** **

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

#### **FORM10-Q**

| ý                                                 | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d)**  |
|--------------------------------------------------------|--------------------------------------------------------|
|                                                   | **OF  THE SECURITIES EXCHANGE ACT OF 1934**            |
|                                                   |                                                   |
| **For  the quarterly period ended September 30, 2001** |
|                                                   |                                                   |
| **OR**                                                 |
|                                                   |                                                   |
| o                                                      | **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          |   | (I.R.S.  Employer    |
| incorporation  or organization)           |   | Identification  No.) |
|                                      |   |                 |
| **740 Bay Road, Redwood City, CA**        |   | **94063**            |
| (Address  of principal executive offices) |   | (Zip  code)          |

**(650) 569-5100**(Registrant'stelephone number, including area code)

**1003 Hamilton Avenue, Menlo Park, CA  94025**(former address, ifchanged since last report)

Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor 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 | ý | NO | o |
|-----|--------|----|---|

Indicate the number of shares outstandingof each of the issuer’s classes of common stock, as of the latest practicabledate:

| Common Stock $0.001  par value |   | 32,074 956                       |
|--------------------------------|--------|----------------------------------|
| Class                          |   | Outstanding at  November 9, 2001 |

** **

**DELTAGEN,INC.**

**FORM10-Q**

**QUARTERLYREPORT**

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

** **

**Part I.              ****Financial Information****Item 1.**             **Financial Statements**

**DELTAGEN,INC.CONSOLIDATED BALANCE SHEETS(unaudited)(in thousands, except share data)**
|                                                                                                                                                                               |   | **September 30,  2001** |       | **December 31,  2000** |       |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|------------|------------------------|------------|
| **Assets**                                                                                                                                                                         |   |                    | ** ** |                   | ** ** |
| Current  assets:                                                                                                                                                                   |   |                    |       |                   |       |
| Cash  and cash equivalents                                                                                                                                                         |   | $                       | 71,020     |                   | $          | 93,352 |   |
| Short  term investments                                                                                                                                                            |   | 9,982                   |       | 24,981                 |       |
| Accounts  receivable, net                                                                                                                                                          |   | 2,896                   |       | 1,682                  |       |
| Prepaid  expenses and other current assets                                                                                                                                         |   | 2,136                   |       | 945                    |       |
| Total  current assets                                                                                                                                                              |   | 86,034                  |       | 120,960                |       |
|                                                                                                                                                                               |   |                    |       |                   |       |
| Property,  plant and equipment, net                                                                                                                                                |   | 14,470                  |       | 8,635                  |       |
| Restricted  cash                                                                                                                                                                   |   | 2,857                   |       | 150                    |       |
| Goodwill                                                                                                                                                                           |   | 1,706                   |       | -                      |       |
| Intangible  assets                                                                                                                                                                 |   | 3,816                   |       | -                      |       |
| Other  assets                                                                                                                                                                      |   | 3,528                   |       | 314                    |       |
| Total  assets                                                                                                                                                                      |   | $                       | 112,411    |                   | $          | 130,059 |   |
| **Liabilities  and Stockholders' Equity**                                                                                                                                          |   |                    | ** ** |                   | ** ** |
| Current  liabilities:                                                                                                                                                              |   |                    |       |                   |       |
| Accounts  payable                                                                                                                                                                  |   | $                       | 3,119      |                   | $          | 1,140 |   |
| Accrued  expenses                                                                                                                                                                  |   | 5,791                   |       | 3,669                  |       |
| Current  portion of capital lease obligations                                                                                                                                      |   | 3                       |       | 25                     |       |
| Current  portion of loans payable                                                                                                                                                  |   | 2,311                   |       | 1,599                  |       |
| Current  portion of deferred revenue                                                                                                                                               |   | 7,184                   |       | 6,820                  |       |
| Total  current liabilities                                                                                                                                                         |   | 18,408                  |       | 13,253                 |       |
| Capital  lease obligations, less current portion                                                                                                                                   |   | 15                      |       | 15                     |       |
| Loans  payable, less current portion                                                                                                                                               |   | 3,560                   |       | 3,248                  |       |
| Other  long-term accrued liabilities                                                                                                                                               |   | 990                     |       | -                      |       |
| Deferred  revenue, less current portion                                                                                                                                            |   | 1,925                   |       | 2,679                  |       |
| Total  liabilities                                                                                                                                                                 |   | 24,898                  |       | 19,195                 |       |
| Commitments  and Contingencies  (Note 4)                                                                                                                                      |   |                    |       |                   |       |
| Stockholders'  equity:                                                                                                                                                             |   |                    |       |                   |       |
| Common  stock, $0.001 par value:  Authorized: 75,000,000 sharesIssued and outstanding: 30,552,429 and  29,867,968 shares at September 30, 2001 and December 31, 2000, respectively |   | 31                      |       | 30                     |       |
| Additional  paid-in capital                                                                                                                                                        |   | 176,458                 |       | 171,064                |       |
| Unearned  stock-based compensation                                                                                                                                                 |   | (3,931                  | )          | (8,750                 | )          |
| Notes  receivable from stockholders                                                                                                                                                |   | (805                    | )          | (805                   | )          |
| Accumulated  deficit                                                                                                                                                               |   | (84,240                 | )          | (50,675                | )          |
| Total  stockholders' equity                                                                                                                                                        |   | 87,513                  |       | 110,864                |       |
| Total  liabilities and stockholders' equity                                                                                                                                        |   | $                       | 112,411    |                   | $          | 130,059 |   |

Theaccompanying notes are an integral part of these consolidated financialstatements.**DELTAGEN, INC.CONSOLIDATED STATEMENTS OFOPERATIONS(unaudited)(in thousands, except per share data)**
|                                                                             |   | **Three Months Ended  September 30,** |    | **Nine Months Ended  September 30,** |   |
|----------------------------------------------------------------------------------|--------|---------------------------------------|---------|--------------------------------------|--------|
|                                                                             |   | **2001**                              |    | **2000**                             |   | **2001** |   | **2000** |   |
|                                                                             |   |                                  |    |                                 |   |   |   |   |   |
| Contract  revenue                                                                |   | $                                     | 2,265   |                                 | $      | 206 |   | $ | 7,451 |   | $ | 760 |   |
| Costs  and expenses:                                                             |   |                                  |    |                                 |   |   |   |   |   |
| Research  and development                                                        |   | 13,080                                |    | 7,008                                |   | 31,688 |   | 19,475 |   |
| Selling,  general and administrative                                             |   | 4,472                                 |    | 2,791                                |   | 12,654 |   | 7,253 |   |
| Total  costs and expenses                                                        |   | 17,552                                |    | 9,799                                |   | 44,342 |   | 26,728 |   |
|                                                                             |   |                                  |    |                                 |   |   |   |   |   |
| Loss  from operations                                                            |   | (15,287                               | )       | (9,593                               | )      | (36,891 | ) | (25,968 | ) |
|                                                                             |   |                                  |    |                                 |   |   |   |   |   |
| Interest  income                                                                 |   | 915                                   |    | 1,194                                |   | 3,887 |   | 1,592 |   |
| Interest  expense                                                                |   | (262                                  | )       | (190                                 | )      | (561 | ) | (372 | ) |
|                                                                             |   |                                  |    |                                 |   |   |   |   |   |
| Net  loss                                                                        |   | (14,634                               | )       | (8,589                               | )      | (33,565 | ) | (24,748 | ) |
| Deemed  dividend related to beneficial conversion feature of preferred stock     |   | -                                     |    | -                                    |   | - |   | (22,360 | ) |
|                                                                             |   |                                  |    |                                 |   |   |   |   |   |
| Net  loss attributable to common stockholders                                    |   | $                                     | (14,634 | )                                    | $      | (8,589 | ) | $ | (33,565 | ) | $ | (47,108 | ) |
| Net  loss per share attributable to common stockholders, basic and diluted       |   | $                                     | (0.50   | )                                    | $      | (0.44 | ) | $ | (1.16 | ) | $ | (5.65 | ) |
| Weighted  average shares used in computing net loss per share, basic and diluted |   | 29,504                                |    | 19,437                               |   | 28,959 |   | 8,332 |   |
|                                                                             |   |                                  |    |                                 |   |   |   |   |   |

The accompanying notesare an integral part of these consolidated financial statements.

 

**DELTAGEN, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(unaudited)(in thousands)**
|                                                                                      |   | **Nine Months Ended September  30,** |       |
|-------------------------------------------------------------------------------------------|--------|--------------------------------------|------------|
|                                                                                      |   | **2001**                             |       | **2000** |   |
|                                                                                      |   |                                 | ** ** |   | ** ** |
| Cash  flows from operating activities:                                                    |   |                                 |       |   |   |
| Net  loss                                                                                 |   | $                                    | (33,565    | ) | $ | (24,748 | ) |
| Adjustments to reconcile net loss  to net cash used in operating activities:              |   |                                 |       |   |   |
| Depreciation  and amortization                                                            |   | 1,872                                |       | 1,032 |   |
| Amortization  of warrants issued in connection with loans                                 |   | 35                                   |       | 30 |   |
| Amortization  of intangible assets                                                        |   | 224                                  |       | - |   |
| Amortization  of unearned stock-based compensation expense                                |   | 3,006                                |       | 8,991 |   |
| Amortization  of discount on short-term investments                                       |   | (637                                 | )          | - |   |
| Lease loss                                                                                |   | 1,312                                |       | - |   |
| Write-off of in-process research  and development costs                                   |   | 907                                  |       | - |   |
| Changes in operating assets and  liabilities:                                             |   |                                 |       |   |   |
| Accounts  receivable                                                                      |   | (1,206                               | )          | (1,189 | ) |
| Prepaid  expenses and other current assets                                                |   | (1,110                               | )          | (1,648 | ) |
| Other  assets                                                                             |   | (3,159                               | )          | (31 | ) |
| Accounts  payable                                                                         |   | 1,028                                |       | (1,409 | ) |
| Accrued  expenses                                                                         |   | 628                                  |       | 1,493 |   |
| Deferred  revenue                                                                         |   | (400                                 | )          | 1,383 |   |
| Net  cash used in operating activities                                                    |   | (31,065                              | )          | (16,096 | ) |
|                                                                                      |   |                                 |       |   |   |
| Cash  flows from investing activities:                                                    |   |                                 |       |   |   |
| Purchase  of short-term investments                                                       |   | (39,364                              | )          | - |   |
| Maturities  of short-term investments                                                     |   | 55,000                               |       | - |   |
| Acquisition  of property, plant and equipment                                             |   | (4,434                               | )          | (2,872 | ) |
| Acquisition  of leasehold improvements                                                    |   | (318                                 | )          | (808 | ) |
| Restricted  cash                                                                          |   | (2,707                               | )          | (150 | ) |
| Acquisition  of Arcaris, Inc., net of cash acquired                                       |   | (450                                 | )          | - |   |
| Net  cash provided by (used in) investing activities                                      |   | 7,727                                |       | (3,830 | ) |
|                                                                                      |   |                                 |       |   |   |
| Cash  flows from financing activities:                                                    |   |                                 |       |   |   |
| Principal  payments under capital lease obligations                                       |   | (22                                  | )          | (24 | ) |
| Repayment  of loans payable                                                               |   | (1,464                               | )          | (618 | ) |
| Proceeds  from the issuance of notes payable                                              |   | 2,453                                |       | 2,911 |   |
| Proceeds  from the issuance of preferred stock, net of issuance costs                     |   | -                                    |       | 22,360 |   |
| Proceeds  from the issuance of common stock, net of issuance costs and stock  repurchased |   | 39                                   |       | 110,747 |   |
| Net  cash provided by financing activities                                                |   | 1,006                                |       | 135,376 |   |
|                                                                                      |   |                                 |       |   |   |
| Net  increase (decrease) in cash and cash equivalents                                     |   | (22,332                              | )          | 115,450 |   |
|                                                                                      |   |                                 |       |   |   |
| Cash  and cash equivalents, beginning of period                                           |   | 93,352                               |       | 848 |   |
|                                                                                      |   |                                 |       |   |   |
| Cash  and cash equivalents, end of period                                                 |   | $                                    | 71,020     |   | $ | 116,298 |   |
|                                                                                      |   |                                 |       |   |   |
| Supplemental  disclosures of cash flow information:                                       |   |                                 |       |   |   |
| Cash  paid during the period for interest                                                 |   | $                                    | 561        |   | $ | 371 |   |
| Supplemental  disclosures of non-cash investing and financing activities:                 |   |                                 |       |   |   |
| Property  and equipment acquired with accounts payable                                    |   | $                                    | 724        |   | $ | 20 |   |
| Unearned  stock-based compensation                                                        |   | $                                    | -          |   | $ | 12,913 |   |
| Reversal  of unearned stock-based compensation                                            |   | $                                    | 1,813      |   | $ | - |   |
| Issuance  of notes receivable in exchange for common stock                                |   | $                                    | -          |   | $ | 805 |   |
| Issuance  of common stock and stock options in connection with Arcaris, Inc.  acquisition |   | $                                    | 7,169      |   | $ | - |   |
|                                                                                           |        |                                      |            |  |  |  |  |  |

Theaccompanying notes are an integral part of these consolidated financialstatements.**DELTAGEN,INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS****(unaudited)September 30, 2001**

**1.  Business of theCompany**

             Deltagen, Inc.(the "Company"), is a leading provider of genomics-based information,products and programs that are used to discover drug targets and drugcandidates and to accelerate pharmaceutical and biotechnology drug and productdevelopment. The Company researches, develops and uses technologies that buildupon technology platforms to discover the function, role, usefulness anddisease relevance of mammalian genes and secreted proteins in drug discoveryand development. The technology enables the Company to select and target genesbelieved to be relevant to disease and delete, or "knock out," thesegenes in mice. The Company then uses an extensive, integrated analysis programto assess the function and potential pharmaceutical relevance of these genesand the proteins these genes encode. The Company believes that the technologyallows the Company to knock out genes in mice and to make discoveries on themammalian function, role, usefulness and disease relevance of genes andsecreted proteins in drug discovery faster and on a larger scale than has beenpreviously possible.

