**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM10-Q**

 

**(Mark One)**

 

| **ý**                                   | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934**  |
|----------------------------------------------|-----------------------------------------------------------------------------------------------------|
|                                         |
| **For the Quarter Ended September 30, 2003** |
| **or**                                       |
|                                         |
| **o**                                        | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |

** **

**Commission file number 333-12570**

 

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**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.10241 Wateridge Circle, Suite C200  San Diego, CA** |   | **92121**                         |
| (Address of principal executive offices)                                                                                                                          |   | (zip code)                        |
|                                                                                                                                                              |
| **(250) 744-2811**                                                                                                                                                |
| **(858) 202-4900**                                                                                                                                                |
| (Registrant’s telephone number, including area code)                                                                                                         |

 

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Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired 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 October27, 2003, the registrant had approximately 61,706,000 shares of Common Stock,no par value, outstanding. 

 

 

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**Stressgen Biotechnologies Corporation and Subsidiaries**

 

**INDEX**

 
|                                    | **Page**     |
|-----------------------------------------|--------------|
| **Part I — Financial Information** |
|                                    |
|                                    | Item 1. | Financial  Statements |   |
|                                    |         |   |   |
|                                    |         | Consolidated Balance Sheet  September 30, 2003 (Unaudited) and December 31, 2002 | 1 |
|                                    |         | Consolidated  Statement of Operations and Accumulated Deficit  Three and Nine Months Ended September 30, 2003 and 2002 (Unaudited) | 2 |
|                                    |         | Consolidated  Statement of Cash FlowsThree and Nine Months Ended September 30, 2003 and 2002 (Unaudited) | 3 |
|                                    |         | Notes to  Consolidated Financial Statements (Unaudited) | 4 |
|                                    |         |   |   |
|                                    | Item 2.      | Management’s Discussion  and Analysis of Financial Condition and Results of Operations | 13 |
|                                    |         | Factors That Could Affect Future  Performance | 17 |
|                                    |         |   |   |
|                                    | Item 3.      | Quantitative and Qualitative  Disclosures About Market Risk | 22 |
|                                    |         |   |   |
|                                    | Item 4.      | Controls and Procedures | 23 |
|                                    |
| **Part II — Other  Information**   |
|                                    |
| Items 1 through 6                       | 23           |
|                                    |
| SIGNATURES  AND CERTIFICATIONS          | 24           |

 

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**CONSOLIDATED BALANCE SHEET**

 

*Stressgen Biotechnologies Corporation andSubsidiaries(Canadian dollars in thousands, except share information)*

 
|                                                                                                                                                                                                        |   | **September 30,  2003** |   | **December 31,  2002** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|--------|------------------------|--------|
|                                                                                                                                                                                                        |   | **(unaudited)**         |   |                   |   |
| **Assets**                                                                                                                                                                                                  |   |                    |   |                   |   |
| Current assets:                                                                                                                                                                                             |   |                    |   |                   |   |
| Cash and cash equivalents                                                                                                                                                                                   |   | $                       | 1,706  |                   | $      | 31,202 |   |
| Short-term investments                                                                                                                                                                                      |   | 36,875                  |   | 14,811                 |   |
| Accounts receivable, net                                                                                                                                                                                    |   | 1,011                   |   | 4,279                  |   |
| Inventories                                                                                                                                                                                                 |   | 632                     |   | 838                    |   |
| Other current assets                                                                                                                                                                                        |   | 603                     |   | 518                    |   |
| Total current assets                                                                                                                                                                                        |   | 40,827                  |   | 51,648                 |   |
|                                                                                                                                                                                                        |   |                    |   |                   |   |
| Capital assets                                                                                                                                                                                              |   | 2,350                   |   | 2,746                  |   |
| Deferred expenses, net of current portion                                                                                                                                                                   |   | 270                     |   | 421                    |   |
|                                                                                                                                                                                                        |   | $                       | 43,447 |                   | $      | 54,815 |   |
| **Liabilities and Stockholders’  Equity**                                                                                                                                                              |   |                    |   |                   |   |
| Current liabilities:                                                                                                                                                                                        |   |                    |   |                   |   |
| Accounts payable and accrued liabilities                                                                                                                                                                    |   | $                       | 5,682  |                   | $      | 8,833 |   |
| Current portion of deferred revenue                                                                                                                                                                         |   | 953                     |   | 1,115                  |   |
| Current portion of notes payable                                                                                                                                                                            |   | 608                     |   | 318                    |   |
| Total current liabilities                                                                                                                                                                                   |   | 7,243                   |   | 10,266                 |   |
|                                                                                                                                                                                                        |   |                    |   |                   |   |
| Long-term liabilities:                                                                                                                                                                                      |   |                    |   |                   |   |
| Deferred revenue, net of current portion                                                                                                                                                                    |   | 2,143                   |   | 3,344                  |   |
| Notes payable, net of current portion                                                                                                                                                                       |   | 736                     |   | 262                    |   |
| Total long-term liabilities                                                                                                                                                                                 |   | 2,879                   |   | 3,606                  |   |
|                                                                                                                                                                                                        |   |                    |   |                   |   |
| Total liabilities                                                                                                                                                                                           |   | 10,122                  |   | 13,872                 |   |
|                                                                                                                                                                                                        |   |                    |   |                   |   |
| Stockholders’ equity:                                                                                                                                                                                  |   |                    |   |                   |   |
| Common shares and other equity – no par value;  unlimited shares authorized, 61,701,789 and   60,209,989 shares issued and outstanding at September 30, 2003 and  December 31, 2002, respectively |   | 180,092                 |   | 175,384                |   |
| Deferred stock compensation                                                                                                                                                                                 |   | (235                    | )      | (392                   | )      |
| Accumulated deficit                                                                                                                                                                                         |   | (146,532                | )      | (134,049               | )      |
| Total stockholders’ equity                                                                                                                                                                             |   | 33,325                  |   | 40,943                 |   |
|                                                                                                                                                                                                        |   | $                       | 43,447 |                   | $      | 54,815 |   |

 

*See accompanyingnotes to consolidated financial statements*.

 

1

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**CONSOLIDATED STATEMENT OF OPERATIONS AND ACCUMULATEDDEFICIT**

**(Unaudited)**

 

*Stressgen Biotechnologies Corporation andSubsidiaries(Canadian dollars in thousands, except per share amounts)*

 
|                                                                                                   |   | **Three months ended  September 30,** |     | **Nine months ended  September 30,** |   |
|--------------------------------------------------------------------------------------------------------|--------|---------------------------------------|----------|--------------------------------------|--------|
|                                                                                                   |   | **2003**                              |     | **2002**                             |   | **2003** |   | **2002** |   |
| Revenue:                                                                                               |   |                                  |     |                                 |   |   |   |   |   |
| Collaborative R&D revenue                                                                          |   | $                                     | 855      |                                 | $      | 4,332 |   | $ | 7,584 |   | $ | 4,332 |   |
| Bioreagent sales                                                                                       |   | 1,316                                 |     | 1,494                                |   | 4,108 |   | 4,390 |   |
| Total revenue                                                                                          |   | 2,171                                 |     | 5,826                                |   | 11,692 |   | 8,722 |   |
|                                                                                                   |   |                                  |     |                                 |   |   |   |   |   |
| Operating expenses:                                                                                    |   |                                  |     |                                 |   |   |   |   |   |
| Research and development                                                                               |   | 6,009                                 |     | 7,447                                |   | 17,293 |   | 26,508 |   |
| Selling, general and administrative                                                                    |   | 1,510                                 |     | 1,904                                |   | 5,666 |   | 6,570 |   |
| Cost of bioreagent sales                                                                               |   | 296                                   |     | 419                                  |   | 1,049 |   | 1,228 |   |
|                                                                                                   |   | 7,815                                 |     | 9,770                                |   | 24,008 |   | 34,306 |   |
|                                                                                                   |   |                                  |     |                                 |   |   |   |   |   |
| Operating loss                                                                                         |   | (5,644                                | )        | (3,944                               | )      | (12,316 | ) | (25,584 | ) |
|                                                                                                   |   |                                  |     |                                 |   |   |   |   |   |
| Other income (expenses):                                                                               |   |                                  |     |                                 |   |   |   |   |   |
| Interest and other income, net                                                                         |   | 41                                    |     | 777                                  |   | 499 |   | 1,059 |   |
| Net foreign exchange (loss) gain                                                                       |   | (12                                   | )        | 902                                  |   | (638 | ) | (164 | ) |
| Interest expense                                                                                       |   | (8                                    | )        | (15                                  | )      | (28 | ) | (54 | ) |
|                                                                                                   |   | 21                                    |     | 1,664                                |   | (167 | ) | 841 |   |
|                                                                                                   |   |                                  |     |                                 |   |   |   |   |   |
| Net loss                                                                                               |   | (5,623                                | )        | (2,280                               | )      | (12,483 | ) | (24,743 | ) |
|                                                                                                   |   |                                  |     |                                 |   |   |   |   |   |
| Accumulated deficit, beginning of period                                                               |   | (140,909                              | )        | (127,710                             | )      | (134,049 | ) | (105,247 | ) |
| Accumulated deficit, end of period                                                                     |   | $                                     | (146,532 | )                                    | $      | (129,990 | ) | $ | (146,532 | ) | $ | (129,990 | ) |
|                                                                                                   |   |                                  |     |                                 |   |   |   |   |   |
| Basic and diluted loss per common share                                                                |   | $                                     | (0.09    | )                                    | $      | (0.04 | ) | $ | (0.20 | ) | $ | (0.42 | ) |
|                                                                                                   |   |                                  |     |                                 |   |   |   |   |   |
| Weighted average shares used to compute basic and  diluted loss per common share  (in  thousands) |   | 61,692                                |     | 60,179                               |   | 61,048 |   | 58,573 |   |

