**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM10-Q**

 
| **(Mark One)**                               |                                                                                                |
|----------------------------------------------|-----------------------------------------------------------------------------------------------------|
|                                         |                                                                                                |
| ý                                       | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934**  |
|                                         |                                                                                                |
| **For the Quarter Ended June 30, 2003** |
|                                         |
| **or**                                       |
|                                         |
| o                                            | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
|                                         |                                                                                                |
| **Commission file number 333-12570**         |

 

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| **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 4B9Parent of Stressgen Biotechnologies,  Inc.10241 Wateridge Circle,  Suite C200****San  Diego, CA** |   | **92121** |
| (Address of principal executive offices)                                                                                                                             |   | (zip code) |
|                                                                                                                                                                 |   |   |
| **(250)  744-2811(858) 202-4900**                                                                                                                                    |
| (Registrant’s telephone number, including area code)                                                                                                            |

 

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

 

As of August 11, 2003, the registrant had approximately 61,690,000shares of Common Stock, no par value, outstanding.

 

 

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**Stressgen Biotechnologies Corporation and Subsidiaries**

 

**INDEX**

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

 

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**CONSOLIDATEDBALANCE SHEET**

 

*Stressgen Biotechnologies Corporation andSubsidiaries*

*(Canadian dollars in thousands, except shareinformation)*

 
|                                                                                                                                                                                            |   | **June 30,  2003** |   | **December 31,  2002** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|--------|------------------------|--------|
|                                                                                                                                                                                            |   | **(unaudited)**    |   |                   |   |
| **Assets**                                                                                                                                                                                      |   |               |   |                   |   |
| Current assets:                                                                                                                                                                                 |   |               |   |                   |   |
| Cash and cash equivalents                                                                                                                                                                       |   | $                  | 1,119  |                   | $      | 31,202 |   |
| Short-term investments                                                                                                                                                                          |   | 40,750             |   | 14,811                 |   |
| Accounts receivable, net                                                                                                                                                                        |   | 1,727              |   | 4,279                  |   |
| Inventories                                                                                                                                                                                     |   | 697                |   | 838                    |   |
| Other current assets                                                                                                                                                                            |   | 334                |   | 518                    |   |
| Total current assets                                                                                                                                                                            |   | 44,627             |   | 51,648                 |   |
|                                                                                                                                                                                            |   |               |   |                   |   |
| Capital assets                                                                                                                                                                                  |   | 2,456              |   | 2,746                  |   |
| Deferred expenses, net of current portion                                                                                                                                                       |   | 301                |   | 421                    |   |
|                                                                                                                                                                                            |   | $                  | 47,384 |                   | $      | 54,815 |   |
|                                                                                                                                                                                            |   |               |   |                   |   |
| **Liabilities and Stockholders’  Equity**                                                                                                                                                  |   |               |   |                   |   |
| Current liabilities:                                                                                                                                                                            |   |               |   |                   |   |
| Accounts payable and accrued liabilities                                                                                                                                                        |   | $                  | 4,732  |                   | $      | 8,833 |   |
| Current portion of deferred revenue                                                                                                                                                             |   | 956                |   | 1,115                  |   |
| Current portion of capital lease obligations                                                                                                                                                    |   | 284                |   | 318                    |   |
| Total current liabilities                                                                                                                                                                       |   | 5,972              |   | 10,266                 |   |
|                                                                                                                                                                                            |   |               |   |                   |   |
| Long-term liabilities:                                                                                                                                                                          |   |               |   |                   |   |
| Deferred revenue, net of current portion                                                                                                                                                        |   | 2,390              |   | 3,344                  |   |
| Capital lease obligations, net of current portion                                                                                                                                               |   | 134                |   | 262                    |   |
| Total long-term liabilities                                                                                                                                                                     |   | 2,524              |   | 3,606                  |   |
|                                                                                                                                                                                            |   |               |   |                   |   |
| Total liabilities                                                                                                                                                                               |   | 8,496              |   | 13,872                 |   |
|                                                                                                                                                                                            |   |               |   |                   |   |
| Stockholders’ equity:                                                                                                                                                                      |   |               |   |                   |   |
| Common shares and other equity – no par value;  unlimited shares authorized, 61,686,690 and 60,209,989 shares issued and  outstanding at June 30, 2003 and December 31, 2002, respectively |   | 180,086            |   | 175,384                |   |
| Deferred stock compensation                                                                                                                                                                     |   | (289               | )      | (392                   | )      |
| Accumulated deficit                                                                                                                                                                             |   | (140,909           | )      | (134,049               | )      |
| Total stockholders’ equity                                                                                                                                                                 |   | 38,888             |   | 40,943                 |   |
|                                                                                                                                                                                            |   | $                  | 47,384 |                   | $      | 54,815 |   |

 

*See accompanyingnotes to consolidated financial statements*.

 

1

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**CONSOLIDATED STATEMENT****OF OPERATIONS ANDACCUMULATED DEFICIT**

**(Unaudited)**

 

*Stressgen Biotechnologies Corporation andSubsidiaries*

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

 
|                                                                                             |   | **Three months ended  June 30,** |     | **Six months ended  June 30,** |   |
|--------------------------------------------------------------------------------------------------|--------|----------------------------------|----------|--------------------------------|--------|
|                                                                                             |   | **2003**                         |     | **2002**                       |   | **2003** |   | **2002** |   |
| Revenue:                                                                                         |   |                             |     |                           |   |   |   |   |   |
| Collaborative  R&D revenue                                                                   |   | $                                | 1,508    |                           | $      | — |   | $ | 6,729 |   | $ | — |   |
| Bioreagent  sales                                                                                |   | 1,373                            |     | 1,491                          |   | 2,792 |   | 2,896 |   |
| Total  revenue                                                                                   |   | 2,881                            |     | 1,491                          |   | 9,521 |   | 2,896 |   |
|                                                                                             |   |                             |     |                           |   |   |   |   |   |
| Operating  expenses:                                                                             |   |                             |     |                           |   |   |   |   |   |
| Research  and development                                                                        |   | 4,791                            |     | 9,778                          |   | 11,284 |   | 19,061 |   |
| Selling,  general and administrative                                                             |   | 1,866                            |     | 2,371                          |   | 4,156 |   | 4,666 |   |
| Cost  of bioreagent sales                                                                        |   | 388                              |     | 413                            |   | 753 |   | 809 |   |
|                                                                                             |   | 7,045                            |     | 12,562                         |   | 16,193 |   | 24,536 |   |
|                                                                                             |   |                             |     |                           |   |   |   |   |   |
| Operating  loss                                                                                  |   | (4,164                           | )        | (11,071                        | )      | (6,672 | ) | (21,640 | ) |
|                                                                                             |   |                             |     |                           |   |   |   |   |   |
| Other  income (expenses):                                                                        |   |                             |     |                           |   |   |   |   |   |
| Interest  and other income, net                                                                  |   | 255                              |     | 292                            |   | 458 |   | 282 |   |
| Net  foreign exchange loss                                                                       |   | (485                             | )        | (1,186                         | )      | (626 | ) | (1,066 | ) |
| Interest  expense                                                                                |   | (9                               | )        | (18                            | )      | (20 | ) | (39 | ) |
|                                                                                             |   | (239                             | )        | (912                           | )      | (188 | ) | (823 | ) |
|                                                                                             |   |                             |     |                           |   |   |   |   |   |
| Net  loss                                                                                        |   | (4,403                           | )        | (11,983                        | )      | (6,860 | ) | (22,463 | ) |
|                                                                                             |   |                             |     |                           |   |   |   |   |   |
| Accumulated  deficit, beginning of period                                                        |   | (136,506                         | )        | (115,727                       | )      | (134,049 | ) | (105,247 | ) |
| Accumulated  deficit, end of period                                                              |   | $                                | (140,909 | )                              | $      | (127,710 | ) | $ | (140,909 | ) | $ | (127,710 | ) |
|                                                                                             |   |                             |     |                           |   |   |   |   |   |
| Basic  and diluted loss per common share                                                         |   | $                                | (0.07    | )                              | $      | (0.21 | ) | $ | (0.11 | ) | $ | (0.39 | ) |
|                                                                                             |   |                             |     |                           |   |   |   |   |   |
| Weighted  average shares used to compute basic and diluted loss per common share (in  thousands) |   | 61,198                           |     | 57,878                         |   | 60,721 |   | 57,757 |   |

 

*See accompanying notes to consolidated financial statements.*

 

2

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**CONSOLIDATEDSTATEMENT OF CASH FLOWS**

**(Unaudited)**

 

