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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-Q



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



For the quarterly period ended March 31, 2003



OR



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



For the transition period from
             to



Commission File Number 000-31147



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DELTAGEN,
INC.

(Exact name of Registrant as specified in its charter)



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|Delaware                                                       |  | 94-3260659                          
|-------------------------------------------------------------- |  | ------------------------------------
|(State or other jurisdiction of Incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                              
|700 Bay Road, Redwood City, CA                                 |  | 94063                               
|(Address of principal executive offices)                       |  | (Zip code)                          



(650)
569-5100

(Registrants telephone number, including area code)



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



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



Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date:



|Common Stock $0.001 par value |  | 38,852,427                
|----------------------------- |  | --------------------------
|Class                         |  | Outstanding at May 9, 2003



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DELTAGEN,
INC.



FORM 10-Q



QUARTERLY REPORT



TABLE OF CONTENTS



|               |  | PART IFINANCIAL INFORMATION                                                          |  |   
|-------------- |  | ------------------------------------------------------------------------------------- |  | --
|              
|Item 1.        |  | Financial Statements                                                                  |  | 3 
|               |  | Consolidated Balance Sheets (unaudited)                                               |  | 3 
|               |  | Consolidated Statements of Operations (unaudited)                                     |  | 4 
|               |  | Consolidated Statements of Cash Flows (unaudited)                                     |  | 5 
|               |  | Notes to Consolidated Financial Statements (unaudited)                                |  | 6 
|              
|Item 2.        |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 16
|              
|Item 3.        |  | Quantitative and Qualitative Disclosures about Market Risk                            |  | 39
|              
|Item 4.        |  | Controls and Procedures                                                               |  | 40
|              
|               |  | PART IIOTHER INFORMATION                                                             |  |   
|              
|Item 1.        |  | Legal Proceedings                                                                     |  | 40
|              
|Item 2.        |  | Changes in Securities and Use of Proceeds                                             |  | 41
|              
|Item 3.        |  | Defaults Upon Senior Securities                                                       |  | 41
|              
|Item 4.        |  | Submission of Matters to a Vote of Security Holders                                   |  | 41
|              
|Item 5.        |  | Other Information                                                                     |  | 41
|              
|Item 6.        |  | Exhibits and Reports on Form 8-K                                                      |  | 42
|              
|Signatures     |  | 43                                                                                   
|              
|Certifications |  | 44                                                                                   



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PART I. FINANCIAL INFORMATION



Item 1. Financial Statements



DELTAGEN, INC.



CONSOLIDATED BALANCE SHEETS

(unaudited)

(in thousands, except share data)



|                                                                                                                                              |  | March 31, 2003 |          |   | December 31, 2002 |  
|--------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------- | -------- | - | ----------------- | -
|Assets                                                                                                                                        |  |                |          |   |                   |  
|Current assets:                                                                                                                               |  |                |          |   |                   |  
|Cash and cash equivalents                                                                                                                     |  | $              | 2,664    |   |                   | $
|Restricted cash                                                                                                                               |  |                | 40       |   |                   |  
|Marketable securities                                                                                                                         |  |                |         |   |                   |  
|Accounts receivable, net                                                                                                                      |  |                | 2,518    |   |                   |  
|Prepaid expenses and other current assets                                                                                                     |  |                | 2,311    |   |                   |  
|                                                                                                                                              |  |                |          |   |                   |  
|Total current assets                                                                                                                          |  |                | 7,533    |   |                   |  
|Property, plant and equipment, net                                                                                                            |  |                | 34,052   |   |                   |  
|Intangible assets, net                                                                                                                        |  |                | 4,580    |   |                   |  
|Notes receivable from related parties                                                                                                         |  |                | 320      |   |                   |  
|Restricted cash                                                                                                                               |  |                | 6,253    |   |                   |  
|                                                                                                                                             
|Other assets                                                                                                                                  |  |                | 2,118    |   |                   |  
|                                                                                                                                              |  |                |          |   |                   |  
|Total assets                                                                                                                                  |  | $              | 54,856   |   |                   | $
|                                                                                                                                              |  |                |          |   |                   |  
|Liabilities and Stockholders Equity                                                                                                          |  |                |          |   |                   |  
|Current liabilities:                                                                                                                          |  |                |          |   |                   |  
|Accounts payable                                                                                                                              |  | $              | 4,916    |   |                   | $
|Accrued liabilities                                                                                                                           |  |                | 12,256   |   |                   |  
|Current portion of capital lease obligations                                                                                                  |  |                | 19       |   |                   |  
|Current portion of loans payable                                                                                                              |  |                | 2,447    |   |                   |  
|Current portion of deferred revenue                                                                                                           |  |                | 12,998   |   |                   |  
|                                                                                                                                              |  |                |          |   |                   |  
|Total current liabilities                                                                                                                     |  |                | 32,636   |   |                   |  
|Capital lease obligations, less current portion                                                                                               |  |                | 5        |   |                   |  
|Loans payable, less current portion                                                                                                           |  |                | 2,551    |   |                   |  
|Other long-term liabilities                                                                                                                   |  |                |         |   |                   |  
|Deferred credit                                                                                                                               |  |                | 2,953    |   |                   |  
|Deferred revenue, less current portion                                                                                                        |  |                | 3,028    |   |                   |  
|                                                                                                                                              |  |                |          |   |                   |  
|Total liabilities                                                                                                                             |  |                | 41,173   |   |                   |  
|                                                                                                                                              |  |                |          |   |                   |  
|Stockholders equity:                                                                                                                         |  |                |          |   |                   |  
|Common stock, $0.001 par value:                                                                                                               |  |                |          |   |                   |  
|Authorized: 75,000,000 shares, issued and outstanding: 39,144,337 and 40,986,893 shares
at March 31, 2003 and December 31, 2002, respectively |  |                | 39       |   |                   |  
|Treasury stock                                                                                                                                |  |                | (863     | ) |                   |  
|Additional paid-in capital                                                                                                                    |  |                | 238,786  |   |                   |  
|Unearned stock-based compensation                                                                                                             |  |                |         |   |                   |  
|Notes receivable from stockholders                                                                                                            |  |                |         |   |                   |  
|Accumulated deficit                                                                                                                           |  |                | (224,279 | ) |                   |  
|                                                                                                                                              |  |                |          |   |                   |  
|Total stockholders equity                                                                                                                    |  |                | 13,683   |   |                   |  
|                                                                                                                                              |  |                |          |   |                   |  
|Total liabilities and stockholders equity                                                                                                    |  | $              | 54,856   |   |                   | $
|                                                                                                                                              |  |                |          |   |                   |  



The
accompanying notes are an integral part of these consolidated financial statements.



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DELTAGEN, INC.



CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

(in thousands, except per share data)



|                                                                                       |  | Three months ended March 31, |        
|-------------------------------------------------------------------------------------- |  | ---------------------------- | -------
|                                                                                       |  | 2003                         |        
|Revenue                                                                                |  | $                            | 4,605  
|                                                                                       |  |                              |        
|Costs and expenses:                                                                    |  |                              |        
|Research and development                                                               |  |                              | 10,126 
|Selling, general and administrative                                                    |  |                              | 3,032  
|Restructuring charges                                                                  |  |                              | 9,262  
|                                                                                       |  |                              |        
|Total costs and expenses                                                               |  |                              | 22,420 
|                                                                                       |  |                              |        
|Loss from operations                                                                   |  |                              | (17,815
|Interest income                                                                        |  |                              | 23     
|Interest expense                                                                       |  |                              | (187   
|                                                                                       |  |                              |        
|Net loss                                                                               |  | $                            | (17,979
|                                                                                       |  |                              |        
|Net loss per common share, basic and diluted                                           |  | $                            | (0.45  
|                                                                                       |  |                              |        
|Weighted average shares used in computing net loss per common share, basic and
diluted |  |                              | 39,795 
|                                                                                       |  |                              |        



The
accompanying notes are an integral part of these consolidated financial statements.



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DELTAGEN, INC.



CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(in thousands)



|                                                                                        |  | Three months ended March 31, |        
|--------------------------------------------------------------------------------------- |  | ---------------------------- | -------
|                                                                                        |  | 2003                         |        
|Cash flows from operating activities:                                                   |  |                              |        
|Net loss                                                                                |  | $                            | (17,979
|Adjustments to reconcile net loss to net cash used in operating
activities:             |  |                              |        
|Depreciation and amortization                                                           |  |                              | 1,613  
|Amortization of equipment under capital lease                                           |  |                              | 7      
|Amortization of warrants issued in connection with loans                                |  |                              |       
|Amortization of intangible assets                                                       |  |                              | 585    
|Amortization of unearned stock-based compensation expense                               |  |                              | 1,008  
|Amortization of premium (discount) on marketable securities                             |  |                              | 145    
|Write-off of in-process research and development costs                                  |  |                              |       
|Changes in operating assets and liabilities, net of effects of
acquisitions:            |  |                              |        
|Accounts receivable                                                                     |  |                              | 3,005  
|Prepaid expenses and other current assets                                               |  |                              | 1,047  
|Other assets                                                                            |  |                              | (187   
|Accounts payable                                                                        |  |                              | (1,502 
|Accrued expenses                                                                        |  |                              | 2,338  
|Deferred revenue                                                                        |  |                              | (1,708 
|                                                                                        |  |                              |        
|Net cash used in operating activities                                                   |  |                              | (11,628
|                                                                                        |  |                              |        
|Cash flows from investing activities:                                                   |  |                              |        
|Purchase of marketable securities                                                       |  |                              |       
|Maturities of marketable securities                                                     |  |                              | 6,000  
|Acquisition of property, plant and equipment                                            |  |                              | (1,796 
|Acquisition of leasehold improvements                                                   |  |                              | 2,216  
|Restricted cash                                                                         |  |                              | 10,482 
|Acquisition of BMSPRL, L.L.C., net of cash acquired                                     |  |                              |       
|Acquisition of XenoPharm, Inc., net of cash acquired                                    |  |                              |       
|                                                                                        |  |                              |        
|Net cash provided by (used in) investing activities                                     |  |                              | 16,902 
|                                                                                        |  |                              |        
|Cash flows from financing activities:                                                   |  |                              |        
|Principal payments under capital lease obligations                                      |  |                              | (3     
|Repayment of loans payable                                                              |  |                              | (10,538
|Proceeds from the issuance of loans payable                                             |  |                              |       
|Collection of notes receivable from stockholders                                        |  |                              | 190    
|Proceeds from the issuance of common stock, net of issuance costs and stock
repurchased |  |                              | 70     
|                                                                                        |  |                              |        
|Net cash provided by (used in) financing activities                                     |  |                              | (10,281
|                                                                                        |  |                              |        
|Net decrease in cash and cash equivalents                                               |  |                              | (5,007 
|Cash and cash equivalents, beginning of period                                          |  |                              | 7,671  
|                                                                                        |  |                              |        
|Cash and cash equivalents, end of period                                                |  | $                            | 2,664  
|                                                                                        |  |                              |        
|Supplemental disclosures of cash flow information:                                      |  |                              |        
|Cash paid during the period for interest                                                |  | $                            | 187    
|Supplemental disclosures of non-cash investing and financing activities:                |  |                              |        
|Property and equipment acquired with accounts payable                                   |  | $                            | 633    
|Reversal of unearned stock-based compensation                                           |  |                              |       
|Issuance of common stock in connection with BMSPRL, L.L.C., acquisition                 |  | $                            |       
|Issuance of common stock in connection with XenoPharm, Inc. acquisition                 |  | $                            |       
|Collection of notes receivable from related parties in exchange for
stock               |  | $                            | 100    
|Collection of notes receivable from stockholders in exchange for stock                  |  | $                            | 615    
|Other assets settled in exchange for stock                                              |  | $                            | 193    



The
accompanying notes are an integral part of these consolidated financial statements.



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DELTAGEN, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

March 31, 2003



1. Business of the Company



Deltagen, founded in 1997 and headquartered in Redwood City, California, uses in vivo mammalian gene function information to define
the function and disease relevance of mammalian genes for the purpose of discovering and validating novel drug targets. The Companys proprietary information platform serves the Companys customers in their efforts to discover potential
new drug therapies.



2. Basis of Presentation



The accompanying interim consolidated
financial statements as of March 31, 2003 of Deltagen, Inc. (the Company) are unaudited and have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information,
the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not contain all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial
statements. The unaudited interim consolidated financial statements have been prepared on the same basis as the annual consolidated financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring
adjustments, necessary to present fairly the Companys financial position and its results of operations and its cash flows for the periods presented. Operating results for the interim periods presented are not necessarily indicative of the
results that may be expected for the fiscal year or any future interim period. Certain costs and expenses in the three months ended March 31, 2002 have been reclassified to conform to the presentation in the three months ended March 31, 2003.
Certain balances at December 31, 2002 have been reclassified to conform to the presentation at March 31, 2003.



These interim financial statements should be read in conjunction with the annual audited consolidated financial statements included in the
Companys Annual Report on Form 10-K/A (File No. 000-31147) filed with the Securities and Exchange Commission (the SEC) on April 30, 2003.



The Companys commercial operations commenced during 2000 at which time it emerged from the development stage. The Company has
incurred net losses since inception of $224,279,000 and may incur net losses and negative cash flow from operations for at least the next several years. These matters raise substantial doubt about the Companys ability to continue as a going
concern. Managements plans include increasing sales by refocusing on providing drug discovery services to the biopharmaceutical industry and reducing cash spending during the current fiscal year resulting from the continued down sizing of the
Company and elimination of the Companys internal small molecule drug discovery programs. These reduction efforts began in the third quarter of fiscal year 2002 and have continued into 2003 and are expected to reduce the current cash outflows.
Management also recognizes the need for an infusion of cash during the year ended December 31, 2003. In April 2003, the Company received a minimum commitment for $10,000,000 in equity capital from existing institutional investors subject to
shareholder approval and satisfaction of closing conditions. The Company will finance its operations primarily through its cash and cash equivalents and future revenues. The Company requires additional funding and will attempt to sell additional
shares of its common or preferred stock through private placements or further public offerings, or it may seek additional credit facilities. The sale of additional equity or debt securities would likely result in additional dilution to existing
stockholders. If additional funds are raised through the issuance of equity or debt securities, these securities could have rights that are senior to existing stockholders and could contain covenants that would restrict operations. Any additional
financing may not be available in amounts or on terms acceptable to the Company, if at all.



While the Company is aggressively pursuing the actions discussed above, there can be no assurance that the Company will be successful in its efforts to achieve future profitable operations, generate
sufficient cash from operations or obtain additional funding sources. The financial statements do not contain any adjustments that might result from the outcome of this uncertainty.



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3. Recent Accounting
Pronouncements



In November 2002, the
Emerging Issues Task Force (EITF) reached a consensus on Issue No. 00-21 (EITF 00-21), Revenue Arrangements with Multiple Deliverables. EITF 00-21 provides guidance on how to account for arrangements that involve
the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The Company believes that the
adoption of EITF 00-21 will not have a material impact on the financial position or results of operations of the Company.



In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial
interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective immediately for all new variable interest entities created or
acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. The Company is currently
evaluating the impact, if any, that the adoption of FIN 46 will have on the financial position or results of operations of the Company.



4. Net Loss Per Share



Basic earnings per share is calculated based on the weighted average number of common shares outstanding during the period. Diluted
earnings per share would give effect to the dilutive effect of potentially dilutive securities consisting of restricted stock, stock options and warrants. Potentially dilutive securities have been excluded from the diluted earnings per share
calculations as they have an antidilutive effect due to the Companys net losses.



A reconciliation of the numerator and denominator used in the net loss per share calculations is as follows:



|                                                                     |  | Three Months endedMarch 31, |        
|-------------------------------------------------------------------- |  | --------------------------- | -------
|                                                                     |  | 2003                        |        
|Basic and diluted:                                                   |  |                             |        
|Net loss                                                             |  | $                           | (17,979
|                                                                     |  |                             |        
|Weighted average shares of common stock outstanding                  |  |                             | 40,539 
|Less: Weighted average shares subject to repurchase                  |  |                             | (744   
|                                                                     |  |                             |        
|Weighted average shares used in basic and diluted net loss per share |  |                             | 39,795 
|                                                                     |  |                             |        
|Net loss per common share                                            |  | $                           | (0.45  
|                                                                     |  |                             |        



The
following unvested common stock subject to repurchase, outstanding options and warrants (prior to the application of the treasury stock method) were excluded from the computation of diluted net loss per share as they had an antidilutive effect:



|                                                                                                                           |  | Three Months ended March 31,
|-------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------
|                                                                                                                           |  | 2003                        
|                                                                                                                           |  | (in thousands)              
|Unvested common stock subject to repurchase                                                                                |  | 1,286                       
|Options to purchase common stock                                                                                           |  | 3,476                       
|Warrants to purchase common stock                                                                                          |  | 472                         
|                                                                                                                           |  |                             
|Total potentially dilutive securities excluded from the computation of earnings per
share as their effect was antidilutive |  | 5,234                       
|                                                                                                                           |  |                             





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5. Accounting for Stock
Based Compensation



The Company accounts for
stock-based employee compensation arrangements in accordance with provisions of Accounting Principles Board Opinion No. 25 (APB 25), Accounting for Stock Issued to Employees, and related interpretations and complies with the
disclosure provisions of Statement of Financial Accounting Standards No. 123 (SFAS 123), Accounting for Stock-Based Compensation.



Under APB 25, compensation expense is based on the difference, if any, on the date of the grant, between the fair value of the
Companys stock and the exercise price. SFAS 123 defines a fair value based method of accounting for an employee stock option or similar equity investment.



The Company accounts for equity instruments issued to non-employees in accordance with the provisions of SFAS
123 and Emerging Issues Task Force Issue No. 96-18 (EITF 96-18), Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, and Financial
Accounting Standards Board Interpretation No. 28 (FIN 28), Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans.



