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

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**FORM 10-Q**

**(Mark One)**

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

For the Quarter Ended **March 31, 2005or**
| 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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**STRESSGEN BIOTECHNOLOGIES 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**        | ** ** | **92121**                          |
| **Parent of Stressgen Biotechnologies, Inc.** |       | (zip  code)                        |
| **6055 Lusk Boulevard**                       |       |                               |
| **San Diego, CA**                        |       |                               |
| (Address  of principal executive offices)     |       |                               |

**(250) 744-2811**

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

 

    Indicate by check mark whetherthe 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

Indicate by check mark whether the registrant is anaccelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes ý  No o

   As of May 6, 2005 the registrant hadapproximately 72,506,000 shares of Common Stock, no par value, outstanding.

 

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**Stressgen Biotechnologies Corporation and Subsidiaries**

 

**INDEX**
| **Part I —  Financial Information** |       | **Page**                                                                                                 |
|------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|
|                                     |       |                                                                                                     |   |   |
| Item 1.                             |       | Financial Statements (Unaudited)                                                                         |   |   |
|                                     |       | Consolidated Balance Sheet  March 31, 2005 and December 31, 2004                                    |   | 1 |
|                                     |       | Consolidated Statement of  Operations and Accumulated Deficit Three Months Ended March 31, 2005 and 2004 |   | 2 |
|                                     |       | Consolidated Statement of Cash  Flows Three Months Ended March 31, 2005 and 2004                         |   | 3 |
|                                     |       | Notes to  Consolidated Financial Statements                                                              |   | 4 |
| Item  2.                                 |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations              |   | 20 |
|                                     |       | Liquidity and Capital  Resources                                                                         |   | 21 |
|                                     |       | Results of Operations                                                                                    |   | 24 |
|                                     |       | Critical Accounting  Policies                                                                            |   | 28 |
|                                     |       | Factors That  Could Affect Future Performance                                                            |   | 30 |
| Item  3.                                 |       | Quantitative  and Qualitative Disclosures About Market Risk                                              |   | 38 |
| Item 4.                                  |       | Controls and  Procedures                                                                                 |   | 38 |
|                                     |       |                                                                                                     |   |   |
| **Part II — Other Information**     |       |                                                                                                     |
| ** **                               | ** ** | ** **                                                                                               |
| Items 1 through 6                        |       | 38                                                                                                       |
|                                     |       |                                                                                                     |
| SIGNATURES AND CERTIFICATIONS            |       | 39                                                                                                       |
|                                     |       |                                                                                                     |

 

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***Stressgen BiotechnologiesCorporation***

*(Unaudited)*

**Consolidated Balance Sheet**

***(Canadiandollars) (In thousands, except share information)***

 
| ** **                                                                                                                                                          | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------|------------|------------------|------------|
| ** **                                                                                                                                                          | ** ** | **2005**      | ** ** | **2004**         | ** ** |
| **Assets**                                                                                                                                                          |       |          |       |             |       |
| Current assets:                                                                                                                                                     |       |          |       |             |       |
| Cash and cash equivalents                                                                                                                                           |       | $             | 5,619      |             | $          | 8,538 |   |
| Short-term investments                                                                                                                                              |       | 7,869         |       | 13,040           |       |
| Prepaid expenses (Note 4)                                                                                                                                           |       | 3,043         |       | 2,196            |       |
| Deferred development expenses, current portion  (Note 4)                                                                                                            |       | 81            |       | 1,747            |       |
| Assets of discontinued operations (Note 10)                                                                                                                         |       | 2,302         |       | 2,447            |       |
| Other current assets                                                                                                                                                |       | 101           |       | 563              |       |
| Total current assets                                                                                                                                                |       | 19,015        |       | 28,531           |       |
|                                                                                                                                                                |       |          |       |             |       |
| Plant and equipment (Note 3)                                                                                                                                        |       | 1,312         |       | 1,481            |       |
| Deferred development expenses, net of current  portion                                                                                                              |       | 142           |       | 162              |       |
|                                                                                                                                                                |       | $             | 20,469     |             | 30,174     |   |
|                                                                                                                                                                |       |          |       |             |       |
| **Liabilities and Stockholders’  Equity**                                                                                                                      |       |          |       |             |       |
| Current liabilities:                                                                                                                                                |       |          |       |             |       |
| Accounts payable and accrued liabilities (Note  3)                                                                                                                  |       | $             | 4,965      |             | $          | 7,862 |   |
| Deferred revenue, current portion                                                                                                                                   |       | 644           |       | 641              |       |
| Notes payable, current portion (Note 3)                                                                                                                             |       | 361           |       | 369              |       |
| Liabilities of discontinued operations (Note  10)                                                                                                                   |       | 297           |       | 324              |       |
| Total current liabilities                                                                                                                                           |       | 6,267         |       | 9,196            |       |
|                                                                                                                                                                |       |          |       |             |       |
| Long-term liabilities:                                                                                                                                              |       |          |       |             |       |
| Deferred revenue, net of current portion                                                                                                                            |       | 1,128         |       | 1,282            |       |
| Notes payable, net of current portion (Note 3)                                                                                                                      |       | 66            |       | 145              |       |
| Total long-term liabilities                                                                                                                                         |       | 1,194         |       | 1,427            |       |
|                                                                                                                                                                |       |          |       |             |       |
| Total liabilities                                                                                                                                                   |       | 7,461         |       | 10,623           |       |
|                                                                                                                                                                |       |          |       |             |       |
| Commitments and contingencies (Note 4)                                                                                                                              |       |          |       |             |       |
|                                                                                                                                                                |       |          |       |             |       |
| Stockholders’ equity:                                                                                                                                          |       |          |       |             |       |
| Common shares and other equity — no par value; unlimited  shares authorized, 72,506,403 shares issued and outstanding at March 31, 2005  and December 31, 2004 |       | 216,412       |       | 216,412          |       |
| Contributed surplus                                                                                                                                                 |       | 15,667        |       | 15,488           |       |
| Accumulated deficit                                                                                                                                                 |       | (219,071      | )          | (212,349         | )          |
| Total stockholders’ equity                                                                                                                                     |       | 13,008        |       | 19,551           |       |
|                                                                                                                                                                |       | $             | 20,469     |             | $          | 30,174 |   |

 

See accompanying notes to consolidated financialstatements

 

1

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***Stressgen Biotechnologies Corporation***

**Consolidated Statement of Operations and AccumulatedDeficit**

***(Unaudited)***

***(Canadian dollars) (In thousands, except pershare amounts)***

 
| ** **                                                                                                       | ** ** | **Three months ended,** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                                                       | ** ** | **March 31,**           | ** ** |
| ** **                                                                                                       | ** ** | **2005**                | ** ** | **2004** | ** ** |
| Revenue:                                                                                                         |       |                    |       |   |   |
| Collaborative R&D revenue                                                                                    |       | $                       | 163        |   | $ | 173 |   |
|                                                                                                             |       |                    |       |   |   |
| Operating expenses:                                                                                              |       |                    |       |   |   |
| Research and development                                                                                         |       | 5,539                   |       | 5,273 |   |
| Selling, general and administrative                                                                              |       | 2,006                   |       | 2,095 |   |
|                                                                                                             |       | 7,545                   |       | 7,368 |   |
|                                                                                                             |       |                    |       |   |   |
| Operating loss                                                                                                   |       | (7,382                  | )          | (7,195 | ) |
|                                                                                                             |       |                    |       |   |   |
| Other income (expenses):                                                                                         |       |                    |       |   |   |
| Interest and other income                                                                                        |       | 359                     |       | 354 |   |
| Net foreign exchange (loss) gain                                                                                 |       | (102                    | )          | 51 |   |
| Interest expense                                                                                                 |       | (14                     | )          | (28 | ) |
|                                                                                                             |       | 243                     |       | 377 |   |
| Net loss from continuing operations                                                                              |       | (7,139                  | )          | (6,818 | ) |
| Net income from discontinued operations (Note  10)                                                               |       | 417                     |       | 534 |   |
|                                                                                                             |       |                    |       |   |   |
| Net loss                                                                                                         |       | (6,722                  | )          | (6,284 | ) |
|                                                                                                             |       |                    |       |   |   |
| Accumulated deficit, beginning of period                                                                         |       | (212,349                | )          | (150,294 | ) |
| Cumulative effect of change in accounting  principle                                                             |       | —                  |       | (32,950 | ) |
| Accumulated deficit, end of period                                                                               |       | $                       | (219,071   | ) | $ | (189,528 | ) |
|                                                                                                             |       |                    |       |   |   |
| Basic and diluted (loss) income per common  share:                                                               |       |                    |       |   |   |
| From continuing operations                                                                                       |       | $                       | (0.10      | ) | $ | (0.09 | ) |
| From discontinued operations                                                                                     |       | $                       | 0.01       |   | $ | 0.00 |   |
|                                                                                                             |       | $                       | (0.09      | ) | $ | (0.09 | ) |
|                                                                                                             |       |                    |       |   |   |
| Weighted average number of common shares used  to compute basic and diluted loss per common share (in thousands) |       | 72,506                  |       | 72,498 |   |

 

See accompanying notes to consolidated financialstatements.

 

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***Stressgen BiotechnologiesCorporation***

**ConsolidatedStatement of Cash Flows**

***(Unaudited)***

*(Canadian dollars in thousands)*

 
| ** **                                                                   | ** ** | **Three months ended**

**March 31,** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                   | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| Cash flows from operating activities:                                        |       |                                  |       |   |   |
| Net loss                                                                     |       | $                                     | (6,722     | ) | $ | (6,284 | ) |
| Net income from discontinued operations                                      |       | (417                                  | )          | (534 | ) |
| Adjustments to reconcile net loss to net cash  used in operating activities: |       |                                  |       |   |   |
| Depreciation of plant and equipment                                          |       | 154                                   |       | 134 |   |
| Loss on disposal of plant and equipment                                      |       | —                                |       | 15 |   |
| Amortization of stock compensation expense                                   |       | 168                                   |       | 631 |   |
| Unrealized foreign exchange loss                                             |       | 10                                    |       | 6 |   |
| (Gain) loss on market value of investments                                   |       | (125                                  | )          | 6 |   |
| Changes in operating assets and liabilities:                                 |       |                                  |       |   |   |
| Collaborative accounts receivable                                            |       | —                                |       | 277 |   |
| Prepaid expenses                                                             |       | (847                                  | )          | 22 |   |
| Deferred development expenses, current portion                               |       | 1,666                                 |       | (1 | ) |
| Other current assets                                                         |       | 462                                   |       | (172 | ) |
| Deferred development expenses, net of current  portion                       |       | 20                                    |       | 18 |   |
| Accounts payable and accrued liabilities                                     |       | (2,897                                | )          | (295 | ) |
| Deferred revenue                                                             |       | (151                                  | )          | (135 | ) |
| Net cash used in operating activities of  continuing operations              |       | (8,679                                | )          | (6,312 | ) |
| Net cash provided by discontinued operations  (Note 10)                      |       | 564                                   |       | 10 |   |
| Net cash used in operating activities                                        |       | (8,115                                | )          | (6,302 | ) |
|                                                                         |       |                                  |       |   |   |
| Cash flows from investing activities:                                        |       |                                  |       |   |   |
| Purchase of short-term investments                                           |       | (2,572                                | )          | (20,919 | ) |
| Sales and maturities of short-term investments                               |       | 8,044                                 |       | 10,935 |   |
| Purchase of plant and equipment                                              |       | (3                                    | )          | (130 | ) |
| Net cash provided by (used in) investing  activities                         |       | 5,469                                 |       | (10,114 | ) |
|                                                                         |       |                                  |       |   |   |
| Cash flows from financing activities:                                        |       |                                  |       |   |   |
| Repayment of borrowings                                                      |       | (87                                   | )          | (117 | ) |
| Proceeds from issuance of common shares                                      |       | —                                |       | 36 |   |
| Share issue costs                                                            |       | —                                |       | (81 | ) |
| Net cash used in financing activities                                        |       | (87                                   | )          | (162 | ) |
|                                                                         |       |                                  |       |   |   |
| Effect of exchange rate changes on cash and  cash equivalents                |       | (186                                  | )          | (11 | ) |
| Decrease in cash and cash equivalents                                        |       | (2,919                                | )          | (16,589 | ) |
| Cash and cash equivalents, beginning of period                               |       | 8,538                                 |       | 19,749 |   |
| Cash and cash equivalents, end of period                                     |       | $                                     | 5,619      |   | $ | 3,160 |   |
| See Note 8 for non-cash disclosures                                          |       |                                  |       |   |   |

 

See accompanying notes to consolidated financialstatements.