*Stressgen Biotechnologies Corporation and Subsidiaries(Canadian dollars in thousands)*

 
|                                                                         |   | **Three months ended  June 30,** |   | **Six months ended  June 30,** |   |
|------------------------------------------------------------------------------|--------|----------------------------------|--------|--------------------------------|--------|
|                                                                         |   | **2003**                         |   | **2002**                       |   | **2003** |   | **2002** |   |
| Cash  flows from operating activities:                                       |   |                             |   |                           |   |   |   |   |   |
| Net  loss                                                                    |   | $                                | (4,403 | )                              | $      | (11,983 | ) | $ | (6,860 | ) | $ | (22,463 | ) |
| Adjustments  to reconcile net loss to net cash used in operating activities: |   |                             |   |                           |   |   |   |   |   |
| Depreciation  and amortization of capital assets                             |   | 171                              |   | 192                            |   | 344 |   | 382 |   |
| Amortization  of deferred stock compensation                                 |   | 52                               |   | 61                             |   | 107 |   | 116 |   |
| Unrealized  foreign exchange loss                                            |   | 178                              |   | 1,182                          |   | 508 |   | 1,218 |   |
| Loss  on market value of investments                                         |   | 15                               |   | —                         |   | 52 |   | 385 |   |
| Changes  in operating assets and liabilities                                 |   | 2,140                            |   | 177                            |   | (2,217 | ) | 2,371 |   |
| Net  cash used in operating activities                                       |   | (1,847                           | )      | (10,371                        | )      | (8,066 | ) | (17,991 | ) |
|                                                                         |   |                             |   |                           |   |   |   |   |   |
| Cash  flows from investing activities:                                       |   |                             |   |                           |   |   |   |   |   |
| Purchase  of short-term investments                                          |   | (8,767                           | )      | (3,754                         | )      | (31,191 | ) | (43,779 | ) |
| Sales  and maturities of short-term investments                              |   | 4,264                            |   | 2,991                          |   | 4,862 |   | 32,853 |   |
| Purchase  of capital assets                                                  |   | (42                              | )      | (44                            | )      | (54 | ) | (168 | ) |
| Net  cash used in investing activities                                       |   | (4,545                           | )      | (807                           | )      | (26,383 | ) | (11,094 | ) |
|                                                                         |   |                             |   |                           |   |   |   |   |   |
| Cash  flows from financing activities:                                       |   |                             |   |                           |   |   |   |   |   |
| Proceeds  on issue of common shares                                          |   | 4,639                            |   | 8,712                          |   | 4,698 |   | 9,106 |   |
| Repayment  of borrowings                                                     |   | (82                              | )      | (122                           | )      | (162 | ) | (247 | ) |
| Stock  subscription receivable                                               |   | —                           |   | (480                           | )      | — |   | (480 | ) |
| Net  cash provided by financing activities                                   |   | 4,557                            |   | 8,110                          |   | 4,536 |   | 8,379 |   |
|                                                                         |   |                             |   |                           |   |   |   |   |   |
| Effect  of exchange rate changes on cash and cash equivalents                |   | (12                              | )      | (428                           | )      | (170 | ) | (413 | ) |
|                                                                         |   |                             |   |                           |   |   |   |   |   |
| Decrease  in cash and cash equivalents                                       |   | (1,847                           | )      | (3,496                         | )      | (30,083 | ) | (21,119 | ) |
| Cash  and cash equivalents, beginning of period                              |   | 2,966                            |   | 15,715                         |   | 31,202 |   | 33,338 |   |
| Cash  and cash equivalents, end of period                                    |   | $                                | 1,119  |                           | $      | 12,219 |   | $ | 1,119 |   | $ | 12,219 |   |

 

*See accompanying notes to consolidated financial statements.*

 

3

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***StressgenBiotechnologies Corporation***

**Notes to Consolidated****FinancialStatements**

***(Canadian dollars)***

 

**1.****                                     ****THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES**

 

*The Company*

 

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

 

*Basis of presentation*

 

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

 

*Financial statements and estimates*

 

The information at June 30, 2003 and forthe three and six month periods ended June 30, 2003 and 2002 has beenprepared by the Company and has not been audited.  The financial statements, in the opinion of management, includeall adjustments necessary for their fair presentation in conformity withCanadian generally accepted accounting principles (“Canadian GAAP”), andconform in all material respects with accounting principles generally acceptedin the United States of America (“U.S. GAAP”), except as discussed in Note5.  These financial statements should beread in conjunction with the financial statements and notes thereto in theCompany’s December 31, 2002 Annual Report on Form 10-K.  Certain information and footnote disclosuresnormally included in financial statements prepared in accordance with Canadianand U.S. GAAP have been condensed or omitted pursuant to the applicableCanadian regulatory and U.S. Securities and Exchange Commission rules andregulations.  Interim results are notnecessarily indicative of results for the full year.

 

The preparation of financial statements inconformity with generally accepted accounting principles requires management tomake estimates and assumptions that affect the reported amounts of assets,liabilities, revenue and expenses and related disclosures as of the date of thefinancial statements.  Significant estimatesare used for, but not limited to, reporting revenue recognition, clinical trialcosts, stock-based compensation, and the allocation of indirect costs.  Actual results could differ from suchestimates.

 

*Foreign currency translation*

 

The Company uses the Canadian dollar as itsconsolidated functional currency. Monetary assets and liabilities that are denominated in U.S. dollars aretranslated into Canadian dollars at the rate of exchange prevailing at thebalance sheet date.  Non-monetary assetsand liabilities are translated at historical exchange rates.  Revenue and expenses are translated at theaverage rate of exchange for the period of such transactions.

 

4

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*Revenue recognition*

 

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

 

Revenue fromcollaborative research and development (“R&D”) arrangements may includemultiple elements within a single contract. The Company’s accounting policy complies with the revenue determinationrequirements set forth in EITF 00-21, *Accounting for Revenue Arrangementswith Multiple Deliverables*,relating to the separation of multiple deliverables into individual accountingunits with determinable fair values. Payments received under collaborative arrangements may include thefollowing:  non-refundable fees at inceptionof contract for technology rights; funding for services performed; milestonepayments for specific achievements; and payments based upon resulting sales ofproducts.

 

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

 

*Clinical trial accruals*

 

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

 

*Stock-based compensation plan*

 

Multiple standards are in use regarding the recognition, measurementand disclosure of stock-based compensation and other stock-based payments. TheCompany has adopted the recommendations of the CICA Handbook section 3870, *Stock-Based Compensation and Other Stock-BasedPayments*, effective January 1, 2002.  This standard requires that all stock-based awards made tonon-employees be measured and recognized using a fair value based method.  The standard encourages the use of a fairvalue based method for all awards granted to employees, but only requires theuse of a fair value based method for direct awards of stock, stock appreciationrights, and awards that call for settlement in cash or other assets.  Awards that a company has the ability tosettle in stock are recorded as equity, whereas awards that the entity isrequired to or has a practice of settling in cash are recorded as liabilities.

 

5

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

 

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

 
|                                                                           |   | **For the three months ended  June 30,** |   | **For the six months ended  June 30,** |   |
|--------------------------------------------------------------------------------|--------|------------------------------------------|--------|----------------------------------------|--------|
| **(in thousands, except per share amounts)**                                   |   | **2003**                                 |   | **2002**                               |   | **2003** |   | **2002** |   |
|                                                                           |   | **(unaudited)**                          |   | **(unaudited)**                        |   |
| Net  loss under Canadian GAAP                                                  |   | $                                        | (4,403 | )                                      | $      | (11,983 | ) | $ | (6,860 | ) | $ | (22,463 | ) |
|                                                                           |   |                                     |   |                                   |   |   |   |   |   |
| Net  loss under U.S. GAAP (See Note 5 for reconciliation to Canadian GAAP)     |   | $                                        | (4,222 | )                                      | $      | (11,229 | ) | $ | (6,470 | ) | $ | (21,273 | ) |
|                                                                           |   |                                     |   |                                   |   |   |   |   |   |
| Employee  stock compensation included in net loss under Canadian and U.S. GAAP |   | 52                                       |   | 61                                     |   | 107 |   | 116 |   |
|                                                                           |   |                                     |   |                                   |   |   |   |   |   |
| Stock-based  employee compensation expense under the fair value method         |   | (611                                     | )      | (884                                   | )      | (1,168 | ) | (1,814 | ) |
|                                                                           |   |                                     |   |                                   |   |   |   |   |   |
| Pro  forma net loss under Canadian GAAP                                        |   | $                                        | (4,962 | )                                      | $      | (12,806 | ) | $ | (7,921 | ) | $ | (24,161 | ) |
|                                                                           |   |                                     |   |                                   |   |   |   |   |   |
| Pro  forma net loss under U.S. GAAP                                            |   | $                                        | (4,781 | )                                      | $      | (12,052 | ) | $ | (7,531 | ) | $ | (22,971 | ) |
|                                                                           |   |                                     |   |                                   |   |   |   |   |   |
| Pro  forma basic loss per common share under Canadian GAAP                     |   | $                                        | (0.08  | )                                      | $      | (0.22 | ) | $ | (0.13 | ) | $ | (0.42 | ) |
|                                                                           |   |                                     |   |                                   |   |   |   |   |   |
| Pro  forma basic loss per common share under U.S. GAAP                         |   | $                                        | (0.08  | )                                      | $      | (0.21 | ) | $ | (0.12 | ) | $ | (0.40 | ) |

