ITEM 1. BUSINESS

Overview

        We are focused on the development of biopharmaceutical products based on our patented gene delivery technologies for the prevention and treatment of serious or life-threatening diseases. Potential applications of our gene delivery technology include:

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Gene therapies for cancer,



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DNA vaccines for infectious diseases or cancer, and



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DNA therapeutic protein delivery.

        Gene Therapies for Cancer.     We currently focus our development on innovative cancer therapies designed to induce an immune response against cancer cells without causing serious side effects. We have retained all rights to our internally developed cancer product candidates. Our lead immunotherapy product candidate, Allovectin-7®, completed enrollment in advanced clinical testing with a low dose in patients with metastatic melanoma. We expect to complete the collection and analysis of data from Phase II and Phase III registration trials, and determine in the second half of 2002 whether the data are sufficient to support the filing of a Biologic License Application, BLA, to seek marketing approval from the U.S. Food and Drug Administration, FDA. Allovectin-7® is also in Phase II clinical testing in patients with newly-diagnosed tumors of the head and neck and at a higher dose in patients with metastatic melanoma. The higher dose of Allovectin-7® may be considered for further development as those data become available. Our second immunotherapy product candidate, Leuvectin®, is in Phase II clinical trials for high-risk patients with locally confined prostate cancer. We expect to announce our future development plans for Leuvectin® in the second half of 2002.

        DNA Vaccines.     We believe DNA vaccines may have the distinguishing characteristic of combining a safe and cost-effective technique with preventive or therapeutic potential. DNA vaccines have been shown to induce a cellular immune response. These features make DNA vaccines a promising approach for the prevention and treatment of diseases caused by elusive pathogens such as the human immunodeficiency virus, HIV. Merck & Co., Inc. is using our naked DNA platform technology as part of a "prime-boost" vaccine regimen in preventive and therapeutic Phase I clinical trials for HIV. Prime-boost is an approach that seeks to optimize the immune response by using two different forms of vaccination in sequence, typically with naked DNA as the "prime" component. The prime-boost regimen used by Merck in these trials combines a naked DNA prime vaccine with Merck's non-replicating adenoviral vector boost vaccine. In a separate program, we have worked in conjunction with the U.S. Navy in efforts to develop a vaccine for preventing malaria. Preliminary results from a Phase I/II study showed the safety of a multi-gene DNA vaccine and the ability of the vaccine to prime cellular immune responses. Vical scientists, in cooperation with the U.S. government, are looking to apply new enhancing technologies to develop a preventive malaria vaccine that uses our DNA technologies to provide 6 to 9 months' protection. The initial indication for use will be aimed at adding a protective vaccine to the licensed malaria prophylaxis used by travelers and the military. We have licensed our technology to Aventis Pasteur, a division of Aventis S.A., and Centocor, Inc., a wholly-owned subsidiary of Johnson & Johnson, for the development of DNA vaccines against specific cancer targets.

        DNA Therapeutic Protein Delivery.     Our technology for the optimized delivery of therapeutic proteins has been licensed by Aventis Pharma and Vascular Genetics Inc., VGI, for the delivery of angiogenic growth factors. Any resulting therapeutics may help the body to grow blood vessels, typically where blood flow has been restricted, such as the heart in coronary artery disease and the limbs in peripheral vascular disease.

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        We have established relationships through licensing our technology to a number of corporate collaborators, including:

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Merck & Co., Inc.



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Two divisions of Aventis S.A.:

Aventis Pasteur

Aventis Pharma

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Merial



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Centocor, Inc., a wholly-owned subsidiary of Johnson & Johnson



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Boston Scientific Corporation



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Human Genome Sciences, Inc. and its affiliate, Vascular Genetics Inc.

        We have also established relationships to gain access to complementary technologies from corporate collaborators including:

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CytRx Corporation



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Ichor Medical Systems, Inc.

Background

        Pharmaceutical medicine traditionally focuses on the discovery and development of chemical compounds as therapeutics. More recently, biological agents such as therapeutic proteins and monoclonal antibodies have been developed as treatments. These agents typically act by enhancing or blocking biological activities, by obstructing or attacking infectious or malignant agents, or by restoring proper chemical balance within affected tissues. The effectiveness of chemical and biological agents is often limited by toxic side effects and the inability to maintain effective levels of the agent where it is needed.

        One possible answer to the weaknesses of previous approaches may be found in the novel therapeutics of gene therapy. "Gene therapy" refers to a collection of processes that add or alter genes, the basic units of heredity found inside living cells, in order to improve the body's natural ability to fight disease or to make a disorder more sensitive to other kinds of therapy.

        Genes themselves are sets of instructions, encoded by DNA, with each gene causing cells to produce, or express, one of the thousands of different proteins essential to cellular structure, growth, and function. The improper expression of even a single gene can severely alter a cell's normal function, frequently resulting in a disease. Gene therapy offers an approach to the treatment and prevention of disease by introducing genes into cells to direct the expression of specific proteins.

        Historically, gene therapy was accomplished by inserting the desired gene into a delivery vehicle, or vector. The most common vectors were viruses that had been genetically disabled so that they could not reproduce and infect other cells. Gene therapy approaches using viruses suffer several drawbacks that may limit their widespread usefulness, including adverse immune responses and inflammation that may inhibit the activity of the virus-based therapy and prevent repeated administration.

Our Gene Delivery Technology

        The key discovery leading to our patented naked DNA gene delivery technology was that muscle tissues can absorb genetic material directly, without the use of viral components, and subsequently express a desired protein for periods ranging from weeks to several months. Our gene delivery approach typically involves the design and construction of plasmids, DNA segments whose ends are

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attached together to form a highly stable closed loop. These plasmids contain the gene encoding the protein of interest, as well as short segments of DNA that control the rate and location of protein expression. Plasmids can be manufactured through straightforward fermentation and purification techniques.

        Since the initial discovery of our naked DNA technology, our researchers have improved the design of our plasmids to provide increases in efficiency of gene delivery, expression and immunogenicity. In addition, we are developing other formulation and delivery technologies, including the use of lipid molecules, synthetic polymers called poloxamers, and electrical stimulation called electroporation, to enhance gene delivery or increase the immune response in DNA vaccine applications. We call ourselves "The Naked DNA Company™" because our product candidates are based on these non-viral gene delivery methods, and because we own broad rights to certain non-viral gene delivery technologies through our series of core patents. Our gene delivery approach may offer novel treatment alternatives for diseases that are currently poorly addressed. Benefits of our gene delivery technology may include:

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Broad Applicability.   Our gene delivery technology may be useful in developing novel treatments for cancer, vaccines to prevent or treat infectious diseases and methods to efficiently deliver human and animal therapeutic proteins.



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Convenience.   Our gene therapies are intended to be administered like conventional pharmaceuticals on an outpatient basis.



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Safety.   Our product candidates contain no viral components that may cause unwanted immune responses, infections, or malignant and permanent changes in the cell's genetic makeup.



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Repeat Administration.   Our product candidates contain no viral components that may preclude multiple dosing with a single product or use in multiple products.



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Ease of Manufacturing.   Our product candidates are manufactured using straightforward fermentation and purification procedures.



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Cost-Effectiveness.   Our gene delivery technology may prove to be more cost-effective than therapies which require genetic modification and controlled propagation of viral vectors. Once introduced into the body, the DNA is intended to stimulate the production of a therapeutic protein over a prolonged period of time, which may be more cost-effective than administering the protein itself. It may also cause fewer potential side effects, which itself may reduce per patient treatment costs.

        Potential applications of our gene delivery technology include gene therapies for cancer, in which the expressed protein is an immune system stimulant or cancer-killing agent; DNA vaccines for infectious diseases or cancer, in which the expressed protein is an antigen; and DNA therapeutic protein delivery, in which the expressed protein is a therapeutic agent.

Business Strategy

        There are three basic elements to our business strategy:

Develop Products Independently

        We currently focus our resources on the independent development of cancer therapeutics and DNA vaccines for infectious diseases.

        Cancer.     We believe that the large and rapidly growing market for cancer products is poorly addressed by existing treatment alternatives. In addition, we believe that this market is attractive to Vical because:

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Clinical testing usually can be conducted in a small number of patients and benefits can be detected and verified in reasonably short periods of time.



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Clinical testing occurs in patients with advanced, life-threatening diseases with limited treatment alternatives, which may expedite the regulatory approval process.



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Product acceptance is supported by objective clinical data, potentially reducing marketing costs.



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Treatment decisions are made at regional cancer centers by oncologists who can be served by a small, specialized sales force.

        Vaccines.     According to the Plan for Preventing Emerging Infectious Diseases , published by the Centers for Disease Control and Prevention, CDC, "Vaccines are among the very best protections we have against infectious diseases." We believe our technology may lead to the development of novel preventive or therapeutic vaccines for infectious disease targets because:

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DNA vaccines may be applicable to diseases for which conventional vaccine methods have been unsuccessful.



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The safety of DNA vaccines may increase public acceptance of preventive care.



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Vaccines are perceived by government and medical communities as an extremely efficient and cost-effective means of healthcare.



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DNA vaccines use straightforward manufacturing processes, making them simple and cost-efficient to produce.

        We intend to retain significant participation in the commercialization of our proprietary cancer and DNA vaccine products, although we may choose to enlist the support of a marketing partner to accelerate market penetration.

Develop Future Product Opportunities

        We are actively pursuing the refinement of our plasmids and lipids, development of future products, evaluation of potential enhancements to our core technologies and exploration of alternative gene delivery technologies. We also seek to develop additional applications for our technologies by testing new approaches to disease control or prevention. These efforts could lead to further independent product development or additional licensing opportunities. In addition, we continually evaluate compatible technologies or products that may be of potential interest for in-licensing or acquisition. Our research and development costs for the year ended December 31, 2001, were approximately $22.1 million.

Expand the Applications of Our Technology Through Strategic Collaborations

        We collaborate with major pharmaceutical and biotechnology companies and government agencies, providing us access to complementary technologies or greater resources. These collaborations provide us with mutually beneficial opportunities to expand our product pipeline and serve significant unmet medical needs. We license intellectual property from companies holding complementary technologies in order to leverage the potential of our own gene delivery technology and to further the discovery of innovative new therapies for internal development. We license our intellectual property to other companies in order to leverage our technologies for applications that may not be appropriate for our independent product development efforts.

Product Development

        We are focused on the development of biopharmaceutical product candidates based on our patented gene delivery technology. A number of therapeutic protein and vaccine product candidates are

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currently under development for the prevention or treatment of cancer, infectious diseases and other disorders. The table below summarizes both our independent and collaborative product development programs. We are exploring various applications for poloxamer and electroporation technologies, and we are investigating several potential cancer and infectious disease vaccine targets. Our current clinical development focus is on the innovative cancer therapies, Allovectin-7® and Leuvectin®.

        Clinical trials are used to determine whether new drugs or treatments are both safe and effective. Traditionally, clinical trials are done in three phases. Phase I clinical trials mark the first time a new drug or treatment is administered to humans and are normally conducted to determine the safety profile of a new drug. Phase II clinical trials are conducted in order to determine preliminary effectiveness, or efficacy, optimal dosage, and to confirm the safety profile. Phase III clinical trials are often large scale, multi-center studies conducted to compare a new treatment with a currently approved therapy. At times, a single trial may incorporate elements from different phases of development. An example might be a trial designed to determine both safety and initial efficacy. Such a trial may be referred to as a Phase I/II clinical trial.

