common shares will generally result in the recognition of gain orloss in an amount equal to the difference between the amount realized on thesale and the holder’s adjusted basis in such common shares.

 

Gain or loss upon the sale of the common shares will be long-term orshort-term capital gain or loss, depending on whether or not the common shareswere held for more than one year prior to the sale. Preferential tax rates forlong-term net capital gains are applicable to a U.S. Holder that is anindividual, estate or trust. There are currently no preferential tax rates forlong-term capital gains for a U.S. Holder that is a corporation. Short-termcapital gains are generally taxed at ordinary income tax rates.  Deductions for net capital losses are subjectto significant limitations.

 

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***PFIC Status***

 

Special rules are applicable to U.S. Holders that hold stock of a “passiveforeign investment company” (“PFIC”).  Aforeign corporation is a PFIC if at least 75% of its gross income for thetaxable year is passive income or if at least 50% by value of the assets itholds during the taxable year produce or are held for the production of passiveincome. For publicly traded corporations such as Stressgen, the asset test ismet if the fair market value of passive income-producing assets equals orexceeds 50% of the sum of the corporation’s liabilities plus the value of itsoutstanding stock.  U.S. Holders ofcommon shares can be adversely affected by the PFIC rules if they hold orhave held our common shares in a year in which we have or had PFIC status.

 

In general, a U.S. Holder of common shares in a PFIC is required toprorate all gains realized on the disposition of such U.S. Holder’s commonshares and all “excess distributions” (as such term is defined by Section 1291)over the entire holding period for the common shares (excluding any periodprior to the first year during which we were a PFIC). All gains or excessdistributions allocated to such prior years are taxed at the highest tax ratefor each such prior year applicable to ordinary income. The U.S. Holder alsowould be liable for interest on the foregoing tax liability for each such prioryear calculated as if such tax liability had come due in each such prioryear.  However, if the U.S. Holder makesa timely election to treat a PFIC as a qualified electing fund (“QEF”) withrespect to such holder’s interest therein, the above-described rules generallywill not apply.  Instead, the electingU.S. Holder would include annually in his gross income his pro rata share ofthe PFIC’s ordinary earnings and net capital gain regardless of whether suchincome or gain was actually distributed. A U.S. Holder of a QEF can, however, elect to defer the payment of U.S.federal income tax on such income inclusions, but would then be obligated topay interest to the government on the deferred payment.  In addition, subject to certain limitations,U.S. Holders owning marketable stock in a PFIC are permitted to elect to markthat stock to market annually.  Amountsincluded in or deducted from income under the mark to market alternative (andactual gains and losses realized upon disposition, subject to certain limitations)will be treated as ordinary gains or losses.

 

We believe that Stressgen was not a PFIC for the year 2004 or prioryears.  However, because PFIC statusdepends on the character of our income and assets in each year, there can be noassurance with respect to whether we will qualify as a PFIC in futureyears.  Further, there can be noassurance that our determination concerning our PFIC status will not bechallenged by the IRS.  If we determinethat Stressgen is a PFIC we will determine at that time whether we will providesufficient information for a U.S. Holder to make the QEF election.  Therefore, each prospective investor is urgedto consult with a tax advisor with respect to how the PFIC rules wouldaffect its tax situation.

 

***Controlled Foreign Corporation Status***

 

If more than 50% of the voting power of all classes of stock or thetotal value of our stock is owned, directly or indirectly, by citizens orresidents of the U.S., U.S. domestic partnerships and corporations or estatesor trusts other than foreign estates or trusts, each of whom own 10% or more ofthe total combined voting power of all classes of stock of the Company (“10%U.S. Shareholders”), Stressgen could be treated as a CFC under Subpart F of theCode. If in 1998 or

 

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thereafter Stressgen qualifies as a CFC, 10% U.S. Shareholders aregenerally not required to apply the PFIC rules, provided that, in some cases,complex tax elections are made. The classification of Stressgen as a CFC wouldeffect many complex results including the required inclusion by 10% U.S.Shareholders in income of their pro rata shares of our Subpart F income. Inaddition, gain from the sale or exchange of stock by a holder of our shares whois or was a 10% U.S. Shareholder at any time during the five-year period endingwith the sale or exchange is treated as ordinary dividend income to the extentof our earnings and profits attributable to the stock sold or exchanged.Because of the complexity of Subpart F, and because it is not clear thatSubpart F would apply to the holders of our shares, a 10% U.S. Holder is urgedto consult with their tax advisors to determine the applicable rules.

 

Due to the complexity of the tax rules, U.S. persons who areshareholders of Stressgen are strongly urged to consult their own tax advisorsconcerning the impact of these rules on their investment in our shares.

 

# **Items 6**, 7and 7A.  SELECTED FINANCIAL DATA;MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS; QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

# ** **

**AnnualFinancial Data**

 

Our consolidated financial statements have beenprepared in accordance with generally accepted accounting principles in Canada(“Canadian GAAP”). These principles differ in certain respects from generallyaccepted accounting principles in the United States of America (“U.S. GAAP”).  The differences as they affect our financialstatements are described in Note 11 to our audited consolidated financialstatements filed as part of Item 8 hereof. Because we report on a consolidated basis, our results include those ofour subsidiaries, including a U.S. subsidiary, which provides management,regulatory and research and development services, and a Barbados subsidiary,which is responsible for the development of HspE7.

 

35

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## **ConsolidatedStatement of Operations Data**

 
| ** **                                                                           | ** ** | **Years  Ended December 31,**                               | ** ** |
|--------------------------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                                                                           | ** ** | **2004**                                                         | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                                                           | ** ** | **(Canadian  dollars) (In thousands, except per share amounts)** | ** ** |
| Net revenues, Canadian and U.S. GAAP from  continuing operations                     |       | $                                                                | 700        |   | $ | 8,094 |   | $ | 8,370 |   | $ | — |   | $ | — |   |
| Research and development expenses from  continued operations, Canadian and U.S. GAAP |       | 25,913                                                           |       | 19,533 |   | 32,735 |   | 35,214 |   | 23,666 |   |
| Net (loss) income, Canadian GAAP (1)                                                 |       |                                                             |       |   |   |   |   |   |   |   |   |
| From continuing operations                                                           |       | (31,845                                                          | )          | (17,663 | ) | (30,826 | ) | (38,224 | ) | (26,781 | ) |
| From discontinued operations (3)                                                     |       | 1,580                                                            |       | 1,418 |   | 2,024 |   | 2,285 |   | 1,374 |   |
| Basic and diluted (loss) income per common  share, Canadian GAAP (1) (4)        |       |                                                             |       |   |   |   |   |   |   |   |   |
| From continuing operations                                                           |       | (0.44                                                            | )          | (0.29 | ) | (0.52 | ) | (0.75 | ) | (0.66 | ) |
| From discontinued operations (3)                                                     |       | 0.02                                                             |       | 0.03 |   | 0.03 |   | 0.05 |   | 0.03 |   |
| Net loss, U.S. GAAP (1)                                                              |       | (28,021                                                          | )          | (15,298 | ) | (29,016 | ) | (36,341 | ) | (35,766 | ) |
| Basic and diluted loss per common share,  U.S. GAAP (1) (4)                     |       | (0.39                                                            | )          | (0.25 | ) | (0.49 | ) | (0.71 | ) | (0.88 | ) |
|                                                                                 |       |                                                             |       |   |   |   |   |   |   |   |   |
| **Consolidated  Balance Sheet Data**                                                 |       |                                                             |       |   |   |   |   |   |   |   |   |
|                                                                                 |       |                                                             |       |   |   |   |   |   |   |   |   |
| ** **                                                                           | ** ** | **As  of December 31,**                                     | ** ** |
| ** **                                                                           | ** ** | **2004**                                                         | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                                                           | ** ** | **(In  thousands of Canadian dollars)**                          | ** ** |
| Cash and short-term investments, Canadian  GAAP                                      |       |                                                             |       |   |   |   |   |   |   |   |   |
| Of continuing operations                                                             |       | $                                                                | 21,578     |   | $ | 51,843 |   | $ | 46,013 |   | $ | 62,682 |   | $ | 70,567 |   |
| Of discontinued operations (3)                                                       |       | 1,066                                                            |       | 247 |   | — |   | — |   | — |   |
| Cash and short-term investments, U.S. GAAP                                           |       |                                                             |       |   |   |   |   |   |   |   |   |
| Of continuing operations                                                             |       | 21,578                                                           |       | 51,843 |   | 46,013 |   | 62,682 |   | 70,710 |   |
| Of discontinued operations (3)                                                       |       | 1,066                                                            |       | 247 |   | — |   | — |   | — |   |
| Total assets (2)                                                                     |       |                                                             |       |   |   |   |   |   |   |   |   |
| Canadian GAAP                                                                        |       | 30,174                                                           |       | 56,430 |   | 54,815 |   | 67,789 |   | 74,325 |   |
| U.S. GAAP                                                                            |       | 30,174                                                           |       | 56,430 |   | 54,815 |   | 67,789 |   | 74,468 |   |
| Long-term obligations, Canadian and U.S.  GAAP                                       |       |                                                             |       |   |   |   |   |   |   |   |   |
| Of continuing operations                                                             |       | $                                                                | 1,427      |   | $ | 2,672 |   | $ | 3,606 |   | $ | 578 |   | $ | 1,036 |   |
| Of discontinued operations (3)                                                       |       | —                                                           |       | — |   | — |   | — |   | — |   |

 

36

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The information set forth above is notnecessarily indicative of the results of future operations and should be readin conjunction with the consolidated financial statements and related notesthereto and with our fiscal 2004 “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.”

 

----

(1)                                  Toconform to U.S. GAAP, our net loss would, decrease by $2,244,000 in 2004 and$947,000 in 2003 and increase by $214,000 in 2002, $402,000 in 2001 and$10,359,000 in 2000.  The principal differences under U.S. GAAP asopposed to Canadian GAAP in 2004 were the reversal of an unrealized foreignexchange loss on investments of $800,000, a reversal of a loss on market valueof investments of $241,000 and the reversal of stock compensation expensetotaling $1,284,000 related to fair value stock option accounting adoptedbeginning January 1, 2004, offset by stock compensation expense of $81,000that would be recorded under APB Opinion No. 25.  In 2003, the principal difference in our net lossunder U.S. GAAP rather than Canadian GAAP was due to the reversal of $541,000in unrealized foreign exchange loss oninvestments and the reversal of a $406,000 loss on market value of investments.  In 2002, the principal difference in our netloss under U.S. GAAP rather than Canadian GAAP was due to the reversal of$69,000 in unrealized foreign exchange gain on investments and the reversal ofa $145,000 gain on market value ofinvestments.  In 2001, theprincipal difference in our net loss under U.S. GAAP rather than Canadian GAAPwas due to the reversal of an unrealized foreign exchange gain on investmentsof $541,000 offset by net $139,000 of other items.  In 2000, the principal difference in our netloss was due to the release of escrow shares of $9,093,000, stock-basedcompensation expenses including non-compensatory costs to non-employees of$1,674,000, and changes related to unrealized losses on available for salesecurities totaling $372,000.  See Note 11to our financial statement for further disclosure.

 

(2)                                  AtDecember 31, 2004, 2003, 2002 and 2001, there were no differences in totalassets under U.S. GAAP relative to Canadian GAAP.  At December 31, 2000, the difference intotal assets under U.S. GAAP relative to Canadian GAAP was $143,000, due to anincrease in market value on available-for-sale securities.

 

(3)                                  SeeManagement’s Discussion and Analysis and Note 12 to our financialstatements for further disclosure on our discontinued operations.

 

(4)                                  Nocash dividends were declared.

 

**Summary of Quarterly Results**

 

The following is a summary of the unauditedquarterly results of operations for the years ended December 31, 2004 and2003.

 

37

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(In thousands except per share amounts)

 
| ** **                                                                            | ** ** | **Quarter ended (b)** |       |
|---------------------------------------------------------------------------------------|------------|-----------------------|------------|
| **2004**                                                                              | ** ** | **March 31**     | ** ** | **June 30** | ** ** | **September 30** | ** ** | **December 31** | ** ** |
| Net  revenues, Canadian and U.S. GAAP                                                 |       |                  |       |   |   |   |   |   |   |
| From  continuing operations                                                           |       | 173                   |       | 190 |   | 174 |   | 163 |   |
|                                                                                  |       |                  |       |   |   |   |   |   |   |
| Research and  development expenses, Canadian and U.S. GAAP from continuing operations |       | 5,273                 |       | 5,636 |   | 6,422 |   | 8,582 |   |
|                                                                                  |       |                  |       |   |   |   |   |   |   |
| Net (loss)  income, Canadian GAAP                                                     |       |                  |       |   |   |   |   |   |   |
| From  continuing operations                                                           |       | (6,818                | )          | (7,029 | ) | (8,367 | ) | (9,631 | ) |
| From  discontinued operations                                                         |       | 534                   |       | 663 |   | 410 |   | (27 | ) |
| Net loss,  Canadian GAAP                                                              |       | (6,284                | )          | (6,366 | ) | (7,957 | ) | (9,658 | ) |
|                                                                                  |       |                  |       |   |   |   |   |   |   |
| Basic and  diluted (loss) income per common share, Canadian GAAP                      |       |                  |       |   |   |   |   |   |   |
| From  continuing operations (a)                                                       |       | (0.09                 | )          | (0.10 | ) | (0.12 | ) | (0.13 | ) |
| From  discontinued operations (a)                                                     |       | (0.00                 | )          | 0.01 |   | 0.01 |   | (0.00 | ) |
| Total basic  and diluted loss per common share                                        |       | (0.09                 | )          | (0.09 | ) | (0.11 | ) | 0.13 |   |
|                                                                                  |       |                  |       |   |   |   |   |   |   |
| Net loss,  U.S. GAAP (c)                                                              |       | (5,657                | )          | (6,014 | ) | (6,519 | ) | (9,831 | ) |
|                                                                                  |       |                  |       |   |   |   |   |   |   |
| Basic and  diluted loss per common share, U.S. GAAP (a) (c)                      |       | (0.08                 | )          | (0.08 | ) | (0.09 | ) | (0.14 | ) |
|                                                                                  |       |                  |       |   |   |   |   |   |   |
| ** **                                                                            | ** ** | **Quarter ended (b)** |       |
| **2003**                                                                              | ** ** | **March 31**     | ** ** | **June 30** | ** ** | **September 30** | ** ** | **December 31** | ** ** |
| Net  revenues, Canadian and U.S. GAAP                                                 |       |                  |       |   |   |   |   |   |   |
| From  continuing operations                                                           |       | 5,221                 |       | 1,508 |   | 855 |   | 510 |   |
|                                                                                  |       |                  |       |   |   |   |   |   |   |
| Research and  development expenses, Canadian and U.S. GAAP from continuing operations |       | 6,231                 |       | 4,408 |   | 5,636 |   | 3,258 |   |
|                                                                                  |       |                  |       |   |   |   |   |   |   |
| Net (loss)  income, Canadian GAAP                                                     |       |                  |       |   |   |   |   |   |   |
| From  continuing operations                                                           |       | (2,881                | )          | (4,677 | ) | (6,034 | ) | (4,071 | ) |
| From  discontinued operations                                                         |       | 424                   |       | 274 |   | 411 |   | 309 |   |
| Net loss,  Canadian GAAP                                                              |       | (2,457                | )          | (4,403 | ) | (5,623 | ) | (3,762 | ) |
|                                                                                  |       |                  |       |   |   |   |   |   |   |
| Basic and  diluted (loss) income per common share, Canadian GAAP                      |       |                  |       |   |   |   |   |   |   |
| From  continuing operations (a)                                                       |       | (0.05                 | )          | (0.08 | ) | (0.10 | ) | (0.06 | ) |
| From  discontinued operations (a)                                                     |       | 0.01                  |       | 0.01 |   | 0.01 |   | 0.00 |   |
| Total basic  and diluted loss per common share                                        |       | (0.04                 | )          | (0.07 | ) | (0.09 | ) | (0.06 | ) |
|                                                                                  |       |                  |       |   |   |   |   |   |   |
| Net loss,  U.S. GAAP (c)                                                              |       | (2,248                | )          | (4,222 | ) | (5,463 | ) | (3,365 | ) |
|                                                                                  |       |                  |       |   |   |   |   |   |   |
| Basic and  diluted loss per common share, U.S. GAAP (a) (C)                      |       | (0.04                 | )          | (0.07 | ) | (0.09 | ) | (0.05 | ) |

 

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(a)          Income(loss) per share is computed independently for each of the quarters presentedand therefore may not sum to the total for the year.

(b)         Amountsfor the first, second and third quarters of 2004 and all quarters in 2003 havebeen

 

38

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reclassified to conform to the presentationof the bioreagent business as discontinued operations.

(c)          Toconform to U.S. GAAP certain adjustments must be made.  The nature of the principal difference isdisclosed in the notes to our 2004 and 2003 audited financial statements.  See Note 11 to the financial statementsfor further disclosure.

 

Our financialresults over the past eight quarters were affected principally by our Roche collaborationand our R&D spending.  See thediscussion under the captions “Results of Operations—Collaborative R&DRevenue” and “Results of Operations—Research and Development” for additionalinformation.

 

**Fourth Quarter 2004 Results**

 

Our net losses from continuing operations for the three months ended December 31,2004 and 2003 were $9,631,000 and $4,071,000, respectively.  The increase in our fourth quarter 2004 netloss over the same period in the previous year is related to an increase in our2004 R&D spending in support of our efforts to develop HspE7.

 

Net revenues earned in the three months ended December 31, 2004declined to $163,000 compared to $510,000 for the same period in 2003.  The 2004 decline in net revenue is related tocollaborative R&D revenue from Roche in 2003 that we did not receive in2004.

 

Spending on R&D activities increased to $8,582,000 for the threemonths ended December 31, 2004 compared to $3,258,000 for the same periodin 2003.  The increase in R&D expensein 2004 is attributed to spending at Avecia to support the developmentactivities of HspE7.

 

**Currency Exchange Rates**

 

Our accounts are maintained in Canadiandollars.  In this report, all dollaramounts are stated in Canadian dollars except where otherwise indicated.

 

The table below shows relevant exchange rateswhich approximate the noon buying rates in Canada as reported by the Bank ofCanada for our five most recent fiscal years. The average rate means the average of the exchange rates on the last dayof each month during a year.

 
| **Year Ended December 31,** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| High                             |       | $        | 1.4003     |     | $          | 1.5747   |       | $        | 1.6128     |     | $          | 1.6023 |   | $ | 1.5600 |   |
| Low                              |       | 1.1746   |       | 1.2924   |       | 1.5108   |       | 1.4933   |       | 1.4350   |       |
| Average                          |       | 1.3015   |       | 1.4015   |       | 1.5702   |       | 1.5518   |       | 1.4855   |       |
| Period End                       |       | 1.2036   |       | 1.2924   |       | 1.5800   |       | 1.5925   |       | 1.4995   |       |
|                                  |            |          |            |          |            |          |            |          |            |          |            |  |  |  |  |  |

 

As of March 8, 2005, the noon buying ratein Canada as reported by the Bank of Canada was US$0.82 = Cdn.$1.00 (equivalentto US$1.00 = Cdn.$1.2169).

 

39

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**Management’sDiscussion and Analysis**

 

This Management’s Discussion and Analysis ofFinancial Condition and Results of Operations is dated as of March 8,2005.  It contains forward-lookingstatements that involve risk and uncertainties. The predictions described in these statements may not materialize ifmanagement’s current expectations regarding our future performance proveincorrect. Our results could also be affected by factors including, but notlimited to, our reliance on collaborative partners and other risks described inour annual report under the heading “Factors That May Affect FuturePerformance.”  Our forward-lookingstatements are based on currently available information; we disclaim anyobligation to update them.

 

The following information should be read inconjunction with our 2004 consolidated financial statements and related notestherein, which are prepared in accordance with Canadian GAAP.  These principles differ in certain respectsfrom U.S. GAAP.  The differences, as theyaffect our consolidated financial statements, are described in Note 11 toour consolidated financial statements. All amounts following are expressed in Canadian dollars unless otherwiseindicated.

 

## **Overview**

## ** **

From our inception in 1990 to 1993, our corebusiness involved the sale of bioreagent products.  Although we retained and expanded ourbioreagent business worldwide, our primary focus since 1993 has been theresearch and development of innovative stress protein-based fusion productsthat will stimulate the body’s immune system to combat viral infections andrelated cancers. Our lead therapeutic vaccine candidate is HspE7.  HspE7 is a broad-spectrum therapeutic vaccinecandidate in development for diseases caused by the human papilloma virus.  HspE7 is derived from our proprietary platformtechnology that enables us to covalently fuse stress proteins to antigens thatinvoke immune system responses.  Bycovalently fusing Hsp and disease-associated antigens, we believe that we cancreate a proprietary portfolio of CoValTM fusion products designed to stimulatethe immune system to identify, target and eliminate virus-infected andcancerous cells.

 

We have incurred significant losses since ourinception and expect to incur substantial losses for the foreseeable future aswe invest in our research and product development programs, includingmanufacturing, pre-clinical studies and clinical trials, and regulatoryactivities.  At December 31, 2004our accumulated deficit was $212,349,000. Historically, we have depended principally on equity financings, cashflows from our bioreagent business and funding from research collaborations tofund our business activities.  In 2005,we plan to sell our bioreagent business for cash to focus our managementresources on our clinical programs and to ensure our resources are adequate tofund our drug development business activities. We intend to pursue additional equity financings, markets permitting,and to seek additional research collaborations to fund our business activities.

 

Our success will depend upon the safety andefficacy of our immunotherapeutic products in pre-clinical studies and clinicaltrials, and upon obtaining the necessary regulatory approvals to market ourproducts.  The marketability of ourproducts will be influenced by competition from alternative therapies and thedegree of protection our intellectual property provides. We believe there willbe significant markets for our therapeutic products should these products proveto be effective in human clinical trials.

 

40

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*Restructured Roche Agreement*

 

In December 2003, we announced arestructuring of our June 2002 collaboration agreement with Rocheproviding for the development and commercialization of HspE7.  Under the restructured terms we granted Rochean option to license the first generation HspE7 product, a license to develop asecond generation HspE7 product, and non-exclusive options to negotiate rightsto CoValTM fusion product candidates for the treatment of cancersand hepatitis C.   Roche can pay feesto make these options exclusive until January 1, 2007.

 

In connection with the first generation ofHspE7, the restructured agreement gives us the right to develop andcommercialize the product for indications other than genital warts, includingcontrol of regulatory matters such as IND applications.  In the original agreement we were responsiblefor clinical expenses only for the development of RRP.  In the new agreement we are responsible forthe manufacturing and other costs of all indications that we develop.  If Roche exercises its rights to the firstgeneration product, it will fund all prospective development costs.  Roche can exercise its rights to the first generationof HspE7 by paying a fee, in which case it would also become responsible forevent-driven milestones that could result in aggregate payments to us of up toUS$138,000,000. Under that scenario, we would receive the revenue from allfirst generation HspE7 product sales in the U.S. and Canada for three yearsfollowing approval of a BLA with the FDA and would receive sales-based payments(similar to royalties) of approximately 35% of net sales in the U.S. and Canadathereafter.  We would receive sales-basedpayments of 20% of net sales in countries other than the U.S. and Canada.

