UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

		For the quarterly period ended March 31, 2005

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

		For the transition period from to .

Commission File Number 000-31275

LARGE SCALE BIOLOGY CORPORATION

(Exact name of registrant as specified in its charter)

Delaware		77-0154648
(State or other jurisdiction of incorporation or organization)		(I.R.S. employer identification number)

3333 Vaca Valley Parkway, Vacaville, CA 95688
(Address of principal executive offices and zip code)

(707) 446-5501
(Registrant’s telephone number, including area code)

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

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

The number of shares outstanding of registrant’s common stock, $0.001 par value, as of May 11, 2005: 31,486,299

Some of the statements contained in this report constitute forward-looking statements that involve substantial risks and uncertainties. In some cases, you can identify these statements by forward-looking words such as “may,” “will,” “expect,” “plan,” “anticipate,” “believe,” “forecast,” “project,” or “continue” and variations of these words or comparable words. In addition, any statements, which refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. Our Management’s Discussion and Analysis of Financial Condition and Results of Operations contain many such forward-looking statements. These forward-looking statements involve known and unknown risks, uncertainties and situations that may cause our or our industry’s actual results, level of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these statements. The risk factors contained in this report, under the heading Factors That May Affect Our Business, as well as any other cautionary language in this report, provide examples of risks, uncertainties and events that may cause our actual results to differ from the expectations described or implied in our forward-looking statements.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this report. Except as required by law, we do not undertake to update or revise any forward-looking statement, whether as a result of new information, future events, or otherwise.

Large Scale Biology Corporation, LSBC, our logo, GENEWAREÒ, BAMF™, GRAMMR™ and other product and trade names are trademarks of or registered trademarks of Large Scale Biology Corporation in the United States and/or other countries. Other product and trade names mentioned herein may be trademarks and/or registered trademarks of their respective companies. References in this report to “the Company,” “our,” “we” and “us” refer collectively to Large Scale Biology Corporation, a Delaware corporation, and its predecessors and subsidiaries.

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

Large Scale Biology Corporation

Condensed Consolidated Balance Sheets

(Unaudited)

	March 31, 2005			December 31, 2004
Assets
Current assets:
Cash and cash equivalents	$	427,000		$	1,112,000
Accounts receivable, net	196,000			133,000
Prepaid expenses	685,000			521,000
Total current assets	1,308,000			1,766,000
Property, plant, and equipment, net	7,401,000			7,798,000
Intangible assets, net	2,044,000			2,194,000
Other assets	1,210,000			1,037,000
	$	11,963,000		$	12,795,000
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	976,000		$	735,000
Accrued employee compensation	390,000			343,000
Accrued expenses	114,000			24,000
Short-term debt	600,000			—
Deferred revenue and customer advances	13,000			28,000
Total current liabilities	2,093,000			1,130,000
Long-term debt	2,900,000			1,000,000
Accrued stock compensation	973,000			898,000
Deferred rent	352,000			336,000
Total liabilities	6,318,000			3,364,000
Stockholders’ equity:
Common stock; issued and outstanding:
March 31, 2005 — 31,486,299 shares;
December 31, 2004 — 31,382,813 shares	201,362,000			201,074,000
Stockholders’ notes receivable	(19,000		)	(20,000		)
Accumulated deficit	(195,698,000		)	(191,623,000		)
Total stockholders’ equity	5,645,000			9,431,000
	$	11,963,000		$	12,795,000

See accompanying notes to condensed consolidated financial statements.

Large Scale Biology Corporation

Condensed Consolidated Statements of Operations

(Unaudited)

	Three Months Ended March 31,
	2005			2004
Revenues	$	433,000		$	319,000
Costs and expenses:
Development agreements	670,000			487,000
Research and development	2,231,000			2,239,000
General and administrative	1,449,000			1,926,000
Total costs and expenses	4,350,000			4,652,000
Loss from operations	(3,917,000		)	(4,333,000		)
Interest income (expense), net	(158,000		)	9,000
Net loss	$	(4,075,000	)	$	(4,324,000	)
Net loss per share – basic and diluted	$	(0.13	)	$	(0.16	)
Weighted average shares outstanding – basic and diluted	31,400,327			27,320,293

See accompanying notes to condensed consolidated financial statements.

Large Scale Biology Corporation

Condensed Consolidated Statements of Cash Flows

(Unaudited)

	Three Months Ended March 31,
	2005			2004
Cash flows from operating activities:
Net loss	$	(4,075,000	)	$	(4,324,000	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation of property, plant and equipment	397,000			363,000
Amortization of intangible assets	150,000			132,000
Stock compensation expense	240,000			200,000
Vesting of warrant issued with long-term debt	109,000			—
Changes in assets and liabilities:
Accounts receivable	(63,000		)	125,000
Prepaid expenses	(164,000		)	(272,000		)
Other assets	(173,000		)	(277,000		)
Accounts payable	367,000			(64,000		)
Accrued employee compensation	47,000			(218,000		)
Accrued expenses	90,000			52,000
Deferred revenue and customer advances	(15,000		)	41,000
Deferred rent	16,000			—
Net cash used in operating activities	(3,074,000		)	(4,242,000		)
Cash flows from investing activities:
Capital expenditures	(126,000		)	(33,000		)
Net cash used in investing activities	(126,000		)	(33,000		)
Cash flows from financing activities:
Proceeds from issuance of common stock	14,000			7,604,000
Proceeds from issuance of short-term debt	600,000			—
Proceeds from issuance of long-term debt	1,900,000			—
Proceeds from stockholder loan payments	1,000			4,000
Change in restricted cash	—			143,000
Principal payments on long-term debt	—			(14,000		)
Net cash provided by financing activities	2,515,000			7,737,000
Net increase (decrease) in cash and cash equivalents	(685,000		)	3,462,000
Cash and cash equivalents at beginning of period	1,112,000			7,737,000
Cash and cash equivalents at end of period	$	427,000		$	11,199,000

See accompanying notes to condensed consolidated financial statements.

Large Scale Biology Corporation

Notes to Condensed Consolidated Financial Statements

(Unaudited)

1. The Company and Summary of Significant Accounting Policies

Large Scale Biology Corporation and its subsidiaries (collectively, the “Company”, “we” or “our”) is a product-focused biotechnology company using proprietary technologies to develop and manufacture recombinant biologics. Our biomanufacturing opportunities include vaccines, complex proteins and follow-on off-patent therapeutics. We are focusing our efforts on the following products:

• Recombinant Aprotinin, a protease inhibitor used in medical, research and manufacturing applications

• Vaccines for human and animal healthcare, including antiviral and anticancer applications

• Certain follow-on off-patent biologics and proprietary products, including Interferon alpha 2a and 2b, Alpha-galactosidase A for treatment of Fabry disease and Lysosomal acid lipase for the treatment of Wolman disease and cholesterol ester storage disorder and reduction of plaque in arteries

The technology employed in our product development and biomanufacturing operations includes our proprietary GENEWARE transient gene expression system and GRAMMR system to shuffle and improve gene sequences. Our manufacturing processes can be used to produce follow-on therapeutic products. We believe that our combination of proprietary technologies and existing manufacturing infrastructure enables us to rapidly and economically develop partner-specified products and to participate in market opportunities in major disease categories.

