##### Table of Contents

---

UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


WASHINGTON, D.C. 20549





---




FORM 10-Q





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




For the quarterly period ended September 30, 2002





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





DELTAGEN, INC.


(Exact name of Registrant as specified in its charter)





Delaware

94-3260659(State or other jurisdiction of Incorporation or organization)

(I.R.S. Employer Identification
No.)





740 Bay Road, Redwood City, CA

94063(Address of principal executive offices)

(Zip code)





(650) 569-5100


(Registrants telephone number, including area code)





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 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

40,936,370Class

Outstanding at November 8, 2002





---



---

##### Table of Contents




DELTAGEN, INC.





FORM 10-Q





QUARTERLY REPORT





TABLE OF CONTENTS





PART IFINANCIAL INFORMATION





Item 1.

Financial Statements

3Consolidated Balance Sheets (unaudited)

3Consolidated Statements of Operations (unaudited)

4Consolidated Statements of Cash Flows (unaudited)

5Notes to Consolidated Financial Statements (unaudited)

6Item 2.

Managements Discussion and Analysis of Financial Condition and Results of Operations

12Item 3.

Quantitative and Qualitative Disclosures about Market Risk

33Item 4.

Controls and Procedures

34





PART IIOTHER INFORMATION





Item 1.

Legal Proceedings

34Item 2.

Changes in Securities and Use of Proceeds

34Item 3.

Defaults Upon Senior Securities

34Item 4.

Submission of Matters to a Vote of Security Holders

34Item 5.

Other Information

34Item 6.

Exhibits and Reports on Form 8-K

34Signatures

36Certifications

37







2




---

##### Table of Contents




PART I.    FINANCIAL INFORMATION





Item 1.    Financial Statements





DELTAGEN, INC.





CONSOLIDATED BALANCE SHEETS


(unaudited)


(in thousands, except share data)





September 30, 2002


December 31, 2001AssetsCurrent assets:Cash and cash equivalents

$
28,415


$
61,363Marketable securities


21,253



15,118Accounts receivable, net


769



2,511Prepaid expenses and other current assets


3,889



2,207Total current assets


54,326



81,199Property, plant and equipment, net


36,606



16,672Goodwill






1,788Intangible assets, net


6,249



3,479Notes receivable from related parties


995



495Restricted cash


3,838



2,869Other assets


2,730



2,548Total assets

$
104,744


$
109,050Liabilities and Stockholders EquityCurrent liabilities:Accounts payable

$
8,877


$
4,131Accrued liabilities


7,193



5,864Current portion of capital lease obligations


21



11Current portion of loans payable


14,008



2,382Current portion of deferred revenue


13,838



7,257Total current liabilities


43,937



19,645Capital lease obligations, less current portion


9



28Loans payable, less current portion


2,374



3,059Other long-term liabilities


990



990Deferred credit


2,953



Deferred revenue, less current portion


2,910



1,657Total liabilities


53,173



25,379Stockholders equity:Common stock, $0.001 par value:Authorized: 75,000,000 shares, issued and outstanding: 40,908,740 and 32,077,012 shares at September 30, 2002 and
December 31, 2001, respectively


41



32Additional paid-in capital


238,615



186,595Unearned stock-based compensation


(1,018
)


(3,019
)Notes receivable from stockholders


(805
)


(805
)Accumulated deficit


(185,262
)


(99,132
)Total stockholders equity


51,571



83,671Total liabilities and stockholders equity

$
104,744


$
109,050





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




3




---

##### Table of Contents




DELTAGEN, INC.





CONSOLIDATED STATEMENTS OF OPERATIONS


(unaudited)


(in thousands, except per share data)





Three months ended September 30,


Nine months ended September 30,2002


2001


2002


2001Contract revenue

$
4,409


$
2,265


$
12,943


$
7,451Costs and expenses:Research and development


20,821



13,080



58,736



31,688Selling, general and administrative


5,316



4,472



14,388



12,654Impairment of goodwill and other long-lived assets


26,793







26,793



Total costs and expenses


52,930



17,552



99,917



44,342Loss from operations


(48,521
)


(15,287
)


(86,974
)


(36,891
)Interest income


686



915



1,566



3,887Interest expense


(325
)


(262
)


(722
)


(561
)Net loss

$
(48,160
)

$
(14,634
)

$
(86,130
)

$
(33,565
)Net loss per common share, basic and diluted

$
(1.19
)

$
(0.50
)

$
(2.34
)

$
(1.16
)Weighted average shares used in computing net loss per common share, basic and diluted


40,517



29,504



36,865



28,959





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




4




---

##### Table of Contents




DELTAGEN, INC.





CONSOLIDATED STATEMENTS OF CASH FLOWS


(unaudited)


(in thousands)





Nine months endedSeptember 30,2002


2001Cash flows from operating activities:Net loss

$
(86,130
)

$
(33,565
)Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization


5,256



1,872Amortization of equipment under capital lease


21



Amortization of warrants issued in connection with loans


55



35Amortization of intangible assets


3,203



224Amortization of unearned stock-based compensation expense


1,344



3,006Amortization of premium (discount) on marketable securities


134



(637
)Lease loss






1,312Write-off of in-process research and development costs


110



907Impairment of goodwill and other long-lived assets


26,793



Changes in operating assets and liabilities, net of effects of acquisitions:Accounts receivable


1,742



(1,206
)Prepaid expenses and other current assets


(1,274
)


(1,110
)Other assets


19



(2,899
)Accounts payable


(880
)


1,028Accrued expenses


481



628Deferred revenue


7,834



(400
)Net cash used in operating activities


(41,292
)


(30,805
)Cash flows from investing activities:Purchase of marketable securities


(11,269
)


(39,364
)Maturities of marketable securities


5,000



55,000Acquisition of property, plant and equipment


(1,729
)


(4,434
)Acquisition of leasehold improvements


(17,001
)


(318
)Increase in restricted cash


(969
)


(2,707
)Issuance of notes receivable


(500
)


(260
)Acquisition of Arcaris, Inc., net of cash acquired






(450
)Acquisition of BMSPRL, L.L.C., net of cash acquired


(445
)


Acquisition of XenoPharm, Inc., net of cash acquired


(536
)


Net cash provided by (used in) investing activities


(27,449
)


7,467Cash flows from financing activities:Principal payments under capital lease obligations


(9
)


(22
)Repayment of loans payable


(3,752
)


(1,464
)Proceeds from the issuance of loans payable


14,000



2,453Proceeds from the issuance of common stock, net of issuance costs and stock repurchased


25,554



39Net cash provided by financing activities


35,793



1,006Net decrease in cash and cash equivalents


(32,948
)


(22,332
)Cash and cash equivalents, beginning of period


61,363



93,352Cash and cash equivalents, end of period

$
28,415


$
71,020Supplemental disclosures of cash flow information:Cash paid during the period for interest

$
722


$
561Supplemental disclosures of non-cash investing and financing activities:Property and equipment acquired with accounts payable

$
5,294


$
724Reversal of unearned stock-based compensation

$
657


$
1,813Issuance of common stock in connection with Arcaris, Inc., acquisition

$



$
7,169Issuance of common stock in connection with BMSPRL, L.L.C., acquisition

$
23,510


$
Issuance of common stock in connection with XenoPharm, Inc. acquisition

$
3,622


$






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




5




---

##### Table of Contents




DELTAGEN, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(unaudited)


September 30, 2002





1.    Business of the Company





Deltagen, founded in 1997 and headquartered in Redwood City, California, 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. Deltagen also plans
to pursue internal drug discovery and development in secreted proteins through collaborations.