**2.  Basis ofPresentation**

             Theaccompanying interim consolidated balance sheet as of September 30, 2001, theconsolidated statements of operations for the three and nine month periodsended September 30, 2001 and 2000 and the consolidated statements of cash flowsfor the nine month periods ended September 30, 2001 and 2000 are unaudited andhave been prepared in accordance with generally accepted accounting principlesfor interim financial information, the instructions to Form 10-Q and Article 10of Regulation S-X.  Accordingly, they donot contain all of the information and footnotes required by generally acceptedaccounting principles for complete financial statements.  The unaudited interim financial statementshave been prepared on the same basis as the annual financial statements and, inthe opinion of management, reflect all adjustments, which include only normalrecurring adjustments, necessary to present fairly the Company's financial positionand its results of operations and its cash flows for the three and nine monthperiods ended September 30, 2001 and 2000. Certain financial statement items have been reclassified to conform tothe current year presentation.  Thesereclassifications had no impact on previously reported net loss.  Operating results for the interim periodspresented are not necessarily indicative of the results that may be expectedfor the fiscal year or any future interim period.

             Theseinterim financial statements should be read in conjunction with the annualaudited financial statements included in the Company’s Annual Report on Form10-K (File No. 000-31147) filed with the Securities and Exchange Commission(the “SEC”) on April 2, 2001.

**3.  Net Loss Per Share**

             Basicearnings per share is calculated based on the weighted-average number of commonshares outstanding during the period. Diluted earnings per share would giveeffect to the dilutive effect of common stock equivalents consisting of stockoptions and warrants.  Dilutivesecurities of 7.9 million and 3.3 million have been excluded from the dilutedearnings per share calculations for the periods ended September 30, 2001 and2000, respectively, as they have an antidilutive effect due to the Company'snet losses.             A reconciliation of sharesused in the calculations is as follows:
|                                                                         |   | **Three Months Ended  September 30,** |       | **Nine Months Ended  September 30,** |       |
|------------------------------------------------------------------------------|--------|---------------------------------------|------------|--------------------------------------|------------|
| **(in  thousands, except per share data)**                                   |   | **2001**                              |       | **2000**                             |       | **2001** |   | **2000** |   |
|                                                                         |   |                                  | ** ** |                                 | ** ** |   | ** ** |   | ** ** |
|                                                                         |   |                                  | ** ** |                                 | ** ** |   | ** ** |   | ** ** |
| Basic  and diluted:                                                          |   |                                  |       |                                 |       |   |   |   |   |
| Net  loss                                                                    |   | $                                     | (14,634    | )                                    | $          | (8,589 | ) | $ | (33,565 | ) | $ | (24,748 | ) |
| Deemed  dividend related to beneficial conversion feature of preferred stock |   | -                                     |       | -                                    |       | - |   | (22,360 | ) |
|                                                                         |   |                                  |       |                                 |       |   |   |   |   |
| Net  loss attributable to common stockholders                                |   | $                                     | (14,634    | )                                    | $          | (8,589 | ) | $ | (33,565 | ) | $ | (47,108 | ) |
|                                                                         |   |                                  |       |                                 |       |   |   |   |   |
| Weighted  average shares of common stock outstanding                         |   | 30,303                                |       | 21,217                               |       | 29,971 |   | 9,522 |   |
| Less:  Weighted average shares subject   to repurchase                  |   | (799                                  | )          | (1,780                               | )          | (1,012 | ) | (1,190 | ) |
|                                                                         |   |                                  |       |                                 |       |   |   |   |   |
| Weighted  average shares used in basic and diluted net loss per share        |   | 29,504                                |       | 19,437                               |       | 28,959 |   | 8,332 |   |
|                                                                         |   |                                  |       |                                 |       |   |   |   |   |
| Net  loss per share attributable to common stockholders                      |   | $                                     | (0.50      | )                                    | $          | (0.44 | ) | $ | (1.16 | ) | $ | (5.65 | ) |
|                                                                         |   |                                  |       |                                 |       |   |   |   |   |
|                                                                              |        |                                       |            |                                      |            |  |  |  |  |  |  |  |  |  |

**4.  Commitments andContingencies**

             OnMay 24, 2000, Lexicon Genetics Incorporated filed a lawsuit against theCompany in the United States District Court for the District of Delaware. Thecomplaint in the lawsuit  alleged thatthe Company's methods of making knockout mice infringed United States PatentNo. 5,789,215 (the '215 patent), under which Lexicon  claimed to be an exclusive licensee. The complaint  sought a judgment that the Company infringedthis patent, a permanent injunction against further infringement of the patentand an award of damages in an unspecified amount that, under certaincircumstances,  could be trebled. OnJune 13, 2000, the Company responded to Lexicon's complaint by filing ananswer and seeking a declaratory judgment in its favor. On October 31,2000, an Order was entered by the Court amending the complaint and addingGenPharm International, the patentee of the '215 patent, as a plaintiff. OnNovember 14, 2000, Deltagen filed an answer as well as federal antitrustcounterclaims under the Sherman Antitrust Act against Lexicon and GenPharm,alleging that Lexicon asserted a fraudulently procured patent (the '215 patent)against Deltagen in an attempt to illegally monopolize the market forproduction and sale of knockout mice, a violation of Section 2 of the ShermanAct. The counterclaim  asserted thatLexicon knew that the '215 patent was obtained by fraud and that the patent wasinvalid when it brought suit against Deltagen. The antitrust counterclaimalso  charged Lexicon and GenPharm withconspiracy to monopolize the market for knockout mice, in violation of Section2 of the Sherman Act, as well as with concerted conduct in restraint of trade,in violation of Section 1 of the Sherman Act. The counterclaim  sought damages, including lost profits, devaluationof the initial public offering and legal fees, as well as a trebling of damagespursuant to Section 4 of the Clayton Act. In addition, the answer  sought a declaratory judgment thatDeltagen  did not infringe the claims ofthe '215 patent and that the patent  wasinvalid. The answer also  asserted thatthe patent was obtained by knowing and willful fraud on the United StatesPatent and Trademark Office, rendering the patent unenforceable.             On October 13, 2000,Lexicon and the University of Utah Research Foundation filed a lawsuit againstthe Company in the United States District Court for the Northern District ofCalifornia. The complaint in this lawsuit alleged that the Company  was infringing United States Patents Nos.5,631,153; 5,464,764; 5,627,059 and 5,487,992 (the Capecchi patents), underwhich Lexicon  claimed to be anexclusive licensee. All of these patents relate to the use of apositive-negative selection vector in gene targeting. The complaint sought ajudgment that the Company infringed these patents, a preliminary and permanentinjunction against further infringement of the patents and an award of damagesin an unspecified amount that, under certain circumstances,  could be trebled. On November 8, 2000,the Company filed an answer denying infringement, and a counterclaim seeking adeclaratory judgment that the patents were invalid. The counterclaim sought anaward of damages including attorney fees.

             OnSeptember 20, 2001, the Company and Lexicon announced the settlement of thelitigation. Under the terms of the settlement, the Company obtained acommercial license under the ‘215 patent and the Capecchi patents, Lexiconobtained a subscription to the Company's DeltaBase TM product, and all of theclaims and counterclaims in the litigation were dismissed with prejudice.  Lexicon's subscription to DeltaBase includesnon-exclusive, perpetual licenses to the drug targets currently represented inDeltaBase and the drug targets that are to be added to DeltaBase over the nextfour years.  Lexicon will make certainmilestone and royalty payments to the Company for any therapeutic anddiagnostic products developed from Lexicon’s use of DeltaBase.  The Company will make payments to Lexiconfor any knockout mice generated by the Company on a fee-for-service basis.  Neither the Company nor Lexicon will pay theother party any subscription or license fees.

 

**Operating Leases**

             InJuly 2001, the Company leased facilities in Redwood City, California underoperating leases which expire in July 2010. Under the terms of the leases, the Company is responsible for 100% ofthe operating expenses, tenants share of common area, tenants share ofutilities and tax expenses. In conjunction with the lease agreements, twostandby letters of credit totaling $2,201,481 were issued in July 2001 with afinancial institution, in favor of the landlords, as collateral for thefulfillment of the contract obligations. The letters of credit arecollateralized by cash deposits of the same amount and will be automaticallyrenewed on an annual basis, unless notice of cancellation is provided 30 daysin advance.

             Futureminimum lease payments related to these leases are as follows (in thousands): 

| Three  months ending December 31, 2001 |   | $      | 740    |   |
|----------------------------------------|--------|--------|--------|--------|
| Year  Ending December 31,              |   |   |   |
| 2002                                   |   | 6,091  |   |
| 2003                                   |   | 6,887  |   |
| 2004                                   |   | 7,120  |   |
| 2005                                   |   | 7,307  |   |
| Later  years                           |   | 35,404 |   |
|                                   |   |   |   |
| Total                                  |   | $      | 63,549 |   |
|                                   |   |   |   |

**5.**          **Research and Development Collaborations and LicenseAgreements**

                          OnAugust 1, 2001, the Company entered into an agreement with Eli Lilly andCompany (“Lilly”) to evaluate, and potentially develop and commercializetherapeutic secreted proteins.  Underthe terms of the agreement, Lilly will provide targets from its secretedprotein pipeline for which the Company will further evaluate the therapeutic potentialof such secreted proteins in mammalian models. Each company may select secreted proteins for commercial developmentwith each company receiving royalties based on sales of therapeuticproducts.  The agreement provides Lillywith certain acquisition, co-promotion, co-marketing and profit sharing optionswith respect to therapeutic products developed and commercialized by theCompany.  The agreement also providesthe Company with certain co-promotion, co-development and profit sharingopportunities.

**6.**          **Acquisition**

             On July 30, 2001, the Companyacquired Arcaris, Inc. (“Arcaris”). Located in Salt Lake City, Utah, Arcarishas developed technologies consisting of genetic, proteomic and cell-biologicalsystems for identification and validation of drug targets and the creation ofsmall molecule screens.  The total purchase price of approximately $7.9million consisted of cash of $450,323 and 766,894 shares of common stock valuedat $6,750,201 and 77,329 vested stock options valued at $418,328 and directacquisition costs of $280,453. Further, the Company may be required to issue upto an additional 516,000 shares of common stock pursuant to the terms ofcertain earn out provisions.  Theacquisition was accounted for using the purchase method of accounting. Accordingly, the results of operations of Arcaris and estimated fair value ofassets acquired and liabilities assumed were included in the Company’sconsolidated financial statements as of July 30, 2001 through September 30,2001.  The Arcaris acquisition adds anew technology platform to the Company's existing high-throughput efforts toidentify and validate small molecule targets relevant to small molecule drugscreening.  The information generatedthrough the Arcaris technologies will be utilized to advance the discovery ofnew disease targets by defining the role of novel non-traditional targetswithin intracellular pathways with particular relevance to oncology, viral andinfectious diseases.  Additionally, theArcaris technologies will be used to facilitate the rapid development of smallmolecule screens against these identified targets.

