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UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


WASHINGTON, D.C. 20549





---




FORM 10-Q





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




For the quarterly period ended June 30, 2002





OR





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




For the transition period from __________ to __________





Commission File Number 000-31147





DELTAGEN, INC.


(Exact name of Registrant as specified in its charter)





Delaware

94-3260659(State or other jurisdiction of

(I.R.S. Employerincorporation or organization)

Identification No.)740 Bay Road, Redwood City, CA

94063(Address of principal executive offices)

(Zip code)





(650) 569-5100


(Registrants telephone number, including area code)





Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.





YESxNO  ̈





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





Common Stock $0.001 par value

40,909,678Class

Outstanding at August 9, 2002





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DELTAGEN, INC.





FORM 10-Q





QUARTERLY REPORT





TABLE OF CONTENTS





PART IFINANCIAL INFORMATIONItem 1.

Financial Statements

3Consolidated Balance Sheets (unaudited)

3Consolidated Statements of Operations (unaudited)

4Consolidated Statements of Cash Flows (unaudited)

5Notes to Consolidated Financial Statements (unaudited)

6Item 2.

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

10Item 3.

Quantitative and Qualitative Disclosures about Market Risk

18PART IIOTHER INFORMATIONItem 1.

Legal Proceedings

32Item 2.

Changes in Securities and Use of Proceeds

32Item 3.

Defaults Upon Senior Debt

32Item 4.

Submission of Matters to a Vote of Security Holders

32Item 5.

Other Information

32Item 6.

Exhibits and Reports on Form 8-K

33Signatures

34






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PART I.    FINANCIAL INFORMATION





Item 1.    Financial Statements





DELTAGEN, INC.





CONSOLIDATED BALANCE SHEETS


(unaudited)


(in thousands, except share data)








June 30, 2002


December 31, 2001AssetsCurrent assets:Cash and cash equivalents

$
54,295


$
61,363Marketable securities


22,302



15,118Accounts receivable, net


3,828



2,511Prepaid expenses and other current assets


2,902



2,207Total current assets


83,327



81,199Property, plant and equipment, net


41,166



16,672Goodwill


9,260



1,788Intangible assets, net


14,144



3,479Notes receivable from related parties


995



495Restricted cash


3,683



2,869Other assets


2,668



2,548Total assets

$
155,243


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

$
9,918


$
4,131Accrued liabilities


6,439



5,864Current portion of capital lease obligations


21



11Current portion of loans payable


7,876



2,382Current portion of deferred revenue


14,463



7,257Total current liabilities


38,717



19,645Capital lease obligations, less current portion


12



28Loans payable, less current portion


9,968



3,059Other long-term liabilities


990



990Deferred credit


2,953



Deferred revenue, less current portion


3,187



1,657Total liabilities


55,827



25,379Stockholders equity:Common stock, $0.001 par value:Authorized: 75,000,000 shares, Issued and outstanding: 40,842,094 and 32,077,012 shares at June 30, 2002 and December
31, 2001, respectively


41



32Additional paid-in capital


238,826



186,595Unearned stock-based compensation


(1,544
)


(3,019
)Notes receivable from stockholders


(805
)


(805
)Accumulated deficit


(137,102
)


(99,132
)Total stockholders equity


99,416



83,671Total liabilities and stockholders equity

$
155,243


$
109,050





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






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DELTAGEN, INC.





CONSOLIDATED STATEMENTS OF OPERATIONS


(unaudited)


(in thousands, except per share data)





Three Months Ended June
30,


Six Months Ended June
30,2002


2001


2002


2001Contract revenue

$
5,919


$
2,735


$
8,534


$
5,186Costs and expenses:Research and development


21,291



10,407



38,425



18,608Selling, general and administrative


4,070



5,289



8,562



8,182Total costs and expenses


25,361



15,696



46,987



26,790Loss from operations


(19,442
)


(12,961
)


(38,453
)


(21,604
)Interest income


421



1,245



880



2,972Interest expense


(201
)


(143
)


(397
)


(299
)Net loss

$
(19,222
)

$
(11,859
)

$
(37,970
)

$
(18,931
)Net loss per common share, basic and diluted

$
(0.52
)

$
(0.41
)

$
(1.09
)

$
(0.66
)Weighted average shares used in computing net loss per common share, basic and diluted


37,117



28,835



35,009



28,697





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






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DELTAGEN, INC.





CONSOLIDATED STATEMENTS OF CASH FLOWS


(unaudited)


(in thousands)





Six Months Ended June
30,2002


2001Cash flows from operating activities:Net loss

$
(37,970
)

$
(18,931
)Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization


3,335



1,114Amortization of equipment under capital lease


14



Amortization of warrants issued in connection with loans


55



12Amortization of intangible assets


1,911



Amortization of unearned stock-based compensation expense


1,085



1,969Amortization of premium (discount) on marketable securities


171



(439
)Lease loss






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


110



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


(1,317
)


(1,579
)Prepaid expenses and other current assets


(288
)


(702
)Other assets


81



(189
)Accounts payable


389



1,617Accrued expenses


(273
)


667Deferred revenue


8,736



(308
)Net cash used in operating activities


(23,961
)


(15,457
)Cash flows from investing activities:Purchase of marketable securities


(12,355
)


(34,423
)Maturities of marketable securities


5,000



40,000Acquisition of property, plant and equipment


(2,759
)


(1,508
)Acquisition of leasehold improvements


(7,900
)


(50
)Increase in restricted cash


(814
)


Issuance of notes receivable


(500
)


(710
)Acquisition of BMSPRL, L.L.C., net of cash acquired


(445
)


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


(536
)


Net cash provided by (used in) investing activities


(20,309
)


3,309Cash flows from financing activities:Principal payments under capital lease obligations


(6
)


(19
)Repayment of loans payable


(2,564
)


(875
)Proceeds from the issuance of loans payable


14,274



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


25,498



(117
)Net cash provided by financing activities


37,202



1,442Net decrease in cash and cash equivalents


(7,068
)


(10,706
)Cash and cash equivalents, beginning of period


61,363



93,352Cash and cash equivalents, end of period

$
54,295


$
82,646Supplemental disclosures of cash flow information:Cash paid during the period for interest

$
397


$
299Supplemental disclosures of non-cash investing and financing activities:Property and equipment acquired with accounts payable

$
5,066


$
169Reversal of unearned stock-based compensation

$
390


$
1,676Issuance of common stock in connection with BMSPRL, L.L.C., acquisition

$
23,510


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

$
3,622


$






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






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DELTAGEN, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(unaudited)


June 30, 2002





1.    Business of the Company





Deltagen, founded in 1997 and headquartered in Redwood City, California, is a leader in using in vivo derived mammalian gene function information to define the function and disease relevance of
mammalian genes for the purposes of discovering and validating novel drug targets. Our proprietary information platform serves our major pharmaceutical partners and customers in their efforts to discover potential new drug therapies. Deltagen is
also an emerging leader in the discovery and development of drugs from the human genome.