Our wholly-owned subsidiary, Predictive Diagnostics, Inc., or PDI, is a diagnostics company established for the commercial development of a proprietary approach to early diagnosis of life-threatening diseases. PDI’s products are supported by our technology developed in the course of our past genomics and medical product development programs. PDI’s initial product focus is in the field of oncology. Our Biomarker Amplification Filter, or BAMF Technology, potentially provides low-cost and rapid analysis of multiple biomarkers derived from profiling thousands of individual proteins, peptides and other metabolites found in clinical blood samples. Current typical diagnostic tests rely on measuring the variations from the normal amount of a single protein or biomarker. Our BAMF Technology finds multiple proteins or biomarkers in blood samples and creates a disease “fingerprint,” potentially leading to an accurate and early detection of disease.

The Company’s proprietary systems are supported by patents and patent applications. The Company’s corporate offices, research and development and its subsidiary company, Predictive Diagnostics, Inc. (“PDI”) are headquartered in Vacaville, California. The Company’s biomanufacturing operation is located in Owensboro, Kentucky.

The Company incurred net losses of $4,075,000 and $17,425,000, and negative operating cash flows of $3,074,000 and $14,566,000 in the three months ended March 31, 2005 and the year ended December 31, 2004, respectively. These negative cash flows were financed primarily by proceeds from the Company’s IPO in 2000, a private placement of our common stock during the first quarter of 2004 and loans received during December 2004 and the first quarter of 2005. The Company’s history of negative cash flows and its cash and cash equivalent balance of $427,000 at March 31, 2005, raise substantial doubt about the Company’s ability to continue as a going concern, absent any new sources of significant cash flows. In an effort to mitigate this near-term concern, the Company received $3,000,000 in cash in exchange for a promissory note on April 15, 2005 (see Note 3) and continues to seek additional debt or equity financing. In addition, the Company is seeking to secure funds for our subsidiary, PDI, and the Company through a sale of PDI stock held by the Company. The Company is also pursuing potential opportunities for significant revenue growth and concurrent sources of working capital with other companies for the joint development and commercialization of recombinant Aprotinin, Lysosomal acid lipase and Interferon alpha 2a and 2b products. The Company is currently in discussions with pharmaceutical companies capable of marketing these products. The commercialization of these products for therapeutic applications will require approval by the Food and Drug Administration (“FDA”) and product scale-up at our biomanufacturing facility under FDA regulations. However, we cannot assure you that we will successfully obtain equity or debt financing or product related revenues as such events are subject to factors beyond the Company’s control. The financial statements do not include any adjustments relating to the recoverability and classification of assets or the amounts and classification of recorded liabilities that might be necessary should the Company be unable to continue as a going concern.

Basis of Presentation — The unaudited condensed consolidated financial statements have been prepared by the Company in accordance with the rules and regulations of the Securities and Exchange Commission regarding interim financial information. Accordingly, these financial statements and notes thereto do not include certain disclosures normally associated with financial statements prepared in accordance with accounting principles generally accepted in the United States of America. This interim financial information should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto for the year ended December 31, 2004 included in the Company’s Annual Report on Form 10-K.

The unaudited condensed consolidated financial statements include the accounts of Large Scale Biology Corporation and its subsidiaries. All intercompany balances and transactions have been eliminated. In the opinion of the Company’s management, the unaudited condensed consolidated financial statements include all adjustments (consisting of only normal recurring adjustments) and disclosures considered necessary for a fair presentation of the results of the interim periods presented. This interim financial information is not necessarily indicative of the results of any future interim periods or for the Company’s full year ending December 31, 2005.

Segment Reporting — The Company operates in one reportable segment.

Intangible Assets — The following table presents the carrying values and accumulated amortization of intangible assets as of March 31, 2005:

Capitalized patent costs	$	1,852,000
Intellectual property licenses	3,264,000
	5,116,000
Accumulated amortization	(3,072,000		)
	$	2,044,000

Stock-Based Compensation — The Company adopted Statement of Financial Accounting Standards No. 123 (“SFAS 123”), “Accounting for Stock-Based Compensation” effective January 1, 2003 for its stock-based employee compensation plans using the prospective recognition method under Statement of Financial Accounting Standards No. 148 (“SFAS 148”), “Accounting for Stock-Based Compensation-Transition and Disclosure, an amendment of SFAS 123.” This method applies the recognition provisions of SFAS 123 to all employee stock awards granted, modified, or settled after January 1, 2003 and accordingly, recognized compensation expense for those issuances under our stock-based employee compensation plans. The fair values of stock options were estimated at the date of grant using the Black-Scholes option-pricing model and are being amortized over the vesting period of generally 3 years. For stock awards granted prior to January 1, 2003, compensation expense has not been recognized under SFAS 123, unless those stock awards were modified after January 1, 2003. During December 2004 Statement of Financial Accounting Standards No. 123 (revised 2004) (“SFAS 123R”), “Share Based Payment,” was issued requiring the expensing of all stock-based compensation. The Company is evaluating the effects of SFAS 123R but believes its implementation will not have a material effect on the Company’s financial statements since the Company had already adopted FASB 123 for its stock-based employee compensation plans as described above.

Prior to January 1, 2003, the Company accounted for stock options granted to employees and directors and other stock-based employee compensation plans using the intrinsic value method of accounting in accordance with Accounting Principles Board Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees” and related interpretations. As such, the Company recognized compensation expense for stock options only if the quoted market value of the Company’s common stock exceeded the exercise price of the option on the grant date. Any compensation expense realized using this intrinsic value method is being amortized over the vesting period of the option.

The following table presents the effect on net loss and net loss per share if we had always applied the fair value recognition provisions of SFAS 123 to stock-based awards to employees:

	Three Months Ended March 31,
	2005			2004
Net loss as reported	$	(4,075,000	)	$	(4,324,000	)
Stock-based employee compensation expense included in reported net loss	240,000			176,000
Stock-based employee compensation expense determined using the fair value method for all awards	(441,000		)	(546,000		)
Pro forma net loss	$	(4,276,000	)	$	(4,694,000	)
Net loss per share:
Basic and diluted – as reported	$	(0.13	)	$	(0.16	)
Basic and diluted – pro forma	$	(0.14	)	$	(0.17	)

The fair values of stock options are estimated at the date of grant using the Black-Scholes option-pricing model and amortized over the vesting period of typically 3 or 4 years for the calculation of stock-based employee compensation in the above table. The Company did not grant any stock options to employees and directors during the three months ended March 31, 2005 and granted 510,000 stock options to employees and directors during the three months ended March 31, 2004.

Stock options issued to non-employees as consideration for services provided to the Company have been and continue to be accounted for under the fair value method in accordance with SFAS 123 and Emerging Issues Task Force No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services,” which requires that compensation expense be recognized for all such options.

Net Loss Per Share — Basic net loss per share is computed by dividing the net loss for the period by the weighted average number of common shares outstanding during the period. Diluted net loss per share is computed by dividing the net loss for the period by the weighted average number of common shares outstanding during the period, plus the potential dilutive effect of common shares issuable upon exercise or conversion of outstanding stock options and warrants during the period. The weighted average number of potentially dilutive common shares were 131,706 and 984,878 for the three months ended March 31, 2005 and 2004, respectively. These shares are excluded from diluted net loss per share because of their anti-dilutive effect.

2. Debt Financings

On December 17, 2004, the Company entered into a $2.9 million loan agreement, with an initial advance of $1.0 million received on December 20, 2004, and a second advance of $1.9 million received on January 14, 2005. Borrowings under the loan bear interest at 8% and are secured by a first priority lien on the Company’s assets located at its Owensboro, Kentucky facility including land, building and improvements; fixtures, machinery and equipment; and certain patented intellectual property and related know-how used at the Owensboro facility. The borrowed funds were partially used to repay existing long-term debt and the use of such funds is restricted to working capital and acquisition of machinery and equipment to be installed at the Owensboro facility. The loan contains certain representations and warranties and financial and other covenants. In addition, the Company is subject to covenants limiting transactions with affiliates, additional indebtedness and leases, asset sales, and liens on properties. The Company believes that it is in full compliance with these covenants. The principal balance under the loan is due on June 17, 2006 and interest is due quarterly commencing on March 17, 2005.

