Special Note Regarding Forward-Looking Statements This discussion and analysis should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2008, and our unaudited condensed consolidated financial statements and related notes thereto appearing in Item 1 of this Quarterly Report on Form 10-Q. In addition to the other information contained or incorporated by reference in this Quarterly Report on Form 10-Q, you should carefully consider the risk factors described in Part II - Item 1A herein when evaluating an investment in our common stock. This Quarterly Report includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, or Securities Act, and Section 21E of the Securities Exchange Act of 1934, or Exchange Act. All statements other than statements of historical fact are "forward-looking statements" for purposes of these provisions, including any statements of the plans and objectives of management for future operations, any statements regarding future operations, any statements concerning proposed new products or services, any statements regarding pending or future mergers or acquisitions, any statements regarding future economic conditions or performance, and any statement of assumptions underlying any of the foregoing. In some cases, forward-looking statements can be identified by the use of terminology such as "may," "will," "expects," "plans," "anticipates," "potential" or "continue" or the negative thereof or other comparable terminology.
There can be no assurance that such expectations or any of the forward-looking statements will prove to be correct, and actual results could differ materially from those projected or assumed in the forward-looking statements. Our forward-looking statements are subject to inherent risks and uncertainties including, but not limited to, the risk factors set forth in this Quarterly Report. Factors that could cause or contribute to such differences include, but are not limited to, our limited cash resources, our significant corporate and Securities and Exchange Commission, or SEC, related expenses and limited revenue to offset these expenses, availability of appropriate prospective acquisitions or investment opportunities, litigation and the risks discussed in our other SEC filings. All forward-looking statements and reasons why results may differ included in this Quarterly Report are made as of the date hereof, and we assume no obligation to update any such forward-looking statement or reason why actual results might differ. When used in the report, unless otherwise indicated, "we," "our" and "us" refers to VaxGen, Inc.
OVERVIEW
We are a biopharmaceutical company based in South San Francisco, California. We own a state-of-the-art biopharmaceutical manufacturing facility with a 1,000-liter bioreactor that can be used to make cell culture or microbial biologic products. This facility is located within leased premises. We have ended all product development activities and sold or otherwise terminated our drug development programs. We are seeking to maximize the value of our remaining assets through a strategic transaction or series of strategic transactions. We are considering various strategic transactions to return value to our stockholders. If we are unable to identify and complete a strategic transaction, we will liquidate. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. Recent Developments
In July 2009, our board of directors disbanded its Strategic Transactions Committee, effective September 1, 2009. The board of directors as a whole will assume the remaining responsibilities formerly delegated to the Strategic Transactions Committee, and, following its disbandment, the members of that committee will cease to receive additional compensation for service on it.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Reference should be made to Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008, filed with the SEC on March 18, 2009, for a description of our critical accounting policies. There have been no significant changes to our policies since we filed that report.

RESULTS OF OPERATIONS
Comparison of Fiscal Quarters and Six Months Ended June 30, 2009 and 2008
Revenues

                   Three Months Ended          Percent         Six Months Ended         Percent
                        June 30,                Change             June 30,              Change
                2009              2008        2009/2008      2009          2008        2009/2008
                     (in thousands)

Revenues for the six months ended June 30, 2008 were primarily from service revenues earned as part of a consulting services agreement with Celltrion to provide technical assistance related to the design, engineering and start-up of Celltrion's manufacturing facility. No services were provided to Celltrion for the six months ended June 30, 2009.
Revenues earned in one period are not indicative of revenues to be earned in future periods. We do not expect any revenues for the remainder of 2009. Research and development expenses

                              Three Months Ended             Percent             Six Months Ended            Percent
                                   June 30,                  Change                  June 30,                 Change
                            2009              2008          2009/2008         2009            2008          2009/2008
                                (in thousands)                                    (in thousands)
Research and

Research and development expenses include the costs of internal personnel, outside contractors, allocated overhead and laboratory supplies. We ceased research and development activities during the first quarter of 2008 and therefore no research and development expenses were incurred during the second quarter of 2008 and the first six months of 2009. We expect no research and development expenses to be incurred during the remainder of 2009. General and administrative expenses

                             Three Months Ended          Percent           Six Months Ended          Percent
                                  June 30,                Change               June 30,               Change
                             2009           2008        2009/2008         2009          2008        2009/2008
                               (in thousands)                               (in thousands)
General and
administrative

General and administrative expenses consist primarily of compensation costs, occupancy costs including depreciation expense, fees for accounting, legal and other professional services and other general corporate expenses.
The decrease in general and administrative expenses of $2.2 million in the three months ended June 30, 2009 over the comparable period of 2008 was primarily due to lower labor and benefit costs of $1 million resulting from reductions in force.
The decrease in general and administrative expenses in the six months ended June 30, 2009 over the comparable period of 2008 was primarily due to:
• Labor and benefits, which decreased by $1.8 million primarily associated with the 2008 reductions in force;

• Consultant and outside labor costs, which decreased by $3.0 million in 2009, following the termination of the proposed merger, or the Merger, with Raven biotechnologies, inc., or Raven, pursuant to which we incurred $2.3 million in consultant and outside labor costs during the first six months of 2008; and

• Facilities costs, which decreased by $1.0 million due to the cessation of operations during the first six months of 2008.