The Companys
commercial operations commenced during 2000 at which time it emerged from the development stage. The Company has incurred net losses since inception of $137.1 million and is expected to incur losses for at least the next several years as research
and development activities exceed revenues. To date, the Company has financed its operations primarily through sales of equity securities, contract payments under DeltaSelect and DeltaBase agreements and equipment financing arrangements and a term
loan facility The Company will finance its operations primarily through its existing cash and cash equivalents and marketable securities and future revenues. The Company expects to require additional funding and may sell additional shares of its
common or preferred stock through private placements or further public offerings, or it may seek additional credit facilities.





2.    Basis of Presentation





The accompanying interim consolidated
financial statements as of June 30, 2002 of Deltagen, Inc. (the Company) are unaudited and have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information,
the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not contain all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial
statements. The unaudited interim consolidated financial statements have been prepared on the same basis as the annual consolidated financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring
adjustments, necessary to present fairly the Companys financial position and its results of operations and its cash flows for the periods presented. Operating results for the interim periods presented are not necessarily indicative of the
results that may be expected for the fiscal year or any future interim period. Certain costs and expenses in the six months ended June 30, 2002 have been reclassified to conform to the presentation in the three months ended June 30, 2002.





These interim financial statements should be read in conjunction with the annual audited consolidated financial
statements included in the Companys Annual Report on Form 10-K (File No. 000-31147) filed with the Securities and Exchange Commission (the SEC) on March 29, 2002.





3.    Recent Accounting Pronouncements





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





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





In June of 2002, the FASB issued Statement of Financial Accounting Standards No. 146 (SFAS 146), Accounting for Costs
Associated with Exit or Disposal Activities, which is effective for exit or disposal activities initiated after December 31, 2002. SFAS 146 nullifies Emerging Issues Task Force Issue No. 94-3, Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). Under SFAS 146, a liability is required to be recognized for a cost associated with an exit or disposal activity when the liability
is incurred. SFAS 146 applies






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to costs associated with an exit activity that does not involve an entity newly acquired in a business
combination or with a retirement or disposal activity covered by FASB Statements No. 143 and 144. The Company believes that the adoption of SFAS 146 will not have a material effect on the financial position or results of the operations of Company.





4.    Net Loss Per Share





Basic earnings per share is calculated based on the weighted-average number of common shares outstanding during the period. Diluted earnings per share would give effect to
the dilutive effect of common stock equivalents consisting of restricted stock, stock options and warrants. Dilutive securities of 10.8 million and 4.3 million shares have been excluded from the diluted earnings per share calculations for the
periods ended June 30, 2002 and 2001, respectively, as they have an antidilutive effect due to the Companys net losses.





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





Three Months Ended June
30,


Six Months Ended June
30,2002


2001


2002


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

$
(19,222
)

$
(11,859
)

$
(37,970
)

$
(18,931
)Weighted average shares of common stock outstanding


37,608



29,750



35,551



29,808Less: Weighted average shares subject to repurchase


(491
)


(915
)


(542
)


(1,111
)Weighted average shares used in basic and diluted net loss per share


37,117



28,835



35,009



28,697Net loss per common share

$
(0.52
)

$
(0.41
)

$
(1.09
)

$
(0.66
)





5.    Loans Payable





On February 28, 2002, the Company entered into a loan agreement with a financial institution to obtain one or more loans totaling up to
$4,000,000. A corresponding amount of machinery, equipment, and other property is pledged as collateral for each loan. On March 1, 2002, the Company received loan proceeds of $2,406,000 and $1,000,000, respectively, under this agreement for a total
financing of $3,406,000. The loans bear interest rates of 8.87% and 8.98%, respectively, and are to be repaid in 36 monthly installments beginning in March 2002. On June 21, 2002, the Company received loan proceeds of $593,000 under this agreement.
The loan bears interest at 9.04% and is to be repaid in 36 monthly installments beginning in June 2002. At June 30, 2002, there is no amount available for future borrowings and $3.7 million was outstanding under this agreement.





On June 27, 2002, the Company entered into two new bank agreements. These include a $20 million term loan facility and a
one-year $5 million accounts receivable facility. The term loan can be drawn down through March 31, 2003 and matures through March 31, 2007. The loan is collateralized by a first position security interest in the Companys assets excluding
intellectual property. The Company has certain restrictions on the assignment or transfer of intellectual property during the term of the loan. The Company borrowed $10 million under this facility on June 28, 2002 at the current interest rate of
6.125%. Interest only payments will be made through the end of the draw down period at which time outstanding principal and interest will we due in 48 equal monthly installments. The loan has financial covenants related to earnings and liquidity,
including a requirement that the Company maintain unrestricted cash balances, as defined, equal to the greater of two times the principal balance outstanding on the loan or six months of net cash used in operating activities. The accounts receivable
facility was not utilized in the June 30, 2002 quarter.





6.    Research and Development Collaborations and License
Agreements





On February 8, 2002, the Company entered into its third DeltaBase subscription agreement with
Merck & Co., Inc. Under the DeltaBase agreement, Merck has the right to access DeltaBase information on gene function and validated gene targets based upon knockout mouse studies. The DeltaBase agreement also grants Merck non-exclusive,
worldwide licenses to knockout mice, materials and intellectual property rights under DeltaBase. The Company will receive an aggregate of $15,250,000 in subscription licensing and access fees during the term of the agreement. Merck will have
non-exclusive access to information related to 750 genes and access to certain of the corresponding DeltaBase intellectual property rights.






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7.    Acquisitions





Acquisition of BMSPRL, L.L.C.





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





Accordingly, the results
of operations of BMSPRL and estimated fair value of assets acquired and liabilities assumed were included in the Companys consolidated financial statements from February 16, 2002 through June 30, 2002.





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





Tangible net assets acquired:Marketable securities

$
3Prepaid expenses and other current assets


424Property and equipment, net


12,039Other assets


191Accounts payable and accrued liabilities


(1,084
)Notes payable


(639
)Tangible net assets acquired


10,934Completed technology


5,560Excess of purchase price over net assets acquired


7,481Total purchase price

$
23,975





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





The amount allocated to completed technology is being amortized over the
estimated useful life of three to ten years using the straight-line method.





The amount of the purchase price in
excess of the net assets acquired was recorded as goodwill and will be periodically evaluated for impairment in accordance with SFAS 142.





Acquisition of XenoPharm, Inc.





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





The results of operations of XenoPharm and estimated fair value of assets acquired and liabilities assumed were included in the Companys consolidated financial statements from March 14, 2002
through June 30, 2002.





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





Tangible net assets acquired:Property and equipment, net

$
79Other assets


1Accounts payable and accrued liabilities


(95
)Tangible net assets acquired


(15
)Acquired in-process research and development


110Completed technology


7,016Deferred credit


(2,953
)Total purchase price

$
4,158





In connection with the purchase of XenoPharm, the Company recorded
a $110,000 charge to in-process research and development in the March 31, 2002 quarter. The amount was determined by identifying research projects for which technological feasibility had not been established and no alternative future uses existed.
The value of the projects identified to be in progress was determined by estimating the future cash flows from the projects once commercially feasible, discounting the net cash flows






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back to their present value and then applying a percentage of completion to the calculated value. The
net cash flows from the identified projects are expected to commence at various times in 2002, and were based on estimates of revenues, cost of revenues, research and development costs, selling, general and administrative costs and applicable income
taxes for the projects. The discount rates used in the present value calculations were typically derived from a weighted-average cost of capital analysis based upon comparable public companies, adjusted upward to reflect additional risks inherent in
the development life cycle. Such discount rates ranged between 45% and 55% for all projects. Development of the technologies remains a substantial risk to the Company due to factors including the remaining effort to achieve technological
feasibility, rapidly changing customer markets and competitive threats from other companies.





