**UNITED STATESSECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549**

 

----

 

**FORM 10-Q**

 
| **(Mark One)**                            |
|-------------------------------------------|
|                                      |
| **ý**                                | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                      |   |
| **For the Quarter  Ended March 31, 2004** |
|                                      |
| **or**                                    |
|                                      |
| **o**                                     | **TRANSITION REPORT PURSUANT TO SECTION 13  OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                      |
| **Commission file  number****333-12570**  |

 

----

 

**STRESSGENBIOTECHNOLOGIES CORPORATION******(Exact name of registrant as specified in its charter) 

 

| **Yukon Territory, Canada**                   |   | **N/A**                           |
|-----------------------------------------------|--------|-----------------------------------|
| (State of incorporation)                      |   | (IRS Employer Identification No.) |
| 350-4243 Glanford Avenue                      |   |                              |
| Victoria, British Columbia V8Z 4B9            |   |                              |
|                                          |   |                              |
| **Parent of Stressgen Biotechnologies, Inc.** |   |                              |
| **6055 Lusk Boulevard**                       |   |                              |
| **San Diego, CA**                        |   | **92121**                         |
| (Address of principal executive offices)      |   | (zip code)                        |

 

**(250) 744-2811**

**(858) 202-4900**(Registrant’s telephone number, including area code)

 

----

 

    Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrantwas required to file such reports) and (2) has been subject to such filingrequirements for the past 90 days. Yes ý  No o

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Exchange Act). Yes ý  No o

 

    As of April 29,2004 the registrant had approximately 72,506,000 shares of Common Stock, no parvalue, outstanding.

 

 

----

 

**StressgenBiotechnologies Corporation and Subsidiaries**

 

**INDEX**

 
| **Part I — Financial Information** |   |
|-----------------------------------------|--------|
|                                    |   |   |   |
| Item 1.                            |   | Financial  Statements |   |
|                                    |   |   |   |
|                                    |   | Consolidated Balance Sheet  March 31, 2004 (Unaudited) and December 31, 2003 |   |
|                                    |   |   |   |
|                                    |   | Consolidated Statement of  Operations and Accumulated Deficit  Three Months Ended March 31, 2004 and 2003 (Unaudited) |   |
|                                    |   |   |   |
|                                    |   | Consolidated  Statement of Cash Flows  Three Months Ended March 31, 2004 and 2003 (Unaudited) |   |
|                                    |   |   |   |
|                                    |   | Notes to  Consolidated Financial Statements (Unaudited) |   |
|                                    |   |   |   |
| Item 2.                                 |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |   |
|                                    |   |   |   |
|                                    |   | Factors  That Could Affect Future Performance |   |
|                                    |   |   |   |
| Item 3.                                 |   | Quantitative and Qualitative  Disclosures About Market Risk |   |
|                                    |   |   |   |
| Item 4.                                 |   | Controls and Procedures |   |
|                                    |   |   |   |
| **Part II —  Other Information**   |   |
|                                    |   |
| Items 1 through 6                       |   |
|                                    |   |
| SIGNATURES  AND CERTIFICATIONS          |   |

 

----

 

**CONSOLIDATED BALANCE SHEET**

 

*StressgenBiotechnologies Corporation and Subsidiaries*

*(Canadian dollarsin thousands, except share information)*

* *
|                                                                                                                                                                                                   |   | **March 31,  2004** |   | **December  31,  2003** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|--------|-------------------------|--------|
|                                                                                                                                                                                                   |   | **(unaudited)**     |   |                    |   |
| **Assets**                                                                                                                                                                                             |   |                |   |                    |   |
| Current assets:                                                                                                                                                                                        |   |                |   |                    |   |
| Cash and cash equivalents                                                                                                                                                                              |   | $                   | 3,818  |                    | $      | 19,996 |   |
| Short-term investments                                                                                                                                                                                 |   | 42,077              |   | 32,094                  |   |
| Accounts receivable, net                                                                                                                                                                               |   | 601                 |   | 733                     |   |
| Inventories                                                                                                                                                                                            |   | 600                 |   | 639                     |   |
| Other current assets                                                                                                                                                                                   |   | 657                 |   | 512                     |   |
| Total current assets                                                                                                                                                                                   |   | 47,753              |   | 53,974                  |   |
|                                                                                                                                                                                                   |   |                |   |                    |   |
| Plant and equipment                                                                                                                                                                                    |   | 2,173               |   | 2,196                   |   |
| Deferred expenses, net of current portion                                                                                                                                                              |   | 242                 |   | 260                     |   |
|                                                                                                                                                                                                   |   | $                   | 50,168 |                    | $      | 56,430 |   |
|                                                                                                                                                                                                   |   |                |   |                    |   |
| **Liabilities and  Stockholders’ Equity**                                                                                                                                                         |   |                |   |                    |   |
| Current liabilities:                                                                                                                                                                                   |   |                |   |                    |   |
| Accounts payable and accrued liabilities                                                                                                                                                               |   | $                   | 3,631  |                    | $      | 3,975 |   |
| Current portion of deferred revenue                                                                                                                                                                    |   | 698                 |   | 688                     |   |
| Current portion of notes payable                                                                                                                                                                       |   | 532                 |   | 518                     |   |
| Total current liabilities                                                                                                                                                                              |   | 4,861               |   | 5,181                   |   |
|                                                                                                                                                                                                   |   |                |   |                    |   |
| Long-term liabilities:                                                                                                                                                                                 |   |                |   |                    |   |
| Deferred revenue, net of current portion                                                                                                                                                               |   | 1,920               |   | 2,065                   |   |
| Notes payable, net of current portion                                                                                                                                                                  |   | 476                 |   | 607                     |   |
| Total long-term liabilities                                                                                                                                                                            |   | 2,396               |   | 2,672                   |   |
|                                                                                                                                                                                                   |   |                |   |                    |   |
| Total liabilities                                                                                                                                                                                      |   | 7,257               |   | 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 March 31, 2004 and  December 31, 2003, respectively |   | 216,412             |   | 196,849                 |   |
| Contributed surplus                                                                                                                                                                                    |   | 16,027              |   | 2,207                   |   |
| Deferred stock compensation (Note 2)                                                                                                                                                                   |   | —              |   | (185                    | )      |
| Accumulated deficit (Note 2)                                                                                                                                                                           |   | (189,528            | )      | (150,294                | )      |
| Total stockholders’ equity                                                                                                                                                                        |   | 42,911              |   | 48,577                  |   |
|                                                                                                                                                                                                   |   | $                   | 50,168 |                    | $      | 56,430 |   |

 

*See accompanying notes to consolidatedfinancial statements*.

 

1

----

 

**CONSOLIDATED STATEMENT****OF OPERATIONS AND ACCUMULATED DEFICIT**

**(Unaudited)**

 

*StressgenBiotechnologies Corporation and Subsidiaries*

*(Canadian dollarsin thousands, except per share amounts)*

 
|                                                                                                   |   | **Three  months ended  March 31,** |     |
|--------------------------------------------------------------------------------------------------------|--------|------------------------------------|----------|
|                                                                                                   |   | **2004**                           |     | **2003** |   |
| Revenue:                                                                                               |   |                               |     |   |   |
| Bioreagent sales                                                                                       |   | $                                  | 1,452    |   | $ | 1,419 |   |
| Collaborative R&D revenue                                                                          |   | 173                                |     | 5,221 |   |
| Total revenue                                                                                          |   | 1,625                              |     | 6,640 |   |
|                                                                                                   |   |                               |     |   |   |
| Operating expenses:                                                                                    |   |                               |     |   |   |
| Research and development                                                                               |   | 5,569                              |     | 6,493 |   |
| Selling, general and administrative                                                                    |   | 2,353                              |     | 2,290 |   |
| Cost of bioreagent sales                                                                               |   | 356                                |     | 365 |   |
|                                                                                                   |   | 8,278                              |     | 9,148 |   |
|                                                                                                   |   |                               |     |   |   |
| Operating loss                                                                                         |   | (6,653                             | )        | (2,508 | ) |
|                                                                                                   |   |                               |     |   |   |
| Other income (expenses):                                                                               |   |                               |     |   |   |
| Interest and other income                                                                              |   | 350                                |     | 203 |   |
| Net foreign exchange gain (loss)                                                                       |   | 47                                 |     | (141 | ) |
| Interest expense                                                                                       |   | (28                                | )        | (11 | ) |
|                                                                                                   |   | 369                                |     | 51 |   |
|                                                                                                   |   |                               |     |   |   |
| Net loss                                                                                               |   | (6,284                             | )        | (2,457 | ) |
|                                                                                                   |   |                               |     |   |   |
| Accumulated deficit, beginning of period                                                               |   | (150,294                           | )        | (134,049 | ) |
| Cumulative effect of change in accounting  policy (Note 2)                                             |   | (32,950                            | )        | — |   |
| Accumulated deficit, end of period                                                                     |   | $                                  | (189,528 | ) | $ | (136,506 | ) |
|                                                                                                   |   |                               |     |   |   |
| Basic and diluted net loss per common share                                                            |   | $                                  | (0.09    | ) | $ | (0.04 | ) |
|                                                                                                   |   |                               |     |   |   |
| Weighted average shares used to compute  basic and diluted loss per common share   (in thousands) |   | 72,498                             |     | 60,238 |   |

 

*See accompanying notes to consolidatedfinancial statements.*

 

2

----

 

**CONSOLIDATED STATEMENT OF CASH FLOWS**

**(Unaudited)**

 

