Deltagen | Investor Relations | Risk Factors 2006 Q1

This report contains forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from any future results, performances or achievements expressed or implied by the forward-looking statements. Forward-looking statements include, but are not limited to, statements about:

. the benefits of knockout mice programs and, in particular, our technologies and products, to the pharmaceutical industry;

. the increasing competition we face in the field of knockout mice from both commercial and government organizations;

. our future revenues and profitability, including any revenues from milestone payments and access extension fees, under our DeltaBase collaboration agreements;

. failures in the drug discovery, development and approval processes by our partners and collaborators;

. our ability to attract customers and establish licensing and other agreements;

. our ability to successfully execute our business plan and to meet contractual obligations, in view of the Company's limited staff; and

In some cases, you can identify forward-looking statements by terms such as "may," "will," "should," "could," "would," "expects," "plans," "anticipates," "believes," "estimates," "projects," "predicts," "potential" and similar expressions intended to identify forward-looking statements. These statements reflect our current views with respect to future events and are based on assumptions and subject to risks and uncertainties. Given these uncertainties, you should not place undue reliance on these forward-looking statements. These forward-looking statements represent our estimates and assumptions only as of the date of this report.

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

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

Deltagen is a provider of research tools to the biopharmaceutical industry and to the academic research community. Deltagen has generated an inventory of "knockout mice" in which a single gene has been deleted ("knocked out"). The knockout mice have been analyzed to determine the phenotypic changes associated with that gene deletion. This phenotypic data has been organized in an integrated database known as DeltaBase. DeltaBase contains phenotypic data on 750 different knockout mouse lines. In addition to those 750 knockout mouse lines, Deltagen has approximately 150 additional knockout mouse lines that have not been characterized phenotypically. Deltagen also has approximately 450 knockout lines at the embryonic stem (ES) cell stage.

Our customers and partners/collaborators have included some of the world's largest pharmaceutical companies, including GlaxoSmithKline plc, Merck & Co., Inc., Pfizer Inc., Eli Lilly and Company and Schering-Plough Research Institute.

DeltaBase is our proprietary database that provides information, based on knockout mouse studies, on gene function and validated gene targets for drug discovery. Each knockout mouse underwent a standardized, detailed and extensive analysis in order to determine the function and role that a particular gene plays in the mouse and that gene's suitability as a drug target.

We have DeltaBase agreements with GlaxoSmithKline, Pfizer and Merck (the "DeltaBase Collaborations"). Deltagen has received and may continue to receive revenues associated with annual access extension fees under the DeltaBase Collaborations where such collaborators opt to continue accessing the DeltaBase database and associated intellectual property and/or associated knockout mouse materials. In addition, Deltagen may receive milestone payments under the DeltaBase Collaborations based on issuance of certain patents to Deltagen and the collaborators' drug development and approval activities relating to DeltaBase.

DeltaOne offers access to our portfolio of knockout mice and/or accompanying phenotypic data, as well as any corresponding intellectual property, on a gene-by-gene basis.

The company has a three-year contract, expiring September 2008, with the United States Government through the National Institutes of Health ("NIH"). Under this contract, the NIH is eligible to order any of the approximately 750 knockout mouse lines (and related phenotypic data) that populate DeltaBase. The NIH is permitted to publish the phenotypic data and make the knockout mouse materials available for licensing to academic institutions. In September 2005, the NIH placed an initial delivery order for 129 knockout lines. No other delivery orders have been submitted.

We derive substantially all of our revenues from a narrow and limited range of sources. Substantially all of our revenues are derived from the provision of knockout mouse lines and related phenotypic data to the biopharmaceutical industry and pursuant to government contracts. Because of continuing consolidation in the biopharmaceutical industry and the finite number of knockout lines in the Company's inventory, significant uncertainty exists with respect to the Company's future revenues.

Our operating results have fluctuated in the past and are likely to do so in the future, and we do not believe that period-to-period comparisons of our operating results are a good indication of our future performance.