Thetotal purchase price was allocated to the estimated fair value of assetsacquired and liabilities assumed based on independent appraisals and managementestimates as follows (in thousands):
| Tangible net assets acquired:                      |   |   |   |
|----------------------------------------------------|--------|--------|--------|
| Accounts receivable, net                           |   | $      | 8      |   |
| Prepaid expenses and other current  assets         |   | 81     |   |
| Property and equipment, net                        |   | 2,231  |   |
| Other assets                                       |   | 55     |   |
| Accounts payable and accrued  liabilities          |   | (1,129 | )      |
| Tangible net assets acquired                       |   |   | 1,246  |   |
| Acquired in-process research and  development      |   | 907    |   |
| Completed technology                               |   | 4,040  |   |
| Excess of purchase price over net  assets acquired |   | 1,706  |   |
| Total purchase price                               |   | $      | 7,899  |   |
|                                               |   |   |   |

In connection with the purchase ofArcaris, the Company recorded a $907,000 charge to in-process research anddevelopment.  The amount was determined by identifying research projectsfor which technological feasibility had not been established and no alternativefuture uses existed.  The value of the projects identified to be in progresswas determined by estimating the cost to recreate the technology and the futurecash flows from the projects once commercially feasible, discounting the netcash flows back to their present value and then applying a percentage ofcompletion to the calculated value.  The net cash flows from theidentified projects are expected to commence at various times in 2002, and werebased on estimates of revenues, cost of revenues, research and developmentcosts, selling, general and administrative costs and applicable income taxesfor the projects.  The percentage of completion for the projects wasdetermined based on man months expended to date as a percentage of totalproject man months for the project. The discount rates used in the presentvalue calculations were typically derived from a weighted-average cost ofcapital analysis based upon comparable public companies, adjusted upward toreflect additional risks inherent in the development life cycle. Such discountrates ranged between 22% and 27% for all projects. Development of thetechnologies remains a substantial risk to the Company due to factors includingthe remaining effort to achieve technological feasibility, rapidly changingcustomer markets and competitive threats from other companies.

 

The amount allocated to completedtechnology is being amortized over their estimated useful life of three yearsusing the straight-line method.

 

The amount of the purchase price in excess of thenet assets acquired was recorded as goodwill and will be periodically evaluatedfor impairment in accordance with FAS 142.

 

The following unaudited pro forma summary isprovided for illustrative purposes only and is not necessarily indicative ofthe consolidated results of operations for future periods or that actuallywould have been realized had the Company and Arcaris been a consolidated entityduring the periods presented. The summary combines the results of operations asif Arcaris had been acquired as of the beginning of the periods presented.  The impact of certain acquisitionadjustments such as amortization of completed technology and the charge relatedto the write-off of the acquired in-process research and development has beenexcluded from the periods presented as they arose from the acquisition ofArcaris.

 
|                                       | **Three  Months Ended  September 30,** |    | **Nine  Months Ended  September 30,** |   |
|--------------------------------------------|----------------------------------------|---------|---------------------------------------|--------|
|                                       | **2001**                               |    | **2000**                              |   | **2001** |   | **2000** |   |
| **(In  thousands, except per share data)** | **(unaudited)**                        |    | **(unaudited)**                       |   |
|                                       |                                   |    |                                  |   |   |   |   |   |
| Revenues                                   | $                                      | 2,375   |                                  | $      | 255 |   | $ | 7,630 |   | $ | 831 |   |
| Net  loss                                  | $                                      | (13,704 | )                                     | $      | (9,887 | ) | $ | (35,399 | ) | $ | (51,480 | ) |
| Basic  and diluted EPS                     | $                                      | (0.46   | )                                     | $      | (0.49 | ) | $ | (1.20 | ) | $ | (5.66 | ) |

**             7.          PropertyPlant and Equipment Financing**

             InAugust 2001, the Company's wholly-owned Deltagen Europe S.A. subsidiary enteredinto a lease purchase arrangement associated with the construction of aresearch and development facility in France. Under the terms of thearrangement, the Company paid $1.5 million for the purchase of land and paidapproximately $700,000 in security deposits in conjunction with a ten-yearfinancing arrangement that provides approximately $6.2 million in funds forconstruction of a 50,000 square-foot research and development building. Theland and security deposits are collateral for the loan. The loans were providedby a consortium of banks and local governmental agencies. The loans bearinterest at the average monthly money market rates plus 1.5% duringconstruction.  Once construction iscompleted, approximately $2.7 million of the loan bears interest at thethree-month Euro Interbank Offered Rate, plus 1.5% and approximately $3.5million bears interest at 1.5%.

             **8.**          **RecentAccounting Pronouncements**

InJuly 2001, the Financial Accounting and Standards Board (“FASB”) issuedStatements of Financial Accounting Standards No. 141 (“SFAS 141”), “BusinessCombinations,” and No. 142 (“SFAS 142”), “Goodwill and Other IntangibleAssets.”  SFAS 141 requires that allbusiness combinations initiated after June 30, 2001 be accounted for under asingle method—the purchase method.  Useof the pooling-of-interests method is no longer permitted.  SFAS 142 requires that goodwill no longer beamortized to earnings, but instead be reviewed for impairment upon initialadoption of the Statement and on an annual basis going forward.  The amortization of goodwill will cease uponadoption of SFAS 142.  The provisions ofSFAS 142 will be effective for fiscal years beginning after December 15, 2001.The Company has adopted the provisions of SFAS 142 in connection with theacquisition of Arcaris, Inc.

             In October 2001, the FASB issued Statementof Financial Accounting Standards No. 144 (“SFAS 144”), “Accounting for theImpairment or Disposal of Long-Lived Assets,” which is effective for fiscalyears beginning after December 15, 2001 and interim periods within those fiscalperiods.  SFAS 144 supersedes FASBStatement No. 121 and APB Opinion No. 30, however, it retains the requirementof Opinion No. 30 to report discontinued operations separately from continuingoperations and extends that reporting to a component of an entity that eitherhas 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 andreporting for the impairment of certain long-lived assets and for long-livedassets to be disposed of.  The Companybelieves that SFAS 144 will not have a material impact on the financialposition or results of operations of the Company.

 

**9.**          **Subsequent Events**

 

**Researchand Development Collaborations and License Agreements**

OnOctober 9, 2001, the Company entered into a collaboration agreement with Hyseq,Inc. (“Hyseq”) to research, develop and commercialize biopharmaceuticalproducts.  Under the terms of theagreement, Hyseq will provide the Company with gene sequences encoding secretedproteins and the Company will utilize its proprietary in vivo mammalian geneknockout technology to discover and validate potential commercially relevantbiopharmaceutical drug targets. The Company and Hyseq will each have certainjoint development and commercialization rights around potentialbiopharmaceutical drug targets discovered through the collaboration. TheCompany and Hyseq will share the collaboration's costs; Hyseq will provide theCompany with approximately $10 million in research and development paymentsover two years.  In addition, theCompany received $10 million in equity proceeds from the sale of 1,508,978shares of the Company's common stock at a price of $6.63 per share to George B.Rathmann, Ph.D., chairman of the Board of Directors of Hyseq.

 

**Item 2. **            **Management's Discussion and Analysis of FinancialConditions and Results of Operations**

 

INFORMATION REGARDING FORWARD-LOOKINGSTATEMENTS

 

             This report containsforward-looking statements.  Theforward-looking statements are contained principally in this section entitled"Management's Discussion and Analysis of Financial Condition and Resultsof Operations."  These statementsinvolve known and unknown risks, uncertainties and other factors which maycause our actual results, performance or achievements to be materiallydifferent from any future results, performances or achievements expressed orimplied by the forward-looking statements. Forward-looking statements include, but are not limited to, statementsabout:

•            limitations in the drug discoveryprocess;

•            the capabilities, development andmarketing of our products and services;

•            the benefits of knockout miceprograms and, in particular, our technology and methods;

•            the requirements of pharmaceuticaland biotechnology companies;

•            our future revenues and profitability;

•            our estimates regarding our capitalrequirements and needs for additional financing;

•            plans for future products andservices and for enhancements of existing products and services;

•            our patent applications, licensedtechnology and proposed patents;

•            our ability to attract customers andestablish licensing and other agreements; and

•            sources of revenues and anticipatedrevenues, including contributions from customers, license agreements andother  collaborative efforts for thedevelopment and commercialization of products, and the continued viability andduration of those agreements and efforts.

             Thisreport contains statistical data regarding the biotechnology and pharmaceuticalindustries that we obtained from private and public industry publications.  These publications generally indicate thatthey have obtained their information from sources believed to be reliable, butdo not guarantee the accuracy and completeness of their information.  Although we believe that the publicationsare reliable, we have not independently verified their data.

             Insome 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 similarexpressions intended to identify forward-looking statements.  These statements reflect our current viewswith respect to future events and are based on assumptions and subject to risksand uncertainties.  Given theseuncertainties, you should not place undue reliance on these forward-lookingstatements.  We discuss many of theserisks in this report in greater detail under the heading "RiskFactors."  Also, theseforward-looking statements represent our estimates and assumptions only as ofthe date of this report.

             Youshould read this report and the documents that we reference in this reportcompletely and with the understanding that our actual future results may bematerially different from what we expect. We qualify all of our forward-lookingstatements by these cautionary statements.

             YOUSHOULD READ THE FOLLOWING DISCUSSION AND ANALYSIS IN CONJUNCTION WITH OURFINANCIAL STATEMENTS AND THE ACCOMPANYING NOTES TO THE FINANCIAL STATEMENTS.

**Overview**

             Deltagenwas formed in 1997 and is a leading provider of genomics-based information,products and programs that are used to discover drug targets and drugcandidates and to accelerate pharmaceutical and biotechnology drug and productdevelopment. We research, develop and use technologies that build upon ourtechnology platforms to discover the function, role, usefulness and diseaserelevance of mammalian genes and secreted proteins in drug discovery anddevelopment. Our technology enables us to select and target genes we believe tobe relevant to disease and delete, or "knock out," these genes inmice. We then use an extensive, integrated analysis program to assess thefunction and potential pharmaceutical relevance of these genes and the proteinsthese genes encode. We believe that our technology allows us to knock out genesin mice and to make discoveries on the mammalian function, role, usefulness anddisease relevance of genes and secreted proteins in drug discovery faster andon a larger scale than has been previously possible.             We are implementing astrategy to integrate our;

•            Data and information generated fromour knockout animal models

•            Mammalian gene function and secretedprotein discoveries

•            Commercialization of theintellectual property we generate on the use of mammalian genes and secretedproteins in drug development through alliances and collaborations with othersand our own internal products and programs

•            Generation of information, productsand services for pharmaceutical and biotechnology drug discovery efforts

•            Development and expansion of our ownproducts and programs in collaboration with other companies and through our owninternal programs

             Wehave established collaborations and relationships with major pharmaceutical andbiotechnology companies worldwide to accelerate the discovery of and tocommercialize therapeutic and diagnostic products to improve human and animalhealth. These companies include Eli Lilly and Company, GlaxoSmithKline plc,Hyseq, Inc., Lexicon Genetics Incorporated, Merck & Co., Inc.,Pfizer Inc., Schering-Plough Research Institute and Vertex PharmaceuticalsIncorporated.

             Webelieve that our ability to determine gene function, to develop products and toidentify potential drug candidates results from leveraging our powerfultechnology platforms. Our genomics technologies, processes and informationsystems are fully integrated with one another and rapidly generate informationon the function of and relationships between genes and the proteins these genesencode and the usefulness of genes as new drug targets and proteins as new drugcandidates.             We have used these systems toestablish our products and programs that include our

•            Large-scale program to generatemammalian gene knockout animals and to discover gene function

•            DeltaBase(TM) portfolioof gene knockout animal models and mammalian gene function data analysis andmanagement database

•            DeltaXpress(TM)microarray-based mammalian gene knockout expression data program

•            Mammalian gene knockout secretedprotein discovery programs, including our Delta-GT(TM) secreted genetrap program

•            Internal early-stagebiopharmaceutical product development programs, including our CD123 antigenprogram in-licensed as a potential treatment for acute myelogenous leukemia(AML)

             Todate, we have generated revenue from our DeltaBase and DeltaSelect(TM)programs.

             DeltaBaseis our database that provides information, based on knockout mouse studies, ongene function and validated gene targets for drug discovery. We createdDeltaBase to be marketed to the pharmaceutical and biotechnology industries tohelp define the role that genes play in biological processes and disease. Atour current rate of production, we expect to provide gene function and targetvalidation information through DeltaBase on approximately 250 differentmammalian genes per year. We select genes for DeltaBase based upon what webelieve to be their potential to become useful drug targets. We generateinformation on these genes by comprehensively analyzing knockout mice generatedthrough our proprietary gene knockout methods. Each knockout mouse undergoes astandardized, detailed and extensive analysis in order to determine thefunction and role that a particular gene plays in the mouse and that gene'ssuitability as a drug target. We currently intend that DeltaBase will deliver atotal of approximately five million individual in vivo function data points peryear. In addition to accessing target validation data, DeltaBase subscriberswill have access to the knockout mice used to generate this data.

             TheDeltaSelect program was our initial product. Customers received targetvalidation information for selected genes on a fee-for-service basis. Thisprogram was provided to validate our proprietary technology and promoteinterest in the DeltaBase product that became available in 2000. DeltaSelectwill now be utilized to develop new technologies and programs in collaborationwith pharmaceutical companies.