 

3

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*** ***

***StressgenBiotechnologies Corporation*Notes toConsolidated Financial Statements**

***(Unaudited)(Canadian dollars)***

 

**1.             ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTINGPOLICIES**

StressgenBiotechnologies Corporation (with its subsidiaries other than discontinuedoperations, “Stressgen” or the “Company”) is a biopharmaceutical company thatdiscovers, develops and seeks to commercialize therapeutic vaccines for thetreatment of infectious diseases and cancers. The Company’s lead candidate,HspE7, targets a broad spectrum of human papilloma virus (HPV) relateddiseases.  It was created using theCompany’s proprietary CoVal fusion product technology, which is based oncovalently linking stress proteins (also known as heat shock proteins) todisease specific antigens. The Company has been researching use of the sametechnology to develop potential treatments for hepatitis B, herpes simplex andhepatitis C.

The accompanyingfinancial statements have been prepared on a going concern basis, whichcontemplates the realization of assets and the satisfaction of liabilities inthe normal course of business.  TheCompany has a history of recurring losses from operations and has anaccumulated deficit of $219,071,000 as of March 31, 2005.  The natureof the Company’s business requires significant spending on R&D activities.Due to the history of losses, high cash burn on R&D activities and the lossof bioreagent revenue as a result of the sale of that business, theCompany is closely monitoring its cash resources.  Based upon the sale ofits reagent business and its current business plan including the recentreduction in headcount and review of timelines regarding the HspE7 program,assuming the Company raises approximately $5,000,000, it will have sufficientresources to fund operations through the first quarter 2006.  Based uponits current forecast, if the Company does not raise at least that amount ofcash it may need to modify or cancel agreements with external contractors, andmake further changes to staffing levels which would impact the developmenttimelines of HspE7.  Under this scenario,the Company will have resources to fund operations through the end of 2005.

*Basis ofpresentation*

The consolidatedfinancial statements include the assets, liabilities and operating results ofthe Company and its wholly-owned subsidiaries. Intercompany accounts and transactions have been eliminated inconsolidation. Prior year balances have been reclassified to conform to currentyear presentation as a result  of thesale of the bioreagent business which has been presented as a discontinuedoperation (Note 10).

*Financialstatements and estimates*

The accompanying unauditedfinancial statements for Stressgen for the three months ended March 31, 2005and 2004, in the opinion of management, include all adjustments necessary fortheir fair presentation in conformity with Canadian generally accepted accounting principles (Canadian GAAP), and conformin material respects with accounting principles generally accepted in theUnited States of America (U.S. GAAP), except as discussed in Note 9.  All such adjustments are of a normaland recurring nature.  These financialstatements should be read in conjunction with the financial statements andnotes thereto in the Company’s December 31, 2004 Annual Report on Form10-K.  Certain information and footnotedisclosures normally included in financial statements prepared in accordancewith Canadian GAAP and U.S. GAAP have been condensed or omitted pursuant to theapplicable Canadian regulatory and U.S. Securities and Exchange Commissionrules and regulations.  Interim resultsare not necessarily indicative of results for the full year.

The preparation of financial statements in conformity with Canadian GAAPand U.S. GAAP requires management to make estimates and assumptions that affectthe reported amounts of assets, liabilities, revenue and expenses and relateddisclosures as of the date of the financial statements.  Significant estimates are used for, but notlimited to, revenue recognition, accrual of clinical trial costs, measurementof stock-based compensation, cancellation fees related to contractualobligations and the allocation of indirect costs between research anddevelopment (R&D) and selling, general and administrative (SG&A).  Actual results could differ from suchestimates.

 

4

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*Foreigncurrency translation*

The Company uses the Canadian dollar as its consolidated functionalcurrency.  Monetary assets andliabilities that are denominated in U.S. dollars or British pounds aretranslated into Canadian dollars at the rates 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.

*Revenue recognition*

Revenue from collaborative research and development arrangements mayinclude multiple elements within a single contract.  The Company’s accounting policy complies withthe revenue determination requirements set forth in Emerging Issues Task Force(EITF) 00-21, *Accounting for Revenue Arrangements withMultiple Deliverables*, and Emerging Issues Committee (EIC) 142, *Revenue Arrangements with Multiple Deliverables*, relating tothe separation of multiple deliverables into individual accounting units withdeterminable fair values.  Paymentsreceived under collaborative arrangements may include the following:  non-refundable fees at inception of contractfor technology rights; funding for services performed; milestone payments forspecific achievements; and payments based upon resulting sales of products.

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

*Clinical trial accruals*

The Company recognizes expenses related to its ongoing clinical trialsusing a methodology designed to accrue estimated costs in the appropriateaccounting periods when the expenses are incurred.  The Company recognizes clinical trial costsin three distinct phases that correspond with the period during which theservices are performed:  the start-upphase, the patient accrual phase, and the close-out phase. The start up portionof the trial contract is accrued during the trial planning and protocol writingperiod.  The per patient accrual cost isrecognized as each patient enters the trial. The close-out portion of the trial is recognized as the final analysesof patient data are prepared.  Based onthe design of the trial including number of patients, number of clinical sites,method of treatment, and follow-up, the proportion of the cost of each phasecould vary from trial to trial.  Inaddition the Company evaluates the nature and structure of each clinical trialcontract and adjusts the algorithm, if necessary, to capture expenses in theappropriate period.  As each trialcontinues, the Company evaluates the total contract costs and makes adjustmentsaccordingly. Changes to the cost estimates are charged or credited to R&Dexpense in the appropriate period based on the facts and timing of theadjustment.

*Stock-based compensation plan*

In September 2003, the Canadian Institute of Chartered Accountants (CICA)Accounting Standards Board released revised transitional provisions for *Stock-Based Compensation and Other Stock-Based Payments*,Section 3870 (CICA 3870), to provide the same alternative methods of transitionas is provided in the U.S. for voluntary adoption of the fair value based methodof accounting.   In January 2004, theCompany

 

5

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adopted CICA 3870.  As a result theCompany recorded a $32,950,000 cumulative change in accounting principle in thequarter ended March 31, 2004.  This standardrequires that all stock-based awards made to non-employees be measured andrecognized using a fair value based method. The standard encourages the use of a fair value based method for allawards granted to employees, but only requires the use of a fair value basedmethod for direct awards of stock, stock appreciation rights, and awards thatcall for settlement in cash or other assets. Awards that a company has the ability to settle in stock arerecorded as equity, whereas awards that the entity is required to or has apractice of settling in cash are recorded as liabilities.  No awards were made that would result inrecording a liability.

The Company hastwo stock-based compensation plans, which are described in Note 5.  The Company grants options with an exerciseprice equal to the fair market value of the underlying common stock.  Under the principles of CICA 3870,compensation expense is recognized on a straight-line basis over the vestingperiod of the grant based on the estimated fair value at the time of grantusing the Black-Scholes method.  Anyconsideration paid by directors, employees and others on exercise of stockoptions together with the fair value of such options is credited to commonshares.

The Companyrecorded expense of $168,000 related to continuing operations and $11,000related to discontinued operations for the three months ended March 31, 2005,representing the amortization of the fair value of compensation based on thevesting period of stock options granted to employees and directors.  The Company recorded expense of $631,000related to continuing operations and $32,000 related to discontinued operationsfor the three months ended March 31, 2004. The weighted-average per-share fair values of the individual optionsgranted during the three months ended March 31, 2005 and 2004 were $0.22 and$0.95, respectively.   The fair value ofthe options was determined using a Black-Scholes option-pricing model with thefollowing average assumptions:

| ** **              | ** ** | **For the three months ended  March 31,** | ** ** |
|-------------------------|------------|-------------------------------------------|------------|
| ** **              | ** ** | **2005**                                  | ** ** | **2004** | ** ** |
| Dividend yield          |       | 0                                         | %          | 0 | % |
| Volatility              |       | 66                                        | %          | 69 | % |
| Risk-free interest rate |       | 3.7                                       | %          | 3.2 | % |
| Expected life           |       | 4 years                                   |       | 4 years |   |

 

*Concentration of credit risk*

 

The Companyinvests its excess cash principally in investment grade government and corporatedebt securities.  The Company hasestablished guidelines relative to diversification and maturities that maintainsafety and liquidity.  These guidelinesare periodically reviewed and modified to reflect changes in marketconditions.  The Company has not experienced any significantlosses on its cash equivalents or short-term investments.  However,the Company recorded write-downs of its fixed income investment portfolio in2004 of $293,000.  The write-downswere due principally to a decrease in the market value of one bond which isstill held.  The market value of thisparticular bond has been fluctuating since the initial write down was recordedin 2003.  In the first quarter of 2005,approximately $128,000 of the write-downs was reversed when a portion of thesecurities which contributed to the write-downs was sold.

At March 31, 2005 and December 31, 2004, approximately 58% and 48% ofcash, cash equivalents and short-term investments were held in U.S.dollars.  At March 31, 2005 and December31, 2004 approximately 38% and 36% of our cash, cash equivalents and short-terminvestments were held in British pounds.

The Company has derived 100% of its collaborationrevenue from Roche.

 

6

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*Net loss per share*

Net loss fromcontinuing and discontinued operations per share is computed using the weightedaverage number of common shares outstanding.  Basic and diluted net loss per common shareamounts are equivalent for the periods presented as the inclusion of common stockequivalents (including options and warrants) in the number of shares used forthe diluted computation would be anti-dilutive.   For the three months ended March 31, 2005and 2004, approximately 10,185,000 and 9,801,000, respectively, in the form ofexercisable options and warrants have been excluded from the shares outstandingfor the diluted computation as the inclusion would result in a smaller net lossper share.

*Deferredexpenses*

The Companyincurred costs in conjunction with its financing efforts in the fourth quarterof 2004 and first quarter of 2005.  As ofDecember 31, 2004, the costs associated with the financing were classified asdeferred expenses included within “Other current assets” on the ConsolidatedBalance Sheet.  However, in April 2005,the Company announced that it elected to withdraw the amended and restatedpreliminary prospectus in connection with the proposed offering of commonshares.  See Note 11 for furtherdiscussion of the subsequent event. Therefore, subsequent to March 31, 2005, the Company determined that itwas appropriate to reflect these costs totaling approximately $550,000 as aselling, general and administrative expense on the March 31, 2005 ConsolidatedStatement of Operations and Accumulated Deficit.

**2.****                                     ****COLLABORATIVE AGREEMENT**

On December 2,2003, the Company announced it had restructured its June 24, 2002collaboration agreement with F. Hoffmann-La Roche Ltd and Hoffmann-La RocheInc. (collectively, “Roche”), providing for the development andcommercialization of the pharmaceutical fusion product candidate, HspE7.  Under the restructured terms Roche wasgranted an option to license the first generation HspE7 product, a license todevelop a second generation HspE7 product, and an option to negotiate rights tothe Company’s CoValTM fusion product candidates for the treatment ofcancer and hepatitis C.

In connection withthe first generation HspE7 product, the restructured agreement gives theCompany the right to develop and commercialize the product for indications otherthan genital warts, including control of regulatory matters such as U.S.Investigational New Drug applications (IND). The Company may also conduct dose-ranging studies in patients withgenital warts.  In the original agreementthe Company was responsible for clinical development expenses related to therecurrent respiratory papillomatosis (RRP) indication.  In addition to the responsibilities in theoriginal agreement, the Company is responsible for the manufacturing and othercosts of all indications it develops under the new agreement.

The Companyrecorded collaborative R&D revenue of $163,000, and $173,000 during thequarters ended March 31, 2005 and 2004, respectively. Collaborative R&Drevenue during both periods relates principally to the amortization of upfrontlicense fees in accordance with CICA Accounting Standards Boardrecommendations, section 3400, *Revenue*, andStaff Accounting Bulletin (SAB) No. 101, *Revenue Recognition inFinancial Statements*.

By paying additional fees, Roche can exclusively develop the secondgeneration HspE7 product.  In such case Roche would be required topay the costs of development, manufacturing and commercialization of theproduct and to make payments to us upon the achievement of defined milestones.We would also receive tiered, progressive sales-based payments that we believeare competitive with other agreements of

 

7

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this stage and type.  Commercial success payments of up toapproximately $102,816,000 become payable depending upon the aggregate netsales of either or both generationsof the HspE7 products. The restructured collaboration agreement gives us theright to discuss, negotiate and execute an alternative agreement with athird-party for the development and commercialization of HspE7 through alicense, partnership, joint venture or similar transaction.  After March 31, 2005 and through the end ofthe option period, Roche can terminate this right by paying us a fee, which weexpect would be either approximately $12,096,000 or $18,144,000 depending onthe stage of development of the product. Management cannot determine if or whenthis option will be exercised.  Theamounts disclosed in this paragraph are reported in the Canadian dollarequivalent to the actual U.S. dollar amounts per the contract converted atexchange rates on March 31, 2005.