*StressgenBiotechnologies Corporation and Subsidiaries*

*(Canadian dollarsin thousands)*

* *
|                                                                         |   | **Three  months ended  March 31,** |   |
|------------------------------------------------------------------------------|--------|------------------------------------|--------|
|                                                                         |   | **2004**                           |   | **2003** |   |
| Cash flows from operating activities:                                        |   |                               |   |   |   |
| Net loss                                                                     |   | $                                  | (6,284 | ) | $ | (2,457 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |   |                               |   |   |   |
| Depreciation and amortization of plant and  equipment                        |   | 138                                |   | 173 |   |
| Loss on disposal of assets                                                   |   | 15                                 |   | — |   |
| Amortization of stock compensation expense                                   |   | 663                                |   | 55 |   |
| Unrealized foreign exchange loss                                             |   | 10                                 |   | 330 |   |
| Loss on market value of investments                                          |   | 6                                  |   | 37 |   |
| Changes in operating assets and liabilities                                  |   | (435                               | )      | (4,357 | ) |
| Net cash used in operating activities                                        |   | (5,887                             | )      | (6,219 | ) |
|                                                                         |   |                               |   |   |   |
| Cash flows from investing activities:                                        |   |                               |   |   |   |
| Purchase of short-term investments                                           |   | (20,919                            | )      | (22,424 | ) |
| Sales and maturities of short-term  investments                              |   | 10,935                             |   | 598 |   |
| Purchase of plant and equipment                                              |   | (130                               | )      | (12 | ) |
| Net cash used in investing activities                                        |   | (10,114                            | )      | (21,838 | ) |
|                                                                         |   |                               |   |   |   |
| Cash flows from financing activities:                                        |   |                               |   |   |   |
| Proceeds on issuance of common shares                                        |   | 36                                 |   | 59 |   |
| Share issue costs                                                            |   | (81                                | )      | — |   |
| Repayment of borrowings                                                      |   | (117                               | )      | (80 | ) |
| Net cash used in financing activities                                        |   | (162                               | )      | (21 | ) |
|                                                                         |   |                               |   |   |   |
| Effect of exchange rate changes on cash and  cash equivalents                |   | (15                                | )      | (158 | ) |
|                                                                         |   |                               |   |   |   |
| Decrease in cash and cash equivalents                                        |   | (16,178                            | )      | (28,236 | ) |
| Cash and cash equivalents, beginning of  period                              |   | 19,996                             |   | 31,202 |   |
| Cash and cash equivalents, end of period                                     |   | $                                  | 3,818  |   | $ | 2,966 |   |

 

*See accompanying notes to consolidatedfinancial statements.*

 

3

----

 

***Stressgen Biotechnologies Corporation***

**Notes to Consolidated Financial Statements**

***(Canadian dollars)***

 

### ***1.***             THE COMPANY AND ITS SIGNIFICANTACCOUNTING POLICIES

 

*TheCompany*

 

Stressgen BiotechnologiesCorporation (with its subsidiaries, “Stressgen” or the “Company”) is abiopharmaceutical company focused on the development and commercialization ofinnovative stress protein-based immunotherapeutics. The Company is developing abroad range of products for the treatment of viral infections and relatedcancers. Its lead product HspE7 targets a broad spectrum of humanpapillomavirus (“HPV”) related diseases. The Company has also initiated research studies to evaluate stressprotein (also known as heat shock protein) fusions, made through itsproprietary CoValTM technology, for the treatment of hepatitis B andherpes simplex and is targeting hepatitis C. Further, Stressgen has an internationally recognized bioreagentsbusiness with sales to scientists worldwide for the study of cellular stress,apoptosis, oxidative stress and neurobiology.

 

*Basisof presentation*

 

The consolidated financial statements include theassets, liabilities and operating results of the Company and its wholly-ownedsubsidiaries.  Intercompany accounts andtransactions have been eliminated in consolidation.

* *

*Financialstatements and estimates*

 

The information at March 31, 2004 and for the threemonth periods ended March 31, 2004 and 2003 has been prepared by the Companyand has not been audited.  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 7. These financial statements should be read in conjunction with thefinancial statements and notes thereto in the Company’s December 31, 2003Annual Report on Form 10-K.  Certaininformation and footnote disclosures normally included in financial statementsprepared in accordance with Canadian and U.S. GAAP have been condensed or omittedpursuant to the applicable Canadian regulatory and U.S. Securities and ExchangeCommission rules and regulations. Interim results are not necessarily indicative of results for the fullyear.

 

The preparation of financial statements in conformitywith generally accepted accounting principles requires management to makeestimates and assumptions that affect the reported amounts of assets,liabilities, revenue and expenses and related disclosures as of the date of thefinancial statements.  Significant estimatesare used for, but not limited to, revenue recognition, accrual of clinicaltrial costs, measurement of stock-based compensation, and the allocation ofindirect costs.  Actual results coulddiffer from such estimates.

* *

*Foreign currency translation*

 

The Company uses the Canadian dollar as itsconsolidated functional currency. Monetary assets and liabilities that are denominated in U.S. dollars orBritish pounds are translated into Canadian dollars at the rates of exchangeprevailing at the balance sheet date. Non-monetary assets and liabilities are translated at historicalexchange rates.  Revenue and expensesare translated at the average rate of exchange for the period of suchtransactions.

 

4

----

 

*Revenuerecognition*

 

Revenue from product sales isrecognized upon delivery to customers when persuasive evidence of anarrangement exists, the price is fixed or determinable and collection isreasonably assured.  Revenue alsoincludes amounts charged for shipping and handling costs.

 

Revenue from collaborativeresearch and development (“R&D”) arrangements may include multiple elementswithin a single contract.  The Company’saccounting policy complies with the revenue determination requirements setforth in EITF 00-21, *Accounting for RevenueArrangements with Multiple Deliverables*, and EIC 142, *Revenue Arrangements with Multiple Deliverables,*relating to the separation of multiple deliverables into individual accountingunits with determinable fair values. Payments received under collaborative arrangements may include thefollowing:  non-refundable fees atinception of contract for technology rights; funding for services performed;milestone payments for specific achievements; and payments based upon resultingsales of products.

 

The Company recognizes collaborative research and development revenuesas services are rendered consistent with the performance requirements of thecontract.  Revenue from non-refundablecontract fees where the Company has continuing involvement through research anddevelopment collaborations or other contractual obligations, less the fairmarket value of any related warrants, is recognized ratably over thedevelopment period or the period for which Stressgen continues to have aperformance obligation.  The period ofdevelopment is evaluated on a regular basis. During December 2003, the Company increased the development period toreflect management’s research and development plan.  Revenue from performance milestones is recognized upon theachievement of the milestones as specified in the agreement, provided paymentis proportionate to the effort expended. Payments are recorded as deferred revenue if they are received inadvance of performance or delivery.

 

*Clinicaltrial accruals*

 

The Company recognizesexpenses related to its ongoing clinical trials using a methodology designed toaccrue estimated costs in the appropriate accounting periods.  The Company recognizes clinical trial costsin three distinct phases:  the start-upphase, the patient accrual phase, and the close-out phase.  The total estimated trial cost is dividedinto these three phases based on the tasks involved in conducting thetrial.  Based on the design of thetrial, the cost of each phase could vary from trial to trial.  Upon the start of the trial, the start-upportion of the trial contract is accrued. As patients enter the trial, the patient accrual cost is ratablyrecognized.  Once the study is completeand analysis of the patient data has been initiated, the close-out portion ofthe trial is recognized.

 

*Stock-basedcompensation plan*

 

In September 2003, the CICA AccountingStandards Board released revised transitional provisions for *Stock-Based Compensation and Other Stock-BasedPayments*, Section 3870 (CICA 3870), to provide the same alternativemethods of transition as is provided in the U.S. for voluntary adoption of thefair value based method of accounting.  In January 2004, the Company adopted the recommendations of the CICAHandbook section 3870, *Stock-Based Compensationand Other Stock-Based Payments*. This standard requires that all stock-based awards made to non-employeesbe measured and recognized using a fair value based method.  The standard encourages the use of a fairvalue based method for all awards granted to employees, but only requires theuse of a fair value based method for direct awards of stock, stock appreciationrights, and awards that call for settlement in cash or other assets.  Awards that a company has the ability tosettle in stock are recorded as equity, whereas awards that the entity isrequired to or has a practice of settling in cash are recorded as liabilities.

 

5

----

 

The Company has two stock-basedcompensation plans, which are described in Note 5.  The Company typically grants options with an exercise price equalto the fair market value of the underlying common stock.  Under the principles of CICA 3870, compensationexpense is recognized over the vesting period of the grant based on the estimatedfair 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 share capital.  See further discussion of the change inaccounting policy in Note 2.

 

**2.****                                     ****CHANGE INACCOUNTING POLICY**

 

In January 2004 the Companychanged its accounting policy relating to stock based compensation awards,retroactive to January 1, 1995, in accordance with the recommendation of CICA3870*.*  As permitted by the September 30, 2003 transitional provisionsissued by the CICA Accounting Standards Board related to CICA 3870, the Companyhas applied this 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 intrinsic value method forvaluing stock-based compensation awards granted to employees and directorswhere compensation expense was recognized for the excess, if any, of the quotedmarket price of Company’s common shares over the common share exercise price onthe day that options were granted.