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





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





Proforma Results





The following unaudited pro forma summary is provided for illustrative purposes only and is not necessarily indicative of the consolidated results of operations for future
periods or that actually would have been realized had the Company, BMSPRL and XenoPharm been a consolidated entity during the periods presented. The summary combines the results of operations as if BMSPRL and XenoPharm had been acquired as of the
beginning of the periods presented. The impact of certain acquisition adjustments such as amortization of completed technology and the charge related to the write-off of the acquired in-process research and development has been excluded from the
periods presented as they arose from the acquisitions.





Three Months Ended June 30,


Six Months Ended June 30,2002


2001


2002


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

$
5,919


$
2,735


$
8,534


$
5,186Net loss

$
(18,830
)

$
(19,969
)

$
(42,399
)

$
(35,003
)Basic and diluted EPS

$
(0.51
)

$
(0.62
)

$
(1.18
)

$
(1.10
)





8.    Goodwill and Intangible Assets





The Company adopted SFAS 142 on January 1, 2002 for all goodwill and intangibles that arose before July 1, 2001. As a result, goodwill is
tested for impairment annually and whenever circumstances indicate that it may no longer be recoverable, and is no longer amortized. In addition, intangible assets acquired prior to July 1, 2001 that do not meet the criteria for recognition under
SFAS 141 have been reclassified to goodwill. Goodwill and intangible assets consist of the following (in thousands):





June 30, 2002

December 31, 2001Gross Carrying Amount

Accumulated Amortization

Gross Carrying Amount

Accumulated AmortizationNon-amortizing:Goodwill

$
9,260

$


$
1,788

$
Amortizing:Acquired completed technology


16,616


2,472


4,040


561Total

$
25,876

$
2,472

$
5,828

$
561





Annual amortization expense is expected to be as follows (in
thousands):





Year Ending December 31,

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

$
2,5842003


5,1682004


4,6072005


8122006


159Thereafter


814Total

$
14,144






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Amortization expense was $1.3 million and $1.9 million in the three months and
six months ended June 30, 2002, respectively. There was no amortization expense in the periods ended June 30, 2001.





During the six months ended June 30, 2002, the Company determined that the fair value of the goodwill exceeded the carrying value and thus did not need to record an impairment charge.





9.    Note Receivable from Related Party





In June 2002, the Company received a promissory note from an officer for $500,000. The promissory note is collateralized by real estate, bears interest at 5.0% per annum and is due and payable in June
2007 or earlier upon the termination of employment. If the officer remains continually employed with the Company, the principal and accrued interest will be forgiven on the fifth anniversary from the date of employment.





10.    Private Placement





In May 2002, the Company completed a private equity financing in which 5,543,822 shares of common stock were sold at $4.57 per share resulting in net proceeds of $25.2 million.





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





INFORMATION REGARDING FORWARD-LOOKING STATEMENTS





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





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




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




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




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




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




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




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




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




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




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




| |  |  | the expansion of our business into drug discovery and development;
| | - |  | ------------------------------------------------------------------




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




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




| |  |  | liquidity.
| | - |  | ----------




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





In some cases, you can identify forward-looking statements by terms such as may, will,
should, could, would, expects, plans, anticipates, believes, estimates, projects, predicts, potential and similar
expressions intended to






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identify forward-looking statements. These statements reflect our current views with respect to future
events and are based on assumptions and subject to risks and uncertainties. Given these uncertainties, you should not place undue reliance on these forward-looking statements. We discuss many of these risks in this prospectus in greater detail under
the heading Risk Factors. Also, these forward-looking statements represent our estimates and assumptions only as of the date of this report.





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






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





Overview





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





Our platform product, DeltaBase, provides
a database of in vivo mammalian gene function information on target genes selected for their disease relevance. We delete, or knock out, these genes in mice and then utilize an extensive, integrated analysis program to assess the
function and potential pharmaceutical relevance of these genes and the proteins these genes encode. We also focus our efforts to determine the function of secreted proteins. We are undertaking the discovery and development of biotechnology drug
candidates internally and in collaboration with other parties.





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





We are also internally
focusing on the discovery and development of biopharmaceutical products through our Target Research and Development, or TRD, program. Building on the DeltaBase platform, our TRD program adds comprehensive in-depth analysis to further characterize
and identify potential key targets for the treatment of disease. The program currently focuses on the identification and validation of targets in oncology, metabolism, inflammatory diseases and certain areas of the central nervous system.





We have assembled an integrated drug discovery platform. With our newly acquired medicinal chemistry and drug
discovery capabilities, coupled with our small molecule screening and drug metabolism technologies, our goal is to advance targets identified through our TRD program to identify clinical drug candidates that will have an improved chance of clinical
success as well as a lower incidence of side effects.





We are implementing a strategy to integrate our:





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




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




| |  |  | internal target validation, lead compound drug discovery and optimization efforts through our comprehensive drug screening capabilities, computational design
technologies integrated with medicinal and analytical chemistries and high-throughput parallel synthesis and purification capabilities;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | development and expansion of our own products and programs in collaboration with other companies and through our own internal programs, including the
advancement of preclinical biopharmaceutical drug candidates;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | commercialization of the intellectual property we generate on the use of mammalian genes and secreted proteins in drug development through alliances and
collaborations with others and our own internal products and programs; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




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




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





Our recent
acquisitions of Arcaris, Inc. (Arcaris,) and XenoPharm, Inc. (XenoPharm,) further complement our internal drug discovery efforts. Arcaris, now a subsidiary known as Deltagen Proteomics, supplements our small molecule
discovery program through its genetic, proteomic and cell-biological systems for identification and validation of drug targets and the creation of small molecule screens. XenoPharm provides a proprietary technology platform to evaluate drug
metabolism of drug candidates, to improve the predictive value of cell- and animal-based biomedical research and predict the reaction of a drug candidate in a human system, thereby screening candidates for improved chances of clinical success.






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We have also integrated established drug discovery capabilities through the
February 2002 acquisition from Bristol-Myers Squibb Company of BMSPRL, L.L.C., (BMSPRL), formerly known as CombiChem, Inc. This subsidiary was renamed Deltagen Research Laboratories. The acquisition provides us with a well-recognized
small molecule drug discovery operation.