The following table provides pro forma disclosures as if the Company had recorded compensation costs based on
the estimated grant date fair value, as defined by SFAS No. 123, for awards granted under its stock option and stock purchase plans.



|                                                                                                        |  | Three Months Ended March 31, |        
|------------------------------------------------------------------------------------------------------- |  | ---------------------------- | -------
|                                                                                                        |  | 2003                         |        
|Net loss, as reported                                                                                   |  | $                            | (17,979
|Add: Stock-based employee compensation expense included in reported net
loss                            |  |                              | 1,008  
|Deduct: Total stock-based employee compensation determined under fair value based method
for all awards |  |                              | (598   
|                                                                                                        |  |                              |        
|Pro forma net loss                                                                                      |  | $                            | (17,569
|                                                                                                        |  |                              |        
|Basic and diluted net loss per common share:                                                            |  |                              |        
|As reported                                                                                             |  | $                            | (0.45  
|                                                                                                        |  |                              |        
|Pro forma                                                                                               |  | $                            | (0.44  
|                                                                                                        |  |                              |        



The
above pro forma disclosures are not likely to be representative of the effects on net income (loss) and basic and diluted net income (loss) per share in future years because options vest over several years and additional grants are made each year.



6. Notes Receivable



Notes Receivable from Related Parties



In January 2003, an amount equal to $41,000, including
accrued interest, of the outstanding balance of a promissory note for $50,000 from an officer was forgiven. The remaining balance of the note and the remaining accrued interest was settled in exchange for the repurchase of 64,383 shares of common
stock.



In January 2003, an amount equal to
$43,000, including accrued interest, of the outstanding balance of a promissory note for $50,000 from an officer was forgiven. The remaining balance of the note and the remaining accrued interest was settled in exchange for the repurchase of 64,657
shares of common stock.



Notes Receivable from Stockholders



In January 2003, a promissory note from an
officer in the amount of $537,000 and accrued interest of $102,000 was settled in exchange for $190,000 in cash payments related to his separation agreement, the repurchase of 573,014 vested shares of common stock at $0.49 per share and 107,146
unvested shares of common stock at $1.57 per share.



In February 2003, a promissory note from an officer in the amount of $268,000 and accrued interest of $53,000 was settled in exchange for the repurchase of 792,601 vested shares of common stock at $0.30 per share and 53,573 unvested
shares of common stock at $1.57 per share.



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7. Loans Payable



In March 2003, the Company repaid in full,
without penalty, the outstanding balance of $10,000,000 under its term loan facility. As a result of this payment, the Company is no longer required to maintain restricted cash balances of $10,500,000 as security for the loan facility.



Future principal payments of loans payable at March 31, 2003
are as follows (in thousands):



|                                               |  | Amount
|---------------------------------------------- |  | ------
|Year Ending December 31,                       |  |       
|2003 (April 1, 2003 through December 31, 2003) |  | $     
|2004                                           |  |       
|2005                                           |  |       
|                                               |  |       
|Total                                          |  | $     
|                                               |  |       



8. Research and
Development Collaborations and License Agreements



On February 8, 2002, the Company entered into its third DeltaBase subscription agreement with Merck & Co., Inc. Under the DeltaBase agreement, Merck has the right to access DeltaBase information on gene function based upon
knockout mouse studies. The DeltaBase agreement also grants Merck non-exclusive, worldwide licenses to knockout mice, materials and intellectual property rights under DeltaBase. The Company will receive an aggregate of $15,250,000 in subscription
licensing and access fees during the term of the agreement. Merck will have non-exclusive access to information related to 750 genes and access to certain of the corresponding DeltaBase intellectual property rights. Revenues recognized related to
this agreement were $1,531,000 in the three months ended March 31, 2003. Deferred revenues related to this agreement were $4,674,000 and $8,990,000 at March 31, 2003 and 2002, respectively. No revenue was recognized related to this agreement during
the three months ended March 31, 2002.



In
February 2003, the Company granted a royalty-free, fully paid, worldwide, non-exclusive, non-transferable, non-sublicenseable, internal license to Bristol-Meyers Squibb Company for certain patent rights in exchange for 1,800,000 shares of Deltagen,
Inc. common stock. No revenue was recognized related to this agreement during the three months ended March 31, 2003.



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9. Acquisitions



Acquisition of BMSPRL, L.L.C.



On February 16, 2002, the Company completed the acquisition
of BMSPRL, L.L.C. (BMSPRL), formerly known as CombiChem, Inc., from Bristol-Myers Squibb Company for 2,647,481 unregistered shares of the Companys common stock valued at approximately $23,510,000 and incurred acquisition related
costs of approximately $465,000. The subsidiary, located in San Diego, California, was renamed Deltagen Research Laboratories, or DRL. The addition of DRL was intended to enable the Company to advance its targets by identifying lead candidate
compounds for drug development.



Accordingly, the
results of operations of BMSPRL and estimated fair value of assets acquired and liabilities assumed were included in the Companys consolidated financial statements starting on February 16, 2002.



The total purchase price was allocated to the estimated fair
value of assets acquired and liabilities assumed based on independent appraisals and management estimates as follows (in thousands):



|Tangible net assets acquired:                     |  |   |        |  
|------------------------------------------------- |  | - | ------ | -
|Marketable securities                             |  | $ | 3      |  
|Prepaid expenses and other current assets         |  |   | 433    |  
|Property and equipment, net                       |  |   | 12,039 |  
|Other assets                                      |  |   | 191    |  
|Accounts payable and accrued liabilities          |  |   | (1,084 | )
|Notes payable                                     |  |   | (639   | )
|                                                  |  |   |        |  
|Tangible net assets acquired                      |  |   | 10,943 |  
|Completed technology                              |  |   | 5,560  |  
|Excess of purchase price over net assets acquired |  |   | 7,472  |  
|                                                  |  |   |        |  
|Total purchase price                              |  | $ | 23,975 |  
|                                                  |  |   |        |  



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BMSPRL had no in-process research and development projects underway at the time of the
acquisition.



The amount allocated to completed
technology was being amortized over the estimated useful life of three to ten years using the straight-line method. All of this completed technology was written-off as part of the charge for intangible asset impairment during 2002.



The amount of the purchase price in excess of the net assets
acquired was recorded as goodwill. This goodwill was written-off as part of the charge for goodwill impairment during 2002.



On October 2, 2002, the Company announced a cost savings and business restructuring plan to reduce cash burn rate. The plan included the
closing of the San Diego facility that housed the DRL operations. As a result of the restructuring plan, substantially all DRL activities and chemistry capabilities have ceased or been eliminated.



Acquisition of XenoPharm, Inc.



On March 14, 2002, the Company acquired XenoPharm, Inc.
(XenoPharm), a San Diego, California-based private company for 498,236 unregistered shares of the Companys common stock valued at approximately $3,622,000 and incurred acquisition related cost of approximately $536,000.
Additionally, the Company may be required to issue up to an additional 1,449,262 shares of common stock upon the satisfaction of certain milestones. XenoPharm provides a proprietary technology platform to pharmaceutical, biotechnology, chemical and
agricultural companies to better understand and predict reactions of foreign substances, termed xenobiotics, in human systems. XenoPharms XenoSensor Mice, implanted with human SXR and CAR, coupled with XenoPharms CleanScreen
high-throughput screening assays provide a proprietary technology platform to improve the predictive value of cell- and animal-based biomedical research.



The results of operations of XenoPharm and estimated fair value of assets acquired and liabilities assumed were included in the
Companys consolidated financial statements starting on March 14, 2002.



The total purchase price was allocated to the estimated fair value of assets acquired and liabilities assumed based on independent appraisals and management estimates as follows (in thousands):



|Tangible net assets acquired:                |  |   |        |  
|-------------------------------------------- |  | - | ------ | -
|Property and equipment, net                  |  | $ | 79     |  
|Other assets                                 |  |   | 1      |  
|Accounts payable and accrued liabilities     |  |   | (95    | )
|                                             |  |   |        |  
|Tangible net assets acquired                 |  |   | (15    | )
|Acquired in-process research and development |  |   | 110    |  
|Completed technology                         |  |   | 7,016  |  
|Deferred credit                              |  |   | (2,953 | )
|                                             |  |   |        |  
|Total purchase price                         |  | $ | 4,158  |  
|                                             |  |   |        |  



In
connection with the purchase of XenoPharm, the Company recorded a $110,000 charge to in-process research and development in the March 31, 2002 quarter. The amount was determined by identifying research projects for which technological feasibility
had not been established and no alternative future uses existed. The value of the projects identified to be in progress was determined by estimating the future cash flows from the projects once commercially feasible, discounting the net cash flows
back to their present value and then applying a percentage of completion to the calculated value. The net cash flows from the identified projects were expected to commence at various times in 2002, and were based on estimates of revenues, cost of
revenues, research and development costs, selling, general and administrative costs and applicable income taxes for the projects. The discount rates used in the present value calculations were typically derived from a weighted-average cost of
capital analysis based upon comparable public companies, adjusted upward to reflect additional risks inherent in the development life cycle. Such discount rates ranged between 45% and 55% for all projects. Development of the technologies remains a
substantial risk to the Company due to factors including the remaining effort to achieve technological feasibility, rapidly changing customer markets and competitive threats from other companies.



The completed technology
consisted of transgenic animal models. The value of the completed technology was determined by estimating the future cash flows from the technology, discounting the net cash flows back to their present value. The net cash flows from the identified
technologies were expected to commence at various times in 2002, and were based on estimates of revenues, cost of revenues, selling, general and administrative costs and applicable income taxes. The discount rates used in the present value
calculations were typically derived from a weighted-average cost of capital analysis based upon comparable public companies, adjusted upward to reflect additional inherent risks. Such discount rates ranged between 45% and 50% for all projects. The
Company has generated no revenue to date from this technology as of March 31, 2003. The future generation of revenues from the technologies remains a substantial risk to the Company due to factors including rapidly changing customer markets and
competitive threats from other companies.



The
amount allocated to completed technology is being amortized over the estimated useful life of three years using the straight-line method due to rapidly changing customer markets and competitive threats from other companies.



The amount of the net assets in excess of the purchase price
was recorded as a deferred credit since the Company may be required to issue additional shares of common stock upon the satisfaction of certain milestones. The amount of additional consideration paid will reduce the deferred credit and be included
as additional purchase price. If the milestones are not met or the value of the common stock issued is less than the deferred credit, the excess will primarily reduce the value of the completed technology.



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Proforma Results



The following unaudited pro forma summary
is provided for illustrative purposes only and is not necessarily indicative of the consolidated results of operations for future periods or that actually would have been realized had the Company, BMSPRL and XenoPharm been a consolidated entity
during the periods presented. The summary combines the results of operations as if BMSPRL and XenoPharm had been acquired as of the beginning of the periods presented.



|                      |  | Three Months EndedMarch 31,                       |        
|--------------------- |  | ------------------------------------------------- | -------
|                      |  | 2003                                              |        
|                      |  | (In thousands, except per share data) (unaudited) |        
|Revenues              |  | $                                                 | 4,605  
|Net loss              |  | $                                                 | (17,979
|Basic and diluted EPS |  | $                                                 | (0.45  



10. Intangible Assets



Intangible assets consist of the following
(in thousands):



|                                                 |  | March 31, 2003      |       | December 31, 2002       |  
|------------------------------------------------ |  | ------------------- | ----- | ----------------------- | -
|                                                 |  | GrossCarryingAmount |       | AccumulatedAmortization |  
|Amortizing:                                      |  |                     |       |                         |  
|Acquired completed technology                    |  | $                   | 7,016 |                         | $
|Impairment loss on acquired completed technology |  |                     |      |                         |  
|                                                 |  |                     |       |                         |  
|Carrying amount                                  |  | $                   | 7,016 |                         | $
|                                                 |  |                     |       |                         |  



At March
31, 2003 amortization expense was expected to be as follows (in thousands):



|                         |  | Amortization
|------------------------ |  | ------------
|Year Ending December 31, |  |             
|2003                     |  | $           
|2004                     |  |             
|2005                     |  |             
|                         |  |             
|Total                    |  | $           
|                         |  |             



Amortization expense was $585,000 and $619,000 in the three months ended March 31, 2003 and 2002, respectively.



11. Business Restructuring



On January 6, 2003, the Company announced a business restructuring and cost reduction plan. The Companys business strategy will
focus on providing drug discovery tools and services to the biopharmaceutical industry utilizing the Companys



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proprietary in vivo mammalian transgenic technologies. The Company has decided to terminate its internal small molecule drug discovery
and development programs.



As part of this
restructuring, the Company reduced its staff to approximately 200 employees. The plan included the closing of its Strasbourg, France operations and its Salt Lake City operations acquired in the acquisition of Arcaris, Inc. and the planned
consolidation of core activities into the Companys Redwood City, California facility.



Facility Leases



In March 2003, the Company entered into an agreement with the landlord of its Menlo Park, California facilities to terminate its remaining lease obligations. The agreement required the Company to make a termination payment
of $500,000 and pay decommissioning costs of $12,000 in March 2003, forfeit restricted cash underlying letters of credit totaling $431,000 in April 2004 and issue warrants to purchase 250,000 shares of the Companys Common or Series A
Convertible Preferred Stock at the landlords option. The value of the warrants at March 31, 2003 was approximately $50,000. The value of the warrant was calculated using the Black-Scholes pricing model. The assumptions used in the
Black-Scholes model are as follows: dividend yield of 0%, term of ten years, volatility of 115.64% and risk-free interest rate of 3.90%. The Company had ceased using these facilities in January 2003. The expenses associated with this agreement were
recorded during the three months ended March 31, 2003 and are included in restructuring charges on the consolidated statement of operations.



In March 2003, the Company entered into an agreement with the landlord of its Alameda, California facility to terminate its remaining
sub-lease obligation. The agreement requires the Company to forfeit restricted cash underlying letters of credit totaling approximately $211,000 and make a termination payment of $590,000 on or before August 31, 2003 or the date of the closing of
the Companys sale of not less than $10,000,000 of its equity securities. The Company had ceased using this facility in February 2003. The expenses associated with this agreement were recorded during the three months ended March 31, 2003 and
are included in restructuring charges on the consolidated statement of operations.



In March 2003, the Company entered into an option agreement with the landlord of one of its Redwood City, California facilities to terminate its remaining lease obligation. The agreement requires the
Company to forfeit restricted cash underlying letters of credit totaling approximately $1,701,000, make termination payments of $1,200,000 on or before August 31, 2003 and $200,000 on or before January 15, 2005 and to issue warrants to purchase
900,000 shares of the Companys Common or Series A Preferred Stock at the landlords option plus additional warrants equal to 0.05 warrants per dollar for each dollar of Series A preferred stock issued in excess of $10,000,000. The value
of the warrants at March 31, 2003 was approximately $278,000. The value of the warrant was calculated using the Black-Scholes pricing model. The assumptions used in the Black-Scholes model are as follows: warrants to purchase 1,400,000 shares of the
Companys Common or Series A Convertible Preferred Stock, dividend yield of 0%, term of ten years, volatility of 115.64% and risk-free interest rate of 3.90%. The Company had ceased using this facility in February 2003. The expenses associated
with this agreement were recorded during the three months ended March 31, 2003 and are included in restructuring charges on the consolidated statement of operations.



In March 2003, the Company entered into an assignment agreement related to its remaining lease obligation on
its San Diego, California facility. The agreement requires the Company to forfeit lease deposits totaling approximately $191,000 and other costs of $275,000. The Company had ceased using this facility in January 2003. The expenses associated with
this agreement were recorded during the three months ended March 31, 2003 and are included in restructuring charges on the consolidated statement of operations.



Business Restructuring Charges



The Company recorded a restructuring charge of $9,262,000 in the first quarter of 2003 for severance and
other employee related costs, costs associated with lease obligations and settlements and other costs associated with the consolidation of the Companys facilities. These costs relate to the Companys operations in the San Francisco Bay
Area, Strasbourg, France, Salt Lake City, Utah (Arcaris acquisition in 2001) and excess facilities in Alameda, Menlo Park and Redwood City, California.



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On October 2,
2002, the Company announced a business restructuring and plan to reduce expenses. The Companys business strategy will focus on tools, services and targets for the discovery and development of small molecule drugs. These products and services
will be marketed to the biopharmaceutical industry and will serve to complement the Companys production and licensing of its DeltaBase product. The Company also expects to continue to pursue its development in secreted proteins through its
current and potential future collaborations.



As
part of this restructuring, the Company reduced its staff by approximately 130 employees. The plan included the closing of its San Diego operations acquired in the acquisition of BMSPRL, L.L.C., as discussed in Note 9, the planned exit from its
operations in Europe and the planned consolidation of core activities into the Companys Redwood City, CA and Salt Lake City, UT facilities.



As a result of these actions, the Company recorded a charge in 2002 of $7,100,000 for the impairment of intangible assets related to
activities that will no longer be pursued or that will be scaled back, $7,500,000 for the impairment of property and equipment and $4,900,000 for the impairment of leasehold improvements. The Company also recorded a charge in 2002 for severance and
other employee related costs, costs associated with lease obligations and other costs. These costs relate primarily to the Companys operations in San Diego, California (BMSPRL, L.L.C. acquisition), Salt Lake City, Utah (Arcaris, Inc.
acquisition in 2001) and Europe.