 

The following pro formainformation presents the net loss and the basic loss per common share for thethree months ended March 31, 2003 had CICA 3870 been retroactively applied:

 

(in thousands, except per share amounts)

 
| Net loss under Canadian GAAP                                           |   | $      | (2,457 | ) |
|------------------------------------------------------------------------|--------|--------|--------|---|
|                                                                   |   |   |   |
| Stock-based compensation expense under APB  Opinion No. 25             |   | 55     |   |
|                                                                   |   |   |   |
| Stock-based employee compensation expense  under the fair value method |   | (718   | )      |
|                                                                   |   |   |   |
| Pro forma net loss under Canadian GAAP                                 |   | $      | (3,120 | ) |
|                                                                   |   |   |   |
| Pro forma basic loss per common share under  Canadian GAAP             |   | $      | (0.05  | ) |

 

To implement the fair value method for stock-based compensation, theCompany recorded an adjustment to beginning accumulated deficit of $32,950,000,comprised of $17,105,000 related to the fair value expense calculated onoptions granted on or after January 1, 1995, $16,434,000 related to compensationexpense on the release of contingently issuable shares completed in 1999,offset by a $589,000 reversal of previously recorded expense under theprinciples of APB Opinion No.25, *Accountingfor Stock Issued to Employees*. Under the principles of CICA 3870, the company reclassified $3,174,000from contributed surplus to common stock related to the historical exercise ofemployee stock options.  The Companyrecorded expense of $663,000 for the three months ended March 31, 2004,representing the amortization of compensation based on the vesting period ofstock options granted to employees and directors.  The weighted-average per-share fair values of the individualoptions granted during the three-month period ended March 31, 2004 was $0.95,compared to $0.93 for the same period in 2003. The fair values of the options were determined using a Black-Scholesoption-pricing model with the following assumptions:

 

6

----

 
|                    |   | **For the  three months  ended March 31,** |   |
|-------------------------|--------|--------------------------------------------|--------|
| **(unaudited)**         |   | **2004**                                   |   | **2003** |   |
| Dividend yield          |   | 0                                          | %      | 0 | % |
| Volatility              |   | 69                                         | %      | 74 | % |
| Risk-free interest rate |   | 3.2                                        | %      | 2.5 | % |
| Expected life           |   | 4 years                                    |   | 4 years |   |

 

The FASB issued SFAS No. 148, *Accountingfor Stock-Based Compensation, Transition and Disclosure*(SFAS 148)**in December 2002.  SFAS 148 provides alternative transitionmethods 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 to adopt theprovisions of SFAS 123.  See Note 7 forthe reconciliation between Canadian and U.S. GAAP.

 

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

 

On December 2, 2003, the Company announced that it had restructured itsJune 24, 2002 collaboration agreement with F. Hoffmann-La Roche Ltdand Hoffmann-La Roche Inc. (together, “Roche”), providing for the developmentand commercialization of Stressgen’s pharmaceutical fusion product candidate,HspE7.

 

Under the terms of the restructured collaboration agreement, the extentof control that the Company originally retained for developing and marketingthe first generation HspE7 product for RRP expanded to all indications otherthan genital warts.  Stressgen remainsresponsible for costs associated with RRP pursuant to the originalagreement.  Stressgen also assumedresponsibility for all manufacturing and other costs of the indications itchooses to develop.

 

For the three months ended March31, 2004 and 2003, the Company recognized collaborative R&D revenue of$173,000 and $5,221,000, respectively, relating to development activities insupport of Roche and amortization of up-front license fees in accordance withSAB No. 101 “Revenue Recognition in Financial Statements.”  Collaborative R&D revenue in 2004relates to the amortization of upfront license fees.  Collaborative R&D revenue in 2003 includes $2,741,000 fordevelopment activities, $2,214,000 related to a time-based developmentmilestone and $266,000 from the amortization of up-front license fees.

 

**4.****                                      SIGNIFICANTCONTRACTUAL ACTIVITY**

 

On January 28, 2004, the Company entered intoa biological services agreement with Avecia Limited for manufacturing andprocess development of HspE7.  Under theterms of the contract payments are due in British pounds.  The contract is a multi-year agreement forprocess development, manufacturing of clinical supplies, and may also includethe manufacturing of commercial drug substance.  The Company purchased British pounds in anticipation of makingpayments in that currency.  The contractis cancelable subject to specified termination conditions.

 

**5.****                                     ****BALANCE SHEET DETAILS**

 

In September2003, the Company entered into a 36-month term loan agreement collateralized byequipment owned by the Company.  AtMarch 31, 2004, the outstanding principal balance was $832,000.  Under the terms of the agreement, theCompany must issue a letter of credit for the outstanding loan balance ifcombined cash, cash equivalents, and short-term investments fall below$6,000,000.

 

7

----

 

The following tables provide details of selected balance sheet items:

 
| **(In thousands)**                           |   | **March 31,  2004** |   | **December 31,  2003** |   |
|----------------------------------------------|--------|---------------------|--------|------------------------|--------|
|                                         |   | **(unaudited)**     |   |                   |   |
| Accounts receivable:                         |   |                |   |                   |   |
| Trade accounts receivable                    |   | $                   | 636    |                   | $      | 492 |   |
| Collaborative receivable                     |   | —              |   | 277                    |   |
| Less:   allowance for doubtful accounts |   | (35                 | )      | (36                    | )      |
|                                         |   | $                   | 601    |                   | $      | 733 |   |
|                                         |   |                |   |                   |   |
| Inventories:                                 |   |                |   |                   |   |
| Raw materials, net                           |   | $                   | 183    |                   | $      | 202 |   |
| Work in progress, net                        |   | 194                 |   | 146                    |   |
| Finished goods, net                          |   | 223                 |   | 291                    |   |
|                                         |   | $                   | 600    |                   | $      | 639 |   |
|                                         |   |                |   |                   |   |
| Accounts payable and accrued liabilities:    |   |                |   |                   |   |
| Trade accounts payable                       |   | $                   | 2,044  |                   | $      | 1,461 |   |
| Accrued compensation and benefits            |   | 803                 |   | 1,009                  |   |
| Clinical trial accruals                      |   | 628                 |   | 1,409                  |   |
| Other accrued liabilities                    |   | 156                 |   | 96                     |   |
|                                         |   | $                   | 3,631  |                   | $      | 3,975 |   |

 
|                   |   | **March 31,  2004 (unaudited)** |   | **December  31,  2003**       |   |
|------------------------|--------|---------------------------------|--------|-------------------------------|--------|
| **(In  thousands)**    |   | **Cost**                        |   | **Accumulated  Depreciation** |   | **Net Book  Value** |   | **Net Book  Value** | ** ** |
| Plant and equipment:   |   |                            |   |                          |   |   |   |   |   |
| Laboratory equipment   |   | $                               | 4,466  |                          | $      | 2,843 |   | $ | 1,623 |   | $ | 1,626 |   |
| Computer equipment     |   | 1,025                           |   | 798                           |   | 227 |   | 292 |   |
| Furniture and fixtures |   | 563                             |   | 397                           |   | 166 |   | 172 |   |
| Leasehold improvements |   | 791                             |   | 634                           |   | 157 |   | 106 |   |
|                   |   | $                               | 6,845  |                          | $      | 4,672 |   | $ | 2,173 |   | $ | 2,196 |   |

* *

*Stockholders’ equity*

 

In June 2002the Company issued 2,036,436 common shares for $7,657,000 pursuant to thecollaboration agreement with Roche (see Note 3).  The equity was issued at a per share price determined by theweighted average price of common shares of the Company during the ten businessdays 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 $1,264,000as the fair value of the warrants, determined by an independent valuationexpert.  In April 2003, Roche exercisedthe first warrant to acquire 1,413,600 common shares at $3.25, resulting in netproceeds of $4,594,000 to the Company. Under the original collaboration agreement, the Company had the right tocall the second warrant resulting in an issuance of a range of shares andexercise price depending upon the price of the Company’s common stock. Inconnection with the restructured collaboration agreement, Roche has a continuedright, but not an

 

8

----

 

obligation, to exercise the second warrantfor 814,574 shares at a purchase price of $3.76 per share at any time untilJune 28, 2007.

 

*Employee share option plan*

 

The following tablesummarizes information related to all stock options outstanding and exercisableas of March 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** |   |
|                          |   |                     |   |                                                           |   |   |   |   |   |   |   |
| $ 1.22 - $1.99                |   | 1,366,189                |   | 7.9                                                            |   | $ | 1.71 |   | 824,134 |   | $ | 1.75 |   |
| $ 2.00 - $3.99                |   | 626,000                  |   | 8.4                                                            |   | $ | 3.24 |   | 323,618 |   | $ | 3.49 |   |
| $ 4.00 - $5.99                |   | 1,221,960                |   | 7.3                                                            |   | $ | 4.91 |   | 1,000,911 |   | $ | 4.90 |   |
| $ 6.00 - $8.00                |   | 1,534,100                |   | 6.2                                                            |   | $ | 6.19 |   | 1,533,224 |   | $ | 6.19 |   |
|                          |   | 4,748,249                |   |                                                           |   |   |   | 3,681,887 |   |   |   |

 

At March 31, 2004, therewere 588,855 options available for future grant under the 2001 Plan.  At April 29, 2004 there were approximately4,756,000 options outstanding.