 

By paying additional fees, Roche canexclusively develop the second generation HspE7 product.  In suchcase Roche would be required to pay the costs of development, manufacturing andcommercialization of the product and to make payments to us upon theachievement of defined milestones. We would also receive tiered, progressivesales-based payments that we believe are competitive with other agreements ofthis stage and type.  Commercial success payments of up to approximatelyUS$85,000,000 become payable depending upon the aggregate net sales of eitheror both generations of the HspE7 products. The restructured collaborationagreement gives us the right to discuss, negotiate and execute an alternativeagreement with a third-party for the development and commercialization of HspE7through a license, partnership, joint venture or similar transaction.  After March 31, 2005 and through the endof the option period, Roche can terminate this right by paying us a fee, whichwould be either US$10,000,000 or US$15,000,000 depending on the stage ofdevelopment of the product.  We cannotdetermine if or when this option will be exercised.

 

## **Liquidity andCapital Resources; Proposed Transactions**

## ** **

Since inception we have relied principally onequity financings, coupled with cash flows generated from our bioreagentsbusiness, to fund our research and development programs, operations and capitalexpenditures.  Through December 31, 2004 we have raised net equityproceeds of $198,238,000, including approximately $18,619,000 of net proceedsfrom an equity financing in December 2003.

 

In February 2004,we filed an amended preliminary prospectus in Canada for the sale of commonshares of the Company. Management and the board of directors are reviewingalternative sources of revenue and strategic transactions in connection withour financial needs.

 

41

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The accompanyingfinancial statements have been prepared on a going concern basis, whichcontemplates the realization of assets and the satisfaction of liabilities inthe normal course of business.  We have ahistory of recurring losses from operations and have an accumulated deficitof $212,349,000 as of December 31, 2004.  The nature of ourbusiness requires significant spending on R&D activities.  Due to ourhistory of losses, high cash burn on R&D activities and the planned loss ofbioreagent revenue as a result of the planned sale of thatbusiness, we are closely monitoring our cash resources.  We have developedvarious operational plans which depend upon the outcome of the financingoptions available.  Assuming we raise approximately $15,000,000 andsell the bioreagent business we will have sufficient resources to fund operationsinto 2006 at our current spending levels.  If we do not raise at leastthat amount of cash we may need to modify or cancel our agreements withexternal contractors, and make changes to our staffing level which would impactthe development timelines of HspE7.  Regardless of the fundingwe receive, we will execute the operational plan necessary to fund operationsinto 2006.

 

We employ a financial performance measurementsystem designed to ensure our revenues and expenses are consistent withmanagement’s operational objectives and budgetary constraints.  Our cashutilization in 2005 will be dependent upon several factors, including thetiming and progress of clinical development of HspE7, the cost of manufacturingclinical supplies and the sale of our bioreagent business.

 

At December 31, 2004 and 2003, we had $21,578,000and $51,843,000, respectively, of cash, cash equivalents and short-terminvestments. The $30,265,000 decrease is due principally to spending related tothe development of HspE7.  At December 31,2004 and 2003, approximately 48% and 24% of cash, cash equivalents andshort-term investments were held in U.S. dollars.   During 2004, we purchased British pounds tofund payments under our Avecia contract. At December 31, 2004 approximately 36% of our cash, cashequivalents and short-term investments were held in British pounds.  Periodically we may purchase additionalBritish pounds based on future anticipated financial obligations in thatcurrency.

 

During 2004, 2003 and 2002, we reported$28,722,000, $18,661,000 and $28,750,000, respectively net cash used inoperating activities from continuing operations.  The increase in 2004 over 2003 is due to anincrease in net losses recorded which was offset by stock compensation expenserecorded in 2004 that was not recorded in 2003.

 

During 2004, purchases of plant and equipmentby continuing operations totaled $203,000 compared with $131,000 and $380,000during 2003 and 2002 respectively. Spending during 2004 consisted of tenant improvements on our facilities,laboratory equipment, and computer related hardware.  Our capital spending during the past threeyears has been consistent other than in 2001 when we made a significant upgradeto our research facility.  We expect our2005 capital spending to include purchases required to preserve our currentlevel of manufacturing, research and administrative capabilities.

 

At December 31, 2003 we had obligationsof $1,125,000 in the form of fixed rate capital leases and term loans.  At December 31, 2004 we had an outstandingterm loan obligation of $514,000.  In September 2003we entered into a 36-month term loan with Oxford Finance Corporation(Oxford).  At December 31, 2004 and2003, respectively, the outstanding principal balances were $514,000 and$906,000 on the Oxford loan.  Under theterms of the Oxford loan, we must

 

42

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issue a letter of credit for the outstandingloan balance if our combined cash, cash equivalents, and short-term investmentsfall below $6,000,000.

 

We expect to seek additional funds fromvarious sources, including corporate partners that enter into research anddevelopment collaborations with us, and public and private equityfinancings.  If we raise additional fundsby issuing equity securities, substantial dilution to our existing shareholdersmay result.  We may need to obtain fundsthrough collaborative arrangements with others that are on unfavorableterms.  We may also have to relinquishrights to certain of our technologies, product candidates or products that wewould otherwise seek to develop ourselves.

 

*Contractual Obligations*

 

Our contractual obligations consist primarily of agreements related tothe development and manufacture of HspE7, operating leases for facilities, aterm loan to increase working capital cash flows and contractual employmentobligations.  We haveseveral contractors working on different aspects of the work regulatoryauthorities require for a biologic product, including stability testing,analytical testing, release testing and the manufacturing and fill/finishactivities noted below.

 

In January 2004 we entered into abiological services agreement with Avecia for the process development, scale-upand manufacture of HspE7.  In addition,we may have Avecia manufacture commercial drug substance.  Under the terms of the agreement, we arerequired to make prepayments for future services and use of the facility.  We were invoiced for two prepayments totaling$3,204,000 in 2004 for services to be rendered and space utilized in 2005.  We made one of these prepayments in2004.  The other prepayment was not madeuntil 2005 and therefore is included in deferred development expenses, currentportion and accrued liabilities.

 

The Avecia agreement is cancelable subject tospecified termination conditions. The cancellation fee is based on a slidingpercentage of certain future program milestones.  Accordingly, the cancellation fee is modifiedeach month during the course of the agreement, based on the timing ofactivities performed by Avecia and prepayments for those activities.  The cancellation fee as of December 31,2004 could have been up to $441,000, depending on Avecia’s ability to reschedule usageof their facility.

 

In October 2004 we entered into anagreement with Cardinal Health (“Cardinal”) in the ordinary course of ourbusiness.  Cardinal will performfill/finish activities to prepare HspE7 for distribution to clinical trialpatients.  At December 31, 2004, wewere contractually obligated to make a prepayment of $293,000 for futureservices to be rendered in 2005. However, this prepayment was not made until early 2005 and therefore isincluded in deferred development expenses, current portion and accruedliabilities.  The agreement with Cardinalincludes cancellation provisions that could require us to pay for work that wasnot performed or equipment that was not used if we terminate the contract whileactivities are at pre-defined stages.  The cancellation fee of $127,000 would have been offset against theprepayment made in 2005.

 

To retain a flexible development program, wetypically negotiate termination provisions so that our financial obligationsare limited to paying for work performed up to the termination date and in somecases, pre-established cancellation fees. Except as disclosed above we currently do not

 

43

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have other significant research anddevelopment contracts subject to cancellation fees.  We have not entered into any minimum supplyagreements with any service vendors or contract manufacturers.

 

We have employment agreements with certainmembers of management which include specific severance packages.  We would be contractually obligated to pay $2,871,000over the next twelve months and an additional $314,000 would be payable duringthe following year, depending upon individual employment agreements.

 

The following table summarizes ourcontractual obligations as of December 31, 2004.  The table does not include items such ascontracts with independent contractors when the commitment to pay does notexist until completion of work.  

 
| ** **                       | ** ** | **Payments due by period** | ** ** |
|----------------------------------|------------|----------------------------|------------|
| ** **                       | ** ** | **Total**                  | ** ** | **Less than 1 year** | ** ** | **1 – 3 years** | ** ** | **3 – 5  years** | ** ** | **More than  5 years** | ** ** |
| Operating lease  obligations (b) |       | $                          | 1,005,000  |   | $ | 966,000 |   | $ | 38,000 |   | $ | 1,000 |   | — |   |
| Term loan (a)                    |       | 559,000                    |       | 409,000 |   | 150,000 |   | — |   | — |   |
| Contractual obligations  (b)     |       | —                     |       | — |   | — |   | — |   | — |   |
|                                  |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(a) Paymentsdisclosed above include interest. Interest rates on the Oxford term loan range from 11.47% to 11.48%.

 

(b) Ourcontracts tend to be cancelable and require payments related to specific work.  As a result they are not discussed in thistable. A discussion of such contractual obligations is included above and in Note 5to our financial statements.

 

**Off-Balance Sheet Arrangements**

 

We did not enter into any off balance sheet arrangements during theyear ended December 31, 2004.

 

**Related Party Transactions**

 

Until the annual meeting in 2002 an independentcontractor who is a researcher in the area of heat shock proteins also servedas a director.  In 2002, this individualreceived consulting fees of $50,000.

 

We have used various affiliates of MDS, Inc., including MDSPharma Services, to provide research services.  Through May 2004and the years ended 2003 and 2002 we paid the various MDS entities anaggregate of $286,000, $235,000 and $139,000, respectively.  One ofthe Company’s board members was an officer of MDS, Inc. through May 2004.

 

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**Discontinued Operations**

 

Our bioreagentbusiness produces and sells bioreagents to researchers and researchorganizations worldwide.  The productssold by the bioreagent business include antibodies, proteins, DNA products,ELISA kits and extracts for use in studying cellular stress response pathways,including oxidative stress, apoptosis, neurobiology and more.

 

At December 31, 2004, we decided to report the bioreagent businessas a discontinued operation pursuant to the requirements of CICA 3475, *Disposal of Long-lived Assets and Discontinued Operations*(CICA 3475), SFAS No. 144, *Accounting for theImpairment or Disposal of Long-Lived Assets* (SFAS 144), and EITF 03-13,*Applying the Conditions in Paragraph 42 of FASBStatement No. 144 in Determining Whether to Report Discontinued Operations*.  We are reporting the business as adiscontinued operation because we have evaluated our intentions for the futureof the bioreagent business, formulated a plan for sale and have taken steps toexecute that plan.

 

We plan to sell the bioreagent business in 2005 so we can focus on ourcorporate strategy, manage resources and provide working capital to fundfurther development and commercialization of HspE7.  We cannot determine the amount of any gain orloss, if any, that would be realized on the sale of the bioreagent business.  If we complete a sale of the business we willreport the gain or loss in our quarterly filings as required by the CICA 3475and SFAS 144.  We will continue toevaluate our plan for the bioreagent business and disclose it appropriately perthe Canadian and U.S. standards.

 

During 2004 the bioreagent businesscontributed net income of $1,580,000 as compared to $1,418,000 in 2003 and$2,024,000 in 2002 ($0.02, $0.03, and $0.03 per share, respectively).  The increase in net income from discontinuedoperations in 2004 compared to 2003 is due principally to revenue growthresulting from new product introductions, a sales price increase and enhancedmarketing initiatives.  The reduction innet income from discontinued operations in 2003 compared to 2002 is dueprincipally to variations in product sales revenue driven by an industry-widedecline in the demand for research reagents and exchange rate fluctuationsaffecting U.S. dollar denominated sales, which constitute approximately 95% ofour sales transactions.

 

The income reported above does not includeinternal overhead and administrative overhead expense allocations that wereassigned to this segment and which will continue to be incurred by thecontinuing entity.  After we sell thebioreagent business we will not have this contribution of net incomethereafter.  We could enter into acontract with the buyer to provide temporary administrative support for atransition period.

 

## **Results ofContinuing Operations**

 

During 2004, we realized a net loss fromcontinuing operations of $31,845,000 or $ 0.44 per common share.  These results compare with a net loss fromcontinuing operations of $17,663,000 in 2003 and $30,826,000 in 2002 ($0.29 and$0.52 per share, respectively).  The$14,182,000 increase in our net loss during 2004 is due principally toincremental spending on research and development (R&D) activities relatedto manufacturing development previously funded by Roche and a time baseddevelopment payment earned in March 2003. Separately, our

 

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third party spending to further thedevelopment of HspE7 increased in 2004 compared to 2003. The $13,163,000improvement in our net loss position from 2002 to 2003 was driven by increasedcollaboration revenue and Roche’s funding of R&D activities related tomanufacturing development in 2003.  Inaddition, the timing of activities in our ongoing clinical trials resulted inless expense recorded in 2003 compared to 2002.

 

***Collaborative R&D revenue***

 

We recorded collaborative R&D revenue of$700,000, $8,094,000 and $8,370,000 in 2004, 2003 and 2002, respectively.  Collaborative R&D revenue during 2004relates principally to the amortization of upfront license fees in accordancewith CICA Accounting Standards Board recommendations, section 3400, *Revenue,* and Staff Accounting Bulletin (SAB) No. 101 *Revenue Recognition in Financial Statements*.  Collaborative R&D revenue in 2003includes $4,912,000 for development activities, $2,214,000 for a time basedmilestone payment and $968,000 for the amortization of upfront license fees.  Collaborative R&D revenue in 2002includes $7,815,000 for development activities and $555,000 from theamortization of upfront license fees. Under the terms of the restructured HspE7 collaboration agreement, weexpect future collaborative R&D revenue to include only amortization of theinitial up-front license fee.

 

### ***Research and development***

### *** ***

Research and development in our continuingoperations includes costs associated with therapeutic product development,clinical studies and ongoing exploratory research.  In order to optimize our financialflexibility, we employ clinical research organizations to conduct our clinicaltrials and engage contract manufacturers to assist us with product developmentand manufacturing.

 

R&D spending in our continuing operationsincreased by approximately 33% to $25,913,000 during the year ended December 31,2004, compared with $19,533,000 for the same period in 2003.  This increase is due principally to spendingat Avecia, which began early in 2004; in contrast, our 2003 third-partyspending focused on Roche-requested manufacturing initiatives, which arecomplete.  Our spending at Avecia isexpected to continue to be a major component of our R&D spending through2005 as we transition from process development activities to initial productionruns of bulk drug substance for our upcoming pivotal trial.  During 2003, R&D spending decreased by40% from $32,735,000 in 2002.  R&Dexpense in 2002 included manufacturing development spending at third partyvendors and service providers.  In 2003these activities were primarily performed and paid for by Roche.  Separately, the timing of expenses recordedfor our on-going clinical trials contributed to the change in R&D expensein 2003 as compared to 2002.

 

Our R&D spending during 2004 was devotedprincipally to our effort to further develop HspE7, including processdevelopment and manufacturing activities, preparation for our pivotal phase IIIRRP trial, the close out on our AIN trials, and initiation of a phase II GWtrial.  During 2004 approximately 91% ofour R&D spending related to efforts developing HspE7, compared toapproximately 67% for the same period in 2003. The remaining spending relates to exploratory research involving ourfollow-on CoValTM fusion proteins.

 

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We held an end-of-phase II meeting with theFDA in June 2004 to present the design of our planned pivotal phase IIIclinical trial to treat RRP.  We areworking with the FDA to review our pivotal clinical trial protocol under a SpecialProtocol Assessment (“SPA”), an agreement with the FDA that is typicallybinding regarding the protocol design for a clinical trial to support abiologics license application (“BLA”). We hope to obtain concurrence of our SPA by the FDA, in the secondquarter of 2005, following review of the Chemistry, Manufacturing, and Controls(“CMC”) information.  We believe that wehave reached an understanding with the FDA on the significant clinical issues.

 

We intend to begin accruing patients in ourpivotal phase III trial to treat RRP by mid-2005.  We expect the trial will be a randomized,double-blind, placebo controlled study with approximately 130 patients.  The pivotal trial is expected to have themedian post surgical interval as the primary end point.  We have begun identifying clinical sites,primarily in the U.S. with additional sites in Canada and Europe.  Accordingly, we recorded the expense relatedto the start-up portion of the pivotal trial in the fourth quarter of 2004pursuant to our accounting policy discussed in Note 1 to our consolidatedfinancial statements.  Depending on theclinical and other results, we anticipate being able to submit a BLA for HspE7to treat RRP in mid-2007.  We plan toapply for priority review when we file the BLA. The FDA has granted HspE7 orphan drug status anddesignated it as a fast track development program for the treatment of RRP.

 

In September 2004, we were issued a U.S.patent covering a method of treating a patient with RRP using a fusion proteincomprised of a heat shock protein from the Hsp60 family and an HPV type 16 E7antigen.  This patent provides additionalpatent exclusivity through mid-2021 for the use of HspE7 to treat patients withRRP.

 

In December 2004, we announced thecompletion of enrollment in a single arm pilot Phase II clinical trial toinvestigate HspE7 in patients with internal genital warts.  Patients are under evaluation for a period ofup to one year.  We expect data from thistrial in the fourth quarter of 2005.

 

During 2005, we expect to continue to devotethe majority of planned R&D spending to support HspE7 development, produceclinical trial supplies and begin patient accrual activities for our RRPpivotal trial.

 

### ***Selling, general and administrative expenses***

### *** ***

Selling, general and administrative expense,or SG&A, includes executive management, business development, investorrelations, legal support and general administrative activities.

 

SG&A spending through continuingoperations increased by approximately 3% to $6,385,000 for the year ended December 31,2004 from $6,170,000 for the same period in 2003.  This increase is primarily due to the use ofexternal consultants and additional fees for attestation services over internalcontrols over financial reporting to ensure compliance with requirements ofSarbanes-Oxley regulations.  During 2003,SG&A expenses decreased by 16% from $7,326,000 in 2002 due principally tohigher 2002 spending on business development activities associated with consummatingour original collaboration agreement with Roche.  We anticipate that in 2005 SG&A spendingwill be consistent with that of 2004.

 

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### ***Interest and other income***

### *** ***

Interest and other income from continuingoperations increased in 2004 to $787,000 compared with $700,000 in 2003.   In 2004 and 2003 we recorded write-downs ofour fixed income investment portfolio of $293,000 and $284,000, respectively.

 

Interest and other income decreased by 45% in2003 from $1,266,000 in 2002 compared with $700,000 in 2003.  Lower market interest rates applied to alower investment portfolio balance contributed to the decline.  Also, a temporary loss of market value oninvestments was recorded in 2003.

 

***Net foreign exchange gain/loss***

 

In 2004 foreign exchange loss from continuingoperations increased by 34% to $938,000 from $701,000 in 2003.  During the third and fourth quarters of 2004,the Canadian dollar strengthened against the U.S. dollar and the British poundcompared to the first half of 2004 and 2003. Since approximately 84% of our cash, cash equivalents and short terminvestments are held in currencies other than the Canadian dollar, weexperienced a foreign exchange loss.

 

In 2003 our foreign exchange loss increasedby 111% to $701,000 from $332,000 in 2002 reflecting, the beginning of anoverall strengthening trend of the Canadian dollar against the U.S. dollar.

 

***Basic and diluted loss per share***

 

The 80% increase in net loss from continuingoperations to $31,845,000 in 2004, compared with $17,663,000 in 2003, wasdiluted by an 18% increase in the weighted average number of common sharesoutstanding. As a result, in basic and diluted loss from continuing operationsper share was $0.44 in 2004 and $0.29 in 2003.

 

The 43% decrease in net loss from continuingoperations to $17,663,000 in 2003 compared with $30,826,000 in 2002, wasdiluted by a 4% increase in the weighted average number of common sharesoutstanding, resulting in basic and diluted loss from continuing operations pershare of $0.29 in 2003 and $0.52 in 2002.

 

### ***Differencesbetween Canadian and U.S. generally accepted accounting principles***

### *** ***

Our financial statements have been preparedin accordance with Canadian GAAP. Certain adjustments would be required if these statements were to beprepared in all material respects in accordance with U.S. GAAP.

 

To conform to U.S. GAAP, our net loss woulddecrease by $2,244,000 in 2004, $947,000 in 2003 and increase by $214,000 in2002.  The principaldifferences under U.S. GAAP as opposed to Canadian GAAP in 2004 were thereversal of an unrealized foreign exchange loss on investments of $800,000, areversal of a loss on market value of investments of $241,000 and the reversalof stock compensation expense totaling $1,284,000 related to fair value stockoption accounting adopted beginning January 1, 2004, offset by stockcompensation expense of $81,000 that would be recorded under APB Opinion No. 25.  U.S. GAAP does not currently require fairvalue accounting on stock based compensation. Therefore, under the provisions of APB Opinion

 

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No. 25, no expense is recorded for options granted with anexercise price equal to the fair value of the stock on the day of grant.  Under APB Opinion No. 25 expense isincurred when stock options are granted at exercise prices less than the fairvalue of the underlying stock.  Further,under U.S. GAAP, adjustments to the market value of our investment portfoliowould be recorded as a component of stockholders’ equity.  Under Canadian GAAP unfavorable market valueadjustments are recorded as a component of operations.

 

Similarly, in 2003, the principal differencein our net loss using U.S. GAAP rather than Canadian GAAP is due to thereversal of an unrealized foreign exchange loss on investments of $541,000,coupled with a $406,000 reversal of a loss on market value of investments. In2002, the principal difference in our net loss using U.S. GAAP rather thanCanadian GAAP is due to the reversal of $69,000 in unrealized foreign exchangegain on investments and a $145,000 reversal of gain on market value ofinvestments.   A complete discussion ofthese differences between U.S. GAAP and Canadian GAAP are described in Note 11to our consolidated financial statements.

 

Net loss per common share under U.S. GAAPwould have been $0.39, $0.25 and $0.49 in 2004, 2003 and 2002,respectively.  Our current assets and ourtotal stockholders’ equity are the same at December 31, 2004 and 2003.

 

## **Critical Accounting Policies**

## ** **

Our significant accounting policies aredisclosed in Note 1 to our consolidated financial statements herein.  Certain of our policies require theapplication of management judgment in making estimates and assumptions thataffect the amounts reported in the consolidated financial statements anddisclosures made in the accompanying notes. Those estimates and assumptions are based on historical experience andvarious other factors deemed applicable and reasonable under the circumstances.  The use of judgment in determining suchestimates and assumptions is, by nature, subject to a degree ofuncertainty.  Accordingly, actual resultscould differ from the estimates made. Our critical accounting policies include:

 

***Revenue recognition***

 

Revenue from collaborative R&Darrangements may include multiple elements within a single contract.  Our accounting policy complies with therevenue determination requirements set forth in EITF 00-21 *Accountingfor Revenue Arrangements with Multiple Deliverables*, and EIC 142 *Revenue Arrangements with Multiple Deliverable*, relating tothe separation of multiple deliverables into individual accounting units withdeterminable fair values.  We estimatethe fair value of deliverables in collaboration agreements using standardindustry techniques.  Changes in thedetermination of fair values or performance periods relating to certaindeliverables, and associated milestones, could impact the timing of futurerevenue streams.