In connection with this loan agreement, the Company issued a common stock purchase warrant to purchase a maximum of 700,000 shares of common stock at $1.42 per share. The warrant is exercisable starting the earlier of July 31, 2006 or 45 days following the prepayment of the promissory note, and expires on December 17, 2011. Issuable under the warrant are 113,372 shares of common stock as of March 31, 2005. The fair value of the shares issuable under this warrant was estimated with the initial advance of $1.0 million received on December 20, 2004 and the final advance of $1.9 million received on January 14, 2005, using the Black-Scholes option-pricing model with the following weighted-average assumptions: expected volatility of 118% and 109%, respectively, risk-free interest rate of 4.2% and 4.1%, respectively, initial expected life of seven years and no expected dividend yield. The resulting fair value is being amortized over the loan period and resulted in $109,000 of interest expense being recorded during the first quarter of 2005 in the consolidated statements of operations.

On March 3, 2005, the Company issued a $600,000 convertible promissory note (“Note”) to Kevin J. Ryan, the Company’s President and Chief Executive Officer and a member of the Company’s Board of Directors. The Note bears interest at 8% and is due on July 1, 2005. The Note is convertible into Common Stock of the Company, at the option of the holder, on or before the due date, at a conversion price equal to the greater of $0.95 per share, or 90% of the average of the closing prices of Company’s common stock over the 22 trading days ending the day before the conversion of the Note. The Note may be prepaid by the Company without penalty at any time.

3. Subsequent Events

On April 15, 2005, the Company received $3,000,000 in cash in exchange for a promissory note (“Promissory Note”) issued to Kevin J. Ryan, the Company’s President and Chief Executive Officer and a member of the Company’s Board of Directors. The Promissory Note bears interest at the prime rate plus two percent per annum initially at 7.75% due monthly starting May 15, 2005 with a rate not less than 7.25%. The Promissory Note is due on April 17, 2006. Borrowings under the loan are secured by certain patented intellectual property. The Promissory Note may be prepaid by the Company without penalty at any time. The holder of the Promissory Note may elect to be repaid up to $1,500,000 as a result of any Company financing event with net proceeds of $4,000,000 or more.

In connection with the Promissory Note, the Company issued a common stock purchase warrant that expires on April 15, 2011. The holder of the warrant has the option either to purchase 903,614 shares of the Company’s common stock at $0.83 per share or common stock of the Company’s subsidiary, Predictive Diagnostic, Inc (“PDI”). The PDI exercise price would be the lowest price per share of the PDI stock in any PDI financing event of no less than $1,500,000. The number of warrant shares would be determined by dividing $3,000,000 by the PDI exercise price. PDI common stock issuable pursuant to the warrant would be subject to exchange and underwriter’s holding period restrictions, or “lock-ups”. The fair value of the shares issuable under this warrant was estimated on April 15, 2005, using the Black-Scholes option-pricing model with the following weighted-average assumptions: expected volatility of 109%, risk-free interest rate of 4.2%, initial expected life of six years and no expected dividend yield. The resulting fair value will be amortized over the loan period.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and related notes included in this Report and our audited consolidated financial statements and related notes for the year ended December 31, 2004 included in our Annual Report on Form 10-K.

Overview

Our current efforts are focused on improving cash flows, developing and manufacturing products and entering into relationships to market and sell our products. Management’s objective is to manufacture and sell products in order to generate sufficient cash flows to sustain our operations.

Our cash balance was $427,000 at March 31, 2005, and we have incurred negative operating cash flows of $3,074,000 during the first quarter of 2005 and $14,566,000 during 2004. The current rate of cash usage raises substantial doubt about the Company’s ability to continue as a going concern, absent any new sources of significant cash flows. In an effort to mitigate this near-term concern, we are seeking to obtain debt financing or equity financing through the private placement of our common or preferred stock. In addition, we are seeking to secure funds for our wholly-owned subsidiary, Predictive Diagnostics, Inc., or PDI, and the Company through a sale of PDI stock held by the Company. A successful PDI related financing may not only improve our balance sheet, but also reduce ongoing expenses, as PDI becomes a separate operation. We are also pursuing opportunities for revenue growth with other companies for the joint development and commercialization of recombinant Aprotinin, Interferon alpha 2a and 2b and Lysosomal acid lipase products. We are currently in discussions with pharmaceutical companies capable of marketing these products. Such arrangements may provide revenues to us through license fees, the reimbursement of research and development costs, milestone payments and product sales. The commercialization of these products for therapeutic applications will require approval by the FDA and product scale-up at our biomanufacturing facility under FDA regulations. However, we cannot assure you that we will successfully obtain equity or debt financing or product related revenues as such events are subject to factors beyond our control. The financial statements do not include any adjustments relating to the recoverability and classification of assets or the amounts and classification of recorded liabilities that might be necessary should the Company be unable to continue as a going concern.

Recent Developments

On December 17, 2004, we entered into a $2.9 million loan agreement, with an initial advance of $1.0 million received on December 20, 2004, and a second advance of $1.9 million received on January 14, 2005. In connection with this loan agreement, we issued a common stock purchase warrant to purchase a maximum of 700,000 shares of common stock at $1.42 per share. On March 3, 2005, we borrowed $0.6 million from Kevin J. Ryan, our President and Chief Executive Officer and a member of the our Board of Directors and issued him a convertible promissory note due on July 1, 2005. On April 15, 2005, we borrowed an additional $3.0 million from Mr. Ryan and issued him a promissory note due on April 17, 2006 and a common stock purchase warrant. The holder of the warrant has the option either to purchase 903,614 shares of our common stock at $0.83 per share or common stock of our subsidiary, Predictive Diagnostic, Inc.

Schering-Plough Animal Health Corporation extended their previously announced research collaboration agreement to fund product development work in the area of animal health vaccines. We entered an agreement to manufacture and supply one of the Company’s proprietary protein products for distribution by EMD Biosciences, Inc., part of Merck KGaA’s Life Science and Analytics division. In addition, we entered a collaborative research and development agreement with Bayer CropScience to investigate the potential application of the Company’s proprietary pharmaceutical product, lysosomal acid lipase, for an important orphan and other therapeutic disease applications.

Related to our diagnostics subsidiary, the results of collaborative research to diagnose multiple sclerosis using a simple blood test were published in the Journal of Molecular Neuroscience. PDI entered into a collaboration with the University of Utah Research Foundation to identify biomarkers from maternal blood tests for the early diagnosis of pregnancy-related complications and disorders such as pre-term birth and preeclampsia. In addition, PDI and PerkinElmer announced the discovery of blood biomarkers for Alzheimer’s disease based on the results of a joint study presented at the American Association for Clinical Chemistry Conference in Baltimore, Maryland.

Deloitte & Touche LLP declined to stand for re-election and ceased being our independent registered public accounting firm on April 15, 2005 after completion of the audit of our consolidated financial statements for the year ended December 31, 2004. We appointed Macias Gini & Company LLP as our new independent registered public accounting firm on May 3, 2005 to audit our financial statements for the year ending December 31, 2005.