Restructuring expenses

                              Three Months Ended            Percent            Six Months Ended           Percent
                                   June 30,                  Change                June 30,                Change
                            2009              2008         2009/2008         2009           2008         2009/2008
                                (in thousands)                                  (in thousands)

During the three months ended June 30, 2008 we reduced our workforce to reduce operating costs. Restructuring costs included employee termination and benefit costs.
Impairment of assets held for sale

                            Three Months Ended          Percent           Six Months Ended          Percent
                                 June 30,                Change               June 30,               Change
                            2009           2008        2009/2008         2009          2008        2009/2008
                              (in thousands)                               (in thousands)
Impairment of assets

We performed an impairment assessment of the facility as of June 30, 2009. At June 30, 2009, we estimated that the fair market values of these assets were less than the carrying values of these assets by $0.2 million, which was recorded as an impairment of assets held for sale in the statement of operations for the three and six months ended June 30, 2009.
Based on the lack of success in finding a buyer for our facility and expectation of need to dismantle to sell, we performed an impairment assessment of the facility as of June 30, 2008. At June 30, 2008, we estimated that the fair market values of these assets were less than the carrying values of these assets by $8.5 million, which was recorded as an impairment of assets held for sale in the statement of operations for the three and six months ended June 30, 2008. The impairment includes all leasehold improvements relating to the facility of approximately $6.5 million, as these items will have no future economic benefit. Other income (expense)

                                           Three Months Ended                Six Months Ended
                                                June 30,                         June 30,
                                          2009             2008            2009            2008
                                             (in thousands)                   (in thousands)
Interest expense                       $      (10 )     $     (601 )    $      (21 )     $  (1,369 )
Interest income                                59              534             163           1,249
Realized gain on sale of available
for sale investments                            -                -             357               -
Valuation adjustments                           -              656               -            (955 )
Gain on convertible debt repurchase             -                -               -             713
Gain on sale of Anthrax Program                 -            2,000               -           2,000
Other                                          (6 )              -              25             (11 )

Total other income (expense), net      $       43       $    2,589      $      524       $   1,627

The decrease in other income, net, for the three months ended June 30, 2009 from the comparable period in 2008 was primarily due to:
• Gain on the sale of our Anthrax Program of $2.0 million in the second quarter of 2008;

• A valuation gain of $0.7 million for mark-to-market adjustments following the valuation of the derivatives on our Convertible Notes during the second quarter of 2008;

• Decreased interest income due to lower interest rates and lower overall cash, cash equivalents and investment balances primarily due to our repurchase of Convertible Notes during 2008; and

• A partial offset of decrease in interest expense in 2009, following the repurchase of our 5 1/2% Convertible Senior Subordinated Notes due April 2010, or Convertible Notes, during 2008.

The decrease in other income, net, for the six months ended June 30, 2009 from the comparable period in 2008 was primarily due to:
• Gain on the sale of our Anthrax Program of $2.0 million in the first six months of 2008;

• A gain of $0.7 million on the repurchase of $1.5 million principal amount of our Notes at a purchase price of $0.8 million plus accrued interest;

• Decreased interest income due to lower overall cash, cash equivalents and investment balances primarily due to our repurchase of Convertible Notes during 2008; and

• A partial offset of decrease in interest expense in 2009, following the repurchase of our 5 1/2% Convertible Senior Subordinated Notes due April 2010, or Convertible Notes, during 2008 and a valuation expense of $1.0 million for mark-to-market adjustments following the valuation of the derivatives on our Convertible Notes during the first six months of 2008.

We anticipate future investment income will fluctuate and will be primarily driven by our future cash, cash equivalent and investment balances.

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

                                                            2009         2008
                                                             (in thousands)
       As of June 30:
       Cash, cash equivalents and investment securities   $ 35,563     $ 59,033
       Working capital                                      35,934       61,786

       Six Months ended June 30:
       Cash provided by (used in)
       Operating activities                               $ (3,234 )   $ (7,668 )
       Investing activities                                      3       (2,017 )
       Financing activities                                      -         (750 )

Our primary capital requirements for the six months ended June 30, 2009 were operating costs. Through June 30, 2009, we financed our operations primarily through sales of our common stock, the issuance of Series A Preferred Stock, the issuance of convertible debt, sales of our Celltrion common stock as well as through revenues from research contracts and grants. Our future capital requirements will depend upon our ability to identify and exploit business development opportunities including actively pursuing avenues to enhance stockholder value through a strategic transaction.
Net cash used in operating activities decreased to $3.2 million for the six months ended June 30, 2009 from $7.7 million for the six months ended June 30, 2008 and was primarily attributable to our reduced operating losses. The effect of non-cash items upon operating activities was significant in both the six months ended June 30, 2009 and 2008 and included:
• Depreciation expense of zero in 2009 and $0.6 million in 2008, reflecting the reclassification of equipment, furniture and fixtures to assets held for sale during the first six months of 2008;

• Impairment of assets held for sale of $0.2 million in 2009 and $8.5 million in 2008;

• Valuation loss of $1.0 million in 2008 reflecting changes in the fair value of outstanding derivatives from the Convertible Notes;

• Stock based compensation expense of $0.1 million in 2009 and $1.1 million in 2008.