 

9

----

 

**6.****              ****SEGMENT INFORMATION**

 

The Company manages its operations in two reportable segments,Biotechnology and Bioreagents.  Revenuesare allocated to countries based on customer locations.

 
|                                |   | **Three months ended  March 31,** |   |
|-------------------------------------|--------|-----------------------------------|--------|
| **(in thousands)**                  |   | **2004**                          |   | **2003** |   |
|                                |   | **(unaudited)**                   |   |
| **Bioreagents**                     |   |                              |   |   |   |
| Revenue:                            |   |                              |   |   |   |
| U.S.                                |   | $                                 | 958    |   | $ | 908 |   |
| Canada                              |   | 73                                |   | 57 |   |
| Other                               |   | 421                               |   | 454 |   |
|                                |   | 1,452                             |   | 1,419 |   |
| Expenses:                           |   |                              |   |   |   |
| Research and development            |   | 441                               |   | 319 |   |
| Selling, general and administrative |   | 355                               |   | 488 |   |
| Cost of bioreagent sales            |   | 356                               |   | 365 |   |
|                                |   | 1,152                             |   | 1,172 |   |
| Operating income                    |   | $                                 | 300    |   | $ | 247 |   |
|                                |   |                              |   |   |   |
| **Biotechnology**                   |   |                              |   |   |   |
| Collaborative R&D revenue       |   | $                                 | 173    |   | $ | 5,221 |   |
|                                |   |                              |   |   |   |
| Expenses:                           |   |                              |   |   |   |
| Research and development            |   | 5,128                             |   | 6,174 |   |
| Selling, general and administrative |   | 1,998                             |   | 1,802 |   |
|                                |   | 7,126                             |   | 7,976 |   |
| Operating loss                      |   | $                                 | (6,953 | ) | $ | (2,755 | ) |
|                                |   |                              |   |   |   |
| **Totals**                          |   |                              |   |   |   |
| Revenue:                            |   |                              |   |   |   |
| Bioreagent sales                    |   | $                                 | 1,452  |   | $ | 1,419 |   |
| Collaborative R&D revenue       |   | 173                               |   | 5,221 |   |
| Total revenue                       |   | 1,625                             |   | 6,640 |   |
|                                |   |                              |   |   |   |
| Expenses:                           |   |                              |   |   |   |
| Research and development            |   | 5,569                             |   | 6,493 |   |
| Selling, general and administrative |   | 2,353                             |   | 2,290 |   |
| Cost of bioreagent sales            |   | 356                               |   | 365 |   |
|                                |   | 8,278                             |   | 9,148 |   |
|                                |   |                              |   |   |   |
| Operating loss                      |   | $                                 | (6,653 | ) | $ | (2,508 | ) |

 

The Companydoes not allocate interest and other income, and interest on capital leaseobligations to each segment.

 

At March 31,2004 and December 31, 2003, respectively, $1,987,000 and $2,006,000 of plantand equipment support the Biotechnology operating segment while the remaining$186,000 and $190,000 support the Bioreagent operating segment.

 

10

----

 

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

 

These financial statements have been prepared inaccordance with Canadian GAAP which, except as set out below, conform in allmaterial respects to U.S. GAAP.  Effecton the consolidated financial statements:

 

*Balance Sheet*

 
| **(in thousands)**                             |   | **March 31,  2004** |   | **December  31,  2003** |   |
|------------------------------------------------|--------|---------------------|--------|-------------------------|--------|
| Current assets under Canadian GAAP             |   | $                   | 47,753 |                    | $      | 53,974 |   |
| Adjustments to Canadian GAAP                   |   | —              |   | —                  |   |
| Current assets under U.S. GAAP                 |   | $                   | 47,753 |                    | $      | 53,974 |   |
|                                           |   |                |   |                    |   |
| Stockholders’ equity under Canadian GAAP  |   | $                   | 42,911 |                    | $      | 48,577 |   |
|                                           |   |                |   |                    |   |
| Adjustment to common stock (a)                 |   | (16,994             | )      | —                  |   |
| Adjustment to deferred stock compensation  (a) |   | (148                | )      | —                  |   |
| Adjustment to accumulated deficit (a)          |   | 17,142              |   | —                  |   |
|                                           |   | —              |   | —                  |   |
|                                           |   |                |   |                    |   |
| Stockholders’ equity under U.S. GAAP      |   | $                   | 42,911 |                    | $      | 48,577 |   |

 

*Statement of Operations*

 
|                                                                                      |   | **Three months ended  March 31,** |   |
|-------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|
| **(In thousands except per share amounts)**                                               |   | **2004**                          |   | **2003** |   |
|                                                                                      |   | **(unaudited)**                   |   |
| Net loss under Canadian GAAP                                                              |   | $                                 | (6,284 | ) | $ | (2,457 | ) |
| Reversal of unrealized foreign exchange  (gain) loss on available-for-sale securities (b) |   | (5                                | )      | 172 |   |
| Reversal of write-down of short-term  investments (b)                                     |   | 6                                 |   | 37 |   |
| Reversal of stock compensation expense (a)                                                |   | 663                               |   | — |   |
| Stock compensation under APB No. 25 (a)                                                   |   | (37                               | )      | — |   |
|                                                                                      |   | 627                               |   | 209 |   |
|                                                                                      |   |                              |   |   |   |
| Net loss under U.S. GAAP                                                                  |   | $                                 | (5,657 | ) | $ | (2,248 | ) |
|                                                                                      |   |                              |   |   |   |
| Basic loss per common share under Canadian  GAAP                                          |   | $                                 | (0.09  | ) | $ | (0.04 | ) |
|                                                                                      |   |                              |   |   |   |
| Basic loss per common share under U.S. GAAP                                               |   | $                                 | (0.08  | ) | $ | (0.04 | ) |
|                                                                                      |   |                              |   |   |   |
| Common shares used to compute basic loss  per share under Canadian and U.S. GAAP          |   | 72,498                            |   | 60,238 |   |

 

*Statement of Cash Flows*

 

For all periods presented there are no significantdifferences under Canadian and U.S. GAAP in net cash (used in) provided byoperating, investing and financing activities.

 

11

----

 

*Differences*

 

As disclosed in Note 11 tothe financial statements in the Company’s December 31, 2003 Annual Report onForm 10-K, differences exist for the Company between Canadian and U.S. GAAP.

 

The following outlines thedifferences that affect the Company for the three month periods ended March 31,2004 and 2003.

 

(a)                                  As discussed in Note 2, on January 1,2004, the Company adopted fair value accounting for all stock options asrequired by CICA 3870.  The Company isrequired to record the expense of the fair value of all stock options overtheir respective vesting term.  TheCompany used the “Retrospective method without Restatement.”  This method requires the Company to recordthe cumulative expense as an adjustment to accumulated deficit for the periodbeginning January 1, 1995 through December 31, 2003 and begin recording theexpense to retained earnings in 2004. The Company has not adopted SFAS 123 for U.S. reporting purposes, whichwould require fair value based accounting for grants made on or after January1, 1995.  Therefore no adjustment toaccumulated deficit or expense is recognized under the provisions of U.S. GAAP.

 

Under the principles ofSFAS 123, the Company would have recorded $19,288,000 of deferred compensationrelated to the total fair value for stock options granted between January 1,1995 and March 31, 2004.  The followingtable illustrates the effect on net loss and loss per share under U.S. GAAP ifthe Company had applied the fair value accounting provisions of SFAS 123 toemployee stock based compensation:

 
|                                                       |   | **Three months ended  March 31,** |   |
|------------------------------------------------------------|--------|-----------------------------------|--------|
| **(In thousands except per share amounts)**                |   | **2004**                          |   | **2003** |   |
|                                                       |   | **(unaudited)**                   |   |
| Net loss under U.S. GAAP                                   |   | $                                 | (5,657 | ) | $ | (2,248 | ) |
|                                                       |   |                              |   |   |   |
| Stock-based compensation under APB No. 25                  |   | 37                                |   | 55 |   |
| Stock-based compensation expense recorded  under AcSB 3870 |   | (663                              | )      | (718 | ) |
| Pro forma net loss under U.S. GAAP                         |   | $                                 | (6,283 | ) | $ | (2,911 | ) |
|                                                       |   |                              |   |   |   |
| Pro forma loss per common share                            |   | $                                 | (0.09  | ) | $ | (0.05 | ) |

 

(b)                                 Under U.S. GAAP Statement of FinancialAccounting Standards (“SFAS”) No. 115, *Accountingfor Certain Investments in Debt and Equity Securities*, the Companyhas classified certain of its short-term securities as available-for-sale and,accordingly, has included the changes in net unrealized holding gains or losseson these securities as a component of stockholders’ equity rather than inoperations.