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(1)

"Research" indicates laboratory studies to evaluate a potential product candidate in a nonclinical setting. "Preclinical" indicates that a specific product candidate has shown utility in meeting a targeted medical need in a nonclinical setting, and is undergoing toxicology testing in preparation for filing an Investigational New Drug application.

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This program is under reevaluation following discontinuation of the clinical trial on April 19, 2001.

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Gene Therapies for Cancer

        Cancer is a disease of uncontrolled cell growth. When detected early and still confined to a single location, surgery or irradiation can often be curative. However, neither surgery nor irradiation is considered curative for cancer that has spread throughout the body. Chemotherapy can sometimes treat cancer that has spread throughout the body; however, a number of non-cancerous cells, such as bone marrow cells, are also highly susceptible to chemotherapy. As a result, chemotherapy often has fairly significant side effects. Finally, because each of these treatments only acts for a short period of time, it is common to see cancer return after apparently successful treatment.

        Immunotherapy, using the patient's own immune system, may have advantages over surgery, irradiation, and chemotherapy in the treatment of cancer. It is generally believed that the immune system can recognize cancer cells and destroy them. Yet many cancers appear to have developed the ability to "hide" from the immune system. A treatment that can augment the immune response against tumor cells by making the cancer more "visible" to the immune system would likely represent a significant improvement in cancer therapy. Immune-enhancing proteins such as interleukin-2, IL-2, and interferon-alpha, IFN-alpha, have shown encouraging results. However, these agents often require large and frequent doses that regularly result in severe side effects.

        We have researched several delivery enhancements that may complement our core gene delivery technology. Our current clinical-stage gene therapy approach consists of injecting immune stimulating genes complexed with a cationic lipid delivery vehicle, DMRIE/DOPE, directly into malignant tumors . Following injection, the lipid delivery vehicle facilitates uptake of the gene product into tumor cells, where it directs the production of protein. Recent preclinical studies indicate that poloxamers, when combined with other enhancing technologies, can elicit tumor antigen responses in mice. Local expression of immune-stimulating proteins often results in the same local effect from the protein with fewer systemic toxicities. These and other findings are being pursued in additional preclinical studies.

        In addition, non-viral gene therapies may offer an added margin of safety compared to viral-based therapies, as no viral particles are contained in the formulation. The ease of manufacture, routine treatment administration performed in the clinic with minimal discomfort, and the excellent toxicity profile suggest that non-viral gene therapies may offer advantages over current modalities of therapy.

        Preclinical studies in animals have demonstrated the safety and potential efficacy of this approach. Subsequently, in early human studies, a low incidence of treatment related adverse events has been observed. Our two lead non-viral gene therapies being developed are reviewed below.

Allovectin-7®

        Allovectin-7® is a DNA/lipid complex containing the human gene encoding HLA-B7, which is found infrequently in the human population. Allovectin-7® is injected directly into tumors, and is designed to make malignant cells express HLA-B7. The treatment may trigger an immune response against tumor cells, both locally and systemically, by enabling the immune system to recognize other features of tumor cells.

        Metastatic Melanoma.     The American Cancer Society, ACS, estimates approximately 53,600 new diagnoses and 7,400 deaths from melanoma in 2002 in the United States. Currently, there are no consistently effective therapies for advanced cases of malignant melanoma. Treatment for these patients normally includes a combination of chemotherapy, radiation therapy, and surgery. In patients with metastatic melanoma, median survival typically ranges from six to eleven months. The toxicity associated with such FDA-approved treatments as IL-2 or IFN-alpha is often significant, resulting in serious or life-threatening side effects in the majority of patients treated.

        We believe immunotherapies such as Allovectin-7® represent an attractive approach for patients with advanced melanoma. In multi-center Phase I/II and Phase II clinical trials, Allovectin-7® was

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well-tolerated and several patients developed durable reductions in overall tumor burden or maintained stable disease. Unadjudicated results, combined from three clinical trials, were updated in December 1999 at the Eighth International Gene Therapy of Cancer Conference. "Adjudication" refers to the process by which important efficacy results reported by trial investigators are reviewed to determine whether they meet protocol-specific endpoints. These early clinical trials provided evidence of the excellent safety profile of Allovectin-7®. Side effects from Allovectin-7® were primarily mild. The most common complaint was temporary pain at the injection site. The side-effect profile for Allovectin-7® appears superior to those of FDA-approved treatments for metastatic melanoma.

        Based on the promising data from earlier clinical trials and discussions with the FDA, we began two concurrent registration trials, a Phase II clinical trial and a Phase III clinical trial, for Allovectin-7® in May 1998. Based on recommendations of an independent Data and Safety Review Board, we announced in May 2000 that we would continue to recruit patients as planned in our two ongoing registration trials with Allovectin-7®. Following a face-to-face status review meeting in March 2001, the FDA reconfirmed the acceptability of the company's registration program to support marketing approval if the Phase III data meet the study objectives, and if the company meets product manufacturing and other typical regulatory requirements. According to the FDA, a robust clinical outcome regarding improvement in time to disease progression would be sufficient to warrant consideration for marketing approval as long as there is no detriment in response rate. In March 2001, the FDA also reconfirmed that the Phase II registration trial could, on its own, provide a basis for marketing approval, if the data meet the clinical endpoints. The FDA further confirmed that data from the Phase II trial and prior trials with Allovectin-7® could support a submission based on Phase III trial results, assuming that the Phase III data are consistent with prior experience.

        At the May 2001 annual meeting of the American Society of Clinical Oncology, we presented unadjudicated, interim safety and efficacy data from our Phase II Allovectin-7® registration trial for patients with late-stage metastatic melanoma. The trial enrolled patients who had failed other treatments. We reported on 73 patients who received at least one injection of Allovectin-7®, the intent-to-treat patient population. The preliminary conclusions based on these unadjudicated data were that the median duration of response and response rate suggested clinical activity of Allovectin-7®, and that the safety profile of Allovectin-7® remained excellent compared with those of FDA-approved treatments for metastatic melanoma. The trial had endpoints of a 15 percent systemic clinical response rate, and a four-month median duration of response. Unadjudicated data from the investigation sites suggested that treatment with Allovectin-7® resulted in systemic clinical responses in 10.9 percent of the patients, with a median duration of response of 4.9 months, and an additional 19.2 percent were reported to have achieved stable disease. These Phase II data alone would likely not support accelerated FDA approval. Nearly all of the drug-related side effects were mild or moderate. Final data from the investigation sites may be reviewed independently, which could materially change the results.

        In September 2001, we completed enrollment of 200 patients in a randomized, controlled Phase III registration trial to evaluate the safety and efficacy of Allovectin-7® for the treatment of chemotherapy-naïve patients with metastatic melanoma. Half the patients received dacarbazine, the only chemotherapeutic agent currently approved by the FDA for metastatic melanoma. The other half received dacarbazine plus Allovectin-7®. The objective of the trial was to determine if Allovectin-7® treatment can increase the response rate or time to disease progression. The trial design allowed for as many as 280 patients. We chose to complete enrollment at 200 patients based on discussions with the FDA in March 2001 and a statistical analysis showing that this number would be sufficient to demonstrate the required robust clinical outcome in one of the trial's primary endpoints, improvement in time to disease progression.

        We expect to complete the collection, analysis and adjudication of data from the Phase III registration trial in the second half of 2002.

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        Based on preliminary data that injected tumors appear to respond more frequently than non-injected lesions, one strategy to increase the response rate to Allovectin-7® is to inject multiple tumors rather than single tumors as in prior studies. In addition, higher doses of Allovectin-7® may generate a stronger immune response. In February 2001, we initiated a Phase II clinical trial evaluating higher doses and different treatment regimens. The new clinical trial, which is not part of our registration program, combines escalating doses of up to a 200-fold increase compared with the registration trials. It also allows for the distribution of that increased dose into as many as five tumor lesions. We believe that the combination of higher dose and multiple tumor injections may provide a relevant increase in efficacy. Recruitment is progressing well, and we have now enrolled more than 50 patients in this 80-patient trial. As a result, we have successfully completed the dose-escalation phase of this trial and are now testing the full 2 mg. dose in multiple tumor injections.

        Head and Neck Cancer.     Head and neck cancer includes several types of localized tumors affecting the oral cavity, the larynx or pharynx. The ACS estimates approximately 37,800 new diagnoses and 11,100 deaths from these cancers in 2002 in the United States. When found early, head and neck cancers are often treated with surgery or irradiation therapy. Results of standard treatment depend on factors such as the number of tumors, their size, and their specific location.

        Unadjudicated results from three sequential Phase I and Phase II clinical trials testing Allovectin-7® in patients with advanced squamous cell carcinoma of the head and neck were published in the July 2001 issue of the Archives of Otolaryngology—Head and Neck Surgery. The data were compiled from a single-center, Phase I study and two multi-center, Phase II studies for patients with unresectable head and neck cancer who had failed to respond to conventional therapies. Of 69 patients who completed the first treatment cycle in the three clinical trials, 6 patients appeared to achieve clinical responses, with a 50 percent or greater reduction in tumor burden, and 14 were reported to have stable disease, with less than 50 percent reduction or less than 25 percent increase in tumor burden. The 20 responding or stable patients went on to a second treatment cycle. Upon completing the second treatment cycle, 5 patients appeared to have a partial response, and 6 patients were reported with stable disease. The reported duration of response for the 5 responding patients ranged from 20 to 79 weeks. The duration of response for the 6 stable patients appeared to range from 20 weeks and remaining stable to 34 weeks. Allovectin-7® was generally well-tolerated, with no serious drug-related side effects. We concluded that treatment with Allovectin-7® appeared to be safe and that further studies were warranted in patients with less-advanced head and neck cancer.

        Based on these conclusions, we initiated a multi-center Phase II clinical trial in February 2001 with Allovectin-7® in up to 25 patients scheduled for surgical treatment of early-stage cancer of the oral cavity and oropharynx. The primary goal in the clinical trial is reduction of the tumor prior to surgery. Additional objectives include assessment of the immune response to Allovectin-7®, evaluation of the treatment's toxicity, and analysis of the time to disease progression. Recruitment for this clinical trial has been very challenging, with one patient enrolled as of December 31, 2001.

Leuvectin®

        Leuvectin® is a DNA/lipid complex containing the gene encoding IL-2, a cytokine that plays a role in stimulating immune response. Systemic IL-2 protein therapy is currently approved by the FDA for treatment of certain cancers, but its administration is associated with serious toxicity in the majority of patients. We expect that Leuvectin®, when injected into tumors, will cause the malignant cells to produce IL-2. Local expression of IL-2 may then stimulate the patient's immune system to attack and destroy the tumor cells. Because Leuvectin® delivers IL-2 locally rather than throughout the body, it may provide efficacy comparable to the protein treatment with fewer side effects. Leuvectin® is being tested in Phase II clinical trials for patients with prostate cancer.

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        Kidney Cancer.     As announced in April 2001, we discontinued our Phase II clinical trial with Leuvectin® for patients with metastatic kidney cancer because the efficacy did not meet interim targets required to continue the trial. We have completed our investigation into this matter and have concluded that a change in the formulation likely resulted in reduced expression of IL-2. We expect to announce our future development plans for Leuvectin® in the second half of 2002.