The consolidated financial statements of Deltagen for the three-month period ended March 31, 2006 have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information. These consolidated financial statements have been prepared so that they present fairly, in the opinion of management, the Company's financial position and its results of operations and its cash flows for the period presented.

Under our revenue recognition policy, revenues are recognized when a definitive agreement with a determinable price exists, product delivery and/or invoicing (in each case where there is reasonable assurance of meeting customer-specified criteria) have occurred, and collectibility is reasonably assured. A change in our revenue recognition policy or changes in the terms of contracts under which we recognize revenues could have an impact on the amount and timing of our recognition of revenues.

The Company's consolidated revenues for the three months ended March 31, 2006 were $1.879 million. The revenues were primarily attributable to license fees associated with the provision of knockout mice and related phenotypic data under its DeltaOne^TM program and access extension fees under its DeltaBase^® collaborations. The access periods under the Company's DeltaBase collaborations expire between June 30, 2006 and March 31, 2007, and there are no assurances that our DeltaBase collaborators will continue to pay access extension fees.

The Company had interest income of $0.100 million for the three months ended March 31, 2006.

Total consolidated expenses for the three months ended March 31, 2006 were $1.548 million. The expenses were primarily attributable to salaries and other general and administrative expenses, third-party royalty and commission obligations, and patent prosecution expenses. Legal and administrative fees associated with prosecution of the Company's patent portfolio were $0.373 million for the three months ended March 31, 2006.

Net income before taxes for the three months ended March 31, 2006 was $0.431 million.

As of March 31, 2006, the Company had $10.392 million in cash and cash equivalents.

No revenues from our NIH contract were recognized and no new delivery orders were placed by the NIH in the first quarter of 2006. We expect that revenues under the NIH contract will be highly variable from quarter to quarter. We currently expect to recognize approximately $3.2 million from the NIH contract in the second quarter of 2006.

The consolidated balance sheet for 2005 is in the process of being audited. The Company currently intends to post the audited 2005 consolidated balance sheet on the Company's website when the audit has been completed, together with the auditors' opinion, explanation of adjustments, and revised notes and revised Management's Discussion and Analysis of Financial Condition and Results of Operations for such period.

The consolidated balance sheet for the first quarter of 2006 reflects certain expected adjustments to the 2005 consolidated balance sheet made in connection with the audit. The accompanying expected adjusted 2005 consolidated balance sheet is subject to further changes or adjustments upon completion of the audit.

On March 30, 2006, the Company issued under its 2000 Stock Incentive Plan options to purchase in the aggregate 5,430,000 shares of common stock to the individuals and in the amounts listed below, each at an option price per share equal to 47 cents, the average of the high and low prices for the Company's common stock on March 30, 2006 (the second full day of trading following release of the Company's 2005 financial results) in the over-the-counter market, as reported by Pink Sheets LLC.

Name	Number of Shares	Vesting
Constantine E. Anagnostopoulos Director	400,000 60,000	25% immediately upon the date hereof. 25% on each of the next three anniversaries of the date hereof. 33% on each of the next three anniversaries of the date hereof.
Thomas A. Penn Director	400,000 60,000	25% immediately upon the date hereof. 25% on each of the next three anniversaries of the date hereof. 33% on each of the next three anniversaries of the date hereof.
William A. Scott Director	400,000 60,000	25% immediately upon the date hereof. 25% on each of the next three anniversaries of the date hereof. 33% on each of the next three anniversaries of the date hereof.
Robert J. Driscoll President & Chief Executive Officer	2,250,000 (5% of fully diluted common stock)*	20% immediately upon the date hereof. 20% on each of the next four anniversaries of the date hereof.
Winston Thomas Chief Operating Officer	900,000 (2% of fully diluted common stock)*	20% immediately upon the date hereof. 20% on each of the next four anniversaries of the date hereof.
Shera Kash VP, Operations	450,000 (1% of fully diluted common stock)*	20% immediately upon the date hereof. 20% on each of the next four anniversaries of the date hereof.
Daniel Ratto Chief Financial Officer	180,000	20% immediately upon the date hereof. 20% on each of the next four anniversaries of the date hereof.
Philippe O. Chambon Director	30,000 initial grant and 60,000 additional grant	33% on each of the next three anniversaries of the date hereof.
Martin J. Hernon Director	30,000 initial grant and 60,000 additional grant	33% on each of the next three anniversaries of the date hereof.
Lawrence Hill Director	30,000 initial grant and 60,000 additional grant	33% on each of the next three anniversaries of the date hereof; provided, however, that if the Board requests Mr. Hill's resignation at the end of his first year of service as a director, his options shall immediately and fully vest.
Total	5,430,000