 

The weighted-average per-share fair values of the individual optionsgranted during the three and six month periods ended June 30, 2003 were$1.60 and $1.05, respectively, compared to $3.75 and $2.81 for the same periodsin 2002.  The fair values of the optionswere determined using a Black-Scholes option-pricing model with the followingassumptions:

 
|                     |   | **For the three months  ended June 30,** |   | **For the six months  ended June 30,** |   |
|--------------------------|--------|------------------------------------------|--------|----------------------------------------|--------|
| **(unaudited)**          |   | **2003**                                 |   | **2002**                               |   | **2003** |   | **2002** |   |
| Dividend  yield          |   | 0                                        | %      | 0                                      | %      | 0 | % | 0 | % |
| Volatility               |   | 88                                       | %      | 60                                     | %      | 74 | % | 60 | % |
| Risk-free  interest rate |   | 2.2                                      | %      | 5.5                                    | %      | 2.5 | % | 5.5 | % |
| Expected  life           |   | 4  years                                 |   | 4  years                               |   | 4  years |   | 4  years |   |

 

6

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*New Accounting Pronouncements*

 

The FASB issued SFAS No. 148, *Accountingfor Stock-Based Compensation, Transition and Disclosure*inDecember 2002.  SFAS No. 148provides alternative transition methods for entities that voluntarily elect toadopt thefair value recognition provisions of the FASB Statement No. 123, *Accounting for Stock-Based Compensation,*tostock-based employee compensation.  Inaddition, SFAS No. 148 requires more prominent pro forma disclosures of theeffect on net income and earnings per share if the company had applied thesefair value recognition provisions.  Thetransition and annual disclosure provisions of SFAS No. 148 are effective forfiscal years ending after December 15, 2002.  While we have not elected to adopt the provisions in SFAS 123, wehave disclosed our pro forma financial results in Note 1 of the accompanying financialstatements.

 

**2.****                                      COLLABORATIVEAGREEMENT**

 

In June 2002 the Company entered into acollaboration agreement for the co-development and global commercialization ofthe Company’s innovative proprietary CoValTM fusion productcandidate, HspE7, with F. Hoffmann-La Roche and Hoffmann-La Roche Inc.(collectively, “Roche”).  Under theterms of the agreement, Roche has the worldwide exclusive right to manufacture,market and sell the HspE7 product and the Company has the right to co-promotethe product in the U.S. to certain physician specialties.  Forthe three and six months ended June 30, 2003, the Company recognizedcollaborative R&D revenue of $1,508,000 and $6,729,000, respectively,including $2,214,000 related to a development milestone earned in March 2003.Further, in July 2002 and April 2003, Roche made equity investments(see Note 3) in the Company totaling $7,657,000 and $4,594,000,respectively.  In June 2003 theCompany reported that additional HspE7 clinical trials would not begin untilRoche manufactures pilot final commercial grade material.

 

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

 

Upon receiving the upfront license fee payment from Roche in 2002, theCompany recorded a $634,320 payable due to MIT/Whitehead and a related deferredexpense.  The payment was made inJanuary 2003.  The Companyrecognizes the related deferred expense over the development period.  At June 30, 2003 and December 31,2002, the Company had a total of $421,649 and $561,778 of deferred expenserelated to this payment.  Upon receivingthe $2,214,000 milestone payment in April 2003 (see Note 2), the Companyrecorded an additional $221,000 payable due to MIT/Whitehead and relateddeferred expense that is due in August 2003.

 

The following tables provide details of selected balance sheet items:

 

7

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| **(In thousands)**                          |   | **June 30,  2003** |   | **December 31,  2002** |   |
|---------------------------------------------|--------|--------------------|--------|------------------------|--------|
|                                        |   | **(unaudited)**    |   |                   |   |
| Accounts  receivable:                       |   |               |   |                   |   |
| Collaborative  receivable                   |   | $                  | 1,080  |                   | $      | 3,790 |   |
| Trade  accounts receivable                  |   | 685                |   | 527                    |   |
| Less:  allowance for doubtful accounts |   | (38                | )      | (38                    | )      |
|                                        |   | $                  | 1,727  |                   | $      | 4,279 |   |
|                                        |   |               |   |                   |   |
| Inventories:                                |   |               |   |                   |   |
| Raw  materials, net                         |   | $                  | 257    |                   | $      | 417 |   |
| Work  in progress, net                      |   | 130                |   | 145                    |   |
| Finished  goods, net                        |   | 310                |   | 276                    |   |
|                                        |   | $                  | 697    |                   | $      | 838 |   |
| Accounts  payable and accrued liabilities:  |   |               |   |                   |   |
| Trade  accounts payable                     |   | $                  | 1,872  |                   | $      | 3,607 |   |
| Clinical  trial accruals                    |   | 1,647              |   | 3,133                  |   |
| Accrued  compensation and benefits          |   | 862                |   | 1,274                  |   |
| Royalty  payable                            |   | 208                |   | 634                    |   |
| Other  accrued liabilities                  |   | 143                |   | 185                    |   |
|                                        |   | $                  | 4,732  |                   | $      | 8,833 |   |

 
|                           |   | **June 30, 2003 (unaudited)** |   | **December 31,  2002**        |   |
|--------------------------------|--------|-------------------------------|--------|-------------------------------|--------|
| **(In thousands)**             |   | **Cost**                      |   | **Accumulated  Depreciation** |   | **Net Book  Value** |   | **Net Book  Value** |   |
| Capital  Assets:               |   |                          |   |                          |   |   |   |   |   |
| Laboratory  equipment          |   | $                             | 2,351  |                          | $      | 1,248 |   | $ | 1,103 |   | $ | 1,188 |   |
| Equipment  under capital lease |   | 2,672                         |   | 1,883                         |   | 789 |   | 903 |   |
| Computer  equipment            |   | 810                           |   | 502                           |   | 308 |   | 355 |   |
| Furniture  and fixtures        |   | 313                           |   | 179                           |   | 134 |   | 149 |   |
| Leasehold  improvements        |   | 554                           |   | 432                           |   | 122 |   | 151 |   |
|                           |   | $                             | 6,700  |                          | $      | 4,244 |   | $ | 2,456 |   | $ | 2,746 |   |

 

*Stockholders’ equity*

 

InJune 2002 the Company issued 2,036,436 common shares for $7,657,000pursuant to the collaboration agreement with Roche (see Note 2).  The equity was issued at a per share pricedetermined by the weighted average price of common shares of the Company duringthe ten business days prior to the Roche transaction.  The Company also issued two warrants to acquire between 2,036,435and 2,356,000 additional common shares. The Company allocated $1,264,000 as the fair value of the warrants, asdetermined by an independent valuation expert. In April 2003 the Company provided notice for Roche toexercise one of the warrants; Roche subsequently purchased 1,413,600 commonshares at $3.25, resulting in net proceeds of $4,594,000 to the Company.  An exercise of the second warrant wouldresult in the future issuance of between 814,574 and 942,400 additional commonshares, at an exercise price ranging from $3.76 to $3.25 per share, dependingupon whether the Company calls the warrant and upon the price of the Company’scommon stock.  Roche may exercise the secondwarrant until June 28, 2007.

 

8

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In 1998 the Company issued Class B Warrants to purchase 4,000,000shares for $3.30 per share or pursuant to a cashless exercise provision.  The unexercised Class B Warrants expired onJune 12, 2003.  As a result theCompany no longer has an obligation to issue up to 3,231,145 common shares thathad been reserved for issuance upon exercise of the Class B Warrants.

 

Stockholders’ equity at June 30, 2003 and December 31, 2002includes $2,179,000 ofcontributed surplus.  At June 30,2003 and December 31, 2002, there were 67,618,160 and 69,973,871 fullydiluted common shares, respectively.