        Prostate Cancer.     According to the ACS, prostate cancer is the second leading cause of cancer fatalities among men in the United States, with an estimated 189,000 new diagnoses and 30,200 deaths from prostate cancer in the United States in 2002.

        Preclinical studies demonstrate that Leuvectin® can stimulate an anti-tumor immune response against prostate cancer cells in the laboratory. In May 1997, we initiated a Phase I clinical trial at the University of California Los Angeles, UCLA, to evaluate the safety and efficacy of intraprostatic Leuvectin® in two groups of patients: those who are pre-prostatectomy or exhibiting rising prostate-specific antigen, PSA, following local irradiation therapy. Unadjudicated results of the trial were published in May 2001 by Dr Arie Belldegrun at UCLA ( Human Gene Therapy , 12(8): 883-92). Dr. Belldegrun reported on 24 patients with locally advanced prostate cancer who were either scheduled to undergo surgical resection of their prostate or who had failed prior local therapy with irradiation therapy. Patients received 300, 750 or 1,500 µg of Leuvectin® administered intraprostatically under ultrasound guidance on days 1 and 8.

        There were no grade 3 or 4 toxicities reported. The most common side effect seen was small amounts of blood in the urine. Patients also reported mild to moderate temporary rectal bleeding and perineal discomfort. Of the 24 patients in the study, 16 (67 percent) demonstrated a temporary decrease in their PSA on day 1, and 14 (58 percent) continued to demonstrate a decrease in PSA on day 8. Prostate tumor samples were taken at the time of surgery or on day 15 in those patients who failed irradiation therapy. Analysis of the prostate biopsies demonstrated an increase in the number of infiltrating T cells following treatment.

        Based on these results, it was concluded that intraprostate injection of Leuvectin® is safe and well-tolerated in this patient population at doses up to 1,500 µg and that further study of Leuvectin® in this indication was warranted. On the basis of these data, we initiated two multi-center Phase II clinical trials in June 1999. These studies are ongoing. We expect to announce our future development plans for Leuvectin® in the second half of 2002.

Vaxid

        In collaboration with Stanford University Medical Center, we were developing a plasmid-based DNA vaccine, Vaxid , against low-grade, non-Hodgkin's, B-cell lymphoma. Vaxid contains a patient-specific gene encoding a characteristic molecule of cancerous B-cells. In March 2001, we announced positive safety and immunogenicity results in an initial Phase I/II clinical trial. The treatment appeared to have been well-tolerated by patients, and appeared to have generated both cellular and humoral immune responses. We have no immediate plans to pursue further development of Vaxid .

gp100 Vaccine

        In collaboration with the National Cancer Institute, we supported development efforts for a plasmid-based DNA vaccine, which may cause cells to produce a modified melanoma-related protein known as gp100. This protein was expected to trigger an immune response against melanoma tumor cells. Our funding of this program ended in October 2001. We have no immediate plans to pursue further development of this program.

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Outlicense of Cancer Targets

        See "Collaborations and Licensing Agreements—Corporate Collaborators—Outlicensing," for discussion of Centocor and Aventis Pasteur collaborations in cancer targets.

DNA Vaccines for Infectious Diseases

        Our infectious disease program is driven by three overarching criteria: the complexity of the product development program, competition, and commercial opportunities. Vaccines are generally recognized as the most cost-effective approach for infectious disease health care. However, the technical limitations of conventional vaccine approaches have constrained the development of effective vaccines for many diseases. We believe our potential vaccine products should be simpler to manufacture than vaccines made using cumbersome and labor-intensive techniques involving difficult tissue culture procedures and live viruses. In addition, our gene delivery technology has the potential to speed certain aspects of vaccine product development such as preclinical evaluation and manufacturing. It has demonstrated a favorable safety profile and contributes to a potent cellular immune response.

        Over the past decade, hundreds of scientific publications have documented the efficacy of DNA vaccines in contributing to potent immune responses in dozens of species from fish to nonhuman primates, and human volunteers. Among the most recent was a January 2002 report in the scientific journal, Nature , on a study conducted by Merck in which a prime-boost vaccine regimen employing our patented naked DNA non-viral gene delivery technology was used to elicit an immune response in monkeys against a hybrid form of HIV that can replicate and cause clinical disease in monkeys. Prime-boost is an approach that seeks to optimize the immune response by using two different forms of vaccination in sequence. In this study, Merck used our naked DNA plus adjuvant to prime the immune response with Merck's non-replicating adenoviral vector vaccine to boost the response. This vaccine combination was shown to provide potent cellular immune responses. In February 2002, Merck presented its initial human data from ongoing Phase I clinical trials at the 9 ^th Conference on Retroviruses and Opportunistic Infections. Merck's preliminary analysis suggests that its HIV-1 gag vaccine candidates for the prevention and treatment of HIV-1 elicit specific antiviral cellular immune responses and are generally well-tolerated in the ongoing studies. The Retrovirus Conference presentation marked the first time Merck scientists have discussed data from human testing of Merck's two leading HIV-1 vaccine candidates—an HIV-1 gag DNA vaccine and an HIV-1 gag replication-defective adenovirus vaccine.

        In the Merck studies, the naked DNA prime vaccine was formulated in a solution containing CRL-1005, a poloxamer that Merck licensed from CytRx Corporation. A recent license agreement has also given us access to CytRx's technical expertise and large library of poloxamers, including CRL-1005, with the exception of four infectious disease targets licensed to Merck, plus a cancer target. We intend to use this technology to enhance our in-house vaccine development pipeline as we explore possible infectious disease targets.

        One of these targets is malaria. The U.S. Navy presented data on a collaborative Phase I/II clinical trial of a DNA vaccine to prevent infection with malaria. Further details on these and other relationships can be found in "Collaboration and Licensing Agreements—Corporate Collaborators—Outlicensing," and "—Research Institutions."

DNA Therapeutic Protein Delivery

        Therapeutic proteins are one of the mainstays of biotechnology. Although recombinant protein and antibody products have established successful markets, gene delivery techniques to produce these

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proteins in vivo are still under development. To be successful, gene-based delivery of protein therapeutics will need to meet the following criteria:

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Appropriate level of protein expression, with concentrations maintained within the therapeutic window offering the required efficacy without unacceptable toxicity;



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Absence of immune response to expressed self proteins, allowing repeat dosing if necessary;



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Adequate bio-distribution, delivering the protein to the right place in the appropriate amounts;



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Varying degrees of regulation depending upon specific applications.

        Significant technical hurdles may need to be overcome in the commercialization of this technology for protein therapeutic applications. The biggest hurdles include the inability to tightly regulate protein expression and, in some cases, to achieve adequate levels of protein expression. For regulated proteins, the greatest challenge is to combine an efficient promoter with a non-toxic small molecule. Protein therapeutics that have a narrow therapeutic window will almost certainly require tightly regulated expression of the gene delivered.

        Based on the performance characteristics of our current naked DNA technology, therapeutic proteins with a broad therapeutic window and cancer immunotherapeutics are the product franchise development areas with the highest probabilities for success. An example of a specific potential application can be found in the emerging field of angiogenesis, the therapeutic goal of which is inducing the growth of blood vessels to replace those blocked by disease. Angiogenesis has been shown to occur by the exogenous administration of angiogenic growth factors. We believe that the sustained delivery of these growth factors will be both safe and effective, and that the therapeutic window for local delivery will be broad. Thus, although several attempts to intermittently deliver recombinant specific angiogenic growth factors directly have been unsuccessful, we believe our approach to deliver locally genes that encode the desired growth factors is quite promising. Local delivery of angiogenic growth factor genes is in human trials. Other potential applications are still being tested in animal models. See "—Collaboration and Licensing Agreements—Corporate Collaborators—Outlicensing."

        See also "—Collaboration and Licensing Agreements—Research Institutions," for discussion of contract manufacturing and contract regulatory support for the National Institutes of Health Vaccine Research Center in Infectious Diseases, and the Institute for AIDS Vaccine Initiative.

Veterinary Applications

        Prior to its development for human therapy, our gene delivery technology was extensively tested in animals. Research scientists have published numerous papers detailing favorable results in many species and covering a broad range of disease indications. Animal health encompasses two distinct market segments: livestock, or animals bred and raised for food or other products; and companion animals, or pets. Serving the animal health markets requires highly efficient manufacturing and specialized distribution channels. Consequently, we have licensed our gene delivery technology for development and commercialization by others. We are independently conducting research on an undisclosed veterinary therapeutic protein application. See "—Collaboration and Licensing Agreements—Corporate Collaborators—Outlicensing."

Intellectual Property

        Patents and other proprietary rights are essential to our business. We file patent applications to protect our technology, inventions, and improvements to our inventions that we consider important to the development of our business. We believe that our patent portfolio is the most comprehensive of any company in the non-viral gene delivery sector.

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        We also rely upon trade secrets, know-how, continuing technological innovations and licensing opportunities to develop and maintain our competitive position. We have filed or participated as licensee in the filing of more than 40 patent applications in the United States and have made over 360 additional counterpart foreign filings in foreign countries relating to our technology. Our patents and patent applications cover, for example, naked DNA gene delivery for immunization and delivery of therapeutic proteins, specific DNA constructs and formulations of gene-based product candidates, methods for producing pharmaceutical-grade DNA, and several families of lipid molecules and their uses in gene delivery. Many of these patents have been issued by the U.S. Patent and Trademark Office, PTO. A number of patent applications are pending in the United States, and corresponding foreign applications have been filed.

        We and our exclusive licensors have received numerous U.S. and foreign patents covering various aspects of our proprietary technology. Most of these patents are recently issued and have considerable patent life remaining. These patents are described as follows:

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Core Gene Delivery Technology.   We own rights to issued U.S. patents covering our core gene delivery technology, including patents on methods of administering gene sequences for the purposes of expressing therapeutic proteins or for inducing immune responses. Other issued patents specifically cover the administration of genes into blood vessels and the heart.

In October 2001, we announced our intention to appeal the ruling by the Opposition Division of the European Patent Office revoking on formal grounds our patent covering the nonviral delivery of genetic material. According to European patent procedures, issued patents may be opposed by parties interested in challenging the issued claims. The patent covering our core DNA delivery technology was issued in 1998 and was subsequently opposed by seven companies. The Opposition Division ruled that, as a result of amendments to the claims made during the process of obtaining the European patent and during the opposition process, the claims did not comply with European patent laws. Our appeal, which we will file by the end of April 2002, will seek to overturn the revocation, and we may also use additional patent applications that are pending in Europe to secure patent protection for our core gene delivery technology. We intend to vigorously defend our patent position in the European opposition proceedings. If we are not successful in the appeal and opposition proceedings, we may lose part or all of our proprietary protection on our product candidates in Europe.

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Core Lipid Technology.   We have received issued U.S. patents covering numerous examples of cationic lipid compounds that are used to facilitate delivery of gene therapies to some tissues. These patented compounds include the lipids contained in our lead product candidates, Allovectin-7® and Leuvectin®. Patent protection of these key lipids also has been obtained in Europe and Japan.



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Specific DNA Therapeutics.   We have supplemented the broad patent coverage described above with patents covering specific product applications of our technology. To date, we have received patents issued in the United States covering Allovectin-7® and Leuvectin® and other patents related to gene delivery to the heart, including delivery of a vascular endothelial growth factor, VEGF, for example.