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 $185.3 million and may incur losses for at least the next several years as research and
development activities exceed revenues. To date, the Company has financed its operations primarily through sales of equity securities, contract payments under DeltaSelect and DeltaBase agreements, equipment financing arrangements and a term loan
facility. The Company expects to finance its operations primarily through its existing cash and cash equivalents, marketable securities and future revenues. The Company also expects to require additional funding and expects to sell additional shares
of its common or preferred stock through private placements or further public offerings, or it may seek additional credit facilities.





2.    Basis of Presentation





The accompanying interim consolidated
financial statements as of September 30, 2002 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 nine months ended September 30, 2002 have been reclassified to conform to the presentation in the three months ended September
30, 2002.





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 (File No. 000-31147) filed with the Securities and Exchange Commission (the SEC) on March 29, 2002.





The Company has sustained significant losses for the last several years. The Company will require additional funding and may sell additional shares of its common stock or
preferred stock through a private placement or further public offerings. There can be no assurance that the Company will be able to obtain additional debt or equity financing, if and when needed, on terms acceptable to the Company. Any additional
equity or debt financing may involve substantial dilution to the Companys stockholders, restrictive covenants or high interest costs. The failure to raise needed funds on sufficiently favorable terms could have a material adverse effect on the
Companys business, operating results and financial condition. The Companys long-term liquidity also depends upon its ability to increase revenues from the sale of its products and achieve profitability. The failure to achieve these goals
could have a material adverse effect on the operating results and financial condition of the Company.





3.    Recent Accounting Pronouncements





In August 2001, the Financial
Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 143 (SFAS 143), Accounting for Asset Retirement Obligations, which is effective for fiscal years beginning after June 15,
2002. SFAS 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS No. 143 requires, among other things, that the retirement
obligations be recognized when they are incurred and displayed as liabilities on the balance sheet. In addition, the assets retirement costs are to be capitalized as part of the assets carrying amount and subsequently allocated to
expense over the assets useful life. The Company believes that the adoption of SFAS 143 will not have a material effect on the financial position or results of operations of the Company.





In August 2001, the FASB issued Statement of Financial Accounting Standards No. 144 (SFAS 144), Accounting for the
Impairment or Disposal of Long-Lived Assets, which is effective for fiscal years beginning after December 15, 2001 and interim periods within those fiscal periods. SFAS 144 supersedes FASB Statement No. 121 and APB Opinion No. 30, however, it
retains the requirement of Opinion No. 30 to report discontinued operations separately from continuing operations and extends that reporting to a component of an entity that either has been disposed of (by sale, by abandonment, or in a distribution
to owners) or is classified as held for sale. SFAS 144 addresses financial accounting and reporting for the impairment of certain long-lived assets and for long-lived assets to be disposed of. The Company recorded an impairment loss of $17,533,000
in the quarter ended September 30, 2002 related to the impairment of fixed assets, including leasehold improvements and equipment, and intangible assets as a result of its cost savings and business realignment plan (see Note 9.).





In April 2002, the FASB issued Statement of Financial Accounting Standards No. 145 (SFAS 145), Rescission of
FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections, which is effective for fiscal years beginning after May 15, 2002. Under SFAS 145, gains and losses from the extinguishment of debt should be
classified as extraordinary items only if they meet the criteria of Accounting Principles Board Opinion No. 30. SFAS also addresses financial accounting and reporting for capital leases that are modified in such a way as to give rise to a new
agreement classified as an operating lease. The Company believes that the adoption of SFAS 145 will not have a material effect on the financial position or results of operations of the Company.




6




---

##### Table of Contents




In June 2002, the FASB issued Statement of Financial Accounting Standards No. 146
(SFAS 146), Accounting for Costs Associated with Exit or Disposal Activities, which is effective for exit or disposal activities initiated after December 31, 2002. SFAS 146 nullifies Emerging Issues Task Force Issue No.
94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). Under SFAS 146, a liability is required to be recognized for a cost
associated with an exit or disposal activity when the liability is incurred. SFAS 146 applies to costs associated with an exit activity that does not involve an entity newly acquired in a business combination or with a retirement or disposal
activity covered by FASB Statements No. 143 and 144. The Company expects to elect early adoption of SFAS 146 in the fourth quarter of 2002 in conjunction with the business realignment discussed in Note 12.





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 common
stock equivalents consisting of restricted stock, stock options and warrants. Dilutive securities of 10.1 million and 7.9 million shares have been excluded from the diluted earnings per share calculations for the periods ended September 30, 2002 and
2001, respectively, as they have an anti-dilutive effect due to the Companys net losses.





A reconciliation
of shares used in the calculations is as follows:





Three Months endedSeptember 30,


Nine months endedSeptember 30,2002


2001


2002


2001(in thousands, except per share data)Basic and diluted:Net loss

$
(48,160
)

$
(14,634
)

$
(86,130
)

$
(33,565
)Weighted average shares of common stock outstanding


40,908



30,303



37,356



29,971Less: Weighted average shares subject to repurchase


(391
)


(799
)


(491
)


(1,012
)Weighted average shares used in basic and diluted net loss per share


40,517



29,504



36,865



28,959Net loss per common share

$
(1.19
)

$
(0.50
)

$
(2.34
)

$
(1.16
)





5.    Loans Payable





On February 28, 2002, the Company entered into a loan agreement with a financial institution to obtain one or more loans totaling up to
$4,000,000. A corresponding amount of machinery, equipment, and other property is pledged as collateral for each loan. On March 1, 2002, the Company received loan proceeds of $2,406,000 and $1,000,000, respectively, under this agreement for a total
financing of $3,406,000. The loans bear interest rates of 8.87% and 8.98%, respectively, and are to be repaid in 36 monthly installments beginning in March 2002. On June 21, 2002, the Company received loan proceeds of $593,000 under this agreement.
The loan bears interest at 9.04% and is to be repaid in 36 monthly installments beginning in June 2002. At September 30, 2002, there is no amount available for future borrowings and $3,290,000 was outstanding under this agreement. In October 2002,
the Company provided letters of credit for $2,316,000 to the lender as additional collateral for these and other equipment loans. The letters of credit required $2,316,000 of the unrestricted cash balances at September 30, 2002 to be restricted in
October 2002.





On June 27, 2002, the Company entered into two new bank agreements. These include a $20,000,000
term loan facility and a one year $5,000,000 accounts receivable facility. The term loan can be drawn down through March 31, 2003 and matures through March 31, 2007. The loan is collateralized by a first position security interest in substantially
all of the Companys assets excluding intellectual property. The Company has certain restrictions on the assignment or transfer of intellectual property during the term of the loan. The Company borrowed $10,000,000 under this facility on June
28, 2002 at a variable interest rate of 6.125%. Interest-only payments will be made through the end of the draw-down period at which time outstanding principal and interest will be due in 48 equal monthly installments. The loan has financial
covenants related to earnings and liquidity, including a requirement that the Company maintain unrestricted cash balances, as defined, equal to the greater of two times the principal balance outstanding on the loan or six months of net cash used in
operating activities. On October 31, 2002, the Companys unrestricted cash balances were below the minimum level and the Company provided restricted cash of $10,500,000 as collateral for the term loan facility and the interest rate on the
$10,000,000 borrowing was reduced to the prime rate (currently 4.25%). At September 30, 2002, $3,057,000 of accounts receivable were sold under the accounts receivable facility.





6.    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 and validated gene targets based




7




---

##### Table of Contents

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.





7.    Acquisitions





Acquisition of Arcaris, Inc.