 

*See accompanying notes to consolidated financial statements.*

 

2

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**CONSOLIDATED STATEMENT OF CASH FLOWS**

**(Unaudited)**

 

*Stressgen Biotechnologies Corporation andSubsidiaries(Canadian dollars in thousands)*

 
|                                                                         |   | **Three months ended  September 30,** |   | **Nine months ended  September 30,** |   |
|------------------------------------------------------------------------------|--------|---------------------------------------|--------|--------------------------------------|--------|
|                                                                         |   | **2003**                              |   | **2002**                             |   | **2003** |   | **2002** |   |
| Cash flows from operating activities:                                        |   |                                  |   |                                 |   |   |   |   |   |
| Net loss                                                                     |   | $                                     | (5,623 | )                                    | $      | (2,280 | ) | $ | (12,483 | ) | $ | (24,743 | ) |
| Adjustments to reconcile net loss to net cash used  in operating activities: |   |                                  |   |                                 |   |   |   |   |   |
| Depreciation and amortization of capital assets                              |   | 206                                   |   | 204                                  |   | 550 |   | 586 |   |
| Amortization of deferred stock compensation                                  |   | 50                                    |   | 57                                   |   | 157 |   | 173 |   |
| Unrealized foreign exchange (gain) loss                                      |   | (15                                   | )      | (1,235                               | )      | 493 |   | (17 | ) |
| Loss (gain) on market value of investments                                   |   | 284                                   |   | (498                                 | )      | 336 |   | (113 | ) |
| Changes in operating assets and liabilities                                  |   | 1,243                                 |   | (1,319                               | )      | (974 | ) | 1,052 |   |
| Net cash used in operating activities                                        |   | (3,855                                | )      | (5,071                               | )      | (11,921 | ) | (23,062 | ) |
|                                                                         |   |                                  |   |                                 |   |   |   |   |   |
| Cash flows from investing activities:                                        |   |                                  |   |                                 |   |   |   |   |   |
| Purchase of short-term investments                                           |   | —                                |   | (13,975                              | )      | (31,191 | ) | (57,754 | ) |
| Sales and maturities of short-term investments                               |   | 3,715                                 |   | 24,342                               |   | 8,577 |   | 57,195 |   |
| Purchase of capital assets                                                   |   | (100                                  | )      | (151                                 | )      | (154 | ) | (319 | ) |
| Net cash provided by (used in) investing  activities                         |   | 3,615                                 |   | 10,216                               |   | (22,768 | ) | (878 | ) |
|                                                                         |   |                                  |   |                                 |   |   |   |   |   |
| Cash flows from financing activities:                                        |   |                                  |   |                                 |   |   |   |   |   |
| Proceeds on issue of common shares                                           |   | 22                                    |   | 1,498                                |   | 4,720 |   | 10,604 |   |
| Proceeds from term loan                                                      |   | 1,004                                 |   | —                               |   | 1,004 |   | — |   |
| Repayment of borrowings                                                      |   | (78                                   | )      | (211                                 | )      | (240 | ) | (458 | ) |
| Stock subscription receivable                                                |   | (12                                   | )      | 480                                  |   | (12 | ) | — |   |
| Net cash provided by financing activities                                    |   | 936                                   |   | 1,767                                |   | 5,472 |   | 10,146 |   |
|                                                                         |   |                                  |   |                                 |   |   |   |   |   |
| Effect of exchange rate changes on cash and cash  equivalents                |   | (109                                  | )      | 345                                  |   | (279 | ) | (68 | ) |
|                                                                         |   |                                  |   |                                 |   |   |   |   |   |
| Decrease in cash and cash equivalents                                        |   | 587                                   |   | 7,257                                |   | (29,496 | ) | (13,862 | ) |
| Cash and cash equivalents, beginning of period                               |   | 1,119                                 |   | 12,219                               |   | 31,202 |   | 33,338 |   |
| Cash and cash equivalents, end of period                                     |   | $                                     | 1,706  |                                 | $      | 19,476 |   | $ | 1,706 |   | $ | 19,476 |   |

 

*See accompanying notes to consolidated financial statements.*

 

3

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***StressgenBiotechnologies Corporation***

**Notes to Consolidated Financial Statements**

***(Canadian dollars)***

 

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

 

*The Company*

 

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 is HspE7, which 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 its proprietaryCoValTM technology, for the treatment of hepatitis B and herpessimplex and is targeting hepatitis C. Further, Stressgen has an internationally recognized research productsupply business with sales to scientists worldwide for the study of cellularstress, apoptosis, oxidative stress and neurobiology.

 

*Basis of presentation*

 

The consolidated financial statements include the assets, liabilitiesand operating results of the Company and its wholly-owned subsidiaries.  Intercompany accounts and transactions havebeen eliminated in consolidation.

 

*Financial statements and estimates*

 

The information at September 30, 2003 and forthe three and nine month periods ended September 30, 2003 and 2002 has beenprepared by the Company and has not been audited.  The financial statements, in the opinion of management, includeall adjustments necessary for their fair presentation in conformity withCanadian generally accepted accounting principles (“Canadian GAAP”), and conformin all material respects with accounting principles generally accepted in theUnited States of America (“U.S. GAAP”), except as discussed in Note 5.  These financial statements should be read inconjunction with the financial statements and notes thereto in the Company’sDecember 31, 2002 Annual Report on Form 10-K. Certain information and footnote disclosures normally included infinancial statements prepared in accordance with Canadian and U.S. GAAP havebeen condensed or omitted pursuant to the applicable Canadian regulatory andU.S. Securities and Exchange Commission rules and regulations.  Interim results are not necessarilyindicative of results for the full year.

 

The preparation of financial statements inconformity with generally accepted accounting principles requires management tomake estimates and assumptions that affect the reported amounts of assets,liabilities, revenue and expenses and related disclosures as of the date of thefinancial statements.  Significantestimates are used for, but not limited to, reporting revenue recognition,accrual of clinical trial costs, measurement of stock-based compensation, andthe allocation of indirect costs. Actual results could differ 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 aretranslated into Canadian dollars at the rate of exchange prevailing at thebalance sheet date.  Non-monetary assetsand liabilities are translated at historical exchange rates.  Revenue and expenses are translated at theaverage rate of exchange for the period of such transactions.

 

4

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*Revenue recognition*

 

Revenuefrom product sales is recognized upon delivery to customers when persuasiveevidence of an arrangement exists, the price is fixed or determinable andcollection is reasonably assured. Revenue also includes amounts charged for shipping and handling costs.

 

Revenuefrom collaborative research and development (“R&D”) arrangements mayinclude multiple elements within a single contract.  The Company’s accounting policy complies with the revenuedetermination requirements set forth in EITF 00-21, *Accountingfor Revenue Arrangements with Multiple Deliverables*, relating to the separation of multipledeliverables into individual accounting units with determinable fairvalues.  Payments received undercollaborative arrangements may include the following:  non-refundable fees at inception of contract for technologyrights; funding for services performed; milestone payments for specificachievements; and payments based upon resulting sales of products.

 

The Company recognizes collaborative researchand development revenues as services are rendered consistent with theperformance requirements of the contract. Revenue from non-refundable contract fees where the Company hascontinuing involvement through research and development collaborations or othercontractual obligations, less the fair market value of any related warrants, isrecognized ratably over the development period or the period for whichStressgen continues to have a performance obligation.  The period of development is evaluated on a regular basis.  Revenue from performance milestones isrecognized upon the achievement of the milestones as specified in theagreement, provided payment is proportionate to the effort expended.  Payments received in advance of performanceor delivery are recorded as deferred revenue.

 

*Clinical trial accruals*

 

The Company recognizes expenses related toits ongoing clinical trials using a methodology designed to accrue estimatedcosts in the appropriate accounting periods. The Company recognizes clinical trial costs in three distinct phases:  the start-up phase, the patient accrualphase, and the close-out phase.  Thetotal estimated trial cost is divided into these three phases based on thetasks involved in conducting the trial. Based on the design of the trial, the cost of each phase could vary fromtrial to trial.  Upon start of thetrial, the start-up portion of the trial contract is accrued.  As patients enter the trial, the patientaccrual cost is ratably recognized. Once the study is complete and analysis of the patient data has beeninitiated, the close-out portion of the trial is recognized.

 

*Stock-based compensation plan*

 

Multiple standards are in use regarding the recognition, measurementand disclosure of stock-based compensation and other stock-based payments. TheCompany has adopted the recommendations of the CICA Handbook section 3870, *Stock-Based Compensation and Other Stock-BasedPayments*, effective January 1, 2002.  This standard requires that all stock-based awards made tonon-employees be 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

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The Company’s accounting methodsfor stock-based compensation plans also materially follow the guidance underthe recognition and measurement principles of APB Opinion No. 25, *Accounting for Stock Issued to Employees,*and related interpretations.  TheCompany has two stock-based compensation plans, which are described in Note3.  New option grants are made with anexercise price equal to the fair market value of the underlying commonstock.  No compensation expense isrecognized for options granted at fair market value under the plan when stockoptions are issued to directors and employees. Deferred stock compensation charges arise where stock options aregranted at exercise prices less than the fair value of the underlying stock andare amortized to expense over the vesting period of the option.  Any consideration paid by directors,employees and others on exercise of stock options is credited to share capital.