 

*Employee share option plan*

 

In 2001 the Company issued out-of-plan stock options prior tostockholder approval of the 2001 Equity Incentive Plan (the “2001 Plan”).  Between the date of grant and stockholderapproval, the market price of the Company’s common stock increased resulting indeferred compensation of $807,000 associated with these options.  The deferred compensation is amortized toexpense over the vesting period of the granted options, which have beenapplied to the 2001 Plan.  Thestockholders subsequently approved adoption of the 2001 Plan reserving anadditional 3,500,000 new common shares for issuance pursuant to the grant ofstock options.  Once the 2001 Plan wasapproved, the grants ceased to be considered out-of plan.  At that time the Company stopped grantingoptions under its pre-existing 1996 Share Incentive Plan.  At June 30, 2003 there were 409,923options available for future grant under the 2001 Plan.

 

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

 
|                          |   | **Options Outstanding** |   | **Options Exercisable**                                        |   |
|-------------------------------|--------|-------------------------|--------|----------------------------------------------------------------|--------|
| **Range of  Exercise Prices** |   | **Number  Outstanding** |   | **Weighted  Average  Remaining  Contractual Life  (in years)** |   | **Weighted  Average  Exercise  Price** |   | **Number  Exercisable** |   | **Weighted  Average  Exercise  Price** |   |
|                          |   |                    |   |                                                           |   |   |   |   |   |   |   |
| $1.22  - $1.97                |   | 1,439,427               |   | 7.58                                                           |   | $ | 1.69 |   | 706,550 |   | $ | 1.73 |   |
| $2.30  - $2.85                |   | 223,500                 |   | 9.80                                                           |   | $ | 2.60 |   | 17,500 |   | $ | 2.62 |   |
| $3.01  - $3.65                |   | 404,500                 |   | 6.58                                                           |   | $ | 2.68 |   | 220,080 |   | $ | 3.57 |   |
| $4.10  - $5.85                |   | 1,504,869               |   | 7.93                                                           |   | $ | 4.87 |   | 923,921 |   | $ | 4.86 |   |
| $6.00  - $8.00                |   | 1,544,600               |   | 6.94                                                           |   | $ | 6.19 |   | 1,344,201 |   | $ | 6.19 |   |
|                          |   | 5,116,896               |   |                                                           |   |   |   | 3,212,252 |   |   |   |

 

At August 11, 2003 there were approximately 5,107,000 optionsoutstanding.

 

9

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**4.****                                      SEGMENTINFORMATION**

 

The Company manages its operations in two reportable segments, Biotechnologyand Bioreagents.  Revenues are allocatedto countries based on customer locations. The Company does not allocate interest and other income, foreignexchange losses or interest on capital lease obligations to each segment.

 
|                                 |   | **Three months ended  June 30,** |   | **Six months ended  June 30,** |   |
|--------------------------------------|--------|----------------------------------|--------|--------------------------------|--------|
| **(In thousands)**                   |   | **2003**                         |   | **2002**                       |   | **2003** |   | **2002** |   |
|                                 |   | **(unaudited)**                  |   | **(unaudited)**                |   |
| **Bioreagents**                      |   |                             |   |                           |   |   |   |   |   |
| Revenue:                             |   |                             |   |                           |   |   |   |   |   |
| U.S.                                 |   | $                                | 947    |                           | $      | 984 |   | $ | 1,855 |   | $ | 1,883 |   |
| Canada                               |   | 69                               |   | 75                             |   | 126 |   | 145 |   |
| Other                                |   | 357                              |   | 432                            |   | 811 |   | 868 |   |
|                                 |   | 1,373                            |   | 1,491                          |   | 2,792 |   | 2,896 |   |
| Expenses:                            |   |                             |   |                           |   |   |   |   |   |
| Research  and development            |   | 435                              |   | 332                            |   | 754 |   | 569 |   |
| Selling,  general and administrative |   | 425                              |   | 424                            |   | 913 |   | 770 |   |
| Cost  of bioreagent sales            |   | 388                              |   | 413                            |   | 753 |   | 809 |   |
|                                 |   | 1,248                            |   | 1,169                          |   | 2,420 |   | 2,148 |   |
| Operating  income                    |   | $                                | 125    |                           | $      | 322 |   | $ | 372 |   | $ | 748 |   |
|                                 |   |                             |   |                           |   |   |   |   |   |
| **Biotechnology**                    |   |                             |   |                           |   |   |   |   |   |
| Collaborative  R&D revenue       |   | $                                | 1,508  |                           | $      | — |   | $ | 6,729 |   | $ | — |   |
|                                 |   |                             |   |                           |   |   |   |   |   |
| Expenses:                            |   |                             |   |                           |   |   |   |   |   |
| Research  and development            |   | 4,356                            |   | 9,446                          |   | 10,530 |   | 18,492 |   |
| Selling,  general and administrative |   | 1,441                            |   | 1,947                          |   | 3,243 |   | 3,896 |   |
|                                 |   | 5,797                            |   | 11,393                         |   | 13,773 |   | 22,388 |   |
| Operating  loss                      |   | $                                | (4,289 | )                              | $      | (11,393 | ) | $ | (7,044 | ) | $ | (22,388 | ) |
|                                 |   |                             |   |                           |   |   |   |   |   |
| **Totals**                           |   |                             |   |                           |   |   |   |   |   |
| Revenue:                             |   |                             |   |                           |   |   |   |   |   |
| Collaborative  R&D revenue       |   | $                                | 1,508  |                           | $      | — |   | $ | 6,729 |   | $ | — |   |
| Bioreagent  sales                    |   | 1,373                            |   | 1,491                          |   | 2,792 |   | 2,896 |   |
| Total  revenue                       |   | 2,881                            |   | 1,491                          |   | 9,521 |   | 2,896 |   |
|                                 |   |                             |   |                           |   |   |   |   |   |
| Expenses:                            |   |                             |   |                           |   |   |   |   |   |
| Research  and development            |   | 4,791                            |   | 9,778                          |   | 11,284 |   | 19,061 |   |
| Selling,  general and administrative |   | 1,866                            |   | 2,371                          |   | 4,156 |   | 4,666 |   |
| Cost  of bioreagent sales            |   | 388                              |   | 413                            |   | 753 |   | 809 |   |
|                                 |   | 7,045                            |   | 12,562                         |   | 16,193 |   | 24,536 |   |
| Operating  loss                      |   | $                                | (4,164 | )                              | $      | (11,071 | ) | $ | (6,672 | ) | $ | (21,640 | ) |

 

10

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

 

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

 

Effect on the consolidated financial statements:

 

*Balance Sheet*

 

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

 

*Statement of Operations*

 
|                                                                               |   | **Three months ended  June 30,** |   | **Six months ended  June 30,** |   |
|------------------------------------------------------------------------------------|--------|----------------------------------|--------|--------------------------------|--------|
| **(In thousands except per share amounts)**                                        |   | **2003**                         |   | **2002**                       |   | **2003** |   | **2002** |   |
|                                                                               |   | **(unaudited)**                  |   | **(unaudited)**                |   |
| Net  loss under Canadian GAAP                                                      |   | $                                | (4,403 | )                              | $      | (11,983 | ) | $ | (6,860 | ) | $ | (22,463 | ) |
| Reversal  of unrealized foreign exchange loss on available-for-sale securities (a) |   | 166                              |   | 754                            |   | 338 |   | 805 |   |
| Reversal  of write-down of short-term investments (a)                              |   | 15                               |   | —                         |   | 52 |   | 385 |   |
|                                                                               |   | 181                              |   | 754                            |   | 390 |   | 1,190 |   |
|                                                                               |   |                             |   |                           |   |   |   |   |   |
| Net  loss under U.S. GAAP                                                          |   | $                                | (4,222 | )                              | $      | (11,229 | ) | $ | (6,470 | ) | $ | (21,273 | ) |
|                                                                               |   |                             |   |                           |   |   |   |   |   |
| Basic  loss per common share under Canadian GAAP                                   |   | $                                | (0.07  | )                              | $      | (0.21 | ) | $ | (0.11 | ) | $ | (0.39 | ) |
|                                                                               |   |                             |   |                           |   |   |   |   |   |
| Basic  loss per common share under U.S. GAAP                                       |   | $                                | (0.07  | )                              | $      | (0.19 | ) | $ | (0.11 | ) | $ | (0.37 | ) |
|                                                                               |   |                             |   |                           |   |   |   |   |   |
| Common  shares used to compute basic loss per share under Canadian and U.S. GAAP   |   | 61,198                           |   | 57,878                         |   | 60,721 |   | 57,757 |   |

 

*Statement of CashFlows*

 

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

 

*Differences*

 

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

 

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

 

----

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

 