On July 30, 2001,
the Company acquired Arcaris, Inc. ("Arcaris"). Located in Salt Lake City, Utah, Arcaris has developed technologies consisting of genetic, proteomic and cell-biological systems for identification and validation of drug targets and the creation of
small molecule screens. The total purchase price of approximately $7,931,000 consisted of cash of approximately $450,000 and 766,894 shares of common stock valued at approximately $6,751,000 and 77,281 vested stock options valued at approximately
$418,000 and direct acquisition costs of approximately $312,000. In October 2002, the Company issued an additional 93,942 shares of common stock related to certain earn out provisions. The acquisition was accounted for using the purchase method
of accounting.





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:Accounts receivable, net

$
8Prepaid expenses and other current assets


81Property and equipment, net


2,231Other assets


55Accounts payable and accrued liabilities


(1,179
)Tangible net assets acquired


1,196Acquired in-process research and development


907Completed technology


4,040Excess of purchase price over net assets acquired


1,788Total purchase price

$
7,931





In connection with the purchase of Arcaris, the Company recorded a
$907,000 charge to in-process research and development. 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 cost to recreate the technology and 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 are 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 percentage of completion for the projects was determined based on man months expended to date as a percentage of total project man months for the project. 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 22% and 27% 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 amount allocated to completed technology is being
amortized over their estimated useful life of three years using the straight-line method. This completed technology was written-off as part of the charge for impairment of intangible assets at September 30, 2002 in accordance with SFAS 142 as
discussed in Note 8.





The amount of the purchase price in excess of the net assets acquired was recorded as
goodwill. This goodwill was written-off as a part of the charge for goodwill impairment at September 30, 2002 in accordance with SFAS 142 as discussed in Note 8.





On October 2, 2002, the Company announced a cost savings and business realignment plan to reduce its cash burn rate. The plan includes the consolidation of core activities into the Companys
Redwood City, California and Salt Lake City, Utah facilities as discussed in Note 12.





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.





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 from February 16, 2002 through September 30, 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

$
3Prepaid expenses and other current assets


424Property and equipment, net


12,039Other assets


191Accounts payable and accrued liabilities


(1,084
)Notes payable


(639
)Tangible net assets acquired


10,934Completed technology


5,560Excess of purchase price over net assets acquired


7,481Total purchase price

$
23,975





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





The amount allocated to completed technology is being amortized over the
estimated useful life of three to ten years using the straight-line method. Substantially all of this completed technology was written-off as part of the charge for intangible asset impairment at September 30, 2002 as discussed in Note 8.





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 at September 30, 2002 in accordance with SFAS 142 as discussed in Note 8.





On October 2, 2002, the Company announced a cost savings and business realignment plan to reduce cash burn rate. The plan includes the closing of the San Diego facility that housed the DRL operations. As a result of the
realignment plan, substantially all DRL activities and chemistry capabilities have ceased or been eliminated as discussed in Note 12.





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 from March 14, 2002
through September 30, 2002.




8




---

##### Table of Contents




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

$
79Other assets


1Accounts payable and accrued liabilities


(95
)Tangible net assets acquired


(15
)Acquired in-process research and development


110Completed technology


7,016Deferred 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 amount allocated to completed technology is being amortized over the estimated useful life of three years using the straight-line method.





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.





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. The impact of certain acquisition adjustments such as amortization of completed technology and the charge related to the write-off of the acquired in-process
research and development and goodwill and intangible asset impairment has been excluded from the periods presented as they arose from the acquisitions.





Three Months EndedSeptember 30,


Nine months endedSeptember 30,2002


2001


2002


2001(unaudited)(in thousands, except per share data)Revenues

$
4,409


$
2,380


$
12,943


$
7,635Net loss

$
(31,004
)

$
(21,508
)

$
(72,620
)

$
(59,274
)Basic and diluted EPS

$
(0.77
)

$
(0.64
)

$
(1.94
)

$
(1.80
)




9




---

##### Table of Contents




8.    Goodwill and Intangible Assets





In July 2001, the FASB issued Statement of Financial Accounting Standards No. 142 (SFAS 142), Goodwill and Other
Intangible Assets. SFAS 142 supersedes Accounting Principles Board Opinion No. 17, Intangible Assets, and discontinues the amortization of goodwill. In addition, SFAS 142 includes provisions regarding reclassification of amounts
between goodwill and identifiable intangible assets in accordance with the new definition of identifiable intangible assets set forth in the Statement of Financial Accounting Standards No. 141, Business Combinations, reassessment of the
useful lives of existing recognized intangibles and testing for impairment of existing goodwill and other intangibles using the discounted cash flows method.





Goodwill and intangible assets consist of the following (in thousands):





September 30, 2002


December 31, 2001Gross Carrying Amount


Accumulated Amortization


Gross Carrying Amount

Accumulated AmortizationNon-amortizing:Goodwill prior to impairment loss

$
9,260


$



$
1,788

$
Goodwill impairment loss


(9,260
)









Carrying amount










1,788


Amortizing:Acquired completed technology prior to impairment loss


16,616



3,764



4,040


561Impairment loss on acquired completed technology


(9,100
)


(2,497
)





Carrying amount


7,516



1,267



4,040


561Total

$
7,516


$
1,267


$
5,828

$
561





At September 30, 2002 amortization expense was expected to be as
follows (in thousands):





Year Ending December 31,

Amortization2002 (July 1, 2002 through December 31, 2002)

$
6382003


2,5532004


2,5532005


5052006


Thereafter


Total

$
6,249





The changes in the carrying value of goodwill for the nine months
ended September 30, 2002 are as follows (in thousands):





Balance as of December 31, 2001

$
1,788Goodwill acquired during the year


7,472Impairment loss during the year


(9,260
)Balance as of September 30, 2002

$






Amortization expense was $1,292,000 and $3,203,000 in the three
months and nine months ended September 30, 2002, respectively. Amortization expense was $224,000 in the three months and nine months ended September 30, 2001.





Note 9.    Impairment of Goodwill and Other Long-Lived Assets





Due to current operating losses, the absence of positive cash flows, recent significant declines in the Companys common stock price and uncertainties resulting from the business
realignment plan, the Company assessed the recoverability of the long-lived assets related to DRL and Arcaris in accordance with SFAS 144 and tested goodwill for impairment in accordance with SFAS No. 142 during the quarter ended September 30, 2002.
Based upon our projection of significantly reduced future cash flows related to the long-lived assets utilized at DRL and Arcaris, an impairment loss of $6,603,000 was recognized for completed technology and $10,930,000 for property and equipment in
the quarter ended September 30, 2002. The carrying value of the long-lived assets has been written down to expected fair value based on appraisals. The impairment test under SFAS 142 was based on a two-step process involving; comparing the estimated
fair value of the related reporting unit to its net book value and comparing the estimated implied fair value of goodwill to its carrying value. As a result of the test, we wrote down goodwill by $9,260,000 in the quarter ended September 30, 2002.




10




---

##### Table of Contents




10.    Note Receivable from Related Party





In June 2002, the Company received a promissory note from an officer for $630,000. The promissory note is collateralized by real estate,
bears interest at 5.0% per annum and is due and payable in June 2007 or earlier upon the termination of employment. If the officer remains continually employed with the Company, the principal and accrued interest will be forgiven on the fifth
anniversary from the date of employment. At September 30, 2002, $500,000 was outstanding under the promissory note. In October 2002, the Company paid $130,000 to the above officer representing a draw of the remaining balance of the promissory note.





11.    Private Placement





In May 2002, the Company completed a private equity financing in which 5,543,822 shares of common stock were sold at $4.57 per share resulting in net proceeds of
approximately $25,300,000.





12.    Subsequent Events





Business Realignment





On October 2, 2002 the
Company announced a business realignment 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 internal drug discovery and development in secreted
proteins through its current and potential future collaborations.