* Calculated by taking the 39,223,411 outstanding and adding (a) the 1,380,000 issued to continuing directors, (b) the 362,857 of director options outstanding, (c) the 312,828 of employee options outstanding and exercisable, (d) 180,000 issued to D. Ratto, (e) 270,000 issued to new directors and (f) the amounts issued to the employees in this grant.

The Company issued no stock options during the course of its chapter 11 bankruptcy case, and no stock options other than those listed above have been issued since the effective date of the Company's plan of reorganization.

A significant portion (approximately 25%) of the Company's total consolidated expenses for the three-month period ended March 31, 2006 related to the prosecution of the Company's patent portfolio. Legal and administrative fees associated with prosecution of the Company's patent portfolio were $0.373 million for the three months ended March 31, 2006. Of the $7.16 million of total consolidated expenses for the year ended December 31, 2005, patent prosecution expenses were $1.138 million.

The milestone payments under our DeltaBase Collaborations are triggered only when all of the following conditions are satisfied: (i) issuance of patents claiming knockout mice; (ii) such patents having claims with specified language relating to certain recited phenotypes and/or diseases; and (iii) the progression of a drug candidate relating to use of DeltaBase data and/or mouse lines to certain specified drug development and approval milestones.

As of June 1, 2006, the Company had been issued ten patents claiming knockout mice. There is significant uncertainty as to how many additional patents, if any, the Company will be successful in obtaining in the future, and what the total cost associated with such patent prosecution efforts will be. In addition, satisfaction of the drug development and approval milestones under our DeltaBase Collaborations depends solely upon the efforts and success of our pharmaceutical collaborators, which are not controlled by Deltagen. We may never know whether our DeltaBase collaborators have been successful in their drug development efforts relating to DeltaBase. Our collaborators may also dispute whether milestone triggers have been satisfied and may resist or refuse to pay milestone payments. Furthermore, the more significant milestone payment amounts are associated with drug approval, which is a rare event and takes many years to achieve. As a result of these factors, there is significant uncertainty as to whether the Company will receive any milestone payments and, if so, how many milestone payments the Company may ultimately receive from its DeltaBase Collaborations and what the value of any such payments may be.

There are no royalty obligations under the DeltaBase Collaborations. The Company is a party to a few DeltaOne agreements that specify royalty payments based on sales of approved drugs by such customers. However, these agreements generally involve a relatively small fraction of the targets involved in the DeltaBase Collaborations. Therefore, given the relatively few targets involved in these deals and the low probability of approval and significant sales for any given drug compound, we currently do not expect that such royalty payments, if any, would be significant.

Of the $7.16 million of total consolidated expenses for the year ended December 31, 2005, $1.14 million were attributable to expenses related to the legal and administration costs of Deltagen's chapter 11 bankruptcy case.

There are numerous risks and uncertainties related to both our business and our industry that could cause actual results or events to differ materially from those indicated by forward-looking statements.

For a list of risk factors that may affect our future operating results, refer to the "Risk Factors" section of "Management's Discussion and Analysis of Financial Conditions and Results of Operations" for the year ended December 31, 2005, as posted on the Company's website (www.deltagen.com). The risk factors listed there are not the only ones we face and additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair or otherwise affect our business operations.