11

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

 
|                                                                                            |   | **Three months ended  June 30,** |   | **Six months ended  June 30,** |   |
|-------------------------------------------------------------------------------------------------|--------|----------------------------------|--------|--------------------------------|--------|
| **(In thousands except per share amounts)**                                                     |   | **2003**                         |   | **2002**                       |   | **2003** |   | **2002** |   |
|                                                                                            |   | **(unaudited)**                  |   | **(unaudited)**                |   |
| Net  loss under U.S. GAAP                                                                       |   | $                                | (4,222 | )                              | $      | (11,229 | ) | $ | (6,470 | ) | $ | (21,273 | ) |
| Other  comprehensive income                                                                     |   |                             |   |                           |   |   |   |   |   |
| Adjustment  to unrealized foreign exchange and market losses on available-for-sale  investments |   | (181                             | )      | (754                           | )      | (390 | ) | (1,190 | ) |
| Comprehensive  net loss under U.S. GAAP                                                         |   | $                                | (4,403 | )                              | $      | (11,983 | ) | $ | (6,860 | ) | $ | (22,463 | ) |
|                                                                                            |   |                             |   |                           |   |   |   |   |   |
| Comprehensive  loss per share under U.S. GAAP                                                   |   | $                                | (0.07  | )                              | $      | (0.21 | ) | $ | (0.11 | ) | $ | (0.39 | ) |

 

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

 

The changes in operating assets andliabilities are as follows:

 
|                                       |   | **Three months ended  June 30,** |   | **Six months ended  June 30,** |   |
|--------------------------------------------|--------|----------------------------------|--------|--------------------------------|--------|
| **(In thousands)**                         |   | **2003**                         |   | **2002**                       |   | **2003** |   | **2002** |   |
|                                       |   | **(unaudited)**                  |   | **(unaudited)**                |   |
| Collaborative  receivable                  |   | $                                | 3,867  |                           | $      | — |   | $ | 2,710 |   | $ | — |   |
| Trade  receivables                         |   | (38                              | )      | 1                              |   | (158 | ) | (106 | ) |
| Inventories                                |   | 145                              |   | 31                             |   | 141 |   | (29 | ) |
| Other  current assets                      |   | 241                              |   | (324                           | )      | 184 |   | (226 | ) |
| Deferred  expenses, net of current portion |   | 58                               |   | —                         |   | 120 |   | — |   |
| Accounts  payable and accrued liabilities  |   | (1,592                           | )      | 469                            |   | (4,101 | ) | 2,732 |   |
| Deferred  revenue                          |   | (541                             | )      | —                         |   | (1,113 | ) | — |   |
|                                       |   | $                                | 2,140  |                           | $      | 177 |   | $ | (2,217 | ) | $ | 2,371 |   |
| Supplemental  disclosures of cash flows:   |   |                             |   |                           |   |   |   |   |   |
| Interest  paid                             |   | $                                | 9      |                           | $      | 18 |   | $ | 20 |   | $ | 39 |   |

 

12

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**MANAGEMENT’SDISCUSSION AND****ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

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

 

The following information should be read in conjunction with ourJune 30, 2003 consolidated financial statements and related notes therein,which are prepared in accordance with Canadian generally accepted accountingprinciples or Canadian GAAP.  Theseprinciples differ in certain respects from accounting principles generallyaccepted in the United States or U.S. GAAP. The differences, as they affect our consolidated financial statements,are described in Note 5 to our June 30, 2003 consolidated financialstatements.  All amounts following areexpressed in Canadian dollars unless otherwise indicated.

 

## **Overview**

## ** **

Our activities are focused primarily on the research and development ofa unique class of proteins, called stress proteins or heat shock proteins, toregulate the body’s own immune response to combat infectious diseases andcancer.  We believe that the use ofstress proteins, genetically combined with various antigens derived fromdisease-causing organisms or cancer cells, can yield novel therapeuticproducts.

 

In June 2002 we entered into a strategic collaboration with F.Hoffmann-La Roche and Hoffmann-La Roche Inc. (collectively, “Roche”) for thedevelopment of HspE7.  In the future wemay seek partners that could enable us to develop additional product candidatesand exploit new applications for our technology, resulting in additionalproduct opportunities.

 

We have incurred significant losses since our inception and expect toincur substantial losses for the foreseeable future as we invest in ourresearch and product development programs, including manufacturing,pre-clinical studies and clinical trials, and regulatory activities.  At June 30, 2003 our accumulateddeficit was $140,909,000.  Historically,we have depended principally on equity financings to fund our businessactivities.  We intend to pursueadditional equity financings to fund our business activities, marketspermitting.

 

## **Liquidity and CapitalResources**

## ** **

Sinceinception we have relied principally on equity financings to fund our researchand development programs, operations and capital expenditures, coupled withcash flows generated from our bioreagent business.  Through June 30,2003 we have raised net equity proceeds of $180,086,000, principally throughour public issuances of stock, the exercise of warrants and stock optionsissued since 1996 and, more recently, the issuance of stock and warrants toRoche in connection with the collaboration agreement.  We employ afinancial performance measurement system designed to ensure our revenues andexpenses are consistent with management’s operational objectives and budgetaryconstraints.  The variability of anticipated cash utilization is dependentupon several factors, including the timing and extent of clinical developmentof HspE7.  We believe that our currentcapital resources are sufficient to fund planned operations into 2005.  This belief is based on current research andclinical development plans, the current regulatory environment, our historicalindustry experience in the development of therapeutics and general economicconditions.

 

13

----

 

At June 30, 2003 we had cash, cash equivalents and short-terminvestments of $41,869,000, a decrease of $4,144,000 from December 31,2002.  Approximately 24% of cash, cashequivalents and short-term investments were held in U.S. dollars as ofJune 30, 2003, compared to approximately 13% as of December 31, 2002.

 

In April 2003 we received two milestones from Roche: an equityinvestment of $4,594,000 and a time-based development payment of$2,214,000.  The $4,594,000 equityinvestment by Roche, consisting of 1,413,600 common shares at $3.25 per share,is from the exercise of the first of two warrants issued as part of theJune 2002 collaboration agreement.

 

During the three and six months ended June 30, 2003, capitalexpenditures totaled $42,000 and $54,000 respectively compared with $44,000 and$168,000 for the same periods in 2002. Capital purchases in 2003 are consistent with management’s investmentpolicy limiting purchases to those required to preserve our current level ofmanufacturing and research capabilities.

 

We have a credit facility for $2,000,000 with a Canadian charteredbank.  At June 30, 2003 andDecember 31, 2002, $401,000 and $541,000, respectively were used andoutstanding under this facility in the form of fixed rate capital leases.

 

We will require additional capital to fund future research and productdevelopment activities.  We expect toseek additional funds from various sources, including research and developmentcollaborations with corporate partners, and public and private equityfinancing.  We cannot assure you thatadditional financing will be available when needed or on satisfactoryterms.  If we raise additional funds byissuing equity securities, substantial dilution to our existing shareholdersmay result.  If adequate funds are notavailable, we may be required to delay, reduce the scope of, or eliminate oneor more of our research or development programs. We may need to obtain fundsthrough collaborative arrangements with others that are on unfavorableterms.  We may also have to relinquishrights to certain of our technologies, product candidates or products that wewould otherwise seek to develop ourselves.

 

## **Results of Operations**

 

For the three and six months ended June 30, 2003, our net loss was$4,403,000 and $6,860,000 or $0.07and $0.11 per common share.  Thiscompares with a net loss of $11,983,000 and $22,463,000 or $0.21 and $0.39 percommon share for the same periods in 2002. The improvement during the three and six month periods is dueprincipally to collaborative R&D revenue, the cost shift of HspE7manufacturing scale-up costs, and the timing of HspE7 clinical trials.

 

***CollaborativeR&D revenue***

 

Collaborative R&D revenue was $1,508,000 and $6,729,000 for thethree and six months ended June 30, 2003. Collaborative R&D revenue for the six months ended June 30,2003 includes $4,003,000 for development activities in support of Roche, atime-based development payment of $2,214,000, and $512,000 from theamortization of up-front license fees in accordance with SAB No. 101, *Revenue Recognition in Financial Statements.*  As noted in the Quarterly Report on Form10-Q for the first quarter of 2003, Collaborative R&D revenue andassociated expenses are expected to decline in the second half of 2003.

 

14

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### ***Bioreagent sales***

 

The production and sale of bioreagents supports our business strategyby building our market presence in stress proteins and strengthening ourstrategic relationships with companies, academic institutions and stressresponse researchers. Our products are sold directly to end-users and throughthird party distributors.  The overalleconomic slowdown in North America caused industry-wide demand for bioreagentsto slow; however, our bioreagent sales have remained relatively constant at$1,373,000 and $2,792,000 for the three and six months ended June 30,2003, respectively, compared with $1,491,000 and $2,896,000, for the sameperiods in 2002.  Our reported salesresults are affected by the foreign exchange rate between the US and Canadiandollar since the majority of our sales originate in US currency.  Despite a significant weakening of the USdollar during the quarter and six months in 2003, our unit sales volumes haveremained strong, mitigating the financial impact of the unfavorable exchangerate fluctuation.