 

The following table summarizesthe effect on net loss and loss per share if the Company had applied the fairvalue recognition provisions of the Financial Accounting Standards Board(“FASB”) Statement No. 123, *Accounting forStock-Based Compensation,*to stock-based employee compensation.

 
|                                                                           |   | **For the three months ended  September 30,** |   | **For the nine months ended  September 30,** |   |
|--------------------------------------------------------------------------------|--------|-----------------------------------------------|--------|----------------------------------------------|--------|
| **(in thousands, except per share amounts)**                                   |   | **2003**                                      |   | **2002**                                     |   | **2003** |   | **2002** |   |
|                                                                           |   | **(unaudited****)**                           |   | **(unaudited****)**                          |   |
| Net loss under Canadian GAAP                                                   |   | $                                             | (5,623 | )                                            | $      | (2,280 | ) | $ | (12,483 | ) | $ | (24,743 | ) |
|                                                                           |   |                                          |   |                                         |   |   |   |   |   |
| Net loss under U.S. GAAP (See Note 5 for  reconciliation to Canadian GAAP)     |   | $                                             | (5,463 | )                                            | $      | (3,668 | ) | $ | (11,933 | ) | $ | (24,941 | ) |
|                                                                           |   |                                          |   |                                         |   |   |   |   |   |
| Employee stock compensation included in net loss  under Canadian and U.S. GAAP |   | $                                             | 50     |                                         | $      | 57 |   | $ | 157 |   | $ | 173 |   |
|                                                                           |   |                                          |   |                                         |   |   |   |   |   |
| Stock-based employee compensation expense under the  fair value method         |   | (628                                          | )      | (907                                         | )      | (1,796 | ) | (2,721 | ) |
|                                                                           |   |                                          |   |                                         |   |   |   |   |   |
| Pro forma net loss under Canadian GAAP                                         |   | $                                             | (6,201 | )                                            | $      | (3,130 | ) | $ | (14,122 | ) | $ | (27,291 | ) |
|                                                                           |   |                                          |   |                                         |   |   |   |   |   |
| Pro forma net loss under U.S. GAAP                                             |   | $                                             | (6,041 | )                                            | $      | (4,518 | ) | $ | (13,572 | ) | $ | (27,489 | ) |
|                                                                           |   |                                          |   |                                         |   |   |   |   |   |
| Pro forma basic loss per common share under  Canadian GAAP                     |   | $                                             | (0.10  | )                                            | $      | (0.05 | ) | $ | (0.23 | ) | $ | (0.47 | ) |
|                                                                           |   |                                          |   |                                         |   |   |   |   |   |
| Pro forma basic loss per common share under U.S.  GAAP                         |   | $                                             | (0.10  | )                                            | $      | (0.08 | ) | $ | (0.22 | ) | $ | (0.47 | ) |

 

The weighted-average per-share fair values of the individual optionsgranted during the three and nine month periods ended September 30, 2003 were$1.00 and $1.06, respectively, compared to $1.74 and $2.63 for the same periodsin 2002.  The fair values of the optionswere determined using a Black-Scholes option-pricing model with the followingassumptions:

 
|                    |   | **For the three months  ended September 30,** |   | **For the nine months  ended September 30,** |   |
|-------------------------|--------|-----------------------------------------------|--------|----------------------------------------------|--------|
| **(unaudited)**         |   | **2003**                                      |   | **2002**                                     |   | **2003** |   | **2002** |   |
| Dividend yield          |   | 0                                             | %      | 0                                            | %      | 0 | % | 0 | % |
| Volatility              |   | 78                                            | %      | 60                                           | %      | 80 | % | 60 | % |
| Risk-free interest rate |   | 2.7                                           | %      | 5.5                                          | %      | 2.5 | % | 5.5 | % |
| Expected life           |   | 4 years                                       |   | 4 years                                      |   | 4 years |   | 4 years |   |

 

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*New Accounting Pronouncements*

 

The FASB issued SFAS No. 148, *Accountingfor Stock-Based Compensation, Transition and Disclosure*in December2002.  SFAS No. 148 provides alternativetransition methods for entities that voluntarily elect to adopt the fair value recognitionprovisions of the FASB Statement No. 123, *Accountingfor Stock-Based Compensation,*to stock-based employeecompensation.  In addition, SFAS No. 148requires more prominent pro forma disclosures of the effect on net income andearnings per share if the company had applied these fair value recognitionprovisions.  The transition and annualdisclosure provisions of SFAS No. 148 are effective for fiscal years endingafter December 15, 2002.  While we havenot elected to adopt the provisions in SFAS 123, we have disclosed our proforma financial results in Note 1 of the accompanying financial statements.

 

**2.****                                      COLLABORATIVEAGREEMENT**

 

In June 2002 the Company entered into a collaboration agreement for theco-development and global commercialization of the Company’s innovativeproprietary CoValTM fusion product candidate, HspE7, with F. Hoffmann-LaRoche and Hoffmann-La Roche Inc. (collectively, “Roche”).  Under the terms of the agreement, Roche hasthe worldwide exclusive right to manufacture, market and sell the HspE7 productand the Company has the right to co-promote the product in the U.S. to certainphysician specialties.  For the three and nine months endedSeptember 30, 2003, the Company recognized collaborative R&D revenue of$855,000 and $7,584,000, respectively, including $2,214,000 related to adevelopment milestone earned in March 2003. Further, in July 2002 and April2003, Roche made equity investments (see Note 3) in the Company totaling$7,657,000 and $4,594,000, respectively.

 

Upon receiving the upfront license fee payment from Roche in 2002, theCompany recorded a $634,320 payable due to MIT/Whitehead and a related deferredexpense.  The payment was made inJanuary 2003.  The Company recognizesthe related deferred expense over the development period.  At September 30, 2003 and December 31, 2002,the Company had a total of $390,116 and $561,778, respectively, of deferredexpense related to this payment.  Uponreceiving the $2,214,000 milestone payment in April 2003 (see Note 2), theCompany recorded an additional $221,000 payable due to MIT/Whitehead and arelated deferred expense.  At September30, 2003 all payments due to MIT/Whitehead have been made.

 

**3.****                                      BALANCESHEET DETAILS**

 

In September 2003, the Company entered into a36 month term loan agreement collateralized by equipment owned by theCompany.  At September 30, 2003, therewas $1,004,000 outstanding on the loan. Under the terms of the agreement, the Company must issue a letter ofcredit for the outstanding loan balance if combined cash, cash equivalents, andshort-term investments fall below $6,000,000.

 

The following tables provide details of selected balance sheet items:

 

7

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| **(In thousands)**                           |   | **September 30,  2003** |   | **December 31,  2002** |   |
|----------------------------------------------|--------|-------------------------|--------|------------------------|--------|
|                                         |   | **(unaudited)**         |   |                   |   |
| Accounts receivable:                         |   |                    |   |                   |   |
| Trade accounts receivable                    |   | $                       | 614    |                   | $      | 527 |   |
| Collaborative receivable                     |   | 435                     |   | 3,790                  |   |
| Less:   allowance for doubtful accounts |   | (38                     | )      | (38                    | )      |
|                                         |   | $                       | 1,011  |                   | $      | 4,279 |   |
|                                         |   |                    |   |                   |   |
| Inventories:                                 |   |                    |   |                   |   |
| Raw materials, net                           |   | $                       | 226    |                   | $      | 417 |   |
| Work in progress, net                        |   | 105                     |   | 145                    |   |
| Finished goods, net                          |   | 301                     |   | 276                    |   |
|                                         |   | $                       | 632    |                   | $      | 838 |   |
|                                         |   |                    |   |                   |   |
| Accounts payable and accrued liabilities:    |   |                    |   |                   |   |
| Clinical trial accruals                      |   | $                       | 2,932  |                   | $      | 3,133 |   |
| Trade accounts payable                       |   | 1,633                   |   | 3,607                  |   |
| Accrued compensation and benefits            |   | 1,007                   |   | 1,274                  |   |
| Royalty payable                              |   | —                  |   | 634                    |   |
| Other accrued liabilities                    |   | 110                     |   | 185                    |   |
|                                         |   | $                       | 5,682  |                   | $      | 8,833 |   |

 
|                   |   | **September 30, 2003 (unaudited)** |   | **December 31,  2002**        |   |
|------------------------|--------|------------------------------------|--------|-------------------------------|--------|
| **(In thousands)**     |   | **Cost**                           |   | **Accumulated  Depreciation** |   | **Net Book  Value** |   | **Net Book  Value** |   |
| Capital Assets:        |   |                               |   |                          |   |   |   |   |   |
| Laboratory equipment   |   | $                                  | 4,395  |                          | $      | 2,678 |   | $ | 1,717 |   | $ | 1,932 |   |
| Computer equipment     |   | 1,025                              |   | 702                           |   | 323 |   | 393 |   |
| Furniture and fixtures |   | 561                                |   | 375                           |   | 186 |   | 240 |   |
| Leasehold improvements |   | 716                                |   | 592                           |   | 124 |   | 181 |   |
|                   |   | $                                  | 6,697  |                          | $      | 4,347 |   | $ | 2,350 |   | $ | 2,746 |   |

 

*Stockholders’ equity*

 

In June 2002 the Company issued 2,036,436 common sharesfor $7,657,000 pursuant to the collaboration agreement with Roche (see Note2).  The equity was issued at a pershare price determined by the weighted average price of common shares of theCompany during the ten business days prior to the Roche transaction.   The Company also issued two warrants toacquire between 2,036,435 and 2,356,000 additional common shares.  The Company allocated $1,264,000 as the fairvalue of the warrants, as determined by an independent valuation expert.  In April 2003 the Company providednotice for Roche to exercise one of the warrants; Roche subsequently purchased1,413,600 common shares at $3.25, resulting in net proceeds of $4,594,000 tothe Company.  An exercise of the secondwarrant would result in the future issuance of between 814,574 and 942,400additional common shares, at an exercise price ranging from $3.76 to $3.25 pershare, depending upon whether the Company calls the warrant and upon the priceof the Company’s common stock.  Rochemay exercise the second warrant until June 28, 2007.