 

SFAS No. 130, *ReportingComprehensive Income,* establishes standards for the reporting anddisplay of comprehensive income and its components (revenue, expenses, gainsand losses) in a full set of general-purpose financial statements.  Comprehensive income is as follows:

 

12

----

 
|                                                                                           |   | **Three months ended  March 31,** |   |
|------------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|
| **(In thousands except per share amounts)**                                                    |   | **2004**                          |   | **2003** |   |
|                                                                                           |   | **(unaudited)**                   |   |
| Net loss under U.S. GAAP                                                                       |   | $                                 | (5,657 | ) | $ | (2,248 | ) |
| Other comprehensive income                                                                     |   |                              |   |   |   |
| Adjustment to unrealized foreign exchange  and market losses on available-for-sale investments |   | (1                                | )      | (209 | ) |
| Comprehensive net loss under U.S. GAAP                                                         |   | $                                 | (5,658 | ) | $ | (2,457 | ) |

 

**8.****            ****SUPPLEMENTAL CASH FLOW INFORMATION**

 

The changesin operating assets and liabilities are as follows:

 
|                                                                                 |   | **Three months ended  March 31,** |   |
|--------------------------------------------------------------------------------------|--------|-----------------------------------|--------|
| **(In thousands)**                                                                   |   | **2004**                          |   | **2003** |   |
|                                                                                 |   | **(unaudited)**                   |   |
| Collaborative receivable                                                             |   | $                                 | 277    |   | $ | (1,157 | ) |
| Trade receivables                                                                    |   | (145                              | )      | (120 | ) |
| Inventories                                                                          |   | 39                                |   | (4 | ) |
| Other current assets                                                                 |   | (145                              | )      | (57 | ) |
| Deferred expenses, net of current portion                                            |   | 18                                |   | 62 |   |
| Accounts payable and accrued liabilities                                             |   | (344                              | )      | (2,509 | ) |
| Deferred revenue                                                                     |   | (135                              | )      | (572 | ) |
|                                                                                 |   | $                                 | (435   | ) | $ | (4,357 | ) |
| Supplemental disclosures of cash flows:                                              |   |                              |   |   |   |
| Interest paid                                                                        |   | $                                 | 28     |   | $ | 11 |   |
|                                                                                 |   |                              |   |   |   |
| Supplemental disclosures of non-cash  transactions Reversal of deferred compensation |   | $                                 | 185    |   | $ | — |   |

 

13

----

 

**MANAGEMENT’S DISCUSSION****AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

The Management’sDiscussion and Analysis of Financial Condition and Results of Operationscontains forward-looking statements that involve risks and uncertainties.  The predictions described in thesestatements may not materialize if management’s current assumptions regardingour future performance prove incorrect. Our results could also be affected byfactors including, but not limited to, our reliance on collaborative partnersand other risks described below under “Factors That Could Affect FuturePerformance.”  The forward-lookingstatements are based on currently available information; we disclaim anyobligation to update them.

 

The following informationshould be read in conjunction with our March 31, 2004 consolidated financialstatements and related notes therein, which are prepared in accordance withCanadian generally accepted accounting principles or Canadian GAAP.  These principles differ in certain respectsfrom accounting principles generally accepted in the United States or U.S.GAAP.  The differences, as they affectour consolidated financial statements, are described in Note 6 to our March 31,2004 consolidated financial statements. All amounts following are expressed in Canadian dollars unless otherwiseindicated.

 

## **Overview**

 

From ourinception in 1990 to 1993, our core business involved the sale ofbioreagents.  Although we have retainedand expanded our bioreagent business worldwide, our primary focus since 1993has been the research and development of innovative stress protein-based fusionproducts that will stimulate the body’s immune system to combat viralinfections and related cancers.  Ourcore, exclusively licensed technology involves the fusion of heat shockproteins with viral or cancer-associated antigens.  The lead product candidate developed with this technology, HspE7,targets a variety of human papillomavirus-related diseases, including genitalwarts, recurrent respiratory papillomatosis, anal intraepithelial neoplasia,cervical intraepithelial neoplasia and cervical cancer, among others.   We are also performing research studies onpotential treatments for hepatitis B and herpes simplex and are evaluating fusionproteins to treat infections caused by hepatitis C.

 

Wehave incurred significant losses since our inception and expect to incursubstantial losses for the foreseeable future as we invest in our research andproduct development programs, including manufacturing, pre-clinical studies andclinical trials, and regulatory activities. At March 31, 2004 our accumulated deficit was $189,528,000.  Historically, we have depended principallyon equity financings, cash flows from our bioreagent business and funding fromresearch collaborations to fund our business activities.  We intend to pursue additional equityfinancings and seek additional research collaborations to fund our businessactivities, markets permitting.

 

Oursuccess will depend upon the safety and efficacy of our immunotherapeutic productsin pre-clinical studies and clinical trials, and upon obtaining the necessaryregulatory approvals to market our products. The marketability of our products will be influenced by competition fromalternative therapies and the degree of protection our intellectual propertyprovides. We believe there will be significant markets for our therapeuticproducts should these products prove to be effective in human clinical trials.

* *

*Restructured Roche Agreement*

 

On December 2, 2003, we announced a restructuring of our June 24,2002 collaboration agreement with F. Hoffmann-La Roche Ltd and Hoffmann-LaRoche Inc. (together, “Roche”), providing for the development andcommercialization of our pharmaceutical fusion product candidate, HspE7.  By regaining control of the HspE7manufacturing program, we expect the restructured agreement to betterfacilitate our clinical development of HspE7 in recurrent respiratorypapillomatosis and additional indications caused by the human papillomavirus,while allowing Roche to develop a second generation HspE7 product targetinggenital warts.  Under the originalagreement we were responsible for the clinical development expenses related tothe RRP indication.  Under therestructured agreement we assumed responsibility for all

 

14

----

 

manufacturing and other costs of indications we chose to develop.   We have the right to record firstgeneration product sales in the U.S. and Canada of HspE7 for three yearsfollowing approval of a Biologics License Application (BLA) with the U.S. Foodand Drug Administration, and receive sales-based payments in other countriesand after the first three years.  Inaddition, the collaboration agreement provides opportunities to obtaindevelopment and commercial milestones of up to $340,500,000 (U.S. $227million).

 

## **Liquidity andCapital Resources**

 

Since inception we have relied principally onequity financings, research collaborations and cash flows generated from ourbioreagents business to fund our research and development programs, operationsand capital expenditures.  Through March31, 2004 we have raised net proceeds of $198,237,000 through equitytransactions.

 

Under the terms of our restructuredcollaboration agreement with Roche, we may receive approximately $15,000,000to $22,500,000 (US$10,000,000 to US$15,000,000) in 2005.  We will need significant additional fundsfor product development, manufacturing and commercialization.  If adequate funds are not available, we maybe required to delay, reduce the scope of, or eliminate the development ofHspE7 or other research or development programs.  We believethat our current capital resources are sufficient to fund operations into2005.  This belief is based on ourresearch and development plans, the current regulatory environment, ourhistorical industry experience in the development of therapeutics and generaleconomic conditions.

 

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 2004 is dependent upon several factors, including the timing andprogress of clinical development of HspE7 and the cost of manufacturingclinical supplies.

 

AtMarch 31, 2004, we had $45,895,000 of cash, cash equivalents and short-terminvestments. The $6,195,000 decrease since December 31, 2003 is due principallyto spending related to the development of HspE7.  At March 31, 2004 and December 31, 2003, approximately 29% and24%, respectively, of cash, cash equivalents and short-term investments wereheld in U.S. dollars.  During theperiod, we purchased British pounds in anticipation of making payments to ourprocess development and manufacturing vendor denominated in that currency.

 

Ourcapital expenditures totaled $130,000 during the first quarter of 2004 comparedto $12,000 in the same period last year. First quarter spending consisted of tenant improvements on ourfacilities, laboratory equipment, and computer related hardware.  Capital expenditures are expected todecrease during the remainder of 2004, although additional purchases areplanned to support our research, development and regulatory requirements.

 

AtMarch 31, 2004 and December 31, 2003 we had outstanding principal balances of$1,008,000 and $1,125,000, respectively, in the form of fixed rate capitalleases and term loan agreements including our September 2003 term loanagreement with Oxford Finance Corporation. At March 31, 2004 and December 31, 2003 the outstanding principalbalances were $832,000 and $906,000 on the Oxford loan.  Under the terms of the Oxford agreement, wemust issue a letter of credit for the outstanding loan balance if our combinedcash, cash equivalents, and short-term investments fall below $6,000,000**.**

 

We expect to seekadditional funds from various sources, including corporate partners that enterinto research and development collaborations with us, and public and privateequity financings.  If we raiseadditional funds by issuing equity securities, substantial dilution to ourexisting shareholders may result.  Wemay need to obtain funds through collaborative arrangements with others thatare on unfavorable terms.  We may alsohave to relinquish rights to certain of our technologies, product candidates orproducts that we would otherwise seek to develop ourselves.

 

15

----

 

## **Results of Operations**

 

For the three monthperiods ended March 31, 2004 and 2003, our net loss was $6,284,000 and$2,457,000, respectively, or $0.09and $0.04 per common share, respectively. Our increased net loss during the current quarter compared to the samequarter in 2003 is due principally to spending on research and development(“R&D”) activities related to manufacturing development that was previouslyfunded by Roche.

 

***CollaborativeR&D revenue***

 

We recorded collaborativeR&D revenue of $173,000 and $5,221,000 during the three month periods endedMarch 31, 2004 and 2003, respectively, relating to development activities in supportof Roche and amortization of up-front license fees in accordance with StaffAccounting Bulletin (“SAB”) No 101 “Revenue Recognition in FinancialStatements.”  Collaborative R&Drevenue in 2004 relates principally to the amortization of upfront licensefees.  Collaborative R&D revenue in2003 includes $2,741,000 for development activities, a time-based developmentpayment of $2,214,000 and $266,000 from the amortization of upfront licensefees.  Under the terms of therestructured HspE7 collaboration agreement, we expect future collaborativeR&D revenue to include amortization of the initial up-front license fee,which was adjusted to reflect the increased development period, and recognitionof future milestone revenues.

 

***Bioreagent sales***

 

Theproduction and sale of bioreagents supports our business strategy by buildingour market presence in stress proteins and strengthening our strategicrelationships with companies, academic institutions and stress responseresearchers. Our products are sold directly to end-users and through thirdparty distributors.  For the three monthperiods ended March 31, 2004 and 2003, we reported a 2% increase in bioreagentsales to $1,452,000 from $1,419,000. U.S. and Canadian dollar denominated sales increased by 14% and 56%,respectively, aided by the introduction of new products and several higherpriced kit-based research products.  Theforeign exchange rate applied to U.S. denominated sales was significantly lowerin the first quarter of 2004 compared to the first quarter of 2003, therebydiluting the reported improvement in U.S. dollar sales.