 

***Research anddevelopment***

 

Research and development, or R&D, includes costs associated withclinical studies, product development, and ongoing exploratory research.  In order to optimize our financialflexibility, we employ clinical research organizations to conduct our clinicaltrials and engage contract manufacturers to assist us with our productdevelopment and manufacturing.

 

R&D spending decreased by approximately 51% and 41% to $4,791,000and $11,284,000, respectively, for the three and six months ended June 30,2003, compared with $9,778,000 and $19,061,000 for the same periods in2002.  The decrease in the first half of 2003 reflects the cost shift ofHspE7 manufacturing scale-up costs and other product development efforts toRoche as well as the timing of HspE7 clinical trials.  Approximately 60% of our R&D spending related to effortsdeveloping HspE7 during the six months ended June 30, 2003, while theremaining spending related to exploratory research, including our follow-onCoValTM fusion product candidates.

 

***Selling, general andadministrative expenses***

 

Selling, general and administrative expense, or SG&A, includesexecutive management, business development, investor relations, legal supportand general administrative activities.

 

SG&A spending decreased by approximately 21% and 11% to $1,866,000and $4,156,000, respectively, for the three and six months ended June 30,2003, compared with $2,371,000 and $4,666,000 for the same periods in2002.  In the first half of 2002, weincurred significant business development costs related to the consummation ofthe Roche agreement that were not repeated during the first half of 2003.

 

***Cost of bioreagentsales***

 

The aggregate cost of bioreagent sales as a percentage of bioreagentsales was approximately 28% and 27%for the three and six months ended June 30, 2003, resulting in grossmargins of 72% and 73% compared with 72% for the same periods in 2002.

 

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

# *** ***

Interest and other income, net decreased by 13% to $255,000 for thethree months ended June 30, 2003 compared to the same period in the prioryear.  The change is due principally toreduced interest income earned on investments resulting from reduced marketinterest rates and a lower investment portfolio balance. Comparatively,interest and other income, net increased by 62% to $458,000 for the six months

 

15

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ended June 30, 2003 over the same period in 2002.  The increase is due principally to awrite-down on our investment portfolio recorded in the first quarter of 2002,which was not repeated in 2003.  Thewrite-down reversed in the third quarter of 2002.

 

***Net realized foreignexchange loss***

 

During the three and six months ended June 30, 2003 and 2002, theUS dollar weakened substantially against the Canadian dollar.  Our loss due to foreign exchange ratefluctuation during the three and six months ended June 30, 2003, was$485,000 and $626,000 respectively, compared to foreign exchange losses of$1,186,000 and $1,066,000, respectively, in 2002.  The improvement is due principally to reduced 2003 investmentlevels denominated in US currency compared to investment levels in 2002.

 

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

# *** ***

The 63% and 69% improvement in net loss to $4,403,000 and $6,860,000for the three and six months ended June 30, 2003, respectively, comparedto $11,983,000 and $22,463,000 in 2002, was diluted by a 6% and 5% increase inthe weighted average number of common shares outstanding for the three and sixmonths ended June 30, 2003, respectively. This improvement resulted in a basic and diluted loss per share of $0.07and $0.11 for the three and six month periods ended June 30, 2003, ascompared with $0.21 and $0.39 for the same periods in 2002.

 

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

### *** ***

Our consolidated financial statements include adjustments necessary fortheir fair presentation 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.

 

To conform to U.S. GAAP our net loss would decrease by $181,000 and$390,000 for the three and six months ended June 30, 2003.  The principal differences under U.S. GAAP asopposed to Canadian GAAP for the current quarter and first half of 2003,respectively, were the reversal of unrealized foreign exchange loss onavailable-for-sale securities of $166,000 and $338,000, coupled with a $15,000and $52,000 reversal of a write-down of short-term investments.

 

Similarly, to conform to U.S. GAAP for the three and six months endedJune 30, 2002, our net loss would decrease by $754,000 and $1,190,000,respectively.  The principal differencesunder U.S. GAAP compared to Canadian GAAP were the reversal of unrealizedforeign exchange loss on available-for-sale securities of $754,000 and $805,000for the same periods in 2002, coupled with a $385,000 reversal of a write-downof short-term investments in the first half of 2002.

 

Basic net loss per common share under U.S. GAAP would have been $0.07and $0.11 in the three and six months ended June 30, 2003, compared to$0.19 and $0.37 during the same periods in the prior year.  Our current assets and stockholders’ equityunder U.S. GAAP would have been the same as the $44,627,000 and $38,888,000reported under Canadian GAAP at June 30, 2003.

 

## **Critical AccountingPolicies**

## ** **

Our significant accounting policies are disclosed in Note 1 to ourconsolidated financial statements. Certain of our policies require the application of management judgmentin making estimates and assumptions that affect the amounts reported in theconsolidated financial statements and disclosures made in the accompanyingnotes.  Those estimates and assumptionsare based on historical experience and various other factors deemed applicableand reasonable under the circumstances. The use of judgment in determining such estimates and assumptions is, bynature, subject to a degree of uncertainty. Accordingly,

 

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actual results could differ from the estimates made.  Our significant accounting policies include:

 

***Revenue recognition***

 

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

 

***Clinical trialaccruals***

 

Clinical trial costs constitute a significant portion of R&Dexpense.  The Company recognizesexpenses related to its ongoing clinical trials using a methodology designed toaccrue estimated costs in the appropriate accounting periods.  Clinical trials can span multiple accountingperiods.  The Company recognizesclinical trial costs in three distinct phases: start-up phase, patient accrual phase, and close-out phase.  Our expenses related to clinical trials varybased on patient availability, additional statistical analysis requirements,and decisions to extend the patient evaluation period.  Using our current trial accrual methodology,our liability for clinical trials is $1,647,000.  Alternately, if we utilized a percentage of completion approachand used an operational estimate of the actual work completed as ofJune 30, 2003 compared to the total contract value, our clinical trialliability would decrease by $400,000.

 

***Stock-basedcompensation***

 

The Company has adopted the recommendations of the CICA Handbooksection 3870, *Stock-Based Compensation andOther Stock-Based Payments*, effective January 1, 2002, and haselected to recognize stock compensation expense in accordance with theprovisions of Accounting Principles Board (APB) Opinion No. 25, *Accounting for Stock Issued to Employees*.  Refer to Note 1 of the accompanyingfinancial statements for our pro forma financial results, which use the fairvalue method of accounting for stock based compensation.

 

**FACTORS THAT****COULD AFFECT FUTURE PERFORMANCE**

 

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

 

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

 

Our biotechnology business is still at an early stage ofdevelopment.  Significant additionalresearch and development and clinical trials must be completed before ourtechnology can be commercialized.  Wehave not completed the development of any therapeutic products and, therefore,have not begun to market or generate revenues from the commercialization of anytherapeutic products.  We haveundertaken only limited human clinical trials for some of our productcandidates and we cannot assure you that the results obtained from laboratoryor research studies will be replicated in human studies or that such humanstudies will not identify undesirable side effects.  We cannot assure you that any of our products will meetapplicable health regulatory standards, obtain required regulatory approvals or

 

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clearances, be produced in commercial quantities at reasonable costs,be successfully marketed or be profitable enough that we will recoup theinvestment made in such product candidates. None of our therapeutic product candidates are expected to becommercially available for several years. There is no precedent for the successful commercialization of productsbased on our CoValTM fusion technology.  It is possible that we will not successfully develop anytherapeutic products.

 

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

 

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

 

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

 

Our revenues from the production and sale of bioreagents and theprojected revenues and expense reimbursements from our HspE7 collaboration arenot adequate to support all of the therapeutic product development programs inour business plan.  We will needsubstantial additional funds to pursue further research and development; carryout clinical trials; obtain regulatory approvals; file, prosecute, defend andenforce our intellectual property rights and market our products.  We will seek additional funds through publicor private equity or debt financing, strategic transactions and/or from othersources.  We could enter intocollaborative arrangements for the development of particular products thatwould lead to our relinquishing some or all of our rights to the relatedtechnology or products.

 

Although we expect to seek additional funding when there are marketopportunities, future funding may not be available on favorable terms or atall.  If additional funding were notobtained, we would reduce, defer or cancel development programs, plannedinitiatives or overhead expenditures, to the extent necessary.  The failure to fund our capital requirementswould have a material adverse effect on its business, financial condition andresults of operations.