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





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




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




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




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




| |  |  | internal characterization, evaluation and validation of targets, including those targets discovered and analyzed using our proprietary in vivo mammalian
functional genomics programs, such as DT011M, a target we believe is involved in the mediation of insulin secretion and a potential target for the development of a drug for the treatment of obesity and related diseases such as diabetes;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Deltagen Research Laboratories drug discovery and candidate optimization capabilities, comprising the screening and identification of potent in
vitro compounds, as well as lead optimization and identification of clinical nomination candidates;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Deltagen Proteomics small molecule target discovery and drug screening technologies;
| | - |  | -------------------------------------------------------------------------------------




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




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




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





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





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





We recently
initiated a pilot study known as DeltaOne  that offers access to our mice, data and intellectual
property on a gene-by-gene basis. We also announced that Millennium Pharmaceuticals has become our first partner in this new program. To date, we have not generated any revenue from our DeltaOne program.






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We have DeltaBase agreements with GlaxoSmithKline, Pfizer and Merck. Each of
these agreements provides for payments aggregating approximately $15 million in exchange for three years worth of DeltaBase targets. In addition, we may receive additional fees for access to certain intellectual property. We began recognizing
revenue from the GlaxoSmithKline agreement in the fourth quarter of 2000. Revenue from the Pfizer agreement began to be recognized in the first quarter of 2001. We began to recognize revenue from the Merck agreement in the second quarter of 2002. We
anticipate that the majority of our revenues for at least the next year will be derived from fees under agreements with DeltaBase subscribers and access to information and tools related to the DeltaBase product offering. Our current DeltaBase
agreements with GlaxoSmithKline and Pfizer are coterminous, each terminating upon our delivery of DeltaBase in June 2003, and, although renewable beyond such date, may not be renewed. The Merck agreement, though confined to 750 genes, may result in
some initial gene data being delivered to Merck subsequent to June 2003.





Revenue for the three and six months
ended June 30, 2002 and 2001 is as follows:





For the Three Months Ended June 30,

For the Six Months Ended June 30,2002

2001

2002

2001(in thousands)Revenue:DeltaBase

$
5,223

$
2,188

$
7,328

$
4,320Other (includes DeltaSelect and research collaborations)


696


547


1,206


866Total

$
5,919

$
2,735

$
8,534

$
5,186





Under our revenue recognition policy, revenues are recognized when
persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered and meet all customer-specified criteria, the price is fixed and determinable and collectibility is reasonably assured. Revenue derived from DeltaBase
agreements is recognized on a straight-line basis over the term in which services are to be provided. Research and development collaboration agreements specify milestones to be met and the payments associated with meeting each milestone. Revenue
derived from these contracts is recognized upon completion of the milestone. The amount of revenue recognized upon completion of each milestone is such that the earned revenue, as a percentage of total anticipated revenue, approximates the costs
incurred in achieving the related milestone, as a percentage of the total anticipated costs. Where the contract does not specify milestones and payment is upon completion of the contract, revenue is recognized based on the percentage-of-completion
method of accounting. Any payments received in advance of the completion of a milestone or services performed are recorded as deferred revenue.





We had net losses of $19.2 million and $11.9 million for the three months ended June 30, 2002 and 2001, respectively. Our losses have resulted primarily from costs incurred in connection with research
and development activities, from selling, general and administrative costs associated with our operations and non-cash charges for amortization of unearned stock-based compensation costs and amortization of intangibles. This amortization totaled
$1.7 million and $1.2 million for the three months ended June 30, 2002 and 2001, respectively. Research and development expenses consist primarily of salaries and related personnel costs, material costs, legal expenses resulting from intellectual
property filings and other expenses related to the development of our DeltaBase, DeltaSelect and secreted protein programs. We expense our research and development costs as they are incurred. Selling, general and administrative expenses consist
primarily of salaries and related expenses for executive, finance and other administrative personnel, professional and other corporate expenses including business development, marketing, litigation costs and general legal activities. In connection
with the development and expansion of our gene function and gene expression databases and our secreted protein program, we expect to incur increasing research and development and selling, general and administrative costs. As a result, we will need
to generate significantly higher revenues to achieve profitability. We expect to report substantial net losses through the next several years.





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





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





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





During the
three months ended June 30, 2002 and 2001 we reversed approximately $252,000 and $254,000 of unearned stock-based compensation, respectively. During the six months ended June 30, 2002 and 2001 we reversed approximately






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$390,000 and $1.7 million of unearned stock-based compensation, respectively. The reversals were related
to terminated employees and changes in the fair market value of our common stock.





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





Merck DeltaBase Agreement





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





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





On February 16, 2002, we
acquired the California-based BMSPRL, formerly known as CombiChem, Inc., from Bristol-Myers Squibb Company for 2,647,481 unregistered shares of our common stock valued at approximately $23.5 million and paid certain transaction expenses. The
subsidiary was renamed Deltagen Research Laboratories. The acquisition provides us with an established and well-recognized small molecule drug discovery capability. The acquisition of Deltagen Research Laboratories significantly advances our efforts
in generating lead candidate compounds for drug development. We plan to select a number of targets for potential compound development in 2002 from our internal in vivomammalian technology platform, with particular emphasis on cancer,
metabolic disorders and inflammatory diseases. Integration of Deltagen Research Laboratories will allow us to utilize the technology and expertise of an experienced team in efforts to discover potential compounds against internal drug targets,
including DT011M. DT011M is our potential insulin-mediating drug target for the treatment of obesity and related diseases such as diabetes. BMSPRL is a company with an integration of computational, medicinal and analytical chemistry capabilities
coupled to biological screening. The companys 77,000 square foot facilities in San Diego include 22 fully-equipped chemistry laboratories and a new biology facility. As of February 16, 2002, Deltagen Research Laboratories employed 70
scientists, including 53 in chemistry.





Stanford Collaboration Agreement





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





Acquisition of XenoPharm, Inc.





On March 14, 2002, we acquired XenoPharm, a San
Diego, California-based private company for 498,236 shares of our unregistered common stock valued at approximately $3.6 million and paid certain transaction expenses. Up to an additional 1,449,262 shares of unregistered common stock may be issued
upon the achievement of certain key milestones. The entity will become our wholly-owned subsidiary. XenoPharm, which was incorporated in November 2000, provides a proprietary technology platform to pharmaceutical, biotechnology, chemical and
agricultural companies to better understand and predict reactions of foreign substances, termed xenobiotics, in human systems. XenoPharms XenoSensor Mice, implanted with human SXR and CAR, coupled with XenoPharms CleanScreen
high-throughput screening assays provide a proprietary technology platform to improve the predictive value of cell- and animal-based biomedical research. The operating expenses of XenoPharm are expected to be insignificant in 2002.





Results of Operations





Total contract revenue increased to $5.9 million for the three months ended June 30, 2002 from $2.7 million for the comparable period in 2001. DeltaBase revenue increased to $5.2 million for the three months ended June 30, 2002 from
$2.2 million for the comparable period of 2001. Both periods included revenue from GlaxoSmithKline and Pfizer. Total contract revenue for the six months ended June 30, 2002 and 2001 was $8.5 million and $5.2 million, respectively. DeltaBase revenues
increased to $7.3 million for the six months ended June 30, 2002 from $4.3 million for the comparable period in 2001. Both periods included revenue from GlaxoSmithKline and Pfizer. The increase in revenue in both the three and six months ended June
30, 2002 was primarily due to revenue from the Merck agreement that was recognized beginning in the quarter ended June 30, 2002.