 

***Research and development***

 

Researchand development, or R&D, includes costs associated with clinical studies,product development, 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.

 

OurR&D spending for the three month period ended March 31, 2004 consistedprincipally of in-house research activities, spending to support the finalstages of our clinical trials, and activities to support the manufacturing anddevelopment of HspE7.  We entered into abiological services agreement with Avecia Limited in January 2004.  The contract is a multi-year agreement forprocess development, manufacturing of clinical supplies, and may also includethe manufacturing of commercial drug substance.  The contract is cancelable subject to specified termination conditions.  Our clinical program initiatives are focusedon preparations for our RRP pivotal trial.

 

R&Dspending decreased by approximately 14% to $5,569,000 during the first quarterin 2004, compared with $6,493,000 for the same period in 2003.  Avecia’s efforts began early in the firstquarter of 2004, whereas in 2003, our third-party spending focused onRoche-requested manufacturing initiatives. This difference, combined with differences in the timing of expensesrecorded for our on-going clinical trials resulted in lower first quarter 2004spending compared to 2003.  Our spendingat Avecia is expected to increase beyond first quarter levels after thetechnology transfer and feasibility studies are completed in the first half of2004.

 

16

----

 

InFebruary 2004 we announced the results from two clinical trials designed toconfirm previous results and/or to validate primary endpoints for future PhaseIII pivotal trials.  Our Phase II trialfor RRP showed high statistical significance in its primary endpoint oflengthening the interval between surgeries. In the clinical trial for anal dysplasia we saw evidence of a treatmenteffect in the secondary endpoints; however, the trial did not meet the primaryendpoint of showingbased on measured adjudicated pathological assessment of biopsies that patientshad downgrading of dysplasia from high grade to low grade or no dysplasia atsix months.  Our experience with this trialwill allow us to better structure future dysplasia trials, if any.

 

Duringthe three months ended March 31, 2004 approximately 75% of our R&D spendingrelated to efforts developing HspE7 as compared with approximately 65% for thesame period in 2003.  The remainingspending related to exploratory research involving our follow-on CoValTM fusionproteins and research supporting our bioreagent business.

 

Duringthe remainder of 2004, we expect to continue to devote the majority of plannedR&D spending to support HspE7 development. We anticipate that R&D spending will continue to increase in 2004over first quarter levels due to our assumption of HspE7 manufacturing anddevelopment activities from Roche and preparation for additional clinicaltrials.

 

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

 

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

 

SG&Aspending increased by approximately 3% to $2,353,000 for the three months ended March 31,2004 compared to $2,290,000 for the three months ended March 31, 2003

 

***Cost of bioreagent sales***

 

The aggregate cost ofbioreagent sales as a percentage of bioreagent sales was approximately 25% and 26% for the three month periods endedMarch 31, 2004 and 2003, respectively, resulting in gross margins of 75% and74%, respectively.

 

***Interest and other income***

 

Interest and other incomeincreased during the three months ended March 31, 2004 by 72% to $350,000compared with $203,000 during the same period in 2003.   Interest earned on a higher investmentportfolio balance contributed to the increase.

 

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

 

Duringthe first quarter in 2004, we recorded foreign exchange gains of $47,000compared to a loss of $141,000 for the same period in 2003.  The volatility of the U.S. dollar in 2003compared to the Canadian dollar exchange rate caused the 2003 foreign exchangeloss.

 

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

 

The156% increase in net loss to $6,284,000 for the three months ended March 31,2004 compared with $2,457,000 for the same period in 2003, was diluted by a 20%increase in the weighted average number of common shares outstanding, resultingin basic and diluted loss per share of $0.09 in 2004 and $0.04 in 2003.

 

17

----

 

### ***Differences between Canadian and U.S. generallyaccepted accounting principles***

 

Our consolidatedfinancial statements include adjustments necessary for their fair presentationin 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 would decrease by $627,000 forthe three months ended March 31, 2004. The principal differences under U.S. GAAP as opposed to Canadian GAAPfor the three months ended March 31, 2004 were the reversal of an unrealizedforeign exchange gain on available-for-sale securities of $5,000, a $6,000reversal of a write-down of short-term investments and the reversal of stockcompensation expense totaling $663,000 related to fair value stock optionaccounting adopted beginning January 1, 2004, offset by stock compensationexpense of $37,000 that would be recorded under APB Opinion No. 25.  Under U.S. GAAP, adjustments to the marketvalue of our investment portfolio would be recorded as a component ofstockholders’ equity.  Under CanadianGAAP, unfavorable market value adjustments are recorded as a component of retainedearnings.   Further, U.S. GAAP does notcurrently require fair value accounting on stock based compensation.  Therefore under the provisions of APBOpinion No. 25, no expense is recorded for options granted with an exerciseprice equal to the fair value of the stock on the day of grant.  Under APB Opinion No. 25, expense isincurred related to stock options granted at exercise prices less than the fairvalue of the underlying stock.

 

Similarly, to conform to U.S. GAAP for the three months ended March 31,2003, our net loss would decrease by $209,000. The principal differences under U.S. GAAP compared to Canadian GAAP werethe reversal of a write-down of short-term investments of $37,000, coupled witha $172,000 reversal of unrealized foreign exchange loss on available for salesecurities.

 

Basicnet loss per common share under U.S. GAAP would have been $0.08 and $0.04 inthe three months ended March 31, 2004 and 2003, respectively.  Our current assets and stockholders’ equityat March 31, 2004 are the same under U.S. GAAP and Canadian GAAP.

 

## **CriticalAccounting Policies**

 

Oursignificant accounting policies are disclosed in Note 1 to our consolidatedfinancial statements.  Certain of ourpolicies require the application of management judgment in making estimates andassumptions that affect the amounts reported in the consolidated financialstatements and disclosures made in the accompanying notes.  Those estimates and assumptions are based onhistorical experience and various other factors deemed applicable andreasonable under the circumstances.  Theuse of judgment in determining such estimates and assumptions is, by nature,subject to a degree of uncertainty. Accordingly, actual results could differ from the estimates made.  Our critical accounting policies include:

 

***Revenue recognition***

 

Revenuefrom collaborative R&D arrangements may include multiple elements within asingle contract.  Our accounting policycomplies with the revenue determination requirements set forth in EITF 00-21“Accounting for Revenue Arrangements with Multiple Deliverables,” and EIC 142“Revenue Arrangements with Multiple Deliverable,” relating to the separation ofmultiple deliverables into individual accounting units with determinable fairvalues.  We estimate the fair value ofdeliverables in collaboration agreements using standard industrytechniques.  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***

 

Clinicaltrial costs constitute a significant portion of R&D expense.  We recognize expenses related to our ongoingclinical trials using a methodology designed to accrue estimated costs in theappropriate accounting periods. Clinical trials can span multiple accounting periods.  We recognize clinical trial costs

 

18

----

 

inthree distinct phases:  start-up phase,patient accrual phase, and close-out phase. Our expenses related to clinical trials could vary based on patient availability,additional statistical analysis requirements, and decisions to extend thepatient evaluation period.  Using ourcurrent trial accrual methodology, our liability for clinical trials as ofMarch 31, 2004 is $628,000, including the estimated effect of anywork-in-process terminated at the end of the reporting period.  Alternately, if we utilized a percentage ofcompletion approach and used an operational estimate of the actual workcompleted as of March 31, 2004 compared to the total contract value, ourclinical trial liability would decrease by approximately $15,000.

 

***Stock-based compensation***

 

In September 2003, theCICA Accounting Standards Board released revised transitional provisions for *Stock-Based Compensation and Other Stock-BasedPayments*, Section 3870, to provide the same alternative methods oftransition as is provided in the U.S. for voluntary adoption of the fair valuebased method of accounting.  The AcSBhas also amended Section 3870 to require that all transactions whereby goodsand services are received in exchange for stock-based compensation and otherpayments result in expenses that should be recognized in financial statements,and that this requirement would be applicable for financial periods beginningon or after January 1, 2004.  Section3870 requires that share-based transactions should be measured on a fair valuebasis. As required for all Canadian companies whose securities are publiclytraded, the Company retroactively adopted the provisions of AcSB Section 3870beginning January 1, 1995.  See detailat Note 2 in the financial statements included herein.

 

**FACTORS THAT****MAY AFFECT FUTURE PERFORMANCE**

 

**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 are an Early Stage Development Company**

 

Our biotechnologybusiness is still at an early stage of development.  Significant additional research and development and clinicaltrials must be completed before our technology can be commercialized.  We have not completed the development of anytherapeutic products and, therefore, have not begun to market or generaterevenues from the commercialization of any therapeutic products.  We have undertaken only limited humanclinical trials for HspE7 and cannot assure you that subsequent trials willgenerate comparable results, that the results obtained from laboratory orresearch studies for our other products will be replicated in human studies,that our human studies will demonstrate efficacy or that our studies and trialswill not identify undesirable side effects of our products.  There are no assurances that any of ourtherapeutic products will:

 

•                  meet applicable healthregulatory standards

 

•                  obtain requiredregulatory approvals or clearances

 

•                  be produced incommercial quantities at reasonable costs

 

•                  be successfully marketedor

 

•                  be profitable enoughthat we will recoup the investment made in such product candidates.

 

None of ourtherapeutic product candidates are expected to be commercially available forseveral years.  It is possible that wewill not successfully develop any therapeutic products.