             We have DeltaBase agreements withboth GlaxoSmithKline plc and Pfizer Inc. Each of these agreements provides forpayments aggregating $15 million over three years. In addition, we may receiveadditional fees for access to our intellectual property.  On May 7, 2001, the Company entered into itsfirst GeneClass DeltaBase subscription agreement with Vertex PharmaceuticalsIncorporated. Under the GeneClass DeltaBase agreement, Vertex has the right toaccess GeneClass DeltaBase information on gene function and validated genetargets based upon knockout mouse studies. The GeneClass DeltaBase agreementalso grants Vertex non-exclusive, worldwide licenses to knockout mice,materials and intellectual property rights under GeneClass DeltaBase. TheCompany may receive up to an aggregate of $2.9 million in subscriptionlicensing fees over the three-year term of the agreement. In addition, theCompany may receive additional licensing fees for access to its intellectualproperty and additional payments on certain milestones achieved and royaltieson products developed by Vertex, if any, using DeltaBase information, materialsand related intellectual property. In September 2001, Lexicon Genetics became asubscriber to DeltaBase as part of the Company’s litigation settlement withLexicon. Lexicon’s subscription to DeltaBase includes non-exclusive, perpetuallicenses to the drug targets currently represented in DeltaBase and the drugtargets that are to be added to DeltaBase over the next four years. Lexiconpays no subscription fees but will make certain milestone and royalty paymentsto Deltagen for any therapeutic and diagnostic products developed fromLexicon’s use of DeltaBase.

             In thefirst nine months of 2000, we derived all of our revenue from the developmentand analysis of knockout mice under our DeltaSelect program. We anticipate thata significant portion of our future revenues will be derived from periodiclicensing fees under agreements with DeltaBase subscribers.
|            |   | **For  the Three Months** |       | **For  the Nine months** |       |
|-----------------|--------|---------------------------|------------|--------------------------|------------|
| **Revenue:**    |   | **Ended  September 30,**  |       | **Ended  September 30,** |       |
| (in  thousands) |   | **2001**                  |       | **2000**                 |       | **2001** |   | **2000** |   |
|            |   |                      | ** ** |                     | ** ** |   | ** ** |   | ** ** |
| DeltaSelect     |   | $                         | 129        |                     | $          | 206 |   | $ | 995 |   | $ | 760 |   |
| DeltaBase       |   | 2,136                     |       | -                        |       | 6,456 |   | - |   |
|            |   |                      |       |                     |       |   |   |   |   |
| Total           |   | $                         | 2,265      |                     | $          | 206 |   | $ | 7,451 |   | $ | 760 |   |
|            |   |                      |       |                     |       |   |   |   |   |

             Underour revenue recognition policy, revenues are recognized when persuasiveevidence of an arrangement exists, delivery has occurred or services have beenrendered and meet all customer-specified criteria, the price is fixed anddeterminable and collectibility is reasonably assured. Revenue derived fromDeltaBase agreements is recognized on a straight-line basis over the term inwhich services are to be provided. Research and development collaborationagreements specify milestones to be met and the payments associated withmeeting each milestone. Revenue derived from these contracts is recognized uponcompletion of the milestone. The amount of revenue recognized upon completionof each milestone is such that the earned revenue, as a percentage of totalanticipated revenue, approximates the costs incurred in achieving the relatedmilestone, as a percentage of the total anticipated costs. Where the contractdoes not specify milestones and payment is upon completion of the contract,revenue is recognized based on the percentage-of-completion method ofaccounting. Any payments received in advance of the completion of a milestoneor services performed are recorded as deferred revenue.

             Wehad net losses of $33.6 million and $24.7 million for the nine months endedSeptember 30, 2001 and 2000, respectively. The net loss attributable to commonstockholders for the nine months ended September 30, 2000, was $47.1 million,after a deemed dividend of $22.4 million relating to a beneficialconversion feature on our Series C redeemable convertible preferred stock.Our losses have resulted primarily from costs incurred in connection withresearch and development activities, from selling, general and administrativecosts associated with our operations and non-cash charges for amortization ofunearned stock-based compensation costs. This amortization was $3.0 million and$9.0 million for the nine months ended September 30, 2001 and 2000,respectively. Research and development expenses consist primarily of salariesand related personnel costs, material costs, legal expenses resulting fromintellectual property filings and other expenses related to the development ofour DeltaBase, DeltaSelect and secreted protein programs. We expense ourresearch and development costs as they are incurred. Selling, general andadministrative expenses consist primarily of salaries and related expenses forexecutive, finance and other administrative personnel, professional and othercorporate expenses including business development, marketing, litigation costsand general legal activities. In connection with the development and expansionof our gene function and gene expression databases and our secreted proteinprogram, we expect to incur increasing research and development and selling,general and administrative costs. As a result, we will need to generatesignificantly higher revenues to achieve profitability. We expect to reportsubstantial net losses through the next several years.

             Weaccount for stock-based employee compensation arrangements in accordance withprovisions of Accounting Principles Board Opinion No. 25 (APB No. 25),"Accounting for Stock Issued to Employees"; Financial AccountingStandards Board Interpretation No. 44 (FIN No. 44), "Accounting forCertain Transactions Involving Stock Compensation—An Interpretation of APB No.25"; and Financial Accounting Standards Board Interpretation No. 28 (FINNo. 28), "Accounting for Stock appreciation Rights and Other VariableStock Option or Award Plans," and comply with the disclosure provisions ofStatement of Financial Accounting Standards No. 123 (SFAS No. 123),"Accounting for Stock-Based Compensation."

             UnderAPB No. 25, compensation expense is based on the difference, if any, on thedate of the grant, between the fair value of our stock and the exercise price.SFAS No. 123 defines a "fair value" based method of accounting for anemployee stock option or similar equity investment.             We account for equityinstruments issued to non-employees in accordance with the provisions of SFASNo. 123 and Emerging Issues Task Force Issue No. 96-18 (EITF No. 96-18),"Accounting for Equity Instruments That Are Issued to Other Than Employeesfor Acquiring, or in Conjunction with Selling, Goods or Services."

             Werecorded approximately $12.9 million of unearned stock-based compensationduring the nine months ended September 30, 2000.  These amounts are being amortized as charges to operations overthe respective vesting period of the individual stock options, generally fouryears.

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

**Acquisition of Arcaris, Inc.**

             OnJuly 30, 2001, the Company acquired Arcaris, Inc. (“Arcaris”). Located in SaltLake City, Utah, Arcaris has developed technologies consisting of genetic,proteomic and cell-biological systems for identification and validation of drugtargets and the creation of small molecule screens.  The total purchaseprice of approximately $7.9 million consisted of cash of $450,323 and 766,894shares of common stock valued at $6,750,201 and 77,329 vested stock optionsvalued at $418,328 and direct acquisition costs of $280,453. Further, theCompany may be required to issue up to an additional 516,000 shares of commonstock pursuant to the terms of certain earn out provisions.  The acquisition was accounted for using thepurchase method of accounting.  Accordingly, the results of operations ofArcaris and estimated fair value of assets acquired and liabilities assumedwere included in the Company’s consolidated financial statements as of July 30,2001 through September 30, 2001.  TheArcaris acquisition adds a new technology platform to the Company's existinghigh-throughput efforts to identify and validate small molecule targetsrelevant to small molecule drug screening. The information generated through the Arcaris technologies will beutilized to advance the discovery of new disease targets by defining the roleof novel non-traditional targets within intracellular pathways with particularrelevance to oncology, viral and infectious diseases.  Additionally, the Arcaris technologies will be used to facilitatethe rapid development of small molecule screens against these identified targets.

**Results of Operations**

             Total contract revenue increased to$2,265,000 for the three months ended September 30, 2001 from $206,000 for thecomparable period in 2000.  DeltaBaserevenue was $2,136,000 for the three months ended September 30, 2001.  There were no DeltaBase revenues during thethree months or nine months ended September 30, 2000.  DeltaSelect revenues decrease by $77,000 to $129,000 for thethree months ended September 30, 2001 from $206,000 for the comparable periodin 2000.  Total contract revenues forthe nine months ended September 30, 2001 and 2000 were $7.5 million and$760,000, respectively.  DeltaBaserevenue was $6.5 million for the nine months ended September 30, 2001.  DeltaSelect revenues increased by $235,000to $995,000 for the nine months ended September 30, 2001 from $760,000 for thecomparable period in 2000.  In the firstnine months of 2000, all of our revenue came from DeltaSelect contracts withMerck & Co., Inc., Pfizer Inc., Schering-Plough ResearchInstitute and Tularik Inc.

             Researchand development expenses were $13.1 million for the three months endedSeptember 30, 2001 and  $7.0 million forthe comparable period in 2000. Research and development expenses for the ninemonths ended September 30, 2001 and 2000 were $31.7 million and $19.5 million,respectively.  Excluding amortization ofunearned stock-based compensation expenses, research and development expensesincreased by $6.9 million to $12.4 million for the three months ended September30, 2001 from $5.5 million in the comparable period of 2000.  This increase was primarily attributable tocontinued growth of research and development activities, including$2.0 million related to increased personnel, $907,000 related toin-process research and development expensed as part of the acquisition ofArcaris, $224,000 related to the amortization of intangible assets, $1.4million related to increased laboratory supply costs to support development ofour gene function database and our DeltaSelect and secreted protein programsand $1.4 million in higher depreciation and amortization and facilitiesexpenses.

             Selling,general and administrative expenses were $4.5 million for the three monthsended September 30, 2001 and $2.8 million for the comparable period of 2000. Selling, general andadministrative expenses for the nine months ended September 30, 2001 and 2000were $12.7 million and $7.3 million, respectively.  Excluding amortization of unearned stock-based compensationcosts, selling, general and administrative expenses increased by $2.7  million to $4.1 million for the three monthsended September 30, 2001 from $1.4 million in the comparable period of2000.  This increase included $1.5 millionrelated to staffing and infrastructure costs, $463,000 related to marketing andadvertising costs and $653,000 related to legal and professional fees.

             Wehad net interest income of $653,000 and $1.0 million for the three months endedSeptember 30, 2001 and 2000, respectively. This decrease is due to lower average investment balances and lowerinterest rates. Interest income for the nine months ended September 30, 2001and 2000 were $3.3 million and $1.2 million, respectively.  This increase resulted from increased cashand investment balances as a result of the completion of our initial publicoffering in August 2000.

**Liquidity and Capital Resources**

             AtSeptember 30, 2001, we had $81.0 million in cash and cash equivalents andshort-term investments. Cash and cash equivalents were $71.0 million atSeptember 30, 2001 compared to $93.4 million at December 31, 2000. We used$31.1 million for operating activities during the first nine months of2001.  This consisted primarily of thenet loss for the period of $33.6 million offset in part by non-cash charges of$1.9 million related to depreciation and amortization expenses and  $3.0 million related to the amortization ofunearned stock-based compensation.   Wereceived $7.7 million from investing activities during the first nine months of2001.  This consisted of $55.0 millionfrom the maturities of short-term investments offset in part by the purchase ofshort-term investments of $39.4 million, $4.8 million used for capitalexpenditures and restricted cash deposits of $2.7 million.  We received $1.0 million from financingactivities during the first nine months of 2001.  This consisted primarily of $2.5 million in net loan proceedspartially offset by $1.5 million of loan repayments.

We expect to devote substantial capitalresources for facilities and equipment to support expansion of our research anddevelopment efforts, to expand our sales and marketing organization and forother general corporate activities. We believe that our current cash andshort-term investment balances, together with revenues we believe will bederived from subscriptions to our gene function database and collaborativeresearch agreements, will be sufficient to fund our operations through at least2003. During or after this period, if cash generated by operations isinsufficient to satisfy our liquidity requirements or we make acquisitions orother investments, we may need to sell additional equity or debt securities orobtain additional credit arrangements. Additional financing may not beavailable on terms acceptable to us or at all. The sale of additional equity orconvertible debt securities may result in additional dilution to ourstockholders. Any debt financing may have restrictive covenants that adverselyaffect our operating plans and flexibility.

             Deltagenhas not paid any cash dividends on its common stock in the past. We currentlyintend to retain any earnings for use in the business and do not anticipatepaying any cash dividends on our common stock in the foreseeable future.

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

**Recent Accounting Pronouncements**

In July 2001, the Financial Accountingand Standards Board (“FASB”) issued Statements of Financial AccountingStandards No. 141 (“SFAS 141”), “Business Combinations,” and No. 142 (“SFAS142”), “Goodwill and Other Intangible Assets.” SFAS 141 requires that all business combinations initiated after June30, 2001 be accounted for under a single method—the purchase method.  Use of the pooling-of-interests method is nolonger permitted.  SFAS 142 requiresthat goodwill no longer be amortized to earnings, but instead be reviewed forimpairment upon initial adoption of the Statement and on an annual basis goingforward.  The amortization of goodwillwill cease upon adoption of SFAS 142. The provisions of SFAS 142 will be effective for fiscal years beginningafter December 15, 2001. The Company has adopted the provisions of SFAS 142 inconnection with the acquisition of Arcaris, Inc.