Results of Operations

Revenues — The following table presents the changes in revenues from the first quarter of 2004 to 2005:

	Quarters ended March 31,				Increase from 2004
	2005		2004		Amount		%
Revenues	$	433,000	$	319,000	$	114,000	36%

The revenue increase is a result of the new contracts with the US Army Medical Research Institute of Infectious Diseases, or USAMRIID, that started in December 2004 and the University of Louisville that started in June 2004. We expect quarterly revenues in 2005 to increase modestly from the first quarter of 2005 with the addition of the collaborative research and development agreement with Bayer CropScience but will not be substantially higher unless we enter into new revenue generating agreements or expand our existing agreements.

Development agreements and research and development costs — The following table presents the changes in total research activities from the first quarter of 2004 to 2005:

	Quarters ended March 31,				Increase (Decrease) from 2004
	2005		2004		Amount			%
Development agreements	$	670,000	$	487,000	$	183,000		38%
Research and development	2,231,000		2,239,000		(8,000		)	—
Total research activities	$	2,901,000	$	2,726,000	$	175,000		6%

Development agreements and research and development costs consist mainly of personnel expenses, outside research services, research materials and laboratory overhead costs. Development agreement costs, as they related to activities performed under revenue generating research agreements and grants, have and are expected to fluctuate consistently with increases or decreases in revenues earned from research agreements and grants. The increase in development agreement expense from 2004 to 2005 is attributed to increased efforts of $0.1 million performed under each of the new contracts with USAMRIID and the University of Louisville. We expect development agreement expense in the second quarter of 2005 to increase modestly from the first quarter directly related to revenues as mentioned above. Research and development expense from 2004 to 2005 has essentially remained the same. We expect research and development expense in the second quarter of 2005 to be materially consistent with the first quarter.

General and administrative — The following table presents the changes in general and administrative expenses from the first quarter of 2004 to 2005:

	Quarters ended March 31,				(Decrease) from 2004
	2005		2004		Amount			%
General and administrative	$	1,449,000	$	1,926,000	$	(477,000	)	(25)%

The decrease in general and administrative expense is primarily attributable to the sublease of our Germantown, Maryland, facility during August 2004. The facility rental, operating and clean-up expenses that were incurred during the first quarter of 2004 were eliminated by 2005.

Interest income and expense — Interest income is not significant because of our declining cash and marketable securities balances available for investment. Interest expense was not significant in 2004 because of the small amount of our long-term debt. With the addition of debt of $2.9 million in December 2004 and January 2005, $0.6 million in March 2005 and $3.0 million in April 2005, we expect interest expense to increase substantially in 2005 which includes charges for warrants issued in connection with this debt. If additional debt is incurred or existing debt repaid, we expect interest expense to increase or decrease accordingly.

Liquidity and Capital Resources

Net cash used in operating activities — The following table presents cash flows from operating activities for the first quarters of 2005 and 2004:

	Quarters Ended March 31,
	2005			2004
Cash paid to employees	$	(1,559,000	)	$	(1,813,000	)
Cash paid to suppliers	(1,820,000		)	(2,923,000		)
Total cash paid to employees and suppliers	(3,379,000		)	(4,736,000		)
Cash received from customers	354,000			485,000
Net interest received (paid)	(49,000		)	9,000
Net cash used in operating activities	$	(3,074,000	)	$	(4,242,000	)

The decrease in cash paid to employees is the result of severance benefits paid during the first quarter of 2004 to employees affected by our closure of our Germantown, Maryland facility. The decrease in cash paid to suppliers is the result of decreased cash expenditures of $0.1 million and offsetting sublease rental receipts of $0.1 million related to our Germantown, Maryland facility, and a $0.5 million increase in account payable and accrued expenses excluding accrued capital expenditures at March 31, 2005.

We expect the negative operating cash flows to continue throughout 2005 at a similar rate as the first quarter of 2005. However, the current rate of cash usage is not sustainable. Our ability to develop our products and sustain operations will require subsequent funding through collaborations, or debt or equity financing in the short term and product sales in the long term.

Net cash used in investing activities — We spent $0.1 million on capital expenditures in the quarter ended March 31, 2005. We have no material capital expenditure commitments at March 31, 2005. We anticipate that our biomanufacturing facility in Owensboro, Kentucky, may require capital expenditures to support our business objectives if we sign revenue-generating contracts.

Net cash provided by financing activities — In 2000 we received net proceeds of $88.8 million from our initial public offering, which sustained our operations through 2003. Financing activities have not provided significant cash flows from 2001 through 2003. On March 8, 2004, we received net proceeds of approximately $7.5 million in a private placement of common stock.

On December 17, 2004, we entered into a $2.9 million loan agreement, with an initial advance of $1.0 million received on December 20, 2004, and a second advance of $1.9 million received on January 14, 2005. Borrowings under the loan bear interest at 8% and are secured by a first priority lien on our assets located at our Owensboro, Kentucky facility including land, building and improvements; fixtures, machinery and equipment; and certain patented intellectual property and related know-how used at the Owensboro facility. The borrowed funds were partially used to repay existing long-term debt and the use of such funds is restricted to working capital and acquisition of machinery and equipment to be installed at the Owensboro facility. The principal balance under the loan is due on June 17, 2006 and interest is due quarterly commencing on March 17, 2005.

On March 3, 2005, we issued a $600,000 convertible promissory note, or Note, to Kevin J. Ryan, our President and Chief Executive Officer and a member of our board of directors. The Note bears interest at 8% and is due on July 1, 2005. The Note is convertible into our common stock, at the option of the holder, on or before the due date, at a conversion price equal to the greater of $0.95 per share, or 90% of the average of the closing prices of our common stock over the 22 trading days ending the day before the conversion of the Note. The Note may be prepaid by us without penalty at any time.

On April 15, 2005, we received $3,000,000 in cash in exchange for a promissory note, or Promissory Note, issued to Kevin J. Ryan, our President and Chief Executive Officer and a member of our board of directors. The Promissory Note bears interest at the prime rate plus two percent per annum initially at 7.75% due monthly starting May 15, 2005 with a rate not less than 7.25%. The Promissory Note is due on April 17, 2006. Borrowings under the loan are secured by certain patented intellectual property. The Promissory Note may be prepaid by us without penalty at any time. The holder of the Promissory Note may elect to be repaid up to $1,500,000 as a result of any Company financing event with net proceeds of $4,000,000 or more.

Our history of negative cash flows and our cash balance of $427,000 at March 31, 2005, raise substantial doubt about the Company’s ability to continue as a going concern, absent any new sources of significant cash flows. In an effort to mitigate this near-term concern, we are seeking debt or equity financing, sale of stock of our subsidiary, PDI, and joint development and commercialization of products with other companies. However, we cannot assure you that we will successfully obtain equity or debt financing or product related revenues as such events are subject to factors beyond our control.

Critical Accounting Policies

We consider the following accounting policies to be critical given they involve estimates and judgments made by management and are important for our investors’ understanding of our operating results and financial condition.

Long-Lived Assets — Our long-lived assets include capitalized costs of filing patent applications, capitalized licenses and property and equipment. We evaluate our long-lived assets for impairment in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Estimates of future cash flows and timing of events for evaluating long-lived assets for impairment are based upon management’s judgment. If any of our intangible or long-lived assets are considered to be impaired, the amount of impairment to be recognized is the excess of the carrying amount of the assets over its fair value.

All long-lived assets are amortized or depreciated over the shorter of their estimated useful lives, the estimated period that the assets will generate revenue, or the statutory or contractual term in the case of patents and intellectual property licenses. Estimates of useful lives and periods of expected revenue generation are reviewed periodically for appropriateness and are based upon management’s judgment.