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DNA Process Technology.   As a result of our pioneering efforts to develop the use of pure DNA as a therapeutic agent, we have also led the development of manufacturing processes for producing pharmaceutical-grade DNA. We have received issued U.S. patents covering various steps involved in the process of economically producing pure plasmid DNA for pharmaceutical use.

        At the beginning of 2000, prosecution of two of our allowed U.S. patent applications and one U.S. patent application that we licensed were under suspension by the PTO pending resolution of possible

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interference proceedings with one or more parties unknown to us. For two of these three applications, the suspensions were lifted during 2000, and patents were issued in 2001. One of these patents was issued to us in April 2001, and expands our broad ownership of naked DNA gene delivery technologies by including the administration of naked DNA into any tissue for the purpose of inducing an immune response. The other patent, issued in October 2001, broadly covers direct injection of genetic material into tumors or surrounding tissue using viral, lipid-based or other non-viral gene delivery compositions. We have licensed exclusive commercial rights to this patent from the University of Michigan. The third patent application has been returned to active prosecution status.

        In addition, a patent was issued to us in May 2001 that covers naked DNA delivery of VEGF to the heart to promote angiogenesis.

        Some components of our gene-based product candidates are, or may become, patented by others. As a result, we may be required to obtain licenses to conduct research, to manufacture, or to market such products. Licenses may not be available on commercially reasonable terms, or at all.

        See "—Additional Business Risks—Our patents and proprietary rights may not provide us with any benefit and the patents of others may prevent us from commercializing our products," and "The legal proceedings to obtain patents and litigation of third-party claims of intellectual property infringement could require us to spend money and could impair our operations."

Commercialization and Manufacturing

        Because of the broad potential applications of our technology, we intend to develop and commercialize products both on our own and through corporate collaborators. We intend to develop and commercialize products to well-defined specialty markets, such as oncology, infectious diseases, and other life-threatening diseases. Where appropriate, we intend to rely on strategic marketing and distribution alliances for manufacturing and marketing products.

        We believe our plasmid DNA can be produced in commercial quantities through straightforward fermentation and purification techniques. The separation and purification of plasmid DNA is a relatively straightforward procedure because of the inherent biochemical differences between plasmid DNA and the majority of other bacterial components. In addition, our lipid formulations consist of components that are synthesized chemically using traditional, readily scaleable organic synthesis procedures.

        We produce and supply our own plasmid DNA for all of our research needs and clinical trials and intend to produce sufficient supplies for all foreseeable clinical investigations. In January 2002, we signed a 15-year lease on a facility that we believe will be sufficient for foreseeable commercial manufacturing requirements. We also engage in contract manufacturing of plasmid DNA investigational products for selected clients. We may also choose to have outside organizations manufacture our products.

Collaboration and Licensing Agreements

        We have entered into various arrangements with corporate, academic, and government collaborators, licensors, licensees, and others. In addition to the agreements summarized below, we conduct ongoing negotiations with potential corporate collaborators.

Corporate Collaborators—Outlicensing

        Merck & Co., Inc.     In May 1991, we entered into a research collaboration and license agreement with Merck to develop and commercialize vaccines utilizing our gene delivery technology to prevent infection and disease in humans. In connection with the 1991 agreement, we granted Merck a worldwide exclusive license to preventive vaccines using our technology against seven human infectious

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diseases including: influenza; HIV; herpes simplex; hepatitis B virus, HBV; hepatitis C virus, HCV; human papilloma virus, HPV; and tuberculosis. Merck has the right to terminate this agreement without cause on 90 days written notice.

        In addition, Merck has rights to therapeutic uses of preventive vaccines developed under the 1991 agreement. In December 1995 and November 1997, Merck acquired additional rights to develop and commercialize therapeutic vaccines against HPV, HIV and HBV. Under the November 1997 amendment, Merck made an investment in Vical of $5.0 million for approximately 262,000 shares of our common stock.

        In September 1997, we entered into an option and license agreement granting Merck the rights to use our technology to deliver certain growth factors. The agreement resulted in a payment to us of $2.0 million. Merck terminated this agreement in June 2000.

        In November 1999, we received a $2.0 million payment from Merck, which extends Merck's license to develop and commercialize therapeutic vaccines against HIV and HBV. In December 1999, Merck initiated a clinical trial with a naked DNA vaccine to prevent AIDS. In January 2000, Merck paid us a $1.0 million milestone payment for the start of this trial. In May 2000, Merck commenced the therapeutic vaccine trial.

        In November 2001, we received a $3.0 million payment from Merck in accordance with our licensing agreement. The payment extends the term of Merck's worldwide rights to use our naked DNA technology to develop and commercialize therapeutic vaccines against both HIV and HBV. We recognized this $3.0 million as license revenue in the fourth quarter of 2001. In connection with these agreements, Merck has paid us approximately $25.1 million, including the $5.0 million payment for the investment in our common stock, through December 31, 2001. Merck is obligated to pay additional fees if certain research milestones are achieved and royalties on net sales if any products are developed and commercialized. For some indications we may have an opportunity to co-promote product sales.

        Merck is currently testing naked DNA vaccines for HIV in human trials. Human testing began in December 1999 in uninfected volunteers and, in May 2000, in volunteers already infected with HIV and receiving highly active anti-retroviral therapy. At its annual business briefing in December 2000, Merck highlighted its investigational HIV vaccine program as a key research initiative. In April 2001, Merck highlighted the success to date of its HIV vaccine development program, which includes a vaccine based on our patented naked DNA gene delivery technology. Merck presented preclinical data from its HIV vaccine program and reviewed the status of clinical trials at the 2001 Keystone Symposium, AIDS Vaccines in the New Millennium, in Keystone, Colorado, and at AIDS Vaccine 2001 in Philadelphia, Pennsylvania. In January 2002, Merck's research results, published in the scientific journal Nature , described the use of our naked DNA technology in monkeys in the ongoing efforts to develop a vaccine to combat HIV.

        The report in Nature described studies conducted by Merck including a study in which a vaccine regimen employing Vical's patented naked DNA, non-viral, gene delivery technology was used in a prime-boost regimen with naked DNA plus adjuvant to prime and Merck's non-replicating adenoviral vector to boost. This vaccine combination was shown to provide potent cellular immune responses to a hybrid form of HIV that can replicate and cause clinical disease in monkeys. In February 2002, Merck presented its initial human data from ongoing Phase I clinical trials at the 9 ^th Conference on Retroviruses and Opportunistic Infections. Merck's preliminary analysis suggests that its HIV-1 gag vaccine candidates for the prevention and treatment of HIV-1 elicit specific antiviral cellular immune responses and are generally well-tolerated in the ongoing studies. The Retrovirus Conference presentation marked the first time Merck scientists have discussed data from human testing of the Merck's two leading HIV-1 vaccine candidates—an HIV-1 gag DNA vaccine and an HIV-1 gag replication-defective adenovirus vaccine.

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        Aventis.     In September 1994, we entered into a research, option, and license agreement with the vaccine manufacturer Aventis Pasteur, a division of Aventis S.A., granting them options to acquire licenses for the use of our proprietary gene delivery technology to develop and commercialize vaccines against specific infectious diseases. Subsequent option exercises and additions eventually led to licenses for a total of four preventive vaccine targets: cytomegalovirus, Helicobacter pylori , malaria and respiratory syncytial virus.

        In October 1997, we entered into an agreement granting Aventis Pharma, a division of Aventis S.A., an exclusive worldwide license to use our gene delivery technology to deliver certain neurologically active proteins for potential treatment of neurodegenerative diseases.

        In December 2001, we completed an agreement restructuring with Aventis Pasteur. Aventis Pasteur obtained rights to use our patented gene delivery technology for specific oncology applications. In exchange, Aventis Pasteur paid a small option fee and gave up rights to develop and commercialize the infectious disease vaccines. Aventis Pasteur has the right to terminate this agreement without cause on six months written notice.Simultaneously, we reacquired rights to gene therapies for neurodegenerative diseases that were previously licensed to Aventis Pharma.

        In 1999, Aventis Pharma began testing the naked DNA delivery of a gene encoding an angiogenic growth factor in patients with peripheral vascular disease, a severe loss of blood flow caused by blockage of arteries feeding the foot and lower leg. They licensed the rights to our gene delivery technology for cardiovascular applications using a specific angiogenic growth factor in June 2000. The angiogenic growth factor agreement, which remains in effect, resulted in an initial payment to us of $1.5 million and could generate milestone payments plus royalties if products advance through commercialization. Aventis Pharma has the right to terminate this agreement without cause on 60 days written notice.

        Through December 31, 2001, we had received approximately $10.3 million under all of the Aventis agreements. The restructured agreement provides for us to receive additional payments based upon achievement of certain defined milestones and royalty payments based on net product sales.

        Pfizer Inc.     In January 1999, we entered into a collaborative research and option agreement with Pfizer to develop and commercialize DNA-based delivery of therapeutic proteins for animal health applications. Pfizer had an option to obtain an exclusive royalty-bearing license to our technology for these applications. The option expired in January 2002. Under the agreement, Pfizer made an investment in Vical of $6.0 million for approximately 318,000 shares of our common stock. Pfizer also paid us a $1.0 million up-front option fee and $1.5 million for research and development over the life of the agreement.

        Merial.     We entered into a corporate collaboration in March 1995 relating to DNA vaccines in the animal health area with Merial, a joint venture between Merck and Aventis S.A. Merial has options to take exclusive licenses to our gene delivery technology to develop and commercialize DNA vaccines to prevent infectious diseases in domesticated animals. In December 1999, Merial paid us $1.6 million for the initial exercise of options and extension of options under the agreement. In March 2000, Merial made a payment to extend their option to March 31, 2001. In 2001, Merial further extended options under the 1995 agreement. Through December 31, 2001, we had received $6.0 million under this agreement. If Merial exercises additional license options and markets these vaccines, cash payments and royalties on sales would be due to us. Merial has the right to terminate this agreement without cause on 30 days written notice.

        Human Genome Sciences, Inc.     In February 2000, we signed a reciprocal, royalty-bearing license with Human Genome Sciences, Inc., HGS. Under the agreement, we have the option to exclusively license up to three genes from HGS for gene-based product development. HGS has the option to license our gene delivery technology for use in up to three gene-based products. Each party has until

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September 30, 2004, to exercise their respective options. As of December 31, 2001, neither party had exercised any of their options.

        Vascular Genetics Inc.     In February 2000, we granted an exclusive, royalty-bearing license to Vascular Genetics Inc., VGI, a company in which HGS is a major shareholder, for naked DNA delivery of a gene encoding Vascular Endothelial Growth Factor 2, VEGF-2. In exchange, we received a minority equity interest in VGI represented by preferred stock.

        VGI has conducted Phase I and Phase II clinical trials using naked DNA delivery of the VEGF-2 gene to promote the growth of blood vessels in patients with coronary artery disease or peripheral vascular disease. The FDA placed the VGI trials on a clinical hold in 2000. We learned from VGI in October 2001 that their Phase II development program is off clinical hold, and they have announced that they are advancing toward new clinical trials. See "Additional Business Risks—We may suffer a material financial loss due to dilution if additional shares of VGI stock are issued at a price below our issuance price, or due to permanent impairment if VGI is unable to successfully complete its development plans."