 

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

 

Dueto the complexity of the process of developing therapeutics, our core businessdepends on our arrangements with pharmaceutical companies, corporate andacademic collaborators, licensors, licensees and others for the research,development, clinical testing, manufacturing, marketing and commercializationof our products. We have various research collaborations and outsource manyother business functions, including clinical trials and manufacturing.  We may not be able to establish or maintaincollaborations that are important to our business on favorable terms, if atall.  The Roche partnership currentlyrequires further information  concerningthe mechanism of action of the HspE7 product in the body.  Studies are underway to provide suchinformation.

 

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

 

We license technologies and materials from third parties for ourtherapeutic and our bioreagent businesses. We plan to acquire additional licenses from other companies and academicinstitutions.  Pursuant to the terms ofour license agreements, we could be obligated to diligently bring potentialproducts to market, make milestone payments that, in some instances, could besubstantial, and incur the costs of 

 

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filing and prosecuting patent applications.  We cannot assure you that these licenses will not terminate orthat they will be renewed.  In addition,we cannot assure you that these licenses will remain in good standing.  Our licensors may attempt to terminate ourlicenses for their own business reasons.

 

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

 

The profitability of our products will depend in part on our ability toobtain and maintain patents and licenses and preserve trade secrets, and theperiod our intellectual property remains exclusive.  We must also operate without infringing the proprietary rights ofthird parties and without third parties circumventing our rights. We havereceived U.S. and European patents and have filed and are actively pursuingapplications for additional patents. The patent positions of pharmaceutical and biotechnology enterprises,including ours, are uncertain and involve complex legal and factual questionsfor which important legal principles are largely unresolved.  For example, no consistent policy hasemerged regarding the breadth of biotechnology patent claims that are grantedby the U.S. Patent and Trademark Office or enforced by the U.S. federalcourts.  In addition, the scope of theoriginally claimed subject matter in a patent application can be significantlyreduced before 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.

 

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, that we will develop additional patentable products,that the patents we have been issued will provide us with any competitiveadvantages, that the patents of others will not impede our ability to dobusiness or that third parties will not be able to circumvent our patents.  On October 22, 2002 Antigenics Inc. announcedthat it had filed an opposition in the European Patent Office to a Europeanpatent and requests for re-examination in the U.S. Patent Office of two U.S.patents we have licensed.  The initialOffice Action from the U.S. Patent Office confirmed most of the originalclaims.  However, until we receive finalresults from the opposition and re-examination processes, we will not be ableto assure you of the success of our planned vigorous defense of the patents.

 

A number 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 only obtain narrow, patent protection.  If patents that cover our activities are issued to othercompanies, we may not be able to obtain licenses at a reasonable cost, or atall, or develop alternative technology. If we are blocked from using our current technologies we may not be ableto introduce, manufacture or sell our planned products.

 

Patent litigation is becoming widespread in the biotechnologyindustry.  Such litigation may affectour efforts to form collaborations, to conduct research or development, toconduct clinical testing or to manufacture or market any products underdevelopment.  We cannot assure you thatour patents would be held valid or enforceable by a court or that competitor’stechnology or product would be found to infringe our patents.  Our business could be materially affected byan adverse outcome to such litigation. Similarly, we may participate in interference proceedings declared bythe U.S. Patent and Trademark Office or equivalent international authorities todetermine priority of invention.  Wecould incur substantial costs and devote significant management resources todefend our patent position or seek a declaration that the patents of others areinvalid.

 

Much of our know-how and technology may not be patentable, though itmay constitute trade secrets. We cannot assure you that we will be able tomeaningfully protect our trade secrets. We cannot

 

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assure you that any of the existing confidentiality agreements with ouremployees, consultants, advisors or collaborators will provide meaningful protectionfor our trade secrets, know-how or other proprietary information in the eventof any unauthorized use or disclosure. Collaborators, advisors or consultants may dispute the ownership ofproprietary rights to our technology, for example by asserting that theydeveloped it independently.

 

**We May Encounter Difficulties in DevelopingManufacturing Capabilities and Facilities or Entering into Contracts forManufacturing with Third Parties**

 

Our manufacturing experience in bioreagents is not directly applicableto the manufacture of therapeutic products. We have not yet introduced any therapeutic products and have nomanufacturing experience for immunotherapies. Before our products can be profitable they must be produced incommercial quantities in a cost-effective manufacturing process that complieswith regulatory requirements.  We do nothave facilities for the production of the products we are developing.  As a result we depend on the manufacturingcapabilities of collaborators.  If wecannot arrange for or maintain commercial-scale manufacturing on acceptableterms, or if there are delays or difficulties in manufacturing, we may not beable to conduct clinical trials, obtain regulatory approval or meet demand forour products.

 

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

 

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

 

Clinical trials vary in design by factors including their dosage, endpoints, length, controls, and numbers and types of patients enrolled.  We may need to conduct a series of trials todemonstrate the safety and efficacy of our products.  In addition, we may be required to determine whether our productsdelay or prevent disease recurrence. Clinical trials to show that a disease does not recur take longer tocomplete than clinical trials that end when patients stop having specificsymptoms.  The actual schedules for ourclinical trials could vary dramatically from the forecasted schedules due tofactors including conflicts with the schedules of participating clinicians andclinical institutions, delayed patient accrual and changes affecting suppliesfor clinical trials.  For example, onJune 10, 2003, we announced that we would likely delay the start of apivotal Phase III study of pediatric recurrent respiratory papillomatosis untilthe second half of 2004 so that we can use pilot final commercial gradematerial in the study.

 

We have limited experience in conducting clinical trials.  We rely on corporate collaborators such asRoche, academic institutions and clinical research organizations to conduct,supervise, monitor and design some or all aspects of clinical trials involvingour products.  In addition, the NCI issponsoring some HspE7 clinical trials. Since these trials depend on governmental participation and funding, wehave less control over their timing and design.  Delays in or failure to commence or complete any planned clinicaltrials could delay the ultimate timelines for product release.  Such delays could reduce investors’confidence in our ability to develop products, likely causing our stock priceto decrease.

 

**We May Not Be Able to Obtain theRegulatory Approvals or Clearances That Are Necessary to Commercialize OurProducts**

 

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

 

Our product candidates, some of which are currently in the early stagesof development, will require significant additional development andpre-clinical and clinical testing prior to their commercialization. These stepsand the process of obtaining required approvals and clearances can be costlyand time-consuming.  If our potentialproducts are not successfully developed, do not prove to be 

 

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safe and effective in clinical trials, or do not receive applicableregulatory approvals and clearances, or if there are delays in the process:

 

•                  the successfulcommercialization of our products could be adversely affected;

 

•                  our competitiveadvantages could be diminished; and

 

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

 

Governmental and regulatory authorities may approve a product candidatefor fewer indications or narrower circumstances than we request or maycondition approval on the performance of post-marketing studies for a productcandidate.  Even if we receiveregulatory approval and clearance, our product candidates may later exhibitadverse side effects that limit or prevent their widespread use or that forceus to withdraw those product candidates from the market.  In addition, any marketed product and itsmanufacturer will continue to be subject to strict regulation afterapproval.  Any unforeseen problems withan approved product or any violation of regulations could result inrestrictions on the product, including its withdrawal from the market.

 

If we, Roche or other manufacturers fail to comply with applicableregulatory requirements at any stage during the regulatory process, we may besubject to sanctions, including fines, product recalls or seizures,injunctions, refusal of regulatory agencies to review pending market approvalapplications or supplements to approval applications, total or partialsuspension of production, civil penalties, withdrawals of previously approvedmarketing applications and criminal prosecution.

 

The manufacturers of our products will be required to comply withapplicable good manufacturing practices regulations, which include requirementsrelating to quality control and quality assurance as well as the correspondingmaintenance records and documentation. If the manufacturers cannot comply with regulatory requirements includingapplicable good manufacturing practice requirements, we may not be allowed todevelop or market product candidates.

 

**Competitors May Develop and Market DrugsThat Are Less Expensive, More Effective or Safer, Making Our Products Obsoleteor Uncompetitive**

 

Many of our competitors and potential competitors have substantiallygreater product development capabilities and financial, scientific, marketingand human resources than ours. Technological competition from pharmaceutical companies and biotechnologycompanies is intense and is expected to increase.  Other companies have developed technologies that could be thebasis for competitive products.  Some ofthese products have an entirely different approach or means of accomplishingthe desired therapeutic effect than products being developed by us and may bemore effective and less costly than the products developed by us.  Competitors may succeed in developingproducts earlier than us, obtaining approvals and clearances for such productsmore rapidly than us, or developing products that are more effective thanours.  In addition, other forms ofmedical treatment may be competitive with our products. Our technology orproducts may become obsolete or uncompetitive.