Stock-Based Compensation — We adopted Statement of Financial Accounting Standards No. 123 (“SFAS 123”), “Accounting for Stock-Based Compensation” effective January 1, 2003 for its stock-based employee compensation plans using the prospective recognition method under Statement of Financial Accounting Standards No. 148 (“SFAS 148”), “Accounting for Stock-Based Compensation-Transition and Disclosure, an amendment of SFAS 123.” This method applies the recognition provisions of SFAS 123 to all employee stock awards granted, modified, or settled after January 1, 2003 and accordingly, recognized compensation expense for those issuances under our stock-based employee compensation plans. Methodologies used for calculations such as the Black-Scholes option-pricing model and variables such as volatility and expected life are based upon management’s judgment. Such methodologies and variables are reviewed and updated periodically for appropriateness and affect the amount of recorded charges.

During December 2004 Statement of Financial Accounting Standards No. 123 (revised 2004) (“SFAS 123R”), “Share Based Payment,” was issued requiring the expensing of all stock-based compensation. The Company is evaluating the effects of SFAS 123R but believes its implementation will not have a material effect on the Company’s financial statements since the Company had already adopted FASB 123 for its stock-based employee compensation plans as described above.

Factors That May Affect Our Business

Risks Related To Our Business

The Company’s recurring losses from operations and current cash and cash equivalent balance raise substantial doubt about its ability to continue as a going concern.

Our cash balance was $427,000 at March 31, 2005, and we have incurred negative operating cash flows of $3,074,000 during the first quarter of 2005. We have realized significant net losses and negative operating cash flows in recent years and in the quarter ended March 31, 2005. Based upon our current cash balance, our current rate of negative operating cash flows and the expected cost to complete the development of our products, we cannot assure you that the Company will be able to continue as a going concern. The financial statements do not include any adjustments relating to the recoverability and classification of assets or the amounts and classification of recorded liabilities that might be necessary should the Company be unable to continue as a going concern.

Our revenues for the year ended December 31, 2004 was $1,767,000 and $433,000 for the first quarter of 2005. We expect a modest increase in our revenues in 2005. We may be required to further reduce our operating costs by further restructuring our operations or reducing the scope of our development programs. These actions would adversely affect our ability to generate new sources of revenue. If we are unable to significantly increase our revenues and cash received from customers, we will not be able to achieve profitability or positive operating cash flows, our working capital will continue to erode, and our business will suffer.

Our product development programs need substantial additional funding to be commercialized. Our recombinant Aprotinin, Alpha-galactosidase A, and Interferon alpha 2a and 2b require clinical trials to prove their efficacy and safety for pharmaceutical applications. We do not have sufficient working capital to complete all phases of clinical trials. Our PDI subsidiary requires funding for its start-up activities. If we are unable to raise sufficient financing or collaborative funding, we may delay or abandon some of our product development initiatives, which would likely harm our business.

Our working capital is not sufficient to fund our operations or all of our product development initiatives.

We require substantial working capital to continue our product development programs and to fund our operations. In addition, the risks inherent in developing innovative products or platforms, such as recombinant Aprotinin, Alpha-galactosidase A, Interferon alpha 2a and 2b, Lysosomal acid lipase and BAMF technology diagnostic tests make it difficult to forecast with certainty the capital required to commercialize our products. We may raise this capital through public or private equity financings or through collaborations or strategic partnerships. We cannot assure you that we will be able to obtain additional financing on commercially reasonable terms, if at all. Our recent operating results and our current stock price may limit our ability to raise capital by selling and issuing additional equity securities. If additional funds are raised through the issuance of equity securities or convertible debt securities, the percentage ownership of our then-current stockholders would be reduced and the value of their investments might decline. In addition, any new securities issued might have rights, preferences or privileges senior to those securities held by our existing stockholders. If we raise additional funds through the issuance of debt, we might become subject to restrictive covenants or high rates of interest, and our assets could become encumbered, which would limit our ability to borrow in the future. We may be unsuccessful in entering into any new collaboration or strategic partnership that results in significant working capital or revenue. Further, any significant revenues we generate from such collaborations or partnerships may not be realized for several quarters or years, as regulatory approval and other matters could impede commercialization of these products. If we are unable to raise sufficient additional capital, we may have to curtail or cease operations.

Our stock could be delisted from the Nasdaq National Market if it does not meet its continued listing requirements.

The Nasdaq National Market, or Nasdaq, maintains listing maintenance standards that requires maintaining stockholders’ equity of $10,000,000 or more, and a common stock a minimum bid price of $1.00. On April 20, 2005, we received notice from the staff of Nasdaq that we failed to meet the stockholders’ equity requirement and that it would be reviewing our eligibility for continued listing on Nasdaq. We submitted to Nasdaq a plan of compliance, which was denied by the staff of Nasdaq on May 18, 2005. We plan to appeal the determination by the staff of Nasdaq. If we are not successful in our appeal, our common stock would be delisted from Nasdaq. In addition, the bid price for our stock has recently closed below $1.00 per share. If the bid price for our common stock remains below $1.00 for 30 consecutive trading days, Nasdaq may choose to notify us that it may delist our stock from Nasdaq. After the initial 30-day trading period, we would have a 180-day cure period during which our stock must meet the $1.00 minimum bid price requirement. If our stock price does not trade above $1.00 for at least ten consecutive days during the 180-day cure period, we would be entitled to a hearing. However, we cannot assure you that our common stock would not be delisted from Nasdaq following such hearing. Delisting from Nasdaq may, among other things, limit liquidity. If our common stock ceases to be listed on Nasdaq, we expect that our common stock would then be traded on the Nasdaq SmallCap Market. If our stock is potentially subject to delisting from Nasdaq, we may have the ability to increase our stock price through certain capital transactions including a reverse stock split or share repurchases.

We may not be able to enter into collaborations necessary to fully develop and commercialize our products and technologies, and we will be dependent on our collaborators if we do.

We are independently pursuing some therapeutic product applications into the development stage. However, we expect to develop and commercialize most of our future products in collaboration with pharmaceutical, biotechnology and other companies. For example, our strategy concerning our recombinant Aprotinin, Alpha-galactosidase A, Interferon alpha 2a and 2b, Lysosomal acid lipase and BAMF technology diagnostic tests involves seeking partners to complete the development and commercialization of these products. We cannot assure you that such collaborative arrangements will be available to us on acceptable terms, or at all. If our cash flows continue to deteriorate or we take significant steps to reduce our expenses, potential partners may question our ability to perform and choose not to do business with us, which would make it harder for us to find a partner and would harm our ability to commercialize our products. Our success will depend in large part on our ability to enter into future collaborations with other companies for the financing of development and/or regulatory approval and commercialization of our products. Our reliance upon these companies for these capabilities will reduce our control over such activities and could make us dependent upon them. Furthermore, obtaining funds through arrangements with collaborative partners or others may require us to relinquish our rights to certain technologies, product candidates or products that we would otherwise seek to develop or commercialize on our own, or to sell or license our rights to certain products or technologies on terms that are worse than we might have been able to obtain in a different environment. To date, we have entered into only a limited number of collaborations. Some of our existing agreements provide us with rights to participate financially in the commercial development of products resulting from the use of our technologies. We may be unable to obtain such rights in future collaborations. In addition, unforeseen delays or complications could arise and result in the breach of our contractual obligations with our collaborators and others, or us not being able to perform at the quality and capacity levels required for success.

We may be unable to recruit and retain senior management and other key scientific personnel on whom we are dependent.