In October 2001, the FASB issued Statementof Financial Accounting Standards No. 144 (“SFAS 144”), “Accounting for theImpairment or Disposal of Long-Lived Assets,” which is effective for fiscalyears beginning after December 15, 2001 and interim periods within those fiscalperiods.  SFAS 144 supersedes FASBStatement No. 121 and APB Opinion No. 30, however, it retains the requirementof Opinion No. 30 to report discontinued operations separately from continuingoperations and extends that reporting to a component of an entity that eitherhas 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 andreporting for the impairment of certain long-lived assets and for long-livedassets to be disposed of.  The Companybelieves that SFAS 144 will not have a material impact on the financialposition or results of operations of the Company. **RISK FACTORS**

**We expect to continue to incur substantial losses and we maynever achieve profitability, which in turn may harm our future operatingperformance and may cause the market price of our stock to decline.**

             Wehave had net losses every year since our inception in 1997 and, as of September30, 2001, had an accumulated deficit of $84.2 million. We had net lossesof $33.6 million and $24.7 million in for the nine months endedSeptember 30, 2001 and 2000, respectively. The net loss for the nine monthsended September 30, 2000 is before a $22.4 million deemed dividend relatedto the beneficial conversion of our preferred stock. Because we anticipatesignificant expenditures for our research and development programs and for thedevelopment, implementation and support of our gene function database, weexpect to report substantial net losses through at least the next several years.We may never achieve profitability. If we do not become profitable within thetime frame expected by securities analysts or investors, the market price ofour stock will likely decline. If we do achieve profitability, we may notsustain or increase profitability in the future.

             Weexpect that our expenditures will continue to increase, 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 and our secreted protein programs; and |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                              |
|   | • | our  increasing investment in management and other employees, sales and marketing  programs, customer service and operational and financial controls.                                                                                                                                                             |

**We are a newly public company with an unproven businessstrategy, and our limited history of operations makes evaluation of ourbusiness and prospects difficult.**

             Wehave had a limited operating history and are at an early stage of development.Our strategy of offering a gene function database and using knockout mice toenable our customers to pursue promising candidates for drug target developmentis unproven. Additionally, our pricing models for offering our products andservices are unproven. We currently have four subscribers for our gene functiondatabase. We have generated only limited revenues amounting to approximately$2.1 million, $1.2 million and $381,000 for the fiscal years ended2000, 1999 and 1998, respectively. For the nine months ended September 30, 2001and 2000 we recognized revenues of $7.5 million and $760,000,respectively.  Our success will dependupon, among other things, our ability to enter into licensing and otheragreements on favorable terms, our ability to determine and generateinformation on those genes which have potential use as drug targets and thecommercialization of products using our data. Moreover, we have had littleexperience selling our data and providing a gene database. Our sales force maynot succeed in marketing our database product, and our employees may notsucceed in implementing and operating our database in a manner that issatisfactory to our subscribers. Furthermore, the plans for our secretedprotein and conditional knockout programs are unproven, and we cannot be surethat we will ever be able to develop these programs or that any program that wedevelop will be commercially successful. As a result of these factors, it isdifficult to evaluate our prospects, and our future success is more uncertainthan if we had a longer or more proven history of operations.

**We currently have only six customers and will not succeedunless we can attract many more customers.**

             Wehave only three customers for our DeltaSelect program. One of these customersis also a subscriber to our gene function database. We expect to enter intoonly a limited number of future DeltaSelect agreements. To succeed we mustattract customers for our database and other programs. Our existing and futureagreements may not be renewed and may be terminated without penalty in theevent either party fails to fulfill its obligations under one of theseagreements. Failure to renew or the cancellation of these agreements by one ofour customers could result in a significant loss of revenues. In 2000,GlaxoSmithKline and Schering-Plough accounted for 56% and 18%, respectively, ofour revenues. Our current customers are GlaxoSmithKline, Lexicon Genetics,Pfizer, Merck, Schering-Plough and Vertex Pharmaceuticals.             Over the past several years,companies in the pharmaceutical industry have undergone significantconsolidation. If two or more of our present or future customers merge, we maynot be able to receive the same fees under agreements with the combined entitiesthat we were able to receive under agreements with these customers prior totheir merger. Moreover, if one of our customers merges with an entity that isnot a customer, the new combined entity may prematurely terminate ouragreement. Any of these developments could harm our business or financialcondition.

**Because we have only recently begun to offer our databaseproduct, which we expect to be our principal source of revenue in the next fewyears, our future prospects are uncertain.**

             Webelieve the majority of our revenues will be derived from fees under agreementswith our database users. We may also derive revenues from royalties receivedfrom these users. We have entered into agreements with three subscribers to ourdatabase, however, we cannot be sure of the terms under which we may enter intofuture agreements, such as fees payable to us or the term of the agreements, ifany. Our agreements with GlaxoSmithKline and Pfizer expire three years afterour first delivery of data.

             Ifour database is not acceptable to our prospective customers, it may notgenerate revenues and our business and financial condition will be materiallyharmed.

             Wemay not be able to comply with minimum performance levels or restrictiveprovisions or other obligations that may be contained in any agreements, suchas minimum data delivery requirements. In addition, we may experienceunforeseen technical complications in the processes we use to generatefunctional data for our gene database and functional genomics resources. Thesecomplications could materially delay or limit the use of our gene functiondatabase, substantially increase the anticipated cost of generating data orprevent us from implementing our processes at appropriate quality and scalelevels, thereby causing our business to suffer.

**No drugs have been developed and commercialized usinggenomics-based research and therefore the future of our products and programsis uncertain.**

             Noneof the limited number of drugs developed to date using genomics-based researchhave reached the commercial market. We cannot assure you that genomics-baseddrug development efforts will ultimately be successful. We have not proven ourability either to identify drug targets with commercial potential orcommercialize drug targets that we do identify. We cannot assure you that aparticular gene function in a mouse will have any correlation to a patient'sresponse to a particular drug. It is difficult to successfully select thosegenes with the most potential for commercial development. Furthermore, we donot know that any products based on genes that are the subject of our researchcan be successfully developed or commercialized. If commercial opportunitiesare not realized from genomic-based research, our existing customers could stopusing our products or we could have difficulty attracting or retainingcustomers and, in any event, we would not realize any product royalties.

**Our customers will control the development andcommercialization of products based on genes that we identify, which may meanthat our research efforts will never result in any royalty or milestonepayments or third party product sales.**

             Ouragreements with our customers may provide us with rights to obtain royaltiesfrom the commercial development of compounds or therapeutic approaches derivedfrom access to our database, technology or intellectual property. However, wemay not be able to obtain these rights under future agreements. Our ability toobtain 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 ournegotiating position relative to each potential customer.             We will have limited or nocontrol over the resources that any customer may devote to the development of compoundsor therapeutic approaches derived from our access to our database. Thesecustomers may breach or terminate their agreements with us, and they are notobligated to conduct any product discovery, development or commercializationactivities at all. Further, our customers may decide not to develop productsarising out of our customer agreements or may not devote sufficient resourcesto the development, approval, manufacture, marketing or sale of these products.If any of these events occurs, our customers may not develop or commercializeany products based on our gene function research, technologies or intellectualproperty, we would not receive royalties on product sales and our results ofoperations would suffer. Furthermore, our customers may resist sharing revenuederived from the successful commercialization of a drug through royalty ormilestone payments or others may have competing claims to all or a portion ofsuch revenues.

**There are a finite number of gene families upon whichpharmaceutical and biotechnology companies focus their research, which limitsour potential revenue and growth.**

             Ourcurrent and potential subscribers and customers traditionally focus theirresearch and development efforts on a finite number of gene families that theyview as reliable drug targets. Once we provide functional information on thesegene families, our ability to attract and retain subscribers to our databasewill depend, in part, on the willingness of our subscribers to expand theirresearch and development activities to other gene families. If our customers donot do this, we may lose existing subscribers or fail to attract newsubscribers for our database services, and as a result, our business andfinancial condition may be harmed. In addition, we have made and will continueto make significant investments in our database and knockout programs which wemay not recoup if we cannot find additional target opportunities.

**We may fail to meet market expectations because offluctuations in our quarterly operating results, which could cause our stockprice to decline.**

             Thefollowing are among the factors that could cause our operating results tofluctuate significantly from period to period:

•           changes in the demand for and pricingof our products and services;

•           the nature, pricing and timing ofother products and services provided by us or our competitors;

•           changes in the research anddevelopment budgets of our customers;

•           acquisition, licensing and othercosts related to the expansion of our operations;

•           the timing of milestones, licensingand other payments under the terms of our customer agreements and agreementspursuant to which others license technology to us;

•           expenses related to, and the resultsof, patent filings and other proceedings relating to intellectual propertyrights; and

•           our unpredictable revenue sources asdescribed below.

             Weanticipate significant fixed expenses due in part to our need to continue toinvest in product development and potential extensive support for our genefunction database subscribers. We may be unable to adjust our expenditures ifrevenues in a particular period fail to meet our expectations, which would harmour operating results for that period.             As a result of thesefluctuations, we believe that period-to-period comparisons of our financialresults will not necessarily be meaningful, and you should not rely on thesecomparisons as an indication of our future performance.

**Ourrevenues will be unpredictable and this may harm our financial condition.**

             Theamount and timing of revenues that we may have from our business will beunpredictable because:

•           the timing of our DeltaSelect programagreements, gene function database subscriber agreements and installations aredetermined by our customers and subscribers;

•           whether any products arecommercialized and generate royalty payments depends on the efforts, timing andwillingness of our customers;

•           we do not expect to receive anymilestone or royalty payment under licenses and other arrangements for asubstantial period of time, if ever;

•           to date, we have entered into onlythree customer agreements for our gene function database and may not enter intoany additional agreements;

•           the time required to complete customorders for our database programs can vary significantly; and

•           our sales cycle is lengthy, asdescribed below.

             Asa result, our revenue may significantly vary from quarter to quarter, and ourquarterly results may be below market expectations. If this happens, the priceof our common stock may decline.

**We expect that our sales cycle will be lengthy, which willcause our revenues to be unpredictable and our business to be difficult tomanage.**

             Ourability to identify and obtain subscribers for our gene function databaseproduct and other services depends upon whether customers believe that ourproducts and services can help accelerate drug discovery efforts. Our salescycle will be lengthy because of the need to educate potential customers andsell the benefits of our products and services to a variety of constituencies withinpotential subscriber companies. These companies are large organizations withmany different layers and types of decision-makers. In addition, each databasesubscription and development program or services agreement will involve thenegotiation of unique terms and issues which will take a significant amount oftime. We may expend substantial funds and management effort with no assurancethat a subscription program or services agreement will result. Actual orproposed mergers or acquisitions of our prospective customers may also affectthe timing and progress of our sales efforts. Any of these developments couldharm our business or financial condition.

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

             Wemay pursue opportunities in fields, such as secreted proteins, that couldconflict with those of our customers. Moreover, disagreements could arise withour customers or their partners over rights to our intellectual property or ourrights to share in any of the future revenues of compounds or therapeuticapproaches developed by our customers. These kinds of disagreements couldresult in costly and time-consuming litigation and could have a negative impacton our relationship with existing customers. Any conflict with our customerscould reduce our ability to attract additional customers or enter into futurecustomer agreements. Some of our customers could also become competitors in thefuture. Our customers could develop competing products, preclude us fromentering into agreements with their competitors or terminate their agreementswith us prematurely.**We experience intense competition from other entities engaged in the study ofgenes, and this competition could adversely affect our business.**

             Thehuman and mouse genomes contain a finite number of genes. The human genome hasbeen mapped and identified. Our competitors have identified and will continueto identify the sequence of numerous genes in order to obtain proprietarypositions with respect to those genes. In addition, our competitors may seek toidentify and determine the biological function of numerous genes in order toobtain intellectual property rights with respect to specific uses of thesegenes, and they may accomplish this before we do. We believe that the firstcompany to determine the functions of commercially relevant genes or thecommercially relevant portions of the genome will have a competitive advantage.

             Anumber of companies, institutions and government-financed entities are engagedin gene sequencing, gene discovery, gene expression analysis, gene functiondetermination and other gene-related service businesses. Many of thesecompanies, institutions and entities have greater financial and human resourcesthan we do and have been conducting research longer than we have. Inparticular, a significant portion of this research is being conducted byprivate companies and under the international Human Genome Project, amulti-billion dollar program funded, in part, by the U.S. government, whichcompleted and released its initial rough draft of the human genome in June ofthis year. Furthermore, other entities have and will continue to discover andestablish a patent position in genes or gene sequences that we wish to study.Significant competition also arises from entities using standard targetidentification approaches, traditional knockout mouse technology and otherfunctional genomics technologies. These competitors may have intellectualproperty rights in functional or other data which are superior to our rights.These competitors may also develop products earlier than we do, obtainregulatory approvals faster than we can and invent products and techniques thatare more effective than ours. Furthermore, other methods for conducting functionalgenomics research may ultimately prove more advanced, in some or all respects,to the use of knockout mice. In addition, technologies more advanced than orsuperior to our gene trap technology and gene function identificationtechnology may be developed, thereby rendering our gene trap and gene functionidentification technologies obsolete. As we expand our range of products andservices, such as our secreted protein program, we will compete with additionalcompanies, some of which may be our customers at that time or our potentialcustomers.