The following
table sets forth certain details associated with the business restructuring charges in 2003 and the obligations recorded in 2002 for cost reductions programs enacted in 2002 (in thousands of dollars):



|                                                         |  | Accrual atDecember 31,2002 |       | 2003RestructuringCharges |   | Cash(Payments)Receipts |  |   | Non-cash Transactions |   |  | Accrual atMarch 31,2003
|-------------------------------------------------------- |  | -------------------------- | ----- | ------------------------ | - | ---------------------- |  | - | --------------------- | - |  | -----------------------
|Retention bonuses, severance, and executive compensation |  | $                          | 1,552 |                          | $ | 2,485                  |  | $ | (2,703                | ) |  | $                      
|Lease settlements                                        |  |                            | 126   |                          |   | 4,206                  |  |   | (1,193                | ) |  |                        
|Legal and consulting fees                                |  |                            | 77    |                          |   | 669                    |  |   | (258                  | ) |  |                        
|Other                                                    |  |                            | 1,099 |                          |   | 1,902                  |  |   | (200                  | ) |  |                        
|                                                         |  |                            |       |                          |   |                        |  |   |                       |   |  |                        
|                                                         |  | $                          | 2,854 |                          | $ | 9,262                  |  | $ | (4,354                | ) |  | $                      
|                                                         |  |                            |       |                          |   |                        |  |   |                       |   |  |                        



It is
anticipated that a majority of the remaining accrual will be paid during fiscal year 2003.



12. Subsequent Events



Business Restructuring



In April 2003, the Company announced a further 50 employee reduction in staff to approximately 150 employees. The Company expects to record a charge of approximately $780,000 in the second quarter of 2003 for final facilities
closures, employee severance and other related costs.



Facility Leases



In April
2003, the Company entered into a forbearance agreement related to the lease of its principal operating and administrative facility in Redwood City, CA. This agreement provides for lease rent and certain facility operating expense to be paid from the
Companys $1,500,000 cash security deposit or $500,000 restricted cash related to letters of credit in 2003. Lease rent is also reduced by approximately 25% during the forbearance period. The agreement has certain default criteria that if
breeched would cause the lease rent to revert to prior levels retroactively.



Events that would cause a default include:



| |  |  | month end unrestricted cash balances of less than $500,000 prior to December 31, 2003 and less than $1.5 million at each month end thereafter;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | default or breach by the Company under any credit agreement, lease guaranty or any other obligation to which it is bound where the liability exceeds $750,000 and
which is not cured within 30 days;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the revocation, termination or suspension of any license, franchise, permit or other authorization necessary for the manufacture or sale of the Companys
product as result of a breach, act or omission by the Company which is not reinstated or reissued within 45 days of such revocation, termination or suspension;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | failure by the Company to receive, on or before August 31, 2003, net additional proceeds of $5 million or more from one or more equity capital investments.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------



Bridge Loan and Commitment for Equity Financing



In April
2003, the Company obtained a minimum commitment for $10,000,000 in equity capital from existing institutional investors to purchase Series A Convertible Preferred Stock in a transaction referred to here in as a private placement. The private
placement is subject to shareholder approval and the satisfaction of closing conditions. In addition to the terms of the private placement, the Companys stockholders will be asked to approve a number of other matters including a reverse stock
split.



Under the terms of the private placement,
the investors have agreed to purchase $10,000,000 of Series A Convertible Preferred Stock. The preferred stock is convertible into common stock on a 1:1 basis. The preferred stock will be issued at a 25% discount to the five-day average closing
common stock price for the period ending three days prior to closing. The preferred stock bears no



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dividend, has a liquidation preference right equal to the amount invested in the preferred stock and standard anti-dilution protections. The
terms of the preferred stock agreement include the right to appoint designees to a total of three seats on the Companys Board of Directors. The Company expects to record a charge related to the beneficial conversion feature in connection with
the issuance of the Series A Convertible Preferred Stock.



The Company also obtained a secured bridge loan commitment from the same investors of $5,000,000. This facility can be increased to $6,000,000 upon the occurrence of certain events and milestones and is collateralized by all of the
Companys assets not pledged to the equipment loans. The loan bears interest at 10% per annum. The principal and interest on the bridge loan will be repaid upon the earlier of the closing of the private placement with a portion of the proceeds
thereof or August 31, 2003. There are financial covenants to the bridge loan associated with cash and earnings before interest, taxes, depreciation and amortization (EBITDA) performance versus forecast which if not met could lead to loan
default and acceleration of the loan.



In
connection with the private placement, the Company has agreed to use reasonable best efforts, as soon as reasonably practicable after the closing of the private placement, to offer stockholders of record as of the last business day prior to the
closing of the private placement (other than the investors in such financing) non-transferable rights to purchase newly issued preferred stock at the same purchase price paid by the investors. The amount of preferred shares so offered to each
stockholder would be sufficient to allow each such stockholder to maintain the percentage ownership interest in the Company held by each such stockholder as of the last business day prior to the closing of the private placement.





Loans Payable



In April
2003, the Company reached an agreement with a General Electric Capital Corporation to restructure its existing loan agreements. The existing loan agreements had outstanding balances at March 31, 2003 of $4,998,000 and were payable in monthly
installments at interest rates ranging from 8.87% to 12.75% with maturities to July 2005. Under the terms of the restructuring, the Company forfeited letters of credit totaling $2,316,000 to the lender in partial payment of the loans and entered
into a new loan for the remaining balance of $2,732,000. The new loan will bear an interest rate of 10.50% and is required to be repaid in 18 monthly installments, beginning in April 2003. The loan is collateralized by a first position security
interest in certain fixed assets and a second position security interest in substantially all of the Companys other assets.



Future principal payments of loans payable after April 1, 2003 are as follows (in thousands):



|                         |  | Amount
|------------------------ |  | ------
|Year Ending December 31, |  |       
|2003                     |  | $     
|2004                     |  |       
|                         |  |       
|Total                    |  | $     
|                         |  |       



Legal Matters



On April 28, 2003, the Company received
from Lexicon a letter which Lexicon claims serves as notice of termination of the sublicense agreement under which the Company obtained a commercial license to the 215 patent and the Capecchi patents. In this letter, Lexicon specified two
grounds that allegedly entitles Lexicon to terminate the sublicense agreement: (1) the Companys purported material breach of the DeltaBase agreement, under which Lexicon obtained a commercial license to our DeltaBase product; and (2) the
Companys purported insolvency. On April 29, 2003, the Company received from Lexicon a letter which Lexicon claims serves as notice under the DeltaBase agreement of: (1) Lexicons alleged entitlement to damages in the amount of
$25,000,000, plus attorneys fees and costs, for the Companys purported material breach of the DeltaBase agreement; and (2) alleged noncompliance with the content criteria in the DeltaBase agreement. The Company believes that
Lexicons claims and allegations are without merit, and intends to promptly address these claims according to the dispute resolution procedures provided by the settlement and other agreements between Lexicon and Deltagen. The possible loss or
the range of the possible loss cannot be estimated at this time.



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Item 2. Managements Discussion and Analysis of Financial Conditions and Results of Operations



INFORMATION REGARDING FORWARD-LOOKING STATEMENTS



This report contains forward-looking statements. The forward-looking statements are contained principally in
the sections entitled Managements Discussion and Analysis of Financial Condition and Results of Operations and Business. These statements involve known and unknown risks, uncertainties and other factors which may cause
our actual results, performance or achievements to be materially different from any future results, performances or achievements expressed or implied by the forward-looking statements. Forward-looking statements include, but are not limited to,
statements about:



| |  |  | our ability to raise additional financing;
| | - |  | ------------------------------------------



| |  |  | liquidity;
| | - |  | ----------



| |  |  | sources of revenues and anticipated revenues, including contributions from customers, license agreements and other collaborative efforts for the development and
commercialization of products, and the continued viability and duration of those agreements and efforts;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | limitations in the drug discovery process;
| | - |  | ------------------------------------------



| |  |  | the capabilities, development and marketing of our products and services;
| | - |  | -------------------------------------------------------------------------



| |  |  | the benefits of knockout mice programs and, in particular, our technologies and methods;
| | - |  | ----------------------------------------------------------------------------------------



| |  |  | the requirements of pharmaceutical and biotechnology companies;
| | - |  | ---------------------------------------------------------------



| |  |  | our future revenues and profitability;
| | - |  | --------------------------------------



| |  |  | our estimates regarding our capital requirements and needs for additional financing;
| | - |  | ------------------------------------------------------------------------------------



| |  |  | plans for future products and services and for enhancements of existing products and services;
| | - |  | ----------------------------------------------------------------------------------------------



| |  |  | our patent applications, licensed technology and proposed patents;
| | - |  | ------------------------------------------------------------------



| |  |  | our ability to attract customers and establish licensing and other agreements; and
| | - |  | ----------------------------------------------------------------------------------



| |  |  | acquisitions.
| | - |  | -------------



This report contains information regarding the biotechnology and pharmaceutical industries that we obtained from private and public
industry publications. These publications generally indicate that they have obtained their information from sources believed to be reliable, but do not guarantee the accuracy and completeness of their information. Although we believe that the
publications are reliable, we have not independently verified their data.



In some cases, you can identify forward-looking statements by terms such as may, will, should, could, would, expects, plans,
anticipates, believes, estimates, projects, predicts, potential and similar expressions intended to identify forward-looking statements. These statements reflect our current
views with respect to future events and are based on assumptions and subject to risks and uncertainties. Given these uncertainties, you should not place undue reliance on these forward-looking statements. We discuss many of these risks in this
prospectus in greater detail under the heading Risk Factors. Also, these forward-looking statements represent our estimates and assumptions only as of the date of this report.



You should read this report and the documents that we reference in this report completely and with the
understanding that our actual future results may be materially different from what we expect. We qualify all of our forward-looking statements by these cautionary statements.



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YOU SHOULD READ THE FOLLOWING
DISCUSSION AND ANALYSIS IN CONJUNCTION WITH OUR FINANCIAL STATEMENTS AND THE ACCOMPANYING NOTES TO THE FINANCIAL STATEMENTS.



Overview



Deltagen, founded in 1997, is a leader in using in vivo derived mammalian gene function information to define the function and
disease relevance of mammalian genes for the purposes of discovering and validating novel drug targets. Our proprietary information platform serves our pharmaceutical partners and customers in their efforts to discover potential new drug therapies.



Our products, based on our platform technology,
provide databases of in vivo mammalian gene function information on target genes of interest to drug researchers. We delete, or knock out, these genes in mice and then utilize an extensive, integrated analysis program to assess
the function and potential pharmaceutical relevance of these genes and the proteins these genes encode. We also focus our efforts to determine the function of secreted proteins. We are undertaking the discovery and development of biotechnology drug
candidates in collaboration with other parties.



Our current customers and partners include many of the worlds largest pharmaceutical companies, Eli Lilly and Company, GlaxoSmithKline plc, Merck & Co., Inc., Pfizer Inc., and Schering-Plough Research Institute, as well as
significant biotechnology and biopharmaceutical companies including Lexicon Genetics Incorporated, Millennium Pharmaceuticals, Nuvelo, Inc. and Tanox, Inc.



We also have the capability to conduct further target discovery and validation efforts through our Target Research and Development, or
TRD, program. Our TRD program adds comprehensive in-depth analysis to further characterize and identify potential key targets for the treatment of disease. The program currently focuses on the identification and validation of targets in metabolism
and inflammatory diseases.



A principal goal of
Deltagen is to validate and characterize potential drug targets through our phenotypic analysis and TRD programs in an effort to further identify and validate potential drug candidates for our biopharmaceutical customers.



We are implementing a strategy to identify, validate and
commercialize potential drug targets through our:



| |  |  | Target Research and Development program, an integrated systems biology infrastructure, comprising data generated from our platform of knockout animal models and
pathophysiological analysis, disease challenge models and biochemical disease pathway analysis;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | in vivo mammalian gene function and secreted protein discoveries;
| | - |  | -----------------------------------------------------------------



| |  |  | develop commercially relevant intellectual property on the use of mammalian genes and secreted proteins in drug development through alliances and collaborations with
third parties; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | generation of information, products and services for pharmaceutical and biotechnology drug discovery efforts.
| | - |  | -------------------------------------------------------------------------------------------------------------



Our recent acquisition of XenoPharm, Inc.
(XenoPharm,) further complements our target validation and characterization technologies. XenoPharm provides a proprietary technology platform to evaluate the metabolism of drug candidates, to improve the predictive value of cell - and
animal-based biomedical research and predict the reaction of a drug candidate in a human system, thereby screening candidates for improved chances of clinical success.



We believe that our ability to determine gene function, to develop products and to identify and validate
potential drug targets is a result of our leveraging of our technology platforms. Our genomics technologies, processes and information systems are integrated with one another and generate information on the function and relationships between genes
and the proteins these genes encode and the usefulness of genes as new drug targets and proteins as new drug candidates. We have used these systems to establish and develop our products and programs that include our:



| |  |  | large-scale program to generate mammalian gene knockout animals and to discover gene function;
| | - |  | ----------------------------------------------------------------------------------------------



| |  |  | DeltaBase portfolio of gene knockout animal models and mammalian gene function data analysis and management database;
| | - |  | ---------------------------------------------------------------------------------------------------------------------



| |  |  | mammalian gene knockout secreted protein discovery collaborations and programs;
| | - |  | -------------------------------------------------------------------------------



| |  |  | Target Research and Development program, which adds additional gene knockouts, disease challenge models, and underlying disease pathway analysis to provide a
comprehensive systems biology approach to assist in identifying key targets for the treatment of disease;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | internal characterization, and evaluation of targets, including those targets discovered and analyzed using our proprietary in vivo mammalian functional
genomics programs; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | XenoPharms drug metabolism and xenobiotic technology platform to potentially predict the reaction of a drug in a human system.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------



DeltaBase is our proprietary database that provides
information, based on knockout mouse studies, on gene function for drug discovery. We created DeltaBase to be marketed to the pharmaceutical and biotechnology industries to help define the role that genes play in biological processes and disease. We
select genes for DeltaBase based upon what we believe to be their potential to become useful drug targets. We generate information on these genes by comprehensively analyzing knockout mice generated through our proprietary gene knockout methods.
Each knockout mouse undergoes a standardized, detailed and extensive analysis in order to determine the function and role that a particular gene plays in the mouse. Additionally, DeltaBase subscribers will have access to the knockout mice used to
generate this data.



The DeltaSelect program was
our initial program. Customers received phenotypic target validation information for selected genes on a fee-for-service basis. This program was provided to validate our proprietary technology and promote interest in the DeltaBase product that
became available in 2000. We believe that the DeltaSelect program has provided validation of our proprietary platform technology and promoted interest in DeltaBase, however, the revenues generated from the DeltaSelect program have to date not been
significant and have with time become relatively less significant. We anticipate that revenues from DeltaSelect will continue to become less significant and that DeltaSelect will be utilized only under very limited circumstances to develop new
technologies, product offerings and programs in collaboration with pharmaceutical companies.



We recently launched a product line known as DeltaOne that offers access to our extensive portfolio of knockout mice and/or accompanying phenotypic data, as well as any corresponding intellectual
property, on a gene-by-gene basis. Our current customers include Aventis Pharmaceuticals, Inc., Euroscreen, S.A. and Millennium Pharmaceuticals.



We have DeltaBase agreements with GlaxoSmithKline, Pfizer and Merck. Each of these agreements provides for payments aggregating
approximately $15 million in exchange for three years worth of DeltaBase targets. In addition, we may receive additional fees for access to certain corresponding intellectual property. We began recognizing revenue from the GlaxoSmithKline
agreement in the fourth quarter of 2000. Revenue from the Pfizer agreement began to be recognized in the first quarter of 2001. We began to recognize revenue from the Merck agreement in the second quarter of 2002. We anticipate that a significant
portion of our revenues for at least the next six months will be derived from fees under agreements with DeltaBase subscribers and access to information and tools related to the DeltaBase product offering. Our current DeltaBase agreements with
GlaxoSmithKline and Pfizer are coterminous, each terminating upon our delivery of DeltaBase in June 2003, and, although renewable beyond such date, may not be renewed. The Merck agreement provides for payments on 600 genes (through our delivery of
DeltaBase in December 2002) with payments for the remaining 150 genes to be paid upon delivery of initial gene data that may be delivered to Merck subsequent to June 2003.



We also have secreted protein agreements with Eli Lilly and Nuvelo.



Secreted Protein Agreements and Collaborations



In August 2001, we entered into a secreted
protein agreement with Eli Lilly (Lilly) to evaluate, and potentially develop and commercialize, therapeutic secreted proteins. Under the terms of the agreement, Lilly has provided potential targets from its secreted protein pipeline for
which we will further evaluate the therapeutic potential in mammalian models. Among those secreted proteins with potential therapeutic value, each company may select proteins for commercial development, with each company receiving royalties based on
sales of therapeutic products. The agreement provides Lilly with certain acquisition, co-promotion, co-marketing and profit-sharing options with respect to therapeutic products developed and commercialized by us. The agreement also provides us with
certain co-promotion, co-development and profit-sharing opportunities.



In October 2001, we entered into a collaboration agreement with Nuvelo to research, develop and commercialize biopharmaceutical products based on secreted proteins. Under the terms of the agreement, Nuvelo has provided us
with gene sequences encoding secreted proteins and we will utilize our proprietary in vivo mammalian gene knockout technology to discover and validate potential commercially relevant biopharmaceutical drug targets. We and Nuvelo will each
have certain joint development and commercialization rights around potential biopharmaceutical drug targets discovered through the collaboration. We and Nuvelo will share the collaborations costs; Nuvelo will provide us with approximately $8
million in research and development payments over two years. In addition, we received $10 million in equity proceeds from the sale of shares of our common stock to George B. Rathmann, Ph.D., chairman of the Board of Directors of Nuvelo.