**3.             BALANCE SHEET DETAILS**

The followingtables provide details of selected balance sheet items of continuingoperations:
| **(In thousands)**     | ** ** | **March 31, 2005** | ** ** |
|------------------------|------------|--------------------|------------|
| ** **             | ** ** | ** **         | ** ** | **Accumulated** | ** ** | **Net Book** | ** ** |
| Plant and equipment:   | ** ** | **Cost**           | ** ** | **Depreciation** | ** ** | **Value** | ** ** |
| Laboratory equipment   |       | $                  | 3,584      |   | $ | 2,586 |   | $ | 998 |   |
| Computer equipment     |       | 910                |       | 740 |   | 170 |   |
| Furniture and fixtures |       | 392                |       | 285 |   | 107 |   |
| Leasehold improvements |       | 748                |       | 711 |   | 37 |   |
|                   |       | $                  | 5,634      |   | $ | 4,322 |   | $ | 1,312 |   |

 
| **(In thousands)**     | ** ** | **December, 31 2004** | ** ** |
|------------------------|------------|-----------------------|------------|
| ** **             | ** ** | ** **            | ** ** | **Accumulated** | ** ** | **Net Book** | ** ** |
| Plant and equipment:   | ** ** | **Cost**              | ** ** | **Depreciation** | ** ** | **Value** | ** ** |
| Laboratory equipment   |       | $                     | 3,648      |   | $ | 2,517 |   | $ | 1,131 |   |
| Computer equipment     |       | 910                   |       | 727 |   | 183 |   |
| Furniture and fixtures |       | 392                   |       | 282 |   | 110 |   |
| Leasehold improvements |       | 749                   |       | 692 |   | 57 |   |
|                   |       | $                     | 5,699      |   | $ | 4,218 |   | $ | 1,481 |   |

 

 
| **(In thousands)**                        | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------|------------|---------------|------------|------------------|------------|
| ** **                                | ** ** | **2005**      | ** ** | **2004**         | ** ** |
| Accounts payable and accrued liabilities: |       |          |       |             |       |
| Trade accounts payable                    |       | $             | 1,426      |             | $          | 4,072 |   |
| Clinical trial accruals                   |       | 1,924         |       | 2,514            |       |
| Accrued compensation and benefits         |       | 1,547         |       | 1,243            |       |
| Other accrued liabilities                 |       | 68            |       | 33               |       |
|                                      |       | $             | 4,965      |             | $          | 7,862 |   |

 

At March 31, 2005 the Company had outstanding term loan obligations of$427,000.  In September 2003 theCompany entered into a 36-month term loan agreement with Oxford FinanceCorporation, collateralized by equipment owned by the Company.  Interest rates on the Oxford term loan rangefrom 11.47% to 11.48%.  At March 31, 2005and December 31, 2004 there was $427,000 and $514,000, respectively,outstanding on the loan.  Under the termsof the agreement, the Company must obtain a letter

 

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of credit for theoutstanding loan balance if combined cash, cash equivalents, and short-term investmentsfall below $6,000,000.

**4.             COMMITMENTS ANDCONTINGENCIES**

The Company’s contractual obligations consist primarily of agreementsrelated to the development and manufacture of HspE7, operating leases forfacilities, a term loan to increase working capital cash flows (Note 3) andcontractual employment obligations. The Company engages several contractors working on different aspects ofthe work which regulatory authorities require for a biologic product, includingstability testing, analytical testing, release testing and the manufacturingand fill/finish activities noted below.

In January 2004 the Company entered into a biological services agreementwith Avecia for the process development, scale-up and manufacture ofHspE7.  In addition, the Company may haveAvecia manufacture commercial drug substance. Under the terms of theagreement, the Company is required to make upfront payment for future servicesand use of the facility.  The Companymade prepayments totaling $3,175,000 for services to be rendered and spaceutilized in 2005.  At March 31, 2005, aportion of the work related to these prepayments has been completed.  The Company made a $1,814,000 prepayment in2004.  The other prepayment of $1,361,000was not made until 2005 and therefore was included in deferred developmentexpenses, current portion and accrued liabilities in the December 31, 2004Consolidated Balance Sheet.

The Avecia agreement iscancelable subject to specified termination conditions. The cancellation fee isbased on a sliding percentage of certain future program milestones.  Accordingly, the cancellation fee is modifiedeach month during the course of the agreement, based on the timing ofactivities performed by Avecia and prepayments for those activities.  However, as of March 31, 2005 there wouldhave been no cancellation penalty.

In October 2004 the Company entered into an agreement with CardinalHealth (Cardinal) in the ordinary course of business.  Cardinal will perform activities to prepareand distribute HspE7 to clinical trial sites.  In 2005 the Company made aprepayment of $295,000 for future services to be rendered in 2005.  At March31, 2005 a portion of the work has been completed related to theseprepayments.  The Company wascontractually obligated to make this prepayment as of December 31, 2004;however the payment was not made until early 2005.  Therefore the amount was included in deferreddevelopment expenses, current portion and accrued liabilities in the December31, 2004 Consolidated Balance Sheet and has been reclassified to prepaid assetsas of March 31, 2005.

The agreement with Cardinalincludes cancellation provisions that could require the Company to pay for workthat was not performed or equipment that was not used if it terminates the contract while activities are at pre-definedstages.   The contract is subject to acancellation fee of approximately $139,000 which would be offset against anyremaining prepaid balance.

To retain a flexible development program, the Company typicallynegotiates termination provisions so that financial obligations are limited topaying for work performed up to the termination date and in some cases, acancellation fee determined under a pre-established formula.  Except as disclosed above, the Companycurrently does not have any other significant research and developmentcontracts subject to cancellationfees.

The Company has not entered into any minimum supply agreements with anyservice vendors or contract manufacturers.

 

9

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*Contractual Employment Obligations*

The Company has employment agreements with certain members of managementwhich include specific severance packages. As discussed in Note 11, in conjunction with the appointment of a newPresident and Chief Executive Officer (CEO), the Company paid the formerPresident and CEO approximately $884,000 in April 2005 which will be includedin the Statement of Operations for the second quarter of 2005.  In addition to the amount paid to the formerCEO in April 2005 and considering the impact of the April 2005 sale of thebioreagent business and the restructuring (see Note 11), the Company is contractually obligated to pay $1,878,000 per employment agreements of certainremaining executives.

*PatentOpposition*

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

*CRAReview*

The Canada Revenue Agency (“CRA”)has asked the Company to provide additional information with respect totransactions between the parent company and its subsidiaries in 2001 and 2002.In February 2005 CRA gave the Company a preliminary indication that it does notagree with elements of the Company’s transfer pricing, including the valueascribed to intellectual property transferred to a subsidiary.  The Company believes that the preliminarydetermination has been made without regard to relevant information and is inthe process of clarifying it and providing further information to CRA. Even ifthe CRA assessment does not change, its determination will not result in achange to the Company’s financial statements due to the consolidatedpresentation of the results for the Company and its subsidiaries; nor willadditional tax become payable for those years. If the Company is found to havefailed to provide timely and adequate information to CRA, a penalty could belevied. The Company believes that it has provided all relevant informationwithin prescribed time periods. The Company does not believe the outcome of thediscussions with the CRA will have a material impact on its financial position.

 

**5.             STOCKHOLDERS’EQUITY**

*CommonShares*

In June 2002 theCompany issued 2,036,436 common shares for $7,657,000 pursuant to the collaborationagreement with Roche (see Note 2).  Theequity was issued at a per share price determined by the weighted average priceof common shares of the Company during the ten business days prior to the Rochetransaction.

At the time of theoriginal collaboration agreement, Roche received two warrants to purchase thecommon stock of Stressgen.  The Companyallocated $1,264,000 as the fair value of the warrants.  In April 2003, Roche exercised the firstwarrant to acquire 1,413,600 common shares at $3.25, resulting in net proceedsof $4,594,000 to the Company.  Under theoriginal collaboration agreement, the Company had the right to call the secondwarrant. In connection with the restructured collaboration agreement, Roche hasa continued

 

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right to exercisethe second warrant for 814,574 shares at a purchase price of $3.76 per share atany time until June 28, 2007.  TheCompany no longer has the right to call the second warrant.

*Contributedsurplus*

The change incontributed surplus from December 31, 2004 is due to expense related to thefair value of stock options recorded in the first quarter of 2005.

*EmployeeShare Option Plans*

The followingtables summarize information related to all stock options outstanding andexercisable granted to employees, directors and non-employees under the Company’s1996 and 2001 stock-based compensation plans as of March 31, 2005.

The total number of options exercisable at December 2004 was4,050,335.  The following tablesummarizes information related to all stock options outstanding and exercisableat March 31, 2005:
| ** **           | ** **    | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|----------------------|---------------|-------------------------|------------|-------------------------|------------|
| ** **           | ** **    | ** **              | ** ** | **Weighted**            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **           | ** **    | ** **              | ** ** | **Average**             | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **           | ** **    | ** **              | ** ** | **Remaining**           | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| **Range of**         | ** **    | **Number**              | ** ** | **Contractual Life**    | ** ** | **Exercise** | ** ** | **Number** | ** ** | **Exercise** | ** ** |
| **Exercise  Prices** | ** **    | **Outstanding**         | ** ** | **(in years)**          | ** ** | **Price** | ** ** | **Exercisable** | ** ** | **Price** | ** ** |
| $                    | 0.30  - $1.99 |                    | 1,386,467  |                    | 7.1        |   | $ | 1.61 |   | 1,023,665 |   | $ | 1.71 |   |
| $                    | 2.00  - $3.99 |                    | 604,000    |                    | 7.4        |   | 3.24 |   | 445,241 |   | 3.34 |   |
| $                    | 4.00  - $5.99 |                    | 1,165,213  |                    | 6.3        |   | 4.91 |   | 1,157,244 |   | 4.91 |   |
| $                    | 6.00  - $8.00 |                    | 1,439,900  |                    | 5.2        |   | 6.18 |   | 1,439,816 |   | 6.18 |   |
|                 |          | 4,595,580               |       |                    |       |   |   | 4,065,966 |   |   |   |
|                      |               |                         |            |                         |            |  |  |  |  |  |  |  |  |  |  |

 

At March 31, 2005, there were 688,907 optionsavailable for future grant under the 2001 Plan. At May 6 2005, there were approximately 3,200,000 optionsoutstanding.  The number of optionsoutstanding decreased from March 31, 2005 to May 6, 2005 due to therestructuring as discussed in Note 11.

 

**6.             RELATED PARTY TRANSACTIONS**

TheCompany has used various affiliates of MDS, Inc., including MDSPharma Services, to provide research services.  During the firstquarter of 2004, the Company paid the various MDS entities an aggregate of$37,000.  One of the Company’s board members was an officer ofMDS, Inc. through May 2004.

 

11

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Long-lived assetsare allocated geographically as follows:

| **(In thousands)** | ** ** | **March 31,**

**2005** | ** ** | **December 31,**

**2004** | ** ** |
|--------------------|------------|-------------------------|------------|----------------------------|------------|
| Canada             |       | $                       | 1,122      |                       | $          | 1,271 |   |
| US                 |       | 190                     |       | 210                        |       |
|               |       | $                       | 1,312      |                       | $          | 1,481 |   |

 

The Companypreviously reported two segments, Biotechnology and Bioreagents.  As discussed in Note 10, at March 31, 2005and December 31, 2004, the Company has presented the bioreagent business as adiscontinued operation and therefore has only one reportable segment.