 

8

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Stockholders’ equity at September 30, 2003 and December 31, 2002includes $2,174,000 and $2,179,000,respectively of contributed surplus. At September 30, 2003 and December 31, 2002, there were 66,088,170 and68,541,541 fully diluted (exercisable) common shares, respectively.

 

*Employee share option plan*

 

In 2001, the Company issued out-of-plan stock options prior tostockholder approval of the 2001 Equity Incentive Plan (the “2001 Plan”).  Between the date of grant and stockholderapproval, the market price of the Company’s common stock increased, resultingin deferred compensation of $807,000 associated with these options.  The deferred compensation is amortized as anexpense over the vesting period of the granted options.  The stockholders subsequently approvedadoption of the 2001 Plan, reserving an additional 3,500,000 new common sharesfor issuance pursuant to the grant of stock options.  Once the 2001 Plan was approved, the 2001 grants ceased to beconsidered out-of plan.   In addition,the Company stopped granting options under its pre-existing 1996 ShareIncentive Plan.  At September 30, 2003,there were 329,423 options available for future grant under the 2001 Plan.

 

The following table summarizes information related to all stock optionsoutstanding and exercisable as of September 30, 2003.

 
|                          |   | **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                |   | 1,521,464                |   | 7.54                                                           |   | $ | 1.70 |   | 853,677 |   | $ | 1.74 |   |
| $ 2.00 - $3.99                |   | 625,333                  |   | 8.91                                                           |   | $ | 3.25 |   | 285,933 |   | $ | 3.50 |   |
| $ 4.00 - $5.99                |   | 1,489,100                |   | 7.67                                                           |   | $ | 4.87 |   | 1,015,932 |   | $ | 4.86 |   |
| $ 6.00 - $8.00                |   | 1,544,600                |   | 6.69                                                           |   | $ | 6.19 |   | 1,416,265 |   | $ | 6.19 |   |
|                          |   | 5,180,497                |   |                                                           |   |   |   | 3,571,807 |   |   |   |

 

At October 27, 2003 there were approximately 5,177,000 optionsoutstanding.

 

9

----

 

**4.****                                      SEGMENTINFORMATION**

 

The Company manages its operations in two reportable segments,Biotechnology and Bioreagents.  Revenuesare allocated to countries based on customer locations.  The Company does not allocate interest andother income, foreign exchange losses or interest on capital lease obligationsto each segment.

 
|                                |   | **Three months ended  September 30,** |   | **Nine months ended  September 30,** |   |
|-------------------------------------|--------|---------------------------------------|--------|--------------------------------------|--------|
| **(in thousands)**                  |   | **2003**                              |   | **2002**                             |   | **2003** |   | **2002** |   |
|                                |   | **(unaudited)**                       |   | **(unaudited)**                      |   |
| **Biotechnology**                   |   |                                  |   |                                 |   |   |   |   |   |
| Collaborative R&D revenue       |   | $                                     | 855    |                                 | $      | 4,332 |   | $ | 7,584 |   | $ | 4,332 |   |
|                                |   |                                  |   |                                 |   |   |   |   |   |
| Expenses:                           |   |                                  |   |                                 |   |   |   |   |   |
| Research and development            |   | 5,569                                 |   | 7,159                                |   | 16,099 |   | 25,651 |   |
| Selling, general and administrative |   | 1,151                                 |   | 1,536                                |   | 4,394 |   | 5,432 |   |
|                                |   | 6,720                                 |   | 8,695                                |   | 20,493 |   | 31,083 |   |
| Operating loss                      |   | $                                     | (5,865 | )                                    | $      | (4,363 | ) | $ | (12,909 | ) | $ | (26,751 | ) |
|                                |   |                                  |   |                                 |   |   |   |   |   |
| **Bioreagents**                     |   |                                  |   |                                 |   |   |   |   |   |
| Revenue:                            |   |                                  |   |                                 |   |   |   |   |   |
| U.S.                                |   | $                                     | 908    |                                 | $      | 1,030 |   | $ | 2,763 |   | $ | 2,913 |   |
| Canada                              |   | 66                                    |   | 75                                   |   | 192 |   | 220 |   |
| Other                               |   | 342                                   |   | 389                                  |   | 1,153 |   | 1,257 |   |
|                                |   | 1,316                                 |   | 1,494                                |   | 4,108 |   | 4,390 |   |
| Expenses:                           |   |                                  |   |                                 |   |   |   |   |   |
| Research and development            |   | 440                                   |   | 288                                  |   | 1,194 |   | 857 |   |
| Selling, general and administrative |   | 359                                   |   | 368                                  |   | 1,272 |   | 1,138 |   |
| Cost of bioreagent sales            |   | 296                                   |   | 419                                  |   | 1,049 |   | 1,228 |   |
|                                |   | 1,095                                 |   | 1,075                                |   | 3,515 |   | 3,223 |   |
| Operating income                    |   | $                                     | 221    |                                 | $      | 419 |   | $ | 593 |   | $ | 1,167 |   |
|                                |   |                                  |   |                                 |   |   |   |   |   |
| **Totals**                          |   |                                  |   |                                 |   |   |   |   |   |
| Revenue:                            |   |                                  |   |                                 |   |   |   |   |   |
| Collaborative R&D revenue       |   | $                                     | 855    |                                 | $      | 4,332 |   | $ | 7,584 |   | $ | 4,332 |   |
| Bioreagent sales                    |   | 1,316                                 |   | 1,494                                |   | 4,108 |   | 4,390 |   |
| Total revenue                       |   | 2,171                                 |   | 5,826                                |   | 11,692 |   | 8,722 |   |
|                                |   |                                  |   |                                 |   |   |   |   |   |
| Expenses:                           |   |                                  |   |                                 |   |   |   |   |   |
| Research and development            |   | 6,009                                 |   | 7,447                                |   | 17,293 |   | 26,508 |   |
| Selling, general and administrative |   | 1,510                                 |   | 1,904                                |   | 5,666 |   | 6,570 |   |
| Cost of bioreagent sales            |   | 296                                   |   | 419                                  |   | 1,049 |   | 1,228 |   |
|                                |   | 7,815                                 |   | 9,770                                |   | 24,008 |   | 34,306 |   |
|                                |   |                                  |   |                                 |   |   |   |   |   |
| Operating loss                      |   | $                                     | (5,644 | )                                    | $      | (3,944 | ) | $ | (12,316 | ) | $ | (25,584 | ) |

 

10

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**5.****                                     ****THE EFFECT OF APPLYINGACCOUNTING PRINCIPLES GENERALLY ACCEPTED IN THE U.S.**

 

These financial statements have been prepared in accordance withCanadian GAAP which, except as set out below, conform in all material respectsto U.S. GAAP.

 

Effect on the consolidated financial statements:

 

*Balance Sheet*

 

For all periods presented there are no significant balance sheetdifferences under Canadian and U.S. GAAP.

 

*Statement of Operations*

 
|                                                                                      |   | **Three months ended  September 30,** |   | **Nine months ended  September 30,** |   |
|-------------------------------------------------------------------------------------------|--------|---------------------------------------|--------|--------------------------------------|--------|
| **(In thousands except per share amounts)**                                               |   | **2003**                              |   | **2002**                             |   | **2003** |   | **2002** |   |
|                                                                                      |   | **(unaudited)**                       |   | **(unaudited)**                      |   |
| Net loss under Canadian GAAP                                                              |   | $                                     | (5,623 | )                                    | $      | (2,280 | ) | $ | (12,483 | ) | $ | (24,743 | ) |
| Reversal of unrealized foreign exchange (gain)  loss on available-for-sale securities (*) |   | (124                                  | )      | (890                                 | )      | 214 |   | (85 | ) |
| Reversal of write-down (up) of short-term  investments (*)                                |   | 284                                   |   | (498                                 | )      | 336 |   | (113 | ) |
|                                                                                      |   | 160                                   |   | (1,388                               | )      | 550 |   | (198 | ) |
|                                                                                      |   |                                  |   |                                 |   |   |   |   |   |
| Net loss under U.S. GAAP                                                                  |   | $                                     | (5,463 | )                                    | $      | (3,668 | ) | $ | (11,933 | ) | $ | (24,941 | ) |
|                                                                                      |   |                                  |   |                                 |   |   |   |   |   |
| Basic loss per common share under Canadian GAAP                                           |   | $                                     | (0.09  | )                                    | $      | (0.04 | ) | $ | (0.20 | ) | $ | (0.42 | ) |
|                                                                                      |   |                                  |   |                                 |   |   |   |   |   |
| Basic loss per common share under U.S. GAAP                                               |   | $                                     | (0.09  | )                                    | $      | (0.06 | ) | $ | (0.20 | ) | $ | (0.43 | ) |
|                                                                                      |   |                                  |   |                                 |   |   |   |   |   |
| Common shares used to compute basic loss per share  under Canadian and U.S. GAAP          |   | 61,692                                |   | 60,179                               |   | 61,048 |   | 58,573 |   |

 

*Statement of CashFlows*

 

For all periods presented there are no significant differences underCanadian and U.S. GAAP in net cash (used in) provided by operating, investingand financing activities.