As part of this realignment, the Company is
reducing its staff by approximately 130 employees. The plan includes the closing of its San Diego operations acquired in the acquisition of BMSPRL, L.L.C., as discussed in Note 7, 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 the third quarter of 2002 for the impairment of intangible assets related to activities that will no longer be pursued or that will be scaled back and for the impairment of fixed assets
including leasehold improvements and equipment. The Company will record a charge in the fourth quarter of 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 acquisition in 2001) and Europe.





At September 30, 2002, contractual cash obligations for these operations were as follows (in thousands):





Year Ending December 31,

Operating Lease

Debt

Total2002 (October 1, 2002 through December 31, 2002)

$
897

$
79

$
9762003


3,508


51


3,5592004


2,747





2,7472005


2,755





2,7552006


2,837





2,837Thereafter


26,214





26,214Total

$
38,958

$
130

$
39,088


Share Issuance





In October 2002, the Company issued 93,942 additional common shares in final settlement of contingent purchase consideration related to the acquisition of Arcaris, Inc. in 2001.




11




---

##### Table of Contents




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:





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




| |  | the capabilities, development and marketing of our present and future 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 newly introduced and future products and services, including Deltagens Small Molecule Discovery products line and DeltaOne product line, and for
enhancements of existing products and services, including DeltaBase;
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




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




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




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




| |  | our ability to manage growth or reduction in staff, resources and subsidiaries;
|- |  | -------------------------------------------------------------------------------




| |  | our ability to successfully execute our business plan and to meet contractual obligations, in view of our staff reductions and business realignment;
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------




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




| |  | acquisitions; and
|- |  | -----------------




| |  | liquidity.
|- |  | ----------




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 report 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.




12




---

##### Table of Contents




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 principal platform product, DeltaBase, provides a database of in vivo mammalian gene function information on target genes
selected for their disease relevance. 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 the worlds largest pharmaceutical companies, GlaxoSmithKline plc, Merck & Co., Inc.,
Pfizer Inc., Eli Lilly and Company and Schering-Plough Research Institute, as well as significant biotechnology and biopharmaceutical companies including Vertex Pharmaceuticals Incorporated, Hyseq, Inc. and Lexicon Genetics Incorporated.





We are also conducting further target discovery and validation efforts through our Target Research and
Development, or TRD, program. Building on the DeltaBase platform, our TRD program adds comprehensive in-depth analysis to further characterize and identify potential key targets for the treatment of disease. The program 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 identify drug candidates for collaborative development with pharmaceutical partners.





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;
| | - |  | -----------------------------------------------------------------




| |  |  | commercialization of the intellectual property we generate 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.
| | - |  | -------------------------------------------------------------------------------------------------------------




We have established collaborations and relationships with major pharmaceutical and biotechnology companies and research institutions in
Europe and North America to accelerate the discovery of and commercialization of therapeutic and diagnostic products to improve human and animal health. These companies include Eli Lilly, GlaxoSmithKline, Hyseq, Merck, Pfizer, Schering-Plough
Research Institute, Lexicon Genetics Incorporated and Vertex Pharmaceuticals Incorporated.





Our recent acquisition
of XenoPharm, Inc. (XenoPharm,) further complements our target validation and characterization technologies. XenoPharm provides a proprietary technology platform to evaluate drug 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;
| | - |  | ---------------------------------------------------------------------------------------------------------------------



13




---

##### Table of Contents




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




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




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




| |  |  | internal early-stage biopharmaceutical product development programs, including our CD123 antigen program in- licensed as a potential treatment for Acute
Myelogenous Leukemia.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




To date, we have generated revenue from our DeltaBase and DeltaSelect
programs.





DeltaBase is our proprietary database that provides information, based on knockout mouse studies, on
gene function and validated gene targets 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 and that genes suitability as a drug target. In addition to accessing target validation data,
DeltaBase subscribers will have access to the knockout mice used to generate this data.





The DeltaSelect program
was our initial program. Customers received 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 historically 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. We announced on August 1, 2002 that
Millennium Pharmaceuticals had become our first partner in this new program. To date, we have not recognized any revenue from our DeltaOne program.





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 the majority 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.





Revenue for the
three and nine months ended September 30, 2002 and 2001 is as follows:





For the Three Months Ended September 30,

For the Nine Months Ended September 30,2002

2001

2002

2001(in thousands)Revenue:DeltaBase

$
3,655

$
2,136

$
10,983

$
6,456Other (includes DeltaSelect and research collaborations)


754


129


1,960


995Total

$
4,409

$
2,265

$
12,943

$
7,451







14




---

##### Table of Contents




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. Where the contract does not specify milestones and payment is upon completion of the contract, revenue is recognized based on the percentage-of-completion method of
accounting. Any payments received in advance of the completion of a milestone or services performed are recorded as deferred revenue.





We had net losses of $48.2 million and $14.6 million for the three months ended September 30, 2002 and 2001, 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 and non-cash charges for amortization of unearned stock-based compensation costs and amortization of intangibles. Amortization totaled $1.6 million and $1.3
million for the three months ended September 30, 2002 and 2001, respectively. The September 30, 2002 quarter included a $26.8 million charge for the impairment of goodwill and other long-lived assets. 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 the development of 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 expect to 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 September
30, 2002 and 2001, we reversed approximately $267,000 and $137,000 of unearned stock-based compensation, respectively. During the nine months ended September 30, 2002 and 2001 we reversed approximately $657,000 and $1.8 million of unearned
stock-based compensation, respectively. The reversals were related to terminated employees 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.





Merck DeltaBase
Agreement





On February 8, 2002, we entered into a license agreement to provide Merck & Co., Inc.
(Merck) with access to our proprietary DeltaBase product, a resource tool for the understanding of in vivo mammalian gene function information. Merck will have non-exclusive access to information related to 750 genes selected for
their biological interest that have been functionally characterized and entered into DeltaBase. Merck will also have access to certain of the corresponding DeltaBase intellectual property rights.





Acquisition of Arcaris, Inc.





On July 30, 2001, we acquired Arcaris, Inc. (Arcaris). Located in Salt Lake City, Utah, Arcaris had developed technologies consisting of genetic, proteomic and
cell-biological systems for identification and validation of drug targets and the creation of small molecule screens. The total purchase price of approximately $7,931,000 consisted of cash of approximately $450,000 and 766,894 shares of common stock
valued at approximately $6,751,000 and 77,329 vested stock options valued at approximately $418,000 and direct acquisition costs of approximately $312,000. In October 2002, we issued an additional 93,942 shares of common stock related to certain
earn out provisions. The acquisition was accounted for using the purchase method of accounting.





Acquisition
of BMSPRL, L.L.C. (formerly CombiChem, Inc.)





On February 16, 2002, we acquired the California-based
BMSPRL, formerly known as CombiChem, Inc., from Bristol-Myers Squibb Company for 2,647,481 unregistered shares of our common stock valued at approximately $23,510,000 and paid certain transaction expenses of approximately $465,000. The subsidiary
was renamed Deltagen Research Laboratories (DRL).




15




---

##### Table of Contents




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





Stanford Collaboration Agreement





On February 19, 2002, we announced that we had signed a target validation and research collaboration agreement with Stanford University. Under the terms of the
three-year collaboration, Stanford and the Company will mutually develop research projects for jointly selected genes under which we will provide Stanford non-exclusive access to knockout mice models using its proprietary high-throughput technology
and Stanford will evaluate and conduct research on such materials. We will have options to obtain exclusive licenses to commercially develop in any and all fields certain inventions developed by Stanford. We will have rights to use, commercialize
and sublicense results developed by Stanford under the research projects.





Acquisition of XenoPharm, Inc.