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Research and development expenses were $21.3 million for the three months ended
June 30, 2002 and $10.4 million for the comparable period in 2001. Research and development expenses for the six months ended June 30, 2002 and 2001 were $38.4 million and $18.6 million, respectively. Excluding depreciation, amortization of unearned
stock-based compensation expenses and amortization of intangibles, research and development expenses increased by $10.1 million to $18 million for the three months ended June 30, 2002 from $7.9 million in the comparable period of 2001. This increase
was primarily attributable to continued growth of research and development activities including the activities of Deltagen Proteomics and Deltagen Research Laboratories acquired subsequent to June 30, 2001. The increase includes $3.2 million related
to increased personnel, $2.6 million related to increased laboratory supply costs to support development of our gene function database and our DeltaSelect and secreted protein programs, $200,000 related to professional fees and $3 million of
facilities related expenses.





Selling, general and administrative expenses were $4.1 million for the three months
ended June 30, 2002 and $5.3 million for the comparable period of 2001. Selling, general and administrative expenses for the six months ended June 30, 2002 and 2001 were $8.6 million and $8.2 million, respectively. Excluding depreciation and
amortization of unearned stock-based compensation costs, selling, general and administrative expenses decreased by $1 million to $3.7 million for the three months ended June 30, 2002 from $4.7 million in the comparable period of 2001. This decrease
included $850,000 related to increased personnel, $165,000 related to decreases in marketing and advertising costs and $1.6 million related to decreases in legal and professional fees.





We had net interest income of $220,000 and $1.1 million for the three months ended June 30, 2002 and 2001, respectively. Net interest income for the six months ended June
30, 2002 and 2001 was $483,000 and $2.7 million, respectively. This decrease is due to lower average cash and investment balances, lower investment interest rates and increased debt.





Liquidity and Capital Resources





We have financed our
operations from inception primarily through issuances of equity securities, contract payments to us under our DeltaSelect and DeltaBase agreements, equipment financing arrangements and a term loan facility. Through June 30, 2002, we had received net
proceeds of $183.4 million from issuances of equity securities, including net proceeds of $25.5 million from an equity issuance in the June 30, 2002 quarter, $36 million from customer agreements, $13 million from equipment financing arrangements and
$10 million from a term loan facility.





At June 30, 2002, we had $54.3 million in cash and cash equivalents
compared to $61.4 million at December 31, 2001. In addition, at June 30, 2002, we had $22.3 million in marketable securities representing highly liquid commercial paper and government agency securities compared to $15.1 million at December 31, 2001.
We used $24 million in cash for operating activities during the six months ended June 30, 2002. This consisted primarily of the net loss for the period of $38 million and increased accounts receivable, prepaid expenses and other current assets of
$1.5 million offset in part by non-cash charges of $5.3 million related to depreciation and amortization expenses and $1.1 million related to the amortization of unearned stock-based compensation and increased accounts payable and deferred revenue
of $8.9 million. Investment activities used $20.3 million in cash during the six months ended June 30, 2002 including $12.4 million related to the purchase of marketable securities, $10.7 million related to capital expenditures and $981,000 related
to the acquisitions of BMSPRL, L.L.C. and XenoPharm, Inc. in February and March 2002, respectively, offset in part by $5 million related to the maturities of marketable securities. We received $37.2 million in cash from financing activities during
the six months ended June 30, 2002, which consisted primarily of $14.3 million from loan proceeds and $25.5 million from the sale of common stock. This was offset partially by loan and capital lease repayments of $2.6 million.





In December 1998, March 1999, June 2000, June 2001 and February 2002, we entered into equipment financing agreements of $1.8
million, $1.5 million, $2.9 million, $2.5 million and $4 million, respectively. We have drawn down approximately $12.7 million during 1999, 2000, 2001 and 2002 . There are no more amounts available to be drawn under these agreements As of
June 30, 2002, $7.3 million remains outstanding on these equipment loans at a weighted average interest rate of approximately 10.64% which is due in monthly installments through 2005. The loans are collateralized by property and equipment.





On June 27, 2002, we entered into two new bank agreements. These include a $20 million term loan facility and a
one-year $5 million accounts receivable facility. The term loan can be drawn down through March 31, 2003 and matures through March 31, 2007. The loan is secured by a first position security interest in the Companys assets excluding
intellectual property. The Company has certain restrictions on the assignment or transfer of intellectual property during the term of the loan. The Company borrowed $10 million under this facility on June 28, 2002 at the current interest rate of
6.125%. Interest only payments will be made through the end of the draw down period at which time outstanding principal and interest will be due in 48 equal monthly installments. The loan has financial covenants related to earnings and liquidity,
including a requirement that the Company maintain unrestricted cash balances, as defined, equal to the greater of two times the principal balance outstanding on the loan or six months of net cash used in operating activities. The accounts receivable
facility was not utilized in the June 30, 2002 quarter.





With the February 2002 acquisition of Deltagen
Research Laboratories and the expansion of our drug discovery efforts, that our operating expenses have increased significantly. Operating expenses associated with Deltagen Research Laboratories will






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likely exceed $20 million in 2002. In addition, we have commenced work on our Redwood City facilities to
establish laboratories to meet the growing size and scope of research activities. It is presently estimated that this project, which involves both equipment purchases and tenant improvements for laboratory and animal space, will cost between $25
million and $27 million and will be substantially complete by the fourth quarter of 2002.





At June 30, 2002 we had
the following contractual cash obligations:





Year Ending December 31,

Operating Leases

Capital Leases (1)

Debt (1)

Total(in thousands)2002

$
5,883

$
5

$
2,907

$
8,7952003


12,977


20


5,090


18,0872004


11,837


8


4,837


16,6822005


11,606





3,615


15,2212006


10,520





1,395


11,915Thereafter


54,824








54,824Total

$
107,647

$
33

$
17,844

$
125,524


---

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




We have issued standing letters of credit totaling $2.8 million as credit support for operating leases. These letters of credit are collateralized by cash deposits of an equal amount and automatically renew on an annual basis during
the lease term. These cash deposits are classified as restricted cash on the consolidated balance sheet.





The
equipment loan agreements have restrictive covenants requiring minimum unrestricted cash balances, generally twelve months cash needs. If unrestricted cash balances fall below the minimum levels, we will be required to provide cash security deposits
of up to $2.3 million. The term loan agreement has restrictive covenants including a requirement that the Company maintain unrestricted cash balances, as defined, equal to the greater of two times the principal balance outstanding on the loan or six
months of net cash used in operating activities. If unrestricted cash balances fall below the minimum level, we will be required to restrict cash equal to 105% of the loan balance outstanding or pay down the loan balance to a level that achieves
compliance with the restrictive covenants.





At June 30, 2002 we had approximately $6.2 million in committed
financing available for the construction of a research and development facility for Deltagen Europe S.A. Construction of this facility has not begun.