 

19

----

 

**We Have a History ofOperating Losses and May Never Become Profitable**

 

We have not recorded any revenues from the sale oftherapeutic products and have accumulated substantial net losses.  We expect we will incur continued losses forat least the next several years while our primary activities are research,development, and clinical trials.  Tobecome profitable we, either alone or with one or more partners, must develop,manufacture and successfully market therapeutic product candidates.

 

**We Must ObtainAdditional Financing to Execute Our Business Plan**

 

The revenues fromthe production and sale of bioreagents and the projected revenues fromcollaborators are not adequate to support either the development of HspE7 underthe restructured Roche Collaboration Agreement or our other therapeutic productdevelopment programs.  We will needsubstantial additional funds to pursue further research and development; carryout clinical trials; obtain regulatory approvals; file, prosecute, defend andenforce our intellectual property rights and market our products.  We will seek additional funds through publicor private equity or debt financing, strategic transactions and/or from othersources.  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 noassurances that future funding will be available on favorable terms or atall.  If additional funding is notobtained, we will need to reduce, defer or cancel development programs, plannedinitiatives or overhead expenditures, to the extent necessary.  The failure to fund our capital requirementswould have a material adverse effect on our business, financial condition andresults of operations.

 

**Our Success DependsOn Collaborative Partners, Licensees and Other Third Parties Over Whom We HaveLimited 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 be ableto establish or maintain collaborations that are important to our business onfavorable terms, or at all.

 

A number of risksarise from our dependence on collaborative agreements with third parties.  Product development and commercializationefforts could be adversely affected if any collaborative partner:

 

•                  terminates or suspendsits agreement with us

 

•                  causes delays

 

•                  fails to timely developor manufacture in adequate quantities a substance needed in order to conductclinical trials

 

•                  fails to adequatelyperform clinical trials

 

•                  determines not todevelop, manufacture or commercialize a product to which it has rights or

 

•                  otherwise fails to meetits contractual obligations.

 

Our collaborativepartners could pursue other technologies or develop alternative products thatcould compete with the products we are developing.

 

20

----

 

**TheProfitability of Our Products Will Depend in Part on Our Ability to ProtectProprietary Rights and Operate Without Infringing the Proprietary Rights ofOthers**

 

The profitability of our products will depend in parton our ability to obtain and maintain patents and licenses and preserve tradesecrets, and the period 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 hasemerged regarding the breadth of biotechnology patent claims that are grantedby the U.S. Patent and Trademark Office or enforced by the U.S. federal courts.  In addition, the scope of the originally claimedsubject matter in a patent application can be significantly reduced before apatent is issued.  The biotechnologypatent situation outside the U.S. is even more uncertain, is currentlyundergoing review and revision in many countries, and may not protect ourintellectual property rights to the same extent as the laws of the U.S.  Because patent applications are maintainedin secrecy 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 similarproducts and design around any patented products we develop.  We cannot assure you that:

 

•              any of our patentapplications will result in the issuance of patents

 

•              we will developadditional patentable products

 

•              the patents we have beenissued will provide us with any competitive advantages

 

•              the patents of otherswill not impede our ability to do business or

 

•              third parties will notbe able to circumvent our patents.

 

On October 22, 2002 Antigenics Inc. announced that ithad filed an opposition in the European Patent Office 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.  It could take severalyears to obtain results from these proceedings.  Until we receive final results from the opposition andre-examination processes, we will not be able to assure investors of thesuccess of our planned vigorous defense of the patents.

 

A number of pharmaceutical, biotechnology, researchand academic companies and institutions have developed technologies, filedpatent applications 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 do notobtain, or obtain only narrow, patent protection.  If patents that cover our activities are issued to othercompanies, we may not be able to obtain licenses at a reasonable cost, or atall; develop our technology; or introduce, manufacture or sell the products wehave planned.

 

Patent litigation is becoming widespread inthe biotechnology industry.  Suchlitigation may affect our efforts to form collaborations, to conduct researchor development, to conduct clinical testing or to manufacture or market anyproducts under development.  There areno assurances that our patents would be held valid or enforceable by a court orthat a competitor’s technology or product would be found to infringe ourpatents in the event of patent litigation. Our business 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

 

21

----

 

invention. We could incur substantial costs and devote significant managementresources to defend our patent position or to seek a declaration that anothercompany’s patents are invalid.

 

Much of ourknow-how and technology may not be patentable, though it may constitute tradesecrets. There are no assurances that we will be able to meaningfully protectour trade secrets.  We cannot assure youthat any of our existing confidentiality agreements with employees, consultants,advisors or collaborators will provide meaningful protection for our tradesecrets, know-how or other proprietary information in the event of anyunauthorized use or disclosure. Collaborators, advisors or consultants may dispute the ownership ofproprietary rights to our technology, for example by asserting that theydeveloped the technology independently.

 

**We May EncounterDifficulties in Manufacturing our Products**

 

Our manufacturingexperience in bioreagents is not directly applicable to the manufacture oftherapeutic products.  We have not yetintroduced any therapeutic products and have no experience manufacturingimmunotherapeutics ourselves.  Beforeour products can be profitable, they must be produced in commercial quantitiesin a cost-effective manufacturing process that complies with regulatoryrequirements, including GMP, production and quality control regulations.  Because we do not have facilities for theproduction of therapeutic products such as HspE7, we contract with third partiesfor process development, the scale-up of manufacturing our products from thelaboratory bench to commercial quantities, manufacturing of bulk materials,product characterization, filling the product into vials, packaging and relatedprocesses.  If we cannot arrange for ormaintain commercial-scale manufacturing on acceptable terms, or if there aredelays or difficulties in transitioning our products between the contractorsperforming different aspects of the manufacturing process, we may not be ableto conduct clinical trials, obtain regulatory approval or meet demand for ourproducts.

 

Production of ourproducts could require raw materials which are scarce or which can be obtainedonly from a limited number of sources. If our manufacturers were unable to obtain adequate supplies of such rawmaterials, the development, regulatory approval and marketing of our productscould be delayed.

 

**We Could Need MoreClinical Trials or Take More Time to Complete Our Clinical Trials Than We HavePlanned**

 

Clinical trialsvary in design by factors including dosage, end points, length, controls, andnumbers and types of patients enrolled. We may need to conduct a series of trials to demonstrate the safety andefficacy of our products.  The resultsof these trials may not demonstrate safety or efficacy sufficiently forregulatory authorities to approve our products.

 

Regulatoryauthorities may require us to determine whether our products delay or preventdisease recurrence.  Clinical trials toshow that a disease does not recur take longer to complete than clinical trialsthat end when patients stop having specific symptoms.  The actual schedules for our clinical trials could varydramatically from the forecasted schedules due to factors including changes intrial design, conflicts with the schedules of participating clinicians andclinical institutions, delayed patient accrual and changes affecting productsupplies for clinical trials.

 

We rely oncollaborators, including academic institutions, governmental agencies andclinical research organizations, to conduct, supervise, monitor and design someor all aspects of clinical trials involving our products.  The National Cancer Institute is sponsoringsome HspE7 clinical trials.  Since thesetrials depend on governmental participation and funding, we have less controlover their timing and design than trials we sponsor.  Delays in or failure to commence or complete any planned clinicaltrials could delay the ultimate timelines for product release.  Such delays could reduce investors’confidence in our ability to develop products, likely causing our share priceto decrease.

 

22

----

 

**We May Not Be Able toObtain the Regulatory Approvals or Clearances That Are Necessary toCommercialize Our Products**

 

The U.S., Canada and other countries impose significant statutory andregulatory obligations upon the manufacture and sale of human therapeuticproducts.  Each regulatory authority typically has a lengthy approval process inwhich it examines pre-clinical and clinical data and the facilities inwhich the product is manufactured.  Regulatory submissions must meet complexcriteria to demonstrate the safety and efficacy of the ultimate products. Addressing these criteria requires considerable data collection,verification and analysis.  We may spendtime and money preparing regulatory submissions or applications withoutassurances as to whether they will be approved on a timely basis or at all.

 

Our product candidates, some of which are currently inthe early stages of development, will require significant additionaldevelopment and pre-clinical and clinical testing prior to theircommercialization. These steps and the process of obtaining required approvalsand clearances can be costly and time-consuming.  If our potential products are not successfully developed, cannotbe proven to be safe and effective through clinical trials, or do not receiveapplicable regulatory approvals and clearances, or if there are delays in theprocess:

 

•                  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.  Even if a product receivesregulatory approval and clearance, it may later exhibit adverse side effectsthat limit or prevent its widespread use or that force us to withdraw theproduct from the market.

 

Any marketed product and its manufacturer will continue to be subjectto strict regulation after approval.  Results of post-marketing programs may limit orexpand the further marketing of products. Unforeseen problems with an approved product or any violation ofregulations could result in restrictions on the product, including itswithdrawal from the market and possiblecivil actions.

 

The manufacturers of our products will be required to comply withapplicable good manufacturing practices regulations, which include requirementsrelating to quality control and quality assurance, as well as the maintenanceof records and documentation.  If themanufacturers cannot comply with regulatory requirements, including applicablegood manufacturing practice requirements, we may not be allowed to develop ormarket the product candidates.  If we orour manufacturers fail to comply with applicable regulatory requirements at anystage during the regulatory process, we may be subject to sanctions, includingfines, product recalls or seizures, injunctions, refusal of regulatory agenciesto review pending market approval applications or supplements to approveapplications, total or partial suspension of production, civil penalties,withdrawals of previously approved marketing applications and criminalprosecution.