On March 14, 2002, we acquired XenoPharm, a San Diego, California-based private company for 498,236
shares of our unregistered common stock valued at approximately $3.6 million and paid certain transaction expenses. Up to an additional 1,449,262 shares of common stock may be issued upon the achievement of certain key milestones. The entity became
our wholly-owned subsidiary. XenoPharm, which was incorporated in November 2000, 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 operating expenses of XenoPharm are expected to be insignificant in 2002.





Results of Operations





Total contract revenue increased to $4.4 million for the
three months ended September 30, 2002 from $2.3 million for the comparable period in 2001. DeltaBase revenue increased to $3.7 million for the three months ended September 30, 2002 from $2.1 million for the comparable period of 2001. Both periods
included revenue from GlaxoSmithKline and Pfizer. Total contract revenue for the nine months ended September 30, 2002 and 2001 was $12.9 million and $7.5 million, respectively. DeltaBase revenues increased to $11.0 million for the nine months ended
September 30, 2002 from $6.5 million for the comparable period in 2001. Both periods included revenue from GlaxoSmithKline and Pfizer. The increase in revenue in both the three and nine months ended September 30, 2002 was primarily due to revenue
from the Merck agreement that was recognized beginning in the quarter ended June 30, 2002.





Research and
development expenses were $20.8 million for the three months ended September 30, 2002 and $13.1 million for the comparable period in 2001. Research and development expenses for the nine months ended September 30, 2002 and 2001 were $58.7 million and
$31.7 million, respectively. Excluding depreciation, amortization of unearned stock-based compensation expenses and amortization of intangibles, research and development expenses increased by $6.2 million to $17.7 million for the three months ended
September 30, 2002 from $11.5 million in the comparable period of 2001. This increase was primarily attributable to growth of research and development activities, including the activities of Deltagen Research Laboratories acquired in February 2002.
The increase includes $2.7 million related to increased personnel, $806,000 related to increased laboratory supply costs to support development of our gene function database and our DeltaSelect and secreted protein programs, $440,000 related to
professional fees and $3.2 million of facilities related expenses.





Selling, general and administrative expenses
were $5.3 million for the three months ended September 30, 2002 and $4.5 million for the comparable period of 2001. Selling, general and administrative expenses for the nine months ended September 30, 2002 and 2001 were $14.4 million and $12.7
million, respectively. Excluding depreciation and amortization of unearned stock-based compensation costs, selling, general and administrative expenses increased by $913,000 to $4.9 million for the three months ended September 30, 2002 from $4.0
million in the comparable period of 2001. This increase included $700,000 related to increased personnel, $670,000 increases in facilities related expenses and $470,000 related to decreases in legal and professional fees.





We recorded an impairment loss of $9.3 million related to the impairment of goodwill in the September 30, 2002 quarter as a result of
performing an impairment test in accordance with SFAS 142.





We recorded an impairment loss of $17.5 million
related to the impairment of fixed assets, including leasehold improvements and equipment, and intangible assets in the September 30, 2002 quarter as a result of performing an impairment test in accordance with SFAS 144.





We had net interest income of $361,000 and $653,000 for the three months ended September 30, 2002 and 2001, respectively. Net interest
income for the nine months ended September 30, 2002 and 2001 was $844,000 and $3.3 million,




16




---

##### Table of Contents

respectively. This decrease is due to lower average cash and investment balances, lower investment interest rates and increased debt.





Business Realignment





On October 2, 2002 we announced a business realignment and plan to reduce expenses. Our 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 production and licensing of our DeltaBase product. We also expect to continue to pursue our internal drug discovery and
development in secreted proteins through current and potential future collaborations.





As part of this
realignment, we are reducing our staff by over 130 employees. The plan includes the closing of our San Diego operations acquired in the acquisition of BMSPRL, L.L.C., the planned exit from our operations in Europe and the planned consolidation of
core activities into our Redwood City, California and Salt Lake City, Utah facilities.





As result of these
actions, we recorded a charge in the third quarter of 2002 for impairment of the intangible assets related to activities that will no longer be pursued or that will be scaled back and for the impairment of fixed assets including leasehold
improvements and equipment. We will record a charge in the fourth quarter of 2002 for severance and other employee related costs, costs associated with lease obligations and restructurings and other costs. These costs and impairments relate
primarily to our operations in San Diego (BMSPRL, L.L.C. acquisition), Salt Lake City (Arcaris acquisition in 2001) and Europe.





At September 30, 2002, contractual cash obligations for these operations were as follows (in thousands):





Year ending December 31,

Operating Lease

Debt

Total2002 (October 1, 2002 through December 31, 2002)

$
897

$
79

$
9762003


3,508


51


3,5592004


2,747





2,7472005


2,755





2,7552006


2,837





2,837Thereafter


26,214





26,214Total

$
38,958

$
130

$
39,088





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, equipment financing arrangements and a term loan facility. Through September 30, 2002, we had received net proceeds of $183.4 million from issuances of equity securities, $39.9 million from customer agreements,
$12.7 million from equipment financing arrangements and $10 million from a term loan facility.





At September 30, 2002, we had $28.4 million in cash and cash equivalents compared to $61.4 million at December 31, 2001. In addition, at September 30, 2002, we had $21.3 million in
marketable securities representing highly liquid commercial paper and government agency securities compared to $15.1 million at December 31, 2001. We used $41.3 million in cash for operating activities during the nine months ended September 30,
2002. This consisted primarily of the net loss for the period of $86.1 million offset in part by non-cash charges totaling $36.6 million including $9.3 million for goodwill impairment, $17.5 million for fixed assets and intangible assets impairment,
$5.3 million related to depreciation and amortization expenses, $3.2 million related to the amortization of intangibles and $1.3 million related to the amortization of unearned stock-based compensation, and increased deferred revenue of $7.8
million. Investment activities used $27.4 million in cash during the nine months ended September 30, 2002 including $11.3 million related to the purchase of marketable securities, $18.7 million related to capital expenditures and $981,000 related to
the acquisitions of BMSPRL, L.L.C. and XenoPharm, Inc. in February and March 2002, respectively, offset in part by $5.0 million related to the maturities of marketable securities. We received $35.8 million in cash from financing activities during
the nine months ended September 30, 2002, which consisted primarily of $14.0 million from loan proceeds and $25.6 million from the sale of common stock. This was offset partially by loan and capital lease repayments of $3.8 million.





In December 1998, March 1999, June 2000, June 2001 and February 2002, we entered into equipment financing agreements of $1.8
million, $1.5 million, $2.9 million, $2.5 million and $4 million, respectively. We have drawn down approximately $12.7 million during 1999, 2000, 2001 and 2002. There are no more amounts available to be drawn under these agreements. As of September
30, 2002, $6.3 million remains outstanding on these equipment loans at a weighted average interest rate of approximately 10.59% which is due in monthly installments through 2005. The loans are collateralized by property and equipment. In October
2002, we provided letters of credit for $2.3 million to the lender as additional collateral for these and other




17




---

##### Table of Contents

equipment loans. The letters of credit required $2.3 million of the unrestricted cash balances at September 30, 2002 to be restricted in October 2002.





On June 27, 2002, we entered into two new bank agreements. These include a $20 million term loan facility and a one-year $5 million
accounts receivable facility. The term loan can be drawn down through March 31, 2003 and matures through March 31, 2007. The loan is secured by a first position security interest in the Companys assets excluding intellectual property. The
Company has certain restrictions on the assignment or transfer of intellectual property during the term of the loan. The Company borrowed $10 million under this facility on June 28, 2002 at the current interest rate of 6.125%. Interest only payments
will be made through the end of the draw down period at which time outstanding principal and interest will be due in 48 equal monthly installments. The loan has financial covenants related to earnings and liquidity, including a requirement that the
Company maintain unrestricted cash balances, as defined, equal to the greater of two times the principal balance outstanding on the loan or six months of net cash used in operating activities. On October 31, 2002, our unrestricted cash balances were
below the minimum level and we provided restricted cash of $10.5 million as collateral for the term loan facility and the interest rate on the $10 million borrowing was reduced to the prime rate (currently 4.25%). At September 30, 2002, $3.1 million
of accounts receivable were sold under the accounts receivable facility.