**8.             SUPPLEMENTAL CASH FLOW INFORMATION**

| **(In thousands)**                                                    | ** ** | **Three months ended March 31,** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                            | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| Interest paid                                                         |       | $                                | 14         |   | $ | 28 |   |
| Sale of assets from continuing operations to  discontinued operations |       | $                                | 18         |   | $ | — |   |
| Reversal of deferred stock compensation                               |       | $                                | —     |   | $ | 185 |   |

 

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**9.****                                     ****THE EFFECT OF APPLYING ACCOUNTINGPRINCIPLES GENERALLY ACCEPTED IN THE U.S.**

These financial statements have been prepared inaccordance with Canadian GAAP which, except as set out below, conform, in all materialrespects, to U.S. GAAP. The effect of applying U.S. GAAP instead of CanadianGAAP on the consolidated financial statements would be as follows:

*Balance Sheet*
| **(In thousands)**                                  | ** ** | ** **    | ** ** | ** **       | ** ** |
|-----------------------------------------------------|------------|---------------|------------|------------------|------------|
| ** **                                          | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
| ** **                                          | ** ** | **2005**      | ** ** | **2004**         | ** ** |
| ** **                                          | ** ** | ** **    | ** ** | ** **       | ** ** |
| Current assets under Canadian GAAP                  |       | $             | 19,015     |             | $          | 28,531 |   |
|                                                |       |          |       |             |       |
| Market value gain on available for sale  securities |       | 69            |       | —           |       |
|                                                |       |          |       |             |       |
| Current assets under U.S. GAAP                      |       | $             | 19,084     |             | $          | 28,531 |   |
|                                                |       |          |       |             |       |
| Stockholders’ equity under Canadian GAAP       |       | $             | 13,008     |             | $          | 19,551 |   |
|                                                |       |          |       |             |       |
| Market value gain on available for sale  securities |       | 69            |       | —           |       |
| Adjustment to common stock (a)                      |       | (16,634       | )          | (16,455          | )          |
| Adjustment to deferred stock compensation (a)       |       | —        |       | (104             | )          |
| Adjustment to accumulated deficit (a)               |       | 16,634        |       | 16,559           |       |
|                                                |       | 69            |       | —           |       |
| Stockholders’ equity under U.S. GAAP           |       | $             | 13,077     |             | $          | 19,551 |   |

 

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*Statementof Operations*
| **(In thousands except per share  amounts)**                                                 | ** ** | **Three months ended** | ** ** |
|----------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                   | ** ** | **March 31,**          | ** ** |
| ** **                                                                                   | ** ** | **2005**               | ** ** | **2004** | ** ** |
| Net loss under Canadian GAAP                                                                 |       | $                      | (6,722     | ) | $ | (6,284 | ) |
| Reversal of unrealized foreign exchange (gain)  loss on investments (b)                      |       | (177                   | )          | (5 | ) |
| (Gain) loss on market value of investments (b)                                               |       | (125                   | )          | 6 |   |
| Reversal of stock compensation expense (a)                                                   |       | 179                    |       | 663 |   |
| Stock compensation expense under APB No. 25 (a)                                              |       | (104                   | )          | (37 | ) |
|                                                                                         |       | (227)                  |       | 627 |   |
|                                                                                         |       |                   |       |   |   |
| Net loss under U.S. GAAP                                                                     |       | $                      | (6,949     | ) | $ | (5,657 | ) |
|                                                                                         |       |                   |       |   |   |
| Basic and diluted loss per common share under  Canadian GAAP                                 |       | $                      | (0.09      | ) | $ | (0.09 | ) |
|                                                                                         |       |                   |       |   |   |
| Basic and diluted loss per common share under  U.S. GAAP                                     |       | $                      | (0.10      | ) | $ | (0.08 | ) |
|                                                                                         |       |                   |       |   |   |
| Common shares used to compute basic and diluted  loss per share under Canadian and U.S. GAAP |       | 72,506                 |       | 72,498 |   |

*Statement of Cash Flows*

For all periodspresented there are no significant differences under Canadian and U.S. GAAP innet cash (used in) provided by operating, investing and financing activities.

*Differences*

The followingnotes outline the differences between Canadian and U.S. GAAP that affect theCompany for the three months ended March 31, 2005 and 2004.

(a)                                  As discussed in Note 1, onJanuary 1, 2004, the Company adopted fair value accounting for all stockoptions as required by CICA 3870.  TheCompany is required to record the expense of the fair value of all stock optionsover their respective vesting term.  TheCompany used the “Retrospective method without Restatement.”  This method requires the Company to recordthe cumulative expense as an adjustment to accumulated deficit for the periodbeginning January 1, 1995 through December 31, 2003 and begin recording theexpense to accumulated deficit in 2004.

 

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The Financial AccountingStandards Board (FASB) issued Statement of Financial Accounting Standards(SFAS) No. 148, *Accounting for Stock-Based Compensation,Transition and Disclosure*(SFAS No. 148)**inDecember 2002.  SFAS No. 148 providesalternative transition methods for entities that voluntarily elect to adopt the fair value recognition provisions of FASBStatement No. 123, *Accounting for Stock-BasedCompensation*(SFAS No. 123)*,*tostock-based employee compensation.  Underthe provisions of SFAS No. 123, fair value accounting is required for allgrants made on or after January 1, 1995. The Company has not elected to adopt the provisions of SFAS No. 123 forU.S. reporting purposes, which would require fair value based accountingfor grants made on or after January 1, 1995.

Under the principles of SFAS No. 123, theCompany would have recorded $17,957,000 of deferred compensation related to thetotal fair value for stock options granted between January 1, 1995 and March31, 2005.  The following tableillustrates the effect on net loss and loss per share under U.S. GAAP if theCompany had applied the fair value accounting provisions of SFAS No. 123 to employeestock based compensation:
| **(In  thousands except per share amounts)**                  | ** ** | **Three months ended** | ** ** |
|---------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                    | ** ** | **March 31,**          | ** ** |
| ** **                                                    | ** ** | **2005**               | ** ** | **2004** | ** ** |
| Net loss under U.S. GAAP                                      |       | $                      | (6,949     | ) | $ | (5,657 | ) |
|                                                          |       |                   |       |   |   |
| Stock-based compensation under APB No. 25                     |       | 104                    |       | 37 |   |
| Stock-based compensation expense recorded under  SFAS No. 123 |       | (179                   | )          | (663 | ) |
| Pro forma net loss under U.S. GAAP                            |       | $                      | (7,024     | ) | $ | (6,283 | ) |
|                                                          |       |                   |       |   |   |
| Pro forma loss per common share                               |       | $                      | (0.10      | ) | $ | (0.09 | ) |
|                                                               |            |                        |            |  |  |  |  |  |  |

(b)                                      Under U.S. GAAPSFAS No. 115, *Accounting for Certain Investments in Debtand Equity Securities*, the Company would have classified certain ofits short-term securities as available-for-sale and, accordingly, would haveincluded the changes in net unrealized holding gains or losses on thesesecurities as a component of stockholders’ equity rather than in operations.

The Emerging Issues Task Force (EITF) recently deliberated regardingIssue No. 03-01, *The Meaning of Other-Than-TemporaryImpairment and Its Application to Certain Investments*.  The Issue is intended to address the meaningof other-than-temporary impairment and its application to certain investmentsheld at cost.  The EITF reached aconsensus regarding disclosure requirements concerning unrealized losses onavailable-for-sale debt and equity securities accounted for under SFAS No.115.  The guidance for evaluating whetheran investment is other-than-temporarily impaired has been deferred.  The Company continues to evaluate the effectof this pronouncement on its financial statements.

 

15

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SFASNo. 130, *Reporting Comprehensive Income*,establishes standards for the reporting and display of comprehensive loss andits components in a full set of general-purpose financial statements.  Comprehensive loss is as follows:
| **(In thousands)**                                             | ** ** | **Three months ended** | ** ** |
|----------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                     | ** ** | **March 31,**          | ** ** |
| ** **                                                     | ** ** | **2005**               | ** ** | **2004** | ** ** |
| Net loss under U.S. GAAP                                       |       | $                      | (6,949     | ) | $ | (5,657 | ) |
| Other comprehensive income                                     |       |                   |       |   |   |
| Adjustment of unrealized foreign exchange gain  on investments |       | 177                    |       | 5 |   |
| Market value loss on investments                               |       | (173                   | )          | (6 | ) |
| Comprehensive net loss under U.S. GAAP                         |       | $                      | (6,945     | ) | $ | (5,658 | ) |
|                                                           |       |                   |       |   |   |

(c)                                   At March 31, 2005 and December 31, 2004, the Companydecided to report the bioreagent business as a discontinued operation pursuantto the requirements of CICA 3475, *Disposal of Long-livedAssets and Discontinued Operations* (CICA 3475), SFAS No. 144, *Accounting for the Impairment or Disposal of Long-Lived Assets*(SFAS No. 144), and EITF 03-13, *Applying the Conditions inParagraph 42 of FASB Statement No. 144 in Determining Whether to ReportDiscontinued Operations*.  SeeNote 10 for further disclosure and subsequent events in Note 11.

***New U.S. GAAP AccountingPronouncement***

*Share-based payment*

In December 2004, the Financial Accounting Standards Board, or FASB,issued SFAS No. 123(R), “*Share-BasedPayment,*” which is a revision of SFAS No. 123, “*Accounting for Stock-Based Compensation*”.SFAS No. 123(R) requires that the compensation cost relating to share-basedpayment transactions be recognized in financial statements. The compensationcost will be measured based on the fair value of the equity or liabilityinstruments issued. On April 14, 2005, the SEC announced that the effectivedate of SFAS No. 123(R) will be postponed until January 1, 2006 for calendaryear companies. The Company will adopt SFAS No. 123(R) on January 1, 2006. TheCompany has not determined the impact of adopting SFAS No. 123(R) on thefootnotes. Further the Company does not yet know the impact that any futureshare-based payment transactions will have on its financial statements.

 

InMarch 2005, the SEC issued Staff Accounting Bulletin No. 107 (SAB No. 107), *Share-Based Payment*, in which the staff expresses its viewsregarding the valuation of share-based payment arrangements.  SAB No. 107 is intended to assist issuers intheir initial implementation of SFAS No. 123R and enhance the informationreceived by investors and other users of financial statements.

 

**10.****                              ****DISCONTINUED OPERATION**

The Company’sbioreagent business produces and sells bioreagents to researchers and research organizations worldwide.  The products sold by the bioreagent businessinclude antibodies, proteins, DNA products, ELISA kits and extracts for use instudying cellular stress response pathways, including oxidative stress,apoptosis, neurobiology and more.

 

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At March 31, 2005and December 31, 2004, the Companyis reporting the bioreagent business as a discontinued operation pursuant tothe requirements of CICA 3475, *Disposal of Long-livedAssets and Discontinued Operations* (CICA 3475), SFAS No. 144, *Accounting for the Impairment or Disposal of Long-Lived Assets*(SFAS No. 144), and EITF 03-13, *Applying the Conditions inParagraph 42 of FASB Statement No. 144 in Determining Whether to ReportDiscontinued Operations*.  TheCompany is reporting the business as a discontinued operation after evaluatingintentions for the future of the bioreagent business, formulating a plan forsale and taking steps to execute that plan.

The significantaccounting principles discussed in Note 1 were applied to all discontinuedoperation transactions.  In addition,inventories are valued at the lower of cost or net realizable value.

In April 2005, theCompany signed a definitive agreement to sell the bioreagent business to allowit to focus its corporate strategy, manage resources and provide workingcapital to further fund the development and commercialization of HspE7.  The sale of the bioreagent business wasclosed effective April 29, 2005. The Company will report any gain realized onthe sale in the second quarter of 2005 on the sale of the bioreagent businessas prescribed by CICA 3475 and SFAS No. 144 (Note 11).

The operatingresults of the bioreagent business have been separately classified and reportedas discontinued operations in the consolidated financial statements.  A summaryof the components of discontinued operations in the Consolidated Statement ofOperations was as follows:
| **(In thousands)**                      | ** ** | **Three months ended** | ** ** |
|-----------------------------------------|------------|------------------------|------------|
| ** **                              | ** ** | **March 31,**          | ** ** |
| ** **                              | ** ** | **2005**               | ** ** | **2004** | ** ** |
| Bioreagent sales                        |       | $                      | 1,581      |   | $ | 1,452 |   |
| Operating expenses                      |       | (1,171                 | )          | (910 | ) |
| Other income (expenses)                 |       | 7                      |       | (8 | ) |
| Net income from discontinued operations |       | $                      | 417        |   | $ | 534 |   |

 

The bioreagentbusiness was previously reported in the segment disclosure of our quarterly andannual filings.  The income reported above does not include internal overhead andadministrative overhead expense allocations that were assigned to this segmentand which will continue to be incurred by the continuing entity.

 

A summary of the components of assets and liabilities of discontinuedoperations on the ConsolidatedBalance Sheets was as follows:

 

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| ** **                                   | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------|------------|---------------|------------|------------------|------------|
| **(In thousands)**                           | ** ** | **2005**      | ** ** | **2004**         | ** ** |
| Assets of discontinued operations:           | ** ** | ** **    | ** ** | ** **       | ** ** |
| Cash and cash equivalents                    |       | $             | 252        |             | $          | 551 |   |
| Short-term investments                       |       | 582           |       | 515              |       |
| Accounts receivable, net                     |       | 679           |       | 589              |       |
| Inventories                                  |       | 570           |       | 561              |       |
| Prepaid expenses                             |       | 9             |       | 15               |       |
| Other current assets                         |       | 36            |       | 60               |       |
| Plant and equipment, net                     |       | 174           |       | 156              |       |
| Total assets of discontinued operations      |       | $             | 2,302      |             | $          | 2,447 |   |
|                                         |       |          |       |             |       |
| Liabilities of discontinued operations       |       |          |       |             |       |
| Accounts payable                             |       | $             | 297        |             | $          | 324 |   |
| Total liabilities of discontinued operations |       | $             | 297        |             | $          | 324 |   |

 

A summary of the components of cash flows for discontinuedoperations was as follows:

** **
| **(In thousands)**                                         | ** ** | **Three months ended** | ** ** |
|------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                 | ** ** | **March 31,**          | ** ** |
| ** **                                                 | ** ** | **2005**               | ** ** | **2004** | ** ** |
| Net cash flows (used in) provided by operating  activities |       | $(233                  | )          | $411 |   |
| Net cash flows used in investing activities                |       | (66                    | )          | — |   |
| Net cash flows provided by financing activities            |       | —                 |       | — |   |
| Net (decrease) increase in cash                            |       | (299                   | )          | 411 |   |
| Cash and cash equivalents at the beginning of  the period  |       | 551                    |       | 247 |   |
| Cash and cash equivalents at the end of the  period        |       | $252                   |       | $658 |   |

 

**11.****                           ****SUBSEQUENTEVENTS**

 

In April 2005, the Companyannounced that it signed a definitive agreement to sell the bioreagent businessto Stressgen Bioreagents Corporation, a newly-formed company funded byAmpersand Ventures (Ampersand), for approximately $8,000,000 (See Note 10).  As part of the agreement, the Company willprovide transitional administrative service, which will provide the Companywith additional funding.  The Companycompleted the sale of the bioreagent business on April 29, 2005.