18



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##### Table of Contents



Revenue for
the three months ended March 31, 2003 and 2002 is as follows (in thousands):



|Revenue                                                        |  | 2003 |       | 2002
|-------------------------------------------------------------- |  | ---- | ----- | ----
|DeltaBase                                                      |  | $    | 3,769 |     
|Other (includes DeltaSelect and other research collaborations) |  |      | 836   |     
|                                                               |  |      |       |     
|Total                                                          |  | $    | 4,605 |     
|                                                               |  |      |       |     



Under
our revenue recognition policy, revenues are recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered and meet all customer-specified criteria, the price is fixed and determinable and
collectibility is reasonably assured. Revenue derived from DeltaBase agreements is recognized on a straight-line basis over the term in which services are to be provided. Research and development collaboration agreements specify milestones to be met
and the payments associated with meeting each milestone. Revenue derived from these contracts is recognized upon completion of the milestone. The amount of revenue recognized upon completion of each milestone is such that the earned revenue, as a
percentage of total anticipated revenue, approximates the costs incurred in achieving the related milestone, as a percentage of the total anticipated costs. Any payments received in advance of the completion of a milestone or services performed are
recorded as deferred revenue.



We had net losses
of $18.0 million and $18.7 million for the three months ended March 31, 2003 and 2002, respectively. Our losses have resulted primarily from costs incurred in connection with research and development activities, from selling, general and
administrative costs associated with our operations, asset impairment and restructuring charges and non-cash charges for amortization of unearned stock-based compensation costs and amortization of intangibles. Amortization totaled $585,000 and
$619,000 for the three months ended March 31, 2003 and 2002, respectively. The quarter ended March 31, 2003 included a $9.3 million charge for restructuring charges. Research and development expenses consist primarily of salaries and related
personnel costs, material costs, legal expenses resulting from intellectual property filings and other expenses related to our DeltaBase, DeltaSelect and secreted protein programs. We expense our research and development costs as they are incurred.
Selling, general and administrative expenses consist primarily of salaries and related expenses for executive, finance and other administrative personnel, professional and other corporate expenses including business development, marketing,
litigation costs and general legal activities. In connection with the development and expansion of our gene function database and our secreted protein program, we may incur research and development and selling, general and administrative costs that
may exceed revenues. As a result, we may report net losses through the next several years.



We account for stock-based employee compensation arrangements in accordance with provisions of Accounting Principles Board Opinion No. 25 (APB 25), Accounting for Stock Issued to
Employees and related interpretations and comply with the disclosure provisions of Statement of Financial Accounting Standards No. 123 (SFAS 123), Accounting for Stock-Based Compensation.



Under APB 25, compensation expense is based on the difference,
if any, on the date of the grant, between the fair value of our stock and the exercise price. SFAS 123 defines a fair value based method of accounting for an employee stock option or similar equity investment.



We account for equity instruments issued to non-employees in
accordance with the provisions of SFAS 123 and Emerging Issues Task Force Issue No. 96-18 (EITF 96-18), Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods
or Services and Financial Accounting Standards Board Interpretation No. 28 (FIN 28), Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans.



During the three months ended March 31, 2003, we recorded
unearned stock-based compensation of approximately $1.0 million. This amount is being amortized as charges to operations over the respective vesting period of the individual stock options, generally four years. During the three months ended March
31, 2002, we reversed approximately $138,000 of unearned stock-based compensation related to unvested stock options due to employee terminations and changes in the fair market value of our common stock.



We may incur additional stock-based compensation expense in
the future as a result of both options or other securities granted at below fair market value and fluctuations in the market value of our stock that have a direct impact on the value of options and warrants held by non-employees.



19



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Major Developments since
December 31, 2002



On January 6, 2003, we
announced a cost savings and business restructuring plan to reduce our cash expenditures. As part of this restructuring plan, we closed the Salt Lake City facility that housed the Deltagen Proteomics, Inc. operations. As a result of the
restructuring plan, substantially all Deltagen Proteomics, Inc. activities and capabilities have ceased or been eliminated.



The Companys restructuring efforts are expected to reduce operating costs and decrease cash outflows from operations going forward.
The restructuring efforts are not expected to impact potential revenues from the Companys core business of providing derived mammalian gene function information to define the function and disease relevance of mammalian genes. Since internal
drug development efforts will no longer be pursued, any potential revenues that the Company might have realized from such pursuits will not occur. There are no available estimates for the forgone revenue opportunities related to such efforts. The
total expected annual cost savings from ongoing operations as well as the abandonment of drug development efforts is expected to be approximately $79 million. Total annual operating cash cost savings from ongoing operations are expected to be
approximately $20 million in 2003 with such savings beginning in Q1 2003 ($13.4 million from R&D activities and $6.6 million from G&A activities which include approximately $9.9 million due to headcount reductions that began in October
2002) Total annual cash cost savings from the abandonment of drug development efforts are expected to be approximately $57.6 million. Depreciation expense is not expected to be materially impacted by the restructuring activities. Due to the
write-off of certain intangible assets in 2002, the expense reduction for the amortization of intangible assets is expected to be $1.4 million in 2003. As a result of the renegotiation of existing and excess facilities, the Company reduced its
aggregate future minimum lease commitments from 2003 forward by approximately $70 million. Additional restructuring charges of $780,000 are expected in the second quarter of 2003.



Restructuring Activities



With the acquisitions of Arcaris, Inc. and BMSPRL, L.L.C. and the expansion of our internal drug development
efforts, the number of employees peaked at 450 by September 30, 2002 and we were leasing ten facilities. Given the significant net cash outflow from operations and the difficulty in accessing additional capital, we undertook a series of cost cutting
measures beginning in October 2002. These included workforce reductions in October 2002, January 2003 and April 2003 and the closure of our operations outside of the San Francisco Bay Area, including the closure of Arcaris, BMSPRL and Europe
operations. Remaining operations are being consolidated into our recently renovated 132,000 square foot facility in Redwood City, California. We discontinued our internal drug discovery efforts and refocused our strategies and operations on
providing drug discovery tools and services to the biopharmaceutical industry utilizing the Companys proprietary core mammalian in vivo transgenic technologies. In addition to the workforce reduction and cost cutting actions, we
negotiated settlement of obligations with certain landlords, lenders and vendors.



Facility Leases



In March 2003, we entered into an agreement with the landlord of our Menlo Park, California facilities to terminate our remaining lease obligations. The agreement required us to make a termination
payment of $500,000 and pay decommissioning costs of $12,000 in March 2003, forfeit restricted cash underlying letters of credit totaling $431,000 in April 2004 and issue warrants to purchase 250,000 shares of our Common or Series A Preferred Stock
at the landlords option. The value of the warrants at March 31, 2003 was approximately $50,000. The value of the warrant was calculated using the Black-Scholes pricing model. The assumptions used in the Black-Scholes model are as follows:
dividend yield of 0%, term of ten years, volatility of 115.64% and risk-free interest rate of 3.90%. We ceased using these facilities in January 2003. The expenses associated with this agreement were recorded during the three months ended March 31,
2003 and are included in restructuring charges on the consolidated statement of operations.



In March 2003, we entered into an agreement with the landlord of our Alameda, California facility to terminate our remaining sub-lease obligation. The agreement requires us to forfeit restricted cash
underlying letters of credit totaling approximately $211,000 and make a termination payment of $590,000 on or before August 31, 2003 or the date of the closing of our sale of not less than $10,000,000 of our equity securities. We ceased using this
facility in February 2003. The expenses associated with this agreement were recorded during the three months ended March 31, 2003 and are included in restructuring charges on the consolidated statement of operations.



In March 2003, we entered into an option agreement with the
landlord of one of our Redwood City, California facilities to terminate our remaining lease obligation. The agreement requires us to forfeit restricted cash underlying letters of credit totaling approximately $1.7 million, make termination payments
of $1.2 million on or before August 31, 2003 and $200,000 on or before January 15, 2005 and to issue warrants to purchase 900,000 shares of our Common or Series A Preferred Stock at the landlords option plus additional warrants equal to 0.05
warrants per dollar for each dollar of Series A preferred stock issued in excess of $10 million. The value of the warrants at March 31, 2003 was approximately $278,000. The value of the warrant was calculated using the Black-Scholes pricing model.
The assumptions used in the Black-Scholes model are as follows: warrants to purchase 1,400,000 shares of the Companys Common or Series A Preferred Stock, dividend yield of 0%, term of ten years, volatility of 115.64% and risk-free interest
rate of 3.90%. We ceased using this facility in February 2003. The expenses associated with this agreement were recorded during the three months ended March 31, 2003 and are included in restructuring charges on the consolidated statement of
operations.



In March 2003, we entered into an
assignment agreement related to our remaining lease obligation on our San Diego, California facility. The agreement requires us to forfeit lease deposits totaling approximately $191,000 and incur other costs of $275,000. We ceased using this
facility in January 2003. The expenses associated with this agreement were recorded during the three months ended March 31, 2003 and are included in restructuring charges on the consolidated statement of operations.



In April 2003 we entered into a forbearance agreement related
to the lease of our principal operating and administrative facility in Redwood City, California. This agreement provides for lease rent and certain facility operating expense to be paid from our $1.5 million cash security deposit or $500,000
restricted cash related to letters of credit in 2003. Lease rent is also reduced by approximately 25% during the forbearance period. The agreement has certain default criteria that if breeched would cause the lease rent to revert to prior levels
retroactively.



Events that would cause a default
include:



| |  |  | month end unrestricted cash balances of less than $500,000 prior to December 31, 2003 and less than $1.5 million at each month end thereafter;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | default or breach by us under any credit agreement, lease guaranty or any other obligation to which we are bound where the liability exceeds $750,000 and which is
not cured within 30 days;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the revocation, termination or suspension of any license, franchise, permit or other authorization necessary for the manufacture or sale of our product as result of
a breach, act or omission by us which is not reinstated or reissued within 45 days of such revocation, termination or suspension;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | failure by us to receive, on or before August 31, 2003, net additional proceeds of $5 million or more from one or more equity capital investments.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------



Lending Arrangements



In March 2003, we repaid in full,
without penalty, the outstanding balance of $10 million under a term loan facility. As a result of this payment, we are no longer required to maintain restricted cash balances of $10.5 million as security for the loan facility.



20



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##### Table of Contents



In March 2003,
we reached an agreement with General Electric Capital Corporation to restructure our existing loan agreements. The existing loan agreements had outstanding balances at March 31, 2003 of $5.0 million and were payable in monthly installments at
interest rates ranging from 8.87% to 12.75% with maturities to July 2005. Under the terms of the restructuring, we forfeited letters of credit totaling $2.3 million to the lender in partial payment of the loans and entered into a new loan for the
remaining balance of $2.7 million. The new loan will bear an interest rate of 10.50% and is required to be repaid in 18 monthly installments beginning in April 2003. The loan is collateralized by a first position security interest in certain fixed
assets and a second position security interest in substantially all of our other assets.



Vendor Arrangements



In March 2003, we negotiated the settlement of a $1.2 million obligation with a vendor for $434,000 in current cash payments, $144,000 to be paid upon completion of the Series A Preferred Stock
financing described below and $290,000 in Series A Preferred Stock to be issued upon closing of the private placement. The remaining $290,000 balance is to be forgiven upon the completion of the preferred financing.



Bridge Loan and Commitment for Equity Financing



In April 2003, we obtained a minimum
commitment for $10 million in equity capital from existing institutional investors to purchase preferred stock in a transaction referred to here in as the private placement. The private placement is subject to shareholder approval and the
satisfaction of closing conditions. In addition to the terms of the private placement, our stockholders will be asked to approve a number of other matters including a reverse stock split.



Under the terms of the private placement, the investors have agreed to purchase $10 million of preferred
stock. The preferred stock is convertible into common stock on a 1:1 basis. The preferred stock will be issued at a 25% discount to the five-day average closing common stock price for the period ending three days prior to closing. The preferred
stock bears no dividend, has a liquidation preference right equal to the amount invested in the preferred stock and standard anti-dilution protections. The terms of the preferred stock agreement include the right to appoint designees to a total of
three seats on the Board of Directors.



We also
obtained a secured bridge loan commitment of $5 million from the same investors. This facility can be increased to $6 million upon the occurrence of certain events and milestones and is secured by all of our assets not pledged to the equipment
loans. The loan bears interest at 10% per annum. The principal and interest on the bridge loan will be repaid upon the earlier of the closing of the private placement with the proceeds thereof or August 31, 2003. There are financial covenants to the
bridge loan associated with cash and earnings before interest, taxes, depreciation and amortization (EBITDA) performance versus forecast which if not met could lead to loan default and acceleration of the loan.



In connection with the private placement, we have agreed to
use reasonable best efforts, as soon as reasonably practicable after the closing of the preferred stock financing, to offer stockholders of record as of the last business day prior to the closing of the private placement (other than the investors in
such financing) non-transferable rights to purchase newly issued preferred stock at the same purchase price paid by the investors. The amount of preferred shares so offered to each stockholder would be sufficient to allow each such stockholder to
maintain the percentage ownership interest in Deltagen held by each such stockholder as of the last business day prior to the closing of the private placement.



Legal Matters



On April 28, 2003, the Company received from Lexicon a letter which Lexicon claims serves as notice of termination of the sublicense
agreement under which the Company obtained a commercial license to the 215 patent and the Capecchi patents. In this letter, Lexicon specified two grounds that allegedly entitles Lexicon to terminate the sublicense agreement: (1) the
Companys purported material breach of the DeltaBase agreement, under which Lexicon obtained a commercial license to our DeltaBase product; and (2) the Companys purported insolvency. On April 29, 2003, the Company received from Lexicon a
letter which Lexicon claims serves as notice under the DeltaBase agreement of: (1) Lexicons alleged entitlement to damages in the amount of $25 million, plus attorneys fees and costs, for the Companys purported material breach of
the DeltaBase agreement; and (2) alleged noncompliance with the content criteria in the DeltaBase agreement. The Company believes that Lexicons claims and allegations are without merit, and intends to promptly address these claims according to
the dispute resolution procedures provided by the settlement and other agreements between Lexicon and Deltagen.



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##### Table of Contents



RESULTS OF
OPERATIONS



Revenue for the three months
ended March 31, is as follows (in thousands):



|                                                               |  | 2003 |       | 2002
|-------------------------------------------------------------- |  | ---- | ----- | ----
|DeltaBase                                                      |  | $    | 3,769 |     
|Other (includes DeltaSelect and Other research collaborations) |  |      | 836   |     
|                                                               |  |      |       |     
|Total                                                          |  | $    | 4,605 |     
|                                                               |  |      |       |     



Costs
and expenses for the three months ended March 31, are as follows (in thousands):



|                                                    |  | 2003 |        | 2002
|--------------------------------------------------- |  | ---- | ------ | ----
|Research and development                            |  |      |        |     
|Before non-cash charges                             |  | $    | 7,624  |     
|Non-cash charges:                                   |  |      |        |     
|Depreciation and amortization                       |  |      | 1,337  |     
|Amortization of intangibles                         |  |      | 585    |     
|Amortization of unearned stock compensation expense |  |      | 580    |     
|                                                    |  |      |        |     
|Total research and development                      |  |      | 10,126 |     
|Selling, general and administrative                 |  |      |        |     
|Before non-cash charges                             |  |      | 2,320  |     
|Non-cash charges:                                   |  |      |        |     
|Depreciation and amortization                       |  |      | 283    |     
|Amortization of unearned stock compensation expense |  |      | 429    |     
|                                                    |  |      |        |     
|Total selling, general and administrative           |  |      | 3,032  |     
|Restructuring charges                               |  |      | 9,262  |     
|                                                    |  |      |        |     
|Total costs and expenses                            |  | $    | 22,420 |     
|                                                    |  |      |        |     





Three Months Ended March 31, 2003 and 2002



Revenues



Contract revenue increased by $2.0 million to $4.6 million in three months ended March 31, 2003 from $2.6 million in the first quarter of
2002. The increase was due primarily to increased revenue from our DeltaBase gene function database product as a result of our collaboration with Merck signed in 2002. Revenue for the Merck agreement was first recognized in the second quarter of
2002. In 2003, our DeltaBase, DeltaOne and DeltaSelect revenue came principally from contracts with GlaxoSmithKline, Merck, Millennium Pharmaceuticals, Pfizer and Schering-Plough Research Institute.



Costs and Expenses



Costs and expenses for the three months ended March 31, 2003
were $22.4 million compared to $21.6 million in the first quarter of 2002. Costs and expenses for the quarter ended March 31, 2003 include charges of $9.3 million for restructuring. These charges are associated with our strategic business
realignments announced in January 2003 and include severance costs of $2.5 million and lease settlement costs of $4.2 million. Further charges for severance and other employee related costs of approximately $780,000 will be recorded in the second
quarter of 2003 related to a additional 50 employee reduction in staff announced on April 10, 2003 as well as final facilities closures.



Research and development expenses decreased by $6.7 million to $10.1 million for the three months ended March 31, 2003 from $16.8 million
for the comparable period in 2002. The decrease in costs and expenses was due primarily to the benefits of the cost reduction actions taken in October 2002 and January 2003. These actions included reductions in our workforce and the discontinuance
of our internal small molecule drug discovery efforts following the closedown of chemistry capabilities in October 2002 and our January 2003 workforce reductions including the close down of our Salt Lake City, Utah operations. The decrease includes
$3.7 million related to decreased personnel, $1.5 million related to decreased laboratory supply costs to support development of our gene function database and secreted protein programs, $158,000 related to decreased professional fees, $2 million
related to decreased facilities related expenses and $552,000 related to increased depreciation expenses.



Selling, general and administrative expenses decreased by $1.8 million to $3.0 million for the three months ended March 31, 2003 from $4.8 million for
the comparable period of 2002. This decrease included $1 million related to decreased personnel and support costs, $501,000 related to decreases in facilities and depreciation related expenses, $60,000 related to decreases in legal and professional
fees and $51,000 related to decreases in marketing and advertising expenses.