 

***Clinical trial accruals***

 

Clinical trial costs constitute a significantportion of R&D expense.  We recognizeexpenses related to our ongoing clinical trials using a methodology designed toaccrue estimated costs in the appropriate accounting periods in which theexpenses are incurred.    We recognizeclinical trial costs in three distinct phases that correspond with the periodduring which the services are performed: the start-up phase, the patient accrual phase, and the close-out phase.Based on the

 

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design of the trial, including the number ofpatients, number of clinical sites, method of treatment, and follow-up, theallocation of trial costs to each phase could vary from trial to trial.   Using our current trial accrual methodology,our liability for clinical trials as of December 31, 2004 is $2,514,000,which includes the estimated effect of any work-in-process terminated at theend of the reporting period. Alternatively, if we utilized a percentage of completion approach andused an operational estimate of the actual work completed as of December 31,2004 compared to the total contract value, our clinical trial liability woulddecrease by approximately $2,375,000.

 

**New Canadian GAAP Accounting Pronouncement**

 

***Impairment of Long-Lived Assets***

 

CICA Section 3063, *Impairment of Long-Lived Assets*, establishes standards forthe recognition, measurement and disclosure of the impairment of long-livedassets by profit oriented enterprises, and replaces the write-down provisionsof Section 3061, Property, Plant and Equipment.

 

Impairment of long-lived assets held foruse is determined by a two-step process. The first step determines when animpairment is recognized and the second step measures the amount of theimpairment.  An impairment loss isrecognized when the carrying amount of a long-lived asset exceeds the sum ofthe undiscounted cash flows expected to result from its use and eventualdisposition.  An impairment loss ismeasured as the amount by which the long-lived asset’s carrying amount exceedsits fair value.

 

The new standard is effective for fiscalyears beginning on or after April 1, 2003. Application is prospective.  Wewill continue to monitor potential impairment of long-lived assets.

 

***Stock-based compensation***

 

In September 2003 the CICA AccountingStandards Board released revised transitional provisions for *Stock-Based Compensation and Other Stock-Based Payments*, Section 3870,to provide the same alternative methods of transition as is provided in theU.S. for voluntary adoption of the fair value based method of accounting.  The AcSB has also amended Section 3870to require that all transactions whereby goods and services are received inexchange for stock-based compensation and other payments result in expensesthat should be recognized in financial statements, and that this requirementwould be applicable for financial periods beginning on or after January 1,2004.  Section 3870 requires thatshare-based transactions should be measured on a fair value basis. Weretroactively adopted the provisions of CICA Section 3870 beginning January 1,1995.  See the detail at Note 2 inthe financial statements included herein.

 

**New U.S. GAAP Accounting Pronouncement**

 

***Other than temporary impairment***

 

The Emerging Issues Task Force (EITF)recently deliberated regarding Issue 03-01, *The Meaning ofOther-Than-Temporary Impairment and Its Application to Certain Investments*.  The Issue is intended to address the meaningof other-than-temporary impairment and its application

 

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to certain investments held at cost.  The EITF reached a consensus regardingdisclosure requirements concerning unrealized losses on available-for-sale debtand equity securities accounted for under SFAS No. 115.  The guidance for evaluating whether aninvestment is other-than-temporarily impaired has been deferred.  The disclosure requirements apply to annualfinancial statements for fiscal years ending after December 15, 2003 forinvestments accounted for under SFAS No. 115.  For all other investments within the scope ofthis Issue, the disclosure requirements have been deferred.  Additional disclosure requirements for costmethod investments apply to fiscal years ending after June 15, 2004.  We continue to evaluate the effect of thispronouncement on our financial statements.

 

***Share-based payment***

 

In January 2005, the FASB issuedStatement No. 123R, *Share-Based Payment*(SFAS 123R), which is a revision of FASB Statement No. 123, *Accounting for Stock-Based Compensation*.  SFAS 123R establishes accounting standardsfor transactions around stock based compensation in exchange for employeeservices.  Similar to CICA 3870, SFAS123R requires fair-value-based method for accounting for stock basedcompensation and eliminates the intrinsic method under APB Opinion 25.  This statement is effective beginning in thesecond quarter of 2005; however as discussed in the Critical AccountingPolicies and Note 2 in the financial statements, we adopted CICA 3870which also requires the fair-value based method.  We will evaluate the impact of SFAS 123R onour current accounting policies and make the necessary changes and disclosuresin the notes to our financial statements in third quarter 2005.

 

**Disclosure of Outstanding Share Data**

 

The following table contains information regarding our outstandingequity as of March 8, 2005:

 
| Common  shares outstanding     |   | 72,506,403 |   |
|--------------------------------|--------|------------|--------|
| Roche  warrants                |   | 814,574    |   |
| Warrants  under 2003 Financing |   | 5,304,149  |   |
| Stock  options outstanding     |   | 4,671,424  |   |

 

**Quantitative and QualitativeDisclosures About Market Risk**

 

We use theCanadian dollar as our measurement and functional currency.  As a result, we are exposed to foreigncurrency fluctuations through our operations because a substantial amount ofour contract research and development spending has been transacted in othercurrencies, principally in U.S. dollars and British pounds.  We hold investment balances in the currenciesin which we have expenditures planned during the foreseeable future.  At December 31,2004 and 2003, approximately 48% and 24% of cash, cash equivalents andshort-term investments were held in U.S. dollars.  During 2004, we purchased Britishpounds to mitigate our currency exposure based on spending plans with Avecia. At December 31, 2004 approximately 36% ofour cash, cash equivalents and short-term investments were held in Britishpounds.   We translate monetary assets and liabilitiesinto Canadian dollars using the rates of exchange prevailing at our balancesheet date. We record the resulting exchange gains and losses in our statementof operations.  Although we do notcurrently engage in hedging or other activities to reduce foreign

 

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currency risk,beyond matching investments proportionately with anticipated spending, we maydo so in the future if conditions change.

 

A hypothetical change in foreign exchange rates by applyinga 10% change to our year-end foreign exchange rate, then applying that rate toour average level of U.S. investments during the year, would result in an$858,000 impact.  If the value of theCanadian dollar relative to the U.S. dollar were to increase by 10%, our netloss would decrease by $858,000. Further, if the value of the Canadian dollar relative to the U.S. dollarwere to decrease by 10%, our net loss would increase by $858,000.

 

A hypothetical change in foreign exchange rates by applyinga 10% change to our year-end foreign exchange rate, then applying that rate toour average level of British pound investments during the year, would result ina $285,000 impact.  If the value of theCanadian dollar relative to the British pound were to increase by 10%, our netloss would decrease by $285,000. Further, if the value of the Canadian dollar relative to the Britishpound were to decrease by 10%, our net loss would increase by $285,000.

 

We are alsoexposed to interest rate risk because we maintain cash equivalents andshort-term investment portfolio holdings of various issuers, types, andmaturity dates with large banks and investment banking institutions.  The market value of these short-terminvestments on any day during the investment term may vary as a result ofmarket interest rate fluctuations.

 

To differentiate between the affect of a change in the market valuationof securities caused by market interest rate changes versus a change in theannual rate of interest we could earn on a security, we calculated that ahypothetical change in interest rates comparable to a 10% change to our averagerate of return would result in a $64,000 impact.  If interest rates were to increase by 10%,our net loss would decrease by $64,000. Further, if interest rates were to decrease by 10%, our net loss wouldincrease by $64,000.

 

We have notused derivative financial instruments in our investment portfolio.  We classify our investments asavailable-for-sale at the time of purchase and re-evaluate this designation asof each balance sheet date. We had $21,578,000 in cash, cash equivalents andshort-term investments as of December 31, 2004.

 

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# **Item 8**.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 

 

**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

To the Board of Directors and Stockholders of

Stressgen Biotechnologies Corporation

 

We have audited the accompanying consolidated balance sheets ofStressgen Biotechnologies Corporation and subsidiaries (the “Company”) as of December 31,2004 and 2003, and the related consolidated statements of operations,stockholders’ equity, and cash flows for each of the three years in the periodended December 31, 2004.  Thesefinancial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these financial statements based on our audits.

 

We conducted our audits in accordance with auditing standards generallyaccepted in Canada and the standards of the Public Company Accounting OversightBoard (United States).  Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement.  An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.

 

In our opinion, such consolidated financial statements present fairly,in all material respects, the financial position of the Company as of December 31,2004 and 2003, and the results of their operations and their cash flows foreach of the three years in the period ended December 31, 2004, inconformity with accounting principles generally accepted in Canada.

 

As discussed in Note 2 to the financial statements, in 2004 theCompany changed its method of accounting for stock based compensation to conformto Certified Institute of Chartered Accountants 3870, retroactively withoutrestatement.

 

As discussed in Note 12 to the financial statements, the Companycommitted to a plan to discontinue the bioreagent segment of its operations in December 2004.

 

The accompanying financial statements have been prepared assuming thatthe Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company’srecurring losses from operations, stockholders’ deficit and difficulty in generatingsufficient cash flow to meet its obligations and sustain its operations, raisesubstantial doubt about its ability to continue as a going concern.  Management’s plans concerning these mattersare also described in Note 1.  Thefinancial statements do not include any adjustments that might result from theoutcome of this uncertainty.

 

We have also audited, in accordance with the standards of the PublicCompany Accounting Oversight Board (United States), the effectiveness of theCompany’s internal control over financial reporting as of December 31,2004, based on  the criteria establishedin Internal

 

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Control—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission and our report dated March 14,2005 expressed  an unqualified opinion onmanagement’s assessment of the effectiveness of the Company’s internal controlover financial reporting and an unqualified opinion on the effectiveness of theCompany’s internal control over financial reporting.

 
| /s/ DELOITTE & TOUCHE LLP |   |
|------------------------------------|--------|
| San Diego, California              |
| March 14, 2005                |

 

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**STRESSGEN BIOTECHNOLOGIESCORPORATION**

**CONSOLIDATED BALANCE SHEET**

**(CANADIAN DOLLARS) (IN THOUSANDS, EXCEPT SHAREINFORMATION)**

 
| ** **                                                                                                                                                                                   | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                   | ** ** | **2004**              | ** ** | **2003**              | ** ** |
|                                                                                                                                                                                         |       |                  |       |                  |       |
| **Assets**                                                                                                                                                                                   |       |                  |       |                  |       |
| Current  assets:                                                                                                                                                                             |       |                  |       |                  |       |
| Cash and  cash equivalents                                                                                                                                                                   |       | $                     | 8,538      |                  | $          | 19,749 |   |
| Short-term  investments                                                                                                                                                                      |       | 13,040                |       | 32,094                |       |
| Collaborative  accounts receivable                                                                                                                                                           |       | —                |       | 277                   |       |
| Prepaid  expenses (Note 5)                                                                                                                                                              |       | 2,196                 |       | 290                   |       |
| Deferred  development expenses, current portion (Notes 4 and 5)                                                                                                                              |       | 1,747                 |       | 87                    |       |
| Assets of  discontinued operations (Note 12)                                                                                                                                            |       | 2,447                 |       | 1,582                 |       |
| Other  current assets                                                                                                                                                                        |       | 563                   |       | 85                    |       |
| Total  current assets                                                                                                                                                                        |       | 28,531                |       | 54,164                |       |
|                                                                                                                                                                                         |       |                  |       |                  |       |
| Plant and  equipment                                                                                                                                                                         |       | 1,481                 |       | 2,006                 |       |
| Deferred  development expenses, net of current portion                                                                                                                                       |       | 162                   |       | 260                   |       |
|                                                                                                                                                                                         |       | $                     | 30,174     |                  | $          | 56,430 |   |
|                                                                                                                                                                                         |       |                  |       |                  |       |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                               |       |                  |       |                  |       |
| Current  liabilities:                                                                                                                                                                        |       |                  |       |                  |       |
| Accounts  payable and accrued liabilities                                                                                                                                                    |       | $                     | 7,862      |                  | $          | 3,567 |   |
| Deferred  revenue, current portion                                                                                                                                                           |       | 641                   |       | 688                   |       |
| Notes  payable, current portion                                                                                                                                                              |       | 369                   |       | 518                   |       |
| Liabilities  of discontinued operations (Note 12)                                                                                                                                       |       | 324                   |       | 408                   |       |
| Total  current liabilities                                                                                                                                                                   |       | 9,196                 |       | 5,181                 |       |
|                                                                                                                                                                                         |       |                  |       |                  |       |
| Long-term  liabilities:                                                                                                                                                                      |       |                  |       |                  |       |
| Deferred  revenue, net of current portion                                                                                                                                                    |       | 1,282                 |       | 2,065                 |       |
| Notes  payable, net of current portion                                                                                                                                                       |       | 145                   |       | 607                   |       |
| Total  long-term liabilities                                                                                                                                                                 |       | 1,427                 |       | 2,672                 |       |
|                                                                                                                                                                                         |       |                  |       |                  |       |
| Total  liabilities                                                                                                                                                                           |       | 10,623                |       | 7,853                 |       |
|                                                                                                                                                                                         |       |                  |       |                  |       |
| Stockholders’  equity:                                                                                                                                                                  |       |                  |       |                  |       |
| Common  shares and other equity – no par value; unlimited shares authorized,  72,506,403 and 72,491,403 shares issued and outstanding at December 31,  2004 and 2003, respectively |       | 216,412               |       | 196,849               |       |
| Contributed  surplus                                                                                                                                                                         |       | 15,488                |       | 2,207                 |       |
| Deferred  stock compensation                                                                                                                                                                 |       | —                |       | (185                  | )          |
| Accumulated  deficit                                                                                                                                                                         |       | (212,349              | )          | (150,294              | )          |
| Total  stockholders’ equity                                                                                                                                                             |       | 19,551                |       | 48,577                |       |
|                                                                                                                                                                                         |       | $                     | 30,174     |                  | $          | 56,430 |   |
|                                                                                                                                                                                         |       |                  |       |                  |       |
| See  accompanying notes to consolidated financial statements                                                                                                                                 |       |                  |       |                  |       |

 
| **/s/**DANIEL L. KORPOLINSKI                     | ** ** | **/s/** GORDON BAREFOOT | ** ** |
|--------------------------------------------------|------------|------------------------------|------------|
| Director, President and Chief Executive  Officer | Director   |

 

55

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**STRESSGEN BIOTECHNOLOGIES CORPORATION**

**CONSOLIDATED STATEMENT OF OPERATIONS**

**(Canadian dollars) (In thousands, except per shareamounts)**

 
| ** **                                                                                       | ** ** | **Years  ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                       | ** ** | **2004**                           | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                                       | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue:                                                                                         |       |                               |       |   |   |   |   |
| Collaborative  R&D revenue                                                                   |       | $                                  | 700        |   | $ | 8,094 |   | $ | 8,370 |   |
|                                                                                             |       |                               |       |   |   |   |   |
| Operating  expenses:                                                                             |       |                               |       |   |   |   |   |
| Research and  development                                                                        |       | 25,913                             |       | 19,533 |   | 32,735 |   |
| Selling,  general and administrative                                                             |       | 6,385                              |       | 6,170 |   | 7,326 |   |
|                                                                                             |       | 32,298                             |       | 25,703 |   | 40,061 |   |
|                                                                                             |       |                               |       |   |   |   |   |
| Operating  loss                                                                                  |       | (31,598                            | )          | (17,609 | ) | (31,691 | ) |
|                                                                                             |       |                               |       |   |   |   |   |
| Other income  (expenses):                                                                        |       |                               |       |   |   |   |   |
| Interest and  other income                                                                       |       | 787                                |       | 700 |   | 1,266 |   |
| Net foreign  exchange loss                                                                       |       | (938                               | )          | (701 | ) | (332 | ) |
| Interest  expense                                                                                |       | (96                                | )          | (53 | ) | (69 | ) |
|                                                                                             |       | (247                               | )          | (54 | ) | 865 |   |
| Net loss  from continuing operations                                                             |       | (31,845                            | )          | (17,663 | ) | (30,826 | ) |
|                                                                                             |       |                               |       |   |   |   |   |
| Net income  from discontinued operations (Note 12)                                          |       | 1,580                              |       | 1,418 |   | 2,024 |   |
|                                                                                             |       |                               |       |   |   |   |   |
| Net loss                                                                                         |       | $                                  | (30,265    | ) | $ | (16,245 | ) | $ | (28,802 | ) |
|                                                                                             |       |                               |       |   |   |   |   |
| Basic and  diluted (loss) income per common share:                                               |       |                               |       |   |   |   |   |
| From  continuing operations                                                                      |       | $                                  | (0.44      | ) | $ | (0.29 | ) | $ | (0.52 | ) |
| From  discontinued operations                                                                    |       | $                                  | 0.02       |   | $ | 0.03 |   | $ | 0.03 |   |
|                                                                                             |       | $                                  | (0.42      | ) | $ | (0.26 | ) | $ | (0.49 | ) |
|                                                                                             |       |                               |       |   |   |   |   |
| Weighted  average shares used to compute basic and diluted loss per common share (in  thousands) |       | 72,504                             |       | 61,458 |   | 58,986 |   |
|                                                                                             |       |                               |       |   |   |   |   |
| See accompanying notes to  consolidated financial statements.                                    |       |                               |       |   |   |   |   |

 

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**STRESSGEN BIOTECHNOLOGIES CORPORATION**

**CONSOLIDATED STATEMENT OF CASH FLOWS**

**(Canadian dollars in thousands)**

 
| ** **                                                                   | ** ** | **Years  ended December 31,** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                   | ** ** | **2004**                           | ** ** | **2003** | ** ** | **2002** | ** ** |
| Cash flows  from operating activities:                                       |       |                               |       |   |   |   |   |
| Net loss                                                                     |       | $                                  | (30,265    | ) | $ | (16,245 | ) | $ | (28,802 | ) |
| Net income  from discontinued operations                                     |       | (1,580                             | )          | (1,418 | ) | (2,024 | ) |
| Adjustments  to reconcile net loss to net cash used in operating activities: |       |                               |       |   |   |   |   |
| Depreciation  of plant and equipment                                         |       | 513                                |       | 632 |   | 797 |   |
| Loss on  disposal of plant and equipment                                     |       | 215                                |       | — |   | — |   |
| Amortization  of stock compensation expense                                  |       | 1,213                              |       | 192 |   | 207 |   |
| Unrealized  foreign exchange loss (gain)                                     |       | 1,145                              |       | 1,030 |   | (20 | ) |
| Loss (gain)  on market value of investments                                  |       | 241                                |       | 406 |   | (145 | ) |
| Changes in  operating assets and liabilities:                                |       |                               |       |   |   |   |   |
| Collaborative  accounts receivable                                           |       | 277                                |       | 3,513 |   | (3,790 | ) |
| Prepaid  expenses                                                            |       | (1,906                             | )          | (8 | ) | (41 | ) |
| Deferred  development expenses, current portion                              |       | (1,660                             | )          | 53 |   | (140 | ) |
| Other  current assets                                                        |       | (478                               | )          | (5 | ) | 94 |   |
| Deferred  development expenses, net of current portion                       |       | 98                                 |       | 161 |   | (421 | ) |
| Accounts  payable and accrued liabilities                                    |       | 4,295                              |       | (5,266 | ) | 1,076 |   |
| Deferred  revenue                                                            |       | (830                               | )          | (1,706 | ) | 4,459 |   |
| Net cash  used in operating activities of continuing operations              |       | (28,722                            | )          | (18,661 | ) | (28,750 | ) |
| Net cash  provided by discontinued operations                                |       | 702                                |       | 1,841 |   | 2,227 |   |
| Net cash  used in operating activities                                       |       | (28,020                            | )          | (16,820 | ) | (26,523 | ) |
|                                                                         |       |                               |       |   |   |   |   |
| Cash flows  from investing activities:                                       |       |                               |       |   |   |   |   |
| Purchase of  short-term investments                                          |       | (38,928                            | )          | (33,255 | ) | (76,641 | ) |
| Sales and  maturities of short-term investments                              |       | 56,983                             |       | 15,025 |   | 91,388 |   |
| Purchase of  plant and equipment                                             |       | (203                               | )          | (131 | ) | (380 | ) |
| Net cash  provided by (used in) investing activities                         |       | 17,852                             |       | (18,361 | ) | 14,367 |   |
|                                                                         |       |                               |       |   |   |   |   |
| Cash flows  from financing activities:                                       |       |                               |       |   |   |   |   |
| Proceeds  from issuance of common shares                                     |       | 36                                 |       | 23,672 |   | 10,604 |   |
| Share issue  costs                                                           |       | (81                                | )          | — |   | — |   |
| Repayment of  borrowings                                                     |       | (611                               | )          | (459 | ) | (535 | ) |
| Proceeds  from borrowings                                                    |       | —                             |       | 1,004 |   | — |   |
| Net cash  (used in) provided by financing activities                         |       | (656                               | )          | 24,217 |   | 10,069 |   |
|                                                                         |       |                               |       |   |   |   |   |
| Effect of  exchange rate changes on cash and cash equivalents                |       | (387                               | )          | (489 | ) | (49 | ) |
| Decrease in  cash and cash equivalents                                       |       | (11,211                            | )          | (11,453 | ) | (2,136 | ) |
| Cash and  cash equivalents, beginning of year                                |       | 19,749                             |       | 31,202 |   | 33,338 |   |
| Cash and  cash equivalents, end of year                                      |       | $                                  | 8,538      |   | $ | 19,749 |   | $ | 31,202 |   |
|                                                                         |       |                               |       |   |   |   |   |
| See Note 10 for  non-cash disclosures                                   |       |                               |       |   |   |   |   |
| See accompanying notes to  consolidated financial statements.                |       |                               |       |   |   |   |   |

 

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**STRESSGEN BIOTECHNOLOGIES CORPORATION**

**CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY**

**(Canadian dollars) (In thousands, exceptshare information)**

 
| ** **                                                                                | ** ** | **Common shares  and other equity** | ** ** | **Warrants** | ** ** | **Deferred  Stock** | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|--------------|------------|---------------------|------------|-----------------|------------|------------|------------|
| ** **                                                                                | ** ** | **Number**                          | ** ** | **Amount**   | ** ** | **Number**          | ** ** | **Amount**      | ** ** | **Comp**   | ** ** | **Deficit** | ** ** | **Total** | ** ** |
| Balance at January 1, 2002                                                           |       | 57,591,888                          |       | $            | 164,794    |                | 3,256,202  |            | $          | —     |       | $ | (630 | ) | $ | (105,247 | ) | $ | 58,917 |   |
| Issued for cash on exercise of stock options                                              |       | 575,902                             |       | 1,706        |       | —              |       | —          |       | —     |       | — |   | 1,706 |   |
| Conversion of warrants to common shares                                                   |       | 3,963                               |       | —       |       | (25,057             | )          | —          |       | —     |       | — |   | — |   |
| Warrants issued in connection with Roche  Collaboration                                   |       | —                              |       | —       |       | 2,036,435           |       | 1,264           |       | —     |       | — |   | 1,264 |   |
| Issued for cash in connection with Roche  Collaboration                                   |       | 2,036,436                           |       | 7,657        |       | —              |       | —          |       | —     |       | — |   | 7,657 |   |
| Other, net                                                                                |       | 1,800                               |       | (37          | )          | —              |       | —          |       | 28         |       | — |   | (9 | ) |
| Compensation expense related to stock option grants                                       |       | —                              |       | —       |       | —              |       | —          |       | 210        |       | — |   | 210 |   |
| Net loss                                                                                  |       | —                              |       | —       |       | —              |       | —          |       | —     |       | (28,802 | ) | (28,802 | ) |
| Balance at December 31, 2002                                                         |       | 60,209,989                          |       | 174,120      |       | 5,267,580           |       | 1,264           |       | (392       | )          | (134,049 | ) | 40,943 |   |
| Issued for cash on exercise of stock options                                              |       | 229,516                             |       | 375          |       | —              |       | —          |       | —     |       | — |   | 375 |   |
| Issued for cash, net of issue costs                                                       |       | 10,638,298                          |       | 17,796       |       | 5,319,149           |       | 904             |       | —     |       | — |   | 18,700 |   |
| Adjustment due to price difference in warrant  transaction related to Roche Collaboration |       | —                              |       | —       |       | 191,739             |       | —          |       | —     |       | — |   | — |   |
| Conversion of warrants to common shares in connection  with Roche Collaboration           |       | 1,413,600                           |       | 5,352        |       | (1,413,600          | )          | (758            | )          | —     |       | — |   | 4,594 |   |
| Expiration of warrants                                                                    |       | —                              |       | —       |       | (3,231,145          | )          | —          |       | —     |       | — |   | — |   |
| Other, net                                                                                |       | —                              |       | 3            |       | —              |       | —          |       | 4          |       | — |   | 7 |   |
| Compensation expense related to stock option grants                                       |       | —                              |       | —       |       | —              |       | —          |       | 203        |       | — |   | 203 |   |
| Net loss                                                                                  |       | —                              |       | —       |       | —              |       | —          |       | —     |       | (16,245 | ) | (16,245 | ) |
| Balance at December 31, 2003                                                         |       | 72,491,403                          |       | 197,646      |       | 6,133,723           |       | 1,410           |       | (185       | )          | (150,294 | ) | 48,577 |   |
| Issued for cash on exercise of warrants                                                   |       | 15,000                              |       | 38           |       | (15,000             | )          | (2              | )          | —     |       | — |   | 36 |   |
| Retroactive adjustment related to adoption of CICA  3870 (Note 2)                    |       | —                              |       | 32,379       |       | —              |       | —          |       | —     |       | (32,379 | ) | — |   |
| Reversal of deferred stock compensation related to  adoption of CICA 3870 (Note 2)   |       | —                              |       | (774         | )          | —              |       | —          |       | 185        |       | 589 |   | — |   |
| Amortization of fair value of stock option expense of  continued operations               |       | —                              |       | 1,213        |       | —              |       | —          |       | —     |       | — |   | 1,213 |   |
| Amortization of fair value of stock option expense of  discontinued operations            |       | —                              |       | 71           |       | —              |       | —          |       | —     |       | — |   | 71 |   |
| Adjustment to share issues costs                                                          |       | —                              |       | (81          | )          | —              |       | —          |       | —     |       | — |   | (81 | ) |
| Net loss                                                                                  |       | —                              |       | —       |       | —              |       | —          |       | —     |       | (30,265 | ) | (30,265 | ) |
| Balance at December 31, 2004                                                         |       | 72,506,403                          |       | $            | 230,492    |                | 6,118,723  |            | $          | 1,408      |       | $ | — |   | $ | (212,349 | ) | $ | 19,551 |   |

 

See accompanying notes to consolidated financial statements.

 

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**StressgenBiotechnologies Corporation**

**Notes toConsolidated Financial Statements**

**(Canadiandollars)**

 

**1.****                                     ****ORGANIZATION AND SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES**

 

Stressgen Biotechnologies Corporation (with its subsidiaries other thandiscontinued operations, “Stressgen” or the “Company”) is a biopharmaceuticalcompany that discovers, develops and seeks to commercialize therapeuticvaccines for the treatment of infectious diseases and cancers. The Company’slead candidate, HspE7, targets a broad spectrum of human papilloma virus (HPV)related diseases.  It was created usingthe Company’s proprietary CoVal fusion product technology, which is based oncovalently linking stress proteins (also known as heat shock proteins) todisease specific antigens. The Company has been researching use of the sametechnology to develop potential treatments for hepatitis B, herpes simplex andhepatitis C.

 

Theaccompanying financial statements have been prepared on a going concern basis,which contemplates the realization of assets and the satisfaction ofliabilities in the normal course of business. The Company has a history of recurring losses from operations and havean accumulated deficit of $212,349,000 as of December 31, 2004. The nature of the Company’s business requires significant spending on R&Dactivities.  Due to a history of losses, high cash burn on R&D activitiesand the planned loss of bioreagent revenue as a result ofthe planned sale of that business, the Company is closely monitoring cashresources.  The Company has developed various operational plans whichdepend upon the outcome of the financing options available.  Assumingthe Company raises approximately $15,000,000 and sells the bioreagent business theCompany will have sufficient resources to fund operations into 2006 at currentspending levels.  If the Company does not raise at least that amount ofcash it may need to modify or cancel agreements with external contractors, andmake changes to staffing level which would impact the development timelines ofHspE7.  Regardless of the funding the Company receives, it willexecute the operational plan necessary to fund operations into 2006.

 

*Basis ofpresentation*

 

The consolidated financial statements includethe assets, liabilities and operating results of the Company and itswholly-owned subsidiaries.  Intercompanyaccounts and transactions have been eliminated in consolidation. Prior yearbalances have been reclassified to conform to current year presentation as aresult of adoption of Canadian Institute of Chartered Accountants (CICA) 3870and disclosure regarding the Company’s discontinued operation.

 

*Financial statements andestimates*

 

The financialstatements, in the opinion of management, include all adjustments necessary fortheir fair presentation in conformity with Canadian generally acceptedaccounting principles (“Canadian GAAP”), and conform in material respects withaccounting principles generally accepted in the United States of America (“U.S.GAAP”), except as discussed in Note 11.

 

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The preparationof financial statements in conformity with Canadian GAAP and U.S. GAAP requiresmanagement to make estimates and assumptions that affect the reported amountsof assets, liabilities, revenue and expenses and related disclosures as of thedate of the financial statements. Significant estimates are used for, but not limited to, revenuerecognition, accrual of clinical trial costs, measurement of stock-basedcompensation, cancellation fees related to contractual obligations and theallocation of indirect costs between research and development (R&D) andselling, general and administrative (SG&A). Actual results could differ from such estimates.

 

*Foreign currency translation*

 

The Company usesthe Canadian dollar as its consolidated functional currency.  Monetary assets and liabilities that aredenominated in U.S. dollars or British pounds are translated into Canadiandollars at the rates of exchange prevailing at the balance sheet date.  Non-monetary assets and liabilities aretranslated at historical exchange rates. Revenue and expenses are translated at the average rate of exchange forthe period of such transactions.

 

*Revenue recognition*

 

Revenue fromcollaborative research and development arrangements may include multipleelements within a single contract.  TheCompany’s accounting policy complies with the revenue determinationrequirements set forth in EITF 00-21, *Accounting for RevenueArrangements with Multiple Deliverables*, and EIC 142, *Revenue Arrangements with Multiple Deliverables*, relating tothe separation of multiple deliverables into individual accounting units withdeterminable fair values.  Paymentsreceived under collaborative arrangements may include the following:  non-refundable fees at inception of contract fortechnology rights; funding for services performed; milestone payments for specificachievements; and payments based upon resulting sales of products.

 

The Companyrecognizes collaborative research and development revenues as services arerendered consistent with the performance requirements of the contract.  Revenue from non-refundable contract feeswhere the Company has continuing involvement through research and developmentcollaborations or other contractual obligations, less the fair market value ofany related warrants, is recognized ratably over the development period or theperiod for which Stressgen continues to have a performance obligation.  The period of development is evaluated on aregular basis.  In December 2003,the Company increased the development period by one year to reflect management’sresearch and development plan.  Revenuefrom performance milestones is recognized upon the achievement of themilestones as specified in the agreement, provided payment is proportionate tothe effort expended.  Payments arerecorded as deferred revenue if they are received in advance of performance ordelivery.

 

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*Clinical trial accruals*

 

The Companyrecognizes expenses related to its ongoing clinical trials using a methodologydesigned to accrue estimated costs in the appropriate accounting periods whenthe expenses are incurred.    The Companyrecognizes clinical trial costs in three distinct phases that correspond withthe period during which the services are performed:  the start-up phase, the patient accrualphase, and the close-out phase. The start up portion of the trial contract isaccrued during the trial planning and protocol writing period.  The per patient accrual cost is recognized aseach patient enters the trial.  Theclose-out portion of the trial is recognized as the final analyses of patientdata are prepared.  Based on the designof the trial including number of patients, number of clinical sites, method oftreatment, and follow-up, the proportion of the cost of each phase could varyfrom trial to trial.   As each trialcontinues, the Company evaluates the total contract costs and makes adjustmentsaccordingly. Changes to the cost estimates are charged to R&D expense inthe appropriate period based on the facts and timing of the adjustment.

 

*Stock-basedcompensation plan*

 

**In September 2003,the CICA Accounting Standards Board released revised transitional provisionsfor *Stock-Based Compensation and Other Stock-BasedPayments*, Section 3870 (CICA 3870), to provide the samealternative methods of transition as is provided in the U.S. for voluntaryadoption of the fair value based method of accounting.   In January 2004, the Company adoptedCICA 3870.  This standard requires thatall stock-based awards made to non-employees be measured and recognized using afair value based method.  The standardencourages the use of a fair value based method for all awards granted toemployees, but only requires the use of a fair value based method for directawards of stock, stock appreciation rights, and awards that call for settlementin cash or other assets. **Awards that a company has the ability to settle instock are recorded as equity, whereas awards that the entity is required to orhas a practice of settling in cash are recorded as liabilities.  No awards were made that would result inrecording a liability.

** **

The Company has two stock-based compensationplans, which are described in Note 6. The Company grants options with an exercise price equal to the fairmarket value of the underlying common stock. Under the principles of CICA 3870, compensation expense is recognized ona straight-line basis over the vesting period of the grant based on theestimated fair value at the time of grant using the Black-Scholes method.  Any consideration paid by directors,employees and others on exercise of stock options is credited to commonshares.  See further discussion of thechange in accounting policy in Note 2.

 

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*Cash, cashequivalents and short-term investments*

 

Cash and cash equivalents consist of cash andhighly liquid investments, including investment grade corporate debt securitieswith original maturities when acquired of three months or less.  Short-term investments consist of investmentgrade securities, which are capable of prompt liquidation and are carried atthe lower of cost plus accrued interest or quoted market value.

 

*Plant andequipment*

 

Plant and equipment arerecorded at cost and depreciated over their estimated useful lives on adeclining-balance basis using the half year convention, except for leaseholdimprovements, which are depreciated on a straight-line basis over the lesser ofthe lease term or the estimated useful life. The approximate annual depreciation rates are as follows:

 
| Laboratory equipment    | 20%                                                        |
|-------------------------|------------------------------------------------------------|
| Computer equipment      | 30%                                                        |
| Furniture and equipment | 20%                                                        |
| Leasehold improvements  | the lesser of the lease term or the estimated  useful life |

 

*Impairment oflong-lived assets*

 

TheCompany assesses potential impairment to its long-lived assets when there isevidence that events or changes in circumstances exist.  The recoverability of long-lived assets isdetermined by evaluating whether the carrying value of such assets can berecovered from estimated undiscounted future operating cash flows.  Should an impairment exist, the impairmentloss would be measured based on the excess of the carrying value of the assetsover the present value of the future operating cash flows.

 

*Fair value offinancial instruments*

 

Managementbelieves that the carrying values of financial instruments, including cash andcash equivalents, short-term investments, accounts receivable, accountspayable, and accrued liabilities approximate fair value as a result of the short-termmaturities of these instruments.  Thecarrying value of fixed rate capital leases and term loan obligationsapproximate fair value, as the imputed interest rate is approximatelyequivalent to the market rates charged on similar arrangements.

 

*Concentrationof credit risk*

 

The Company invests its excess cashprincipally in investment grade government and corporate debt securities.  The Company has established guidelinesrelative to

 

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diversification and maturities that maintainsafety and liquidity.  These guidelinesare periodically reviewed and modified to reflect changes in marketconditions.  The Company has notexperienced any significant losses on its cash equivalents or short-terminvestments.  However, the Company recorded write-downs ofits fixed income investment portfolio in 2004 and 2003 of $293,000 and$284,000, respectively.  The write-downs were due principally to adecrease in the market value of one bond which we still hold.  The market value of this particular bond has beenfluctuating since we recorded a write down in 2003.

 

At December 31,2004 and 2003, approximately 48% and 24% of cash, cash equivalents andshort-term investments were held in U.S. dollars.   During 2004, the Company purchased Britishpounds.  At December 31, 2004approximately 36% of our cash, cash equivalents and short-term investments wereheld in British pounds.

 

TheCompany has derived 100% of its collaboration revenue from Roche.

 

*Patent License Agreement*

 

The Company has aworldwide, exclusive license agreement with Massachusetts Institute of Technologyand the Whitehead Institute for Biomedical Research.  The patents and patent applications coveredby this license agreement include various pending applications andcontinuation-in-part applications and their foreign counterparts, includingpatent applications filed in the U.S., Canada and Japan in1994 for the use of Hsp fusions with viral or cancer-associated antigens asimmunotherapeutics.   Historically, the Company’s patent-related costs are related totherapeutic products that have not obtained regulatory approval and are notmarketable. As a result, the Company has treated such costs as costs for whichrecoverability cannot be determined, and has expensed them to R&D expenseas incurred.

 

*Research anddevelopment costs*

 

Research and development costs associatedwith the Company’s various research and development programs consist of directand indirect expenditures, including a reasonable allocation of overheadexpenses.  Overhead expenses arecomprised of general and administrative support provided to the research anddevelopment programs. These expenses include costs associated with supportactivities such as information technology, finance and human resources as wellas for the use of facilities.  Researchand development costs are expensed as incurred, unless they meet criteria fordeferral and amortization.  The Companyreassesses whether it has met the relevant criteria for deferral andamortization at each reporting date.  Todate, no research and development costs have been deferred.

 

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*Income taxes*

 

Futureincome tax assets and liabilities relate to the expected future taxconsequences of differences between the carrying amount of balance sheet itemsand their corresponding tax values, and for loss carry-forwards and otherdeductions.  Future tax assets, if any,are recognized only to the extent that, in the opinion of management, it ismore likely than not that the future income tax assets will be realized.  Future income tax assets and liabilities areadjusted for the effects of changes in tax laws and rates on the date ofenactment or substantive enactment.

 

*Net loss pershare*

 

Net loss from continued and discontinuedoperations per share is computed using the weighted average number of commonshares outstanding.  Basic and dilutednet loss per common share amounts are equivalent for the periods presented asthe inclusion of common stock equivalents (options and warrants) in the numberof shares used for the diluted computation would be anti-dilutive.   Approximately, 10,169,000, 9,745,000 and8,140,000 in the form of exercisable options and warrants have been excludedfrom the shares outstanding for the diluted computation as the inclusion wouldresult in a smaller net loss per share.

 

**New Canadian GAAPAccounting Pronouncements**

 

*Impairment of Long-Lived Assets*

 

CICA Section 3063,*Impairment of Long-Lived Assets*,establishes standards for the recognition, measurement and disclosure of theimpairment of long-lived assets by profit oriented enterprises, and replacesthe write-down provisions of Section 3061, Property, Plant and Equipment.

 

Impairment oflong-lived assets held for use is determined by a two-step process. The firststep determines when an impairment is recognized and the second step measuresthe amount of the impairment.  Animpairment loss is recognized when the carrying amount of a long-lived assetexceeds the sum of the undiscounted cash flows expected to result from its useand eventual disposition.  An impairmentloss is measured as the amount by which the long-lived asset’s carrying amountexceeds its fair value.

 

The newstandard is effective for fiscal years beginning on or after April 1,2003.  Application is prospective.  The Company continues to monitor potentialimpairment of long-lived assets.

 

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*Stock-based compensation*

 

As discussedin Note 2 in the financial statements, the Company adopted CICA 3870.

 

**2.****                                     ****CHANGE IN ACCOUNTING POLICY**

 

In January 2004the Company changed its accounting policy relating to stock based compensationawards, retroactive to January 1, 1995, in accordance with therecommendations of CICA 3870.  Aspermitted by the September 30, 2003 transitional provisions issued by theCICA Accounting Standards Board related to CICA 3870, the Company has appliedthis change using the retroactive method without restatement.  Expense related to stock-based compensationawards is calculated using the Black-Scholes option pricing model andrecognized over the vesting period of the grant.  Previously, the Company used the intrinsicvalue method for valuing stock-based compensation awards granted to employeesand directors where compensation expense was recognized for the excess, if any,of the quoted market price of Company’s common shares over the compensationaward exercise price on the day that options were granted.

 

The followingpro forma information presents the net loss and the basic loss per common sharehad CICA 3870 been retroactively applied:

 
| ** **                                                                  | ** ** | **Years ended  December 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|------------------------------------|------------|
| **(in thousands, except per share  amounts)**                               | ** ** | **2003**                           | ** ** | **2002** | ** ** |
|                                                                        |       |                               |       |   |   |
| Net  loss under Canadian GAAP                                               |       | $                                  | (16,245    | ) | $ | (28,802 | ) |
|                                                                        |       |                               |       |   |   |
| Stock-based  compensation expense under the intrinsic value method     |       | 207                                |       | 224 |   |
|                                                                        |       |                               |       |   |   |
| Stock-based  employee compensation expense under the fair value method |       | (2,675                             | )          | (2,764 | ) |
|                                                                        |       |                               |       |   |   |
| Pro  forma net loss under Canadian GAAP                                     |       | $                                  | (18,713    | ) | $ | (31,342 | ) |
|                                                                        |       |                               |       |   |   |
| Pro  forma basic loss per common share under Canadian GAAP                  |       | $                                  | (0.30      | ) | $ | (0.53 | ) |

 

To implement the fair value method forstock-based compensation beginning January 1, 2004, the Company recordedan adjustment to beginning accumulated deficit of $31,790,000, comprised of$15,945,000 related to the fair value expense calculated on options granted onor after January 1, 1995, $16,434,000 related to compensation expense onthe release of contingently issuable shares completed in 1999, offset by a$589,000 reversal of previously recorded expense under the intrinsic valuemethod.  Under the principles of CICA3870, the Company reclassified $3,174,000 from contributed

 

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surplus to common shares related to thehistorical exercise of employee stock options. The Company recorded expense of $1,213,000 related to continuingoperations and $71,000 related to discontinued operations for the year ended December 31,2004, representing the amortization of the fair value of compensation based onthe vesting period of stock options granted to employees and directors.  The weighted-average per-share fair values ofthe individual options granted during the years ended December 31, 2004,2003 and 2002 were $0.43, $1.06 and $2.63, respectively.   The fair value of the options was determinedusing a Black-Scholes option-pricing model with the following averageassumptions:

 
| ** **              | ** ** | **Years  ended December 31,** | ** ** |
|-------------------------|------------|------------------------------------|------------|
| ** **              | ** ** | **2004**                           | ** ** | **2003** | ** ** | **2002** | ** ** |
| Dividend yield          |       | 0                                  | %          | 0 | % | 0 | % |
| Volatility              |       | 67                                 | %          | 75 | % | 78 | % |
| Risk-free interest rate |       | 3.69                               | %          | 2.54 | % | 3.50 | % |
| Expected life           |       | 4 years                            |       | 4 years |   | 4 years |   |

 

**3.****                                     ****COLLABORATIVE AGREEMENT**

 

On December 2, 2003, the Companyannounced it had restructured its June 24, 2002 collaboration agreementwith F. Hoffmann-La Roche Ltd and Hoffmann-La Roche Inc. (together, “Roche”),providing for the development and commercialization of the pharmaceuticalfusion product candidate, HspE7.  Underthe restructured terms Roche was granted an option to license the firstgeneration HspE7 product, a license to develop a second generation HspE7product, and an option to negotiate rights to the Company’s CoValTMfusion product candidates for the treatment of cancer and hepatitis C.

 

In connection with the first generation HspE7product, the restructured agreement gives the Company the right to develop andcommercialize the product for indications other than genital warts, includingcontrol of regulatory matters such as U.S. Investigational New Drugapplications (IND).  The Company may alsoconduct dose-ranging studies in patients with genital warts.  In the original agreement the Company wasresponsible for clinical development expenses related to the recurrentrespiratory papillomatosis (RRP) indication. In addition to the responsibilities in the original agreement, theCompany is responsible for the manufacturing and other costs of all indicationsit develops under the new agreement.

 

The Company recorded collaborative R&Drevenue of $700,000, $8,094,000 and $8,370,000 during the years ended December 31,2004, 2003 and 2002, respectively. Collaborative R&D revenue during 2004relates principally to the amortization of upfront license fees in accordancewith CICA Accounting Standards Board recommendations, section 3400, *Revenue*, and Staff Accounting Bulletin (SAB) No. 101 *Revenue Recognition in Financial Statements*.  Collaborative R&D revenue in 2003 includes

 

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$4,912,000 for development activities,$2,214,000 for a time based milestone payment and $968,000 for the amortizationof upfront license fees.  CollaborativeR&D revenue in 2002 includes $7,815,000 for development activities and$555,000 from the amortization of up-front license fees.

 

By payingadditional fees, Roche can exclusively develop the second generation HspE7product.  In such case Roche would be required to pay the costs ofdevelopment, manufacturing and commercialization of the product and to makepayments to us upon the achievement of defined milestones. We would alsoreceive tiered, progressive sales-based payments that we believe arecompetitive with other agreements of this stage and type.  Commercialsuccess payments of up to approximately $102,306,000 become payable dependingupon the aggregate net sales of either or both generations of the HspE7products. The restructured collaboration agreement gives us the right todiscuss, negotiate and execute an alternative agreement with a third-party forthe development and commercialization of HspE7 through a license, partnership,joint venture or similar transaction. After March 31, 2005 and through the end of the option period,Roche can terminate this right by paying us a fee, which would be either $12,036,000or $18,054,000 depending on the stage of development of the product. Managementcannot determine if or when this option will be exercised.

 

**4.****                                      BALANCESHEET DETAILS**

 

At December 31, 2004 and 2003, our short-terminvestments consisted of corporate debt securities and government issued debtsecurities, which had a net book value and fair market value of $13,040,000 and$32,094,000, respectively.