 

**CompetitorsMay Develop and Market Drugs That Are Less Expensive, More Effective or Safer,Making Our Products Obsolete or Uncompetitive**

 

Many competitors andpotential competitors have substantially greater product developmentcapabilities and financial, scientific, marketing and human resources than wedo.  Technological competition frompharmaceutical companies and biotechnology companies is intense and is expectedto increase.  Other companies havedeveloped technologies that could be the basis for competitive products.  Some of these products have an entirelydifferent approach or means of accomplishing the desired therapeutic effectthan

 

23

----

 

products we aredeveloping.  Alternative products may bedeveloped that are more effective, work faster and are less costly than ourproducts.  Competitors may succeed indeveloping products earlier than us, obtaining approvals and clearances forsuch products more rapidly than us, or developing products that are moreeffective than ours.  In addition, otherforms of medical treatment, such as surgery, may be competitive with our products.Over time, our technology or products may become obsolete or uncompetitive.

 

**Our Products May NotGain Market Acceptance**

 

Products such asHspE7 may not gain market acceptance among physicians, patients, healthcarepayors and the medical community.  Thedegree of market acceptance of any product depends on a number of factors,including establishment 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 factors is available inconnection with our products or products that may compete with ours.

 

Our sales experience is limited to the saleof bioreagents.  To directly market anddistribute any pharmaceutical products, we or our collaborators will need amarketing and sales force with appropriate technical expertise and supportingdistribution capabilities.  We may notbe able to establish sales, marketing and distribution capabilities or enterinto arrangements 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 andthe Use of Our Products Could Subject Us to Damages Relating to Injuries orAccidental Contamination**

 

The humanclinical trials we conduct, including trials in children, may have unforeseenlong-term health implications.  We haveonly limited amounts of product liability insurance for our clinical trials.  We may not correctly anticipate or be ableto maintain on acceptable terms the level of insurance coverage that wouldadequately cover potential liabilities from proposed clinical trials andeventual commercial sales.  Productliability insurance is expensive, difficult to obtain and may not be availablein the future.  If we cannot obtainsufficient insurance coverage or other protection against potential productliability claims, the commercialization of our products may become financiallyinfeasible.  If any liabilities from aclaim exceed the limit of insurance coverage, we may not have the resources topay them.

 

Our research anddevelopment processes involve the controlled use of hazardous and radioactivematerials.  We are subject to federal,provincial and local laws and regulations governing the use, manufacture,storage, handling and disposal of such materials and waste products.  The risk of accidental contamination orinjury from handling and disposing of such materials cannot be completelyeliminated. In the event of an accident involving hazardous or radioactivematerials, we could be held liable for resulting damages.  We are not insured with respect to thisliability. Such liability could exceed our resources.  In the future we could incur significant costs to comply withenvironmental laws and regulations.

 

**Our Success DependsOn Attracting and Retaining Qualified Personnel**

 

We depend on acore management and scientific team. The loss of any of these individuals could prevent us from achieving ourbusiness objective of commercializing our product candidates.  Our future success will depend in large parton our continued ability to attract and retain other highly qualifiedscientific, technical and management personnel, as well as personnel withexpertise in clinical testing and government regulation.  We face competition for personnel from othercompanies, universities, public and private research institutions, governmententities and other organizations.  Ifour recruitment and retention efforts are unsuccessful, our business operationscould suffer.

 

24

----

 

**Our Revenues WillDepend Upon the Availability of Reimbursement from Third-Party Payors That AreIncreasingly Challenging the Price and Examining the Cost Effectiveness ofMedical Products and Services**

 

Sales oftherapeutic products depends in part upon the availability of reimbursementfrom third-party payors, including government health administrationauthorities, managed care providers, private health insurers and otherorganizations.  These third-party payorsincreasingly attempt to contain costs by challenging the price of products andservices and limiting the coverage and level of reimbursement for pharmaceuticalproducts.  Third party reimbursement forour products may be inadequate to enable us to maintain prices that provide areturn on our product development investment. Governments continue to propose and pass legislation designed to reducehealthcare costs.  This legislationcould further limit reimbursement.  Ifgovernment and third-party payors do not adequately reimburse patients for thecosts of our products, the market for our products may be limited.

 

**Our Share Price HasBeen and Is Likely to Continue to Be Highly Volatile**

 

As is typical for biotechnology companies without an approved product onthe market, our share price has been highly volatile in the past and is likelyto continue to be volatile. The price of our shares could be materiallyaffected by factors including:

 

•                  the announcement ofclinical trials results by us or our competitors

 

•                  regulatory actions

 

•                  safety issues

 

•                  changes affectingpatents or exclusive licenses

 

•                  future issuances ofshares

 

•                  the announcement oftechnological innovations

 

•                  the release ofpublications

 

•                  the development of newcommercial products

 

•                  changes in regulations

 

•                  the release of financialresults

 

•                  public concerns overrisks relating to biotechnology

 

•                  sales of shares byexisting shareholders and

 

•                  changes in analystrecommendations.

 

**Item 3****.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

We use the Canadian dollaras our measurement and functional currency. As a result, we are exposed to foreign currency fluctuations through ouroperations because a substantial amount of our contract research anddevelopment spending has been transacted in other currencies, principally inU.S. dollars and British pounds.  Wehold investment balances in the currencies in which we have expenditures plannedduring the foreseeable future.  Duringthe first quarter 2004, we purchased British pounds to mitigate our currencyexposure based on spending plans with Avecia Limited.  Our U.S. dollar denominated expenses and

 

25

----

 

revenues are partially matchedby our bioreagent product sales, 95% of which are in U.S. dollars.  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 currencyrisk, beyond matching investments proportionately with anticipated spending, wemay do so in the future if conditions change.

 

A hypothetical change in U.S dollar exchangerates by applying a 10% change to our March 31, 2004 foreign exchange rate,then applying that rate to our average level of U.S. investments during 2004,would result in a $972,000 impact.  Ifthe value of the Canadian dollar relative to the U.S. dollar were to increaseby 10%, our net loss would decrease by $972,000.  Further, if the value of the Canadian dollar relative to the U.S.dollar were to decrease by 10%, our net loss would increase by $972,000.

 

A hypothetical change in British pound exchangerates by applying a 10% change to our March 31, 2004 foreign exchange rate,then applying that rate to our average level of British pound investmentsduring the year, would result in a $178,000 impact.  If the value of the Canadian dollar relative to the British poundwere to increase by 10%, our net loss would decrease by $178,000.  Further, if the value of the Canadian dollarrelative to the British pound were to decrease by 10%, our net loss wouldincrease by $178,000.

 

We are also exposed tointerest rate risk, because we maintain cash equivalent and short-terminvestment portfolio holdings of various issuers, types, and maturity dateswith large banks and investment banking institutions.  We occasionally hold short-term investments beyond 120 days. Themarket value of these short-term investments on any day during the investmentterm may vary as a result of market interest rate fluctuations.

 

A hypothetical change ininterest rates comparable to a 10% change to our average rate of return wouldresult in a $94,000 impact.  If interestrates were to increase by 10%, our net loss would decrease by $94,000.  Further, if interest rates were to decreaseby 10%, our net loss would increase by $94,000.

 

We have not used derivativefinancial instruments in our investment portfolio.  We classify our investments as available-for-sale orheld-to-maturity at the time of purchase and re-evaluate this designation as ofeach balance sheet date. We had $45,895,000 in cash, cash equivalents andshort-term investments as of March 31, 2004.

 

**Item 4**. CONTROLS AND PROCEDURES

 

Ourchief financial officer and chief executive officer concluded as of March 31,2004 that our disclosure controls and procedures (as defined in Rule 15d-15(e)promulgated under the Securities Exchange Act of 1934, as amended) areeffective and designed to alert them to material information relating toStressgen and its consolidated subsidiaries, based on the evaluation of thesecontrols and procedures as required by paragraph (b) of Rule 15d-15.

 

26

----

 

#### **PART II**—OTHERINFORMATION

 

###### **Item6**.  EXHIBITS AND REPORTS ON FORM8-K

 

(a)           Exhibits: For a list of exhibits filed with this report, refer to the Index to Exhibits set forth after the signature page hereto.

 

(b)           On February 23, 2004 we filed a report on Form 8-K attaching two press releases.  The first press release reported the results from an RRP clinical trial and an AIN clinical trial.  The second press release reported earnings and other financial results for our 2003 fiscal year, which ended December 31, 2003.

 

## **SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized. 

 
|               | Stressgen  Biotechnologies Corporation                                                                                                                                              |
|--------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Date:  May 6, 2004 | /s/ Gregory M. McKee                                                                                                                                                                |   |
|               | Gregory  M. McKee                                                                                                                                                                   |
|               | Vice  President, Corporate Development  and Chief Financial Officer  (Principal Financial and Accounting  Officer duly authorized to sign  this report on behalf of the registrant) |

 

27

----

 

INDEX OF EXHBITS

 
| **Exhibit No.** |   | **Description**                                                                                                   |
|-----------------|--------|-------------------------------------------------------------------------------------------------------------------|
| 3.9*            |   | Articles of Continuance of the Company                                                                            |
| 3.10*           |   | By-Laws of the Company                                                                                            |
| 4.4*            |   | Form of Stock Certificate                                                                                         |
| 10.16           |   | Biological Service Agreement dated January 27, 2004 between Avecia  Limited and Stressgen Development Corporation |
| 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                                                                                        |

 

----

* Incorporated by reference to the Company’s Form 10-Q for the quarterended June 30, 2001, as filed with the Commission on August 2, 2001

 

28

----