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##### Table of Contents



Net Interest Income



Net interest expense was $164,000 in the
three months ended March 31, 2003 compared to net interest income of $263,000 in the three months ended March 31, 2002. This decrease resulted from reduced average cash and investment balances, lower interest rates on cash investments and increased
borrowings during 2003 and as compared to 2002.



Business
Restructuring



On January 6, 2003, we
announced additions to our business restructuring and cost reduction plan. As part of this restructuring, we reduced our staff to approximately 200 employees. The plan included the closing of our Strasbourg, France operations and our Salt Lake City
operations acquired in the acquisition of Arcaris, Inc. and the consolidation of core activities into our Redwood City, California facility. As a result, the Company recorded a charge in the first quarter of 2003 for severance and other employee
related costs, costs associated with lease obligations and settlements and other costs. These costs relate to the Companys operations in the San Francisco Bay Area, Strasbourg, France, Salt Lake City, Utah (Arcaris acquisition in 2001) and
excess facilities in Alameda, Menlo Park and Redwood City, California.



The Companys restructuring efforts are expected to reduce operating costs and decrease cash outflows from operations going forward. The restructuring efforts are not expected to impact potential revenues from the
Companys core business of providing derived mammalian gene function information to define the function and disease relevance of mammalian genes. Since internal drug development efforts will no longer be pursued, any potential revenues that the
Company might have realized from such pursuits will not occur. There are no available estimates for the forgone revenue opportunities related to such efforts. The total expected annual cost savings from ongoing operations as well as the abandonment
of drug development efforts is expected to be approximately $79 million. Total annual operating cash cost savings from ongoing operations are expected to be approximately $20 million in 2003 with such savings beginning in Q1 2003 ($13.4 million from
R&D activities and $6.6 million from G&A activities which include approximately $9.9 million due to headcount reductions that began in October 2002). Total annual cash cost savings from the abandonment of drug development efforts are
expected to be approximately $57.6 million. Depreciation expense is not expected to be materially impacted by the restructuring activities. Due to the write-off of certain intangible assets in 2002, the expense reduction for the amortization of
intangible assets is expected to be $1.4 million in 2003. As a result of the renegotiation of existing and excess facilities, the Company reduced its aggregate future minimum lease commitments from 2003 forward by approximately $70 million.



The following table sets forth certain details
associated with the business restructuring charges in 2003 and the obligations recorded in 2002 for cost reductions programs enacted in 2002 (in thousands of dollars):



|                                                         |  | Accrual atDecember 31,2002 |       | 2003RestructuringCharges |   | Cash(Payments)Receipts |  |   | Non-cash Transactions |   |  | Accrual atMarch 31,2003
|-------------------------------------------------------- |  | -------------------------- | ----- | ------------------------ | - | ---------------------- |  | - | --------------------- | - |  | -----------------------
|Retention bonuses, severance, and executive compensation |  | $                          | 1,552 |                          | $ | 2,485                  |  | $ | (2,703                | ) |  | $                      
|Lease settlements                                        |  |                            | 126   |                          |   | 4,206                  |  |   | (1,193                | ) |  |                        
|Legal and consulting fees                                |  |                            | 77    |                          |   | 669                    |  |   | (258                  | ) |  |                        
|Other                                                    |  |                            | 1,099 |                          |   | 1,902                  |  |   | (200                  | ) |  |                        
|                                                         |  |                            |       |                          |   |                        |  |   |                       |   |  |                        
|                                                         |  | $                          | 2,854 |                          | $ | 9,262                  |  | $ | (4,354                | ) |  | $                      
|                                                         |  |                            |       |                          |   |                        |  |   |                       |   |  |                        



It is
anticipated that a majority of the remaining accrual will be paid during fiscal year 2003.



We will record a charge of approximately $780,000 in the second quarter of 2003 for final facilities closures, employee severance and other related costs associated with a further reduction in the
workforce to approximately 150 employees announced on April 10, 2003.



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In March 2003,
we entered into an agreement with the landlord of our Menlo Park, California facilities to terminate our remaining lease obligations. The agreement required us to make a termination payment of $500,000 and pay decommissioning costs of $12,000 in
March 2003, forfeit restricted cash underlying letters of credit totaling $431,000 in April 2004 and issue warrants to purchase 250,000 shares of our Common or Series A Preferred Stock at the landlords option. The value of the warrants at
March 31, 2003 was approximately $50,000. The value of the warrant was calculated using the Black-Scholes pricing model. The assumptions used in the Black-Scholes model are as follows: dividend yield of 0%, term of ten years, volatility of 115.64%
and risk-free interest rate of 3.90%. We ceased using these facilities in January 2003. The expenses associated with this agreement were recorded during the three months ended March 31, 2003 and are included in restructuring charges on the
consolidated statement of operations.



In March
2003, we entered into an agreement with the landlord of our Alameda, California facility to terminate our remaining sub-lease obligation. The agreement requires us to forfeit restricted cash underlying letters of credit totaling approximately
$211,000 and make a termination payment of $590,000 on or before August 31, 2003 or the date of the closing of our sale of not less than $10,000,000 of our equity securities. We ceased using this facility in February 2003. The expenses associated
with this agreement were recorded during the three months ended March 31, 2003 and are included in restructuring charges on the consolidated statement of operations.



In March 2003, we entered into an option agreement with the landlord of one of our Redwood City, California
facilities to terminate our remaining lease obligation. The agreement requires us to forfeit restricted cash underlying letters of credit totaling approximately $1.7 million, make termination payments of $1.2 million on or before August 31, 2003 and
$200,000 on or before January 15, 2005 and to issue warrants to purchase 900,000 shares of our Common or Series A Preferred Stock at the landlords option plus additional warrants equal to 0.05 warrants per dollar for each dollar of Series A
preferred stock issued in excess of $10 million. The value of the warrants at March 31, 2003 was approximately $278,000. The value of the warrant was calculated using the Black-Scholes pricing model. The assumptions used in the Black-Scholes model
are as follows: warrants to purchase 1,400,000 shares of the Companys Common or Series A Preferred Stock, dividend yield of 0%, term of ten years, volatility of 115.64% and risk-free interest rate of 3.90%. We ceased using this facility in
February 2003. The expenses associated with this agreement were recorded during the three months ended March 31, 2003 and are included in restructuring charges on the consolidated statement of operations.



In March 2003, we entered into an assignment agreement related
to our remaining lease obligation on our San Diego, California facility. The agreement requires us to forfeit lease deposits totaling approximately $191,000 and incur other costs of $275,000. We ceased using this facility in January 2003. The
expenses associated with this agreement were recorded during the three months ended March 31, 2003 and are included in restructuring charges on the consolidated statement of operations.



In April 2003 we entered into a forbearance agreement related to the lease of our principal operating and
administrative facility in Redwood City, California. This agreement provides for lease rent and certain facility operating expense to be paid from our $1.5 million cash security deposit or $500,000 restricted cash related to letters of credit in
2003. Lease rent is also reduced by approximately 25%, approximately $8.8 million, during the forbearance period. The agreement has certain default criteria that if breeched would cause the lease rent to revert to prior levels retroactively.



Events that would cause a default include:



| |  |  | month end unrestricted cash balances of less than $500,000 prior to December 31, 2003 and less than $1.5 million at each month end thereafter;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | default or breach by us under any credit agreement, lease guaranty or any other obligation to which we are bound where the liability exceeds $750,000 and which is
not cured within 30 days;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the revocation, termination or suspension of any license, franchise, permit or other authorization necessary for the manufacture or sale of our product as result of
a breach, act or omission by us which is not reinstated or reissued within 45 days of such revocation, termination or suspension;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | failure by us to receive, on or before August 31, 2003, net additional proceeds of $5 million or more from one or more equity capital investments.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------



If the private placement is
completed and the forbearance reductions continue, the remaining lease obligations will be as follows (in thousands):



|Year Ending December 31,                       |  |  
|---------------------------------------------- |  | -
|2003 (April 1, 2003 through December 31, 2003) |  | $
|2004                                           |  |  
|2005                                           |  |  
|2006                                           |  |  
|2007                                           |  |  
|Thereafter                                     |  |  
|                                               |  |  
|Total                                          |  | $
|                                               |  |  



Liquidity and Capital
Resources



We have financed our operations
from inception primarily through issuances of equity securities, contract payments to us under our DeltaSelect and DeltaBase agreements and equipment financing arrangements. Through March 31, 2003, we had received net proceeds of $183.4 million from
issuances of equity securities, $49.4 million from customer agreements, $12.7 million from equipment financing arrangements and $10 million from a term loan facility.



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At March 31,
2003, we had $2.7 million in cash and cash equivalents compared to $7.7 million at December 31, 2002. In addition, at December 31, 2002, we had $6.1 million in marketable securities representing highly liquid commercial paper and government agency
securities. We used $11.6 million in cash for operating activities in the three months ended March 31, 2003. This consisted primarily of the net loss for the period of $18.0 million offset in part by non-cash charges totaling $3.2 million including
$1.6 million related to depreciation and amortization expenses, $585,000 related to the amortization of intangibles and $1.0 million related to the amortization of unearned stock-based compensation. Prepaid expenses and other current assets
decreased by $1 million and accounts payable and accrued liabilities increased by $836,000. Decreases in deferred revenue of $1.7 million were offset by decreases in customer receivables of $3 million. Investment activities provided $16.9 million in
cash in the first quarter of 2003 including $6.0 million related to maturities of marketable securities and the release of restricted cash of $10.5 million. Financing activities in the three months ended March 31, 2003 included loan and capital
lease repayments of $10.5 million.



At March 31,
2003 we had the following contractual cash obligations (including operating lease obligations that were restructured pursuant to our business realignment discussed above) (in thousands):



|                                               |  | OperatingLeases |        | CapitalLeases(1) |   | Debt(1) |  | Total
|---------------------------------------------- |  | --------------- | ------ | ---------------- | - | ------- |  | -----
|Year Ending December 31,                       |  |                 |        |                  |   |         |  |      
|2003 (April 1, 2003 through December 31, 2003) |  | $               | 9,480  |                  | $ | 17      |  | $    
|2004                                           |  |                 | 11,837 |                  |   | 7       |  |      
|2005                                           |  |                 | 11,606 |                  |   |        |  |      
|2006                                           |  |                 | 10,521 |                  |   |        |  |      
|2007                                           |  |                 | 10,674 |                  |   |        |  |      
|Thereafter                                     |  |                 | 44,150 |                  |   |        |  |      
|                                               |  |                 |        |                  |   |         |  |      
|Total                                          |  | $               | 98,268 |                  | $ | 24      |  | $    
|                                               |  |                 |        |                  |   |         |  |      

---

|(1) |  | Excludes interest
|--- |  | -----------------



We have issued standing letters of credit totaling $3.0 million and security deposits of $1.5 million as credit support for operating
leases. These letters of credit are collateralized by cash deposits of an equal amount and automatically renew on an annual basis during the lease term. These cash deposits are classified as restricted cash on the consolidated balance sheets. We
expect that substantially all of these letters of credit and deposits will be paid to landlords in the first half of 2003 as part of settlement consideration for lease termination and lease reduction arrangements.



The equipment loan agreements have restrictive covenants
requiring minimum unrestricted cash balances, generally twelve months cash needs. In October 2002, we provided letters of credit for $2.3 million as additional collateral for the equipment loans. There are no further collateral requirements
contingently required under these loans. This loan was amended in 2003 and the restricted cash supporting the letter of credit was released as prepayment of the debt obligation in April 2003.



Our immediate sources of cash for operating activities are:



| |  |  | Existing customer agreements
| | - |  | ----------------------------



| |  |  | Potential new customer agreements.
| | - |  | ----------------------------------



Our immediate requirements for cash include:



| |  |  | Ongoing operating expenses (research and development costs and selling, general and administrative expenses)
| | - |  | ------------------------------------------------------------------------------------------------------------



| |  |  | Costs associated with the business realignment including severance and other employee related costs, facility closedown costs and lease and lease termination and
settlement costs associated with excess facilities under long-term leases.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



In April 2003, we received $5 million in proceeds from a bridge loan and received a commitment from investors to purchase a minimum $10 million in newly issued preferred stock. The bridge loan can be
increased to $6 million upon the occurrence of certain events and milestones and is collateralized by all of our assets not pledged to the equipment loan. Principal and interest on the loan is to be repaid upon the earlier of the closing of the
preferred financing with the proceeds thereof or August 31, 2003.



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If we are not
able to complete the equity financing on time, it is likely that we will cease our operations in the third quarter of 2003. Our inability to obtain additional funding through the private placement would likely cause us to explore liquidation
alternatives, including the initiation of bankruptcy proceedings. If this were to occur, after repayment of our obligations including the bridge loan received from the private placement investors, any investment in us would likely decline to zero.



The equity financing is subject to shareholder
approval and the satisfaction of closing conditions. There are financial covenants to the bridge loan associated with cash and earnings before interest, taxes, depreciation and amortization (EBITDA) performance versus forecast which if
not met could lead to loan default and acceleration of the loan. In order to have sufficient cash to operate in 2003 we may be required to further reduce the level of operating expenses through additional workforce reductions and access additional
debt or equity capital. We continue to evaluate alternative means of financing to meet our long-term needs; however, additional financing may not be available on terms acceptable to us or at all. The sale of additional equity or convertible debt
securities may result in substantial additional dilution to our stockholders. Any debt financing may have restrictive covenants that adversely affect our operating plans and flexibility.



We continue to evaluate alternative means of financing to meet our needs on terms that are attractive to us.
Although we have recently implemented a business realignment and staff reductions to reduce our cash burn rate, if we are not able to obtain needed capital, we will have to take additional actions to conserve our cash balances, including further
reductions in our operating expenses, downsizing of our staff and closing of facilities, all of which would likely have a material adverse effect on our business, financial condition and our ability to reduce losses or generate profits.



We have not paid any cash dividends on our
common stock in the past. We currently intend to retain any earnings for use in the business and do not anticipate paying any cash dividends on our common stock in the foreseeable future.



Recent Accounting Pronouncements



In November 2002, the Emerging Issues Task Force (EITF) reached a consensus on Issue No. 00-21
(EITF 00-21), Revenue Arrangements with Multiple Deliverables. EITF 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use
assets. The provisions of EITF 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. We believe that the adoption of EITF 00-21 will not have a material impact on our financial position or results of
operations.



In January 2003, the FASB issued
FASB Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity
if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other
parties. FIN 46 is effective immediately for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for
the first interim or annual period beginning after June 15, 2003. We are currently evaluating the impact, if any, that the adoption of FIN 46 will have on our financial position or results of operations.



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Risk Factors Affecting
Future Operating Results



We may be unable to complete
the private placement.



As more fully
described in Item 1, Note 12 of this report under the heading Bridge Loan and Commitments for Equity Financing, on April 2, 2003, we entered into a definitive purchase agreement with certain investors to raise a minimum of $10 million
through the issuance of Series A Preferred Stock. Consummation of the transactions contemplated by the purchase agreement is subject to our obtaining stockholder approval and other closing conditions. If we are not able to complete the private
placement on time, it is likely that we will cease our operations. Our inability to obtain additional funding through the private placement would likely cause us to explore liquidation alternatives, including the initiation of bankruptcy
proceedings. If this were to occur, after repayment of our obligations including the bridge loan received from the private placement investors, any investment in us would likely decline to zero.



We expect to continue to incur substantial losses and we may never achieve
profitability, which in turn may harm our future operating performance and may cause the market price of our stock to decline.



We have had net losses every year since our inception in 1997 and, as of March 31, 2003, had an accumulated deficit of $224.3 million. We
had net losses of $107.2 million and $48.5 million in 2002 and 2001, respectively. Because we anticipate significant expenditures for our research and development programs and for the development, implementation and support of our gene function
database, we may report substantial net losses through at least the next several years. We may never achieve profitability. If we do not become profitable within the time frame expected by securities analysts or investors, the market price of our
stock will likely decline. If we do achieve profitability, we may not sustain or increase profitability in the future.



We will need to raise additional capital that may not be available, which if not available, will adversely affect our operations.



With our acquisitions in 2001 and 2002 and the corresponding
expansion of the scope of our activities, our expenditures and our underlying burn rate increased significantly in 2002. In that same time, our products and services have not produced revenues sufficient to fund our expanded activities for an
adequate period of time into the future to continue to execute our business plan. In addition, our products and services may not in the future produce revenues that, together with our existing cash and other resources, are adequate to meet our
anticipated cash needs. We plan to continue to fund our operations from our existing cash balances, cash flows and attempting to raise additional funds from the sale of stock, either through private financing and/or a public offering, or from debt
financing. Our cash requirements depend on numerous factors, including:



| |  |  | our ability to attract and retain customers for our gene function database and other products and services;
| | - |  | -----------------------------------------------------------------------------------------------------------



| |  |  | expenses in connection with the development and expansion of our gene function database, our secreted protein or other products and services;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | expenditures in connection with license agreements and acquisitions of and investments in complementary technologies and businesses; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the need to increase research and development spending to keep up with competing technologies and market developments.
| | - |  | ----------------------------------------------------------------------------------------------------------------------



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Substantial
capital has been used to fund our operating losses. Since inception, we have experienced negative cash flows from operations and expect to experience negative cash flows from operations for the near future.



We have required substantial amounts of capital, and though
operating costs have been significantly reduced over the past six months, we will continue to require additional capital in the future, to fund our business operations. The rate at which our capital is utilized is affected by the operational and
developmental costs incurred and the extent to which our products gain acceptance.



We continue to evaluate alternative means of financing to meet our needs on terms that are attractive to us. Although we have recently implemented a business realignment and staff reductions to reduce
our cash burn rate, if we are not able to obtain needed capital, we will have to take additional actions to conserve our cash balances, including further reductions in our operating expenses, downsizing of our staff and reduction in facilities, all
of which may have a material adverse effect on our business, financial condition and our ability to reduce losses or generate profits.