        Centocor, Inc.     In February 1998, we entered into an exclusive license and option agreement allowing Centocor, Inc., subsequently acquired by Johnson & Johnson, Inc., to use our gene delivery technology to develop and commercialize certain DNA vaccines for the potential treatment of some types of cancer. We received an initial payment of $2.0 million plus reimbursement of $0.2 million of patent costs. In 2001, we also received scheduled milestone payments of $1.0 million. We may receive additional payments based upon achievement of milestones and royalty payments on product sales. Centocor has the right to terminate this agreement without cause on 180 days written notice.

        Boston Scientific Corporation.     In April 1997, we entered into a sublicense agreement with Cardiogene Therapeutics, Inc., formerly known as Genocor, Inc., for the development of catheter-based intravascular gene delivery technology under our license agreement with the University of Michigan, described below. Boston Scientific Corporation has subsequently acquired Cardiogene Therapeutics' rights under this agreement. We received $1.1 million in October 1998 under this agreement. The agreement provides for us to receive royalty payments on any related product sales. Boston Scientific has the right to terminate this agreement without cause on 30 days written notice.

Corporate Collaborators—Inlicensing

        Ichor Medical Systems, Inc.     In October 2001, we entered into an exclusive agreement with Ichor Medical Systems, Inc. to develop products based on our gene delivery technology and delivered using Ichor's proprietary electroporation systems. Both companies are applying this innovative approach toward the initial development of selected products.

        CytRx Corporation.     In December 2001, we entered into an exclusive agreement with CytRx Corporation which grants to us the rights to use or sublicense CytRx's poloxamer technology to enhance viral or non-viral delivery of polynucleotides in all preventive and therapeutic human and animal health applications, except for four infectious disease vaccine targets licensed to Merck and prostate-specific membrane antigen. In addition, the agreement permits our use of CytRx's technology to enhance the delivery of proteins in prime-boost vaccine applications that involve the use of polynucleotides. As part of the agreement, we made a $3.8 million up-front payment and agreed to make potential future milestone and royalty payments. The license fee is being amortized to expense over the estimated ten-year average useful life of the technology.

        Under the Merck, Aventis, Merial, Centocor, HGS and VGI agreements, we would be required to pay up to 10 percent of some milestone payments and a small percentage of some royalty payments to Wisconsin Alumni Research Foundation, WARF. The CytRx and Ichor agreements would require us to make payments to CytRx and Ichor, respectively, and to WARF only if the results of our research

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resulted in the generation of revenue. Under the Boston Scientific agreement, if we were to receive milestone or royalty payments, we would be required to pay up to 25 percent of some of these payments to the University of Michigan. See "—Research Institutions—Wisconsin Alumni Research Foundation," and "—Research Institutions—The University of Michigan."

Research Institutions

        Office of Naval Research.     In September 1998, we entered into an agreement with the Office of Naval Research, ONR, for development work on a potential multi-gene DNA vaccine to prevent malaria. Malaria is a severe infectious disease characterized by fever, headache and joint pain, which if untreated can lead to death. Infection normally occurs when the parasite enters a victim's bloodstream during a mosquito bite. There is currently no effective vaccine against the disease.

        In August 2000, a Phase I/II clinical trial was initiated to test the safety and efficacy of a naked DNA vaccine to prevent infection by the malaria parasite. In November 2001, the U.S. Navy presented preliminary trial results at the 50th Annual Meeting of the American Society of Tropical Medicine and Hygiene. The preliminary results indicated that vaccination was safe and well-tolerated, and caused specific T-cell immune responses against encoded antigens. Although all volunteers contracted the disease, measurements after the challenge indicated specific antibody and T-cell immune responses, which were stronger in volunteers receiving the vaccine than in volunteers who did not receive the vaccine, suggesting a vaccine-induced prime and parasite-induced boost effect. Results of this trial provide the basis for planning further development toward a malaria vaccine product. Vical scientists, in cooperation with the U.S. government, are looking to apply several new enhancing technologies to develop a preventive malaria vaccine that uses our DNA technologies to provide 6 to 9 months' protection. The initial indication for use will be aimed at the travel and military markets, for which there are currently licensed medications that have limitations such as drug resistance, side effects and duration of treatment both before and after travel.

        The agreement with the ONR, as amended in January 2002, could provide us with up to $5.5 million in funding through April 30, 2002. Through December 31, 2001, we had recognized revenue of $5.0 million of the total contract amount. We intend to pursue additional agreements with ONR to continue funding for this development program, however, we may not be able to enter into any further agreements.

        The University of Michigan.     In October 1992, we entered into a license agreement with the University of Michigan and obtained the exclusive license to technology for delivering gene-based products into cancer cells and blood vessels by catheters. In April 1997, we entered into a sublicense agreement, the rights under which are currently held by Boston Scientific Corporation, for the development of catheter-based intravascular gene delivery technology.

        Wisconsin Alumni Research Foundation.     Under a 1989 research agreement, scientists at the University of Wisconsin, Madison, and our scientists co-invented a core technology related to intramuscular naked DNA administration. In 1991, we licensed from WARF its interest in that technology. We paid WARF an initial license fee and agreed to pay WARF a royalty on sales of any products incorporating the licensed technology and a percentage of up-front license payments from third parties.

Contract Manufacturing and Regulatory Support

         National Institutes of Health,—National Institutes of Allergic and Infectious Disease/Division of AIDS. In 2001, we performed contract manufacturing of DNA for infectious disease vaccines under three contracts with the NIH. One of these contracts continues into 2002. Total revenue recognized under these contracts was $1.3 million in 2001. We also provided regulatory support to Division of AIDS under one contract. Total revenue recognized under this contract in 2001 was $0.3 million.

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        International AIDS Vaccine Initiative.     In 2002, we signed a contract with International AIDS Vaccine Initiative, IAVI, a not-for-profit entity, to provide clinical supplies. The initial term of this contract extends to December 31, 2002. Thereafter the term shall be renewed automatically for successive one-year periods unless either party gives at least 90 days prior notice to terminate. The Chairman of our Board of Directors, R. Gordon Douglas, M.D., serves on the Board of Directors of IAVI. Our President and Chief Executive Officer, Vijay B. Samant, serves on the Project Management Subcommittee of IAVI.

Scientific Advisory Board

        In September 2001, we named a Scientific Advisory Board, SAB, consisting of academic and industrial experts in such fields as gene therapy, vaccines, oncology, drug delivery and genomics. We intend to meet with members of the SAB twice per year to discuss research and development strategies, though certain members may communicate with our scientists more frequently to discuss the details of specific projects. All SAB members have been granted options to acquire shares of our common stock. Each SAB member has entered into a consulting agreement specifying the terms and scope of the advisory relationship with us, which provides that the consultant will not consult or otherwise provide services to any other company engaged in gene therapy without our prior consent. We do not believe that termination of any individual consulting agreement would materially affect our business. All of the SAB members are employed by employers other than us and may have other commitments to, or consulting or advisory contracts with, other entities which may conflict or compete with their obligations to us. See "—Scientific Advisory Board Members."

Competition

        The field of gene-based drug development is new and rapidly evolving, and it is expected to continue to undergo significant and rapid technological change. Rapid technological development could result in our product candidates or technologies becoming obsolete before we recover a significant portion of our related research, development, and capital expenditures. We may experience competition both from other companies in the field and from companies which have other forms of treatment for the diseases we are targeting.

        We are aware of several development-stage and established enterprises, including major pharmaceutical and biotechnology firms, which are exploring gene-based drugs or are actively engaged in gene delivery research and development. These include Avigen, Inc., Cell Genesys, Inc., Introgen Therapeutics, Inc., Targeted Genetics Corp., Transgene SA, and Valentis, Inc., among others. We may also experience competition from companies that have acquired or may acquire technology from companies, universities and other research institutions. As these companies develop their technologies, they may develop proprietary technologies which may materially and adversely affect our business.

        In addition, a number of companies are developing products to address the same diseases that we are targeting. For example, AVAX Technologies, Inc., Corixa Corp., Antigenics, Inc., CancerVax Corp., Maxim Pharmaceuticals, Inc. and Genta, Inc., among others, are conducting advanced clinical trials for the treatment of melanoma. In addition, Introgen Therapeutics, Inc., Onyx Pharmaceuticals, Inc., and ImClone Systems, Inc., among others, are conducting clinical trials of their products to treat head and neck cancer. If these or any other companies develop products with efficacy or safety profiles significantly better than our products, we may not be able to commercialize our products, and sales of any of our commercialized products could be harmed.

        Some of our competitors and potential competitors have substantially greater product development capabilities and financial, scientific, marketing and human resources than we do. Competitors may develop products earlier, obtain FDA approvals for products more rapidly, or develop products that are more effective than those under development by us. We will seek to expand our technological

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capabilities to remain competitive; however, research and development by others may render our technology or products obsolete or noncompetitive, or result in treatments or cures superior to ours.

        Regulatory agencies such as the FDA and other government agencies may expand current requirements for public disclosure of development information for gene-based product development data technology which may harm our competitive position with foreign companies and U.S. companies developing non-gene-based products for similar indications.

        Our competitive position will be affected by the disease indications addressed by our product candidates and those of our competitors, the timing of market introduction for these products and the stage of development of other technologies to address these disease indications. For us and our competitors, proprietary technologies, the ability to complete clinical trials on a timely basis and with the desired results, and the ability to obtain timely regulatory approvals to market these product candidates are likely to be significant competitive factors. Other important competitive factors will include the efficacy, safety, reliability, availability and price of products and the ability to fund operations during the period between technological conception and commercial sales.

Government Regulation

        Any products we develop will require regulatory clearances prior to clinical trials and additional regulatory clearances prior to commercialization. New human gene therapies are expected to be subject to extensive regulation by the FDA and comparable agencies in other countries. The precise regulatory requirements with which we will have to comply are uncertain at this time due to the novelty of the gene-based products and therapies currently under development. We believe that our potential products will be regulated either as biological products or as drugs. Drugs are subject to regulation under the Federal Food, Drug and Cosmetic Act; biological products, in addition to being subject to provisions of that Act, are regulated under the Public Health Service Act. Both statutes and related regulations govern, among other things, the testing, manufacturing, safety, efficacy, labeling, storage, record keeping, advertising, and other promotional practices. FDA approval or other clearances must be obtained before clinical testing, and before manufacturing and marketing of biologics or drugs.

        FDA approval is required prior to marketing a pharmaceutical product in the United States. To obtain this approval the FDA requires clinical trials to demonstrate the safety, efficacy and potency of the product candidates. Clinical trials are the means by which experimental drugs or treatments are tested in humans. New therapies typically advance from research through preclinical testing, and finally through several phases of clinical trials, or human testing. Clinical trials may be conducted within the United States or in foreign countries. If clinical trials are conducted in foreign countries, the products under development as well as the trials are subject to regulations of the FDA and/or its counterparts in the other countries. Upon successful completion of clinical trials, approval to market the therapy for a particular patient population may be requested from the FDA in the United States and/or its counterparts in other countries.