As discussed in Note 1, inApril 2005, the Company also announced that it elected to withdraw the amendedand restated preliminary prospectus dated February 24, 2005, in connection witha proposed offering of common shares in Canada. In conjunction with this news and the sale of the bioreagent business,the Company will be pursuing several corporate initiatives that will allow fordevelopment of HspE7 and also preserve cash.

Alsoin April 2005, the Company announced the appointment of a new President andCEO.  See Note 4 for discussion ofseverance paid to the former President and CEO in April 2005.

 

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InApril 2005, the Company announced a restructuring that will allow the Companyto focus its resources on the advancement of HspE7.  As a result of the restructuring, the Companyreduced its workforce by approximately 49% and is redirecting its researchefforts in order to reduce the Company’s annual cash expenditures.

 

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

This“Management’s Discussion and Analysis of Financial Condition and Results ofOperations” is dated as of May 6, 2005. It contains forward-looking statements that involve risk anduncertainties.  The predictions describedin these statements may not materialize if management’s current expectationsregarding our future performance prove incorrect.  Our results could also be affected by factorsincluding, but not limited to, our reliance on collaborative partners and otherrisks described in our annual report under the heading “Factors That May AffectFuture Performance.”  Our forward-lookingstatements are based on currently available information; we disclaim anyobligation to update them.

Thefollowing information should be read in conjunction with our March 31, 2005consolidated quarterly financial statements and related notes therein, whichare prepared in accordance with Canadian GAAP. These principles differ in certain respects from U.S. GAAP.  The differences, as they affect ourconsolidated financial statements, are described in Note 9 to our consolidatedfinancial statements.  All amountsfollowing are expressed in Canadian dollars unless otherwise indicated.

## **Overview**

Fromour inception in 1990 to 1993, our core business involved the sale ofbioreagent products.  Although weretained and expanded our bioreagent business worldwide, our primary focussince 1993 has been the research and development of innovative stressprotein-based fusion products that will stimulate the body’s immune system tocombat viral infections and related cancers. Our lead therapeutic vaccinecandidate is HspE7.  HspE7 is abroad-spectrum therapeutic vaccine candidate in development for diseases causedby the human papilloma virus.  HspE7 isderived from our proprietary platform technology that enables us to covalentlyfuse stress proteins to antigens that invoke immune system responses.  By covalently fusing Hsp anddisease-associated antigens, we believe that we can create a proprietaryportfolio of CoValTM fusion products designed to stimulate the immune system toidentify, target and eliminate virus-infected and cancerous cells.

Wehave incurred significant losses since our inception and expect to incursubstantial losses for the foreseeable future as we invest in our research andproduct development programs, including manufacturing, pre-clinical studies andclinical trials, and regulatory activities. At March 31, 2005 our accumulated deficit was $219,071,000.  Historically, we have depended principally onequity financings, cash flows from our bioreagent business and funding fromresearch collaborations to fund our business activities.  In April 2005, we signed a definitiveagreement to sell the bioreagent business to allow us to focus our corporatestrategy, manage resources and provide working capital to further fund thedevelopment and commercialization of HspE7. We completed the sale of that business effective April 29, 2005.  We intendto pursue additional equity financings, markets permitting, and to seekadditional research collaborations to fund our business activities.

Oursuccess will depend upon the safety and efficacy of our immunotherapeuticproducts in pre-clinical studies and clinical trials, and upon obtaining thenecessary regulatory approvals to market our products.  The marketability of our products will beinfluenced by competition from alternative therapies and the degree ofprotection our intellectual property provides. We believe there will be significantmarkets for our therapeutic products should these products prove to beeffective in human clinical trials.

### *Restructured Roche Agreement*

In December 2003, we announced a restructuring ofour June 2002 collaboration agreement with Roche providing for thedevelopment and commercialization of HspE7. Under the restructured terms we granted Roche an option to license thefirst generation HspE7 product, a license to develop a second generation HspE7product, and non-exclusive options to negotiate rights to CoValTMfusion product candidates for the treatment of cancers and hepatitis C.   Roche can pay fees to make theseoptions exclusive until January 1, 2007.

 

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Inconnection with the first generation of HspE7, the restructured agreement givesus the right to develop and commercialize the product for indications otherthan genital warts, including control of regulatory matters such as INDapplications.  In the original agreementwe were responsible for clinical expenses only for the development of RRP.  In the new agreement we are responsible forthe manufacturing and other costs of all indications that we develop.  If Roche exercises its rights to the firstgeneration product, it will fund all prospective development costs.  Roche can exercise its rights to the firstgeneration of HspE7 by paying a fee, in which case it would also becomeresponsible for event-driven milestones that could result in aggregate paymentsto us of up to US$138,000,000. Under that scenario, we would receive therevenue from all first generation HspE7 product sales in the U.S. and Canadafor three years following approval of a BLA with the FDA and would receivesales-based payments (similar to royalties) of approximately 35% of net salesin the U.S. and Canada thereafter.  Wewould receive sales-based payments of 20% of net sales in countries other thanthe U.S. and Canada.

Bypaying additional fees, Roche can exclusively develop the second generationHspE7 product.  In such case Roche would be required to pay the costsof development, manufacturing and commercialization of the product and to makepayments to us upon the achievement of defined milestones. We would alsoreceive tiered, progressive sales-based payments that we believe are competitivewith other agreements of this stage and type.  Commercial success paymentsof up to approximately US$85,000,000 become payable depending upon theaggregate net sales of either or both generations of the HspE7 products. Therestructured collaboration agreement gives us the right to discuss, negotiateand execute an alternative agreement with a third-party for the development andcommercialization of HspE7 through a license, partnership, joint venture orsimilar transaction.  After March 31,2005 and through the end of the option period, Roche can terminate this rightby paying us a fee, which we expect would be either US$10,000,000 orUS$15,000,000 depending on the stage of development of the product.  We cannot determine if or when this optionwill be exercised.

## **Liquidity and 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.  Through March31, 2005 we have raised net equity proceeds of $198,238,000.

The accompanyingfinancial statements have been prepared on a going concern basis, whichcontemplates the realization of assets and the satisfaction of liabilities inthe normal course of business.  We have ahistory of recurring losses from operations and have an accumulated deficitof $219,071,000 as of March 31, 2005.  The nature of our businessrequires significant spending on R&D activities.  Due to our historyof losses, high cash burn on R&D activities and the loss of bioreagentrevenue as a result of the sale of that business, we are closelymonitoring our cash resources.  Based upon the sale of our reagentbusiness and our current business plan including the recent reduction inheadcount and review of our timelines regarding the HspE7 program, assuming weraise approximately $5,000,000, we will have sufficient resources to fundoperations through the first quarter 2006.  Based on our current forecast,if we do not raise at least that amount of cash we may need to modify or cancelagreements with external contractors, and make further changes to our staffinglevel which would impact the development timelines of HspE7.  Under this scenario, we will have resourcesto fund operations through the end of 2005.

Weemploy a financial performance measurement system designed to ensure ourrevenues and expenses are consistent with management’s operational objectivesand budgetary constraints.  Our cash utilization in 2005 will be dependentupon several factors, including the timing and progress of clinical developmentof HspE7, the cost of manufacturing clinical supplies and the sale of ourbioreagent business.

At March 31, 2005 and December 31, 2004, we had$13,488,000 and $21,578,000, respectively, of cash, cash equivalents andshort-term investments. The $8,090,000 decrease is due principally to spendingrelated to the development of HspE7.  AtMarch 31, 2005 and December 31, 2004, approximately 58% and 48% of cash, cashequivalents and short-term investments were held in U.S. dollars.   During 2004, we purchased British pounds tofund payments under our Avecia contract. At March 31, 2005 and December 31, 2004 approximately 38% and 36% of ourcash, cash equivalents and short-term investments were held 

 

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inBritish pounds.  Periodically we maypurchase additional British pounds based on future anticipated financialobligations in that currency.

Duringthe three months ended March 31, 2005 and 2004, we reported $8,679,000 and$6,312,000, respectively net cash used in operating activities from continuingoperations.  The increase in 2005 over2004 is primarily due to the prepayments to our third party vendors.

Duringthe three months ended March 31, 2005, purchases of plant and equipment bycontinuing operations totaled $3,000 compared with $130,000 during the sameperiod in 2004.  Spending during 2004consisted of tenant improvements on our facilities, laboratory equipment andcomputer related hardware.  We expect our2005 capital spending to include purchases required to preserve our currentlevel of manufacturing, research and administrative capabilities.

AtMarch 31, 2005 and December 31, 2004 we had an outstanding term loan obligationof $427,000 and $514,000, respectively. In September 2003 we entered into a 36-month term loan with OxfordFinance Corporation (Oxford).  Under theterms of the Oxford loan, we must issue a letter of credit for the outstandingloan balance if our combined cash, cash equivalents, and short-term investmentsfall below $6,000,000.

Weexpect to seek additional funds from various sources, including corporatepartners that enter into research and development collaborations with us, andpublic and private equity financings.  Ifwe raise additional funds by issuing equity securities, substantial dilution toour existing shareholders may result.  Wemay need to obtain funds through collaborative arrangements with others thatare on unfavorable terms.  We may alsohave to relinquish rights to certain of our technologies, product candidates orproducts that we would otherwise seek to develop ourselves.

### *Contractual Obligations*

Ourcontractual obligations consist primarily of agreements related to thedevelopment and manufacture of HspE7, operating leases for facilities, a termloan to increase working capital cash flows and contractual employmentobligations.  We have severalcontractors working on different aspects of the work regulatory authoritiesrequire for a biologic product, including stability testing, analyticaltesting, release testing and the manufacturing and fill/finish activities notedbelow.

InJanuary 2004 we entered into a biological services agreement with Avecia forthe process development, scale-up and manufacture of HspE7.  In addition, we may have Avecia manufacturecommercial drug substance.  Under theterms of the agreement, we arerequired to make upfront payment for future services and use of thefacility.  We made prepayments totaling$3,175,000 for services to be rendered and space utilized in 2005.  At March 31, 2005, a portion of the workrelated to these prepayments has been completed.  We made a $1,814,000 prepayment in 2004.  The other prepayment of $1,361,000 was notmade until 2005 and therefore was included in deferred development expenses,current portion and accrued liabilities in the December 31, 2004 ConsolidatedBalance Sheet.

TheAvecia agreement is cancelablesubject to specified termination conditions. The cancellation fee is based on asliding percentage of certain future program milestones.  Accordingly, the cancellation fee is modifiedeach month during the course of the agreement, based on the timing ofactivities performed by Avecia and prepayments for those activities.  However, as of March 31, 2005 there wouldhave been no cancellation penalty.

In October 2004, we entered into an agreementwith Cardinal Health (Cardinal) in the ordinary course of our business.  Cardinal will perform activities to prepareand distribute HspE7 to clinical trial sites.  In 2005 we made aprepayment of $295,000 for future services to be rendered in 2005.  At March31, 2005 a portion of the work has been completed related to theseprepayments.  We were contractuallyobligated to make this prepayment as of December 31, 2004; however the paymentwas not made until early 2005.  Thereforethe amount was included in deferred development expenses, current portion andaccrued 

 

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liabilitiesin the December 31, 2004 Consolidated Balance Sheet and has been reclassifiedto prepaid assets as of March 31, 2005.

Theagreement with Cardinal includes cancellation provisions that could require usto pay for work that was not performed or equipment that was not used if weterminate the contract while activities are at pre-defined stages.  The contract is subject to a cancellation feeof approximately $139,000 which would be offset against any remaining prepaidbalance.

Toretain a flexible development program, we typically negotiate terminationprovisions so that our financial obligations are limited to paying for workperformed up to the termination date and in some cases, pre-establishedcancellation fees.  Except as disclosedabove we currently do not have other significant research and developmentcontracts subject to cancellation fees. We have not entered into any minimum supply agreements with any servicevendors or contract manufacturers.

Wehave employment agreements with certain members of management which includespecific severance packages.  Asdiscussed in Note 11 to our consolidated financial statements, in conjunctionwith the appointment of a new President and Chief Executive Officer (CEO), wepaid the former President and CEO approximately $884,000 in April 2005 whichwill be included in the Consolidated Statement of Operations for the secondquarter of 2005.  In addition to theamount paid to the former CEO in April 2005 and considering the impact of theApril 2005 sale of the bioreagent business and the restructuring (Note 11), weare contractually obligated to pay$1,878,000 per employment agreements of certain remaining executives.