 

The MIT/Whitehead license agreement discussed in Note 1requires certain license maintenance fees and royalty payments.  Upon receiving the upfront license feepayment from Roche in 2002, the Company recorded a $634,320 payable due toMIT/Whitehead and a related deferred expense. The payment was made in January 2003.  The Company recognizes the related deferredexpense over the development period, which was adjusted in conjunction with therestructured Roche collaborative agreement. At December 31, 2004 and 2003 the Company had a total of $242,000and $347,000 of deferred expense related to this payment.

 

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The following tables provide details of selectedbalance sheet items of continuing operations:

 
| ** **              | ** ** | **December 31, 2004** | ** ** |
|-------------------------|------------|----------------------------|------------|
| **(In thousands)**      | ** ** | **Cost**                   | ** ** | **Accumulated  Depreciation** | ** ** | **Net Book  Value** | ** ** |
| Plant and equipment:    |       |                       |       |   |   |   |   |
| Laboratory  equipment   |       | $                          | 3,648      |   | $ | 2,517 |   | $ | 1,131 |   |
| Computer  equipment     |       | 910                        |       | 727 |   | 183 |   |
| Furniture  and fixtures |       | 392                        |       | 282 |   | 110 |   |
| Leasehold  improvements |       | 749                        |       | 692 |   | 57 |   |
|                    |       | $                          | 5,699      |   | $ | 4,218 |   | $ | 1,481 |   |
|                    |       |                       |       |   |   |   |   |
| ** **              | ** ** | **December, 31 2003**      | ** ** |
| **(In thousands)**      | ** ** | **Cost**                   | ** ** | **Accumulated  Depreciation** | ** ** | **Net Book  Value** | ** ** |
| Plant and  equipment:   |       |                       |       |   |   |   |   |
| Laboratory  equipment   |       | $                          | 4,127      |   | $ | 2,688 |   | $ | 1,439 |   |
| Computer  equipment     |       | 1,021                      |       | 732 |   | 289 |   |
| Furniture  and fixtures |       | 563                        |       | 390 |   | 173 |   |
| Leasehold  improvements |       | 716                        |       | 611 |   | 105 |   |
|                    |       | $                          | 6,427      |   | $ | 4,421 |   | $ | 2,006 |   |

 
| **(In thousands)**                         | ** ** | **December 31,  2004** | ** ** | **December 31,  2003** | ** ** |
|--------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
|                                       |       |                        |       |                        |       |
| Accounts  payable and accrued liabilities: |       |                        |       |                        |       |
| Trade  accounts payable                    |       | $                           | 4,072      |                        | $          | 1,147 |   |
| Clinical  trial accruals                   |       | 2,514                       |       | 1,409                       |       |
| Accrued  compensation and benefits         |       | 1,243                       |       | 915                         |       |
| Other  accrued liabilities                 |       | 33                          |       | 96                          |       |
|                                       |       | $                           | 7,862      |                        | $          | 3,567 |   |

 

AtDecember 31, 2004 the Company had outstanding term loan obligations of$514,000.  InSeptember 2003 the Company entered into a 36-month term loan agreementwith Oxford Finance Corporation, collateralized by equipment owned by theCompany.  Interest rates on the Oxfordterm loan range from 11.47% to 11.48%. At December 31, 2004 and 2003 there was $514,000 and $906,000,respectively, outstanding on the loan. Under the terms of the agreement, the Company must obtain a letter ofcredit for the outstanding loan balance if combined cash, cash equivalents, andshort-term investments fall below $6,000,000.

 

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At December 31,2004 total future minimum payments under term loan agreements are as follows:

 
| **(In thousands)**                  | ** ** | ** ** | ** ** |
|-------------------------------------|------------|------------|------------|
| Year ending  December 31,      |       |       |       |
| 2005                                |       | $          | 409        |   |
| 2006                                |       | 150        |       |
| Total                               |       | 559        |       |
| Less: amount  representing interest |       | (45        | )          |
| Present  value of minimum payments  |       | 514        |       |
| Less:  current portion              |       | (369       | )          |
| Long term  notes payable            |       | $          | 145        |   |

 

**5.****                                      COMMITMENTSAND CONTINGENCIES**

 

The Company’s contractual obligations consistprimarily of agreements related to the development and manufacture of HspE7,operating leases for facilities, a term loan to increase working capital cashflows (Note 4) and contractual employment obligations.  The Company engages several contractorsworking on different aspects of the work regulatory authorities require for abiologic product, including stability testing, analytical testing, releasetesting and the manufacturing and fill/finish activities noted below.

 

In January 2004the Company entered into a biological services agreement with Avecia for theprocess development, scale-up and manufacture of HspE7.  In addition, the Company may have Aveciamanufacture commercial drug substance. Under the terms of the agreement, the Company is required to makeprepayments for future services and use of the facility.  The Company was invoiced for two prepaymentstotaling $3,204,000 in 2004 for services to be rendered and space utilized in2005.  The Company made one of theseprepayments in 2004.  The otherprepayment was not made until 2005 and therefore is included in deferreddevelopment expenses, current portion and accrued liabilities.

 

The Aveciaagreement is cancelable subject to specified termination conditions. Thecancellation fee is based on a sliding percentage of certain future programmilestones.  Accordingly, thecancellation fee is modified each month during the course of the agreement,based on the timing of activities performed by Avecia and prepayments for thoseactivities.  The cancellation fee as of December 31,2004 could have been up to $441,000, depending on Avecia’s ability to reschedule usageof their facility.

 

In October 2004the Company entered into an agreement with Cardinal Health (Cardinal) toperform fill/finish activities to prepare HspE7 for distribution to clinicaltrial patients in the ordinary course of its business.  At December 31, 2004, the Company wascontractually obligated to make a prepayment of $293,000 for future services tobe

 

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rendered in2005.  However, this prepayment was notmade until early 2005 and therefore is included in deferred developmentexpenses, current portion and accrued liabilities.

 

The agreementwith Cardinal includes cancellation provisions that could require the Companyto pay for work that was not performed or equipment that was not used if itterminates the contract while activities are at pre-defined stages.   The cancellation fee of $127,000 would havebeen offset against the prepayment made in 2005.

 

To retain aflexible development program, the Company typically negotiates terminationprovisions so that financial obligations are limited to paying for workperformed up to the termination date and in some cases, a cancellation feedetermined under a pre-established formula. Except as disclosed above the Company currently does not have othersignificant research and development contracts subject to cancellationfees.  The Company has not entered intoany minimum supply agreements with any service vendors or contract manufacturers.

 

*Leases*

 

The Company has enteredinto operating lease agreements for office space and laboratory space thatexpire at various times through 2005. These leases require the Company to makeminimum lease payments, plus a share of facility maintenance costs, taxes,insurance and maintenance.  In additionthe Company has entered into various other operating leases primarily foroffice equipment that expire during 2009.

 

At December 31,2004 total future minimum lease commitments under operating leases are asfollows:

 
| **(In thousands)**             | ** ** | ** ** | ** ** |
|--------------------------------|------------|------------|------------|
| Year ending  December 31, |       |       |       |
| 2005                           |       | $          | 966        |   |
| 2006                           |       | 23         |       |
| 2007                           |       | 12         |       |
| 2008                           |       | 3          |       |
| 2009                           |       | 1          |       |
| Total                          |       | $          | 1,005      |   |

 

*Contractual Employment Obligations*

 

The Company hasemployment agreements with certain members of management which include specificseverance packages.  The Company would becontractually obligated to pay $2,871,000 over the next twelve months and anadditional $314,000 would be payable during the following year, depending upon individualemployment agreements.

 

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*PatentOpposition*

 

On October 22, 2002Antigenics Inc. announced that it had filed an opposition in the EuropeanPatent Office to a European patent and requests for re-examination in the U.S.Patent and Trademark Office of two U.S. patents we licensed in connection withthe Company’s platform technology.  In October 2003Antigenics filed an opposition in the European Patent Office to an additional,product specific, European patent.  TheEPO may hold an oral hearing as early as this fall if the parties do notrequest a change in the date.  TheCompany does not know when results from these proceedings will be obtained.  Until the Company receives final results fromthe opposition and re-examination processes, the Company will not be able toassure investors of the success of planned vigorous defense of the patents.  However, management does not expect that thiswill have a material impact to its financial statements.

 

**6.****                                     ****STOCKHOLDERS’ EQUITY**

 

*Common Shares*

 

In June 2002 the Company issued 2,036,436 commonshares for $7,657,000 pursuant to the collaboration agreement with Roche (see Note 3).  The equity was issued at a per share pricedetermined by the weighted average price of common shares of the Company duringthe ten business days prior to the Roche transaction.

 

At the time of the original collaborationagreement, Roche received two warrants to purchase the common stock ofStressgen.  The Company allocated$1,264,000 as the fair value of the warrants. In April 2003, Roche exercised the first warrant to acquire1,413,600 common shares at $3.25, resulting in net proceeds of $4,594,000 tothe Company.  Under the originalcollaboration agreement, the Company had the right to call the second warrant.In connection with the restructured collaboration agreement, Roche has acontinued right to exercise the second warrant for 814,574 shares at a purchaseprice of $3.76 per share at any time until June 28, 2007.  The Company no longer has the right to callthe second warrant.

 

The Company has unlimited authorized commonshare capital.

 

*Contributed surplus*

 

Stockholders’ equity balances at December 31,2004, 2003 and 2002 includes $15,488,000, $2,207,000 and $2,179,000,respectively, if contributed surplus. The increase in contributed surplus in 2004 over 2003 is due to aretroactive adjustment of $15,945,000 related fair value expense of optionsgranted between January 1, 1999 through December 31, 2003 and $1,284,000of fair value expense of options granted in 2004 offset by $3,174,000 relatedto the reclassification to common shares of fair value expense on optionsexercised and $774,000 related to the reversal of deferred stock

 

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compensation. The decrease in contributed surplus from 2002 to 2003, primarily relatesto the change of status of an employee to a consultant.

 

*Common ShareFinancings*

 

In December 2003,the Company completed an offering of 10,638,298 units at a price of $1.88 perUnit for gross proceeds of $20,000,000. Each unit consists of one common share in the capital of the Company andone-half of one common share purchase warrant. The Company incurred total share issue costs on the offering ofapproximately $1,381,000.  Under the conditions of the offering, theCompany agreed to indemnify the underwriters and their broker/dealer affiliatesagainst certain liabilities, including liabilities under the United Statessecurities laws and under Canadian securities legislation and to contribute topayments that the underwriters may be required to make in respect thereof.

 

*1998 SpecialWarrants*

 

In 1998 the Company issued Class BWarrants to purchase 4,000,000 shares for $3.30 per share or pursuant to acashless exercise provision.  Theunexercised Class B Warrants expired on June 12, 2003.  As a result the Company no longer has theobligation to issue up to 3,231,145 common shares that had been reserved forissuance upon exercise of the Class B Warrants.

 

*Employee ShareOption Plans*

 

In 2001, the Company issued out-of-plan stockoptions prior to stockholder approval of the 2001 Equity Incentive Plan (the “2001Plan”).  Between the date of grant andstockholder approval, the market price of the Company’s common stock increased,resulting in deferred compensation of $807,000 associated with theseoptions.  The deferred compensation hasbeen amortized to expense over the vesting period of the granted options.  However, as discussed in Note 2, thistreatment has been reversed as of January 1, 2004 as a result of the adoptionof fair value accounting for stock based compensation.  Once the 2001 Plan was approved, the Companystopped granting options under its pre-existing 1996 Share Incentive Plan.  The following tables summarize informationrelated to all stock options outstanding and exercisable granted to employees,directors and non-employees under the Company’s 1996 and 2001 stock-basedcompensation plans as of December 31, 2004.

 

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The following tablesummarizes stock option activity under the Plans:

 
| ** **                         | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
|------------------------------------|------------|-----------------------|------------|---------------------------------------|------------|
|                               |       |                  |       |                                  |       |
| Balance at  January 1, 2002   |       | 4,175,583             |       | $                                     | 4.59       |   |
| Granted                            |       | 1,092,250             |       | 4.41                                  |       |
| Exercised                          |       | (575,902              | )          | 2.96                                  |       |
| Cancelled                          |       | (387,368              | )          | 5.46                                  |       |
| Balance at  December 31, 2002 |       | 4,304,563             |       | 4.69                                  |       |
| Granted                            |       | 1,157,500             |       | 1.80                                  |       |
| Exercised                          |       | (229,516              | )          | 1.63                                  |       |
| Cancelled                          |       | (254,429              | )          | 3.66                                  |       |
| Balance at  December 31, 2003 |       | 4,978,118             |       | 4.21                                  |       |
| Granted                            |       | 164,250               |       | 0.81                                  |       |
| Exercised                          |       | —                |       | —                                |       |
| Cancelled                          |       | (444,769              | )          | 4.51                                  |       |
| Balance at December 31,  2004 |       | 4,697,599             |       | $                                     | 4.07       |   |

 

Thetotal number of options exercisable at December 2004 was 4,050,335.  There were 3,611,370 and 2,872,233 optionsexercisable as of December 31, 2003 and 2002, respectively.

 

Thefollowing table summarizes information related to all stock options outstandingand exercisable at December 31, 2004:

 
| ** **                    | ** ** | **Options Outstanding** | ** ** | **Options Exercisable**                                        | ** ** |
|-------------------------------|------------|-------------------------|------------|----------------------------------------------------------------|------------|
| **Range of  Exercise Prices** | ** ** | **Number  Outstanding** | ** ** | **Weighted  Average  Remaining  Contractual Life  (in years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  Exercisable** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|                          |       |                    |       |                                                           |       |   |   |   |   |   |   |
| $0.42 -  $1.99                |       | 1,451,194               |       | 7.0                                                            |       | $ | 1.61 |   | 1,029,102 |   | $ | 1.71 |   |
| $2.00 -  $3.99                |       | 605,822                 |       | 7.7                                                            |       | 3.24 |   | 422,191 |   | 3.35 |   |
| $4.00 -  $5.99                |       | 1,193,588               |       | 6.4                                                            |       | 4.91 |   | 1,152,256 |   | 4.91 |   |
| $6.00 -  $8.00                |       | 1,446,995               |       | 5.4                                                            |       | 6.18 |   | 1,446,786 |   | 6.18 |   |
|                          |       | 4,697,599               |       |                                                           |       |   |   | 4,050,335 |   |   |   |
|                               |            |                         |            |                                                                |            |  |  |  |  |  |  |  |  |

 

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**7.****                                     ****INCOME TAXES**

 

Thereported income tax recovery differs from the amount computed by applying theCanadian basic statutory rates to the net loss. The reasons for this difference and the related tax effects are asfollows:

 
| ** **                                     | ** ** | **Years  ended December 31,** | ** ** |
|------------------------------------------------|------------|------------------------------------|------------|
| **(In thousands)**                             | ** ** | **2004**                           | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                           |       |                               |       |   |   |   |   |
| Canadian  basic statutory tax rates            |       | 35.6                               | %          | 35.6 | % | 39.6 | % |
|                                           |       |                               |       |   |   |   |   |
| Expected  income tax recovery                  |       | $                                  | (10,781    | ) | $ | (5,786 | ) | $ | (11,411 | ) |
| Foreign tax  rate differences                  |       | 7,722                              |       | 1,669 |   | (2,080 | ) |
| Prior year  losses producing current benefit   |       | —                             |       | — |   | (125 | ) |
| Losses  producing no current tax benefit       |       | 1,737                              |       | 2,232 |   | 13,682 |   |
| Non-deductible  expenses and other deductions  |       | 738                                |       | 21 |   | (54 | ) |
| Research and  development expenses             |       | 678                                |       | 2,143 |   | 900 |   |
| Benefit of  temporary differences (recognized) |       | —                             |       |   |   |   |   |
| not  recognized                                |       | 308                                |       | (279 | ) | (912 | ) |
| Other                                          |       | (402                               | )          | — |   | — |   |
|                                           |       | $                                  | —     |   | $ | — |   | $ | — |   |

 

Future income taxes result principally fromtemporary differences in the recognition of certain revenue and expense itemsfor financial and income tax reporting purposes.  Significant components of the Company’sfuture tax assets and liabilities are as follows:

 
| ** **                                               | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------|------------|-----------------------|------------|
| **(In thousands)**                                       | ** ** | **2004**              | ** ** | **2003** | ** ** |
|                                                     |       |                  |       |   |   |
| Future  income tax assets:                               |       |                  |       |   |   |
| Tax loss  carry-forwards                                 |       | $                     | 21,738     |   | $ | 20,001 |   |
| Tax credits                                              |       | 8,431                 |       | 7,450 |   |
| Research and  development expenses                       |       | 8,678                 |       | 8,000 |   |
| Book and tax  base differences on assets and liabilities |       | 1,500                 |       | 1,192 |   |
| Total future  income tax assets                          |       | 40,347                |       | 36,643 |   |
|                                                     |       |                  |       |   |   |
| Valuation  allowance for future income tax assets        |       | (40,347               | )          | (36,643 | ) |
| Net future  income tax assets                            |       | $                     | —     |   | $ | — |   |
|                                                     |       |                  |       |   |   |
| Future  income tax liabilities:                          |       |                  |       |   |   |
| Book and tax  base differences on assets and liabilities |       | $                     | —     |   | $ | — |   |
| Net future  income tax liabilities                       |       | $                     | —     |   | $ | — |   |

 

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Due to theuncertainty surrounding the realization of the future income tax assets, theCompany has a 100% valuation allowance against its future income taxassets.  The valuation allowanceincreased by $3,704,000 during 2004.

 

At December 31,2004, the Company has approximately $24,364,000 of scientific research andexperimental development expenditures available for unlimited carry forward, $55,869,000of non-capital losses expiring between 2006 and 2014 and $8,431,000 ofunclaimed tax credits expiring between 2005 and 2013, all of which may be usedto reduce future Canadian income taxes otherwise payable.  In addition,the Company has US$11,549,000 of net operating losses expiring in 2013, which maybe used to reduce future income taxes in California otherwise payable.

 

TheCanada Revenue Agency (“CRA”) has asked us to provide additional informationwith respect to transactions between us and our subsidiaries in 2001 and2002.  In February 2005 CRA gave usa preliminary indication that it does not agree with elements of our transferpricing, including the value ascribed to intellectual property transferred to asubsidiary. We believe that the preliminary determination has been made withoutregard to relevant information and are in the process of clarifying it andproviding further information to CRA. Even if the CRA assessment does not change, its determination will notresult in a change to our financial statements due to the consolidatedpresentation of the results for us and our subsidiaries; nor will additionaltax become payable for those years.  Ifwe are found to have failed to provide timely and adequate information to CRA,a penalty could be levied. We believe that we have provided all relevantinformation within prescribed time periods. We do not believe the outcome of the discussions with the CRA will havea material impact on our financial position.

 

**8.****                                     ****RELATED PARTY TRANSACTIONS**

 

Until theannual meeting in 2002 an independent contractor who is a researcher in thearea of heat shock proteins also served as a director of the Company.  In 2002, this individual received consultingfees of $50,000.

 

The Company has used variousaffiliates of MDS, Inc., including MDS Pharma Services, to provideresearch services.  Through May 2004 and the years ended 2003and 2002 the Company paid the various MDS entities an aggregate of$286,000, $235,000 and $139,000, respectively.  One of the Company’s boardmembers was an officer of MDS, Inc. through May 2004.

 

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**9.****                                      SEGMENTINFORMATION**

 

Long-lived assets are allocatedgeographically as follows:

 
| ** **         | ** ** | **December 31,** | ** ** |
|--------------------|------------|-----------------------|------------|
| **(In thousands)** | ** ** | **2004**              | ** ** | **2003** | ** ** |
|               |       |                  |       |   |   |
| Canada             |       | $                     | 1,271      |   | $ | 1,763 |   |
| US                 |       | 210                   |       | 243 |   |
|               |       | $                     | 1,481      |   | $ | 2,006 |   |

 

The Company previously reported two segments,Biotechnology and Bioreagents.  Asdiscussed in Note 12, at December 31, 2004, the Company has disclosedthe bioreagent business as a discontinued operation and therefore has only onereportable segment.

 

**10.****                              ****SUPPLEMENTAL CASH FLOW INFORMATION**

 
| ** **                                                                  | ** ** | **Years ended December 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|-----------------------------------|------------|
| **(In thousands)**                                                          | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                                        |       |                              |       |   |   |   |   |
| Supplemental  disclosures of cash flows:                                    |       |                              |       |   |   |   |   |
| Interest  paid                                                              |       | $                                 | 96         |   | $ | 53 |   | $ | 69 |   |
|                                                                        |       |                              |       |   |   |   |   |
| Supplemental  disclosures of non-cash investing and financing transactions: |       |                              |       |   |   |   |   |
| Reversal of  deferred stock compensation                                    |       | $                                 | 185        |   | $ | 4 |   | $ | 28 |   |

 

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**11.****                              ****THE EFFECT OF APPLYING ACCOUNTING PRINCIPLES GENERALLY ACCEPTED IN THEU.S.**

 

These financial statements have been preparedin accordance with Canadian GAAP which, except as set out below, conform, inall material respects, to U.S. GAAP. The effect of applying U.S. GAAP insteadof Canadian GAAP on the consolidated financial statements would be as follows:

 

*BalanceSheet*

(In thousands)

 
| ** **                                     | ** ** | **December 31,  2004** | ** ** | **December 31,  2003** | ** ** |
|------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Current  assets under Canadian GAAP            |       | $                           | 28,531     |                        | $          | 54,164 |   |
| Adjustments  to Canadian GAAP                  |       | —                      |       | —                      |       |
| Current  assets under U.S. GAAP                |       | $                           | 28,531     |                        | $          | 54,164 |   |
|                                           |       |                        |       |                        |       |
| Stockholders’  equity under Canadian GAAP |       | $                           | 19,551     |                        | $          | 48,577 |   |
|                                           |       |                        |       |                        |       |
| Adjustment  to common stock (a)                |       | (16,455                     | )          | —                      |       |
| Adjustment  to deferred stock compensation (a) |       | (104                        | )          | —                      |       |
| Adjustment  to accumulated deficit (a)         |       | 16,559                      |       | —                      |       |
|                                           |       | —                      |       | —                      |       |
| Stockholders’  equity under U.S. GAAP     |       | $                           | 19,551     |                        | $          | 48,577 |   |

 

77

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*Statementof Operations*

 
| ** **                                                                                    | ** ** | **Years ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| **(In thousands except per share amounts)**                                                   | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net loss  under Canadian GAAP                                                                 |       | $                                 | (30,265    | ) | $ | (16,245 | ) | $ | (28,802 | ) |
|                                                                                          |       |                              |       |   |   |   |   |
| Reversal of  unrealized foreign exchange loss (gain) on investments (b)                       |       | 800                               |       | 541 |   | (69 | ) |
| Loss (gain)  on market value of investments (b)                                               |       | 241                               |       | 406 |   | (145 | ) |
| Reversal of  stock compensation expense (a)                                                   |       | 1,284                             |       | — |   | — |   |
| Stock  compensation expense under APB No. 25 (a)                                         |       | (81                               | )          | — |   | — |   |
|                                                                                          |       | 2,244                             |       | 947 |   | (214 | ) |
|                                                                                          |       |                              |       |   |   |   |   |
| Net loss  under U.S. GAAP                                                                     |       | $                                 | (28,021    | ) | $ | (15,298 | ) | $ | (29,016 | ) |
|                                                                                          |       |                              |       |   |   |   |   |
| Basic and  diluted loss per common share under Canadian GAAP                                  |       | $                                 | (0.42      | ) | $ | (0.26 | ) | $ | (0.49 | ) |
|                                                                                          |       |                              |       |   |   |   |   |
| Basic and  diluted loss per common share under U.S. GAAP                                      |       | $                                 | (0.39      | ) | $ | (0.25 | ) | $ | (0.49 | ) |
|                                                                                          |       |                              |       |   |   |   |   |
| Common  shares used to compute basic and diluted loss per share under Canadian and  U.S. GAAP |       | 72,504                            |       | 61,458 |   | 58,986 |   |

 

78

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*Statement of Cash Flows*

 

Forall periods presented there are no significant differences under Canadian andU.S. GAAP in net cash (used in) provided by operating, investing and financingactivities.