 

**Our Products May Not Gain MarketAcceptance**

 

Our products may not gain market acceptance among physicians, patients,healthcare payors and the medical community. The degree of market acceptance of any product that we may develop willdepend on a number of factors, including establishment and demonstration ofclinical efficacy and safety, cost effectiveness of the products, theirpotential advantage over alternative products and marketing and distributionsupport for the products.

 

Our sales experience is limited to the sale of our bioreagents.  To directly market and distribute any pharmaceuticalproducts we may develop, we or our collaborators will need a substantialmarketing 

 

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and sales force with appropriate technical expertise and supportingdistribution capabilities.  We may not beable to establish sales, marketing and distribution capabilities of our own orenter into arrangements with third parties on terms that are acceptable tous.  If marketing and sales throughpartnering arrangements is not successful and we do not successfully developinternal marketing and sales expertise, our ability to generate revenue fromproduct sales will be limited.

 

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

 

We conduct human clinical trials, including trials in children, whichmay have unforeseen long-term health implications.  We have only limited amounts of product liability insurance forour clinical trials.  We may notcorrectly anticipate or be able to maintain on acceptable terms the level ofinsurance coverage that would adequately cover potential liabilities fromproposed clinical trials.  This type ofinsurance is expensive, difficult to obtain and may not be available in thefuture.  If we cannot obtain sufficientinsurance coverage or other protection against potential product liabilityclaims, we may not be able to commercialize potential products.  If any liabilities from a claim exceed thelimit of our insurance coverage, we may not have the resources to pay them.

 

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

 

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

 

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

 

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

 

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

 

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

 

As is typical for biotechnology companieswithout an approved product on the market, our share price has been highlyvolatile in the past and is likely to continue to be volatile. The price of ourshares could be materially affected by factors including the announcement oftechnological innovations, the

 

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release of publications, the announcement of clinical trials results byus or our competitors, the development of new commercial products, changesaffecting patents or exclusive licenses, changes in regulations, the release offinancial results, public concerns over risks relating to biotechnology, futureissuances of shares by us, sales of shares by our shareholders and changes inanalyst recommendations.

 

The volatility of our stock may be heightenedwhile it is traded primarily on the Toronto Stock Exchange, which attractsprimarily Canadian shareholders.  Because some institutional investors invest in Toronto StockExchange companies in proportion to their weight on that index, changes withinthe S&P/TSX Composite Index may also increase volatility in our share price.  We continue to explore a cross-listing onthe Nasdaq or a U.S. exchange, but can provide no assurances regarding thetiming or ultimate results of such a transaction.

 

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

 

We are exposed to foreign currency fluctuations through our operationsin the U.S. because a substantial amount of our contract research anddevelopment spending is transacted in U.S. dollars. However, sinceapproximately 95% of our bioreagent product sales are in U.S. dollars, there ispartial matching of U.S. currency expenses and revenues.  We use the Canadian dollar as ourmeasurement and functional currency.  Asa result, we translate monetary assets and liabilities into Canadian dollars atthe rate of exchange prevailing at our balance sheet date and include resultingexchange gains and losses in the other income line item.  We do not currently engage in hedging orother activities to reduce foreign currency risk, beyond matching investmentsproportionately with anticipated spending, but may do so in the future undercertain conditions. A substantial amount of our receivables and payables aredenominated in U.S. dollars. We record resulting exchange gains and losses inour statement of operations.

 

Our sales and contract research and development expenses aredenominated in U.S. dollars and produce a price risk from exposure tofluctuations in the U.S. exchange rate. We do not believe this will have a material impact on our results ofoperations in the foreseeable future. We maintain cash equivalent and short-term investment portfolio holdingsof various issuers, types, and maturity dates with large banks and investmentbanking institutions.  Typically, 75% ofour investments are in government bonds rated AAA. We occasionally holdshort-term investments beyond 120 days, and the market value of theseinvestments during the investment term varies as a result of market interestrate fluctuations.

 

We maintain a non-trading investment portfolio.  Our market risk exposure is limited tointerest rate risk and foreign exchange rate risk.  We computed a hypothetical change in interest rates by applying a10% change to our average rate of return, resulting in a $86,000 impact.  If interest rates were to increase by 10%,our net loss would decrease by $86,000. Further, if interest rates were to decrease by 10%, our net loss wouldincrease by $86,000.  In addition, wecomputed a hypothetical change in foreign exchange rates by applying a 10%change to our year-end foreign exchange rate and then applied that rate to ouraverage level of U.S. investments during the year, resulting in a $606,000impact.  If the value of the Canadiandollar relative to the U.S. dollar were to increase by 10%, our net loss woulddecrease by $606,000.  Further, if thevalue of the Canadian dollar relative to the U.S. dollar were to decrease by10%, our net loss would increase by $606,000. We have not used derivativefinancial instruments in our investment portfolio.  We classify our investments as available-for-sale orheld-to-maturity at the time of purchase and re-evaluate this designation as ofeach balance sheet date. We had $41,869,000 in cash, cash equivalents andshort-term investments as of June 30, 2003.

 

**Item 4.****  CONTROLS AND PROCEDURES**

 

Our chief financial officer and chief executive officer concluded as ofJune 30, 2003 that our disclosure controls and procedures (as defined inRules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of1934, as amended) are effective and designed to alert them to material informationrelating to Stressgen and its consolidated subsidiaries.

 

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#### **PART II**—OTHERINFORMATION

 

**Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS**

 

OnApril 30, 2003 Roche Finance Ltd. exercised a warrant dated June 28,2002 to purchase 1,413,600 shares of our common stock for an aggregate exerciseprice of $4,594,000.  The issuance ofthe warrant, and shares issuable upon exercise of the warrant, were exempt fromregistration under the Securities Act of 1933, as amended, pursuant toRegulation S (because the warrant was issued by a Canadian issuer to a Swissacquirer) and Regulation D (because the warrant was issued to a singleaccredited investor).

 

**Item 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

(a)                                  TheAnnual Shareholders’ Meeting was held on May 6, 2003.

 

(b)                                 PROPOSALI. The Board of Directors nominated for election in our proxy circular waselected in its entirety by the following votes:

 

Joann L. Data, by 24,368,729 votes with 58,013 votes withheldKenneth Galbraith, by 24,306,579 votes, with 126,913 votes withheldElizabeth Greetham, by 24,368,344 votes, with 58,013 votes withheldDaniel L. Korpolinski, by 24,300,379 votes with 133,113 votes withheldR. Ian Lennox, by 24,301,579 votes, with 126,913 votes withheldMargot Northey, by 24,229,544 votes, with 123,463 votes withheldJay M. Short, Ph.D., by 24,375,429 votes, with 54,963 votes withheld.

 

(c)                                  Inaddition to PROPOSAL I described in paragraph (b) above, Deloitte & ToucheLLP, San Diego, California, was appointed as the auditors of the Company tohold office until the close of the next annual general meeting of the Companyor until a successor is appointed, by 24,355.432 affirmative votes, with 78,460votes withheld.  A proposal to amend the2001 Equity Incentive Plan was withdrawn by a vote of the board of directors.

 

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

 

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

 

(b)                                 Two reports on Form8-K were filed during the quarter for which this report was filed:

 

•                  Areport dated June 11, 2003 summarizing results from results a Phase II trial in pediatricrecurrent respiratory papillomatosis with HspE7 and plans for starting apivotal Phase III RRP study in the second half of 2004.

 

•                  A report datedMay 5, 2003 announcing the April 30, 2003 exercise of a warrant byRoche Finance Ltd. and attaching a pressrelease reporting earnings and other financial results for Stressgen’s firstquarter of 2003.

 

## **SIGNATURES**

## ** **

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

 

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|                             | Stressgen  Biotechnologies Corporation                                                                                                                                         |
|----------------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                             |                                                                                                                                                                           |
|  Date: August 11, 2003 | /s/ DONALD  D. TARTRE                                                                                                                                                     |   |
|                             | Donald  D. Tartre  Vice President and Chief Financial Officer   (Principal Financial and Accounting  Officer duly authorized to sign  this report on behalf of the registrant) |

 

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INDEX OF EXHBITS

 
| **Exhibit No.** |   | **Description**                                                   |
|-----------------|--------|-------------------------------------------------------------------|
| 3.9*            |   | Articles of Continuance of the Company                            |
| 3.10*           |   | By-Laws of the Company                                            |
| 4.4*            |   | Form of Stock Certificate                                         |
| 31.1            |   | Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer |
| 31.2            |   | Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer |
| 32              |   | Section 1350 Certification                                        |

 

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

 

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