             Someof our competitors have developed commercially available databases containinggene sequence, gene expression, gene function, genetic variation or otherfunctional genomics information and are marketing or plan to market their datato pharmaceutical and biotechnology companies. Additional competitors mayattempt to establish databases containing this information in the future. Weexpect that competition in our industry will continue to intensify. We also believethat some pharmaceutical and biotechnology companies are discussing thepossibility of working together to discover the functions of genes and sharegene function-related data among themselves. The formation of this type ofconsortium could reduce the prospective customer base for our genefunction-related business. Moreover, the pharmaceutical industry has undergonesignificant mergers and this trend is expected to continue. This concentrationof the industry could further limit our potential customer base and thereforeharm our business.

**If we fail to properly manage our growth, our business couldbe adversely affected.**

             Weexpect to continue to experience significant growth in the number of ouremployees and the scope of our operations, including an increase in the scaleof our mouse knockout program. As of September 30, 2001, we had approximately330 full-time employees. We expect our number of employees to continue toincrease for the foreseeable future. In addition, we have substantiallyincreased the scale of our knockout mouse production in the last year andexpect to continue doing so for the foreseeable future. Our overall growth andneed to develop many different areas of our company have placed, and maycontinue to place, a strain on our management and operations. If we are unableto manage our growth effectively, our losses could increase. The management ofour growth will depend, among other things, upon our ability to broaden ourmanagement team and attract, hire, train and retain skilled employees. Oursuccess will also depend on the ability of our officers and key employees tocontinue to implement and improve our operational and other systems. We willalso be required to expend funds, which may be substantial, to improve ouroperational, financial and management controls, reporting systems andprocedures.             In addition, we will have toinvest in additional customer support resources. Our current and potentialdatabase subscribers typically have worldwide operations and may requiresupport at multiple U.S. and foreign sites and in multiple languages. Toprovide this support, we may need to open offices in addition to our Menlo Parkand San Carlos, California facilities, which will result in additional burdenson our systems and resources and require additional capital expenditures.

**Ourmerger with Arcaris might not produce the expected benefits.**

             Weoperate in the field of genomics-based information, products and programsmarket.  It may turn out that there areno advantages or “synergies” to adding Arcaris’s research capabilities to ourproduct line and technology platform. Moreover, there is no assurance that Arcaris’s operations can besuccessfully integrated into our operations or that any of the benefitsexpected from such integration will be realized.  Although Arcaris will remain as a separate operating subsidiaryof Deltagen (renamed Deltagen Proteomics, Inc.), we intend to explore theintegration of certain aspects of the operations of Arcaris with ouroperations.  Furthermore, there can beno assurance that the operations, management and personnel of the two companieswill be compatible or that we or Arcaris will not experience the loss of keypersonnel.  The Arcaris acquisitioncould result in the incurrence of contingent liabilities and amortizationexpenses related to intangible assets, which could adversely affect our resultsof operations and financial condition.

**We may engage in future acquisitions, which could adverselyaffect your investment in us as we may never realize any benefits from suchacquisitions, which also could be expensive and time consuming.**

             Weintend to acquire and license additional products and programs, if we determinethat these products or programs complement our existing technology or augmentour existing information technology platforms. We are continuously engaged inreview of opportunities and discussions with third parties; there is noguarantee that any of these discussions will result in consummatedtransactions. If we do undertake any transactions of this sort, the process ofintegrating an acquired business, technology, service or product may result inoperating difficulties and expenditures and may absorb significant managementattention that would otherwise be available for ongoing development of ourbusiness. Moreover, we may never realize the anticipated benefits of anyacquisition. Future acquisitions could result in potentially dilutive issuancesof equity securities, the incurrence of debt and contingent liabilities andamortization expenses related to goodwill and other intangible assets, whichcould adversely affect our results of operations and financial condition.

**We may need to raise additional capital that may not beavailable, which could adversely affect our operations.**

             Ourproducts and services may not produce revenues that, together with our existingcash and other resources, are adequate to meet our cash needs. We plan to fundour operations from our existing cash balances, but we may in the future seekto raise additional funds from the sale of stock or from debt financing. Ourcash requirements depend on numerous factors, including:

•           our ability to attract and retaincustomers for our gene function database and other products and services;

•           expenses in connection with thedevelopment and expansion of our gene function database, our secreted proteinprogram or other products and services;

•           expenditures in connection withlicense agreements and acquisitions of and investments in complementarytechnologies and businesses;

•           the need to increase research anddevelopment spending to keep up with competing technologies and marketdevelopments; and

•           expenditures as we expand our sales,marketing and customer service organizations and improve our management,operational and financial systems.

             If we needadditional funding, we may be unable to obtain it on favorable terms, or atall. If adequate funds are not available, we may have to curtail operationssignificantly or obtain funds by entering into arrangements requiring us torelinquish rights to certain technologies, products or markets. In addition, ifwe raise funds by selling stock or convertible securities, our existingstockholders could suffer dilution.

**We depend on key employees in a competitive market forskilled personnel, and without additional employees, we cannot grow or achieveprofitability.**

             Weare highly dependent on the principal members of our management, operations andscientific staff, including William Matthews, Ph.D., our President andChief Executive Officer, and Mark W. Moore, Ph.D., our Chief ScientificOfficer. The loss of either of their services would harm our business.

             Ourfuture success also will depend in part on the continued service of our keyscientific, software, consultant and management personnel and our ability toidentify, hire and retain additional personnel, including customer service,marketing and sales staff. We experience intense competition for qualifiedpersonnel. We may be unable to attract and retain personnel necessary for thedevelopment of our business. Moreover, our business is located in the SanFrancisco Bay Area of California, where demand for personnel with the skills weseek is extremely high and is likely to remain high. Because of thiscompetition, our compensation costs may increase significantly.

**We currently have four patents, and if we are unable toprotect our proprietary information, our business will be adversely affected.**

             Ourbusiness and competitive position depends upon our ability to protect andexploit our proprietary techniques, methods, compositions, inventions, databaseinformation and software technology. However, our strategy of obtaining suchproprietary rights around as many genes as possible is unproven. Unauthorizedparties may attempt to obtain and use information that we regard asproprietary. Although we intend for our gene function database subscriptionagreements to require our potential subscribers to control access to ourdatabase and information, policing unauthorized use of our database informationand software may be difficult.

             Wehave no registered copyrights. We currently have four issued patents, none ofwhich relate to knockout mice. Patents have been issued to other entities basedon claims relating to knockout mice. In addition, many applications have beenfiled seeking to protect partial human gene sequences, many of which are basedprimarily on gene sequence information alone. Some of these applications haveissued as patents. Some of these may claim sequences which we have used or mayuse in the future to generate knockout mice in our gene knockout program. Inaddition, other applications have been filed which seek to protect methods ofusing genes and gene expression products, some of which attempt to assignbiological function to the DNA sequences based on laboratory experiments,computer predictions, mathematical algorithms and other methods. The issuanceof these applications as patents will depend, in part, upon whether practicalutility can be sufficiently established for the claimed sequences and whethersufficient correlation exists between the experimental results predictions,algorithms and other methods and actual functional utility. The patentapplication process before the United States Patent and Trademark Office andother similar agencies in other countries is confidential in nature. As eachapplication is evaluated independently and confidentially, we cannot predictwhether applications have been filed or which, if any, will ultimately issue aspatents. However, it is probable that patents will be issued to our competitorsclaiming knockout mice, partial human gene sequences and methods of using genesand gene expression products.

          Numerousapplications have been filed by other entities claiming gene sequences. Manypatents have already issued and we expect more will issue in the future. Inaddition, others may discover uses for genes or proteins other than usescovered in any patents issued to us, and these other uses may be separatelypatentable. We may not be able to obtain additional issued patents on ourpatent applications because our patent applications may not meet therequirements of the patent office. The holder of a patent covering a particularuse of a gene or a protein, isolated gene sequence or deduced amino acidsequence could exclude us from using that gene, protein or sequence. Inaddition, a number of entities make gene information, techniques and methodspublicly available, which may affect our ability to obtain additional patents.

             Other companies orinstitutions have filed and may file patent applications that attempt to patentelectronic databases that may be similar to our DeltaBase database.  If such patents were to issue, the holdersmay claim that DeltaBase infringes such patents.   We may dispute this claim in a proceeding.  Any such proceeding would be costly, and wemay not prevail.  In this event, theprevailing party may require us or our collaborators to stop using DeltaBase orto negotiate a license arrangement to continue to use DeltaBase.  We may not be able to obtain a license fromthe prevailing party on acceptable terms, or at all.

             Someof our patent applications may claim compositions, methods or uses that mayalso be claimed in patent applications filed by others. In some or all of theseapplications, a determination of priority of inventorship may need to bedecided in an interference proceeding before the U.S. Patent and TrademarkOffice. Regardless of determined outcome, this process is time-consuming andexpensive.

             Issuedpatents may not provide commercially-meaningful protection against competitors.Other companies or institutions may challenge our or our customers' patents orindependently develop similar products that could result in an interferenceproceeding in the U.S. Patent and Trademark Office or a legal action. In theevent any researcher or institution infringes upon our or our customers' patentrights, enforcing these rights may be difficult and can be time-consuming.Others may be able to design around these patents or develop unique productsproviding effects similar to our products.

             Ourability to use our patent rights to limit competition in the creation and useof knockout mice, as well as our ability to obtain patent rights, may be morelimited in certain markets outside of the United States because the protectionsavailable in other jurisdictions may not be as extensive as those availabledomestically.

             Wepursue a policy of having our employees, consultants and advisors executeproprietary information and invention agreements when they begin working forus. However, these agreements may not be enforceable or may not providemeaningful protection for our trade secrets or other proprietary information inthe event of unauthorized use or disclosure. We also cannot prevent others fromindependently developing technology or software that might be covered bycopyrights issued to us, and trade secret laws do not prevent independentdevelopment.

**We may be subject to litigation and infringement claims whichmay be costly and divert management's attention.**

             Thetechnology we use in our business may subject us to claims that we infringe onthe patents, intellectual property or proprietary rights of others. The risk ofthis occurring will tend to increase as the genomics, biotechnology and softwareindustries expand, more patents are issued and other companies attempt todiscover gene function through mouse gene knockouts and engage in othergenomics-related businesses. Furthermore, many of our competitors and othercompanies performing research on genes have already applied for patentscovering some of the genes upon which we perform research, and many patentshave already been issued which cover these genes, as well as genes we may wishto use in the future.

 

             Wemay be involved in future lawsuits alleging patent infringement or otherintellectual property rights violations. In addition, litigation may benecessary to:

•           assert claims of infringement;

•           enforce our patents, if any;

•           protect our trade secrets orknow-how; and

•           determine the enforceability, scopeand validity of the proprietary rights of others.             We may be unsuccessful indefending or pursuing these lawsuits. Regardless of the outcome, litigation canbe very costly, can divert management's efforts and could materially affect ourbusiness and operating results. An adverse determination may subject us tosignificant liabilities or restrict or prohibit us from selling our products.

             Becausewe do not have any issued patents, and because knockout mouse and gene-relatedpatents even if obtained may not be enforceable, our intellectual property maynot have any material value, which would diminish our business prospects.

             Oneof our strategies is to obtain proprietary rights around as many gene knockoutsas possible. Although we have filed patent applications covering the knockoutmice we produce, we do not currently have any issued patents. We rely on acombination of copyright and trademark law, trade secrets, non-disclosureagreements and contractual provisions in our agreements with our customers toestablish and maintain intellectual property rights. While the U.S. Patent andTrademark Office in the past has issued patents to others covering function ofgenes, 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 becomesnecessary. If a court finds these types of inventions to be unpatentable, orinterprets them narrowly, the benefits of our strategy may not materialize andour business and financial condition could be harmed.

**Our rights to the use of technologies licensed to us by thirdparties are not within our control, and without these technologies, ourproducts and programs may not be successful and our business prospects could beharmed.**

             Werely, in part, on licenses to use certain technologies which are material toour business, including a secreted protein gene trap which we licenseexclusively from the University of Edinburgh. We do not own the patents thatunderlie these licenses. Our rights to use these technologies and employ theinventions claimed in the licensed patents are subject to our licensors abidingby the terms of those licenses and not terminating them. In most cases, we donot control the prosecution or filing of the patents to which we hold licenses.Instead we rely upon our licensors to prevent infringement of those patents.Some of the licenses under which we have rights, such as the license from theUniversity of Edinburgh, provide us with exclusive rights in specified fields,but we cannot assure you that the scope of our rights under these and otherlicenses will not be subject to dispute by our licensors or third parties.