 

*Differences*

 

As disclosed in Note 11 to the financialstatements in the Company’s December 31, 2002 Annual Report on Form 10-K,differences exist for the Company between Canadian and U.S. GAAP.

 

The following outlines the differences thataffect the Company for the three and nine month periods ended September 30, 2003and 2002.

 

----

(*)                                 Under U.S. GAAPStatement of Financial Accounting Standards (“SFAS”) No. 115, *Accounting for Certain Investments in Debt and EquitySecurities*, the Company has classified certain of its short-termsecurities as available-for-sale and, accordingly, has included the changes innet unrealized holding gains or losses on these securities as a component ofstockholders’ equity rather than in operations.

 

11

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SFAS No. 130, *Reporting ComprehensiveIncome,* establishes standards for the reporting and display ofcomprehensive income and its components (revenue, expenses, gains and losses)in a full set of general-purpose financial statements.  Comprehensive income is as follows:

 
|                                                                                                   |   | **Three months ended  September 30,** |   | **Nine months ended  September 30,** |   |
|--------------------------------------------------------------------------------------------------------|--------|---------------------------------------|--------|--------------------------------------|--------|
| **(In thousands except per share amounts)**                                                            |   | **2003**                              |   | **2002**                             |   | **2003** |   | **2002** |   |
|                                                                                                   |   | **(unaudited)**                       |   | **(unaudited)**                      |   |
| Net loss under U.S. GAAP                                                                               |   | $                                     | (5,463 | )                                    | $      | (3,668 | ) | $ | (11,933 | ) | $ | (24,941 | ) |
| Other comprehensive income                                                                             |   |                                  |   |                                 |   |   |   |   |   |
| Adjustment to unrealized foreign exchange and  market gains (losses) on available-for-sale investments |   | (160                                  | )      | 1,388                                |   | (550 | ) | 198 |   |
| Comprehensive net loss under U.S. GAAP                                                                 |   | $                                     | (5,623 | )                                    | $      | (2,280 | ) | $ | (12,483 | ) | $ | (24,743 | ) |
|                                                                                                   |   |                                  |   |                                 |   |   |   |   |   |
| Comprehensive loss per share under U.S. GAAP                                                           |   | $                                     | (0.09  | )                                    | $      | (0.04 | ) | $ | (0.20 | ) | $ | (0.42 | ) |

 

**6.****                                      SUPPLEMENTALCASH FLOW INFORMATION**

 

The changes in operating assets andliabilities are as follows:

 
|                                                               |   | **Three months ended  September 30,** |   | **Nine months ended  September 30,** |   |
|--------------------------------------------------------------------|--------|---------------------------------------|--------|--------------------------------------|--------|
| **(In thousands)**                                                 |   | **2003**                              |   | **2002**                             |   | **2003** |   | **2002** |   |
|                                                               |   | **(unaudited)**                       |   | **(unaudited)**                      |   |
| Collaborative receivable                                           |   | $                                     | 645    |                                 | $      | (3,673 | ) | $ | 3,355 |   | $ | (3,673 | ) |
| Trade receivables                                                  |   | 71                                    |   | 24                                   |   | (87 | ) | (82 | ) |
| Inventories                                                        |   | 65                                    |   | (15                                  | )      | 206 |   | (44 | ) |
| Other current assets                                               |   | (269                                  | )      | (121                                 | )      | (85 | ) | (347 | ) |
| Deferred expenses, net of current portion                          |   | 31                                    |   | (459                                 | )      | 151 |   | (459 | ) |
| Accounts payable and accrued liabilities                           |   | 950                                   |   | (1,830                               | )      | (3,151 | ) | 902 |   |
| Deferred revenue                                                   |   | (250                                  | )      | 4,755                                |   | (1,363 | ) | 4,755 |   |
|                                                               |   | $                                     | 1,243  |                                 | $      | (1,319 | ) | $ | (974 | ) | $ | 1,052 |   |
| Supplemental disclosures of cash flows:                            |   |                                  |   |                                 |   |   |   |   |   |
| Interest paid                                                      |   | $                                     | 8      |                                 | $      | 15 |   | $ | 28 |   | $ | 54 |   |
|                                                               |   |                                  |   |                                 |   |   |   |   |   |
| Supplemental disclosures of non-cash transactions                  |   |                                  |   |                                 |   |   |   |   |   |
| Reversal of deferred compensation related to  terminated employees |   | $                                     | 4      |                                 | $      | — |   | $ | 4 |   | $ | 28 |   |

 

12

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**MANAGEMENT****’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS**

 

TheManagement’s Discussion and Analysis of Financial Condition and Results ofOperations contains forward-looking statements that involve risks anduncertainties.  The predictionsdescribed in these statements may not materialize if management’s currentexpectations regarding our future performance prove incorrect. Our resultscould also be affected by factors including, but not limited to, our relianceon collaborative partners and other risks described below under “Factors ThatCould Affect Future Performance.”  Theforward-looking statements are based on currently available information; wedisclaim any obligation to update them.

 

The followinginformation should be read in conjunction with our September 30, 2003consolidated financial statements and related notes therein, which are preparedin accordance with Canadian generally accepted accounting principles orCanadian GAAP.  These principles differin certain respects from accounting principles generally accepted in the UnitedStates or U.S. GAAP.  The differences,as they affect our consolidated financial statements, are described in Note 5to our September 30, 2003 consolidated financial statements.  All amounts following are expressed inCanadian dollars unless otherwise indicated.

 

## **Overview**

## ** **

Our activitiesare focused primarily on the research and development of a unique class ofproteins, called stress proteins or heat shock proteins, to regulate the body’sown immune response to combat infectious diseases and cancer.  We believe that the use of stress proteins,genetically combined with various antigens derived from disease-causingorganisms or cancer cells, can yield novel therapeutic products.

 

In June 2002we entered into a strategic collaboration with F. Hoffmann-La Roche andHoffmann-La Roche Inc. (collectively, “Roche”) for the development of ourproduct for the treatment of human papilloma virus, known as HspE7.   This partnership and future partnershipscould enable us to develop our product candidates and exploit new applicationsfor our technology, resulting in additional product opportunities.

 

We haveincurred significant losses since our inception and expect to incur substantiallosses for the foreseeable future as we invest in our research and productdevelopment programs, including manufacturing, pre-clinical studies andclinical trials, and regulatory activities. At September 30, 2003 our accumulated deficit was $146,532,000.  Historically, we have depended principallyon equity financings to fund our business activities.  We intend to pursue additional equity financings to fund ourbusiness activities, markets permitting.

 

## **Liquidityand Capital Resources**

## ** **

Sinceinception we have relied principally on equity financings, coupled with cashflows generated from our bioreagents business, to fund our research anddevelopment programs, operations and capital expenditures.  ThroughSeptember 30, 2003 we have raised net equity proceeds of $180,092,000,principally through our public issuances of stock, the exercise of warrants andstock options issued since 1996 and, more recently, the issuance of stock andwarrants to Roche in connection with the collaboration agreement.  Weemploy a financial performance measurement system designed to ensure ourrevenues and expenses are consistent with management’s operational objectivesand budgetary constraints.  The variability of anticipated cashutilization is dependent upon several factors, including the timing and extentof clinical development of HspE7.  Webelieve that our current capital resources are sufficient to fund operationsinto 2005.  This belief is based on ourevolving research and development plans, the current regulatory environment,our historical industry experience in the development of therapeutics andgeneral economic conditions.  Under ourcollaborative agreement, Roche is obligated to fund process development and manufactureHspE7 for clinical development and commercialization.  At this time, we do not have

 

13

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internal manufacturing capabilities to supplyclinical trials or commercial quantities of HspE7.  If we are required or choose to manufacture HspE7 for clinicaltrials or on a commercial scale, we will need significant additionalfunds.  If adequate funds are notavailable, we may be required to delay, reduce the scope of, or eliminate thedevelopment of HspE7 or other research or development programs.

 

At September 30, 2003 we had cash, cash equivalents and short-terminvestments of $38,581,000, a decrease of $7,432,000 from December 31,2002.  Approximately 23% of cash, cashequivalents and short-term investments were held in U.S. dollars as of September30, 2003, compared to approximately 13% as of December 31, 2002.

 

During the three and nine months ended September 30, 2003, capitalexpenditures totaled $100,000 and $154,000 respectively compared with $151,000and $319,000 for the same periods in 2002. Capital purchases in 2003 are consistent with management’s investmentpolicy limiting purchases to those required to preserve our current level ofmanufacturing and research capabilities.

 

We have a credit facility for $2,000,000 with a Canadian charteredbank.  At September 30, 2003 andDecember 31, 2002, $328,000 and $541,000, respectively were used andoutstanding under this facility in the form of fixed rate capital leases.   In September 2003 we entered into a termloan agreement with Oxford Finance Corporation, collateralized by equipmentowned by the Company.  At September 30,2003 there was $1,004,000 outstanding on the loan.  Under the terms of the agreement, the Company must issue a letterof credit for the outstanding loan balance if combined cash, cash equivalents,and short-term investments fall below $6,000,000.