The loss of a number of our senior management or other key scientific personnel could significantly harm our business, cause collaborators to cease doing business with us, cause potential collaborators to decline to do business with us, or inhibit our research and development and commercialization efforts. None of our key personnel are subject to employment agreements that prevent them from leaving our employment. We face competition for research scientists and technical staff from other companies, academic institutions, government entities, nonprofit laboratories and other organizations. We have implemented 10% cash salary reductions substituting non-cash stock compensation for our highest paid employees to conserve cash. In addition, we adhere to an eighteen-month salary review process for senior personnel. Our compensation practices may be less attractive compared to our

competition. Failure to recruit and retain senior management and scientific personnel on acceptable terms may prevent us from achieving our business objectives.

We are in the early or middle stages of product commercialization, and we may not be able to successfully develop our products and technologies nor sustain commercial use of our technology.

We are in the early or middle stages of commercializing our products under development, and we are subject to all of the risks inherent in the development of a business enterprise, including the need for substantial capital to support the development of our products and technologies. Our anticipated products most likely will require that we enter into new collaborations before we can manufacture and/or market them. For instance, we believe that our NHL vaccine, which is ready for Phase II trials, cannot be further developed without collaboration. The prospects for development of our Alpha-galactosidase A, recombinant Aprotinin, Interferon alpha 2a and 2b, and Lysosomal acid lipase products are limited without collaboration or partnering support. Because we are in new and developing fields such as diagnostic tests for disease, and our research focuses on new and unproven products, our therapeutic vaccines, proteins and other therapeutics under development may not be effective for their intended purpose, or may not meet regulatory requirements for safety and efficacy. In addition, even if we successfully develop a product, there may not be a substantial commercial market for that product at commercially viable prices.

We are in new and developing fields and there may not be a market for our technologies.

Our technologies, including our GENEWARE and BAMF technology, have limited commercial precedent. Much of our research is fundamentally unique, and we cannot assure the acceptance of its scientific merit or the benefits of products produced by it, nor that the public will react favorably to it. The usefulness of the information and products generated by our proteomics, functional genomics and bioinformatics technologies is unproven, and our collaborators and potential collaborators may determine that they are not useful, cost-effective, or otherwise unacceptable to them. We generate large amounts of data from our research with genes and proteins and we may not be able to mine or integrate this data in a timely manner or turn it into commercially viable information. In addition, because our fields are characterized by rapid innovation, we must complete development of our technologies in time to meet market demand, if any. If we fail to do so, it is likely that other technologies and companies will predominate and we will not be able to earn a sufficient return on our investment.

Alternative technologies may supersede our technologies or make them non-competitive.

Genomics, proteomics, biomanufacturing and bioinformatics are intensely competitive fields. They are characterized by extensive research efforts, which result in rapid technological progress that can render existing technologies obsolete or economically noncompetitive. If our competitors succeed in developing more effective technologies or render our technologies obsolete or noncompetitive, our business will suffer. Many universities, public agencies and established pharmaceutical, biotechnology, health care, chemical and other life sciences companies with substantially greater resources than we have are developing and using technologies and are actively engaging in the development of products similar to or competitive with our products and technologies. Like us, our competitors are using proteomics and genomics technologies to identify potential drug targets, therapeutic proteins and diagnostic marker proteins. To remain competitive, we must continue to invest in new technologies and improve existing technologies. If our revenues and cash flows do not improve significantly, we will not have the resources to continue such investment.

Our competitors may devise faster, more complete or more accurate methods to obtain proteomic and functional genomic information than our technologies and systems, including our GENEWARE systems and BAMF technology. There has been and continues to be substantial academic and commercial research effort devoted to the development of such methods. If successful competitive methods were developed, it would undermine the commercial basis for the products and technologies we intend to provide.

General economic conditions may cause uncertainty with respect to other companies and entities collaborating with us or otherwise dealing with us, and this can have an adverse effect on our revenues and cash flows.

To a large extent, decisions by businesses and other entities to collaborate or otherwise do business with us are discretionary, and the decision making process typically takes many months to complete. We believe that the previous slowdown in the U.S. and global economies, and the biotechnology and pharmaceutical industries in particular, has caused potential collaborators and customers to defer decisions to work with us or to access our technologies. As a result, revenues and cash flows have been uncertain. Future results are difficult to predict, as it is difficult to accurately assess and predict the future demand for our products, technologies and services. General economic conditions are expected to improve as the economy grows. However, we cannot assure you that any such improvement will cause our results of operations to improve. If economic conditions decline or stagnate, our revenues and operating results could be adversely affected.

Conflicts with collaborators or licensees could harm our business.

Conflicts with collaborators could have a negative impact on our relationships with them, and our revenues to be derived from these relationships, and impair our ability to enter into future collaborations, all of which could adversely affect our business. Collaborators could develop competing products, preclude us from entering into collaborations with their competitors or terminate their agreements with us prematurely. Moreover, disagreements could arise with collaborators or licensees over rights to our intellectual property, our rights to share in any of the future revenues from products or technologies resulting from use of our technologies, our rights to payments for achievement of milestones or our performance of research and development activities on behalf of collaborators, or our activities in separate fields may conflict with other business plans of our collaborators or licensees.

We must enter into agreements with third parties to provide sales and marketing services, or develop these capabilities on our own, if we are to successfully commercialize our products and technologies.

Although we plan to enter into sales and marketing arrangements with third parties, we may not be able to enter into these arrangements on favorable terms, if at all. We must also expand our business development force with sufficient technical expertise to generate demand for our products and technologies. Our possible inability to hire business development personnel, or contract for effective sales and marketing capabilities would significantly impair our ability to commercialize our products and technologies.

We may not be able to successfully manufacture products in commercial quantities or at acceptable costs.

The failure of our technologies to provide safe, effective, useful or commercially viable approaches to the discovery, development and/or production of drug targets and proteins which can be used as therapeutics and diagnostic tests for diseases, such as cancer, would significantly limit our business plan and future growth.

Concentration of ownership among our existing executive officers, directors and principal stockholders may enable them to collectively influence significant corporate transactions that require stockholder approval.

Our directors, our executive officers and principal stockholders affiliated with our directors and executive officers beneficially own, in the aggregate, approximately 21% of our outstanding common stock as of May 11, 2005. The concentration of ownership in combination with other common stockholders may collectively influence significant corporate transactions such as mergers, changes in control, consolidation or sale of some or all of our assets, and other significant corporate transactions requiring shareholder approval.

Our stockholder rights plan and provisions of our charter documents and Delaware law may inhibit a takeover, which could adversely affect our stock price.

We have adopted a stockholder rights plan and declared a dividend distribution of one right for each outstanding share of common stock to stockholders of record as of May 4, 2001. Subject to certain specified exceptions and limitations under the rights plan, we will continue to issue one right for each share of common stock that becomes outstanding after May 4, 2001. Each right entitles the holder to purchase one unit consisting of one one-hundredth of a share of our Series A Junior Participating Preferred Stock for $45 per unit. Under certain circumstances, if a person or group acquires 15% or more of our outstanding shares of common stock, holders of the rights (other than the person or group causing their exercisability) will be able to purchase, in exchange for the $45 exercise price, shares of our common stock or of any company into which we are merged having a value of $90. In addition, the board of directors has the option, under certain circumstances, to exchange each right (other than rights held by the person or group triggering the board of directors’ option) for a share of common stock for no additional consideration on the part of the holder of the right. The rights expire on April 27, 2011. Our rights plan could make it more difficult for a third party to acquire us (or a significant percentage of our outstanding capital stock) by causing substantial dilution of the stock ownership of a person or group attempting to acquire control of us. Our rights plan may have the effect of discouraging takeover attempts because a potential acquirer would have to negotiate with our board of directors to avoid suffering dilution.