Therehave been no other changes in our future contractual obligations from theamounts reported as of December 31, 2004.

### ***Off-Balance Sheet Arrangements***

We did not enter into anyoff balance sheet arrangements during the three months ended March 31, 2005 and2004.

### ***Related Party Transactions***

We have used variousaffiliates of MDS, Inc., including MDS Pharma Services, to provide researchservices.  During the first quarter of 2004, we paid the various MDSentities an aggregate of $37,000.  One of the Company’s boardmembers was an officer of MDS, Inc. through May 2004.

### ***Discontinued Operations***

Our bioreagent businessproduces and sells bioreagents to researchers and research organizationsworldwide.  The products sold by thebioreagent business include antibodies, proteins, DNA products, ELISA kits andextracts for use in studying cellular stress response pathways, including oxidativestress, apoptosis, neurobiology and more.

At March 31, 2005 andDecember 31, 2004, we decided to report the bioreagent business as adiscontinued operation pursuant to the requirements of CICA 3475, *Disposal of Long-lived Assets and Discontinued Operations*(CICA 3475), SFAS No. 144, *Accounting for theImpairment or Disposal of Long-Lived Assets* (SFAS 144), and EITF03-13, *Applying the Conditions in Paragraph 42 of FASBStatement No. 144 in Determining Whether to Report Discontinued Operations*.  We are reporting the business as adiscontinued operation because we have evaluated our intentions for the futureof the bioreagent business, formulated a plan for sale and have taken steps toexecute that plan.

In April 2005, we signed a definitive agreement to sell the bioreagentbusiness to allow us to focus our corporate strategy, manage resources andprovide working capital to further fund the development and commercializationof HspE7.  We completed the sale of the bioreagentbusiness effective April 29, 2005. We will report any gain realized on the salein the second quarter of 2005 on the sale of the bioreagent business asprescribed by CICA 3475 and SFAS No. 144.

 

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Duringthe three months ended March 31, 2005 the bioreagent business contributed netincome of $417,000 as compared to $534,000 for the same period in 2004 ($0.01and $0.00 per share, respectively).  Thedecrease in net income from discontinued operations for the three months endedMarch 31, 2005 compared to the same period in 2004 was due principally toincreased spending related to sales and marketing efforts.  This spending was partially offset byimproved contributions from revenue.

Theincome reported above does not include internal overhead and administrativeoverhead expense allocations that were assigned to this segment and which willcontinue to be incurred by the continuing entity.  After we sell the bioreagent business we willnot have this contribution of net income thereafter.  We entered into a contract with the buyer toprovide temporary administrative support for a transition period.

## **Results of Continuing Operations**

Duringthe three months ended March 31, 2005, we realized a net loss from continuingoperations of $7,139,000 or $0.10 per common share as compared to $6,818,000 or$0.09 for the same period in 2004.  The$321,000 increase in our net loss for the first quarter 2005 as compared to thefirst quarter 2004 is due principally to incremental third party spending tofurther the development of HspE7.

### *Collaborative R&D revenue*

Werecorded collaborative R&D revenue of $163,000 and $173,000 in the threemonths ended March 31, 2005 and 2004, respectively.  Collaborative R&D revenue relatesprincipally to the amortization of upfront license fees in accordance with CICAAccounting Standards Board recommendations, section 3400, *Revenue,*and Staff Accounting Bulletin (SAB) No. 101, *RevenueRecognition in Financial Statements*.

### *Research and development*

Researchand development in our continuing operations includes costs associated withtherapeutic product development, clinical studies and ongoing exploratoryresearch.  In order to optimize ourfinancial flexibility, we employ clinical research organizations to conduct ourclinical trials and engage contract manufacturers to assist us with productdevelopment and manufacturing.

R&Dspending in our continuing operations increased by approximately 5% to$5,539,000 during the three month periods ended March 31, 2005, compared with$5,273,000 for the same period in 2004. This increase is due principally to spending at Avecia, which beganearly in 2004 along with additional spending with other vendors to manufactureHspE7 in preparation for our phase III pivotal trial. Our spending at Avecia isexpected to continue to be a major component of our R&D spending through2005 as we transition from process development activities to initial productionruns of bulk drug substance for our upcoming pivotal trial.

OurR&D spending during the three month periods ended March 31, 2005 wasdevoted principally to our effort to further develop HspE7, including processdevelopment and manufacturing activities, preparation for our pivotal phase IIIRRP trial.  During the first quarter of2005, primarily all of our R&D spending related to efforts developingHspE7.  Beginning in mid-2004, we focusedthe majority of our resources on developing HspE7.  In periods prior to mid-2004, we allocated someof our R&D spending to exploratory research involving our follow-on CoValTMfusion proteins.

In March 2005 we announced that data from a phaseII study in high grade cervical dysplasia using HspE7 was presented by MarkEinstein, M.D, of Albert Einstein College of Medicine on behalf of the New Yorkphase II Consortium and under the sponsorship of the National Cancer Institute(NCI) at the Society of Gynecologic Oncologists Annual Meeting on Women’sCancer TM.  This NCI phase IItrial was designed to evaluate the efficacy and safety of HspE7 against CINIII.  There were 31 women who completedthe trial and of the 31 patients, 10 had a complete pathologic response; 12 hada partial response, and 9 had stable disease. No patient had progressive disease. The overall response rate was 71%. These data from the 

 

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NCI-sponsoredtrial, along with the data of Dr. Jeffery Weber announced in November 2004,will be used to guide our phase III development plans.

Over the next severalmonths, we intend to dedicate our strategic and financial resources to supportthe further advancement of HspE7.  Wewill continue to focus on process development and the manufacture ofcommercial-grade HspE7, a requirement that must be met prior to beginning theplanned pivotal Phase III study of HspE7 in patients with recurrent respiratorypapillomatosis (RRP).  We will also needto raise additional funds to begin and continue to conduct that trial.  Due to recent technical developments regardingthe manufacture of commercial-grade HspE7, there is uncertainty as to whetherwe will be able to manufacture material satisfactory to begin our pivotal PhaseIII study.  If we are able to do so, theearliest we could initiate the planned pivotal Phase III trial in RRP is at thebeginning of the fourth quarter of 2005. If certain manufacturing runs do not produce satisfactory material, wemay need to invest additional time and resources into the program, which couldlead to further delays in the initiation of any Phase III trial.  We will provide an update on our progress bythe end of July 2005.

Ourpivotal phase III trial to treat RRP will be a randomized, double-blind,placebo controlled study with approximately 130 patients.  The pivotal trial is expected to have themedian post surgical interval as the primary end point.  We have begun identifying clinical sites,primarily in the U.S. with additional sites in Canada.  Accordingly, we recorded the expense relatedto the start-up portion of the pivotal trial in the fourth quarter of 2004pursuant to our accounting policy discussed in Note 1 to our consolidatedfinancial statements.  We plan to applyfor priority review when we file the BLA for HspE7.  The FDA has granted HspE7 orphan drugstatus and designated it as a fast track development program for the treatmentof RRP.

InDecember 2004, we announced the completion of enrollment in a single arm pilotPhase II clinical trial to investigate HspE7 in patients with internal genitalwarts.  Patients are under evaluation fora period of up to one year.

During2005, we expect to continue to devote the majority of planned R&D spendingto support HspE7 development, produce clinical trial supplies and begin patientaccrual activities for our RRP pivotal trial.

### *Selling, general and administrativeexpenses*

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

SG&Aspending through continuing operations decreased by approximately 4% to$2,006,000 for the three months ended March 31, 2005 from $2,095,000 for thesame period in 2004.  We anticipate thatin 2005 SG&A spending will be consistent with that of 2004.

We incurred costs inconjunction with its financing efforts in the fourth quarter of 2004 and firstquarter of 2005.  As of December 31,2004, the costs associated with the financing were classified as deferredexpenses included within “Other current assets” on the Consolidated BalanceSheet.  However, in April 2005, weannounced that we elected to withdraw the amended and restated preliminaryprospectus in connection with the proposed offering of common shares.  Therefore, subsequent to March 31, 2005, wedetermined that it was appropriate to reflect these costs totalingapproximately $550,000 as a selling, general and administrative expense on theMarch 31, 2005 Consolidated Statement of Operations and Accumulated Deficit.

### *Interest and other income*

Interest and other income from continuingoperations decreased for the three months ended March 31, 2005 to $359,000compared with $354,000 in for the same period in 2004.

 

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### *Net foreign exchange gain/loss*

Duringthe three months ended March 31, 2005 we reported a foreign exchange loss fromcontinuing operations of $102,000 compared to a reported $51,000 foreignexchange gain for the same period in 2004. During the second half of 2004 through the first quarter of 2005, theCanadian dollar strengthened against the U.S. dollar and the British poundcompared to the first half of 2004. Since approximately 96% of our cash, cash equivalents and short terminvestments are held in currencies other than the Canadian dollar, weexperienced a foreign exchange loss.

### *Basic and diluted loss per share*

Wereported a 5% increase in net loss from continuing operations to $7,139,000 forthe three months ended March 31, 2005, compared with $6,818,000 for the sameperiod in 2004.  There was a nominalchange in average number of common shares outstanding since the beginning of2004.  Therefore there was consistentdilution of the net loss from continuing operations resulting in $0.10 net lossfrom continuing operations per common share for the three months ended March31, 2005 as compared to $0.09 for the same period in 2004.

## **Differences betweenCanadian and U.S. generally accepted accounting principles**

Ourfinancial statements have been prepared in accordance with Canadian GAAP.  Certain adjustments would be required ifthese statements were to be prepared in all material respects in accordancewith U.S. GAAP.

Toconform to U.S. GAAP, our net loss would increase by $227,000 and decrease by$627,000 for the three months ended March 31, 2005 and 2004, respectively.  The principal differences under U.S.GAAP as opposed to Canadian GAAP for the three months ended March 31, 2005 werethe reversal of an unrealized foreign exchange gain on investments of $177,000,a reversal of a gain on market value of investments of $125,000 and thereversal of stock compensation expense totaling $179,000 related to fair valuestock option accounting adopted beginning January 1, 2004, offset by stockcompensation expense of $104,000 that would be recorded under APB Opinion No.25.  U.S. GAAP does not currently requirefair value accounting on stock-based compensation.  Therefore, under the provisions of APBOpinion No. 25, no expense is recorded for options granted with an exerciseprice equal to the fair value of the stock on the day of grant.  Under APB Opinion No. 25 expense is incurredwhen stock options are granted at exercise prices less than the fair value ofthe underlying stock.  Further, underU.S. GAAP, adjustments to the market value of our investment portfolio would berecorded as a component of stockholders’ equity.  Under Canadian GAAP unfavorable market valueadjustments are recorded as a component of operations.

Similarly,the principal differences under U.S. GAAP as opposed to Canadian GAAPfor the three months ended March 31, 2004 were the reversal of an unrealizedforeign exchange gain on investments of $5,000, a reversal of a loss on marketvalue of investments of $6,000 and the reversal of stock compensation expensetotaling $663,000 related to fair value stock option accounting adoptedbeginning January 1, 2004, offset by stock compensation expense of $37,000 thatwould be recorded under APB Opinion No. 25. These differences between U.S. GAAPand Canadian GAAP are described in Note 9 to our consolidated financialstatements.

Net loss per common share under U.S. GAAP wouldhave been $0.10 and $0.08 for the three months ended March 31, 2005 and 2004,respectively.  Our current assets andstockholders’ equity under Canadian GAAP as of March 31, 2005 would haveincreased by $69,000 under U.S. GAAP as a result of market value adjustments onavailable for sale securities.  Therewere no balance sheet differences between U.S. and Canadian GAAP as of December31, 2004.