**Ouractivities involve hazardous material and may subject us to environmentalliability, which would seriously harm our financial condition.**

             Our research and developmentactivities involve the controlled use of hazardous and radioactive materialsand generate biological waste. We are subject to federal, state and local lawsand regulations governing the storage, handling and disposal of these materialsand waste products. Although we believe that our safety procedures for handlingand disposing of these materials and wastes comply with legally prescribedstandards, the risk of accidental contamination or injury from these materialscannot be completely eliminated. We may be sued for any injury or contaminationthat results from our use or the use by third parties of these materials, andour liability may exceed our insurance coverage and our total assets. Futureenvironmental regulations could require us to incur significant costs.**Compliance with governmental regulations regarding animal welfare andgenetically modified organisms could increase our operating costs or adverselyaffect our customers' ability to obtain governmental approval of gene basedproducts, which would adversely affect the commercialization of our technology.**

             TheAnimal Welfare Act, or AWA, is the federal law that currently covers animals inlaboratories. It applies to institutions or facilities using any regulated liveanimals for research, testing, teaching or experimentation, includingdiagnostic laboratories and private companies in the pharmaceutical andbiotechnology industries. The AWA currently does not cover rats, mice or birds.However, the United States Department of Agriculture, which enforces the AWA,has been sued on this matter and recently agreed, as part of the settlement ofthis lawsuit, to begin the process of changing the regulations issued under theAWA to include rats, mice and birds within its coverage. Congress subsequentlyprohibited, for the next fiscal year ending September 30, 2001, theexpenditure of any money for the purpose of changing the regulations withrespect to including rats, mice and birds.

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

             Sincewe develop animals containing changes in their genetic make-up, we may becomesubject to a variety of laws, guidelines, regulations and treaties specificallydirected at genetically modified organisms, or GMOs. The area of environmentalreleases of GMOs is rapidly evolving and is currently subject to intenseregulatory scrutiny, particularly internationally. If we become subject to theselaws we could incur substantial compliance costs. For example, the BiosafetyProtocol, or the BSP, a recently adopted treaty, is expected to cover certainshipments from the U.S. to countries abroad that have signed the BSP. The BSPis also expected to cover the importation of living modified organisms, acategory that could include our animals. If our animals are not contained asdescribed in the BSP, our animals could be subject to the potentially extensiveimport requirements of countries that are signatories to the BSP.

**If we, or our collaborators, do not comply with governmentregulations, we may not be able to develop or sell our technologies andproducts.**

**Regulation of New Drugs or Biological Drugs for Human Use**

             Weare planning to engage in the future in the development and commercializationof therapeutic products that will be subject to United States Federal, stateand local, and foreign regulation, principally in the United States under theFood, Drug & Cosmetic Act as amended, the Public Health Service Act asamended, and other laws. Governmental authorities in the United States and inother countries, including the Food and Drug Administration (FDA) extensivelyregulate the testing, manufacturing, labeling, advertising, promotion,recordkeeping, safety, efficacy, storing, exporting and marketing, among otherthings, of human therapeutic products.

             Inthe United States, our potential therapeutic products likely will be regulatedas human drugs (including biological drugs). The FDA will require us to fileand obtain approval of a Biologics License Application (BLA) (for biologicaldrugs) or a New Drug Application (NDA) (for other drugs) before we cancommercialize any such products. BLAs cover both the facility in which theproducts are manufactured and the products themselves. Generally, biologicaldrug regulation is more rigorous than other drug regulation, particularlybecause biologics are subject to lot-to-lot release requirements whereas otherdrugs are not.

             Thesteps required before approval of a new human drug (including a biologicaldrug) for marketing in the United States generally include:

•           preclinical laboratory tests andanimal tests;

•           the submission to the FDA of anInvestigational New Drug, or IND, application for human clinical testing, whichmust become effective before human clinical trials may lawfully commence;

•           adequate and well-controlled humanclinical trials to establish the safety and efficacy of the product;

•           the submission to the FDA of a BLA orNDA;

•           FDA review of the BLA or NDA; and

•           satisfactory completion of an FDA inspection of themanufacturing facilities at which the product is made to assess compliance withcurrent Good Manufacturing Practices which includes elaborate testing, control,documentation and other quality assurance procedures.

             Thetesting and approval process requires substantial time, effort and financialresources. After approval is obtained, a supplemental approval is generallyrequired for each proposed new indication and for many different types ofmanufacturing changes. The supplement often contains data similar to thatsubmitted in the original BLA or NDA.

             Preclinicalstudies include laboratory evaluation of the product chemistry, formulation,and stability, as well as animal studies to assess the safety and potentialefficacy of the product. Preclinical safety tests must be conducted bylaboratories that comply with FDA regulations regarding Good LaboratoryPractices. The results of the preclinical studies, together with manufacturinginformation and analytical data are submitted to the FDA as part of the IND andare reviewed by the FDA before the commencement of clinical trials. The INDautomatically will become effective in 30 days unless the FDA, before thattime, raises concerns or questions and imposes a "clinical hold". Insuch case, the IND sponsor must resolve with the FDA any outstanding concernsbefore the trial can proceed. Once trials have commenced, the FDA may stop thetrials by imposing a clinical hold because of concerns about, for example, thesafety of the product being tested or the adequacy of the trial design.

             Clinicaltrials involve the administration of investigational products to healthyvolunteers or patients under the supervision of a qualified principalinvestigator consistent with an informed consent. An independent InstitutionalReview Board, or IRB, must review and approve each clinical trial at eachinstitution at which the study will be conducted. The IRB will consider, amongother things, ethical factors, the safety of human subjects and the possibleliability of the institution.

             Clinicaltrials typically are conducted in three sequential phases, but the phases mayoverlap. In Phase I, the initial introduction of the drug into human subjects,the drug is usually tested for safety or adverse effects, dosage tolerance,absorption, metabolism, distribution, excretion and pharmacodynamics. Phase IIclinical trials usually involve studies in a limited patient population toevaluate the efficacy of the drug for specific, targeted indications, todetermine dosage tolerance and optimal dosage and to identify possible adverseeffects and safety risks. Phase III clinical trials generally further evaluateclinical efficacy and test further for safety within an expanded patientpopulation and at multiple clinical sites. The goal of these studies is toobtain definitive statistical and clinical evidence of the efficacy and safetyof the drug and dosage regimens. Phase IV clinical trials are conducted afterapproval to gain additional experience from the treatment of patients in theintended therapeutic indication. If the FDA approves a product, additionalclinical trials may be necessary. A company may be able to use the data fromthese clinical trials to meet all or part of any Phase IV clinical trialrequirement. These clinical trials are often referred to as Phase III/IVpost-approval clinical trials.

             Insome cases, drug reviews may proceed under the accelerated approvalregulations, "fast track" statutory provisions, or the expeditedreview regulations. The accelerated approval provisions apply to products usedin the treatment of serious or life-threatening illnesses that appear toprovide meaningful therapeutic benefits over existing treatments. The expeditedreview regulations apply to products for life-threatening andseverely-debilitating illnesses, especially where no satisfactory alternativetherapy exists. These regulations permit approval of such products at the endof phase 2, or before clinical research is completed based on the drug's effecton a clinical endpoint or surrogate endpoint. FDA retains considerablediscretion to determine eligibility for expedited and accelerated review andapproval mechanisms.

             Theresults of the preclinical studies and clinical trials, together with detailedinformation on the manufacture and composition of the product, are submitted tothe FDA in the NDA or BLA requesting approval to market the product. Beforeapproving an NDA or BLA, the FDA will inspect the facilities at which the productis manufactured and will not approve the product unless the manufacturingfacility is in compliance with current Good Manufacturing Practices. The FDAmay delay approval of an NDA or BLA if applicable regulatory criteria are notsatisfied, require additional testing or information, and/or requirepostmarketing testing and surveillance to monitor safety, purity or potency ofa product. It may also limit the indicated uses for which an approval is given.There can be no assurance that FDA will approve any future NDAs or BLAs or thatmanufacturing facilities will pass FDA preapproval inspections.**Pervasive and Continuing Human Drug Regulation**

             Anyfuture drug approvals that are granted remain subject to continual FDA review,and newly discovered or developed safety or efficacy data may result inwithdrawal of products from marketing. Moreover, if and when such approval isobtained, the manufacture and marketing of future drugs will remain subject toextensive regulatory requirements administered by the FDA and other regulatorybodies, including compliance with current Good Manufacturing Practices, adverseevent reporting requirements and the FDA's general prohibitions againstpromoting products for unapproved or "off-label" uses. Companies aresubject to inspection and market surveillance by the FDA for compliance withthese regulatory requirements. Domestic manufacturing facilities are subject tobiennial inspections by the FDA and must comply with the FDA's GoodManufacturing 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 technicalcompliance. The FDA stringently applies regulatory standards for manufacturing.Failure to comply with the requirements can, among other things, result inwarning letters, product seizures, recalls, fines, injunctions, suspensions orwithdrawals of regulatory approvals, operating restrictions and criminalprosecutions. Any such enforcement action could have a material adverse effecton Deltagen. Unanticipated changes in existing regulatory requirements or theadoption of new requirements could also have a material adverse effect onDeltagen.

**Foreign Regulation**

             Companiesare be subject to a variety of regulations governing clinical trials and salesof their products outside the United States. Companies must obtain approval oftheir products by the comparable non-U.S. regulatory authorities prior to thecommencement of product marketing in the country whether or not the company hasobtained FDA approval. The approval process varies from country to country andthe time needed to secure approval may be longer or shorter than that requiredfor FDA approval. The European Union requires approval of a MarketingAuthorization Application by the European Medicines Evaluation Agency. Theseapplications require the completion of extensive preclinical and clinicalstudies and manufacturing and controls information.

**Other Regulation**

             Weare also subject to a variety of other federal and state laws and regulationsin the U.S. and in other countries pertaining to our facilities, the shipment,exportation and importation of various articles and health and safety matters.For example, the Department of Transportation and various internationalguidelines and regulations govern the transport of different types ofmaterials. The Bureau of Export Administration of the Department of Commerceexercises export controls over technology such as our gene database. TheDepartment of Health and Human Services and USDA both regulate various types ofarticles that present the possibility of spreading communicable and otherdiseases, including the regulation of vectors, such as animals and articlesthat present risks of other harm to plants, human beings and other animals. TheEnvironmental Protection Agency has responsibility for facility emissions andother environmental matters, including the regulation of new chemicalsubstances, which could include gene sequences.

**Ethical and social issues may limit or discourage the use ofknockout mice or other genetic processes which could reduce our revenues andadversely affect our business.**

             Governmentalauthorities could, for social or other purposes, limit the use of genetic processesor prohibit the practice of our gene trap and knockout mouse technologies.Public attitudes may be influenced by claims that genetically engineeredproducts are unsafe for consumption or pose a danger to the environment. Thesubject of genetically modified organisms, like knockout mice, has receivednegative publicity and aroused public debate. In addition, animal rightsactivists could protest or make threats against our facilities, which mayresult in property damage. Ethical and other concerns about our methods,particularly our use of knockout mice, could adversely affect our marketacceptance.**All our research is conductedat two facilities, and a natural disaster at these facilities is possible andcould result in a prolonged interruption of our business.**

             Weconduct all our scientific and management activities at two facilities inCalifornia. Both locations are in seismically active areas. We have takenprecautions to safeguard our mouse colony including through insurance, storageof animals off-site at a back-up facility in Massachusetts, the freezing ofsperm and the storing of embryonic stem cells, or ES cells, to allow for theregeneration of mice. However, a natural disaster, such as an earthquake, fire,flood or outbreak of infectious disease, could cause substantial delays. Thiscould interrupt mouse breeding, cause us to incur additional expenses andadversely affect our reputation with customers.

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

             Wemay provide access to our gene function database on the Internet. A fundamentalrequirement to conduct our business over the Internet is the securetransmission of confidential information over public networks. Advances incomputer capabilities, new discoveries in the field of cryptography or otherdevelopments may result in a compromise or breach of the security measures weuse to protect the content in our gene function database. Anyone who is able tocircumvent our security measures could misappropriate our proprietaryinformation or confidential customer information or cause interruptions in ouroperations. We may be required to incur significant costs to protect againstsecurity breaches or to alleviate problems caused by breaches, and theseefforts may not be successful. Further, a well-publicized compromise ofsecurity could deter people from using the Internet to conduct transactionsthat involve transmitting confidential information. For example, recent attacksby computer hackers on major e-commerce web sites have heightened concernsregarding the security and reliability of the Internet.