        Clinical trials are normally done in three phases. Phase I clinical trials are typically conducted with a small number of patients or healthy volunteers to determine the safety profile, the pattern of drug distribution and metabolism and early evidence on effectiveness. Phase II clinical trials are conducted with a larger group of patients afflicted with a target disease in order to determine preliminary efficacy, optimal dosages and expanded evidence of safety. Phase III clinical trials involve large scale, multi-center, comparative trials that are conducted with patients afflicted with a target disease in order to provide enough data for the statistical proof of safety, efficacy, and potency required by the FDA and other regulatory authorities. For life-threatening diseases, initial human testing generally is done in patients rather than healthy volunteers. These studies may provide results traditionally obtained in Phase II trials and are referred to as "Phase I/II" trials.

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        Obtaining FDA approval is a costly and time-consuming process. Generally, in order to gain FDA pre-market approval, preclinical studies must be conducted in the laboratory and in animal model systems to gain preliminary information on an agent's efficacy and to identify any major safety concerns. The results of these studies are submitted as a part of an application for an Investigational New Drug, IND, which the FDA must review and allow before human clinical trials can start. The IND includes a detailed description of the clinical investigations.

        A company must sponsor and file an IND for each proposed product and must conduct clinical studies to demonstrate the safety, efficacy, and potency that are necessary to obtain FDA approval. The FDA receives reports on the progress of each phase of clinical testing and it may require the modification, suspension, or termination of clinical trials if an unwarranted risk is presented to patients. Human DNA therapeutics are a new category of therapeutics and the clinical trial period may be lengthy or the number of patients may be numerous in order to establish safety, efficacy, and potency.

        After completion of clinical trials of a new product, FDA marketing approval must be obtained. If the product is regulated as a biologic, a Biologic License Application, BLA, is required. If the product is classified as a new drug, a New Drug Application, NDA, is required. The NDA or BLA must include results of product development activities, preclinical studies, and clinical trials in addition to detailed manufacturing information.

        Applications submitted to the FDA are subject to an unpredictable and potentially prolonged approval process. The FDA may ultimately decide that the application does not satisfy its criteria for approval or require additional preclinical or clinical studies. Even if FDA regulatory clearances are obtained, a marketed product is subject to continual review, and later discovery of previously unknown problems or failure to comply with the applicable regulatory requirements may result in restrictions on the marketing of a product or withdrawal of the product from the market as well as possible civil or criminal sanctions. Before marketing clearance is secured, the manufacturing facility will be inspected for current compliance with Good Manufacturing Practices, GMP, by FDA inspectors. The manufacturing facility must satisfy current GMP requirements prior to marketing clearance. In addition, after marketing clearance is secured, the manufacturing facility will be inspected periodically for GMP compliance by FDA inspectors, and, if the facility is located in California, by inspectors from the Food and Drug Branch of the California Department of Health Services.

        In addition to the FDA requirements, the NIH has established guidelines for research involving human genetic materials, including recombinant DNA molecules. These guidelines apply to all recombinant DNA research that is conducted at facilities supported by the NIH, including proposals to conduct clinical research involving gene therapies. The NIH review of clinical trial proposals and safety information is a public process and often involves review and approval by the Recombinant DNA Advisory Committee of the NIH.

        In both domestic and foreign markets, sales of any approved products will depend on reimbursement from third-party payers, such as government and private insurance plans. Third-party payers are increasingly challenging the prices charged for medical products and services. If we succeed in bringing one or more products to market, these products may not be considered cost-effective, reimbursement may not be available, or reimbursement policies may adversely affect our ability to sell our products on a profitable basis.

        We also are subject to various federal, state and local laws, regulations, and recommendations relating to safe working conditions, laboratory and manufacturing practices, the experimental use of animals, and the use and disposal of hazardous or potentially hazardous substances, including radioactive compounds and infectious disease agents, used in connection with our research. The extent of government regulation which might result from any future legislation or administrative action cannot be accurately predicted.

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Human Resources

        As of March 1, 2002, we had 152 full-time employees, 21 of whom hold degrees at the doctorate level. Of these employees, 121 are engaged in, or directly support, research and development activities, and 31 are in administrative and business development positions. A significant number of our management and professional employees have prior experience with pharmaceutical and biotechnology companies. None of our employees is covered by collective bargaining agreements, and our management considers relations with our employees to be good.

Facilities

        We lease approximately 51,000 square feet of manufacturing, research laboratory and office space in an established commercial neighborhood in northern San Diego, California, at three sites and with three leases. The leases terminate in 2004. We have the option to renew two of these three leases for an additional five-year period and can renew the third for two additional five-year periods.

        In January 2002, we signed a 15-year lease for a new building, in Sorrento Mesa, in northern San Diego. The new facility will hold approximately 68,400 square feet of manufacturing, research laboratory and office space. This site will allow us to join most of our personnel under one roof while also allowing us to increase our manufacturing capacity for both clinical and commercial production, with the planned addition of a 500-liter or larger fermenter and associated processing equipment. As this is a build-out process, phased-in occupancy should commence by the end of 2002. We will continue to hold the leases on our three existing facilities until they expire. We intend to sublease the majority of this space as it becomes available.

        Within our existing facilities, we have manufactured sufficient quantities of pharmaceutical-grade product to supply our previous and ongoing clinical trials, including the current registration trials. In addition, we have manufactured preclinical and clinical supplies of DNA for our corporate collaborators, for government agencies and for numerous academic researchers.

ADDITIONAL BUSINESS RISKS

         You should carefully consider the risks described below, together with all of the other information included in this report, before deciding whether to invest in our common stock. In addition, the risks and uncertainties described below are not the only ones facing us because we are also subject to additional risks and uncertainties not presently known to us. If any of these risks actually occurs, our business, financial condition, results of operations or cash flow could be seriously harmed. This could cause the trading price of our common stock to decline, and you may lose all or part of your investment.

None of our products have been approved for sale. If we do not develop commercially successful products, we may be forced to curtail or cease operations.

        Very little data exists regarding the safety and efficacy of gene therapies. All of our potential products are either in research or development. We must conduct a substantial amount of additional research and development before any U.S. or foreign regulatory authority will approve any of our products. Results of our research and development activities may indicate that our potential products are unsafe or ineffective. In this case, regulatory authorities will not approve them. Even if approved, our products may not be commercially successful. If we fail to develop and commercialize our products, we may be forced to curtail or cease operations.

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We have a history of net losses. We expect to continue to incur net losses and we may not achieve or maintain profitability.

        To date, we have not sold any products and do not expect to sell any products for the next few years. Our net losses were approximately $9.2 million, $8.5 million and $6.9 million for 2001, 2000 and 1999, respectively. As of December 31, 2001, we have incurred cumulative net losses totaling approximately $62.4 million. Moreover, we expect that our negative cash flow and losses from operations will continue and increase for the foreseeable future. For 2002, we have forecast a net loss of between $28 million and $32 million. We may not be able to achieve the projected results. We may never generate sufficient product revenue to become profitable. We also expect to have quarter-to-quarter fluctuations in revenues, expenses, and losses, some of which could be significant.

We may need additional capital in the future. If additional capital is not available, we may have to curtail or cease operations.

        We may need to raise more money to continue the research and development necessary to bring our products to market and to establish manufacturing and marketing capabilities. We may seek additional funds through public and private stock offerings, arrangements with corporate collaborators, borrowings under lease lines of credit or other sources. We may not be able to raise additional funds on favorable terms, or at all. If we are unable to obtain additional funds, we may have to reduce our capital expenditures, scale back our development of new products, reduce our workforce and license to others products or technologies that we otherwise would seek to commercialize ourselves. The amount of money we may need will depend on many factors, including:

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the progress of our research and development programs



•

the scope and results of our preclinical studies and clinical trials



•

the time and costs involved in:



•

obtaining necessary regulatory approvals,



•

filing, prosecuting and enforcing patent claims, and



•

scaling up our manufacturing capabilities.




•

the commercial arrangements we may establish

The regulatory approval process is expensive, time consuming and uncertain which may prevent us from obtaining required approvals for the commercialization of our products.

        Our product candidates under development and those of our collaborators are subject to extensive and rigorous regulations by numerous governmental authorities in the United States and other countries. The regulations are evolving and uncertain. The regulatory process can take many years and require us to expend substantial resources. For example:

•

The FDA has not established guidelines concerning the scope of clinical trials required for gene therapies.



•

The FDA has not indicated how many patients it will require to be enrolled in clinical trials to establish the safety and efficacy of gene therapies.



•

Current regulations are subject to substantial review by various governmental agencies.

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        Therefore, U.S. or foreign regulations could prevent or delay regulatory approval of our products or limit our ability to develop and commercialize our products. Delays could:

•

impose costly procedures on our activities;



•

diminish any competitive advantages that we attain; or



•

negatively affect our ability to receive royalties.

        We understand that both the FDA and NIH are considering rules and regulations that would require public disclosure of commercial development data that is presently confidential. This potential disclosure of commercial confidential information, if implemented, may result in loss of advantage of competitive secrets.

        We believe that the FDA and comparable foreign regulatory bodies will regulate separately each product containing a particular gene depending on its intended use. Presently, to commercialize any product we must sponsor and file a regulatory application for each proposed use. We then must conduct clinical studies to demonstrate the safety and efficacy of the product necessary to obtain FDA approval. The results obtained so far in our clinical trials may not be replicated in our on-going or future trials. This may prevent any of our potential products from receiving FDA approval.

        We use recombinant DNA molecules in our product candidates, and therefore we also must comply with guidelines instituted by the NIH and its Recombinant DNA Advisory Committee. The NIH could restrict or delay the development of our product candidates.

Adverse events in the field of gene therapy, or with respect to our product candidates, may negatively impact regulatory approval or public perception of our products.

        The death in 1999 of a patient undergoing a viral-based gene therapy at the University of Pennsylvania in an investigator-sponsored trial was widely publicized. This death and other adverse events in the field of gene therapy could result in greater governmental regulation of gene therapies, including our non-viral gene delivery technology, and potential regulatory delays relating to the testing or approval of our product candidates. In addition, the field of gene therapy is under increased scrutiny, which may affect our product development efforts or clinical trials.

        For example, one patient who had undergone treatment with Allovectin-7® for advanced metastatic melanoma died more than two months later of progressive disease and numerous other factors after receiving multiple other cancer therapies. The death was originally reported as unrelated to the treatment. Following an autopsy, the death was reclassified as "probably related" to the treatment because the possibility could not be ruled out. We do not believe Allovectin-7® was a significant factor in the patient's death.

        The commercial success of our product candidates will depend in part on public acceptance of the use of gene therapies for the prevention or treatment of human diseases. Public attitudes may be influenced by claims that gene therapies are unsafe and our gene therapies may not gain the acceptance of the public or the medical community. Negative public reaction to adverse events in our trials or gene therapy in general could result in greater government regulation and stricter labeling requirements of gene therapies, including our gene therapies, and could cause a decrease in the demand for any products we may develop.

Our patents and proprietary rights may not provide us with any benefit and the patents of others may prevent us from commercializing our products.

        We may not receive any patents from our current applications. Moreover, if patents are issued to us, governmental authorities may not allow claims sufficient to protect our technology. Finally, others may challenge or seek to circumvent or invalidate our patents. In that event, the rights granted under

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our patents may be inadequate to protect our proprietary technology or to provide any commercial advantage.

        Our core gene delivery technology was covered by a patent issued in Europe, which was opposed by seven companies under European patent procedures. In October 2001, we announced our intention to appeal a ruling by the Opposition Division of the European Patent Office that revoked our patent on formal grounds. If we are not successful in the appeal and opposition proceedings we may lose part or all of our proprietary protection on our product candidates in Europe.