• Gain on redemption of the Convertible Notes of $0.7 million in 2008;

• Gain on sale of Celltrion common stock of $0.4 million in 2009; and

• $1.9 million of Raven merger costs capitalized at December 31, 2007 that were expensed as general and administrative expense during the six months ended June 30, 2008.

The decrease in cash used in operating activities was also affected by the following:
• Accounts payable, which increased by $0.2 million in 2009 and decreased by $2.0 million in 2008 primarily due to the timing of payments and the reduced level of operating activities; and

• Accrued and other liabilities, which decreased by $0.1 million in 2009 and increased by $1.1 million in 2008 primarily due to $1.9 million of the Merger costs capitalized at December 31, 2007 that were expensed as general and administrative expense during the six months ended June 30, 2008.

Net cash provided by investing activities of $3,000 in six months ended June 30, 2009 was primarily attributable to activities relating to the purchase and sale of investment securities of $0.5 million, partially offset by proceeds from the sale of our Celltrion common stock of $0.4 million. Net cash used in investing activities of $2.0 million in the six months ended June 30, 2008 was primarily attributable to the $4.7 million bridge loan to Raven in connection with the proposed merger partially offset by net proceeds of $2.3 million from investment activity.
Net cash used in financing activities in the six months ended June 30, 2008 was attributable to the repurchase of $1.5 million principal amount of Convertible Notes at a purchase price of $0.8 million.
At June 30, 2009, $35.6 million, or 92%, of our total assets consisted of cash, cash equivalents and investment securities. We had working capital of $35.9 million at June 30, 2009, compared to $61.8 million at June 30, 2008. This decrease in working capital is primarily due to the following:
• Cash, cash equivalents and investments decreased by $23.5 million primarily due to our repurchase of Convertible Notes in 2008 and operating losses;

• Loan to Raven decreased by $6.0 million due to repayment;

• Assets held for sale decreased by $0.8 million primarily due to impairment charges; and

• A partial offset by the elimination of the derivative liability of $4.5 million resulting from the repurchase of our Convertible Notes in 2008.

We believe that our existing cash, cash equivalents and investment securities will be sufficient to cover our working capital needs and commitments through at least June 30, 2010. Our future capital requirements will depend on our ability to identify and complete additional business opportunities. We are considering various strategic transactions to return value to our stockholders. If we are unable to identify and complete an alternate strategic transaction, we will liquidate.
Off-Balance Sheet Arrangements
As of June 30, 2009, we did not have any off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.
Recent Accounting Pronouncements
On June 30, 2009, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 165, "Subsequent Events," (SFAS 165). SFAS 165 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. Specifically, SFAS 165 sets forth the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements, and the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. The adoption of SFAS 165 had no impact on the Company's Consolidated Financial Statements as the Company already followed a similar approach prior to the adoption of this standard.

In April 2009, the FASB issued three Staff Positions ("FSPs") that are intended to provide additional application guidance and enhance disclosures about fair value measurements and impairments of securities. FSP FAS 157-4, "Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly", clarifies the objective and method of fair value measurement even when there has been a significant decrease in market activity for the asset being measured. FSP FAS 115-2 and FAS 124-2, "Recognition and Presentation of Other-Than-Temporary Impairments", establishes a new model for measuring other-than-temporary impairments for debt securities, including establishing criteria for when to recognize a write-down through earnings versus other comprehensive income. FSP FAS 107-1 and APB 28-1, "Interim Disclosures about Fair Value of Financial Instruments", expands the fair value disclosures required for all financial instruments within the scope of SFAS No. 107, "Disclosures about Fair Value of Financial Instruments", to interim periods. All of these FSPs are effective for interim and annual reporting periods ending after June 15, 2009. The implementation of these FSPs did not have a material impact on the Company's financial statements.
In June 2009, the FASB issued SFAS No. 168, "The FASB Accounting Standards CodificationTM and the Hierarchy of Generally Accepted Accounting Principles-a replacement of FASB Statement No. 162," (SFAS 168). SFAS 168 replaces SFAS No. 162, "The Hierarchy of Generally Accepted Accounting Principles," and establishes the FASB Accounting Standards Codification TM (Codification) as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with GAAP. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. The FASB will no longer issue new standards in the form of Statements, FASB Staff Positions, or Emerging Issues Task Force Abstracts; instead the FASB will issue Accounting Standards Updates. Accounting Standards Updates will not be authoritative in their own right as they will only serve to update the Codification. The issuance of SFAS 168 and the Codification does not change GAAP. SFAS 168 becomes effective for us for the quarter ending September 30, 2009. We are presently evaluating the impact that the adoption of SFAS 168 will have on the Company's Consolidated Financial Statements.