Provisions in our charter and bylaws and applicable provisions of the Delaware General Corporation Law may also make it more difficult for a third party to acquire control of us without the approval of our board of directors. These provisions may make it more difficult or expensive for a third party to acquire a majority of our common stock or delay, prevent or deter a merger, acquisition, tender offer or proxy contest, which may adversely affect our stock price.

Risks Related to Our Industry

If companies in the pharmaceutical, biotechnology, healthcare, and life sciences industries do not succeed or their demand for our products and technologies decreases, then our revenues could be reduced.

We expect to derive our revenues primarily from products and technologies provided to the pharmaceutical, biotechnology, healthcare and life sciences industries. Accordingly, our success will depend directly on the success of companies in these industries and their demand for our products, services and technologies. Our operating results may fluctuate substantially due to reductions and delays in expenditures by companies in those industries, or their unwillingness or inability to use our products and technologies. These reductions and delays may result from factors that are not within our control, such as:

• changes in economic conditions generally;

• the extent to which companies in these industries conduct research and development involving diagnostics, proteomics and functional genomics in-house or through industry consortia;

• the extent to which genomic information is or is not made publicly available;

• consolidation within one or more of these industries;

• changes in the regulatory environment affecting these industries;

• pricing pressures;

• market-driven pressures on companies to consolidate and reduce costs; and/or

• other factors affecting spending in these industries.

If competitive products are better than our products, then our business may fail.

Our human and veterinary therapeutics and vaccines are included in the highly competitive markets for protein development and production. We face significant competition in our protein product development and production efforts from entities using alternative, and in some cases, higher volume and larger scale, approaches for the same purpose. Competitors with substantially greater resources are actively developing products similar to or competitive with our products and potential products. Our competitors may succeed in developing products or obtaining regulatory approval before we do or in developing products that are more effective than those we develop or propose to develop. A large number of universities and other not-for-profit institutions, many of which are funded by the U.S. and foreign governments, are also conducting research to discover genes and their functions. Any one or more of these entities may discover and establish a patent position in one or more of the genes or proteins that we wish to commercialize.

Several pharmaceutical, biotechnology, chemical and other life sciences companies engage in research and development in the use of unique gene expression systems to produce therapeutic proteins. These competitors may develop products earlier or obtain regulatory approvals faster than we may be able to, or develop products that are more effective than ours. New developments are expected to continue, and discoveries by others may render our products and technologies noncompetitive, which could lead to the failure of our business.

Diagnostics companies in the health care industry with more resources than us constitute varied competition for our diagnostic technology, which is early stage. Competing diagnostic technologies may be developed and marketed that may be competitively superior to ours.

Our collaborators and we may not obtain FDA and other approvals for our products in a timely manner, or at all.

Drugs and certain diagnostic products and tests are subject to an extensive and uncertain regulatory approval process by the FDA and comparable agencies in other countries. The regulation of new products and certain diagnostic products and tests is extensive, and the required process of laboratory testing and human studies is lengthy, expensive and uncertain. The burden of these regulations will fall on us to the extent we are developing proprietary products. We may not be able to obtain the clearances and approvals necessary for the clinical testing, field-testing, manufacturing or marketing of our products. If the products or diagnostic tests are the result of a collaborative effort, these burdens may fall on our collaborators or we may share these burdens with them. We may not obtain FDA or other approvals for those products or tests in a timely manner, or at all. We may encounter significant delays or excessive costs in our efforts to secure necessary approvals or licenses. Even if we obtain FDA regulatory approvals, the FDA extensively regulates manufacturing, labeling, marketing, promotion and advertising after product approval. Further, once a manufacturer obtains regulatory approval, a marketed product and its manufacturer are subject to continual review, and discovery of previously unknown problems with a product, test or manufacturer may result in restrictions on the product, test, manufacturer or manufacturing facility, including withdrawal of the product or test from the market. In some countries, regulatory agencies also set or approve the sale prices for drug and diagnostic products and tests. Additionally, several of our product development areas may involve relatively new technology that has not been the subject of extensive product testing in humans. The regulatory requirements governing these drug and diagnostic products, tests, and related clinical procedures remain uncertain and the products and tests themselves may be subject to substantial review by the FDA and foreign governmental regulatory authorities that could prevent or delay approval. Regulatory requirements ultimately imposed on our products could limit our ability to test, manufacture and commercialize our products and tests.

USDA rules could adversely affect us or our collaborators.

We must comply with USDA regulations for outdoor releases of genetically engineered organisms as well as other products designed for use on or with agricultural products. In addition, the USDA prohibits growing and transporting genetically modified plants except pursuant to an exemption or under special permits. We may use genetically modified plants as screening or production hosts. Changes in USDA policy regarding the movement or field release of genetically modified plant hosts could adversely affect our business by increasing the cost of our products and technologies or decreasing consumer demand for those products and technologies or causing the government to prohibit their sale or use. If we fail to comply with such rules or policies, we may be subject to financial loss or be liable for costs incurred as a result of non-compliance.

If there is negative public reaction to the use of genetically engineered products and technologies, then the market for certain products and technologies we develop will be adversely affected.

Future commercial success of some of our products and of the products of some of our collaborators will depend in part on public acceptance of the use of genetically engineered products including drugs, plants and plant products. Claims that genetically engineered products are unsafe for consumption or pose a danger to the environment may influence public attitudes. Negative public reaction to genetically modified organisms and products could result in greater government regulation of genetic research and resultant products, including stricter labeling requirements, and could cause a decrease in the demand for our products, even if such products do not result from GMO organisms.

We may be sued for product liability and our product liability insurance may not be adequate.

The testing, marketing and sale of our and our collaborators’ products and diagnostic tests will entail a risk of allegations of product liability, and third parties may assert substantial product liability claims against us. While we have limited product liability insurance to protect against this risk, adequate insurance coverage may not be available at an acceptable cost, if at all, in the future and a product liability claim or product recall could materially and adversely affect our business. Inability to obtain sufficient insurance coverage at an acceptable cost or otherwise to protect against potential product liability claims could prevent or inhibit the commercialization of the products and diagnostic tests developed by our collaborators or us. If we are sued for any injury allegedly caused by our products or our collaborators’ products, our liability could exceed our total assets and our ability to pay the liability.

If we use hazardous materials in our business in a manner that causes injury or violates laws, we may be liable for substantial damages.

Our research and development processes involve the use of hazardous materials, including chemicals and radioactive and biological materials. Our operations also produce hazardous waste products. The chemicals we use include, but are not limited to, flammable solvents such as methanol and ethanol; ethidium dye, which is a commonly used fluorescent dye for visualizing DNA; buffer solutions used in the purification of DNA; and various organic solvents, acids and bases. We also use several radioisotopes including phosphorous-32, carbon-14, sulfur-35, phosphorous-33, iodine-125 and hydrogen-3. We cannot eliminate the risk of accidental contamination or discharge and any resultant injury from these materials. Federal, state and local laws and regulations govern the use, manufacture, storage, handling and disposal of these materials. We could be subject to civil damages and criminal penalties in the event of an improper or unauthorized release of, or exposure of individuals to, hazardous materials. Further, it is possible that the materials we use could contaminate another party’s property. In addition, claimants may sue us for injury or contamination that results from our use or the use by third parties of these materials, and our liability may exceed our total assets and our ability to pay the liability. In addition, compliance with environmental laws and regulations is expensive, and current or future environmental regulations may impair our research and development and production efforts. Although we have general liability insurance, these policies do not cover claims arising from pollution from chemical, radioactive or biological materials. Our collaborators may also be working with various types of hazardous materials in connection with our collaborations. In the event of a lawsuit or investigation, we could be held responsible for any injury we or our collaborators cause to persons or property by exposure to, or release of, any hazardous materials.