When we need additional funding, we may be unable to obtain it on favorable terms, or at all. For example, we may be forced to enter into
financing arrangements at significant discounts. If adequate funds are not available, we may have to curtail operations significantly or obtain funds by entering into arrangements requiring us to relinquish rights to certain technologies, products
or markets. In addition, if we raise funds by selling stock or convertible securities, our existing stockholders could suffer dilution.



If we complete the private placement and the related rights offering, our current stockholders will experience substantial dilution.



Consummation of the private placement will have a highly
dilutive effect on our current stockholders. The number of shares issued pursuant to the private placement will increase substantially the number of shares of our capital stock currently outstanding and thereby the percentage ownership of our
current stockholders will significantly decline as a result of the private placement. Further, the conversion of the preferred stock issued in the private placement would increase substantially the number of shares of our common stock currently
outstanding. The percentage represented by the shares issued in the private placement could be higher or lower depending on the per share purchase price to be determined just prior to the closing. By way of example, based on the currently committed
amount of $10 million plus certain shares to be issued to Charles Rivers Laboratories, a per share purchase price of $0.20 would mean a percentage ownership of 57%, whereas a per share purchase price of $0.40 would mean a percentage ownership of
40%. In addition, the committed amount could increase, which would increase the percentage ownership associated with the newly issued shares. If the per share purchase price was $0.20, a committed amount of $15 million would mean a percentage
ownership of 66%, and a committed amount of $25 million would mean a percentage ownership of 76%. For purposes of example only, based on a committed amount of $10 million and a per share purchase price of $0.20, a stockholder who owned approximately
10% of our outstanding stock prior to the private placement, would own approximately 4.3% of our outstanding stock immediately after consummation of the private placement.



Following consummation of the private placement, we will conduct a registered rights offering to our other
shareholders that would enable them to purchase a number of shares of preferred stock sufficient to maintain their percentage ownership in Deltagen at the same per share price as is paid by the investors in the private placement. The more shares
purchased in the rights offering, the lower the percentage ownership of the private placement investors, although we expect they will continue to have a significant ownership percentage going forward. This rights offering will represent further
dilution to those stockholders who do not choose to participate by buying shares of preferred stock in that offering.



We have recently implemented business restructurings and several staff reductions, and may need to do so again in order to further reduce burn rate and
operating expenses.





In October 2002, we instituted a cost savings and business restructuring plan to reduce our cash burn rate in response to market
conditions. As part of the restructuring, we reduced our staff by approximately 130 employees, a reduction of about 30%. The plan also included the closing of facilities, including our DRL site in San Diego, California, and the consolidation of
certain core activities into our Redwood City, California and Salt Lake City, Utah facilities. In January 2003, we decided to close additional operations and facilities including Salt Lake City, Utah and Deltagen Europe and reduce our staff to
approximately 200 employees. A further workforce reduction to 150 employees was announced in April 2003. The benefit of implementing this plan is expected to be realized over the first half of 2003. As a result of these actions, we recorded charges
in 2002 for the impairment of goodwill and intangible assets related to activities that will no longer be pursued or that will be scaled back, for the impairment of fixed assets including leasehold improvements and equipment and restructuring
charges for severance and other employee related costs, costs associated with lease obligations and other costs. We expect to record further charges for impairment of fixed assets, restructuring charges for severance and other employee related
costs, costs associated with lease obligations and other costs in the first and second quarters of 2003.



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Due to the
uncertainties in predicting our future revenues and our ability to obtain additional financing, we may need to consider and implement another business restructuring, which may also comprise staff reductions in order to further reduce our cash burn
rate and to maintain viability.



We have recently experienced
a significant reduction in our workforce, which may have a material impact on our operations and our ability to meet our existing contractual obligations



In October 2002, we announced that we were reducing our staff by approximately 130 employees, a reduction of about 30%. In January 2003,
we decided to close additional facilities and reduce our staff to approximately 200 employees. Further staff reductions were announced in April 2003 in order to reduce our work force to approximately 150 employees. Because of the magnitude of the
workforce reductions, it is uncertain whether these layoffs will have a material adverse impact on our ability to meet our existing contractual obligations and whether we will be able to expand our operations in the future to meet customers or
partners needs.



We have experienced problems managing
our growth, and if we fail to properly manage our growth in the future, our business could be adversely materially affected.



From 2000 through September 30, 2002, we had experienced significant growth in the number of our employees to approximately 450 employees
and the scope of our operations, including acquisitions of Arcaris (renamed Deltagen Proteomics) and BMSPRL (renamed Deltagen Research Laboratories), and an increase in the scale of our mouse knockout program, as well as our secreted protein and
biopharmaceutical drug discovery and development programs. As of December 31, 2002, we had approximately 290 full-time equivalent employees.



As of December 31, 2002, we also had multiple offices and facilities in North America and Europe, which presented significant challenges
and strain on our management and operations. In addition to our corporate headquarters in Redwood City, California, we had offices or facilities in Menlo Park, Alameda and San Carlos, California, as well as facilities in Strasbourg, France for
Deltagen Europe, S.A., in Salt Lake City, Utah for Deltagen Proteomics and in San Diego, California for Deltagen Research Laboratories.



In response to market conditions, our cash position, and the cost and challenges associated with multiple facilities and a rapidly growing
workforce and operational scope, we announced in October 2002, that we were implementing a cost savings and business realignment plan to reduce our cash burn rate. As part of the realignment, we reduced our staff by approximately 130 employees, a
reduction of about 30%. The plan also included the closing of facilities, including our DRL site in San Diego, California, and the consolidation of certain core activities into our Redwood City, California and Salt Lake City, Utah facilities. In
January 2003, we decided to close additional facilities, including our Deltagen Europe, S.A. site in Strasbourg, France and Deltagen Proteomics site in Salt Lake City, Utah. We reduced our staff to approximately 200 employees. Subsequently we
further consolidated our facilities to one site in Redwood City, California and one site in San Carlos, California. In April 2003 we announced further staff reductions that are expected to bring our head count to 150 employees.



We may need in the future to again increase our workforce,
acquire additional businesses or technologies, expand the size and number of our offices and facilities, and broaden the scope of our operations. It is uncertain whether we will be able to accomplish those objectives and, further, we may not be able
to manage our future growth successfully. If we are unable to manage our future growth successfully, our business could be adversely materially affected.



We are a relatively new public company with an unproven and evolving business strategy, and our limited history of operations makes evaluation of our
business and prospects difficult.



We have
had a limited operating history and are at an early stage of development. Our pricing models for offering our products and services are unproven. We currently have four full subscribers for our DeltaBase gene function database, only three of which
are paying subscription fees. We have generated only limited revenues amounting to approximately $17.7 million, $9.9 million and $2.1 million for the fiscal years 2002, 2001 and 2000, respectively. Our success will depend on, among other things, our
ability to enter into future licensing and other agreements on favorable terms, our ability to determine and generate information on those genes that have potential use as drug targets and the commercialization of products using our data. Our sales
force may not succeed in marketing our DeltaBase and DeltaOne products, and our employees may not succeed in implementing and operating our database products in a manner that is satisfactory to our subscribers. Furthermore, the plans for our
secreted protein and conditional knockout programs are unproven, and we cannot be sure that we will ever be able to develop these programs or that any program that we develop will be commercially successful. As a result of these factors, it is
difficult to evaluate our prospects, and our future success is more uncertain than if we had a longer or more proven history of operations.



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We currently have only four
DeltaBase subscribers, two customers for a subset of DeltaBase and four DeltaOne customers and will not succeed unless we can attract more customers.



DeltaBase has been our principal source of revenue. We also expect a significant portion of our revenues for at least the next six months
will be derived from fees under our DeltaBase agreements.



We currently have only four DeltaBase customers (including Lexicon, which does not involve the receipt of any subscription fees) and two customers for a subset of DeltaBase. Because of our reliance on revenue generated under our
DeltaBase agreements, we will likely not succeed unless we can attract more DeltaBase customers. In addition, we cannot be sure of the terms under which we may enter into future agreements, such as fees payable to us or the term of the agreements,
if any, or whether existing customers will continue as customers once their DelatBase agreements end. Also, if our database is not acceptable to our prospective customers, it may not generate revenues and our business and financial condition will be
materially harmed.



We may not be able to comply
with minimum performance levels or restrictive provisions or other obligations that may be contained in any agreements, such as minimum data delivery requirements. In addition, we may experience unforeseen technical complications in the processes we
use to generate functional data for our gene database and functional genomics resources. These complications could materially delay or limit the use of our gene function database, substantially increase the anticipated cost of generating data or
prevent us from implementing our processes at appropriate quality and scale levels, thereby causing our business to suffer.



We currently have only three customers for our DeltaSelect program and only four DeltaOne customers. Revenues from our DeltaSelect program
have historically not been significant, and we expect to enter into only a limited number, if any, of future DeltaSelect agreements. To succeed we must attract customers for our DeltaBase and other programs. DeltaOne is a new program and it is
uncertain whether we can attract customers or whether it will affect our ability to attract further DeltaBase customers. Our existing and future agreements may not be renewed and may be terminated without penalty in the event either party fails to
fulfill its obligations under one of these agreements. Failure to renew or the cancellation of these agreements by one of our customers could result in a significant loss of revenues.



Over the past several years, companies in the pharmaceutical industry have undergone significant
consolidation. As such companies merge, we will have fewer potential customers for our products. Also, if two or more of our present or future customers merge, we may not be able to receive the same fees under agreements with the combined entities
that we were able to receive under agreements with these customers prior to their merger. Moreover, if one of our customers merges with an entity that is not a customer, the new combined entity may prematurely terminate our agreement. Any of these
developments could materially harm our business or financial condition.



There have been very few drugs developed and commercialized using genomics-based research and, therefore, the future of our products and programs is uncertain.



Very few of the limited number of drugs developed to date using genomics-based research have reached the
commercial market. We cannot assure you that genomics-based drug development efforts will ultimately be commercially successful. We have not proven our ability either to identify drug targets with definite commercial potential or commercialize drug
targets that we do identify. We cannot assure you that a particular gene function in a mouse will have any correlation to a human patients response to a particular drug. It is difficult to successfully select those genes with the most
potential for commercial development. Furthermore, we do not know that any products based on genes that are the subject of our research can be successfully developed or commercialized. If commercial opportunities are not realized from genomics-based
research, our existing customers could stop using our products or we could have difficulty attracting or retaining customers and, in any event, we would not realize any product royalties.



There may be ethical and other concerns surrounding the use of genetic information that could limit our ability to develop
and sell our existing products and new products.



The genetic screening of humans has raised ethical issues regarding the confidentiality and appropriate uses of the resulting information. Government authorities may regulate or prohibit the use of genetic testing to determine
genetic predispositions to certain conditions. The FDA currently is considering different mechanisms for regulating certain types of genetic tests. To the extent any of our technology or products based on our technology involve human genetic
testing, such products could be subject to additional FDA regulation in the future. Additionally, the public may disfavor and reject the use of genetic testing. It is possible that the government authorities and the public may fail to distinguish
between the genetic screening of humans and genomic and proteomic research. If this occurs, our products and the processes for which our products are used may be subject to government regulations intended to affect genetic screening. Further, if the
public fails to distinguish between the two fields, it



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may pressure our customers to discontinue the research and development initiatives for which our products are used. If this occurs, the
potential market for our products could be reduced, which could seriously harm our financial condition and results of operations.



Our DeltaBase customers will control the development and commercialization of products, which may mean that our research efforts will never result in
any royalty payments or third party product sales.



Our DeltaBase agreements with our customers may provide us with rights to obtain milestone payments and/or royalties from the commercial development of therapeutic or diagnostic compounds derived from access to our mice, database,
technology or intellectual property. However, we may not be able to obtain these rights under future agreements. Our ability to obtain these rights depends in part on the advantages and novelty of our technologies, the validity of our intellectual
property, the usefulness of our data and our negotiating position relative to each potential customer.



We will have limited or no control over the resources that any customer may devote to product development based on its access to our
database. These customers may breach or terminate their agreements with us, and they are not obligated to conduct any product discovery, development or commercialization activities at all. Further, our customers may decide not to develop products
arising out of our agreements or may not devote sufficient resources to the development, approval, manufacture, marketing or sale of these products. If any of these events occurs, our customers may not develop or commercialize any products based on
our gene function research, technologies or intellectual property, we would not receive milestone payments or royalties on product sales and the results of our operations would suffer. Furthermore, our customers may resist sharing revenue derived
from the successful commercialization of a drug through royalty payments or others may have competing claims to all or a portion of such revenues.



Our ability to discover, develop or commercialize products could be adversely affected if our research and marketing collaborations are terminated.



Under certain of our agreements,
particularly our secreted protein collaboration agreements, we share with our collaborators certain co-development, co-promotional and co-marketing rights to pharmaceutical products based on our discoveries. Many of these collaborators have much
greater financial, scientific and human resources capabilities and more experience than us in developing, marketing, promoting and selling pharmaceutical products. As a result, our ability to discover, develop and commercialize products will depend
on the continuation of these collaborations. If any of these collaborations are terminated, we may not be able to enter into acceptable collaborations with other collaborators that have similar resources or experience. In addition, our existing
collaborations may not be successful. Disputes may arise between us and our collaborators as to a variety of matters, including financing obligations under our agreements and ownership of intellectual property rights. These disputes may be both
costly and time-consuming and may result in delays in the development and commercialization of products.



There are a finite number of gene families upon which pharmaceutical and biotechnology companies focus their research, which limits our potential revenue and growth.



Our current and potential subscribers and customers
traditionally focus their research and development efforts on a finite number of gene families that they view as reliable drug targets. Once we provide functional information on these gene families, our ability to attract and retain subscribers to
our database will depend, in part, on the willingness of our subscribers to expand their research and development activities to other gene families. If our customers do not do this, we may lose existing subscribers or fail to attract new subscribers
for our database services and, as a result, our business and financial condition may be significantly harmed. In addition, we have made and will continue to make significant investments in our database and knockout programs that we may not recoup if
we cannot find additional target opportunities.



We may fail
to meet market expectations, which could cause our stock price to decline.



The following are among the factors that could cause our operating results to vary significantly from market expectations:



| |  |  | changes in the demand for and pricing of our products and services;
| | - |  | -------------------------------------------------------------------



| |  |  | the nature, pricing and timing of other products and services provided by us or our competitors;
| | - |  | ------------------------------------------------------------------------------------------------



| |  |  | changes in the research and development budgets of our customers;
| | - |  | -----------------------------------------------------------------



| |  |  | acquisition, licensing and other costs related to our operations;
| | - |  | -----------------------------------------------------------------



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| |  |  | the timing of milestones, licensing and other payments under the terms of our customer agreements and agreements pursuant to which others license technology to us;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our capital needs and availability of additional capital;
| | - |  | ---------------------------------------------------------



| |  |  | expenses related to, and the results of, patent filings and other proceedings relating to intellectual property rights, including litigation and similar expenses;
and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our unpredictable revenue sources as described below.
| | - |  | -----------------------------------------------------



Our revenues will be unpredictable and this may harm our financial condition.



The amount and timing of revenues that we may have from our business will be unpredictable because:



| |  |  | the timing of our DeltaBase, DeltaSelect and other agreements are determined largely by our customers and subscribers;
| | - |  | ----------------------------------------------------------------------------------------------------------------------



| |  |  | our DeltaBase agreements with GlaxoSmithKline and Pfizer are coterminous, each terminating upon our delivery of DeltaBase in June 2003, and, although renewable
beyond such date, may not be renewed;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our agreement with Merck requires the delivery of approximately 150 designated targets subsequent to December 31, 2002 and, although renewable, may not be renewed;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | whether any products are commercialized and generate royalty payments depends on the efforts, timing and willingness of our customers;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------



| |  |  | we do not expect to receive any milestone or royalty payment under licenses and other arrangements for a substantial period of time, if ever;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | to date, we have entered into only four customer agreements for our DeltaBase gene function database and two agreements for our GeneClass DeltaBase, and may not
enter into any additional DeltaBase agreements; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our sales cycle is lengthy, as described below.
| | - |  | -----------------------------------------------



As a result, our results may be below market expectations. If this happens, the price of our common stock may decline.



We expect that our sales cycle will be lengthy, which will cause our
revenues to be unpredictable and our business to be difficult to manage.



Our ability to identify and obtain subscribers for our gene function database product and other services depends upon whether customers believe that our products and services can help accelerate drug
discovery efforts. Our sales cycle will be lengthy because of the need to educate potential customers and sell the benefits of our products and services to a variety of constituencies within potential subscriber companies. These companies are
typically large organizations with many different layers and types of decision-makers. In addition, each database subscription and development program or services agreement will involve the negotiation of unique terms and issues which will take a
significant amount of time. We may expend substantial funds and management effort with no assurance that a subscription program or services agreement will result. Actual or proposed mergers or acquisitions of our prospective customers may also
affect the timing and progress of our sales efforts. Any of these developments could harm our business or financial condition.



We may have conflicts or be in competition with our customers, which will hurt our business prospects.



Disagreements could arise with our customers or their
partners over rights to our intellectual property or our rights to share in any of the future revenues of compounds or therapeutic approaches developed by our customers. These kinds of disagreements could result in costly and time-consuming
litigation and could have a negative impact on our relationship with existing customers. Any conflict with our customers could reduce our ability to attract additional customers or enter into future customer agreements. Some of our customers could
also become competitors in the future. Our customers could develop competing products, preclude us from entering into agreements with their competitors or terminate their agreements with us prematurely.



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We experience intense
competition from other entities engaged in the study of genes, and this competition could adversely affect our business.