 

*Differences*

 

Thefollowing notes outline the differences between Canadian and U.S. GAAP thataffect the Company for the years ended December 31, 2004, 2003, and 2002.

 

(a)                                  Asdiscussed in Note 2, on January 1, 2004, the Company adopted fairvalue accounting for all stock options as required by CICA 3870.  The Company is required to record the expenseof the fair value of all stock options over their respective vesting term.  The Company used the “Retrospective methodwithout Restatement.”  This methodrequires the Company to record the cumulative expense as an adjustment toaccumulated deficit for the period beginning January 1, 1995 through December 31,2003 and begin recording the expense to accumulated deficit in 2004.

 

The FASB issued SFAS No. 148, *Accounting for Stock-Based Compensation, Transitionand Disclosure*(SFAS 148)**inDecember 2002.  SFAS 148 provides alternativetransition methods for entities that voluntarily elect to adopt the fair value recognitionprovisions of FASB Statement No. 123, *Accountingfor Stock-Based Compensation*(SFAS 123)*,*to stock-based employee compensation.  Under the provisions of SFAS 123, fair valueaccounting is required for all grants made on or after January 1,1995.  The Company has not elected toadopt the provisions of SFAS 123 for U.S. reporting purposes, whichwould require fair value based accounting for grants made on or after January 1,1995.

 

Under the principles of SFAS 123, the Companywould have recorded $17,958,000 of deferred compensation related to the totalfair value for stock options granted between January 1, 1995 and December 31,2004.  The following table illustratesthe effect on net loss and loss per share under U.S. GAAP if the Company hadapplied the fair value accounting provisions of SFAS 123 to employee stockbased compensation:

 

79

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| ** **                                                | ** ** | **Years ended December 31,** | ** ** |
|-----------------------------------------------------------|------------|-----------------------------------|------------|
| **(In thousands except per share amounts)**               | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net loss  under U.S. GAAP                                 |       | $                                 | (28,021    | ) | $ | (15,298 | ) | $ | (29,016 | ) |
|                                                      |       |                              |       |   |   |   |   |
| Stock-based  compensation under APB No. 25           |       | 81                                |       | 207 |   | 224 |   |
| Stock-based  compensation expense recorded under SFAS 123 |       | (1,284                            | )          | (2,675 | ) | (2,764 | ) |
| Pro forma  net loss under U.S. GAAP                       |       | $                                 | (29,224    | ) | $ | (17,766 | ) | $ | (31,556 | ) |
|                                                      |       |                              |       |   |   |   |   |
| Pro forma  loss per common share                          |       | $                                 | (0.40      | ) | $ | (0.29 | ) | $ | (0.53 | ) |

 

(b)                                 UnderU.S. GAAP Statement of Financial Accounting Standards (SFAS) No. 115, *Accounting for Certain Investments in Debt and EquitySecurities*, the Company would have classified certain of itsshort-term securities as available-for-sale and, accordingly, would haveincluded the changes in net unrealized holding gains or losses on thesesecurities as a component of stockholders’ equity rather than in operations.

 

TheEmerging Issues Task Force (EITF) recently deliberated regarding Issue 03-01,*The Meaning of Other-Than-Temporary Impairment andIts Application to Certain Investments*.  The Issue is intended to address the meaningof other-than-temporary impairment and its application to certain investmentsheld at cost.  The EITF reached aconsensus regarding disclosure requirements concerning unrealized losses onavailable-for-sale debt and equity securities accounted for under SFAS No. 115.  The guidance for evaluating whether aninvestment is other-than-temporarily impaired has been deferred.  The disclosure requirements apply to annualfinancial statements for fiscal years ending after December 15, 2003 forinvestments accounted for under SFAS No. 115.  For all other investments within the scope ofthis Issue, the disclosure requirements have been deferred.  Additional disclosurerequirements for cost method investments apply to fiscal years ending after June 15,2004.  The Company continues to evaluate the effectof this pronouncement on its financial statements.

 

SFASNo. 130, Reporting Comprehensive Income, establishes standards for thereporting and display of comprehensive loss and its components in a full set ofgeneral-purpose financial statements. Comprehensive loss is as follows:

 

80

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| ** **                                                            | ** ** | **Years ended December 31,** | ** ** |
|-----------------------------------------------------------------------|------------|-----------------------------------|------------|
| **(In thousands)**                                                    | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net loss  under U.S. GAAP                                             |       | $                                 | (28,021    | ) | $ | (15,298 | ) | $ | (29,016 | ) |
| Other  comprehensive income                                           |       |                              |       |   |   |   |   |
| Adjustment  of unrealized foreign exchange (loss) gain on investments |       | (800                              | )          | (541 | ) | 69 |   |
| Market value  adjustments on investments                              |       | (241                              | )          | (406 | ) | 145 |   |
| Comprehensive  net loss under U.S. GAAP                               |       | $                                 | (29,062    | ) | $ | (16,245 | ) | $ | (28,802 | ) |

 

(c)                                  At December 31,2004, the Company decided to report the bioreagent business as a discontinuedoperation pursuant to the requirements of CICA 3475, *Disposal ofLong-lived Assets and Discontinued Operations* (CICA 3475), SFAS No. 144,*Accounting for the Impairment or Disposal ofLong-Lived Assets* (SFAS 144), and EITF 03-13, *Applying the Conditions in Paragraph 42 of FASB Statement No. 144in Determining Whether to Report Discontinued Operations*.  See Note 12 for further disclosure.

 

**New U.S. GAAP Accounting Pronouncement**

 

*Share-based payment*

 

In January 2005,the FASB issued Statement No. 123R, *Share-Based Payment*(SFAS 123R), which is a revision of FASB Statement No. 123, *Accounting for Stock-Based Compensation*.  SFAS 123R establishes accounting standardsfor transactions around stock based compensation in exchange for employeeservices.  Similar to CICA 3870, SFAS123R requires fair-value-based method for accounting for stock basedcompensation and eliminates the intrinsic method under APB Opinion 25.  This statement is effective beginning in thesecond quarter of 2005; however as discussed in the Critical AccountingPolicies and Note 2 in the financial statements, the Company adopted CICA3870 which also requires the fair-value based method.  The Company will evaluate the impact of SFAS123R on current accounting policies and make the necessary changes anddisclosures in the notes to the financial statements in third quarter 2005.

 

**12.****                              ****DISCONTINUED OPERATION**

 

The Company’s bioreagentbusiness produces and sells bioreagents to researchers and researchorganizations worldwide.  The productssold by the bioreagent business include antibodies, proteins, DNA products,ELISA kits and extracts for use in studying cellular stress response pathways,including oxidative stress, apoptosis, neurobiology and more.

 

81

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At December 31, 2004,the Company decided to report the bioreagent business as a discontinuedoperation pursuant to the requirements of CICA 3475, *Disposal ofLong-lived Assets and Discontinued Operations* (CICA 3475), SFAS No. 144,*Accounting for the Impairment or Disposal ofLong-Lived Assets* (SFAS 144), and EITF 03-13, *Applying the Conditions in Paragraph 42 of FASB Statement No. 144in Determining Whether to Report Discontinued Operations*.  The Company is reporting the business as adiscontinued operation after evaluating intentions for the future of thebioreagent business, formulating a plan for sale and taking steps to executethat plan.

 

The Company plans to sellthe bioreagent business in 2005 so it can focus on the corporate strategy,manage resources and provide working capital to fund further development andcommercialization of HspE7.  The Companycannot determine the amount of any gain or loss, if any, that would be realizedon the sale of the bioreagent business.  Whena sale of the business is completed the gain or loss on the sale will bereported in quarterly filings as required by the CICA 3475 and SFAS 144.  The Company continues to evaluate the planfor the bioreagent business and disclose it appropriately per the Canadian andU.S. standards.

 

The significantaccounting principles discussed in Note 1 were applied to all discontinuedoperation transactions.  In addition, thefollowing accounting principals are specific to the bioreagent businesstransactions.  Revenue from product salesof the bioreagent business is recognized upon delivery to customers whenpersuasive evidence of an arrangement exists, the price is fixed ordeterminable and collection is reasonably assured.  Revenue also includes amounts charged forshipping and handling costs.

 

Inventoriesare valued at the lower of cost or net realizable value.  Assets initially purchased in 2003 by thebioreagent business are depreciated on a straight-line basis over the estimateduseful life.  All other plant andequipment are recorded and depreciated as described in Note 1.

 

The operating results ofthe bioreagent business have been separately classified and reported asdiscontinued operations in the consolidated financial statements.  A summary of the components of discontinuedoperations in the Consolidated Statement of Operations was as follows:

 
| **(In thousands)**                       | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Bioreagent  sales                        |       | $        | 5,772      |     | $          | 5,325    |       | $ | 5,672 |   |
| Operating  expenses                      |       | (4,074   | )          | (3,777   | )          | (3,658   | )          |
| Other  (expenses) income                 |       | (118     | )          | (130     | )          | 10       |       |
| Net income  from discontinued operations |       | $        | 1,580      |     | $          | 1,418    |       | $ | 2,024 |   |

 

82

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The bioreagent business was previouslyreported in the segment disclosure of our quarterly and annual filings.  Theincome reported above does not include internal overhead and administrativeoverhead expense allocations that were assigned to this segment and which willcontinue to be incurred by the continuing entity.

 

Asummary of the components of assets and liabilities of discontinued operationson the Consolidated Balance Sheets at December 31 was as follows:

 
| **(In thousands)**                            | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|-----------------------------------------------|------------|------------|------------|------------|------------|
| Assets of  discontinued operations:           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash and  cash equivalents                    |       | $          | 551        |       | $          | 247 |   |
| Short term  investments                       |       | 515        |       | —     |       |
| Accounts  receivable, net                     |       | 589        |       | 456        |       |
| Inventories                                   |       | 561        |       | 639        |       |
| Prepaid  expenses                             |       | 15         |       | 28         |       |
| Other  current assets                         |       | 60         |       | 22         |       |
| Plant and  equipment                          |       | 156        |       | 190        |       |
| Total assets  of discontinued operations      |       | $          | 2,447      |       | $          | 1,582 |   |
|                                          |       |       |       |       |       |
| Liabilities  of discontinued operations       |       |       |       |       |       |
| Accounts  payable                             |       | $          | 324        |       | $          | 408 |   |
| Total  liabilities of discontinued operations |       | $          | 324        |       | $          | 408 |   |

 

A summary of thecomponents of cash flows for discontinued operations for the years ended December 31was as follows:

 
| **(In thousands)**                                        | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net cash  flows provided by operations activities         |       | $        | 909        |     | $          | 281      |       | $ | — |   |
| Net cash  flows used in investing activities              |       | (605     | )          | (34      | )          | —   |       |
| Net cash  flows provided by financing activities          |       | —   |       | —   |       | —   |       |
| Net increase  in cash                                     |       | 304      |       | 247      |       | —   |       |
| Cash and  cash equivalents at the beginning of the period |       | 247      |       | —   |       | —   |       |
| Cash and  cash equivalents at the end of the period       |       | $        | 551        |     | $          | 247      |       | $ | — |   |

 

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**13.****                              ****INTERIM FINANCIAL INFORMATION – UNAUDITED**

 

The following is asummary of the unaudited quarterly results of operations for the years ended December 31,2004 and 2003.

 

(In thousands except pershare amounts)

 
| ** **                                                                            | ** ** | **Quarter ended (b)** | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------------------|------------|
| **2004**                                                                              | ** ** | **March 31**     | ** ** | **June 30** | ** ** | **September 30** | ** ** | **December 31** | ** ** |
| Net  revenues, Canadian and U.S. GAAP                                                 |       |                  |       |   |   |   |   |   |   |
| From  continuing operations                                                           |       | 173                   |       | 190 |   | 174 |   | 163 |   |
|                                                                                  |       |                  |       |   |   |   |   |   |   |
| Research and  development expenses, Canadian and U.S. GAAP from continuing operations |       | 5,273                 |       | 5,636 |   | 6,422 |   | 8,582 |   |
|                                                                                  |       |                  |       |   |   |   |   |   |   |
| Net (loss)  income, Canadian GAAP                                                     |       |                  |       |   |   |   |   |   |   |
| From  continuing operations                                                           |       | (6,818                | )          | (7,029 | ) | (8,367 | ) | (9,631 | ) |
| From  discontinued operations                                                         |       | 534                   |       | 663 |   | 410 |   | (27 | ) |
| Net loss,  Canadian GAAP                                                              |       | (6,284                | )          | (6,366 | ) | (7,957 | ) | (9,658 | ) |
|                                                                                  |       |                  |       |   |   |   |   |   |   |
| Basic and  diluted (loss) income per common share, Canadian GAAP                      |       |                  |       |   |   |   |   |   |   |
| From  continuing operations (a)                                                       |       | (0.09                 | )          | (0.10 | ) | (0.12 | ) | (0.13 | ) |
| From  discontinued operations (a)                                                     |       | (0.00                 | )          | 0.01 |   | 0.01 |   | (0.00 | ) |
| Total basic  and diluted loss per common share                                        |       | (0.09                 | )          | (0.09 | ) | (0.11 | ) | 0.13 |   |
|                                                                                  |       |                  |       |   |   |   |   |   |   |
| Net loss,  U.S. GAAP (c)                                                              |       | (5,657                | )          | (6,014 | ) | (6,519 | ) | (9,831 | ) |
|                                                                                  |       |                  |       |   |   |   |   |   |   |
| Basic and  diluted loss per common share, U.S. GAAP (a) (c)                      |       | (0.08                 | )          | (0.08 | ) | (0.09 | ) | (0.14 | ) |

 

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| ** **                                                                            | ** ** | **Quarter ended (b)** | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------------------|------------|
| **2003**                                                                              | ** ** | **March 31**     | ** ** | **June 30** | ** ** | **September 30** | ** ** | **December 31** | ** ** |
| Net  revenues, Canadian and U.S. GAAP                                                 |       |                  |       |   |   |   |   |   |   |
| From  continuing operations                                                           |       | 5,221                 |       | 1,508 |   | 855 |   | 510 |   |
|                                                                                  |       |                  |       |   |   |   |   |   |   |
| Research and  development expenses, Canadian and U.S. GAAP from continuing operations |       | 6,231                 |       | 4,408 |   | 5,636 |   | 3,258 |   |
|                                                                                  |       |                  |       |   |   |   |   |   |   |
| Net (loss)  income, Canadian GAAP                                                     |       |                  |       |   |   |   |   |   |   |
| From  continuing operations                                                           |       | (2,881                | )          | (4,677 | ) | (6,034 | ) | (4,071 | ) |
| From  discontinued operations                                                         |       | 424                   |       | 274 |   | 411 |   | 309 |   |
| Net loss,  Canadian GAAP                                                              |       | (2,457                | )          | (4,403 | ) | (5,623 | ) | (3,762 | ) |
|                                                                                  |       |                  |       |   |   |   |   |   |   |
| Basic and  diluted (loss) income per common share, Canadian GAAP                      |       |                  |       |   |   |   |   |   |   |
| From  continuing operations (a)                                                       |       | (0.05                 | )          | (0.08 | ) | (0.10 | ) | (0.06 | ) |
| From  discontinued operations (a)                                                     |       | 0.01                  |       | 0.01 |   | 0.01 |   | 0.00 |   |
| Total basic  and diluted loss per common share                                        |       | (0.04                 | )          | (0.07 | ) | (0.09 | ) | (0.06 | ) |
|                                                                                  |       |                  |       |   |   |   |   |   |   |
| Net loss,  U.S. GAAP (c)                                                              |       | (2,248                | )          | (4,222 | ) | (5,463 | ) | (3,365 | ) |
|                                                                                  |       |                  |       |   |   |   |   |   |   |
| Basic and  diluted loss per common share, U.S. GAAP (a) (c)                      |       | (0.04                 | )          | (0.07 | ) | (0.09 | ) | (0.05 | ) |

 

----

(a)          Income(loss) per share is computed independently for each of the quarters presentedand therefore may not sum to the total for the year.

(b)         Amountsfor the first, second and third quarters of 2004 and all quarters in 2003 havebeen reclassified to conform to the presentation of the bioreagent business asdiscontinued operations.

(c)          Toconform to U.S. GAAP certain adjustments must be made.  See Note 11

 

85

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# **Item 9**.                                   CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 

# ** **

None.

 

# **Item 9A**.                          CONTROLSAND PROCEDURES

# ** **

**Conclusion Regarding the Effectiveness ofDisclosure Controls and Procedures**

 

Under the supervision and with the participation of our management,including our principal executive officer and principal financial officer, weconducted an evaluation of our disclosure controls and procedures, as such termis defined under Rule 13a-15(e) promulgated under theSecurities Exchange Act of 1934, as amended (the Exchange Act).  Based on this evaluation, our principalexecutive officer and principal financial officer concluded that our disclosurecontrols and procedures were effective as of the end of the period covered bythis annual report.

 

**Management’s Report on Internal Control OverFinancial Reporting**

 

Our management is responsible for establishing and maintaining adequateinternal control over financial reporting, as such term is defined in ExchangeAct Rule 13a-15(f).  Under thesupervision and with the participation of our management, including ourprincipal executive officer and principal financial officer, we conducted anevaluation of the effectiveness of our internal control over our financialreporting based on the framework in *Internal Control –Integrated Framework* by the Committee of Sponsoring Organizations ofthe Treadway Commission.  Based on ourevaluation under the framework in *Internal Control –Integrated Framework*, our management concluded that our internalcontrol over financial reporting was effective as of December 31, 2004.

 

Our management’s assessment of the effectiveness of our internalcontrol over financial reporting as of December 31, 2004 has been auditedby Deloitte & Touche LLP, an independent registered public accountingfirm, as stated in their report which is included herein.

 

**REPORT OF INDEPENDENT REGISTERED PUBLICACCOUNTING FIRM**

 

To the Board of Directors and Stockholders of

Stressgen Biotechnologies Corporation

 

We have audited management’s assessment, included in the accompanying Management’sReport on Internal Control Over Financial Reporting, that StressgenBiotechnologies Corporation.and subsidiaries (the “Company”) maintained effectiveinternal control over financial reporting as of December 31, 2004, based on the criteria established in InternalControl—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission. The Company’s management is responsible for maintaining effectiveinternal control over financial reporting and for its assessment of theeffectiveness of internal control over financial reporting.  Our responsibility is to express an opinion on

 

86

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management’s assessment and an opinion on the effectiveness of theCompany’s internal control over financial reporting based on our audit.

 

We conducted our audit in accordance with and the standards of thePublic Company Accounting Oversight Board (United States).  Those standards require that we plan andperform the audit to obtain reasonable assurance about whether effectiveinternal control over financial reporting was maintained in all material respects.  Our audit included obtaining an understandingof internal control over financial reporting, evaluating management’sassessment, testing and evaluating the design and operating effectiveness ofinternal control, and performing such other procedures as we considerednecessary in the circumstances.  Webelieve that our audit provides a reasonable basis for our opinions.

 

A company’s internal control over financial reporting is a processdesigned by, or under the supervision of, the company’s principal executive andprincipal financial officers, or persons performing similar functions, andeffected by the company’s board of directors, management, and other personnelto provide reasonable assurance regarding the reliability of financialreporting and the preparation of financial statements for external purposes inaccordance with generally accepted accounting principles.  A company’s internal control over financialreporting includes those policies and procedures that (1) pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and (3) provide reasonable assurance regarding preventionor timely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

 

Because of the inherent limitations of internal control over financialreporting, including the possibility of collusion or improper managementoverride of controls, material misstatements due to error or fraud may not beprevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internalcontrol over financial reporting to future periods are subject to the risk thatthe controls may become inadequate because of changes in conditions, or thatthe degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, management’s assessment that the Company maintainedeffective internal control over financial reporting as of December 31,2004, is fairly stated, in all material respects, based on the criteriaestablished in Internal Control—Integrated Framework issued by the Committee ofSponsoring Organizations of the Treadway Commission.  Also in our opinion, the Company maintained,in all material respects, effective internal control over financial reportingas of December 31, 2004, based on the criteria established in InternalControl—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission.

 

We have also audited, in accordance with auditing standards generallyaccepted in Canada and the standards of the Public Company Accounting OversightBoard (United States), the consolidated financial statements  as of and for the year ended December 31,2004 of the

 

87

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Company and our report dated March 14, 2005  expressed an unqualified opinion on those financial statements and includedexplanatory paragraphs regarding (1) the Company’s adoption of CICA 3870, (2) thereporting of the bioreagent business as a discontinued operation and (3) theCompany’s ability to continue as a going concern..

 
| /s/ DELOITTE & TOUCHE LLP |   |
|------------------------------------|--------|
| San Diego, California              |
| March 14, 2005                |

 

# **Item 9B**.                          OTHERINFORMATION

# ** **

None.