 

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**Summary of Quarterly Results**
| ** **                                                                            | ** ** | **Quarter ended (b)** | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                            | ** ** | **June 30,**          | ** ** | **September 30,** | ** ** | **December 31,** | ** ** | **March 31,** | ** ** |
| ** **                                                                            | ** ** | **2004**              | ** ** | **2004** | ** ** | **2004** | ** ** | **2005** | ** ** |
| Net revenues, Canadian and U.S. GAAP   From continuing operations                     |       | 190                   |       | 174 |   | 163 |   | 163 |   |
|                                                                                  |       |                  |       |   |   |   |   |   |   |
| Research and development expenses, Canadian and  U.S. GAAP from continuing operations |       | 5,636                 |       | 6,422 |   | 8,582 |   | 5,539 |   |
|                                                                                  |       |                  |       |   |   |   |   |   |   |
| Net (loss) income, Canadian GAAP                                                      |       |                  |       |   |   |   |   |   |   |
| From continuing operations                                                            |       | (7,029                | )          | (8,367 | ) | (9,631 | ) | (7,139 | ) |
| From discontinued operations                                                          |       | 663                   |       | 410 |   | (27 | ) | 417 |   |
| Net loss, Canadian GAAP                                                               |       | (6,366                | )          | (7,957 | ) | (9,658 | ) | (6,722 | ) |
|                                                                                  |       |                  |       |   |   |   |   |   |   |
| Basic and diluted (loss) income per common  share, Canadian GAAP                      |       |                  |       |   |   |   |   |   |   |
| From continuing operations (a)                                                        |       | (0.10                 | )          | (0.12 | ) | (0.13 | ) | (0.10 | ) |
| From discontinued operations (a)                                                      |       | 0.01                  |       | 0.01 |   | (0.00 | ) | 0.01 |   |
| Total basic and diluted loss per common share                                         |       | (0.09                 | )          | (0.11 | ) | 0.13 |   | (0.09 | ) |
|                                                                                  |       |                  |       |   |   |   |   |   |   |
| Net loss, U.S. GAAP (c)                                                               |       | (6,014                | )          | (6,519 | ) | (9,831 | ) | (6,949 | ) |
|                                                                                  |       |                  |       |   |   |   |   |   |   |
| Basic and diluted loss per common share, U.S.  GAAP (a) (c)                           |       | (0.08                 | )          | (0.09 | ) | (0.14 | ) | (0.10 | ) |

 

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| ** **                                                                            | ** ** | **Quarter ended (b)** | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                            | ** ** | **June 30,**          | ** ** | **September 30,** | ** ** | **December 31,** | ** ** | **March 31,** | ** ** |
| ** **                                                                            | ** ** | **2003**              | ** ** | **2003** | ** ** | **2003** | ** ** | **2004** | ** ** |
| Net revenues, Canadian and U.S. GAAP   From continuing operations                     |       | 1,508                 |       | 855 |   | 510 |   | 173 |   |
|                                                                                  |       |                  |       |   |   |   |   |   |   |
| Research and development expenses, Canadian and  U.S. GAAP from continuing operations |       | 4,408                 |       | 5,636 |   | 3,258 |   | 5,273 |   |
|                                                                                  |       |                  |       |   |   |   |   |   |   |
| Net (loss) income, Canadian GAAP                                                      |       |                  |       |   |   |   |   |   |   |
| From continuing operations                                                            |       | (4,677                | )          | (6,034 | ) | (4,071 | ) | (6,818 | ) |
| From discontinued operations                                                          |       | 274                   |       | 411 |   | 309 |   | 534 |   |
| Net loss, Canadian GAAP                                                               |       | (4,403                | )          | (5,623 | ) | (3,762 | ) | (6,284 | ) |
|                                                                                  |       |                  |       |   |   |   |   |   |   |
| Basic and diluted (loss) income per common  share, Canadian GAAP                      |       |                  |       |   |   |   |   |   |   |
| From continuing operations (a)                                                        |       | (0.08                 | )          | (0.10 | ) | (0.06 | ) | (0.09 | ) |
| From discontinued operations (a)                                                      |       | 0.01                  |       | 0.01 |   | 0.00 |   | (0.00 | ) |
| Total basic and diluted loss per common share                                         |       | (0.07                 | )          | (0.09 | ) | (0.06 | ) | (0.09 | ) |
|                                                                                  |       |                  |       |   |   |   |   |   |   |
| Net loss, U.S. GAAP (c)                                                               |       | (4,222                | )          | (5,463 | ) | (3,365 | ) | (5,657 | ) |
|                                                                                  |       |                  |       |   |   |   |   |   |   |
| Basic and diluted loss per common share, U.S.  GAAP (a) (c)                           |       | (0.07                 | )          | (0.09 | ) | (0.05 | ) | (0.08 | ) |
|                                                                                  |       |                  |       |   |   |   |   |   |   |

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| (a) |   | Income (loss) per share is computed independently for each of the  quarters presented and therefore may not sum to the total for the year.                                                                                                                               |
|-----|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (b) |   | Amounts for the first, second and third quarters of 2004 and all  quarters in 2003 have been reclassified to conform to the presentation of the  bioreagent business as discontinued operations.                                                                         |
| (c) |   | To conform to U.S. GAAP certain adjustments must be made. The nature  of the principal difference is disclosed in the notes to our 2004 and 2003  audited financial statements. See Note 9 to the March 30, 2005 quarterly  financial statements for further disclosure. |

 

Ourquarterly financial results over the past eight quarters were principallyaffected by variations in revenues from our Roche collaboration and variationsin R&D spending.  Our collaborativeR&D revenues have decreased over time due principally to our December 2003restructured Roche agreement under which we are not reimbursed for R&Dspending related to HspE7.  Thefluctuation of R&D expense over the most recent eight quarters relates totiming of spending associated with our clinical trials, process development andmanufacturing of HspE7.  See thediscussion under the captions “Results of Operations — Collaborative R&Drevenue” and  “Results of Operations —Research and Development” for additional information.

## **Critical Accounting Policies**

Our significant accounting policies are disclosedin Note 1 to our consolidated financial statements herein and our 2004 AnnualReport on Form 10-K.  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 

 

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toa degree of uncertainty.  Accordingly,actual results could differ from the estimates made.  Our critical accounting policies include:

### *Revenue recognition*

Revenuefrom collaborative R&D arrangements may include multiple elements within asingle contract.  Our accounting policycomplies with the revenue determination requirements set forth in EITF 00-21 *Accounting for Revenue Arrangements with Multiple Deliverables*,and EIC 142 *Revenue Arrangements with Multiple Deliverable*,relating to the separation of multiple deliverables into individual accountingunits with determinable fair values.  Weestimate the fair value of deliverables in collaboration agreements usingstandard industry techniques.  Changes inthe determination of fair values or performance periods relating to certaindeliverables, and associated milestones, could impact the timing of futurerevenue streams.

### *Clinical trial accruals*

Clinicaltrial costs constitute a significant portion of R&D expense.  We recognize expenses related to our ongoingclinical trials using a methodology designed to accrue estimated costs in theappropriate accounting periods in which the expenses are incurred.    We recognize clinical trial costs in threedistinct phases that correspond with the period during which the services areperformed:  the start-up phase, thepatient accrual phase, and the close-out phase. Based on the design of thetrial, including the number of patients, number of clinical sites, method oftreatment, and follow-up, the allocation of trial costs to each phase couldvary from trial to trial.   Using ourcurrent trial accrual methodology, our liability for clinical trials as of March31, 2005 is $1,924,000, which includes the estimated effect of anywork-in-process terminated at the end of the reporting period.  Alternatively, if we utilized a percentage ofcompletion approach and used an operational estimate of the actual work completedas of March 31, 2005 compared to the total contract value, our clinical trialliability would decrease by approximately $660,000.

## **New U.S. GAAPAccounting Pronouncement**

### *Share-based payment*

In December 2004, the Financial Accounting Standards Board, or FASB,issued SFAS No. 123(R), “*Share-BasedPayment,*” which is a revision of SFAS No. 123, “*Accounting for Stock-Based Compensation*”.SFAS No. 123(R) requires that the compensation cost relating to share-basedpayment transactions be recognized in financial statements. The compensationcost will be measured based on the fair value of the equity or liabilityinstruments issued. On April 14, 2005, the SEC announced that the effectivedate of SFAS No. 123(R) will be postponed until January 1, 2006 for calendaryear companies. We will adopt SFAS No. 123(R) on January 1, 2006.  We have not determined the impact of adoptingSFAS No. 123(R) on the footnotes. Further we do not yet know the impact thatany future share-based payment transactions will have on its financialstatements.

In March 2005, the SEC issued Staff AccountingBulletin No. 107 (SAB No. 107), *Share-Based Payment*,in which the staff expresses its views regarding the valuation of share-basedpayment arrangements.  SAB No. 107 isintended to assist issuers in their initial implementation of SFAS No. 123R andenhance the information received by investors and other users of financialstatements.

**Subsequent Events**

 

InApril 2005, we announced that we signed a definitive agreement to sell thebioreagent business to Stressgen Bioreagents Corporation, a newly-formedcompany funded by Ampersand Ventures (Ampersand), for approximately $8,000,000(See Note 10).  As part of the agreement,we will provide transitional administrative service, which will provide theCompany with additional funding.  Wecompleted the sale of the bioreagent business on April 29, 2005.

 

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In April 2005, we also announced that we elected to withdraw theamended and restated preliminary prospectus dated February 24, 2005, inconnection with a proposed offering of common shares in Canada.  In conjunction with this news and the sale ofthe bioreagent business, we will be pursuing several corporate initiatives thatwill allow for development of HspE7 and also preserve cash.

Also in April 2005, we announced the appointment of a new President andCEO

In April 2005, we announced a restructuring that will allow us to focusits resources on the advancement of HspE7. As a result of the restructuring, we reduced our workforce byapproximately 49% and are redirecting its research efforts in order to reduceour annual cash expenditures.

## **Disclosure ofOutstanding Share Data**

The following tablecontains information regarding our outstanding equity as of May 6, 2005:
| Common shares outstanding     |   | 72,506,403 |   |
|-------------------------------|--------|------------|--------|
| Roche warrants                |   | 814,574    |   |
| Warrants under 2003 Financing |   | 5,304,149  |   |
| Stock options outstanding     |   | 3,200,051  |   |

## ** **

**FACTORS THAT MAY AFFECT FUTURE PERFORMANCE**

 

**Before investing in our common stock you should carefullyconsider the following risk factors, the other information included herein andthe information included in our other reports and filings.  Our business, financial condition, and thetrading price of our common stock could be adversely affected by these andother risks.**

**Werequire additional financing to execute our business plan**

We will need substantialadditional funds to pursue further research and development; carry out clinicaltrials; obtain regulatory approvals; file, prosecute, defend and enforce ourintellectual property rights and market our products.  We will seekadditional funds through public or private equity or debt financing, strategictransactions and/or from other sources.  If we fund our programs through equityfinancings and if the price of the shares ultimately sold in that offering isless than the net tangible book value of your common shares, you will sufferdilution.  Depending upon the amount ofcapital we raise through the sale of equity, the dilution may be substantial.  We could enter into collaborativearrangements for the development of particular products that would lead to ourrelinquishing some or all rights to the related technology or products.

There are no assurancesthat future funding will be available on favorable terms or at all.  Ifadditional funding is not obtained, we will need to reduce, defer or canceldevelopment programs, planned initiatives or overhead expenditures, to theextent necessary.  The failure to fund our capital requirements would havea material adverse effect on our business, financial condition and results ofoperations.

**We arean early stage development company**

Our biotechnology businessis still at an early stage of development. Significant additional research and development and clinical trials mustbe completed before our technology can be commercialized.  We have not completed the development of anytherapeutic products and, therefore, have not begun to market or generaterevenues from the commercialization of any therapeutic products.  We have 

 

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undertaken only limitedhuman clinical trials for HspE7 and cannot assure you that subsequent trialswill generate favourable results, that the results obtained from laboratory orresearch studies for our other products will be replicated in human studies,that our human studies will demonstrate efficacy or that our studies and trialswill not identify undesirable side effects of our products.  There are no assurances that any of ourtherapeutic products will:

•                  meet applicable health regulatory standards;

•                  obtain required regulatory approvals orclearances;

•                  be produced in commercial quantities atreasonable costs;

•                  be successfully marketed; or

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

None of our therapeuticproduct candidates are expected to be commercially available for severalyears.  It is possible that we will notsuccessfully develop any therapeutic products.

**We have a history of operatinglosses and may never become profitable**

We have not recorded any revenues from thesale of therapeutic products and have accumulated substantial net losses.  We expect we will continue to incur lossesfor at least the next several years while our primary activities are research,development and clinical trials.  OnApril 29, 2005, we sold our bioreagents business, which had been a source ofon-going revenue for us.  Once the proceedsfrom the sale have been exhausted, we could incur larger operating losses infuture fiscal periods than we incurred during comparable periods in 2003 or2004.  To become profitable we, eitheralone or with one or more partners, must develop, manufacture and successfullymarket therapeutic product candidates.

**Our success depends oncollaborative partners, licensees and other third parties over whom we havelimited control**

Due to the complexity of the process ofdeveloping therapeutics, our core business depends on arrangements withpharmaceutical companies, contractors, corporate and academic collaborators,licensors, licensees and others for the research, development, clinicaltesting, technology rights, manufacturing, marketing and commercialization ofour products. We have various research collaborations and outsource many otherbusiness functions, including clinical trials and manufacturing.  Our license agreements could obligate us todiligently bring potential products to market, make milestone payments androyalties that, in some instances, could be substantial, and incur the costs offiling and prosecuting patent applications. There are no assurances that we will be able to establish or maintaincollaborations that are important to our business on favorable terms, or atall.

Anumber of risks arise from our dependence on collaborative agreements withthird parties.  Product development andcommercialization efforts could be adversely affected if key collaborativepartners:

•                  terminate or suspend their agreements withus;

•                  cause delays;

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

 

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•                  fail to adequately perform clinical trials;

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

•                  otherwise fail to meet their contractualobligations.