We believe that our current cash and cash equivalents and marketable securities balances, together with revenues from subscriptions to our gene function database and collaborative research agreements,
will be sufficient to fund our operations for at least the next twelve months. This may require the Company to reduce the level of operating expenses through reductions in our workforce in order to reduce the level of operating losses. We continue
to evaluate alternative means of financing to meet our long-term needs. These include the possible sale of additional equity or debt securities, equipment financing, secured bank lines of credit and various facility improvement financing
arrangements. Additional financing may not be available on terms acceptable to us or at all. The sale of additional equity or convertible debt securities may result in additional dilution to our stockholders. Any debt financing may have restrictive
covenants that adversely affect our operating plans and flexibility.





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





Recent Accounting Pronouncements





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





In April of 2002, the FASB issued Statement of Financial Accounting Standards No. 145 (SFAS 145), Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections, which is effective for fiscal years beginning after May 15, 2002. Under SFAS 145, gains and losses from the extinguishment of debt should be






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classified as extraordinary items only if they meet the criteria of Accounting Principles Board Opinion
No. 30. SFAS also addresses financial accounting and reporting for capital leases that are modified in such a way as to give rise to a new agreement classified as an operating lease. The Company believes that the adoption of SFAS 145 will not have a
material effect on the financial position or results of operations of the Company.





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





Item 3.    Quantitative and Qualitative Disclosures About Market Risk





We invest our excess cash primarily in obligations of governmental agencies and marketable debt securities of financial institutions and corporations with strong credit ratings. These instruments have maturities of twenty- four
months or less when acquired. We do not utilize derivative financial instruments, derivative commodity instruments or other market risk sensitive instruments, positions or transactions in any material fashion. Accordingly, we believe that, while the
instruments we hold are subject to changes in the financial standing of the issuer of such securities, we are not subject to any material risks arising from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices
or other market changes that affect market risk sensitive instruments. Loans payable of $10 million at June 30, 2002 have a current variable interest rate of 6.125%





Our loans payable of $17.8 million at June 30, 2002 carry fixed interest rates ranging from 8.87% to 12.75% per annum with payments due in 36 or 48 monthly installments.
Our capital lease obligations of $33,000 at June 30, 2002 carry fixed interest rates ranging from 0% to 10.39% per annum with payments due in 36 monthly installments. Loans payable of $10 million at June 30, 2002 have a current variable interest
rate of 6.125%.





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





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


2003


2004


2005


2006


Thereafter

Total(in thousands)Assets:Cash and cash equivalents

$
54,295


$



$



$



$



$


$
54,295Marketable securities

$
22,302





















$
22,302Weighted average interest rate


2.15
%


















Liabilities:Capital lease obligations

$
5


$
20


$
8


$



$



$


$
33Weighted average interest rate


2.79
%


6.24
%














Loans payable

$
2,907


$
5,090


$
4,837


$
3,615


$
1,395


$


$
17,844Weighted average interest rate


8.86
%


8.51
%


8.09
%


7.12
%


6.12
%








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






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RISK FACTORS





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





We have had net losses every year since our inception in 1997 and, as of June 30, 2002 had an
accumulated deficit of $137.1 million. We had net losses of $38 million and $18.9 million for the six months ended June 30, 2002 and 2001, respectively. We had net losses of $48.5 million, $32.2 million, and $13.8 million in 2001, 2000 and 1999,
respectively. The 2000 net loss is before a $22.4 million deemed dividend-related to the beneficial conversion of our preferred stock. Because we anticipate significant expenditures for our research and development programs and for the development,
implementation and support of our gene function database, we expect to report substantial net losses through at least the next several years. We may never achieve profitability. If we do not become profitable within the time frame expected by
securities analysts or investors, the market price of our stock will likely decline. If we do achieve profitability, we may not sustain or increase profitability in the future.





Our expenditures have increased in 2002 due in part to:





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




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




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




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





With our recent acquisitions and our expanded scope of activities, our expenditures, and our
underlying burn rate, has increased significantly. Our products and services may not produce revenues that, together with our existing cash and other resources, are adequate to meet our cash needs. We plan to fund our operations for at least the
next twelve months from our existing cash balances and cash flows, but expect to seek to raise additional funds from the sale of stock, either through private financing and/or a public offering, or from debt financing. Our cash requirements depend
on numerous factors, including:





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




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




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




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




| |  |  | increased expenditures relating to our expanded and further expanding commercial activities in biopharmaceutical drug discovery and development;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------




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




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




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





We require substantial amounts of capital, and will require substantially increased amounts of capital in the future, to fund our business operations. The continued development of our drug discovery and development efforts requires
significant amounts of capital. The rate at which our capital is utilized is affected by the operational and developmental costs incurred and the extent to which our products gain acceptance.






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We continue to evaluate alternative means of financing to meet our needs on terms
that are attractive to us. We currently anticipate that our available funds will be sufficient to meet our projected needs to fund operations for at least the next twelve months. We expect that we will need to raise additional capital to fund our
operations by the second quarter of 2003.





If we are not able to obtain needed capital, we will have to take
actions to conserve our cash balances, including significantly reducing our operating expenses, downsizing our staff and closing existing facilities, all of which would likely have a material adverse effect on our business, financial condition and
our ability to reduce losses or generate profits.





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





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





We have had a limited operating history and are at an early stage of development.
Our pricing models for offering our products and services are unproven. We currently have four full subscribers for our DeltaBase gene function database, only three of which are paying subscription fees. We have generated only limited revenues
amounting to approximately $9.9 million, $2.1 million and $1.2 million for the fiscal years 2001, 2000 and 1999, respectively. For the six months ended June 30, 2002 and 2001 we recognized revenues of $8.5 million and $5.2 million, respectively. Our
success will depend on, among other things, our ability to enter into future licensing and other agreements on favorable terms, our ability to determine and generate information on those genes that have potential use as drug targets and the
commercialization of products using our data. Our sales force may not succeed in marketing our database product, and our employees may not succeed in implementing and operating our database in a manner that is satisfactory to our subscribers.
Furthermore, the plans for our secreted protein and conditional knockout programs are unproven, and we cannot be sure that we will ever be able to develop these programs or that any program that we develop will be commercially successful. As a
result of these factors, it is difficult to evaluate our prospects, and our future success is more uncertain than if we had a longer or more proven history of operations.





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





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





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





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





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





Over the past several years, companies in the pharmaceutical industry have undergone significant consolidation. As such companies merge,
we will have fewer potential customers for our products. Also, if two or more of our present or future customers merge, we may not be able to receive the same fees under agreements with the combined entities that we were able to receive under
agreements with these customers prior to their merger. Moreover, if one of our customers merges with an entity that






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is not a customer, the new combined entity may prematurely terminate our agreement. Any of these
developments could materially harm our business or financial condition.





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





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





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





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





Results of our product development are uncertain.





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





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




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




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




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




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




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




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




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






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





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





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





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





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





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





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





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





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





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





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





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




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




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




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





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




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




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




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




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





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





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




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




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




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




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




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




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





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





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





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





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





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





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






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





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





If we fail to properly manage our growth, our business could be adversely affected.