The human and mouse genomes contain a finite number of genes. The human genome has been mapped and identified. Our competitors have
identified and will continue to identify the sequence of numerous genes in order to obtain proprietary positions with respect to those genes. In addition, our competitors may seek to identify and determine the biological function of numerous genes
in order to obtain intellectual property rights with respect to specific uses of these genes, and they may accomplish this before we do. We believe that the first company to determine the functions of commercially relevant genes or the commercially
relevant portions of the genome will have a competitive advantage.



A number of companies, institutions and government-financed entities are engaged in gene sequencing, gene discovery, gene expression analysis, gene function determination and other gene-related service businesses. Many of
these companies, institutions and entities have greater financial and human resources than we do and have been conducting research longer than we have. In particular, a significant portion of this research is being conducted by private companies and
under the international Human Genome Project, a multi-billion dollar program funded, in part, by the U.S. government, which completed and released its initial rough draft of the human genome in June 2000; a final, high-quality sequence analysis is
expected as early as 2003. Furthermore, other entities have and will continue to discover and establish a patent position in genes or gene sequences that we wish to study. Significant competition also arises from entities using standard target
identification approaches, traditional knockout mouse technology and other functional genomics technologies. These competitors may have or may acquire intellectual property rights in functional or other data that are superior to or dominant over our
rights. These competitors may also develop products earlier than we do, obtain regulatory approvals faster than we can and invent products and techniques that are more effective than ours. Furthermore, other methods for conducting functional
genomics research may ultimately prove more advanced, in some or all respects, to the use of knockout mice. In addition, technologies more advanced than or superior to our gene function identification technology may be developed, thereby rendering
our gene trap and gene function identification technologies obsolete. As we expand our range of products and services, such as our secreted protein and biopharmaceutical development programs, we will compete with additional companies, some of which
may be our customers at that time or our potential customers.



Some of our competitors have developed commercially available databases containing gene sequence, gene expression, gene function, genetic variation or other functional genomic information and are marketing or plan to market their
data to pharmaceutical and biotechnology companies. Additional competitors may attempt to establish databases containing this information in the future. We expect that competition in our industry will continue to intensify. We also believe that some
pharmaceutical and biotechnology companies are discussing the possibility of working together to discover the functions of genes and share gene function-related data among themselves. The formation of this type of consortium could reduce the
prospective customer base for or interest in our gene function-related business. Moreover, the pharmaceutical industry has undergone significant mergers and this trend is expected to continue. This concentration of the industry could further limit
our potential customer base and therefore materially harm our business.



Our acquisition of XenoPharm might not produce the expected benefits.



It may turn out that there are no advantages or synergies to adding XenoPharms research capabilities to Deltagens product line and technology platform. XenoPharm continues to
incur legal expenses in connection with its patent applications and the patent applications of its licensors. It is expected that these expenses will increase as the level of patent prosecution increases. In the case of certain of these patent
applications, it is our understanding that several major pharmaceutical companies have also filed patent applications covering such technologies and these pharmaceutical companies have sufficient capital resources to withstand potentially costly and
lengthy patent interference and opposition proceedings, if they should choose to challenge these applications or any patents issuing there from. We cannot assure that we will prevail in any such proceedings. If we do not prevail, the value of these
technologies will likely be significantly reduced.



We may
engage in future acquisitions or licenses, which could adversely affect your investment in us as we may never realize any benefits from such acquisitions or licenses, which also could be expensive and time consuming.



We may acquire and license additional products and programs,
if we determine that these products or programs complement our existing technology or augment our existing information technology platforms. We currently have no firm commitments or agreements with respect to any material acquisitions. If we do
undertake any transactions of this sort, the process of integrating an acquired business, technology, service or product may result in operating difficulties and expenditures and may absorb significant management attention that would otherwise be
available for ongoing development of our business. Moreover, we may never realize the anticipated benefits of any acquisition or license. Future acquisitions could result in potentially dilutive issuances of equity securities, the incurrence of debt
and contingent liabilities and amortization expenses related to goodwill and other intangible assets, which could adversely affect our results of operations and financial condition.



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We depend on key employees,
and without the services of our key employees, we may not achieve profitability or remain viable.



Our future success also will depend in part on the continued service of our key scientific, software, legal, consultant and management
personnel and our ability to identify, hire and retain additional personnel, including customer service, marketing and sales staff. We experience intense competition for qualified personnel. We may be unable to attract and retain personnel necessary
for our business. Moreover, our business is located in the San Francisco Bay Area of California, where demand for personnel with the skills we seek is extremely high and is likely to remain high. Because of this competition, our compensation costs
may increase significantly.



We currently do not have any
issued U.S. patents relating to knockout mice or therapeutics, and if we are unable to protect our proprietary information, our business will be adversely affected.



Our business and competitive position depends upon our ability to protect and exploit our proprietary
techniques, methods, compositions, inventions, database information and software technology. However, our strategy of obtaining such proprietary rights around as many genes as possible is unproven. Protecting our intellectual property rights is
costly and we may not therefore be in a position to obtain protection around all of our inventions and other intellectual property rights. Unauthorized parties may attempt to obtain and use information that we regard as proprietary. Although we
intend for our gene function database subscription agreements to require our potential subscribers to control access to our database and information, policing unauthorized use of our database information and software may be difficult.



Although we currently have certain issued United States
patents, none of these relate to knockout mice or therapeutics. Patents have been issued to other entities based on claims relating to knockout mice or therapeutics. In addition, many applications have been filed seeking to protect partial human
gene sequences, many of which are based primarily on gene sequence information alone. Some of these applications have issued as patents. Some of these may claim sequences that we have used or may use in the future to generate knockout mice in our
gene knockout program or that we have used or may use in the future to discover and develop biopharmaceutical products. In addition, other applications have been filed which seek to protect methods of using genes and gene expression products, some
of which attempt to assign biological function to the DNA sequences based on laboratory experiments, computer predictions, mathematical algorithms and other methods.



The issuance of these applications as patents will depend, in part, upon whether practical utility can be
sufficiently established for the claimed sequences and whether sufficient correlation exists between the experimental results, predictions, algorithms and other methods and actual functional utility. The patent application process before the U.S.
Patent and Trademark Office and other similar agencies in other countries is confidential in nature. Although certain patent applications are published prior to issuance, as each application is evaluated independently and confidentially, we cannot
predict whether applications have been filed or which, if any, will ultimately issue as patents. However, it is probable that patents will be issued to our competitors claiming knockout mice, partial human gene sequences and methods of using genes
and gene expression products.



Numerous
applications have been filed by other entities claiming gene sequences. Many patents have already issued and we expect more will issue in the future. In addition, others may discover uses for genes or proteins other than uses covered in any patents
issued to us, and these other uses may be separately patentable. We may not be able to obtain additional issued patents on our patent applications because our patent applications may not meet the requirements of the patent office. The holder of a
patent covering a particular use of a gene or a protein, isolated gene sequence or deduced amino acid sequence could exclude us from using that gene, protein or sequence. In addition, a number of entities make gene information, techniques and
methods publicly available, which may affect our ability to obtain patents.



Some of our patent applications may claim compositions, methods or uses that may also be claimed in patent applications filed by others. In some or all of these applications, a determination of
priority of inventorship may need to be decided in an interference proceeding before the U.S. Patent and Trademark Office. Regardless of the outcome, this process is time-consuming and expensive.



Issued patents may not provide commercially meaningful
protection against competitors. Other companies or institutions may challenge our or our customers patents or independently develop similar products that could result in a legal action. In the event any researcher or institution infringes upon
our or our customers patent rights, enforcing these rights may be difficult and can be time-consuming. Others may be able to design around these patents or develop unique products or technologies providing effects or results similar to our
products or technologies.



Our ability to use our
patent rights to limit competition in the creation and use of knockout mice, as well as our ability to obtain patent rights, may be more limited in certain markets outside of the United States because the protections available in other jurisdictions
may not be as extensive as those available domestically.



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We pursue a
policy of having our employees, consultants and advisors execute nondisclosure and nonuse confidentiality agreements, as well as proprietary information and invention agreements when they begin working for us. However, these agreements may not be
enforceable or may not provide meaningful protection for our trade secrets or other proprietary information in the event of unauthorized use or disclosure. We also cannot prevent others from independently developing technology or software that might
be covered by copyrights issued to us, and trade secret laws do not prevent independent development.



We may be subject to litigation and infringement claims that may harm our business or reputation, be costly and divert managements attention.



The technology we use in our business may subject us to
claims that we infringe on the patents or proprietary rights of others. The risk of this occurring will tend to increase as the genomics, biotechnology and software industries expand, more patents are issued and other companies attempt to discover
gene function through mouse gene knockouts and engage in other genomics-related businesses. Furthermore, many of our competitors and other companies performing research on genes have already applied for patents covering some of the genes upon which
we perform research, and many patents have already been issued which cover these genes, as well as genes we may wish to use in the future.



We may be involved in future lawsuits alleging patent infringement or other intellectual property rights violations. In addition,
litigation may be necessary to:



| |  |  | assert claims of infringement;
| | - |  | ------------------------------



| |  |  | enforce our patents, if any;
| | - |  | ----------------------------



| |  |  | protect our trade secrets or know-how; and
| | - |  | ------------------------------------------



| |  |  | determine the enforceability, scope and validity of the proprietary rights of others.
| | - |  | -------------------------------------------------------------------------------------



We may be unsuccessful in defending or pursuing these lawsuits. Regardless of the outcome, litigation can be
very costly, can divert managements efforts and could materially affect our business, operating results, financial condition and cash flows. An adverse determination may subject us to significant liabilities or restrict or prohibit us from
selling our products.



Whether or not
meritorious, litigation brought against us could result in substantial costs, divert managements attention and resources, and harm our financial condition and results of operations.



Because our issued U.S. patents are not related to knockout mice or therapeutics, and because knockout mouse and
gene-related patents even if obtained may not be enforceable, our intellectual property may not have any material value, which would diminish our business prospects.



One of our strategies is to obtain proprietary rights around our commercially relevant gene knockouts.
Although we have filed patent applications covering the large majority of knockout mice we have produced, we do not currently have any issued patents related to knockout mice and may not have the financial means to maintain all or most of these
applications. We rely on a combination of copyright and trademark law, trade secrets, non-disclosure agreements and contractual provisions in our agreements with our customers to establish and maintain intellectual property rights. While the U.S.
Patent and Trademark Office in the past has issued patents to others covering function of genes, knockout mice, types of cells, gene sequences and methods of testing cells, we do not know whether or how courts may enforce those patents, if that
becomes necessary. If a court finds these types of inventions to be unpatentable, or interprets them narrowly, the benefits of our strategy may not materialize and our business and financial condition could be significantly harmed.



Our rights to the use of technologies licensed to us by third parties are
not within our control, and without these technologies, our products and programs may not be successful and our business prospects could be harmed.



We rely, in part, on licenses to use certain technologies that are material to our business, including a secreted protein gene trap that
we license exclusively from the University of Edinburgh. We do not own the patents that underlie these licenses. Our rights to use these technologies and employ the inventions claimed in the licensed patents are subject to our licensors abiding by
the terms of those licenses and not terminating them. In many cases, we do not control the prosecution or filing of the patents to which we hold licenses. Some of the licenses under which we have rights, such as the license from the University of
Edinburgh, provide us with exclusive rights in specified fields, but we cannot assure you that the scope of our rights under these and other licenses will not be subject to dispute by our licensors or third parties.



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Our activities involve
hazardous material and may subject us to environmental liability, which would seriously harm our financial condition.



Our research and development activities involve the controlled use of hazardous and radioactive materials and generate biological waste.
We are subject to federal, state and local laws and regulations governing the storage, handling and disposal of these materials and waste products. Although we believe that our safety procedures for handling and disposing of these materials and
wastes comply with legally prescribed standards, the risk of accidental contamination or injury from these materials cannot be completely eliminated. We may be sued for any injury or contamination that results from our use or the use by third
parties of these materials, and our liability may exceed our insurance coverage and our total assets. Future environmental regulations could require us to incur significant costs.



Compliance with governmental regulations regarding animal welfare and genetically modified organisms could increase our
operating costs or adversely affect our customers ability to obtain governmental approval of gene based products, which would adversely affect the commercialization of our technology.



The Animal Welfare Act, or AWA, is the federal law that
currently covers animals in laboratories. It applies to institutions or facilities using any regulated live animals for research, testing, teaching or experimentation, including diagnostic laboratories and private companies in the pharmaceutical and
biotechnology industries. Rats, birds and mice, including the mice in our knockout programs, are currently excluded from the definition of animal and, therefore, are not subject to regulation under the AWA. However, the United States
Department of Agriculture, which enforces the AWA, has been sued on this matter and agreed, as part of the settlement of this lawsuit on September 25, 2000, to begin the process of changing the regulations issued under the AWA to include rats, mice
and birds within its coverage. Congress subsequently prohibited, in the Agricultural Appropriations Act for fiscal year 2001 and again for fiscal year 2002, the expenditure of any money or commencing rulemaking for the purpose of changing the
regulations with respect to including rats, mice and birds prior to October 1, 2002. We cannot predict whether mice will at any time after such date be included under the AWA.



Currently, the AWA imposes a wide variety of specific regulations which govern the humane handling, care,
treatment and transportation of certain animals by producers and users of research animals, most notably personnel, facilities, sanitation, cage size, feeding, watering and shipping conditions. We cannot assure you that the USDA will not in the
future include rats, mice and birds in its regulations and that we will not become subject to registration, inspections and reporting requirements. Compliance with the AWA could be expensive, and current or future regulations could impair our
research and production efforts.



Since we
develop animals containing changes in their genetic make-up, we may become subject to a variety of laws, guidelines, regulations and treaties specifically directed at genetically modified organisms, or GMOs. The area of environmental releases of
GMOs is rapidly evolving and is currently subject to intense regulatory scrutiny, particularly internationally. If we become subject to these laws we could incur substantial compliance costs. For example, the Biosafety Protocol, or the BSP, a
recently adopted treaty, is expected to cover certain shipments from the U.S. to countries abroad that have signed and ratified the BSP. The BSP is also expected to cover the importation of living modified organisms, a category that could include
our animals. If our animals are not contained as described in the BSP, our animals could be subject to the potentially extensive import requirements of countries that are signatories to the BSP.



Ethical and social issues may limit or discourage the use of knockout mice
or other genetic processes, which could reduce our revenues and adversely affect our business.



Governmental authorities could, for social or other purposes, limit the use of genetic processes or prohibit the practice of our gene trap
and knockout mouse technologies. Public attitudes may be influenced by claims that genetically engineered products are unsafe for consumption or pose a danger to the environment. The subject of genetically modified organisms, like knockout mice, has
received negative publicity and aroused public debate. In addition, animal rights activists could protest or make threats against our facilities, which may result in property damage. Ethical and other concerns about our methods, particularly our use
of knockout mice, could adversely affect our market acceptance.



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Almost all of our knockout
mouse research and storage is conducted at our San Francisco Bay Area facilities in San Carlos and Redwood City, and a natural disaster at one or more of these facilities is possible and could result in a prolonged interruption of our business.



We conduct all of our scientific and
management activities at our San Carlos and Redwood City facilities in California. These locations are in or proximate to seismically active areas. We have taken precautions to safeguard our mouse colony including through insurance, the
freezing of sperm and the storage of embryonic stem cells, or ES cells, to allow for the regeneration of mice. However, a natural disaster, such as an earthquake, fire, flood or outbreak of infectious disease, could cause substantial delays. This
could interrupt mouse breeding, cause us to incur additional expenses and adversely affect our reputation with customers.



Security risks in electronic commerce or unfavorable internet regulations may deter future use of our products and services.



We do provide access to our gene function database on the
Internet. A fundamental requirement to conduct our business over the Internet is the secure transmission of confidential information over public networks. Advances in computer capabilities, new discoveries in the field of cryptography or other
developments may result in a compromise or breach of the security measures we use to protect the content in our gene function database. Anyone who is able to circumvent our security measures could misappropriate our proprietary information or
confidential customer information or cause interruptions in our operations. We may be required to incur significant costs to protect against security breaches or to alleviate problems caused by breaches, and these efforts may not be successful.
Further, a well-publicized compromise of security could deter people from using the Internet to conduct transactions that involve transmitting confidential information. For example, recent attacks by computer hackers on major e-commerce web sites
have heightened concerns regarding the security and reliability of the Internet.



Because of the growth in electronic commerce, the U.S. Congress has held hearings on whether to further regulate providers of services and transactions in the electronic commerce market, and federal
and state authorities could enact laws, rules and regulations affecting our business and operations. If enacted, these laws, rules and regulations could make our business and operations more costly and burdensome as well as less efficient.



We rely on third-party data sources, and without these
sources, our products and programs would be incomplete and less appealing to customers, seriously harming our business prospects.



We rely on scientific and other data supplied by third parties, and all of the gene sequence data for our internal programs comes from
public genomics data. This data could be defective, be improperly generated or contain errors or other defects, which could corrupt our gene function database and our other programs and services. In addition, we cannot guarantee that our sources
acquired this data in compliance with legal requirements. In the event of any such defect, corruption or finding of noncompliance, our business prospects could be adversely affected.



Our common stock may continue to experience extreme price and volume fluctuations, which could lead to costly litigation
for us and make an investment in us less appealing.