With the February 2002 acquisition of
Deltagen Research Laboratories (DRL) and the related chemistry and drug discovery efforts, our operating expenses increased significantly during the first nine months of 2002 from the comparable period of 2001. Operating expenses associated with
Deltagen Research Laboratories will likely exceed $20 million in 2002; however, with the business realignment and the closing of DRLs facilities in San Diego, it is not anticipated that operating expenses associated with DRL will be
significant in 2003. In addition, in 2002 we added significant leasehold improvements to our Redwood City facilities. It is presently estimated that this project, which involves both equipment purchases and tenant improvements for laboratory and
animal space, will cost approximately $25 million and will be substantially complete by the fourth quarter of 2002.





At September 30, 2002 we had the following contractual cash obligations (including operating lease obligations for facilities that will be closed pursuant to our business realignment):








Year Ending December 31,

Operating Leases

Capital Leases (1)

Debt (1)

Total(in thousands)2002

$
2,927

$
2

$
10,600

$
13,5292003


12,853


20


2,627


15,5002004


11,817


8


2,248


14,0732005


11,606





907


12,5132006


10,520








10,520Thereafter


54,824








54,824Total

$
104,547

$
30

$
16,382

$
120,959





---

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




We have issued standing letters of credit totaling $3.0 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.





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.
The letters of credit required $2.3 million of unrestricted cash balances to be restricted subsequent to September 30, 2002. There are no further collateral requirements contingently required under these loans.





The term loan agreement has restrictive covenants including a requirement that we maintain unrestricted cash balances, as defined, equal
to the greater of two times the principal balance outstanding on the loan or six months of net cash used in operating activities. If unrestricted cash balances fall below the minimum level, we will be required to restrict cash equal to 105% of the
loan balance outstanding or pay down the loan balance to a level that achieves compliance with the restrictive covenants. At October 31, 2002, our unrestricted cash balances were below the minimum level and we provided restricted cash of $10.5
million as collateral for the term loan facility. We may choose to repay the loan in full, without penalty, by December 31, 2002.





At September 30, 2002 we had approximately $6.2 million in committed financing available for the construction of a research and development facility for Deltagen Europe S.A. Construction of this facility has not begun and in October
2002 we cancelled the construction project and expect the committed financing to be withdrawn.





At September 30,
2002 we had unrestricted cash, cash equivalents and marketable securities totaling $49.7 million, of which $12.8 million became restricted subsequent to September 30, 2002 in order to provide additional collateral to lenders




18




---

##### Table of Contents

under the terms of our equipment loan and term loan borrowing arrangements. In addition, we expect that the $5 million accounts receivable facility will not be available at December 31, 2002. At
September 30, 2002, $3.1 million of this facility was utilized.





Our immediate sources of cash for operating
activities are:





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

| | - |  | Potential new customer agreements (DeltaBase, DeltaOne, sale or licensing of programs, R&D funding arrangements)
| | - |  | ----------------------------------------------------------------------------------------------------------------

| | - |  | Proceeds from liquidation of assets from closed facilities (primarily assets from the BMSPRL, L.L.C. acquisition) and exited activities. These net proceeds are
not expected to be significant in relationship to the $22 million in assets related to these terminated activities
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




Our immediate requirements for cash include:





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

| | - |  | Completion of our Redwood City, California animal facility and laboratory expansion
| | - |  | -----------------------------------------------------------------------------------

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




In the absence of significant
cash availability from new customer agreements, we expect to require additional cash within the next three months in order to fund our operations and meet our obligations. Additionally, we may be required to further reduce the level of operating
expenses through additional workforce reductions. 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 August 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial
Accounting Standards No. 143 (SFAS 143), Accounting for Asset Retirement Obligations, which is effective for fiscal years beginning after June 15, 2002. SFAS 143 addresses financial accounting and reporting for obligations
associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS No. 143 requires, among other things, that the retirement obligations be recognized when they are incurred and displayed as liabilities on
the balance sheet. In addition, the assets retirement costs are to be capitalized as part of the assets carrying amount and subsequently allocated to expense over the assets useful life. We believe that the adoption of SFAS 143
will not have a material effect on our financial position or results of operations.





In August 2001, the FASB
issued Statement of Financial Accounting Standards No. 144 (SFAS 144), Accounting for the Impairment or Disposal of Long-Lived Assets, which is effective for fiscal years beginning after December 15, 2001 and interim periods
within those fiscal periods. SFAS 144 supersedes FASB Statement No. 121 and APB Opinion No. 30, however, it retains the requirement of Opinion No. 30 to report discontinued operations separately from continuing operations and extends that reporting
to a component of an entity that either has been disposed of (by sale, by abandonment, or in a distribution to owners) or is classified as held for sale. SFAS 144 addresses financial accounting and reporting for the impairment of certain long-lived
assets and for long-lived assets to be disposed of. We recorded an impairment loss of $17.5 million in the quarter ended September 30, 2002 related to the impairment of fixed assets, including leasehold improvements and equipment, and intangible
assets as a result of our cost savings and business realignment plan.





In April 2002, the FASB issued Statement of
Financial Accounting Standards No. 145 (SFAS 145), Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections, which is effective for fiscal years beginning after May 15,
2002. Under SFAS 145, gains and losses from the extinguishment of debt should be classified as extraordinary items only if they meet the criteria of Accounting Principles Board Opinion No. 30. SFAS also addresses financial accounting and reporting
for capital leases that are modified in such a way as to give rise to a new agreement classified as an operating lease. We believe that the adoption of SFAS 145 will not have a material effect on our financial position or results of operations.





In June 2002, the FASB issued Statement of Financial Accounting Standards No. 146 (SFAS 146),
Accounting for Costs Associated with Exit or Disposal Activities, which is effective for exit or disposal activities initiated after December 31, 2002. SFAS 146 nullifies Emerging Issues Task Force Issue No. 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). Under SFAS 146, a liability is required to be recognized for a cost associated with an exit or
disposal activity when the liability is incurred. SFAS 146 applies to costs associated with an exit activity that does not involve an entity newly acquired in a business combination or with a retirement or disposal activity covered by FASB
Statements No. 143 and 144. We expect to elect early adoption of SFAS 146 in the fourth quarter of 2002 in conjunction with the business realignment discussed above.




19




---

##### Table of Contents




Risk Factors Affecting Future Operating Results





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 September 30, 2002 had an accumulated deficit of $185.3 million. We had net losses of $86.1 million and $33.6 million for the nine months ended September 30, 2002 and 2001, respectively. We had net losses of $48.5 million, $32.2 million,
and $13.8 million in 2001, 2000 and 1999, respectively. The 2000 net loss is before a $22.4 million deemed dividend-related to the beneficial conversion of our preferred stock. 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.





Our expenditures have increased in 2002 due in part to:





| |  |  | continued investment in the research and development of our new and existing products and our technology, including increased investment for the development,
implementation and support of our gene function database, our standard and conditional knockout programs, our secreted protein programs and identification of lead candidate compounds for drug development;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | our acquisitions of Arcaris, Inc. and BMSPRL, L.L.C.;
| | - |  | -----------------------------------------------------




| |  |  | our increased investment in management and other employees, sales and marketing programs, customer service and operational and financial controls; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | an impairment of our goodwill and certain long-lived assets.
| | - |  | ------------------------------------------------------------




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 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 and cash flows, but expect to
seek 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;
| | - |  | -----------------------------------------------------------------------------------------------------------




| |  |  | expansion of facilities to support development activities;
| | - |  | ----------------------------------------------------------




| |  |  | 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; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------







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 require substantial amounts of capital, and will continue to require substantial amounts of 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 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.