Also,our collaborative partners could pursue other technologies or developalternative products that could compete with the products we are developing.

**The profitability of our products will depend in part on our ability toprotect proprietary rights and operate without infringing the proprietaryrights of others**

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

The reduction inthe number of employees as the result of our reduction in force in April 2005could adversely affect our ability to obtain and maintain patents and licenses and preserve trade secrets,and the period our intellectual property remains exclusive.

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

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

•                  we will develop additional patentable products;

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

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

•                  third parties will not be able to circumventour patents.

On October 22,2002 Antigenics Inc. announced that it had filed an opposition in the EuropeanPatent Office to a European patent and requests for re-examination in the U.S.Patent and Trademark Office of two U.S. patents we licensed in connection withthe Company’s platform technology.  InOctober 2003 Antigenics filed an opposition in the European Patent Office to anadditional, product specific, European patent. The EPO may hold an oral hearing as early as this fall concerning theopposition of the product specific patent if the parties do not request achange in the date.  The Company does notknow when results from these proceedings will be obtained.  Until the Company receives final results 

 

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from theopposition and re-examination processes, the Company will not be able to assureinvestors of the success of planned vigorous defense of the patents.  However, management does not expect that thiswill have a material impact to its financial statements.

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

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.  There are no assurances that our patentswould be held valid or enforceable by a court or that a competitor’s technologyor product would be found to infringe our patents in the event of patentlitigation.  Our business could bematerially affected by an adverse outcome to such litigation.  Similarly, we may need to participate ininterference proceedings declared by the U.S. Patent and Trademark Office orequivalent international authorities to determine priority of invention.  We could incur substantial costs and devotesignificant management resources to defend our patent position or to seek adeclaration that another company’s patents are invalid.

Muchof our know-how and technology may not be patentable, though it may constitutetrade secrets. There are no assurances that we will be able to meaningfullyprotect our trade secrets.  We cannotassure you that any of our existing confidentiality agreements with employees,consultants, advisors or collaborators will provide meaningful protection forour trade secrets, know-how or other proprietary information in the event ofany unauthorized use or disclosure. Collaborators, advisors or consultants may dispute the ownership ofproprietary rights to our technology, for example by asserting that theydeveloped the technology independently.

**We may encounterdifficulties in manufacturing our products**

Wehave not yet introduced any therapeutic products and have no experiencemanufacturing therapeutic vaccines ourselves. Before our products can be profitable, they must be produced incommercial quantities in a cost-effective manufacturing process that complieswith regulatory requirements, including good manufacturing practices (“GMP”),production and quality control regulations. Because we do not have facilities for the production of therapeuticproducts such as HspE7, we contract with third parties for process development,the scale-up of manufacturing our products from the laboratory bench tocommercial quantities, manufacturing of bulk materials, product characterization,filling the product into vials, packaging and related processes.  If there are delays or difficulties indeveloping a commercial manufacturing process, performing manufacturing ortransferring HspE7 between contractors performing different aspects of themanufacturing process, we may not be able to conduct clinical trials, obtainregulatory approval or meet demand for our products.

The reduction inthe number of employees as the result of our reduction in force in April 2005could adversely affect our ability to successfully work with third parties for process development, thescale-up of manufacturing our products from the laboratory bench to commercialquantities, manufacturing of bulk materials, product characterization, fillingthe product into vials, packaging and related processes.

Production of futureproducts could require raw materials which are scarce or which can be obtainedonly from a limited number of sources. If our manufacturers were unable to obtain adequate supplies 

 

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of such raw materials, thedevelopment, regulatory approval and marketing of our products could bedelayed.

**Wecould need additional clinical trials or take more time to complete ourclinical trials than we have planned**

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

Regulatoryauthorities may require us to determine whether our products delay or preventdisease recurrence.  Clinical trials toshow that a disease does not recur take longer to complete than clinical trialsthat end when patients stop having specific symptoms.  The actual schedules for our clinical trialscould vary dramatically from the forecasted schedules due to factors includingchanges in trial design, conflicts with the schedules of participatingclinicians and clinical institutions, delayed patient accrual and changesaffecting product supplies for clinical trials.

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

**We may not be able toobtain the regulatory approvals or clearances that are necessary tocommercialize our products**

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

Our product candidates, some of which are currently in the early stagesof development, will require significant additional development 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 clinical trials, or do not receive applicable regulatoryapprovals and clearances, or if there are delays in the process:

•                  the commercialization of ourproducts could be adversely affected;

•                  any competitive advantagesof the products could be diminished; and

•                  revenues or collaborativemilestones from the products could be reduced or delayed.

Governmental and regulatoryauthorities may approve a product candidate for fewer indications or narrowercircumstances than requested or may condition approval on the performance ofpost-marketing studies for a product candidate. Similarly, phase IV clinical trials could be a condition to regulatoryapproval.  Even if a product receivesregulatory approval and clearance, it may later exhibit 

 

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adverse side effects that limit or preventits widespread use or that force us to withdraw the product from the market.

Any marketed product and its manufacturerwill continue to be subject to strict regulation after approval.  Resultsof post-marketing programs may limit or expand the further marketing ofproducts.  Unforeseen problemswith an approved product or any violation of regulations could result inrestrictions on the product, including its withdrawal from the market and possible civil actions.

The manufacturers of our products will berequired to comply with applicable GMP regulations, which include requirementsrelating to quality control and quality assurance, as well as the maintenanceof records and documentation.  If the manufacturerscannot comply with regulatory requirements, including applicable GMPrequirements, we may not be allowed to develop or market the productcandidates.  If we or our manufacturersfail to comply with applicable regulatory requirements at any stage during theregulatory process, we may be subject to sanctions, including fines, productrecalls, product seizures, injunctions, refusal of regulatory agencies toreview pending market approval applications or supplements to approveapplications, total or partial suspension of production, civil penalties,withdrawals of previously approved marketing applications and criminalprosecution.

**Competitors may develop and market drugs that are less expensive, moreeffective or safer, making our products obsolete or uncompetitive**

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

 

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**Our products may not gain marketacceptance**

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

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

**Our operations and the useof our products could subject us to damages relating to injuries or accidentalcontamination**

Thehuman clinical trials we conduct, including trials in children, may haveunforeseen long-term health implications. We have only limited amounts of product liability insurance for ourclinical trials.  We may not correctlyanticipate or be able to maintain on acceptable terms the level of insurancecoverage that would adequately cover potential liabilities from proposedclinical trials and eventual commercial sales. Product liability insurance is expensive, difficult to obtain and maynot be available in the future.  If wecannot obtain sufficient insurance coverage or other protection againstpotential product liability claims, the commercialization of our products maybecome financially infeasible.  If anyliabilities from a claim exceed the limit of insurance coverage, we may nothave the resources to pay them.

Ourresearch and development processes involve the controlled use of hazardous andradioactive materials.  We are subject tofederal, state, provincial and local laws and regulations governing the use,manufacture, storage, handling and disposal of such materials and wasteproducts.  The risk of accidentalcontamination or injury from handling and disposing of such materials cannot becompletely eliminated. In the event of an accident involving hazardous orradioactive materials, we could be held liable for resulting damages.  We are not insured with respect to this liability.Such liability could exceed our resources. In the future we could incur significant costs to comply withenvironmental laws and regulations.

**Oursuccess depends on attracting and retaining qualified personnel**

We depend on a coremanagement and scientific team.  The lossof one or more of these individuals could cause delays or prevent us fromachieving our business objective of commercializing our productcandidates.  Our future success willdepend 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. Employee uncertainty resulting from our reduction in force inApril 2005 may adversely affect our ability to attract and retain employeesnecessary to implement our strategies and may disrupt our operations.  Ifour recruitment and retention efforts are unsuccessful, our business operationscould suffer.

 

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**Our revenues will depend upon the availability of reimbursement fromthird-party payors that are increasingly challenging the price and examiningthe cost effectiveness of medical products and services**

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

**Ourshare price has been and is likely to continue to be highly volatile**

Ourshare price has been highly volatile in the past and is likely to continue tobe volatile. The price of our shares could be materially affected by factorsincluding:

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

•                  regulatory actions;

•                  safety issues;

•                  changes affecting patents or exclusivelicenses;

•                  delays or difficulties in manufacturingclinical or commercial grade material;

•                  future issuances of shares;

•                  the announcement of technologicalinnovations;

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

•                  the development of new commercial products;

•                  changes in regulations;

•                  the release of financial results;

•                  public concerns over risks relating tobiotechnology;

•                  sales of shares by existing shareholders; and

•                  changes in analyst recommendations.

 

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## **Quantitative and Qualitative DisclosuresAbout Market Risk**

We use the Canadiandollar as our measurement and functional currency.  As a result, we are exposed to foreigncurrency fluctuations through our operations because a substantial amount ofour contract research and development spending has been transacted in othercurrencies, principally in U.S. dollars and British pounds.  We hold investment balances in the currenciesin which we have expenditures planned during the foreseeable future.  At March31, 2005, approximately 58% of cash, cash equivalents and short-terminvestments were held in U.S. dollars. At March 31, 2005 approximately 38% of our cash, cash equivalents andshort-term investments were held in British pounds.   We translate monetary assets and liabilitiesinto Canadian dollars using the rates of exchange prevailing at our balancesheet date. We record the resulting exchange gains and losses in our statementof operations.  Although we do notcurrently engage in hedging or other activities to reduce foreign currencyrisk, beyond matching investments proportionately with anticipated spending, wemay do so in the future if conditions change.

A hypothetical change inforeign exchange rates by applying a 10% change to our quarter-end foreignexchange rate, then applying that rate to our average level of U.S. investmentsduring the year, would result in an $922,000 impact.  If the value of the Canadian dollar relativeto the U.S. dollar were to increase by 10%, our net loss would decrease by$922,000.  Further, if the value of theCanadian dollar relative to the U.S. dollar were to decrease by 10%, our netloss would increase by $922,000.

A hypothetical change inforeign exchange rates by applying a 10% change to our year-end foreignexchange rate, then applying that rate to our average level of British poundinvestments during the year, would result in a $283,000 impact.  If the value of the Canadian dollar relativeto the British pound were to increase by 10%, our net loss would decrease by$283,000.  Further, if the value of theCanadian dollar relative to the British pound were to decrease by 10%, our netloss would increase by $283,000.

We are also exposed tointerest rate risk because we maintain cash equivalents and short-terminvestment portfolio holdings of various issuers, types, and maturity dateswith large banks and investment banking institutions.  The market value of these short-terminvestments on any day during the investment term may vary as a result ofmarket interest rate fluctuations.

To differentiate betweenthe affect of a change in the market valuation of securities caused by marketinterest rate changes versus a change in the annual rate of interest we couldearn on a security, we calculated that a hypothetical change in interest ratescomparable to a 10% change to our average rate of return would result in a$24,000 impact.  If interest rates wereto increase by 10%, our net loss would decrease by $24,000.  Further, if interest rates were to decreaseby 10%, our net loss would increase by $24,000.

We have not usedderivative financial instruments in our investment portfolio.  We classify our investments asavailable-for-sale at the time of purchase and re-evaluate this designation asof each balance sheet date. We had $13,488,000 in cash, cash equivalents andshort-term investments as of March 31, 2005.

**Item 4.  CONTROLS AND PROCEDURES**

Our chief financial officerand chief executive officer concluded as of March 31, 2005 that our disclosurecontrols and procedures (as defined in Rule 15d-15(e) promulgated under theSecurities Exchange Act of 1934, as amended) are effective and designed toalert them to material information relating to Stressgen and its consolidatedsubsidiaries, based on the evaluation of these controls and procedures asrequired by paragraph (b) of Rule 15d-15.

#### **PART II—OTHER INFORMATION**

###### *Item 6. EXHIBITS*

 

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

 

 

## **SIGNATURES**

Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized. 
|               | Stressgen Biotechnologies  Corporation    |
|--------------------|-------------------------------------------|
| Date: May 10, 2005 | /s/ Gregory M. McKee                      |   |
|               | Gregory M. McKee                          |
|               | President and Chief  Executive Officer,   |
|               | Vice President, Corporate  Development    |
|               | and Chief Financial  Officer              |
|               | (Principal Financial and  Accounting      |
|               | Officer duly authorized to  sign          |
|               | this report on behalf of  the registrant) |

 

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INDEXOF EXHIBITS

 
| **Exhibit No.** | ** ** | **Description**                                                                                                     |
|-----------------|------------|---------------------------------------------------------------------------------------------------------------------|
| 3.9*            |       | Articles of Continuance of  the Company                                                                             |
| 3.10*           |       | By-Laws of the Company                                                                                              |
| 4.4*            |       | Form of Stock Certificate                                                                                           |
| 10.19           |       | Fourth Amendment to the  License Agreement dated November 29, 1992 among Whitehead Institute, MIT and  the Company. |
| 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’sForm 10-Q for the quarter ended June 30, 2001, as filed with the Commission onAugust 2, 2001

 

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