 

We willrequire additional capital to fund future research and product developmentactivities.  We expect to seekadditional funds from various sources, including corporate partners that enterinto research and development collaborations with us, and public and privateequity financings.  We cannot assure youthat additional financing will be available when needed or on satisfactoryterms.  If we raise additional funds byissuing equity securities, substantial dilution to our existing shareholdersmay result.  We may need to obtain fundsthrough collaborative arrangements with others that are on unfavorable terms.  We may also have to relinquish rights tocertain of our technologies, product candidates or products that we wouldotherwise seek to develop ourselves.

 

## **Results of Operations**

## ** **

For the threeand nine months ended September 30, 2003, our net loss was $5,623,000 and$12,483,000 or $0.09 and $0.20per common share.  This compares with anet loss of $2,280,000 and $24,743,000 or $0.04 and $0.42 per common share forthe same periods in 2002.  Our increasednet loss during the current quarter compared to the same quarter in 2002 isdue, in part, to the timing of research and development (“R&D”) activities,including the current quarter’s completion of phase III AIN and phase II RRPclinical studies, together with a reduction in collaboration revenue generatedby R&D activities reimbursable by Roche. The aggregate improvement during the nine month period in 2003 over 2002is also attributed to the extent of collaboration revenue and timing of HspE7clinical trials.

 

***CollaborativeR&D revenue***

 

CollaborativeR&D revenue was $855,000 and $7,584,000 for the three and nine months endedSeptember 30, 2003, compared with $4,332,000 for the same periods in 2002.  Collaborative R&D revenue for the ninemonths ended September 30, 2003 includes $4,615,000 for development activitiesin support of Roche, a time-based development payment of $2,214,000, and$755,000 from the amortization of up-front license fees in accordance with SABNo. 101, *Revenue Recognition in FinancialStatements.*Collaborative R&D revenue declined in the currentthree month period due to fewer research activities being performed by theCompany compared to the period immediately after the consummation of thecollaboration agreement.

 

14

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### ***Bioreagent sales***

### *** ***

The productionand sale of bioreagents supports our business strategy by building our marketpresence in stress proteins and strengthening our strategic relationships withcompanies, academic institutions and stress response researchers. Our productsare sold directly to end-users and through third party distributors.  The overall economic slowdown in NorthAmerica caused industry-wide demand for bioreagents to slow; consequently, ourbioreagent sales have declined to $1,316,000 and $4,108,000 for the three andnine months ended September 30, 2003, respectively, compared with $1,494,000and $4,390,000, for the same periods in 2002. Foreign exchange fluctuations between the U.S. and Canadian dollar alsohad an unfavorable effect on our reported sales results, totaling approximately$168,000 and $393,000 during the three and nine month periods ended September30, 2003 compared to last year’s foreign currency exchange during the sameperiods.  These impacts were partiallyoffset by the introduction of several higher priced kit-based research products.

 

***Research anddevelopment***

 

Research anddevelopment, 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 our productdevelopment and manufacturing.

 

R&Dspending decreased by approximately 19% and 35% to $6,009,000 and $17,293,000,respectively, for the three and nine months ended September 30, 2003, comparedwith $7,447,000 and $26,508,000 for the same periods in 2002.  Thedecrease for the nine month period in 2003 reflects the cost shift of HspE7manufacturing scale-up costs and other product development efforts to Roche,partially offset by the timing of HspE7 clinical trials.  Approximately 65% of our R&D spendingrelated to efforts developing HspE7 during the nine months ended September 30,2003, while most of the remaining spending related to exploratory research,including our follow-on CoValTM fusion product candidates.

 

***Selling, general andadministrative expenses***

 

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

 

SG&Aspending decreased by approximately 21% and 14% to $1,510,000 and $5,666,000,respectively, for the three and nine months ended September 30, 2003, comparedwith $1,904,000 and $6,570,000 for the same periods in 2002.  The decline in spending is attributed to significantbusiness development costs incurred in 2002 to consummate the Rochecollaboration agreement.

 

***Cost of bioreagentsales***

 

The aggregatecost of bioreagent sales as a percentage of bioreagent sales was approximately22% and 26% for the three andnine months ended September 30, 2003, resulting in gross margins of 78% and 74%compared with 72% for the same periods in 2002.    The improvement compared to the prior period is due principallyto improved efficiency in the manufacturing process and related allocated****overhead.

 

# ***Interest and other income, net***

# *** ***

Interest andother income, net decreased to $41,000 and $499,000 for the three and ninemonths ended September 30, 2003 compared to $777,000 and $1,059,000 in the sameperiods in the prior year.  The reductionin interest and other income in the current three month period compared to thesame period last year is principally due to a temporary loss on the marketvalue of investments, which is expected to reverse during the fourth quarter of2003.  Further, lower market interestrates applied to a lower investment portfolio balance contributed to thedecline.

 

15

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***Net realized foreignexchange loss***

 

During thethree and nine months ended September 30, 2003 and 2002, the US dollar weakenedagainst the Canadian dollar.  Our lossdue to foreign exchange rate fluctuation during the three and nine months endedSeptember 30, 2003, was $12,000 and $638,000 respectively, compared to aforeign exchange gain of $902,000 and a loss of $164,000, respectively, in2002.  During the past several quarters,the U.S. and Canadian dollar exchange rate has fluctuated dramatically, causinggains and losses from quarter to quarter. We have attempted to minimize this foreign exchange volatility byensuring that the majority of our investments are denominated in Canadiandollars.

 

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

# *** ***

The 147% increase and 50% decrease in net loss to $5,623,000 and$12,483,000 for the three and nine months ended September 30, 2003,respectively, compared to $2,280,000 and $24,743,000 in 2002, was diluted by a3% and 4% increase in the weighted average number of common shares outstandingfor the three and nine months ended September 30, 2003, respectively.   This improvement resulted in a basic anddiluted loss per share of $0.09 and $0.20 for the three and nine month periodsended September 30, 2003, as compared with $0.04 and $0.42 for the same periodsin 2002.

 

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

### *** ***

Ourconsolidated financial statements include adjustments necessary for their fairpresentation in 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 $160,000 and$550,000 for the three and nine months ended September 30, 2003.  The principal differences under U.S. GAAP asopposed to Canadian GAAP for the three and nine month periods in 2003,respectively, were the reversal of an unrealized foreign exchange gain onavailable-for-sale securities of $124,000 and a loss of $214,000, coupled witha $284,000 and $336,000 reversal of a write-down of short-term investments.  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 ofretained earnings.

 

Similarly, toconform to U.S. GAAP for the three and nine months ended September 30, 2002,our net loss would increase by $1,388,000 and $198,000, respectively.  The principal differences under U.S. GAAPcompared to Canadian GAAP were the reversal of unrealized foreign exchangegains on available-for-sale securities of $890,000 and $85,000 for the sameperiods in 2002, coupled with a $498,000 and $113,000 reversal of a write-up ofshort-term investments in those same periods.

 

Basicnet loss per common share under U.S. GAAP would have been $0.09 and $0.20 inthe three and nine months ended September 30, 2003, compared to $0.06 and $0.43during the same periods in the prior year. Our current assets and stockholders’ equity at September 30, 2003 arethe same under U.S. GAAP and Canadian GAAP: $40,827,000 and $33,325,000,respectively.

 

## **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:

 

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***Revenue recognition***

 

Revenue from collaborative R&D arrangements may include multipleelements within a single contract.  Ouraccounting policy complies with the revenue determination requirements setforth in EITF 00-21 “Accounting for Revenue Arrangements with MultipleDeliverables,” relating to the separation of multiple deliverables intoindividual accounting units with determinable fair values.  Under the guidance of EIT 00-21, we haveestimated the fair value of deliverables in the Roche agreement using standardindustry techniques.  Changes in thedetermination of fair values or performance periods relating to certain deliverables,and associated milestones, could impact the timing of future revenue streams.

 

***Clinical trialaccruals***

 

Clinical trialcosts constitute a significant portion of R&D expense.  The Company recognizes expenses related toits ongoing clinical trials using a methodology designed to accrue estimatedcosts in the appropriate accounting periods. Clinical trials can span multiple accounting periods.  The Company recognizes clinical trial costsin three distinct phases:  start-upphase, patient accrual phase, and close-out phase.  Our expenses related to clinical trials vary based on patientavailability, additional statistical analysis requirements, and decisions toextend the patient evaluation period. Using our current trial accrual methodology, our liability for clinicaltrials as of September 30,2003 is $2,932,000, including the effect of any workin 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 September 30, 2003 compared to the total contract value, ourclinical trial liability would decrease by approximately $1,100,000.

 

**FACTORSTHAT COULD 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 adversely affectedby these and other risks.**

 

**We Are At an Early Stage of Development**

 

Our biotechnology business is still at an early stage ofdevelopment.  Significant additionalresearch and development and clinical trials must be completed before ourtechnology can be commercialized.  Wehave not completed the development of any therapeutic products and, therefore,have not begun to market or generate revenues from the commercialization of anytherapeutic products.  We haveundertaken only limited human clinical trials for some of our productcandidates and we cannot assure you that the results obtained from laboratoryor research studies will be replicated in human studies or that such humanstudies will not identify undesirable side effects.  We cannot assure you that any of our products will meetapplicable health regulatory standards, obtain required regulatory approvals orclearances, be produced in commercial quantities at reasonable costs, besuccessfully marketed or be profitable enough that we will recoup theinvestment made in such product candidates.  None of our therapeutic product candidates are expected to becommercially available for several years. There is no precedent for the successful commercialization of productsbased on our CoValTM fusion technology.  It is possible that we will not successfully develop anytherapeutic products.