        Others may have or may receive patents which contain claims applicable to our products. These patents may impede our ability to commercialize our products.

The legal proceedings to obtain patents and litigation of third-party claims of intellectual property infringement could require us to spend money and could impair our operations.

        Our success will depend in part on our ability to obtain patent protection for our products and processes both in the United States and in other countries. The patent positions of biotechnology and pharmaceutical companies, however, can be highly uncertain and involve complex legal and factual questions. Therefore, it is difficult to predict the breadth of claims allowed in the biotechnology and pharmaceutical fields.

        We also rely on confidentiality agreements with our corporate collaborators, employees, consultants and certain contractors to protect our proprietary technology. However, these agreements may be breached and we may not have adequate remedies for such breaches. In addition, our trade secrets may otherwise become known or independently discovered by our competitors.

        Protecting intellectual property rights can be very expensive. Litigation will be necessary to enforce patents issued to us or to determine the scope and validity of third-party proprietary rights. Moreover, if a competitor were to file a patent application claiming technology also invented by us, we would have to participate in an interference proceeding before the PTO or in a foreign counterpart to determine the priority of the invention. We may be drawn into interferences with third parties or may have to provoke interferences ourselves to unblock third-party patent rights to allow us or our licensees to commercialize products based on our technology. Litigation could result in substantial costs and the diversion of management's efforts regardless of the results of the litigation. An unfavorable result in litigation could subject us to significant liabilities to third parties, require disputed rights to be licensed or require us to cease using some technology.

        Our products and processes may infringe, or be found to infringe on, patents not owned or controlled by us. Patents held by others may require us to alter our products or processes, obtain licenses, or stop activities. If relevant claims of third-party patents are upheld as valid and enforceable, we could be prevented from practicing the subject matter claimed in the patents, or may be required to obtain licenses or redesign our products or processes to avoid infringement. A number of genetic sequences or proteins encoded by genetic sequences that we are investigating are, or may become, patented by others. As a result, we may have to obtain licenses to test, use or market these products. Our business will suffer if we are not able to obtain licenses at all or on terms commercially reasonable to us and we may not be able to redesign our products or processes to avoid infringement.

Competition and technological change may make our product candidates and technologies less attractive or obsolete.

        We compete with companies, including major pharmaceutical and biotechnology firms, that are pursuing other forms of treatment or prevention for diseases that we target. We also may experience competition from companies that have acquired or may acquire technology from universities and other

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research institutions. As these companies develop their technologies, they may develop proprietary positions which may prevent us from successfully commercializing products.

        Some of our competitors are established companies with greater financial and other resources. Other companies may succeed in developing products and obtaining FDA approval faster than we do, or in developing products that are more effective than ours. While we will seek to expand our technological capabilities to remain competitive, research and development by others will seek to render our technology or products obsolete or noncompetitive or result in treatments or cures superior to any therapy developed by us. Additionally, even if our product development efforts are successful, and even if the requisite regulatory approvals are obtained, our product may not gain market acceptance among physicians, patients, healthcare payers and the medical communities. If any of our product candidates do not achieve market acceptance, we may lose our investment in that product, which may cause our stock price to decline.

The method of administration of some of our product candidates can cause adverse events in patients, including death.

        Some of our potential products are designed to be injected directly into malignant tumors. There are medical risks inherent in direct tumor injections. For example, in clinical trials of our potential products, attending physicians have punctured patients' lungs in less than one percent of procedures, requiring hospitalization. In addition, a physician administering our product in an investigator-sponsored clinical trial inadvertently damaged tissue near the heart of a patient, which may have precipitated the patient's death. These events are reported as adverse events in our clinical trials and illustrate the medical risks related to direct injection of tumors. These risks may adversely impact market acceptance of some of our product candidates.

Commercialization of some of our potential products depends on collaborations with others. If our collaborators are not successful or if we are unable to find collaborators in the future, we may not be able to develop these products.

        Our strategy for the research, development and commercialization of some of our product candidates requires us to enter into contractual arrangements with corporate collaborators, licensors, licensees and others. Our success depends upon the performance by these collaborators of their responsibilities under these arrangements. Some collaborators may not perform their obligations as we expect or we may not derive any revenue from these arrangements.

        We have collaborative agreements with several pharmaceutical companies. We do not know whether these companies will successfully develop and market any products under their respective agreements. Moreover, some of our collaborators are also researching competing technologies to treat the diseases targeted by our collaborative programs. We may be unsuccessful in entering into other collaborative arrangements to develop and commercialize our products.

We may suffer a material financial loss due to dilution if additional shares of VGI stock are issued at a price below our issuance price, or due to permanent impairment if VGI Is unable to successfully complete its development plans.

        In February 2000, we received Series B Preferred Stock in VGI in exchange for a license to our technology. This investment is recorded on our balance sheet at estimated fair value on the date of investment of $5.0 million. The preferred stock is convertible into common stock of VGI. If additional shares of VGI common or preferred stock are issued at a price below our issuance price, the conversion rate would change and the percentage of our equity ownership in VGI would decrease.

        VGI is a privately-held company developing gene-based delivery of the angiogenic growth factor VEGF-2 for cardiovascular applications. VGI has completed Phase I and Phase II trials. VGI still

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needs to raise substantial cash to complete its development plans, and there can be no assurance that the therapy will work or that the FDA will approve such a therapy. VGI, which currently has few employees and limited resources, may not be able to successfully commercialize a product even if it receives FDA approval. We do not believe there has been any permanent impairment to our investment to date, however, this may change depending on the funding and development status of VGI, which is beyond our control.

If we lose our key personnel or are unable to attract and retain additional personnel, we may not be able to pursue collaborations or develop our own products.

        We are highly dependent on the principal members of our scientific, manufacturing, clinical, regulatory and management personnel, the loss of whose services might significantly delay or prevent the achievement of our objectives. We depend on our continued ability to attract, retain and motivate highly qualified management and scientific personnel. We face competition for qualified individuals from other companies, academic institutions, government entities and other organizations in attracting and retaining personnel. To pursue our product development plans, we will need to hire additional management personnel and additional scientific personnel to perform research and development, as well as personnel with expertise in clinical trials, government regulation and manufacturing. We may not be successful in hiring or retaining qualified personnel.

We may not be able to manufacture products on a commercial scale.

        We have limited experience in manufacturing our product candidates in commercial quantities. We may be dependent initially on corporate collaborators, licensees or others to manufacture our products commercially. We also will be required to comply with extensive regulations applicable to manufacturing facilities. We may be unable to enter into any arrangement for the manufacture of our products.

We may not be able to sublease our existing manufacturing, research laboratory and office sites upon completion of our new facility.

        We currently hold three leases at three sites for our existing manufacturing, research laboratory and offices facilities. The leases do not terminate until 2004. These spaces will become progressively unnecessary during the scheduled phased-in occupancy of our new facility. We may be unable to sublease the sites as we vacate them.

We have no marketing or sales experience, and if we are unable to develop our own sales and marketing capability, we may not be successful in commercializing our products.

        Our current strategy is to market our proprietary cancer products directly in the United States, but we currently do not possess pharmaceutical marketing or sales capabilities. In order to market and sell our proprietary cancer products, we will need to develop a sales force and a marketing group with relevant pharmaceutical experience, or make appropriate arrangements with strategic partners to market and sell these products. Developing a marketing and sales force is expensive and time consuming and could delay any product launch. Our inability to successfully employ qualified marketing and sales personnel and develop our sales and marketing capabilities will harm our business.

Health care reform and restrictions on reimbursement may limit our returns on potential products.

        Our ability to earn sufficient returns on our products will depend in part on the extent to which reimbursement for our products and related treatments will be available from:

•

government health administration authorities,

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•

private health coverage insurers,



•

managed care organizations, and



•

other organizations.

        If we fail to obtain appropriate reimbursement, it could prevent us from successfully commercializing our potential products.

        There are efforts by governmental and third-party payers to contain or reduce the costs of health care through various means. We expect that there will continue to be a number of legislative proposals to implement government controls. The announcement of proposals or reforms could impair our ability to raise capital. The adoption of proposals or reforms could impair our business.

        Additionally third-party payers are increasingly challenging the price of medical products and services. If purchasers or users of our products are not able to obtain adequate reimbursement for the cost of using our products, they may forego or reduce their use. Significant uncertainty exists as to the reimbursement status of newly approved health care products, and whether adequate third-party coverage will be available.

We use hazardous materials in our business. Any claims relating to improper handling, storage or disposal of these materials could be time consuming and costly.

        Our research and development processes involve the controlled storage, use and disposal of hazardous materials, biological hazardous materials and radioactive compounds. We are subject to federal, state and local regulations governing the use, manufacture, storage, handling and disposal of materials and waste products. Although we believe that our safety procedures for handling and disposing of these hazardous materials comply with the standards prescribed by law and regulation, the risk of accidental contamination or injury from hazardous materials cannot be completely eliminated. In the event of an accident, we could be held liable for any damages that result, and any liability could exceed the limits or fall outside the coverage of our insurance. We may not be able to maintain insurance on acceptable terms, or at all. We could be required to incur significant costs to comply with current or future environmental laws and regulations.

We may have significant product liability exposure.

        We face an inherent business risk of exposure to product liability and other claims in the event that our technologies or products are alleged to have caused harm. These risks are inherent in the development of chemical and pharmaceutical products. Although we currently maintain product liability insurance, we may not have sufficient insurance coverage and we may not be able to obtain sufficient coverage at a reasonable cost. Our inability to obtain product liability insurance at an acceptable cost or to otherwise protect against potential product liability claims could prevent or inhibit the commercialization of any products developed by us or our collaborators. We also have liability for products manufactured by us on a contract basis for third parties. If we are sued for any injury caused by our technology or products, our liability could exceed our total assets.

Our stock price could continue to be highly volatile and you may not be able to resell your shares at or above the price you paid for them.

        The market price of our common stock, like that of many other life sciences companies, has been highly volatile and is likely to continue to be highly volatile. The following factors, among others, could have a significant impact on the market price of our common stock:

•

the results of our preclinical studies and clinical trials or those of our collaborators or competitors or for gene therapies in general,

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•

evidence of the safety or efficacy of our potential products or the products of our competitors,



•

the announcement by us or our competitors of technological innovations or new products,



•

governmental regulatory actions,



•

changes or announcements in reimbursement policies,



•

developments with our collaborators,



•

developments concerning our patent or other proprietary rights or those of our competitors, including litigation,



•

concern as to the safety of our potential products,



•

period-to-period fluctuations in our operating results,



•

market conditions for life science stocks in general, and



•

changes in estimates of our performance by securities analysts.

We are at risk of securities class action litigation due to our expected stock price volatility.

        In the past, stockholders have often brought securities class action litigation against a company following a decline in the market price of its securities. This risk is especially acute for us because life science companies have experienced greater than average stock price volatility in recent years and, as a result, have been subject to, on average, a greater number of securities class action claims than companies in other industries. We may in the future be the target of similar litigation. Securities litigation could result in substantial costs and divert management's attention and resources, and could seriously harm our business.

Our anti-takeover provisions could discourage potential takeover attempts and make attempts by stockholders to change management more difficult.