 

**PART III**

 

# **Item 10**.  OURDIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES 

# ** **

Certain information about our directorsand executive officers, the positions held by them and their ages as of March 14,2005 are as follows:

 
| **Name**                       | ** ** | **Age** | ** ** | **Position**                                                       | ** ** | **Residence**            | ** ** |
|--------------------------------|------------|---------|------------|--------------------------------------------------------------------|------------|--------------------------|------------|
| Gordon R. Barefoot (1)         |       | 53      |       | Director                                                           |       | British Columbia, Canada |       |
|                           |       |    |       |                                                               |       |                     |       |
| Joann Data, M.D., Ph.D. (2, 3) |       | 60      |       | Director                                                           |       | California, U.S.         |       |
|                           |       |    |       |                                                               |       |                     |       |
| Elizabeth M. Greetham (1)      |       | 55      |       | Director                                                           |       | Bermuda                  |       |
|                           |       |    |       |                                                               |       |                     |       |
| Ian Lennox (1, 2)              |       | 52      |       | Director                                                           |       | Ontario, Canada          |       |
|                           |       |    |       |                                                               |       |                     |       |
| Margot Northey, Ph. D. (3)     |       | 65      |       | Director                                                           |       | British Columbia, Canada |       |
|                           |       |    |       |                                                               |       |                     |       |
| Jay M. Short, Ph.D. (2)        |       | 47      |       | Director                                                           |       | California, U.S.         |       |
|                           |       |    |       |                                                               |       |                     |       |
| Daniel L. Korpolinski          |       | 62      |       | Director, President  and Chief Executive Officer                   |       | Michigan, U.S.           |       |
|                           |       |    |       |                                                               |       |                     |       |
| Howard T. Holden, Ph.D.        |       | 61      |       | Vice President, Regulatory Affairs and  Compliance                 |       | California, U.S.         |       |
|                           |       |    |       |                                                               |       |                     |       |
| Gregory M. McKee               |       | 41      |       | Vice President, Corporate Development and  Chief Financial Officer |       | California, U.S.         |       |
|                           |       |    |       |                                                               |       |                     |       |
| John R. Neefe, M.D.            |       | 61      |       | Senior Vice President, Clinical Research                           |       | Pennsylvania, U.S.       |       |
|                           |       |    |       |                                                               |       |                     |       |
| Marvin I. Siegel, Ph.D.        |       | 58      |       | Executive Vice President, Research and  Development                |       | Pennsylvania, U.S.       |       |

 

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(1) Memberof the Audit Committee

(2) Memberof the Compensation Committee

(3) Memberof the Governance Committee

 

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***GORDON R. BAREFOOT***joined our Board of Directors in October 2004.  Mr. Barefoot is the Senior VicePresident of Finance and Chief Financial Officer of Terasen Inc. (formerly BCGas Inc.), where he has served in various senior executive positions inCorporate Development, Strategic Planning and Multi-Utility Services since July 1998.  Mr. Barefoot also serves as the Chairmanof the Board of Vancouver Community College and as a director of privatecompanies Clean Energy Fuels Corporation, Customerworks and Fairbanks Sewer andWater Inc.  Before joining Terasen, Mr. Barefootspent more than 20 years at Ernst & Young, where he was a partner ofthe firm. During his tenure with Ernst & Young, Mr. Barefootworked for clients in industries including utilities, education, healthcare,mining, transportation, forestry and financial services. Mr. Barefootreceived a B. Com (Hons.) from the University of Manitoba and is a CharteredAccountant.

 

***JOANN L. DATA, M.D., PH.D.***joined our Board of Directorseffective October 1, 2001.  She hasserved at Amylin Pharmaceuticals, Inc. as Senior Vice President ofRegulatory Affairs and Quality Assurance since August 1999.   While at Amylin, she provided regulatory andclinical consulting services to Cortex Pharmaceuticals, Inc. in 2002, 2003and through November 2004 and to Allergan Pharmaceutics in 2003 throughthe present.  Dr. Data previouslyserved as Executive Vice President, Product Development and Regulatory Affairsfor CoCensys Inc. Her prior experience includes several positions at the UpjohnCompany, including Corporate Vice President for Pharmaceutical RegulatoryAffairs and Project Management, and a number of positions at Hoffmann-La Roche,including Vice President of Clinical Research and Development.  Dr. Data has been an adjunct assistantprofessor in medicine and pharmacology at Duke University Medical Center since1982 and at Cornell Medical Center since 1986. She earned her M.D. from Washington University School of Medicine andher Ph.D. in Pharmacology from Vanderbilt University.

 

***ELIZABETH M. GREETHAM***has served as one of our directorssince September 2002.  Since December 2003she has been the Chief Executive Officer and President of ACCL FinancialConsultants.  From August 2000 to October 2003,she served as the Chief Executive Officer and Chairman of the Board ofDrugAbuse Sciences, Inc., a private biopharmaceutical company in Hayward,California. From March 1999 to October 2003, she worked at the sameentity as Chief Financial Officer and Senior Vice President, BusinessDevelopment.  Before joining DrugAbuseSciences, Ms. Greetham spent nearly a decade as a portfolio manager forWeiss, Peck & Greer, an institutional investment management firm.  She managed the WPG Life Sciences Funds,L.P., which invests in select biotechnology stocks.  She has over 25 years of investmentexperience as a portfolio manager and healthcare analyst in the U.S. andEurope.  Ms. Greetham also serves asa member of the Board of Directors of publicly traded Guilford PharmaceuticalsInc. and King Pharmaceuticals, Inc. Her prior board experience includes service on the boards of directorsof Sangstat Medical Corporation, PathoGenesis Corporation and CliniChemDevelopment Inc. Ms. Greetham earned a BSc and a MA (Hons.) from theUniversity of Edinburgh, Scotland.

 

***R. IAN LENNOX*****has served as one of our directors since May 2002and our Chairman since May 6, 2003. From April 2000 to May 2004, he served as President and ChiefExecutive Officer of Pharmaceutical & Biotechnology Markets, MDSInc.  Prior to joining MDS Inc., Mr. Lennoxwas President and Chief Executive Officer of Phoenix International LifeSciences Inc. from 1999

 

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to 2000, and President and Chief Executive Officer of Drug RoyaltyCorporation Inc. from 1997 to 1999.  Mr. Lennoxalso held many positions with Monsanto Company beginning in 1978, includingPresident and Chief Executive Officer of Monsanto Company (Canada) Inc. from1991 to 1997.  Mr. Lennox currentlyserves on the Board of Directors and audit committee of Cedara Software Corp.and on the board of directors of Labopharm Inc. In the past he served on various boards of directors, including as theChairman of the Boards of Drug Royalty Corporation Inc. and the MississaugaHospital Foundation, and as director of Hemosol Inc., GenSci RegenerationSciences Inc., Marsulex Inc. and the Mississauga Hospital.  Mr. Lennox attended the ColumbiaUniversity School of Business and received his Masters of Business and HSBc. inPhysiology and Pharmacology from the University of Western Ontario.

 

***MARGOT NORTHEY, M.A., PH.D.***joined our Boardof Directors in June 2002. Dr. Northey was a professor and the deanof Queen’s School of Business, Queen’s University in Kingston, Ontario, from September 1995to June 2002. She is also the author of several best-selling books oncommunications. Dr. Northey currently serves on diverse corporate boards,including the boards of public companies Aliant Inc., Norbord Inc., FraserPapers Inc. and Alliance Atlantis Communications Inc., and privately heldBritish Columbia Transmission Corp. and Wawanesa Insurance. She is a graduateof University of Toronto, with a M.A. and Ph.D. from York University.

 

***JAY M. SHORT, PH.D.***hasserved as one of our directors since March 1994. Dr. Short is afounding member of Diversa Corporation, and he has served as Chief TechnologyOfficer and Director of the company since its inception in 1994.  He assumed the additional roles of Presidentin 1998 and Chief Executive Officer in 1999. Prior to joining Diversa Corporation, Dr. Short served as Presidentof Stratacyte, Inc. and Vice President of Research and Development andOperations for Stratagene Cloning Systems both molecular biologycompanies.  Dr. Short serves as aDirector for Invitrogen, a leading biotechnology company in the area of geneexpression and Senomyx, Inc., a leader in discovering new and improvedproprietary flavor and fragrance molecules. Dr. Short received a B.A. in chemistry from Taylor University and aPh.D. in biochemistry from Case Western Reserve University.

 

***DANIEL L. KORPOLINSKI***hasserved as our President and Chief Executive Officer, U.S. Operations, since March 2000,and as one of our directors and our President and Chief Executive Officer sinceMay 2000. Mr. Korpolinski was President and Chief Executive Officerof Copley Pharmaceutical Inc., a generic pharmaceutical company, from September 1998until the company was acquired by Teva Pharmaceutical Industries Ltd. in September 1999.He was also a director of Copley from August 1998 until itsacquisition.  Between 1991 and 1996, Mr. Korpolinskiserved as the President and Chief Executive Officer of CoCensys Inc., abiotechnology company specializing in the development of therapeutics for thecentral nervous system.  From 1988 to1991, Mr. Korpolinski was President of Adria Laboratories North America,an oncology company.  Mr. Korpolinskistarted his career in the pharmaceutical industry with the Upjohn Company,where he spent 24 years, ultimately in the capacity as an Executive Director ofseveral pharmaceutical business groups. He received his B.S. from Niagra University in New York.

 

***HOWARD T. HOLDEN,PH.D.*** hasserved as Vice President, Regulatory Affairs and Compliance of StressgenBiotechnologies, Inc. since July 1, 2002.  He served as Vice President,

 

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Regulatory Affairs and Compliance with LigandPharmaceuticals from September 1992 until he joined us.  Prior to his employment with Ligand, Dr. Holdenwas Senior Director, Worldwide Regulatory Affairs at Parke-Davis PharmaceuticalResearch Division of the Warner-Lambert Company (now Pfizer, Inc.).  Dr. Holden also spent 14 years at theNCI as Section Head/Senior Investigator in the Cancer Therapy EvaluationProgram and the Biological Response Modifiers Program.  He received a B.A. in zoology from DrewUniversity and a Ph.D. in microbiology from the University of Miami.

 

***GREGORY M. McKEE*** has served as our Vice President,Corporate Development and Chief Financial Officer since January 15,2004.  From June 2003 to mid-January 2004,he was our Vice President, Corporate Development and Strategic Planning.  From July 2000 through June 2003, Mr. McKeeserved as Senior Director, Corporate Development for Valentis, Inc., a SanFrancisco based gene therapy company. Prior to his employment with Valentis,from June 1996 through December 1999, Mr. McKee served inseveral management positions at Genzyme Corporation, a biotechnology company. Mr. McKeealso spent five years in investment banking. Mr. McKee graduated with aB.A. degree in Economics from the University of Washington, an M.A. inInternational Studies from The Joseph H. Lauder Institute at the University ofPennsylvania and earned an MBA from the Wharton School.

 

***JOHN R. NEEFE, M.D.***becamethe Senior Vice President Clinical Research of Stressgen Biotechnologies, Inc.in mid-2002, after serving as Vice-President, Clinical Research andRegulatory Affairs starting in December 1998.  Prior to joining us in 1998, Dr. Neefeserved as Vice President, Clinical Oncology and International Director ofClinical Oncology at Sanofi Research Division, Sanofi Pharmaceuticals from mid-1995to December 1998.  From 1993 untilits acquisition by Sanofi in 1995, Dr. Neefe was Senior Director ofSterling-Winthrop, leading the company’s clinical oncology drug developmentunit.  Dr. Neefe has also held theposition as director of Clinical Research at Centocor, has attained academicappointments at the University of Kentucky and at Georgetown University andheld a research position at the NCI.  Dr. Neefereceived his B.A. from Harvard University and his M.D. from the University ofPennsylvania School of Medicine.

 

***MARVIN I. SIEGEL, PH.D.***hasserved as the Executive Vice President, Research & Development ofStressgen Biotechnologies, Inc. since February 1997.  Dr. Siegel was a director of DeltaPharmaceuticals, Inc., a Chapel Hill, North Carolina pharmaceuticalcompany between 1997 and 1999.  From February 1995to February 1997, Dr. Siegel was Vice President in charge of scienceand research and development, Terrapin Technologies Inc., a San Francisco,California private company specializing in drugs for allergy, oncology anddiabetes, which is now a public company known as Telik Inc.  Dr. Siegel was a senior executive withSchering-Plough Research Institute in Kenilworth, N.J., from May 1982 to February 1994,where he was responsible for biological research in immunology andallergy.  From August 1975 to May 1982,Dr. Siegel was a research scientist at Burroughs Wellcome Company inResearch Triangle Park, NC.  He hasattained academic appointments at Rutgers University and at the School ofMedicine of the University of North Carolina at Chapel Hill. Dr. Siegelreceived his B.S. from Lafayette College, his M.A. from Columbia University andhis Ph.D. from The Johns Hopkins University School of Medicine in 1973. He is aFellow of the American Academy of Asthma, Allergy and Immunology and of theAmerican Institute of Chemists.

 

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The term of office of each director continues until the next annualgeneral meeting of our shareholders.  Eachofficer serves at the discretion of our Board of Directors.  Our Articles permit the authorized number ofdirectors to range from three to fifteen directors.  We currently have seven directors and novacancies.

 

## **Board Committees**

## ** **

Our Board of Directors hasestablished three standing committees, the Audit Committee, the CompensationCommittee and our Governance Committee, which also acts as a nominatingcommittee. Our Board of Directors has delegated certain responsibilities toeach of these Committees and has also instructed each of them to performcertain advisory functions and make recommendations and report to our Board ofDirectors.  Where considered prudent,certain matters falling under the responsibility of these Committees are attimes dealt with at a meeting of the entire Board of Directors.  Additional committees are established fromtime to time for particular purposes.

 

*Compositionof the Audit Committee*

 

The Audit Committee meets withour financial management and the independent auditors to review and inquireinto matters affecting financial reporting matters, the system of internalaccounting and financial controls and procedures and audit procedures andplans.  This Committee also makesrecommendations to our Board of Directors regarding the appointment ofindependent auditors.  In addition, theAudit Committee reviews and recommends for approval to our Board of Directorsour annual financial statements, annual report and certain other documentsregulatory authorities require.  TheAudit Committee is also responsible for approving the policies under which ourfinancial management may invest the funds in excess of those required forcurrent operations.  The charter of theAudit Committee is set forth in Exhibit 99.1.  In 2004, the Audit Committee met eighttimes.  The current members of thecommittee are Gordon Barefoot, Elizabeth Greetham and Ian Lennox, none of whomis one of our current or former officers. The Board of Directors has determined that all three members of theAudit Committee are:

 

•                  audit committee financial expertsunder the definition of the U.S. Securities and Exchange Commission;

 

•                  independent directors as defined bythe Toronto Stock Exchange Company Manual

 

•                  independent as defined by Canada’sMultilateral Instrument 52-110 (*Audit Committees*);and

 

•                  financially literate under thepolicies of the policies of the Canadian Securities Administrators.

 

*Compositionof the Governance Committee*

 

The Governance Committee isresponsible for identifying, evaluating and recommending nomineesfor our Board of Directors and reviewing incumbent directors for re-election toour Board of Directors.  Incumbent andpotential new directors are evaluated by this Committee with

 

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the objective of obtaining abalanced mix of Board members with the experience and expertise to ensure thatour Board of Directors is composed of individuals who will best serve ourinterests and assist management in reaching our strategic goals. The Governance Committee met once in 2004. The current members of theGovernance Committee are Margot Northey and Joann Data.  The Governance Committee will considernominees for directors that are recommended by shareholders.  Submissions should be directed to theGovernance Committee in care of our corporate secretary and general counsel atthe address set forth on the cover of this report.

 

*Compositionof the Compensation Committee*

 

The Compensation Committee isresponsible for establishing and monitoring our long range plans and programsfor attracting, training, developing and motivating employees.  This Committee reviews recommendations forthe appointment of persons to senior executive positions, considers terms ofemployment, including succession planning and matters of compensation andrecommends any awards of over 20,000 shares to one individual under our 2001Equity Incentive Plan.  The Compensation Committee also reviews allcompensation for executive officers reporting directly to the Chief ExecutiveOfficer, including the Named Executive Officers, for market comparability andreasonableness in light of the performance and realization of pre-establishedobjectives of the executive officers. In 2004, this committee met sixtimes.  The current members of thecommittee are Joann Data, Ian Lennox and Jay Short.

 

**Code ofEthics**

 

We have adopted a code of ethicsthat applies to all of our employees including the Named Executive Officersdefined below.  Copies of our currentCode of Ethics may be requested from our corporate secretary and generalcounsel at the address set forth on the cover of this report for no charge.

 

# **Item 11**.  COMPENSATIONOF DIRECTORS AND EXECUTIVE OFFICERS 

# ** **

We hold annual elections for the members of theBoard of Directors. In the aggregate, the non-employee directors earned$202,750 for their service in 2004.  Eachof our non-employee directors is entitled to receive $10,000 annually otherthan the Chairman of the Board, who is entitled to receive $25,000 annually.  In addition, the head of our Audit Committeereceives $5,000, and the heads of our Compensation and Governance Committeesreceive $2,500 annually.  Each directorreceives $1,000 for board or committee meetings attended in person, or $500 formeetings attended by teleconference. Board compensation is paid twice a year,after the annual general meeting and around the end of the year.  We also reimburse directors for expensesincurred on our behalf, including expenses associated with attendance atmeetings of our Board of Directors.

 

The Board of Directors agreed it would notreceive annual option grants in 2004. Gordon Barefoot, who joined the board in 2004, was granted an initialoption to acquire 30,000 shares, exercisable at the price per share that equalsthe closing sales price reported on the TSX from the date before he joined theboard.

 

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**Compensationof Executive Officers**

 

The following table sets forth, in U.S. dollars, all compensationawarded or paid to and earned by, our Chief Executive Officer, the four mosthighly compensated executive officers who were serving as executive officers atthe end of 2004 (collectively, the “Named Executive Officers”) for servicesrendered during the years ended December 31, 2004, 2003 and 2002.

 

**SummaryCompensation Table, in U.S. Dollars**

 
| ** **                                                          | ** ** | **Annual compensation** | ** ** | **Long term  compensation** | ** ** |
|---------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| **Name and  Principal  Position**                                   | ** ** | **Year**                | ** ** | **Salary**                  | ** ** | **Bonus** | ** ** | **Other Annual  Compensation** | ** ** | **Securities  Underlying  Options** | ** ** |
| ** **                                                          | ** ** | ** **              | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Daniel L. Korpolinski                                               |       | 2004                    |       | $                           | 395,200    |   | $ | — |   | $ | 91,290 | (2) | — |   |
| President and Chief  Executive Officer                              |       | 2003                    |       | 395,200                     |       | 95,000 |   | 106,269 | (2) | 150,000 | (8) |
|                                                                | 2002       |                    | 380,000    |                        | 136,800    |   | 143,832 | (2) | 100,000 |   |
|                                                                |       |                    |       |                        |       |   |   |   |   |   |   |
| Howard T. Holden, Ph.D.                                             |       | 2004                    |       | $                           | 279,761    |   | $ | 24,188 |   | — |   | — |   |
| Vice President, Regulatory  Affairs and Compliance                  |       | 2003                    |       | 270,300                     |       | 33,788 |   | — |   | 30,000 | (8) |
|                                                                | 2002       |                    | 132,500    | (3)                         | 63,125     | (4) | — |   | 100,000 |   |
|                                                                |       |                    |       |                        |       |   |   |   |   |   |   |
| Gregory M. McKee                                                    |       | 2004                    |       | $                           | 223,502    |   | $ | 24,375 |   | — |   | — |   |
| Vice President, Corporate  Development and Chief  Financial Officer |       | 2003                    |       | 115,312                     | (5)        | 15,000 |   | 28,823 | (6) | 175,000 |   |
|                                                                |       |                    |       |                        |       |   |   |   |   |   |   |
| John R. Neefe, M.D.                                                 |       | 2004                    |       | $                           | 300,492    |   | $ | 24,188 |   | — |   | — |   |
| Senior Vice President,                                              |       | 2003                    |       | 294,600                     |       | 36,825 |   | — |   | 50,000 | (8) |
| Clinical Research                                                   |       | 2002                    |       | 286,000                     |       | 60,000 |   | — |   | 50,000 |   |
|                                                                |       |                    |       |                        |       |   |   |   |   |   |   |
| Marvin I. Siegel, Ph.D.                                             |       | 2004                    |       | $                           | 269,400    |   | $ | 14,513 |   | — |   | — |   |
| Executive Vice President,  Research and Development                 |       | 2003                    |       | 269,400                     |       | 33,675 |   | 1,983 | (7) | 30,000 | (8) |
|                                                                | 2002       |                    | 261,500    |                        | 42,500     |   | 2,078 | (7) | 30,000 |   |
|                                                                     |            |                         |            |                             |            |  |  |  |  |  |  |  |  |  |

 

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| (1) | Intentionally omitted.                                                                                                                                                                                                                                                                                                                                     |
|-----|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | Amount includes medical premiums, life  insurance premiums, automobile costs, and amounts paid under Mr. Korpolinski’s  contract to compensate for the differential between the Canadian and U.S.  effective tax rates. The cost of Mr. Korpolinski’s San Diego housing is  included in his compensation through August 31, 2004. |
| (3) | Dr. Holden commenced employment on July 1,  2002.                                                                                                                                                                                                                                                                                                |
| (4) | Amount includes a $30,000 signing bonus and  a $33,125 bonus granted in February 2003 relating to Dr. Holden’s  performance from July 1, 2002 through December 31, 2002.                                                                                                                                                          |

 

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| (5) | Mr. McKee commenced employment on June 9,  2003. |
|-----|------------------------------------------------------------|
| (6) | Amount includes relocation costs.                          |
| (7) | Amount includes long-term disability  premiums.            |
| (8) | Granted in 2003 based on 2002 performance.                 |

 

**Stock Option Grants andExercises in Last Fiscal Year**

** **

Historically, we have granted options to our executive officers topurchase our common stock under our 2001 Equity Incentive Plan.  However, no options were granted to the NamedExecutive Officers during the fiscal year ended December 31, 2004.

 

Once the 2001 Plan was approved by our shareholders, we ceased to grantoptions under our 1996 Share Incentive Plan. As of December 31, 2004, options to purchase a total of 2,896,713shares were issued and outstanding under the 2001 Plan and 1,800,886 shareswere outstanding under the 1996 Plan. Options to purchase 599,338 shares remained available for grant underthe 2001 Plan.