20




---

##### Table of Contents

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.





We have recently implemented a business realignment and staff reduction, and may need to do so again in order to further reduce burn rate and operating expenses.





On October 2, 2002, we instituted a cost savings and business realignment plan to reduce our cash burn rate in response to market conditions. As part of the
realignment, we are reducing our staff by approximately 130 employees, a reduction of about 30%. The plan also includes 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. We estimate these actions will reduce cash operating expenses to approximately $55-60 million in 2003. The benefit to us of implementing this plan is expected to be realized beginning
in the first quarter of 2003. As a result of these actions, we recorded a charge in the quarter ending September 30, 2002 for the impairment of intangible assets related to activities that will no longer be pursued or that will be scaled back and
for the impairment of fixed assets including leasehold improvements and equipment. We will record a restructuring charge in the quarter ending December 31, 2002 for severance and other employee related costs, costs associated with lease obligations
and other costs.





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 realignment, 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. an impact on our ability to meet our existing contractual
obligations





On October 2, 2002, we announced that we are reducing our staff by approximately 130 employees, a
reduction of about 30%. Because this represents the first such workforce reduction in our history and because of the magnitude of the workforce reduction, 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 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 September 30, 2002, we had approximately 460 full-time equivalent employees.





As of September 30, 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 addition,
we had commenced expanding our Redwood City facilities to establish laboratories to meet our growing size and scope of research activities.





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 on October 2,
2002, that we were implementing a cost savings and business realignment plan to reduce our cash burn rate. As part of the realignment, we are reducing our staff by approximately 130 employees, a reduction of about 30%. The plan also includes 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.





We will probably 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 $9.9 million, $2.1 million and $1.2 million for the fiscal years 2001, 2000 and 1999, respectively. For the nine months
ended September 30, 2002 and 2001 we recognized revenues of $12.9 million and $7.5 million, 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.








We currently have only four DeltaBase
subscribers, two GeneClass DeltaBase customers and one DeltaOne customer and may not succeed unless we can attract more customers.








DeltaBase, our database product, is our principal source of revenue. We also expect that the majority of our revenues for at least the next six months will be derived from
fees under our DeltaBase agreements. We may also derive revenues from royalties received from these users.





We
currently have only four DeltaBase customers (including Lexicon, which does not involve the receipt of any subscription fees) and two GeneClass DeltaBase customers. 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. 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.







21




---

##### Table of Contents

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 one
DeltaOne customer. 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 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.





Results of our product development are uncertain.





We intend to pursue an aggressive product development program. Successful product development in the biotechnology industry is highly uncertain, and very few research and
development projects produce a commercial product. Product candidates that appear promising in the early phases of development, such as in early human clinical trials, may fail to reach the market for a number of reasons, such as:





| |  |  | the product candidate did not demonstrate acceptable clinical trial results even though it demonstrated positive preclinical trial results;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | the product candidate was not effective in treating a specified condition or illness;
| | - |  | -------------------------------------------------------------------------------------






22




---

##### Table of Contents

| |  |  | the product candidate had harmful side effects on humans;
| | - |  | ---------------------------------------------------------




| |  |  | the necessary regulatory bodies (such as the FDA) did not approve the product candidate for an indicated use;
| | - |  | -------------------------------------------------------------------------------------------------------------




| |  |  | the product candidate was not economical to manufacture;
| | - |  | --------------------------------------------------------




| |  |  | other companies or people have proprietary rights to the product candidate (e.g. patent rights) and will not permit its sale on reasonable terms, or at all; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | the product candidate is not cost effective in light of existing therapeutics.
| | - |  | ------------------------------------------------------------------------------




We cannot guarantee we will be able to produce commercially successful products. Further, clinical trial results are frequently susceptible to varying interpretations by
scientists, medical personnel, regulatory personnel, statisticians and others, which may delay, limit or prevent further clinical development or regulatory approvals of a product candidate. Also, the length of time that it takes to complete clinical
trials and obtain regulatory approval for product marketing varies significantly by product and by the indicated use of a product. Therefore, we cannot predict the length of time to complete necessary clinical trials and obtain regulatory approval.
In addition, we have no experience in conducting clinical trials, obtaining regulatory approval, manufacturing, marketing and selling of a pharmaceutical product. Each of these is a significant challenge that will require substantial investments of
financial, scientific and human resources, and our ability to successfully meet these challenges is uncertain.





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.





We may be required to defend lawsuits or pay damages for product liability claims.





Product liability is a major risk in testing and marketing biotechnology and pharmaceutical products. We face substantial product liability exposure in human clinical trials and for products that we sell after regulatory approval.
Product liability claims, regardless of their merits, could be costly and divert managements attention, or adversely affect our reputation and the demand for our products. When we reach the clinical trial stage with our future products, we
intend to engage and maintain product liability and other insurance coverage, as commercially appropriate in view of our product portfolio, sales volumes and claims experienced to date, among other considerations. However, this insurance may not
provide us with adequate coverage against




23




---

##### Table of Contents

potential liabilities either for clinical trials or commercial sales. In addition, insurers may not offer us product liability insurance at reasonable rates, or at all, or may offer inadequate
coverage limits for our potential liabilities.





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;
| | - |  | -----------------------------------------------------------------




| |  |  | 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, Pfizer and Merck are coterminous, each terminating upon our delivery of DeltaBase in June 2003, and, although
renewable beyond such date, 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.




24




---

##### Table of Contents

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.





We may pursue opportunities in fields, such as secreted proteins and other drug discovery and development that could conflict with those
of our customers. Moreover, 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.





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




25




---

##### Table of Contents

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. Moreover, there is no assurance that XenoPharms technology can be successfully integrated into Deltagens operations or that any of the benefits expected from such integration will be realized. 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.








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





We are highly dependent on the principal
members of our management, operations and scientific staff, including William Matthews, Ph.D., our Chairman and Chief Executive Officer, and Mark W. Moore, Ph.D., our Chief Scientific Officer. The loss of either of their services would harm our
business.







26




---

##### Table of Contents

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. 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.





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




27




---

##### Table of Contents

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 as many gene knockouts as possible. 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. 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.





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




28




---

##### Table of Contents

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.





If we, or our collaborators, do not comply with government regulations, we may not be able to develop or sell our technologies and products.





Any future drug approvals that are granted remain subject to continual FDA review, and newly discovered or developed safety or efficacy data may result in withdrawal
of products from the market. Moreover, if and when such approval is obtained, the manufacture and marketing of future drugs will remain subject to extensive regulatory requirements administered by the FDA and other regulatory bodies, including
compliance with current Good Manufacturing Practices, adverse event reporting requirements and the FDAs general prohibitions against promoting products for unapproved or off-label uses. Companies are subject to inspection and
market surveillance by the FDA for compliance with these regulatory requirements. Domestic manufacturing facilities are subject to biennial inspections by the FDA and must comply with the FDAs Good Manufacturing Practices regulations. In
complying with these regulations, manufacturers must spend funds, time and effort in the areas of production, record keeping, personnel and quality control to ensure full technical compliance. The FDA stringently applies regulatory standards for
manufacturing. Failure to comply with the requirements can, among other things, result in warning letters, product seizures, recalls, fines, injunctions, suspensions or withdrawals of regulatory approvals, operating restrictions and criminal
prosecutions. Any such enforcement action could have a material adverse effect on us. Unanticipated changes in existing regulatory requirements or the adoption of new requirements could also have a material adverse effect on us.