Healthcare reform and restrictions on reimbursements may limit the financial returns from our products and diagnostic tests.

Our ability and that of our collaborators to commercialize therapeutics and diagnostic products and tests may depend in part on the extent to which government health administration authorities, private health insurers and other organizations will pay the cost of these products and tests. These third parties are increasingly challenging both the need for and the price of new medical products, tests and services. Significant uncertainty exists as to the reimbursement status of newly approved therapeutics and diagnostics, and adequate third party reimbursement may not be available for any product to enable us to maintain price levels sufficient to realize an appropriate return on our investment in research and product development.

Risks Related to Our Intellectual Property

Patent protection in the biotechnology, pharmaceutical, and healthcare industries is uncertain, which may result in a decrease in the value of our products and technologies.

We are involved in overlapping and rapidly evolving areas of biotechnology, pharmaceutical development, healthcare, and diagnostics and basic research involving viral vectors, plant transgenics, proteomics, functional genomics, protein transformation, and immunotherapy. Each of these areas has been the subject of intense research and patenting activity throughout the world by our commercial competitors, actual and potential collaborators, academic institutions and government researchers. We cannot determine whether or not there are patents currently pending that, if issued, would prevent us from practicing our core technologies, commercializing them or developing commercially viable products and diagnostic tests based upon them.

The patent positions of biotechnology firms generally are highly uncertain and involve complex legal and factual questions that will determine who has the right to develop a particular product. Changes in, or different interpretations of, patent laws in the United States and other countries might allow others to use our discoveries or to develop and commercialize products and technologies similar to our products and technologies without any compensation to us. Our potential collaborators or customers may conclude that uncertainties about patent protection decrease the value of our databases, products and services.

Throughout the world there are numerous issued patents, as well as published foreign patent applications which may be issued as patents, many of which relate to our current operations, our anticipated future operations and the products we are likely to develop. The scope of these patents is a matter of legal interpretation and is subject to uncertainty. We have not obtained, but we may in the future obtain, opinions from our patent counsel that we have freedom to conduct our commercial activities free of claims of patent infringement from third parties. From time to time, we receive letters from third parties offering to negotiate a license to LSBC based on a perception that our processes or products might infringe a patent owned by the third party. Disagreements could arise from these letters, and could result in costly and time-consuming litigation and divert our financial and managerial resources. In addition, if we are ever determined to infringe the patent of any third party, we may be required to obtain a license to use this patent, which would increase our cost of doing business.

Our patent applications may not result in issued patents that are enforceable.

Our disclosures in our patent applications may not be sufficient to meet the statutory requirements for patentability in all cases. As a result, we do not know which of our patent applications will result in enforceable patents. Our patent applications may not be issued as patents, and any patents that are issued to us may not provide commercially meaningful protection against competitors. Any issued patent may not provide us with competitive advantages. Others may challenge our patents or independently file patent applications that could result in an interference proceeding in the U.S. Patent and Trademark Office. Others may be able to design around our issued patents or develop products similar to our products. In addition, others may discover uses for genes or proteins other than those uses covered in our patents, and these other uses may be separately patentable.

Public disclosure and patents relating to our proprietary products, processes, and diagnostic products and tests held by others may limit our proprietary rights.

We are aware of issued patents and patent applications containing subject matter such that we or our licensees or collaborators may require a license or rights in order to research, develop or commercialize some of our products, diagnostic tests and technologies. We may find that licenses relating to such subject matter will not be available on acceptable terms, or at all.

Patent infringement or enforcement litigation or interference proceedings could be costly and disrupt our business and may prevent us from commercializing our products and diagnostic tests.

The technology that we use to develop our products, diagnostic tests and key resources, and those that we incorporate into our products, diagnostic tests and technologies, may be subject to claims by third parties, including our collaborators, that they infringe the patents or proprietary rights of others. Technologies of our collaborators may also be subject to infringement or similar claims which could impair our collaborative product and diagnostic test development and commercialization efforts. We also may need to enforce our patent rights in actions against others, which could be expensive. The risk of such events occurring will tend to increase as the fields of generic drug, vaccine, diagnostic, health care and the biotechnology industry expand, more patents are issued and other companies engage in other generic drug, vaccine, diagnostics and biotechnology-related businesses.

With respect to identifying proteins uniquely associated with disease states or as targets for drug therapy, we are aware that companies have published patent applications relating to nucleic acids encoding specific proteins. We are also aware of issued and pending patent applications covering certain aspects of bioinformatic-based diagnostic testing. The issued patents by the U.S. Patent and Trademark Office to these companies may limit our ability and the ability of our collaborators to practice under any patents that may be issued to us. Also, even if the U.S. Patent and Trademark office issues us a patent, the scope of coverage or protection afforded to the patent may be limited.

We may not be able to protect our know-how and trade secrets.

We generally control the disclosure and use of our know-how and trade secrets using confidentiality agreements. It is possible, however, that:

• Some or all confidentiality agreements will not be honored without our knowledge;

• Third parties will independently develop equivalent technology;

• Disputes might arise with our consultants, collaborators or others concerning the ownership of intellectual property; and/or

• Unauthorized disclosure of our know-how or trade secrets will occur without our knowledge.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Information regarding our exposures to market risks is provided in Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2004. There have been no material changes to our exposures to market risk since December 31, 2004.

Item 4. Controls and Procedures

(a) Disclosure controls and procedures. Our Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of our “disclosure controls and procedures” (as defined in the Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this report on Form 10-Q, have concluded that as of the end of the period covered by this report, our disclosure controls and procedures were effective.

(b) Changes in internal control over financial reporting. There were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rule 13a-15 that occurred during the first fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

On March 3, 2005, we issued a $600,000 convertible promissory note, or Note, to Kevin J. Ryan, our President and Chief Executive Officer and a member of the our board of directors. The Note bears interest at 8% and is due on July 1, 2005. The Note is convertible into our common stock, at the option of the holder, on or before the due date, at a conversion price equal to the greater of $0.95 per share, or 90% of the average of the closing prices of our common stock on the 22 trading days ending the day before the conversion of the Note. The Note may be prepaid by the Company without penalty at any time. This sale was made in reliance on Section 4(2) of the Securities Act and was made without general solicitation or advertising. Mr. Ryan is an accredited investor and has access to all relevant information to evaluate the investment.

Item 6. Exhibits

List of Exhibits:

Exhibit Number		Exhibit Title or Description
31.1		Certification of the Principal Executive Officer pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification of the Principal Financial Officer pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1		Certification of the Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2		Certification of the Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

	Large Scale Biology Corporation

Date: May 23, 2005	By:	/s/ Ronald J. Artale
		Ronald J. Artale
		Senior Vice President, Chief Operating Officer
		and Chief Financial Officer
		(Principal Financial Officer)

		PAGE
PART I – FINANCIAL INFORMATION

Item 1.	Financial Statements

	Condensed Consolidated Balance Sheets as of March 31, 2005 and December 31, 2004 (Unaudited)	1

	Condensed Consolidated Statements of Operations for the three months ended March 31, 2005 and 2004 (Unaudited)	2

	Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2005 and 2004 (Unaudited)	3

	Notes to Condensed Consolidated Financial Statements (Unaudited)	4

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	8

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	21

Item 4.	Controls and Procedures	21

PART II – OTHER INFORMATION

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	22

Item 6.	Exhibits	22

SIGNATURE		23