We have experienced significant growth in the number of our employees and the scope of our operations, including an increase in the scale of our mouse knockout program, as well as our secreted protein and biopharmaceutical
drug discovery and development programs. As of June 30, 2002, we had approximately 460 full-time equivalent employees. Our overall growth and need to develop many different areas of our company have placed, and may continue to place, a strain on our
management and operations. If we are unable to manage our growth effectively, our losses could increase. The management of our growth will depend, among other things, upon our ability to broaden our management team and attract, hire, train and
retain skilled employees. Our success will also depend on the ability of our officers and key employees to continue to implement and improve our operational and other systems. We will also be required to expend funds, which may be substantial, to
improve our operational, financial and management controls, reporting systems and procedures.





We also have
multiple offices and facilities in North America and Europe, which presents significant challenges and strain on our management and operations. In addition to our corporate headquarters in Redwood City, California, we currently have offices or
facilities in Menlo Park, Alameda and San Carlos, California, as well as facilities in Strasbourg, France for Deltagen Europe, S.A., in Salt Lake City, Utah for Deltagen Proteomics and in San Diego, California for Deltagen Research Laboratories. In
addition, we have commenced work on our Redwood City facilities to establish laboratories to meet our growing size and scope of research activities. It is presently estimated that this project, which involves both equipment purchases and build out
of current facilities, will cost between $25 million and $27 million and is expected to be substantially complete in the fourth quarter of 2002. These estimates may materially differ from our expectations. We may also acquire additional offices or
facilities in the event that we merge with or acquire other companies. These additional offices or facilities will present even greater challenges and strain on management and operations.





Our merger with Arcaris might not produce the expected benefits.





Prior to our acquisition of Arcaris, we operated primarily in the field of genomics-based information, products and programs, and have not had significant experience operating in the proteomics field. It may turn out that
there are no advantages or synergies to adding Arcaris research capabilities to our product line and technology platform. There are no assurances that the technologies used by Arcaris will not infringe third party intellectual
property rights or that it will be able to obtain all licenses necessary to use its current technologies. Moreover, there is no assurance that Arcaris operations, which are located in Salt Lake City, Utah, can be successfully integrated into
our operations or that any of the benefits expected from such integration will be realized. Although Arcaris will remain as our separate operating subsidiary of (renamed Deltagen Proteomics), we intend to explore the integration of certain aspects
of the operations of Arcaris with our operations. Furthermore, there can be no assurance that the operations, management and personnel of the two companies will be compatible or that we or Arcaris will not experience






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the loss of key personnel. The Arcaris acquisition could result in the incurrence of contingent
liabilities and amortization expenses related to intangible assets, which could adversely affect our results of operations and financial condition.





Our merger with BMSPRL, L.L.C., formerly known as CombiChem, Inc., might not produce the expected benefits.





Prior to our acquisition of BMSPRL, L.L.C,, we operated primarily in the field of genomics-based information, products and programs market, and have no experience in drug discovery and development activities such as
medicinal chemistry, high-throughput compound screening, and chemical synthesis. It may turn out that there are no advantages or synergies to adding BMSPRLs research capabilities to our product line and technology platform.
Moreover, there is no assurance that BMSPRLs operations, which are located in San Diego, California, can be successfully integrated into our operations or that any of the benefits expected from such integration will be realized. Although
BMSPRL will become our subsidiary (renamed Deltagen Research Laboratories), there can be no assurance that the operations, management and personnel of the two companies will be compatible or that we or BMSPRL will not experience the loss of key
personnel. The BMSPRL acquisition could result in the incurrence of contingent liabilities and amortization expenses related to intangible assets, which could adversely affect our results of operations and financial condition. We do not currently
expect the need in the next few years to make significant capital investments in equipment or facilities for Deltagen Research Laboratories, as BMSPRL at the time we acquired it had a 77,000 square foot facility, including 22 modern chemistry
laboratories and a newly-added biology laboratory. We also do not anticipate the need to hire additional research staff, as BMSPRL at the time we acquired it employed 70 scientists, including 53 in chemistry. However, we cannot assure you that our
needs or focus will not change or that such changes may require us to expand or supplement Deltagen Research Laboratories facilities or supplement its research staff. We had 47 scientists, including 26 in chemistry, at Deltagen Research
Laboratories on June 30, 2002.





Our acquisition of XenoPharm might not produce the expected benefits.





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





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





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





We depend on key employees in a competitive market for skilled personnel, and without additional employees,
we cannot grow or achieve profitability.





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





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









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





Our business and
competitive position depends upon our ability to protect and exploit our proprietary techniques, methods, compositions, inventions, database information and software technology. However, our strategy of obtaining such proprietary rights around as
many genes as possible is unproven. Unauthorized parties may attempt to obtain and use information that we regard as proprietary. Although we intend for our gene function database subscription agreements to require our potential subscribers to
control access to our database and information, policing unauthorized use of our database information and software may be difficult.





Although we currently have certain issued United States patents, none of these relate to knockout mice or therapeutics. Patents have been issued to other entities based on claims relating to knockout mice or therapeutics. In
addition, many applications have been filed seeking to protect partial human gene sequences, many of which are based primarily on gene sequence information alone. Some of these applications have issued as patents. Some of these may claim sequences
that we have used or may use in the future to generate knockout mice in our gene knockout program or that we have used or may use in the future to discover and develop biopharmaceutical products. In addition, other applications have been filed which
seek to protect methods of using genes and gene expression products, some of which attempt to assign biological function to the DNA sequences based on laboratory experiments, computer predictions, mathematical algorithms and other methods. The
issuance of these applications as patents will depend, in part, upon whether practical utility can be sufficiently established for the claimed sequences and whether sufficient correlation exists between the experimental results, predictions,
algorithms and other methods and actual functional utility. The patent application process before the U.S. Patent and Trademark Office and other similar agencies in other countries is confidential in nature. Although certain patent applications are
published prior to issuance, as each application is evaluated independently and confidentially, we cannot predict whether applications have been filed or which, if any, will ultimately issue as patents. However, it is probable that patents will be
issued to our competitors claiming knockout mice, partial human gene sequences and methods of using genes and gene expression products.





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





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





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





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





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





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





The technology we use in our business may subject us to claims that we infringe on the patents or proprietary rights of others. The risk of this occurring will tend to increase as the genomics, biotechnology and software industries
expand, more patents are issued and other companies attempt to discover gene function through mouse gene knockouts and engage in other






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genomics-related businesses. Furthermore, many of our competitors and other companies performing
research on genes have already applied for patents covering some of the genes upon which we perform research, and many patents have already been issued which cover these genes, as well as genes we may wish to use in the future.





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





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




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




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




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




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





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





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





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





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





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





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





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





The Animal Welfare Act, or AWA, is the federal law
that currently covers animals in laboratories. It applies to institutions or facilities using any regulated live animals for research, testing, teaching or experimentation, including diagnostic laboratories and private companies in the
pharmaceutical and biotechnology industries. Rats, birds and mice, including the mice in our knockout programs, are currently excluded from the definition of animal and, therefore, are not subject to regulation under the AWA. However,
the United States Department of Agriculture, which enforces the AWA, has been sued on this matter and agreed,






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as part of the settlement of this lawsuit on September 25, 2000, to begin the process of changing the
regulations issued under the AWA to include rats, mice and birds within its coverage. Congress subsequently prohibited, in the Agricultural Appropriations Act for fiscal year 2001 and again for fiscal year 2002, the expenditure of any money or
commencing rulemaking for the purpose of changing the regulations with respect to including rats, mice and birds prior to October 1, 2002. We cannot predict whether mice will at any time after such date be included under the AWA.