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

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

             Wemay rely on scientific and other data supplied by third parties, and all of ourgene sequence data comes from public genomics data. This data could bedefective, be improperly generated or contain errors or other defects, whichcould corrupt our gene function database and our other programs and services.In addition, we cannot guarantee that our sources acquired this data incompliance with legal requirements. In the event of any such defect, corruptionor finding of nonconformance, our business prospects could be adverselyaffected.**Ourcommon stock may experience extreme price and volume fluctuations, which couldlead to costly litigation for us and make an investment in us less appealing.**

             Themarket price of our common stock may fluctuate substantially due to a varietyof factors, including:

•           announcements of technologicalinnovations or new products by us or our competitors;

•           developments or disputes concerningpatents or proprietary rights, including announcements with respect to ourlitigation with Lexicon or of infringement, interference or other litigationagainst us or our licensors;

•           the timing and development of ourproducts and services;

•           media reports and publications aboutgenetics and gene-based products;

•           changes in pharmaceutical andbiotechnology companies' research and development expenditures;

•           announcements concerning ourcompetitors, or the biotechnology or pharmaceutical industry in general;

•           changes in government regulation ofgenetic research or gene-based products, and the pharmaceutical or medicalindustry in general;

•           general and industry-specificeconomic conditions;

•           actual or anticipated fluctuations inour operating results;

•           changes in financial estimates orrecommendations by securities analysts;

•           changes in accounting principles; and

•           the loss of any of our key scientificor management personnel.

             Inaddition, the stock market has experienced extreme price and volumefluctuations. The market prices of the securities of biotechnology companies,particularly companies like ours without consistent product revenues andearnings, have been highly volatile and may continue to be highly volatile inthe future. This volatility has often been unrelated to the operatingperformance of particular companies. For example, the stock prices of manybiotechnology companies, even those that would benefit from publicly availablegene sequence information, declined on news of the announcement by formerPresident Clinton and British Prime Minister Blair that, as their respectivegovernments had each advocated before, gene sequence information should befreely available in the public domain. In the past, securities class actionlitigation has often been brought against companies that experience volatilityin the market price of their securities. Moreover, market prices for stocks ofbiotechnology-related and technology companies, particularly following aninitial public offering, frequently reach levels that bear no relationship tothe operating performance of such companies. These market prices generally arenot sustainable and are subject to wide variations. Whether or not meritorious,litigation brought against us could result in substantial costs, divertmanagement's attention and resources and harm our financial condition andresults of operations.**Thefuture sale of common stock could negatively affect our stock price.**

             Wehad 30,552,429 shares of common stock outstanding at September 30, 2001.

             Ifour common stockholders sell substantial amounts of common stock in the publicmarket, or the market perceives that such sales may occur, the market price ofour common stock could fall. The holders of approximately 18,180,856 shares ofour common stock will have rights, subject to some conditions, to require us tofile registration statements covering their shares or to include their sharesin registration statements that we may file for ourselves or otherstockholders. Furthermore, if we were to include in a company-initiatedregistration statement shares held by those holders pursuant to the exercise oftheir registration rights, those sales could impair our ability to raise neededcapital by depressing the price at which we could sell our common stock.

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

             Asof September 30, 2001, our executive officers and directors and entitiesaffiliated with them beneficially own, in the aggregate, approximately 63.9% ofour common stock which includes, as applicable, shares issuable upon theexercise of all options and warrants exercisable within 60 days of September30, 2001. This significant concentration of share ownership may adverselyaffect the trading price for our common stock because investors often perceivedisadvantages in owning stock in companies with controlling shareholders. Thesestockholders, acting together, will have the ability to exert substantialinfluence over all matters requiring approval by our stockholders, includingthe election and removal of directors and any proposed merger, consolidation orsale of all or substantially all of our assets. In addition, they could dictatethe management of our business and affairs. This concentration of ownershipcould have the effect of delaying, deferring or preventing a change in control,or impeding a merger or consolidation, takeover or other business combinationthat could be favorable to you.

**Our incorporation documents and Delaware law may inhibit atakeover that stockholders consider favorable and could also limit the marketprice of your stock.**

             Ourrestated certificate of incorporation and bylaws contain provisions that coulddelay or prevent a change in control of our company. Some of these provisions:

•           authorize the issuance of preferredstock which can be created and issued by the board of directors without priorstockholder approval, commonly referred to as "blank check" preferredstock, with rights senior to those of common stock;

•           provide for a classified board ofdirectors; and

•           prohibit stockholder action bywritten consent.

             Inaddition, we are governed by the provisions of Section 203 of DelawareGeneral Corporate Law. These provisions may prohibit large stockholders, inparticular those owning 15% or more of our outstanding voting stock, frommerging or combining with us. These and other provisions in our amended andrestated certificate of incorporation and bylaws and under Delaware law couldreduce the price that investors might be willing to pay for shares of ourcommon stock in the future and result in the market price being lower than itwould be without these provisions.**Item3. **            **Quantitative andQualitative Disclosures About Market Risk**

             Weinvest our excess cash primarily in obligations of governmental agencies andmarketable debt securities of financial institutions and corporations withstrong credit ratings.  Theseinstruments have maturities of twenty-four months or less when acquired.  We do not utilize derivative financialinstruments, derivative commodity instruments or other market risk sensitiveinstruments, positions or transactions in any material fashion.  Accordingly, we believe that, while theinstruments we hold are subject to changes in the financial standing of theissuer of such securities, we are not subject to any material risks arisingfrom changes in interest rates, foreign currency exchange rates, commodityprices, equity prices or other market changes that affect market risk sensitiveinstruments.  Therefore no quantitativetabular disclosure is included in this report.

**PARTII.  OTHER INFORMATION****Item 1. –****Legal Proceedings**

             Wemay be involved in litigation, investigations or proceedings in the future. Anylitigation, investigation or proceeding, with or without merit, could be costlyand time-consuming and could divert our management's attention and resourceswhich in turn could harm our business and financial results.

             OnMay 24, 2000, Lexicon Genetics Incorporated filed a lawsuit against the Companyin the United States District Court for the District of Delaware. The complaintin the lawsuit alleged that the Company’s methods of making knockout miceinfringed United States Patent No. 5,789,215 (the ’215 patent), under whichLexicon claimed to be an exclusive licensee. The complaint sought a judgmentthat the Company infringed this patent, a permanent injunction against furtherinfringement of the patent and an award of damages in an unspecified amount that,under certain circumstances, could be trebled. On June 13, 2000, the Companyresponded to Lexicon’s complaint by filing an answer and seeking a declaratoryjudgment in its favor. On October 31, 2000, an Order was entered by the Courtamending the complaint and adding GenPharm International, the patentee of the‘215 patent, as a plaintiff. On November 14, 2000, Deltagen filed an answer aswell as federal antitrust counterclaims under the Sherman Antitrust Act againstLexicon and GenPharm, alleging that Lexicon asserted a fraudulently procuredpatent (the ‘215 patent) against Deltagen in an attempt to illegally monopolizethe market for production and sale of knockout mice, a violation of Section 2of the Sherman Act. The counter claim asserted that Lexicon knew that the ‘215patent was obtained by fraud and that the patent was invalid when it broughtsuit against Deltagen. The antitrust counterclaim also charged Lexicon andGenPharm with conspiracy to monopolize the market for knockout mice, inviolation of Section 2 of the Sherman Act, as well as with concerted conduct inrestraint of trade, in violation of Section 1 of the Sherman Act. The counterclaim sought damages, including lost profits, devaluation of the initial publicoffering and legal fees, as well as a trebling of damages pursuant to Section 4of the Clayton Act. In addition, the answer sought a declaratory judgment thatDeltagen did not infringe the claims of the ‘215 patent and that the patent wasinvalid. The answer also asserted that the patent was obtained by knowing andwillful fraud on the United States Patent and Trademark Office, rendering thepatent unenforceable.

             OnOctober 13, 2000, Lexicon and the University of Utah Research Foundation fileda lawsuit against the Company in the United States District Court for theNorthern District of California. The complaint in this lawsuit alleged that theCompany was infringing United States Patents Nos. 5,631,153; 5,464,764;5,627,059 and 5,487,992 (the Capecchi patents), under which Lexicon claimed tobe an exclusive licensee. All of these patents relate to the use of apositive-negative selection vector in gene targeting. The complaint sought ajudgment that the Company infringed these patents, a preliminary and permanentinjunction against further infringement of the patents and an award of damagesin an unspecified amount that, under certain circumstances, could be trebled.On November 8, 2000, the Company filed an answer denying infringement, and acounterclaim seeking a declaratory judgment that the patents were invalid. Thecounterclaim sought an award of damages including attorney fees.

             OnSeptember 20, 2001, Deltagen and Lexicon announced the settlement of thelitigation. Under the terms of the settlement, Deltagen obtained a commerciallicense under the ‘215 patent and the Capecchi patents, Lexicon obtained asubscription to Deltagen’s DeltaBase, and all of the claims and counterclaimsin the litigation were dismissed with prejudice. Lexicon’s subscription toDeltaBase includes non-exclusive, perpetual licenses to the drug targetscurrently represented in DeltaBase and the drug targets that are to be added toDeltaBase over the next four years. Lexicon will make certain milestone androyalty payments to Deltagen for any therapeutic and diagnostic productsdeveloped from Lexicon’s use of DeltaBase. Deltagen will make payments toLexicon for any knockout mice generated by Deltagen on a fee-for-service basis.Neither Deltagen nor Lexicon will pay the other party any subscription orlicense fees.

**Item 2. – Changes in Securities**

a)          Not applicable.

b)          Not applicable.

c)          During the third quarter of fiscal2001, the Company issued an aggregate of 766,894 of its common shares pursuantto a merger in exchange for the outstanding capital shares of Arcaris, Inc.held by 39 shareholders. The shares were issued pursuant to an exemption byreason of Section 4(2) of the Securities Act of 1933. These sales were madewithout general solicitation or advertising. In connection with this merger, 21of the former Arcaris, Inc. shareholders represented that he, she or it was anaccredited investor. Shareholders who signified that they were not accreditedinvestors were represented by a qualified purchaser’s representative. TheCompany has filed a Registration Statement on Form S-3 covering the resale ofsuch securities. All net proceeds from the sale of such securities will go tothe selling shareholders who offer and sell their shares. The Company has notreceived and will not receive any proceeds from the sale of these common sharesother than the assets and liabilities of the acquired companies.

d)          On August 2, 2000, our RegistrationStatement on Form S-1 (File No. 333-34668), the IPO Registration Statement, wasdeclared effective by the Securities and Exchange Commission.  The IPO Registration Statement registered atotal of 7,000,000 shares of common stock all of which were issued and sold byus.  The offering commenced on August 3,2000 and was closed on August 8, 2000. The shares sold by us were sold at an aggregate offering price of $105million, netting proceeds of approximately $95.9 million to us afterunderwriting fees of approximately $7.4 million and other offering expenses ofapproximately $1.7 million.  On August 30,2000 the underwriters' of our offeringexercised their over–allotment for the purchase of approximately1,025,000 shares.  The sharessold by us were sold at an aggregate offering price of $15.4 million, nettingproceeds of approximately $14.3 million to us after underwriting fees ofapproximately $1.1 million and other offering expenses.

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

| Repayment  of indebtedness                                          |   | $      | 1,055   |   |
|---------------------------------------------------------------------|--------|--------|---------|--------|
| Purchase  and installation of equipment and build out of facilities |   | 4,503  |    |
| Working  capital                                                    |   | 23,640 |    |
| Bank  Deposits and temporary investments                            |   | 81,002 |    |
| Net  offering proceeds                                              |   | $      | 110,200 |   |

Noneof the net offering proceeds have been paid to any director, officer, or 10% orgreater stockholder of the Company or an affiliate of these persons.

**Item 3. – Defaults Upon Senior Securities**

             Notapplicable.

**Item 4. – Submission of Matters to a Vote of Security Holders**

**            **Not applicable.**Item 5. – Other Information**

             Notapplicable.

**Item 6. – Exhibits and Reports on Form 8-K**

a)               Exhibits

None

b)          Reports on Form 8-K

 
|   | A  report on Form 8-K related to the acquisition of Arcaris, Inc. was filed on  August 14, 2001. |
|--------|--------------------------------------------------------------------------------------------------|
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**DELTAGEN, INC.**

**SIGNATURES**

Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.
|                                      |   | DELTAGEN,  INC.                        |
|-------------------------------------------|--------|----------------------------------------|
|                                      |   |                                   |
|                                      |   |                                   |
| Date:    November 14, 2001 |   | /s/  William Matthews, Ph.D.           |
|                                      |   | William  Matthews, Ph.D.               |
|                                      |   | President  and Chief Executive Officer |
|                                      |   |                                   |
|                                      |   |                                   |
| Date:    November 14, 2001 |   | /s/  Richard H. Hawkins                |
|                                      |   | Richard  H. Hawkins                    |
|                                      |   | Chief  Financial Officer               |