        The approval of two-thirds of our voting stock is required to approve some transactions and to take some stockholder actions, including the calling of a special meeting of stockholders and the amendment of any of the anti-takeover provisions contained in our certificate of incorporation. Further, pursuant to the terms of our stockholder rights plan adopted in March 1995, we have distributed a dividend of one right for each outstanding share of common stock. These rights will cause substantial dilution to the ownership of a person or group that attempts to acquire us on terms not approved by our Board of Directors and may have the effect of deterring hostile takeover attempts.

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         Vijay B. Samant joined us as President and Chief Executive Officer in November 2000. Mr. Samant has 23 years of diverse U.S. and international sales, marketing, operations, and business development experience with Merck. From 1998 to mid-2000, he was Chief Operating Officer of the Merck Vaccine Division. From 1990 to 1998, he served in the Merck Manufacturing Division as Vice President of Vaccine Operations, Vice President of Business Affairs, and Executive Director of Materials Management. Mr. Samant earned his M.B.A. from the Sloan School of Management at the Massachusetts Institute of Technology in 1983. He received a master's degree in chemical engineering from Columbia University in 1977 and a bachelor's degree in chemical engineering from the University of Bombay, University Department of Chemical Technology, UDCT, in 1975.

         David C. Kaslow, M.D., joined us as Chief Scientific Officer in October 2001. Dr. Kaslow has more than 15 years of vaccine research experience, including the last two at Merck, most recently as Head of the Department of Vaccine Research and Technology. From 1986 to 1999, he held various senior research positions at the National Institutes of Health, including Head of the Recombinant Protein Development Unit and the Malaria Vaccine Development Unit at the Laboratory of Parasitic Diseases. Dr. Kaslow has been awarded numerous professional honors, including the U.S. Public Health Service Outstanding Service Medal. He has published some 122 scientific papers, and authored more than 20 review articles and book chapters. He holds or co-holds 13 patents. Dr. Kaslow received his bachelor's degree from the University of California, Davis, in 1979, and his M.D. from the School of Medicine at the University of California, San Francisco, in 1983.

         Martha J. Demski joined us as Chief Financial Officer in December 1988 and currently serves as Vice President, Chief Financial Officer, Treasurer and Secretary. From August 1977 until joining us, Ms. Demski held various positions with Bank of America, lastly as Vice President/Section Head of the Technology Section. She also served as an adviser to Bank of America on a statewide basis regarding the biotechnology industry in California. Ms. Demski received a B.A. from Michigan State University in 1974 and an M.B.A. in Finance and Accounting from The University of Chicago Graduate School of Business in 1977.

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         Kevin R. Bracken joined us as Vice President, Manufacturing in October 2001. From July 1998 to October 2001, Mr. Bracken was Vice President, Process Engineering and Manufacturing for Universal Preservation Technologies, Inc. and Director of Engineering for Molecular Biosystems, Inc. from November 1995 to July 1998. He brings experience in commercial scale-up of biopharmaceutical manufacturing facilities, process development and optimization, and direction of research, pre-clinical, clinical, production and contract manufacturing. Prior to November 1995, he held a variety of process and engineering positions with Gilead Sciences, Inc., and a predecessor company, Vestar, Inc., with Baxter International, and with E.I. duPont de Nemours and Company. Mr. Bracken earned his M.S. degree in chemical engineering from the University of Rochester in 1973, and his B.S. degree in chemical engineering from the University of Delaware in 1970.

         Alan E. Dow, J.D., Ph.D., joined Vical in June 2001 as Vice President and General Counsel. Dr. Dow came to Vical from Pillsbury Winthrop LLP, where he was a Senior Attorney practicing general corporate and intellectual property law for clients in the United States and abroad. His focus was in the areas of biotechnology, genomics, pharmaceuticals, agricultural biotechnology and chemistry. From 1998 to 2000, Dr. Dow was Corporate Counsel, Intellectual Property, for Pharmacia Corporation, and from 1994 to 1998 he was an Associate Attorney with Klarquist, Sparkman, Campbell, Leigh & Whinston of Portland, Oregon. Dr. Dow earned his J.D. from Stanford Law School in 1994, his Ph.D. from Harvard University in 1992, and a B.S. degree in chemistry, with high distinction, from the University of Maine at Orono in 1977.

         Jon A. Norman, Ph.D., joined us in January 1993 as Vice President, Research. From 1986 until joining us, Dr. Norman was the Group Leader/Section Head for the Departments of Pharmacology and Biochemistry at Bristol-Myers Squibb Corporation. He was a Senior Research Scientist at Ciba-Geigy Corporation from 1981 to 1986. Dr. Norman received his B.A. in 1970 and M.A. in 1972 from the University of California at Santa Barbara and his Ph.D. in Biochemistry from the University of Calgary in 1977, after which he was awarded a fellowship at the Friederich Miescher Institute in Basel, Switzerland.

         David J. Pyrce joined us in October 2001 as Vice President, Business Development. Since 1993, Mr. Pyrce was a General Partner of Bear Creek Capital Management, a healthcare-based investment management firm. In addition, he served as Vice President and Senior Healthcare Analyst at First Security, Van Kasper & Company from 1993 to 1997 and as Vice President, Corporate Communications and Investor Relations, at Imagyn Medical Technologies from 1997 to 1999. He was Vice President of Diagnostic Products for Glyko Biomedical, Inc., from 1991 to 1993, and Director of Business Development at SmithKline Beecham from 1986 to 1991. From 1979 to 1986, he advanced through several sales and marketing positions at Baxter Healthcare, lastly as Vice President of Sales and Marketing. Mr. Pyrce received an M.B.A. in Financial Management and an M.S. in Financial Markets and Trading from the Stuart School of Business at the Illinois Institute of Technology in 1984. He received a B.S. degree in Biochemistry and Molecular Biology from Northern Illinois University in 1978. He is also an alumnus of the Advanced Executive Program at the Kellogg School of Business at Northwestern University.

Scientific Advisory Board Members

        Members of our Scientific Advisory Board, SAB, are selected by our executive officers. Our SAB members are as follows:

         C. Thomas Caskey, M.D., F.A.C.P., a world-renowned leader in genomics and genetics, recently served as Senior Vice President of Research at Merck Research Laboratories and as Trustee and President of The Merck Genome Research Institute, Inc. He is President and Chief Operating Officer of Cogene BioTech Ventures, Ltd., Chairman of the Board of Lexicon Genetics, and a member of the Board of Directors of Athersys Inc., and currently serves as an adjunct professor at Baylor College of

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Medicine. In addition to his work in the pharmaceutical industry, Dr. Caskey has served as President of the American Society of Human Genetics and as a member of the advisory committees for the National Institutes of Health's Program Advisory Committee on the Human Genome, and the Department of Energy on Mapping the Human Genome. He was awarded the Distinguished Texas Geneticist in 1998 and the Presidency of the Human Genome Organization in 1993. A member of the National Academy of Sciences and the Institute of Medicine, he is the recipient of numerous research and teaching awards. Dr. Caskey is board certified in internal medicine, clinical genetics and biochemical and molecular genetics, and earned his medical doctorate from Duke University.

         Phyllis Gardner, M.D., is a tenured associate professor in the Department of Medicine at Stanford University School of Medicine. She has conducted extensive research in cell biology, including gene therapy, with emphasis in the area of cystic fibrosis. She has received numerous national awards and honors, including the Faculty Development Award from the Pharmaceutical Research and Manufacturers Association Foundation and Burroughs Wellcome Faculty Scholar in Clinical Pharmacology. In 1998, Dr. Gardner co-founded Genomics Collaborative, Inc., a functional genomics company focused on developing target discovery and validation intellectual property. From 1996 to 1998, she also served as Vice President of Research and head of ALZA Technology Institute of ALZA Corporation, a pharmaceutical company specializing in drug delivery technologies. She currently serves on the Board of Directors of several companies, including Aronex, Health Hero Network, Pharmacyclics, and Aerogen Inc. Dr. Gardner received her medical doctorate from Harvard Medical School.

         Paul A. Offit, M.D., is Chief of Infectious Diseases, the Henle Professor of Immunologic and Infectious Diseases, and Director of the Vaccine Education Center at the Children's Hospital of Philadelphia. He is also Professor of Pediatrics at the University of Pennsylvania School of Medicine. Dr. Offit is an internationally recognized expert in the fields of immunology and virology. He is a member of the Advisory Committee on Immunization Practices to the Center for Disease Control and Prevention, CDC. He has received numerous awards, including the J. Edmund Bradley Prize for Excellence in Pediatrics and the Young Investigator Award in vaccine development. Dr. Offit is the co-holder of a patent on a bovine human reassortant rotavirus vaccine and serves as a consultant to Merck on the vaccine's development. Dr. Offit has written two books, Vaccines: What Every Parent Should Know , with Louis Bell, M.D., and Breaking the Antibiotic Habit: A Parent's Guide to Coughs, Colds, Ear Infections, and Sore Throats , with Louis Bell, M.D., and Bonnie Fass-Offit. He received his medical doctorate from University of Maryland.

         Eric N. Olson, Ph.D., is a world leader in scientific discovery and basic research into the workings of muscle cells. His research has defined the molecular events that control cell development, particularly discovering genes that control the development of heart muscle and skeletal muscle cells. Dr. Olson has been an Established Investigator of the American Heart Association, and his previous honors include the Edgar Haber Cardiovascular Research Award, the American Heart Association Basic Research Prize, and Gill Heart Institute Award for Outstanding Contributions to Cardiovascular Medicine. Dr. Olson is Director of the Hamon Center for Basic Cancer Research and Professor and Chairman of the Department of Molecular Biology at the University of Texas Southwestern Medical Center. He is also an elected member of the American Academy of Arts and Sciences and the National Academy of Sciences. Dr. Olson received his Ph.D. in biochemistry from the Bowman Gray School of Medicine of Wake Forest University, and completed postdoctoral fellowships at the American Heart Association and National Institutes of Health.

         Douglas D. Richman, M.D., Professor of Pathology and Medicine, University of California, San Diego, UCSD, and VA Healthcare System, is a recognized expert in infectious diseases and medical virology. He is Director of the UCSD Center for AIDS Research . Dr. Richman is also a Fellow of the American Association for the Advancement of Science, the American Association of Physicians, and the Infectious Disease Society of America, and is a member of the NIH AIDS Vaccine Research

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Committee. Dr. Richman's laboratory is credited with the discovery of HIV drug resistance in 1988, and now is focused on several aspects of HIV infection: 1) the investigation of antiviral drugs and drug resistance; 2) the pathogenesis and immune responses of primary HIV infection; and 3) the mechanisms involved with latent HIV infection. Dr. Richman received his medical doctorate at Stanford University, where he completed his residency.

         George W. Sledge, M.D., is the Ballvé-Lantero Professor of Oncology at Indiana University. Dr. Sledge specializes in the treatment of breast cancer, and is active in research involving monoclonal antibodies and anti-angiogenesis. In this role, he chaired the committee that developed the School of Medicine's first multi-disciplinary cancer program, the Breast Care and Research Center. Dr. Sledge has served as chairman of the Hoosier Oncology Group's Breast Cancer committee, as a member and vice-chairman of the Eastern Cooperative Oncology Group's Breast Cancer Committee, and as a member of the editorial board of The Breast Journal . He is editor-in-chief of Clinical Breast Cancer . He is an active member of the American Association for Cancer Research and the American Society for Clinical Oncology. Dr. Sledge received his medical degree from Tulane University.