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





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





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





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





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





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





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





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






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





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





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





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





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





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





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





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




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




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




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




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




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




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




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




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




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




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




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




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






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





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





We had 40,842,094 shares of common stock outstanding at June
30, 2002.





If our common stockholders sell substantial amounts of common stock in the public market, or the market
perceives that such sales may occur, the market price of our common stock could fall. The holders of approximately 23.2 million shares of our common stock have rights, subject to some conditions, to require us to file registration statements
covering their shares or to include their shares in registration statements that we may file for ourselves or other stockholders. Furthermore, if we were to include in a company-initiated registration statement shares held by those holders pursuant
to the exercise of their registration rights, those sales could impair our ability to raise needed capital by depressing the price at which we could sell our common stock.





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





As of June 30, 2002, our executive officers and
directors, and entities affiliated with them, beneficially own, in the aggregate, approximately 53.2% of our common stock. This significant concentration of share ownership may adversely affect the trading price for our common stock because
investors often perceive disadvantages in owning stock in companies with controlling shareholders. These stockholders, acting together, will have the ability to exert substantial influence over all matters requiring approval by our stockholders,
including the election and removal of directors and any proposed merger, consolidation or sale of all or substantially all of our assets. In addition, they could dictate the management of our business and affairs. This concentration of ownership
could have the effect of delaying, deferring or preventing a change in control, or impeding a merger or consolidation, takeover or other business combination that could be favorable to you.





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





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





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




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




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




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





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





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






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technologies become available. Our drug discovery processes may be rendered obsolete or uneconomical by
technological advances or by entirely different approaches developed by one or more of our competitors. The existing drug discovery approaches of our competitors or new approaches or technology developed by our competitors may be more effective than
those developed by us.





Our drug discovery technology is unproven and has not been shown to be successful in discovering new
commercially viable drugs.





We have only very recently acquired drug discovery capabilities through our
acquisition in February 2002 of BMSPRL formerly known as CombiChem, from Bristol-Myers Squibb Company. This subsidiary was renamed Deltagen Research Laboratories. We have not yet shown that our newly-acquired drug discovery technologies can
successfully be used to discover drug candidates that ultimately become commercial products. Development of new drugs is highly uncertain. Our drug discovery process may not result in drug candidates that will be safe or effective or commercially
successful as products.






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PART II.    OTHER INFORMATION





Item 1.Legal Proceedings





None





Item 2.Changes in Securities





(a)  Not applicable.





(b)  Not applicable.





(c)  During the second quarter of fiscal 2002, the Company issued an aggregate of 5,543,822 shares of its common stock at a price of $4.57 a share pursuant to a private placement with 23
investors. Each of the investors represented that he, she or it was an accredited investor. The shares were issued pursuant to an exemption by reason of Section 4(2) of the Securities Act of 1933. These sales were made without general solicitation
or advertising. The Company has filed a Registration Statement on Form S-3 covering the resale of such securities. All net proceeds from the sale of such securities will go to the selling shareholders who offer and sell their shares. The Company has
not received and will not receive any proceeds from the sale of these common shares.





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





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





Repayment of indebtedness

$
4,801Purchase and installation of equipment and build out of facilities


21,039Working capital


60,135Bank Deposits and temporary investments


24,225Net offering proceeds

$
110,200





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





Item 3.Defaults Upon Senior Securities





Not applicable.





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








The Companys Annual Meeting of Stockholders was held on May 22, 2002. Constantine E. Anagnostopoulos, Ph.D., Philippe O. Chambon, M.D., Ph.D. and Thomas A. Penn were elected to three-year terms ending with the 2005
Annual Meeting. The voting was as follows:





For

Against

AbstainConstantine E. Anagnostopoulos, Ph.D.

31,636,901

2,435

Philippe O. Chambon, M.D., Ph.D.

31,636,925

2,411

Thomas A. Penn

31,636,925

2,411







Item 5.Other Information





Not applicable.






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





(a)  Exhibits





4.6

Common Stock Purchase Agreement dated May 15, 2002 (1)10.41

Amendment to Employment Agreement with William Matthews dated June 26, 200210.42

Agreement with Michael Sember dated July 30, 200210.43

Promissory Note from Michael Sember dated June 24, 200210.44

Loan Agreement with Michael Sember dated June 24, 200210.45

Loan and Security Agreement with Silicon Valley Bank dated June 27, 2002 (2)10.46

Non-recourse Receivables Purchase Agreement dated July 1, 2002 (3)10.47

Change of Control Severance Pay Plan for Officers adopted June 26, 200299.1

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

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


---

|(1) |  | Incorporated by reference to Exhibit 99.2 filed with the Registrants Current Report on Form 8-K (File No. 000-31147) filed on May 16, 2002
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | Incorporated by reference to Exhibit 99.2 filed with the Registrants Current Report on Form 8-K (File No. 000-31147) filed on July 1, 2002
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------

|(3) |  | Incorporated by reference to Exhibit 99.3 filed with the Registrants Current Report on Form 8-K (File No. 000-31147) filed on July 1, 2002
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------




(b)  Reports on Form 8-K





A report on Form 8-K/A related to the acquisition of BMSPRL, L.L.C. was filed on May 2, 2002





| |  |  | Audited special purpose statements of Bristol-Myers Squibb Pharma Research Labs, Inc., the notes related thereto and the report of independent accountants
thereon
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Unaudited pro forma condensed combined financial statements and the notes related thereto
| | - |  | -----------------------------------------------------------------------------------------




A report on Form 8-K related to the sale of 5,543,822 shares of the Companys common stock was filed on May 16, 2002





A report on Form 8-K related to the sale of 5,543,822 shares of the Companys common stock was filed on May 23, 2002





A report on Form 8-K related to the appointment of Edward E. Penhoet, Ph.D. as a new member of the Companys
Board of Directors was filed on June 18, 2002





A report on Form 8-K related to the appointment of Donald
Karanewsky, Ph.D. as senior vice president and new site director of Deltagen Research Laboratories, L.L.C. was filed on June 20, 2002





A report on Form 8-K related to the signing of two new bank financings was filed on July 1, 2002





A report on Form 8-K related to the discovery of a drug target for the potential treatment of rheumatoid arthritis was filed on July 18, 2002





A report on Form 8-K related to the announcement that the Company would host a telephonic and internet-available conference call to discuss its second quarter 2002 financial results on Thursday, August
1, 2002 was filed on July 25, 2002





A report on Form 8-K related to the Companys second quarter earnings was
filed on August 1, 2002






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DELTAGEN, INC.





SIGNATURES





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





DELTAGEN,INC.Date: August 13, 2002

/s/    WILLIAMMATTHEWS,
PH.D. William Matthews, Ph.D.
Chairman and Chief Executive OfficerDate: August 13, 2002

/s/    RICHARD H.
HAWKINS Richard H. Hawkins Chief Financial Officer