The market price of our common stock may continue to fluctuate substantially due to a variety of factors, including:



| |  |  | announcements of technological innovations or new products by us or our competitors;
| | - |  | ------------------------------------------------------------------------------------



| |  |  | developments or disputes concerning patents or proprietary rights, including announcements with respect to infringement claims or lawsuits, interference proceedings,
or other litigation against us or our licensors;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the timing and development of our products and services;
| | - |  | --------------------------------------------------------



| |  |  | media reports and publications about genetics and gene-based products;
| | - |  | ----------------------------------------------------------------------



| |  |  | changes in pharmaceutical and biotechnology companies research and development expenditures;
| | - |  | ---------------------------------------------------------------------------------------------



| |  |  | announcements concerning our competitors, or the biotechnology or pharmaceutical industry in general;
| | - |  | -----------------------------------------------------------------------------------------------------



| |  |  | changes in government regulation of genetic research or gene-based products, and the pharmaceutical or medical industry in general;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------



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| |  |  | general and industry-specific economic conditions;
| | - |  | --------------------------------------------------



| |  |  | actual or anticipated fluctuations in our operating results;
| | - |  | ------------------------------------------------------------



| |  |  | changes in financial estimates or recommendations by securities analysts;
| | - |  | -------------------------------------------------------------------------



| |  |  | changes in accounting principles;
| | - |  | ---------------------------------



| |  |  | the loss of any of our key scientific or management personnel; and
| | - |  | ------------------------------------------------------------------



| |  |  | difficulty in accessing sufficient capital to finance operations.
| | - |  | -----------------------------------------------------------------



Over the past two years our stock price has been, and in the future may be, highly volatile and could
continue to decline. Since the close of the quarter ended September 30, 2002, our stock has had minimum closing bid prices of less than $1.00 per share, which is the minimum bid price requirement for continued listing with the Nasdaq National
Market. Nasdaq may commence delisting proceedings and we may be delisted from the Nasdaq National Market. Our shares will continue to trade on the Nasdaq National Market unless and until the delisting proceedings have commenced and been completed
and the Nasdaq National Market has made a determination to delist us. In the event our shares are delisted from the Nasdaq National Market, we will attempt to have our common stock traded on the Nasdaq Small Cap Market. If our common stock is
delisted, it could seriously limit the liquidity of our common stock and would limit our potential to raise future capital through the sale of our common stock, which could seriously harm our business.



In addition, the stock market has experienced extreme price
and volume fluctuations. The market prices of the securities of biotechnology companies, particularly companies like ours without consistent product revenues and earnings, have been highly volatile and may continue to be highly volatile in the
future. This volatility has often been unrelated to the operating performance of particular companies. For example, the stock prices of many biotechnology companies, even those that would benefit from publicly available gene sequence information,
declined on news of the announcement by former President Clinton and British Prime Minister Blair that, as their respective governments had each advocated before, gene sequence information should be freely available in the public domain. In the
past, securities class action litigation has often been brought against companies that experience volatility in the market price of their securities. Whether or not meritorious, litigation brought against us could result in substantial costs, divert
managements attention and resources, and harm our financial condition and results of operations. Moreover, market prices for stocks of biotechnology-related and technology companies, particularly following an initial public offering,
frequently reach levels that bear no relationship to the operating performance of such companies. These market prices generally are not sustainable and are subject to wide variations.



The future sale of common stock could negatively affect our stock price.



We had 39,144,337 shares of common stock outstanding at March
31, 2003.



If our common stockholders sell
substantial amounts of common stock in the public market, or the market perceives that such sales may occur, the market price of our common stock could fall. The holders of approximately 13.0 million shares of our common stock have rights, subject
to some conditions, to require us to file registration statements covering their shares or to include their shares in registration statements that we may file for ourselves or other stockholders. Furthermore, if we were to include in a
company-initiated registration statement shares held by those holders pursuant to the exercise of their registration rights, those sales could impair our ability to raise needed capital by depressing the price at which we could sell our common
stock.



In April 2003, we secured a minimum
commitment for $10 million in equity capital from existing institutional investors to purchase preferred stock in a private placement. The private placement is subject to shareholder approval and the satisfaction of closing conditions. In addition
to the terms of the private placement, our stockholders will be asked to approve a number of other matters including a reverse stock split.



In connection with the private placement, we have agreed to use reasonable best efforts, as soon as reasonably practicable after the
closing of the private placement, to offer stockholders of record as of the last business day prior to the closing of the private placement (other than the investors in such financing) non-transferable rights to purchase newly issued preferred stock
at the same purchase price paid by the investors. The amount of preferred shares so offered to each stockholder would be sufficient to allow each such stockholder to maintain the percentage ownership interest in Deltagen, held by each such
stockholder as of the last business day prior to the closing of the private placement.



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Our principal stockholders,
executive officers and directors own a significant percentage of our stock, and as a result, the trading price for our shares may be depressed and these stockholders can take actions that may be adverse to your interests.



As of March 31, 2003, our executive officers and directors,
and entities affiliated with them, beneficially own, in the aggregate, approximately 43.5 % of our common stock. This significant concentration of share ownership may adversely affect the trading price for our common stock because investors often
perceive disadvantages in owning stock in companies with controlling shareholders. These stockholders, acting together, will have the ability to exert substantial influence over all matters requiring approval by our stockholders, including the
election and removal of directors and any proposed merger, consolidation or sale of all or substantially all of our assets. In addition, they could dictate the management of our business and affairs. This concentration of ownership could have the
effect of delaying, deferring or preventing a change in control, or impeding a merger or consolidation, takeover or other business combination that could be favorable to you.



Our incorporation documents and Delaware law may inhibit a takeover that stockholders consider favorable and could also
limit the market price of your stock.



Our
restated certificate of incorporation and bylaws contain provisions that could delay or prevent a change in control of our company. Some of these provisions:



| |  |  | authorize the issuance of preferred stock which can be created and issued by the board of directors without prior stockholder approval, commonly referred to as
blank check preferred stock, with rights senior to those of common stock;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | provide for a classified board of directors; and
| | - |  | ------------------------------------------------



| |  |  | prohibit stockholder action by written consent.
| | - |  | -----------------------------------------------



In addition, we are governed by the provisions of Section 203 of Delaware General Corporate Law. These provisions may prohibit large
stockholders, in particular those owning 15% or more of our outstanding voting stock, from merging or combining with us. These and other provisions in our amended and restated certificate of incorporation and bylaws and under Delaware law could
reduce the price that investors might be willing to pay for shares of our common stock in the future and result in the market price being lower than it would be without these provisions.



Item 3. Quantitative and Qualitative Disclosures About Market Risk



We invest our excess cash primarily in obligations of governmental agencies and marketable debt securities of financial institutions and corporations with strong credit ratings. These instruments have
maturities of twenty- four months or less when acquired. We do not utilize derivative financial instruments, derivative commodity instruments or other market risk sensitive instruments, positions or transactions in any material fashion. Accordingly,
we believe that, while the instruments we hold are subject to changes in the financial standing of the issuer of such securities, we are not subject to any material risks arising from changes in interest rates, foreign currency exchange rates,
commodity prices, equity prices or other market changes that affect market risk sensitive instruments.



Our loans payable of $5.0 million at March 31, 2003 carry interest rates ranging from 8.87% to 12.75% with maturities to July 2005. Our
capital lease obligations of $24,000 at March 31, 2003 carry fixed interest rates ranging from 0% to 10.39% per annum with payments due in 36 monthly installments.



The following table presents, as of March 31, 2003, the future principal amounts and related weighted average
interest rate by year for our cash and cash equivalents, marketable securities and debt obligations (in thousands).



|                               |  | Expected Maturity Date (as of March 31, 2003)
|------------------------------ |  | ---------------------------------------------
|                               |  | 2003                                         
|Assets:                        |  |                                              
|Cash and cash equivalents      |  | $                                            
|Marketable securities          |  |                                              
|Weighted average interest rate |  |                                              
|Liabilities:                   |  |                                              
|Capital lease obligations      |  | $                                            
|Weighted average interest rate |  |                                              
|Loans payable                  |  | $                                            
|Weighted average interest rate |  |                                              



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Prior to
February, 2001 we operated solely in the United States. Beginning February 15, 2001, our European subsidiary, Deltagen Europe S.A. began operations. The expenses of these European operations have not been material and all sales of our products to
date have been made in U.S. dollars. Accordingly, we have not had any material exposure to foreign currency rate fluctuations.



Item 4. Controls and Procedures



Our Chief Executive Officer and the Chief Financial Officer have reviewed, within 90 days of this filing, the disclosure controls and procedures (as defined in the Securities Exchange Act of 1934 Rules 13a-14(c) and 15d-14(c)) that
ensure that information relating to the company required to be disclosed by us in the reports that we file or submit under the Exchange Act, is recorded, processed, summarized and reported in a timely and proper manner. Based upon this review, we
believe that there are adequate controls and procedures in place to ensure that information relating to the company that is required to be disclosed by us in the reports that we file or submit under the Exchange Act is properly disclosed as required
by the Exchange Act and related regulations. There have been no significant changes in the controls or other factors that could significantly affect the controls since the evaluation was performed.



PART II. OTHER INFORMATION



Item 1.Legal Proceedings



On May 24, 2000, Lexicon Genetics Incorporated filed a lawsuit against us in the United States District Court for the District of Delaware. The complaint in the lawsuit alleged that our methods of making knockout mice infringed
United States Patent No. 5,789,215, or the 215 patent, under which Lexicon claimed to be an exclusive licensee. In addition, on October 13, 2000, Lexicon and the University of Utah Research Foundation filed a lawsuit against us in the United
States District Court for the Northern District of California. The complaint in this lawsuit alleged that we infringed United States Patents Nos. 5,631,153, 5,464,764, 5,627,059 and 5,487,992, or the Capecchi patents, under which Lexicon claimed to
be an exclusive licensee. On September 20, 2001, we and Lexicon announced the settlement of the litigation. Under the terms of the settlement, we obtained a commercial license under the 215 patent and the Capecchi patents, Lexicon obtained a
subscription to our DeltaBase product, and all of the claims and counterclaims in the litigation were dismissed with prejudice. Lexicons subscription to DeltaBase includes non-exclusive, perpetual licenses to the 250 drug targets represented
in DeltaBase as of September 2001 and the approximately 1,000 drug targets that were and are expected to be added to DeltaBase over the subsequent four years. Lexicon will make certain milestone and royalty payments to us for therapeutic and
diagnostic products developed from Lexicons use of DeltaBase. We will make payments to Lexicon for knockout mice generated by us on a fee-for-service basis. Neither we nor Lexicon will pay the other party any subscription or license fees.



On April 28, 2003, we received from Lexicon a
letter which Lexicon claims serves as notice of termination of the sublicense agreement under which we obtained a commercial license to the 215 patent and the Capecchi patents. In this letter, Lexicon specified two grounds that allegedly
entitles Lexicon to terminate the sublicense agreement: (1) our purported material breach of the DeltaBase agreement, under which Lexicon obtained a commercial license to our DeltaBase product; and (2) our purported insolvency. On April 29, 2003, we
received from Lexicon a letter which Lexicon claims serves as notice under the DeltaBase agreement of: (1) Lexicons alleged entitlement to damages in the amount of $25 million, plus attorneys fees and costs, for our purported material
breach of the DeltaBase agreement; and (2) alleged noncompliance with the content criteria in the DeltaBase agreement. We note that these letters from Lexicon follow shortly after our press release on April 4, 2003, in which we announced our receipt
of a bridge loan and our efforts to obtain an equity financing. We believe that Lexicons claims and allegations are without merit, and intend to promptly address these claims according to the dispute resolution procedures provided by the
settlement and other agreements between Lexicon and Deltagen.



Deltagen is a party to two civil actions filed March 12, 2003 in the Superior Court of California, County of San Mateo, entitled Willow Park Holding Company II v. Deltagen, Inc., Case No. 429871 (the Willow Park
Action) and AMB Property, L.P. v. Deltagen, Inc., Case No. 429872 (the AMB Action). The plaintiff in the AMB Action is the owner of real property located at 1210 and 1255 Hamilton Court, in Menlo Park, California. The
plaintiff in the Willow Park Action is the owner of real property located at 1003 Hamilton Court, also in Menlo Park, California. We did not timely pay our rent on the 1003 and 1210 Hamilton Court premises for March 2003, or our rent on the 1255
Hamilton Court premises for February and March 2003.



The complaints allege that we breached our leases for the three properties. In the AMB Action, the plaintiff seeks past due rent and additional rent in the amount of $88,211, late charges in the amount of $8,821, and future rent and
additional rent in the amount of $1,773,266. In the Willow Park Action, the plaintiff seeks past due rent and additional rent in the amount of $75,946, late charges in the amount of $7,594, and future rent and additional rent in the amount of
$921,898.





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On March 14,
2003, the plaintiffs in both actions applied for an ex parte right to attach order, writ of attachment, and temporary protective order. The plaintiff sought to attach $1,873,794 in the AMB Action, and $1,168,845 in the Willow Park Action. On
March 14, 2003, the court granted the plaintiffs applications in part, and denied them in part. In the AMB Action, the court ordered that the plaintiff has a right to attach our property in the amount of $97,032. In the Willow Park Action, the
court ordered that the plaintiff has a right to attach our property in the amount of $83,541. The court also issued a temporary protective order in each case, restricting us from transferring interests in specified property, and from disposing of
the proceeds of any transfer of inventory. The temporary protective orders will expire no later than April 23, 2003. We executed a Lease Termination Agreement with the plaintiffs effective March 31, 2003. Under this agreement the plaintiffs agreed
to dismiss these actions promptly after June 30, 2003 except under certain circumstances as defined in the agreement.



We may be involved in additional litigation, investigations or proceedings in the future. Any litigation, investigation or proceeding,
with or without merit, could be costly and time-consuming and could divert our managements attention and resources, which in turn could harm our business, financial position, and financial results and cash flows.



Item 2.Changes in Securities and Use of Proceeds



(a) Not applicable.



(b) Not applicable.



(c)
Not applicable.



(d) Not applicable



Item 3.Defaults Upon Senior Securities



Not applicable.



Item 4.Submission of Matters to a Vote of Security Holders



None.



Item 5.Other Information



Not applicable.



41



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##### Table of Contents



Item 6.Exhibits and Reports on Form 8-K



(a) Exhibits



|        
|--------
|4.5.1   
|        
|10.64   
|        
|10.64.1+
|        
|10.64.2+
|        
|10.64.3+
|        
|99.1    
|        
|99.2    
|        

| | + |  | Confidential treatment has been requested with respect to portions of these agreements.
| | - |  | ---------------------------------------------------------------------------------------



(b) The Company filed the following reports on Form 8-K during the first quarter of fiscal 2003.



A report on Form 8-K related to a realignment of
business strategy and a cost reduction plan was filed on January 6, 2003.



A report on Form 8-K related to changes in management and the Board of Directors was filed on January 21, 2003.



A report on Form 8-K related to the resignation of William Matthews, Ph.D., chief executive officer and member of the Board of Directors,
was filed on February 13, 2003.



42



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##### Table of Contents



DELTAGEN,
INC.



SIGNATURES



Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



|                    |  |  |  | DELTAGEN, INC.                                                                
|------------------- |  |  |  | ------------------------------------------------------------------------------
|                   
|Date:  May 20, 2003 |  |  |  | /s/    JOSEPH M.
LIMBER                                                       
|                    |  |  |  | Joseph M. Limber Interim Chief Executive Officer (Principal Executive Officer)
|                   
|Date:  May 20, 2003 |  |  |  | /s/    JOHN W.
VARIAN                                                         
|                    |  |  |  | John W. Varian Interim Chief Financial Officer (Principal Financial Officer)  



43



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##### Table of Contents



CERTIFICATIONS



I, Joseph M. Limber,
certify that:



|1. |  | I have reviewed this quarterly report on Form 10-Q of Deltagen, Inc.;
|-- |  | ---------------------------------------------------------------------



|2. |  | Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|3. |  | Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|4. |  | The registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and we have:
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a) |  | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | b) |  | evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report
(the Evaluation Date); and
| | -- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | c) |  | presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation
Date;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------



|5 |  | The registrants other certifying officers and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit committee
of registrants board of directors (or persons performing the equivalent function):
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a) |  | all significant deficiencies in the design or operation of internal controls which could adversely affect the registrants ability to record, process, summarize
and report financial data and have identified for the registrants auditors any material weaknesses in internal controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | b) |  | any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal controls; and
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



|6. |  | The registrants other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                   
|-------------------
|Date:  May 20, 2003
|                   



44



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##### Table of Contents



I, John Varian, certify that:



|1. |  | I have reviewed this quarterly report on Form 10-Q of Deltagen, Inc.;
|-- |  | ---------------------------------------------------------------------



|2. |  | Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|3. |  | Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|4. |  | The registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and we have:
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a) |  | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | b) |  | evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report
(the Evaluation Date); and
| | -- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | c) |  | presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation
Date;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------



|5. |  | The registrants other certifying officers and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit committee
of registrants board of directors (or persons performing the equivalent function):
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a) |  | all significant deficiencies in the design or operation of internal controls which could adversely affect the registrants ability to record, process, summarize
and report financial data and have identified for the registrants auditors any material weaknesses in internal controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | b) |  | any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal controls; and
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



|6. |  | The registrants other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                   
|-------------------
|Date:  May 20, 2003
|                   



45



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##### Table of Contents



EXHIBIT
INDEX



|ExhibitNumber |  | Description                                                                                   
|------------- |  | ----------------------------------------------------------------------------------------------
|             
|4.5.1         |  | Stockholder Agreement with Bristol-Myers Squibb Company dated February 28,
2003.              
|             
|10.64.1+      |  | Settlement Agreement with Lexicon Genetics Incorporated Dated September 19,
2001.             
|             
|10.64.2+      |  | Sublicense Agreement with Lexicon Genetics Incorporated dated September 19,
2001.             
|             
|10.64.3+      |  | DeltaBase Collaboration Agreement with Lexicon Genetics Incorporated Dated September 19,
2001.
|             
|99.1          |  | Certification of Principal Executive Officer Pursuant to 18 U.S.C. Section
1350.              
|             
|99.2          |  | Certification of Principal Financial Officer Pursuant to 18 U.S.C. Section
1350.              

---

|+ |  | Confidential treatment has been requested with respect to portions of these agreements.
|- |  | ---------------------------------------------------------------------------------------