 

**Aggregated Option Exercises in LastFiscal Year**

**And FiscalYear-End Option Values**

 

The following table sets forth certaininformation as of December 31, 2004, regarding options held by the NamedExecutive Officers.  There were no stockappreciation rights outstanding on December 31, 2004.

 
| ** **               | ** ** | **Shares**      | ** ** | ** **            | ** ** | **Unexercised Options at** | ** ** | **Value of Unexercised  In-The-Money Options** | ** ** |
|--------------------------|------------|-----------------|------------|-----------------------|------------|----------------------------|------------|------------------------------------------------|------------|
| ** **               | ** ** | **Acquired on** | ** ** | **Aggregate Value**   | ** ** | **December 31, 2004** | ** ** | **as of FY-End (Cdn. $)**                      | ** ** |
| **Name**                 | ** ** | **Exercise**    | ** ** | **Realized (Cdn. $)** | ** ** | **Exercisable**            | ** ** | **Unexercisable**                              | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** |
| Daniel L.  Korpolinski   |       | —          |       | —                |       | 1,188,888                  |       | 61,112                                         |       | $ | — |   | $ | — |   |
| Howard T.  Holden, Ph.D. |       | —          |       | —                |       | 78,749                     |       | 51,251                                         |       | $ | — |   | $ | — |   |
| Gregory M.  McKee        |       | —          |       | —                |       | 65,624                     |       | 109,376                                        |       | $ | — |   | $ | — |   |
| John R.  Neefe, M.D.     |       | —          |       | —                |       | 174,166                    |       | 20,834                                         |       | $ | — |   | $ | — |   |
| Marvin I.  Siegel, Ph.D. |       | —          |       | —                |       | 142,499                    |       | 12,501                                         |       | $ | — |   | $ | — |   |

 

**Employment Contracts and Termination ofEmployment and Change-in-Control Arrangements**

 

Daniel L.Korpolinski has been employed as President and Chief Executive Officer since March 8,2000.  He is employed under an amendedand restated employment agreement dated September 1, 2004.  The agreement provides for a base salary ofUS$395,200 and eligibility for incentive compensation of up to 40% of his basesalary.  In addition, Mr. Korpolinskiand our Board of Directors agreed in principle that Mr. Korpolinski may beeligible for a special bonus in an amount to be agreed in the event of atransaction that the Board of Directors determines substantially increases thevalue of Stressgen to its shareholders, such as new capital formation orregulatory and commercial milestones. In the event of a termination orsignificant change in responsibilities in connection with an acquisition,directly or indirectly, of more than 50% of our issued voting shares, Mr. Korpolinskiwould receive an amount equal to his “Average Salary”

 

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(defined ashis base salary plus an average of the annual bonus, if any, awarded for thepreceding three fiscal years, but excluding any special bonus) for 18months.  His employee benefits wouldcontinue during that period.  After sucha change of control, all unvested stock options Mr. Korpolinski holdswould vest immediately and be exercisable for six months.  In the event of a termination without cause, Mr. Korpolinskiwould receive a severance package equivalent to 18 months of his AverageSalary, payable in equal monthly installments, and employee benefits during the18 months.

 

Dr. Howard T. Holden, our Vice President, Regulatory Affairs andCompliance, is employed under an agreement dated May 8, 2002.  In 2004 Dr. Holden received a basesalary of US$279,761 under this agreement. He also is eligible for an annual bonus of up to 25% of his base salary,depending upon the achievement of corporate goals and the measure of his individualperformance as determined by the Chief Executive Officer in consultation withthe Board of Directors.  In addition, toserve as incentive compensation in lieu of a 2004 option grant, Dr. Holdenwill be eligible for an incentive bonus of up to $8,062.50 if specific HspE7development program milestones contemplated by our 2005 business plan areachieved by June 30, 2005.  In theevent that Dr. Holden is terminated without cause, he is entitled to sixmonths of severance payments.  Dr. Holdenis also entitled to 12 months of his base salary as severance payments in theevent of termination or significant change in title or responsibilities within12 months after a specified change in control.  Dr. Holden’s stock option agreements under the 2001 Plan providethat the vesting and exercisability of his options will accelerate in full inthe event his employment is involuntarily terminated without cause orvoluntarily terminated for specified reasons within 24 months after a specifiedchange in control.

 

Mr. Gregory M. McKee, our Vice President, Corporate Developmentand Chief Financial Officer, is employed under an agreement dated June 9,2003.  In 2004, Mr. McKee received abase salary of US$223,502 under this agreement. Mr. McKee is eligible for an annual bonus of up to 25% of his basesalary, depending upon the achievement of corporate goals and the measure ofhis individual performance as determined by the Chief Executive Officer inconsultation with the Board of Directors. In addition, to serve as incentivecompensation in lieu of a 2004 option grant, Mr. McKee will be eligiblefor an incentive bonus of up to $8,125 in 2005 based on capital formation theboard of directors considers to be successful. In the event that Mr. McKeeis terminated without cause, he is entitled to nine months of severancepayments.  Mr. McKee is alsoentitled to severance payments equal to nine months base salary in the event ofa termination or constructive termination within two years after a change incontrol.  Mr. McKee’s stock optionagreements under the 2001 Plan provide that the vesting and exercisability ofhis options will accelerate in full in the event his employment isinvoluntarily terminated without cause or voluntarily terminated for specifiedreasons within 24 months after a specified change in control.

 

John R. Neefe, M.D., our Senior Vice President, Clinical Research, isemployed under an employment agreement dated December 14, 1998, as amendedon December 16, 1999.  In 2004, Dr. Neefe’sbase salary was US$300,492 under this agreement. He is eligible for an annualbonus of up to 20% of his base salary based on performance as determined by theChief Executive Officer in consultation with the Board of Directors.  In addition, to serve as incentivecompensation in lieu of a 2004 option grant, Dr. Neefe will be eligiblefor an incentive bonus of up to $8,062.50 if specific HspE7 development programmilestones contemplated by our 2005

 

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business plan are achieved by June 30, 2005. In order to terminateDr. Neefe’s employment for other than just cause, we must provide Dr. Neefewith 12 month’s prior notice.  Dr. Neefeis also entitled to severance payments equal to his last two years’compensation in the event of termination within 12 months’ after a change inownership of our common stock within any three month period of at least 50%which results in a change in the majority of the members of our Board ofDirectors.  Dr. Neefe’s stock optionagreements under the 2001 Plan provide that the vesting and exercisability ofhis options will accelerate in full in the event his employment isinvoluntarily terminated without cause or voluntarily terminated for specifiedreasons within 24 months after a specified change in control.  Stock options granted under the 1996 Planbecome fully exercisable after a specified change in control.

 

Marvin I. Siegel, Ph.D., our Executive Vice President, Research andDevelopment, is employed under an employment agreement dated February 5,1997, as amended on January 11, 1999. In 2004, Dr. Siegel’s base salary was US$269,400 under thisagreement. He is eligible for a bonus based on exemplary service as determinedby the Chief Executive Officer in consultation with the Board ofDirectors.  In addition, to serve asincentive compensation in lieu of a 2004 option grant, Dr. Siegel will beeligible for an incentive bonus of up to $4,837.50 if specific HspE7development program milestones contemplated by our 2005 business plan areachieved by June 30, 2005.  In theevent that Dr. Siegel is terminated without cause, he is entitled to 12months notice or severance payments.  Dr. Siegelis also entitled to severance payments equal to 24 months base salary in theevent of termination within 12 months after an acquisition of more than 50% ofour outstanding shares as a result of which a majority of the members of ourBoard of Directors change within 3 months. Dr. Siegel’s stock option agreements under the 2001 Plan providethat the vesting and exercisability of his options will accelerate in full inthe event his employment is involuntarily terminated without cause orvoluntarily terminated for specified reasons within 24 months after a specifiedchange in control.  Stock options grantedunder the 1996 Plan become fully exercisable after a specified change incontrol.

 

Subject to the *BusinessCorporations Act* (Yukon Territory), if specific preconditions aremet, we will indemnify persons including a director, officer, former directoror officer, person who has undertaken any liability on behalf of thecorporation, and his or her heirs against losses reasonably incurred by reasonof such status.  Indemnification coverslosses, charges and expenses incurred as a result of actions in such capacities.  We are also empowered under our By-laws andthe BCA (Yukon Territory) to purchase insurance on behalf of any person who weare required or permitted to indemnify. Pursuant to this provision, we currently maintain directors and officersinsurance coverage.  In addition, we haveentered into indemnity agreements with our directors and officers and intend toenter into similar agreements with future directors and officers. Theseagreements could require us to indemnify those officers and directors againstliabilities that arise by reason of their status or service as officers ordirectors. In certain circumstances the agreements would also require us toadvance the expenses an officer or director incurs in legal proceedings. Webelieve that the provisions in our By-laws and contractual indemnification arenecessary to attract and retain qualified persons as directors and officers. Atpresent, there is no pending litigation or proceeding involving any of ourdirectors, officers, employees or agents where indemnification will be requiredor permitted. We are not aware of any threatened litigation or proceeding thatmay result in a claim for indemnification.

 

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# **Item 12**.  SECURITY OWNERSHIP OF CERTAIN BENEFICIALOWNERS AND MANAGEMENT

# ** **

The following table sets forthinformation as of March 8, 2005 with respect to (i) each stockholderknown to us to be the beneficial owner of more than 5% of our outstandingcommon stock, (ii) each director, (iii) our Chief Executive Officerand our four most highly compensated executive officers other than the ChiefExecutive Officer who were serving as executive officers at the end of the lastcompleted fiscal year (together, the “Named Executive Officers”) and (iv) allof our directors and executive officers as a group.  Except as set forth below, each of the namedpersons has sole voting and investment power with respect to the shares shown.

 
| **Beneficial Owner of Common Stock (1)**                                                                                                                                                             | ** ** | **Amount and Nature of  Beneficial Ownership of  Common Stock (2)(3)** | ** ** | **Percent of Class of  Common Stock (2)(3)** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
|                                                                                                                                                                                                 |       |                                                                   |       |                                              |       |
| Fidelity  Management & Research Company (4)  Fidelity Management Trust Company  82 Devonshire Street  Boston, MA 02109  and Fidelity International Limited  42 Crow Lane  Penbroke, Bermuda |       | 5,847,700                                                              |       | 8.1                                               | %          |
| RBC Asset Management, Inc. (5)Royal Trust Tower, Suite 3800  P.O. Box 121, Toronto  Dominion Centre  77 King Street West  Toronto, ON M5K 1H1  Canada                                 |       | 5,341,400                                                              |       | 7.4                                               | %          |
| Gordon  Barefoot                                                                                                                                                                                     |       | 15,000                                                                 |       |                                              | *          |
| Joann L.  Data, M.D., Ph.D.                                                                                                                                                                          |       | 55,000                                                                 |       |                                              | *          |
| Ian Lennox                                                                                                                                                                                           |       | 55,000                                                                 |       |                                              | *          |
| Elizabeth  Greetham                                                                                                                                                                                  |       | 45,000                                                                 |       |                                              | *          |
| Margot  Northey                                                                                                                                                                                      |       | 45,000                                                                 |       |                                              | *          |
| Jay M.  Short, Ph.D (6)                                                                                                                                                                              |       | 117,000                                                                |       |                                              | *          |
| Daniel L. Korpolinski                                                                                                                                                                                |       | 1,228,499                                                              |       | 1.7                                               | %          |
| Howard Holden, Ph.D.                                                                                                                                                                                 |       | 93,331                                                                 |       |                                              | *          |
| Gregory M. McKee                                                                                                                                                                                     |       | 80,207                                                                 |       |                                              | *          |
| John R. Neefe, M.D.                                                                                                                                                                                  |       | 190,832                                                                |       |                                              | *          |
| Marvin I. Siegel, Ph.D.                                                                                                                                                                              |       | 164,499                                                                |       |                                              | *          |
| All  Directors and Executive Officers as a Group (11 persons)                                                                                                                                        |       | 2,089,368                                                              |       | 2.9                                               | %          |

 

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*Less than one percent

 

(1)                                  Thistable is based upon information known to Stressgen or supplied by its officers,directors and principal shareholders. Except as shown otherwise in the table, the address of each personlisted is in the care of Stressgen Biotechnologies, Inc., 6055 LuskBoulevard, San Diego, California 92121.

 

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(2)                                  Exceptas otherwise indicated in the footnotes of this table and pursuant toapplicable community property laws, the persons named in the table have solevoting and investment power with respect to all shares of common stock.  Beneficial ownership is determined inaccordance with the rules of the Commission and generally includes votingor investment power with respect to securities. Shares of common stock subjectto options or warrants exercisable within 60 days of March 8, 2005 aredeemed outstanding for computing the percentage of the person or entity holdingsuch options or warrants but are not deemed outstanding for computing thepercentage of any other person.

 

(3)                                  Inthe case of the individuals listed below, the number of shares beneficiallyowned includes a specified number of shares issuable upon exercise of stockoptions exercisable within 60 days of March 8, 2005: Mr. Barefoot(15,000); Dr. Data (55,000); Mr. Lennox (55,000); Ms. Greetham(45,000); Ms. Northey (45,000); Dr. Short (95,000); Mr. Korpolinski(1,212,499); Dr. Holden (93,331); Dr. Neefe (182,499) and Dr. Siegel(147,499).  Percentage of beneficialownership is based upon 72,506,403 shares of our common stock deemedoutstanding as of March 8, 2005.

 

(4)                                  Informationfrom an Early Warning Report filed on the System for Electronic DocumentAnalysis and Retrieval for the Canadian Securities Administrators(www.sedar.com) on November 9, 2004.

 

(5)                                  Informationfrom RBC Asset Management Inc.

 

(6)                                  Mr. Shortdisclaims beneficial ownership of 22,000 shares of common stock, which are heldby the Ryco 2001 Family Trust on beha-lf of Mr. Short and his immediatefamily.

 

**EquityCompensation Plans**

 

We have two plans under which directors, employees and in some casesconsultants, have been granted equity compensation. Both plans were approved byour shareholders.   The following tableaggregates as of December 31, 2004 the data from the two plans, a 1996Share Incentive Plan and a 2001 Equity Incentive Plan:

 
| **Number of securities to  be  issued upon exercise of  outstanding options********(a)** | ** ** | **Weighted-average  exercise  price of outstanding options********(b)** | ** ** | **Number  of securities  remaining available for future  issuance under equity  compensation plans  (excluding securities reflected  in column (a))********(c)** | ** ** |
|------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| 4,697,599                                                                                |       | $                                                                       | 4.07       |                                                                                                                                                             | 599,338    |   |
|                                                                                          |            |                                                                         |            |                                                                                                                                                                  |            |  |

 

# **Item 13**.  CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS

 

None.

 

# **Item 14**.  PRINCIPAL ACCOUNTING FEES ANDSERVICES

# ** **

The information presented belowis denominated in U.S. dollars unless otherwise noted.

 

**AuditFees**

 

Deloitte & Touche LLP, the memberfirms of Deloitte Touche Tohmatsu, and their respective affiliates(collectively, the “Deloitte Entities”) performed services related tothe audit of our

 

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financial statements for theyear, including assessment of our internal controls under the Sarbanes-OxleyAct and for the reviews of our interim financial statements.  The amount billed related to the years ended December 31,2004 and 2003 was $604,000 and $110,000, respectively.  Of these amounts, $14,000 and $20,000 relatedto translation services performed in 2004 and 2003 respectively.

 

**Audit-RelatedFees**

 

We paid Deloitte Entitiesapproximately $3,000 and $4,000 during the years ended December 31, 2004and 2003, respectively, related to audit-related services.  The nature of these services related toreview and comment regarding revised MD&A disclosure requirements inCanada.

 

**TaxFees**

 

During the years ended December 31,2004 and 2003, we paid Deloitte Entities aggregate fees and related expenses of$85,000 and $64,000 for preparation of our income tax returns and other taxconsulting.

 

**AllOther Fees**

 

We incurred fees for otherprofessional services rendered by Deloitte Entities of approximately $95,000and $57,000 during the years ended December 31, 2004 and 2003,respectively.  In 2004, these servicesrelated to the equity offering we began in September 2004.  In 2003, these services related primarily tosupport of our 2003 equity offering.

 

Generally, before we engageDeloitte Entities to render audit or non-audit services, the engagement isapproved by our audit committee.  Ouraudit committee reviews written engagement letters prepared by DeloitteEntities for engagements such as the annual audit.  It has also pre-approved the engagement of DeloitteEntities for tax matters including the preparation of federal, provincial andstate income tax returns pursuant to specific pre-approval guidelinesestablished by the audit committee.  In2004, 2% of the services were approved by the audit committeeretroactively.  Management engaged DeloitteEntities to perform these services in compliance with audit committee policy,and informed the audit committee of each such service thereafter. For purposesof the Canadian Securities Administrators rules regarding Audit Committeesin Multilateral Instrument 52-110 we relied on the exemption in Section 2.4,entitled De Minimis Non-Audit services.

 

**PART IV**

 

# **Item 15**.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES

# ** **

(1)  Financial Statements

 

Our financial statements are included herein under Item 8 of this AnnualReport.

 

(2)  Financial Statement Schedules

 

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Financial statement schedules have been omitted since they are eithernot required, not applicable, or the information is otherwise included.

 

(3)  Exhibits

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                      |
|----------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.9(A)               |       | Articles of Continuance of the Company                                                                                                                                                               |
| 3.10(A)              |       | By-Laws of the Company                                                                                                                                                                               |
| 4.4 (A)              |       | Form of Stock Certificate                                                                                                                                                                       |
| 10.1(B)              |       | License Agreement dated November 29, 1992 among  Whitehead Institute for Biomedical Research, MIT and the Company, as amended  (1)                                                              |
| 10.2(B)              |       | Lease for the Company’s offices in  Victoria, British Columbia                                                                                                                                  |
| 10.10(B)             |       | 1996 Share Incentive Plan                                                                                                                                                                            |
| 10.12(C)             |       | 2001 Equity Incentive Plan                                                                                                                                                                           |
| 10.13(C)             |       | Form of Executive Stock Option  Agreement                                                                                                                                                       |
| 10.15(D)             |       | Restructured and Restated  HspE7 Collaboration Agreement dated December 1, 2003 among the Company,  Stressgen Development Corporation, F.Hoffmann-La Roche Ltd. and Hoffmann-La  Roche Inc. (1) |
| 10.16(E)             |       | Biological Services Agreement dated January 27,  2004 between Stressgen Development Corporation and Avecia Limited (1)                                                                          |
| 10.17(F)             |       | Employment Agreement dated September 1,  2004 between the Company and Daniel Korpolinski                                                                                                        |
| 10.18(G)             |       | Summary Sheet describing management  incentive bonuses established November 3, 2004                                                                                                             |
| 21.3(H)              |       | List of Subsidiaries                                                                                                                                                                                 |
| 23.1                 |       | Independent Registered Public Accountants’ Consent                                                                                                                                              |
| 24.1                 |       | Power of Attorney (Included on the  signature page of this Annual Report on Form 10-K)                                                                                                     |
| 31.1                 |       | Rule 13a-14(a)/15d-14(a) Certification  of Chief Financial Officer                                                                                                                         |
| 31.2                 |       | Rule 13a-14(a)/15d-14(a) Certification  of Chief Executive Officer                                                                                                                         |
| 32                   |       | Section 1350 Certification                                                                                                                                                                      |
| 99.1                 |       | Charters of the Board of Directors and its  Committees                                                                                                                                               |

 

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(A) Incorporatedby reference to the Company’s Form 10-Q for the quarter ended June 30,2001, as filed with the Commission on August 2, 2001

 

(B) Incorporatedby reference to the Company’s Form 10-K for the year ended December 31,2000, as filed with the Commission on April 2, 2001

 

(C) Incorporatedby reference to Exhibit 99.1 and 99.2 of the Company’s RegistrationStatement on Form S-8, as filed with the Commission on May 30,2001

 

(D) Incorporatedby reference to the Company’s Form 10-K for the year ended December 31,2003, as filed with the Commission on February 19, 2004

 

(E) Incorporatedby reference to the Company’s Form 10-Q for the quarter ended March 31,2004, as filed with the Commission on May 6, 2004.

 

(F) Incorporatedby reference to the Company’s Form 10-Q for the quarter ended September 30,2004, as filed with the Commission on October 18, 2004.

 

(G) Incorporatedby reference to Exhibit 99.1 of the Company’s Form 8-K thataddresses items 1.01, 5.02, and 7.01, as filed with the Commission on February 24,2005.

 

(H) Incorporatedby reference to the Company’s Form 10-K for the year ended December 31,2002, as filed with the Commission on February 10, 2003

 

(1) Portionsof this Exhibit were omitted and separately filed with the Securities andExchange Commission with a request for confidential treatment.

 

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###### **SIGNATURES**

###### ** **

Pursuant to the requirements of Section 13or 15(d) of the Securities Exchange Act of 1934, as amended, theRegistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 

 
|                     | STRESSGEN BIOTECHNOLOGIES CORPORATION |
|--------------------------|---------------------------------------|
|                     |                                  |
|                     |                                  |
| Date March 14, 2005 | BY:                                   | /s/ Daniel L. Korpolinski |
|                     |                                  | Daniel L. Korpolinski |
|                     |                                  | President and Chief Executive Officer |

 

**Supplemental Information to be Furnished with Reports Filed Pursuant toSection 15(d) of the Act by Registrants Which Have Not RegisteredSecurities Pursuant to section 12 of the Act.**

 

Asof the date hereof, no annual report for the 2004 fiscal year or proxymaterials have been sent to our shareholders. An annual report and proxy materials will be furnished to shareholdersand the Securities and Exchange Commission on or about April 9, 2005.

 

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**POWER OF ATTORNEY**

** **

KNOW ALL PERSONS BY THESE PRESENTS, that eachperson whose signature appears below constitutes and appoints Daniel L.Korpolinski and Gregory M. McKee, as his true and lawful attorneys-in-fact andagents, with full power of substitution and resubstitution, for him and in hisname, place and stead, in any and all capacities, to sign any and all amendmentsto this Annual Report on Form 10-K, and to file the same with allexhibits thereto, and other documents in connection therewith, with theSecurities and Exchange Commission, granting unto said attorneys-in-fact andagents, and full power and authority to do and performance each and every actand thing requisite and necessary to be done in connection therewith, as fullyto intents and purposes as he might or could do in person, hereby ratifying andconfirming that all said attorneys-in-fact and agents, or any of them or theiror his substitute or resubstitute, may lawfully do or cause to be done byvirtue hereof.

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, as amended, this report has been signed belowby the following person on behalf of the Registrant and in the capacities andon the dates indicated.

 
| **Signature**              | ** ** | **Title**                                                          | ** ** | **Date**            |
|----------------------------|------------|--------------------------------------------------------------------|------------|---------------------|
|                       |       |                                                               |       |                |
| /s/ Daniel L. Korpolinski  |       | Chief Executive Officer, President and  Director                   |       | March 14, 2005 |
| Daniel L. Korpolinski      | * *   | *(Principal Executive Officer)*                                    |       |                |
|                       |       |                                                               |       |                |
|                       |       |                                                               |       |                |
| /s/ Gregory M. McKee       |       | Vice President, Corporate Development and  Chief Financial Officer |       | March 14, 2005 |
| Gregory M. McKee           | * *   | (*Principal Financial and Accounting  Officer)*                    |       |                |
|                       |       |                                                               |       |                |
|                       |       |                                                               |       |                |
| /s/ Gordon Barefoot        |       | Director                                                           |       | March 14, 2005 |
| Gordon Barefoot            |       |                                                               |       |                |
|                       |       |                                                               |       |                |
|                       |       |                                                               |       |                |
| /s/ Joann L. Data          |       | Director                                                           |       | March 14, 2005 |
| Joann L. Data, M.D., Ph.D. |       |                                                               |       |                |
|                       |       |                                                               |       |                |
|                       |       |                                                               |       |                |
| /s/ Ian Lennox             |       | Chairman of the Board of Directors                                 |       | March 14, 2005 |
| R. Ian Lennox              |       |                                                               |       |                |
|                       |       |                                                               |       |                |
|                       |       |                                                               |       |                |
| /s/ Margot Northey         |       | Director                                                           |       | March 14, 2005 |
| Margot Northey             |       |                                                               |       |                |
|                       |       |                                                               |       |                |
|                       |       |                                                               |       |                |
| /s/ Jay Short              |       | Director                                                           |       | March 14, 2005 |
| Jay Short                  |       |                                                               |       |                |

 

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