 

**We Have a History of Operating Losses and WeMay Never Become Profitable**

 

We have not recorded any revenues from the sale of therapeutic productsand have accumulated substantial net losses. We expect to incur continued losses for at least the next several yearsas we continue research and development, and clinical trials.  To become profitable we, either alone orwith one or more partners, must develop, manufacture and successfully marketour product candidates.

 

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**We Must Obtain Additional Financing toExecute Our Business Plan**

 

Our revenues from the production and sale of bioreagents and theprojected revenues and expense reimbursements from our HspE7 collaboration arenot adequate to support the therapeutic product development programs.  We will need substantial additional funds topursue further research and development; carry out clinical trials; obtainregulatory approvals; file, prosecute, defend and enforce our intellectualproperty rights and market our products. We will seek additional funds through public or private equity or debtfinancing, strategic transactions and/or from other sources.  We could enter into collaborativearrangements for the development of particular products that would lead to ourrelinquishing some or all of our rights to the related technology or products.

 

Although we expect to seek additional funding when there are marketopportunities, future funding may not be available on favorable terms or atall.   If additional funding were notobtained, we would 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 its business, financial condition andresults of operations.

 

**Our Success Depends On Collaborative Partners, Licensees andOther Third Parties Over Whom We Have Limited Control**

 

Dueto the complexity of the process of developing therapeutics, our core businessdepends on our arrangements with pharmaceutical companies, corporate andacademic collaborators, licensors, licensees and others for the research,development, clinical testing, manufacturing, marketing and commercializationof our products. We have various research collaborations and outsource manyother business functions, including clinical trials and manufacturing.  We may not be able to establish or maintaincollaborations that are important to our business on favorable terms, if atall.  The Roche partnership currentlyrequires further information concerning the mechanism of action of the HspE7product.  We are working with Roche toaddress these questions.

 

A number of risks arise from our dependence on collaborative agreementswith third parties.  Our productdevelopment and commercialization efforts could be adversely affected if anycollaborative partner, including Roche, terminates or suspends its agreementwith us, causes delays, fails to timely develop or manufacture in adequatequantities a substance we need in order to conduct clinical trials, fails toadequately perform clinical trials, determines not to develop, manufacture orcommercialize a product to which it has or we have rights, or otherwise failsto meet its contractual obligations. Our collaborative partners could pursue other technologies or developalternative products that could compete with our future products.

 

We license technologies and materials from third parties for ourtherapeutic and our bioreagent businesses. We plan to acquire additional licenses from other companies and academicinstitutions.  Pursuant to the terms ofour license agreements, we could be obligated to diligently bring potentialproducts to market, make milestone payments that, in some instances, could besubstantial, and incur the costs of filing and prosecuting patentapplications.  We cannot assure you thatthese licenses will not terminate or that they will be renewed.  In addition, we cannot assure you that theselicenses will remain in good standing.  Our licensors may attempt to terminate our licenses for their ownbusiness reasons.

 

**The Profitability of Our Products Will DependOn Our Ability to Protect Our Proprietary Rights and Operate Without Infringingthe Proprietary Rights of Others**

 

Theprofitability of our products will depend in part on our ability to obtain andmaintain patents and licenses and preserve trade secrets, and the period ourintellectual property remains exclusive. We must also operate without infringing the proprietary rights of thirdparties and without third parties circumventing our rights. We have receivedU.S. and European patents and have filed and are actively pursuing applicationsfor additional patents.  The patentpositions of pharmaceutical and biotechnology enterprises, including ours, areuncertain and involve complex legal and factual questions for which

 

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important legal principles arelargely unresolved.  For example, noconsistent policy has emerged regarding the breadth of biotechnology patentclaims that are granted by the U.S. Patent and Trademark Office or enforced bythe U.S. federal courts.  In addition,the scope of the originally claimed subject matter in a patent application canbe significantly reduced before a patent is issued.  The biotechnology patent situation outside the U.S. is even moreuncertain, is currently undergoing review and revision in many countries, andmay not protect our intellectual property rights to the same extent as the lawsof the U.S.  Because patent applicationsare maintained in secrecy in some cases, we cannot be certain that we or ourlicensors are the first creators of inventions described in our pending patentapplications or patents or the first to file patent applications for suchinventions.

 

Othercompanies may independently develop similar products and design around anypatented products we develop.  We cannotassure you that any of our patent applications will result in the issuance ofpatents, that we will develop additional patentable products, that the patentswe have been issued will provide us with any competitive advantages, that thepatents of others will not impede our ability to do business or that thirdparties will not be able to circumvent our patents.  On October 22, 2002 Antigenics Inc. announced that it had filedan opposition in the European Patent Office to a European patent and requestsfor re-examination in the U.S. Patent Office of two U.S. patents we havelicensed.  Until we receive finalresults from the opposition and re-examination processes, we will not be ableto assure you of the success of our planned vigorous defense of the patents.

 

A number ofpharmaceutical, biotechnology, research and academic companies and institutionshave developed technologies, filed patent applications or received patents ontechnologies that may relate to our business. If these technologies, applications or patents conflict with ours, thescope of our current or future patents could be limited or our patentapplications could be denied.  Ourbusiness may be adversely affected if competitors independently developcompeting technologies, especially if we do not obtain, or only obtain narrow,patent protection.  If patents thatcover our activities are issued to other companies, we may not be able toobtain licenses at a reasonable cost, or at all, or develop alternativetechnology.  If we are blocked fromusing our current technologies we may not be able to introduce, manufacture orsell our planned products.

 

Patentlitigation is becoming widespread in the biotechnology industry.  Such litigation may affect our efforts toform collaborations, to conduct research or development, to conduct clinicaltesting or to manufacture or market any products under development.  We cannot assure you that our patents wouldbe held valid or enforceable by a court or that competitor’s technology orproduct would be found to infringe our patents.  Our business could be materially affected by an adverse outcometo such litigation.  Similarly, we mayparticipate in interference proceedings declared by the U.S. Patent andTrademark Office or equivalent international authorities to determine priorityof invention.  We could incursubstantial costs and devote significant management resources to defend ourpatent position or seek a declaration that the patents of others are invalid.

 

Much of our know-how and technology may not be patentable, though itmay constitute trade secrets. We cannot assure you that we will be able tomeaningfully protect our trade secrets. We cannot assure you that any of the existing confidentiality agreementswith our employees, consultants, advisors or collaborators will providemeaningful protection for our trade secrets, know-how or other proprietaryinformation in the event of any unauthorized use or disclosure.  Collaborators, advisors or consultants maydispute the ownership of proprietary rights to our technology, for example byasserting that they developed it independently.

 

**We May Encounter Difficulties in Developing ManufacturingCapabilities and Facilities or Entering into Contracts for Manufacturing withThird Parties**

 

Our manufacturing experience in bioreagents is not directly applicableto the manufacture of therapeutic products. We have not yet introduced any therapeutic products and have nomanufacturing experience with immunotherapeutics.  Before our products can be profitable they must be produced incommercial quantities in a cost-effective manufacturing process that complies withregulatory requirements.  Because we donot have facilities for the production of the products we are developing, we

 

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will depend on themanufacturing capabilities of collaborators. If we cannot arrange for or maintain commercial-scale manufacturing onacceptable terms, or if there are delays or difficulties in manufacturing, wemay not be able to conduct clinical trials, obtain regulatory approval or meetdemand for our products.

 

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

 

**We Could Need to Conduct More Clinical Trialsor Take More Time to Complete Our Clinical Trials Than We Originally Plan**

 

Clinical trials vary in design by factors including their dosage, endpoints, length, controls, and numbers and types of patients enrolled.  We may need to conduct a series of trials todemonstrate the safety and efficacy of our products.  In addition, we may be required to determine whether our productsdelay or prevent disease recurrence. Clinical trials to show that a disease does not recur take longer tocomplete than clinical trials that end when patients stop having specificsymptoms.  The actual schedules for ourclinical trials could vary dramatically from the forecasted schedules due tofactors including conflicts with the schedules of participating clinicians andclinical institutions, delayed patient accrual and changes affecting suppliesfor clinical trials.  For example, onJune 10, 2003, we announced that we would delay the start of a pivotal PhaseIII study of pediatric recurrent respiratory papillomatosis until we can usepilot final commercial grade material in the study.

 

We have limited experience in conducting clinical trials.  We rely on corporate collaborators such asRoche, academic institutions and clinical research organizations to conduct,supervise, monitor and design some or all aspects of clinical trials involvingour products.  In addition, the NCI issponsoring some HspE7 clinical trials. Since these trials depend on governmental participation and funding, wehave less control over their timing and design.  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 stock priceto decrease.

 

**We May Not Be Able to Obtain the RegulatoryApprovals or Clearances That Are Necessary to Commercialize Our Products**

 

The U.S., Canada and other countries impose significant statutory andregulatory obligations upon the manufacture and sale of human therapeuticproducts.  In order for our products toobtain marketing approval and clearance for each indication, our preclinicaland clinical data and manufacturing facilities will need to meet complexcriteria establishing the safety and efficacy of the ultimate products.