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.







29




---

##### Table of Contents




Almost all of our knockout mouse research and storage is conducted at our San Francisco Bay Area
facilities in San Carlos, Menlo Park, Alameda 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 most of our scientific and all of our management activities at our San Carlos, Menlo Park, Alameda and Redwood City facilities
in California. All of these locations are in or proximate to seismically active areas. We have taken precautions to safeguard our mouse colony including through insurance, storage of animals off-site at a back-up facility, 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;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------




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




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



30




---

##### Table of Contents




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




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




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




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. If we fail to comply with the minimum bid price requirement for 30
straight trading days, we will receive a deficiency notice from the Nasdaq National Market. We will then have 90 calendar days to reestablish compliance with that requirement. To reestablish compliance, our minimum closing bid price must be more
than $1.00 per share for 10 consecutive trading days. If we do not reestablish compliance with this requirement during the 90-day period, Nasdaq will 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 40,908,740 shares of common stock outstanding at September 30, 2002.





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 14.5 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.





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 September 30, 2002, our executive officers and directors, and entities affiliated with them, beneficially own, in the aggregate,
approximately 53.1% 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:







31




---

##### Table of Contents




| |  |  | 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.





We
face significant competition in our future drug discovery and development efforts.





Many organizations are
actively attempting to identify, optimize and generate lead compounds for potential pharmaceutical development. We will compete in our drug discovery efforts with the research departments of pharmaceutical companies, biotechnology companies,
combinatorial chemistry companies and research and academic institutions, as well as other computationally based drug discovery companies. Many of these competitors have greater financial and human resources and more experience in research and
development than we have. Historically, large pharmaceutical companies have maintained close control over their research activities, including the synthesis, screening and optimization of chemical compounds. Many of these companies, which represent
one of the largest potential markets for our products and services, are internally developing combinatorial and computational approaches and other methodologies to improve productivity, including major investments in robotics technology to permit
the automated parallel synthesis of compounds. In addition, these companies may already have large collections of compounds previously synthesized or ordered from chemical supply catalogs or other sources against which they may screen new targets.
Other sources of compounds include compounds extracted from natural products, such as plants and microorganisms, and compounds created using rational drug design. Academic institutions, governmental agencies and other research organizations are also
conducting research in areas in which we are working, either on their own or through collaborative efforts. We anticipate that we will face increased competition in the future as new companies enter the market and advanced technologies become
available. Our drug discovery processes may be rendered obsolete or uneconomical by technological advances or by entirely different approaches developed by one or more of our competitors. The existing drug discovery approaches of our competitors or
new approaches or technology developed by our competitors may be more effective than those developed by us.







32




---

##### Table of Contents




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 $16.4 million at
September 30, 2002 consist of $10 million with a variable interest rate of 6.125% at September 30, 2002 and $6.4 million which carry fixed interest rates ranging from 8.87% to 12.75% per annum with payments due in 36 or 48 monthly installments. Our
capital lease obligations of $30,000 at September 30, 2002 carry fixed interest rates ranging from 0% to 10.39% per annum with payments due in 36 monthly installments. At October 31, 2002, our unrestricted cash balances were below the minimum level
and we provided restricted cash of $10.5 million as additional collateral for the loan. The interest rate of the $10 million loan payable was reduced to the prime rate (currently 4.25%) in November 2002.





The following table presents, as of September 30, 2002, the future principal amounts and related weighted average interest rate by year
for our cash and cash equivalents, marketable securities and debt obligations.





Expected Maturity Date (as of September 30, 2002)2002


2003


2004


2005


2006

Thereafter

Total(in thousands)Assets:Cash and cash equivalents

$
28,415


$



$



$



$


$


$
28,415Marketable securities

$
21,253




















$
21,253Weighted average interest rate


3.19
%

















Liabilities:Capital lease obligations

$
2


$
20


$
8


$



$


$


$
30Weighted average interest rate


3.72
%


6.24
%













Loans payable

$
10,600


$
2,627


$
2,248


$
907


$


$


$
16,382Weighted average interest rate


6.57
%


10.78
%


10.41
%


10.16
%





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.




33




---

##### Table of Contents




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





None





Item 2.Changes in Securities and Use of Proceeds





(a) Not applicable.





(b) Not applicable.





(c) Not applicable.





(d) On August 2, 2000, our Registration
Statement on Form S-1 (File No. 333-34668), the IPO Registration Statement, was declared effective by the Securities and Exchange Commission. The IPO Registration Statement registered a total of 7,000,000 shares of common stock all of which were
issued and sold by us. The offering commenced on August 3, 2001 and was closed on August 8, 2001. The shares sold by us were sold at an aggregate offering price of $105 million, netting proceeds of approximately $95.9 million to us after
underwriting fees of approximately $7.4 million and other offering expenses of approximately $1.7 million. On August 30, 2001 the underwriters of our offering exercised their over-allotment for the purchase of approximately 1,025,000 shares.
The shares sold by us were sold at an aggregate offering price of $15.4 million, netting proceeds of approximately $14.3 million to us after underwriting fees of approximately $1.1 million and other offering expenses.





Since the effective date of the IPO Registration Statement, the net offering proceeds of $110.2 million have been invested in bank
deposits, money market funds, corporate debt securities and obligations of government agencies.





Repayment of indebtedness

$
5,259Purchase and installation of equipment and build out of facilities


26,118Working capital


78,823Net offering proceeds

$
110,200





None of the net offering proceeds have been paid to any director,
officer, or 10% or greater stockholder of the Company or an affiliate of these persons.





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.





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




34




---

##### Table of Contents




(a) Exhibits





10.48

Amendment of Employment Agreement with Michael Sember dated October 21, 2002.10.49

Loan Modification Agreement to Loan and Security Agreement with Silicon Valley bank dated June 27, 200299.1

Section 906 certification by William Matthews, Chief Executive Officer, dated November 13, 200299.2

Section 906 certification by Richard H. Hawkins, Chief Financial Officer, dated November 13, 2002





(b) Reports on Form 8-K





A report on Form 8-K related to the execution of term and accounts receivable loan agreements was filed on July 1, 2002.





A report on Form 8-K related to discovery of a drug target was filed on July 18, 2002.





A report on Form 8-K related to a conference call announcing financial results was filed on July 25, 2002.





A report on Form 8-K related to the announcement of second quarter results was filed on August 1, 2002.





A report on Form 8-K related to a cost savings plan and realignment of business to focus on revenue growth through expanded offerings was
filed on October 4, 2002.





A report on Form 8-K related to the announcement of third quarter results was filed on
November 14, 2002.




35




---

##### 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:    November 14, 2002

/s/    WILLIAM MATTHEWS, PH.D.William Matthews, Ph.D.Chairman and Chief Executive OfficerDate:    November 14, 2002

/s/    RICHARD H. HAWKINSRichard H. HawkinsChief Financial Officer




36




---

##### Table of Contents




CERTIFICATIONS





I, William Matthews, 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:

November 14, 2002



By:

/s/    WILLIAM MATTHEWSWilliam Matthews Chairman and
Chief Executive Officer (Principal Executive Officer)




37




---

##### Table of Contents




I, Richard H. Hawkins, 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:

November 14, 2002By:

/s/    RICHARD H. HAWKINSRichard H. Hawkins Chief
Financial Officer (Principal Financial Officer)







38




---

##### Table of Contents

EXHIBIT INDEX





Exhibit Number

Description10.48

Amendment of Employment Agreement with Michael Sember10.49

Loan Modification Agreement to Loan and Security Agreement with Silicon Valley Bank dated June 27, 2002.99.1

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.