 

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

 

•                  the successfulcommercialization of our products could be adversely affected;

 

•                  our competitiveadvantages could be diminished; and

 

•                  revenues orcollaborative milestones from our products could be reduced or delayed.

 

Governmental and regulatory authorities may approve a product candidatefor fewer indications or narrower circumstances than we request or maycondition approval on the performance of post-marketing studies for a productcandidate.  Even if we receiveregulatory approval and clearance, our product candidates may later exhibitadverse side effects that limit or prevent their widespread use or that forceus

 

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to withdraw those productcandidates from the market.  Inaddition, any marketed product and its manufacturer will continue to be subjectto strict regulation after approval.  Anyunforeseen problems with an approved product or any violation of regulationscould result in restrictions on the product, including its withdrawal from themarket.

 

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 correspondingmaintenance records and documentation. If the manufacturers cannot comply with regulatory requirements includingapplicable good manufacturing practice requirements, we may not be allowed todevelop or market our product candidates. If we or our manufacturers fail to comply with applicable regulatoryrequirements at any stage during the regulatory process, we may be subject tosanctions, including fines, product recalls or seizures, injunctions, refusalof regulatory agencies to review pending market approval applications orsupplements to approval applications, total or partial suspension ofproduction, civil penalties, withdrawals of previously approved marketingapplications and criminal prosecution.

 

**Competitors May Develop and Market Drugs ThatAre Less Expensive, More Effective or Safer, Making Our Products Obsolete orUncompetitive**

 

Many of our competitors and potential competitors have substantiallygreater product development capabilities and financial, scientific, marketingand human resources than ours. Technological competition from pharmaceutical companies andbiotechnology companies is intense and is expected to increase.  Other companies have developed technologiesthat could be the basis for competitive products.  Some of these products have an entirely different approach ormeans of accomplishing the desired therapeutic effect than products beingdeveloped by us.  Alternative productsmay be developed that are more effective and less costly than the productsdeveloped by us.  Competitors maysucceed in developing products earlier than us, obtaining approvals andclearances for such products more rapidly than us, or developing products thatare more effective than ours.  Inaddition, other forms of medical treatment may be competitive with ourproducts. Our technology or products may become obsolete or uncompetitive.

 

**Our Products May Not Gain Market Acceptance**

 

Our products may not gain market acceptance among physicians, patients,healthcare payors and the medical community. The degree of market acceptance of any product that we may develop willdepend on a number of factors, including establishment and demonstration ofclinical efficacy and safety, cost-effectiveness, clinical advantages overalternative products, and marketing and distribution support for the products.

 

Our sales experience is limited to the sale of our bioreagents.  To directly market and distribute anypharmaceutical products we may develop, 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 of our ownor enter into arrangements with third parties on terms that are acceptable tous.  If we or our partners cannotsuccessfully market and sell our products, our ability to generate revenue willbe limited.

 

**Our Operations Involve Risks Which CouldSubject Us to Damages Resulting from Accidental Contamination or Injury**

 

The human clinical trials we conduct, including trials in children, mayhave unforeseen long-term health implications. We have only limited amounts of product liability insurance for our clinicaltrials.  We may not correctly anticipateor be able to maintain on acceptable terms the level of insurance coverage thatwould adequately cover potential liabilities from proposed clinical trials.  Product liability insurance is expensive,difficult to obtain and may not be available in the future.  If we cannot obtain sufficient insurancecoverage or other protection against potential product liability claims, we maynot be able to commercialize our products. If any liabilities from a claim exceed the limit of our insurancecoverage, we may not have the resources to pay them.

 

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Our research and development processes involve the controlled use ofhazardous and radioactive materials.  Weare subject to federal, provincial and local laws and regulations governing theuse, manufacture, storage, handling and disposal of such materials and certainwaste products.  The risk of accidentalcontamination or injury from handling and disposing of such materials cannot becompletely eliminated. In the event of or an accident involving hazardous orradioactive materials, we could be held liable for any damages that result. Weare not insured with respect to this liability. Such liability could exceed ourresources.  In the future we may berequired to incur significant costs to comply with environmental laws andregulations.

 

**Our Success Depends On Our Ability to Attractand Retain Qualified Personnel**

 

We depend on a core management and scientific team.  The loss of any of these individuals mayprevent us from achieving our business objective of commercializing our productcandidates.  Our future success willalso depend in large part on our continued ability to attract and retain otherhighly qualified scientific, technical and management personnel, as well aspersonnel with expertise in clinical testing and government regulation.  We face competition for personnel from othercompanies, universities, public and private research institutions, governmententities and other organizations.  If weare unsuccessful in our recruitment and retention efforts, our businessoperations will suffer.

 

**We Will Depend Upon the Availability ofReimbursement from Third-Party Payors Who Are Increasingly Challenging thePrice and Examining the Cost Effectiveness of Medical Products and Services**

 

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

 

**Our Share Price Has Been and Is Likely toContinue to Be Highly Volatile**

 

As is typical for biotechnology companieswithout an approved product on the market, our share price has been highlyvolatile in the past and is likely to continue to be volatile. The price of ourshares could be materially affected by factors including the announcement of technologicalinnovations, the release of publications, the announcement of clinical trialsresults by us or our competitors, the development of new commercial products,changes affecting patents or exclusive licenses, changes in regulations, therelease of financial results, public concerns over risks relating tobiotechnology, future issuances of shares by us, sales of shares by ourshareholders and changes in analyst recommendations.

 

The volatility of our stock may be heightenedwhile it is traded primarily on the Toronto Stock Exchange, which attractsprimarily Canadian shareholders. Because some institutional investors invest in Toronto Stock Exchangecompanies in proportion to their weight on that index, changes within theS&P/TSX Composite Index may also increase volatility in our shareprice.  We continue to explore across-listing on the Nasdaq or a U.S. exchange, but can provide no assurancesregarding the timing or ultimate results of such a transaction.

 

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

 

We are exposedto foreign currency fluctuations through our operations in the U.S. because asubstantial amount of our contract research and development spending istransacted in U.S. dollars.

 

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However, since approximately95% of our bioreagent product sales are in U.S. dollars, there is partialmatching of U.S. currency expenses and revenues.  We use the Canadian dollar as our measurement and functional currency.  As a result, we translate monetary assetsand liabilities into Canadian dollars at the rate of exchange prevailing at ourbalance sheet date and include resulting exchange gains and losses in the otherincome line item.  We do not currentlyengage in hedging or other activities to reduce foreign currency risk, beyondmatching investments proportionately with anticipated spending, but may do soin the future under certain conditions. A substantial amount of our receivablesand payables are denominated in U.S. dollars. We record resulting exchangegains and losses in our statement of operations.

 

Our sales andcontract research and development expenses are denominated in U.S.dollars.  Because our financialstatements are stated in Canadian dollars, we are exposed to fluctuations ofthe U.S. exchange rate.  We do notbelieve this currency risk will have a material impact on our results ofoperations in the foreseeable future.

 

We maintaincash equivalent and short-term investment portfolio holdings of variousissuers, types, and maturity dates with large banks and investment bankinginstitutions.  Typically, 75% of ourinvestments are in government bonds rated AAA. We occasionally hold short-terminvestments beyond 120 days, and the market value of these investments duringthe investment term varies as a result of market interest rate fluctuations.

 

We maintain anon-trading investment portfolio.  Ourmarket risk exposure is limited to interest rate risk and foreign exchange raterisk.  We computed a hypothetical changein interest rates by applying a 10% change to our average rate of return,resulting in a $82,000 impact.  Ifinterest rates were to increase by 10%, our net loss would decrease by$82,000.  Further, if interest rateswere to decrease by 10%, our net loss would increase by $82,000.  In addition, we computed a hypotheticalchange in foreign exchange rates by applying a 10% change to our year-endforeign exchange rate and then applied that rate to our average level of U.S.investments during the year, resulting in a $542,000 impact.  If the value of the Canadian dollar relativeto the U.S. dollar were to increase by 10%, our net loss would decrease by$542,000.  Further, if the value of theCanadian dollar relative to the U.S. dollar were to decrease by 10%, our net losswould increase by $542,000. We have not used derivative financial instrumentsin our investment portfolio.  Weclassify our investments as available-for-sale or held-to-maturity at the timeof purchase and re-evaluate this designation as of each balance sheet date. Wehad $38,581,000 in cash, cash equivalents and short-term investments as ofSeptember 30, 2003.

 

**Item 4****.  CONTROLS ANDPROCEDURES**

 

Our chief financial officer and chief executive officer concluded as ofSeptember 30, 2003 that our disclosure controls and procedures (as defined inRule 15d-15(e) promulgated under the Securities Exchange Act of 1934, asamended) are effective and designed to alert them to material informationrelating to Stressgen and its consolidated subsidiaries, based on theevaluation of these controls and procedures as required by paragraph (b) ofRule 15d-15.

 

#### **PART II**—OTHERINFORMATION

#### ** **

**Item 6.****  EXHIBITS AND REPORTS ON FORM 8-K**

 

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

 

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## **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:  October 27, 2003 | /s/ Donald D. Tartre                                                                                            |   |
|                    | Donald  D. Tartre                                                                                               |
|                    | Vice  President and Chief Financial Officer                                                                     |
|                    | (Principal  Financial and Accounting  Officer duly authorized to sign  this report on behalf of the registrant) |

 

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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                                         |
| 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                                        |

 

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* 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

 

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