<PAGE>

                          SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
-------------------------------------------------------------------------------

                                    FORM 10-K

(Mark one)
   /X/   Annual Report Pursuant to Section 13 or 15(D) of the
         Securities Exchange Act of 1934 for the Fiscal Year Ended December
         31, 2001 or

  / /    Transition Report Pursuant to Section 13 or 15(D) of the
         Securities Exchange Act of 1934 for the Transition Period from
         ______________ to ______________

                        Commission File Number 000-30231

                                  TANOX, INC.
             (Exact name of registrant as specified in its charter)

                   Delaware                        76-0196733
  (State or other jurisdiction of         (I.R.S. Employer Identification No.)
   incorporation or organization)

              10301 Stella Link
               Houston, Texas                        77025
  (Address of principal executive offices)         (Zip code)

   (Registrant's telephone number, including area code) 713-578-4000

   Securities Registered Pursuant to Section 12(b) of the Act:  None

   Securities Registered Pursuant to Section 12(g) of the Act:  Common Stock,
                                                                $.01 par value
                                                                Preferred Share
                                                                Purchase Rights

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

         Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. Yes /X/

         The aggregate market value of the registrant's common stock held by
nonaffiliates as of February 28, 2002 was $325,022,645.

         Indicate the number of shares outstanding of the issuer's common stock
as of February 28, 2002: 44,077,401 shares.

                       DOCUMENTS INCORPORATED BY REFERENCE

         The information called for by Items 10, 11, 12 and 13 of Part III will
be included in the registrant's definitive proxy statement to be filed pursuant
to Regulation 14A and is incorporated herein by reference.
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                               TABLE OF CONTENTS

<TABLE>
<CAPTION>
PART I                                                                                         Page
                                                                                               ----
<S>                                                                                            <C>
ITEM 1.  Business............................................................................   1
           Overview..........................................................................   1
           Background........................................................................   1
           Our Strategy......................................................................   2
           Our Product Development Programs..................................................   4
           Collaboration and Licensing Agreements............................................  10
           Patents and Proprietary Rights....................................................  12
           Government Regulation.............................................................  14
           Competition.......................................................................  16
           Manufacturing.....................................................................  17
           Research and Development..........................................................  18
           Marketing and Sales...............................................................  18
           Employees.........................................................................  18
           Corporate History.................................................................  19
           Forward-Looking Statements........................................................  19
           Factors That May Affect our Future Results........................................  20
           Executive Officers of Tanox.......................................................  30
           Scientific Advisors...............................................................  32
ITEM 2.  Properties..........................................................................  32
ITEM 3.  Legal Proceedings...................................................................  33
ITEM 4.  Submission Of Matters To A Vote Of Security Holders.................................  34

PART II
ITEM 5.  Market Price of the Registrant's Common Stock and Related Stockholder Matters.......  35
ITEM 6.  Selected Financial Data.............................................................  36
ITEM 7.  Management's Discussion and Analysis of Financial Condition and Results of
          Operations.........................................................................  36
           Overview..........................................................................  36
           Critical Accounting Policies......................................................  37
           Results of Operations.............................................................  38
           Liquidity and Capital Resources...................................................  40
           Recent Accounting Developments....................................................  41
ITEM 7A. Qualitative and Quantitative Disclosures About Market Risk..........................  42
ITEM 8.  Financial Statements And Supplementary Data.........................................  43
ITEM 9.  Changes in and Disagreements with Accountants on Accounting and Financial
           Disclosure........................................................................  66

PART III
ITEM 10. Directors and Executive Officers of the Registrant..................................  66
ITEM 11. Executive Compensation..............................................................  66
ITEM 12. Security Ownership of Certain Beneficial Owners and Management......................  66
ITEM 13. Relationships and Related Transactions..............................................  66

PART IV
ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.....................  66
</TABLE>

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ITEM 1.  BUSINESS

OVERVIEW

Tanox identifies and develops therapeutic monoclonal antibodies to address
significant unmet medical needs in the areas of asthma, allergy, autoimmune,
inflammation and other related diseases. Tanox's products are genetically
engineered antibodies that target a specific substance, or antigen. In 1987, we
discovered a novel approach for treating allergies and asthma by using
anti-immunoglobulin E, or anti-IgE, antibodies capable of blocking IgE, a
causative agent of the allergy pathway, thus preventing the onset of disease
symptoms. XolairTM (tradename for Omalizumab), our most advanced product in
development, is a humanized monoclonal antibody that blocks IgE. Its therapeutic
effect has been validated through clinical trials in patients suffering from
allergic asthma, seasonal allergic rhinitis (hay fever) and perennial allergic
rhinitis. We are developing Xolair in collaboration with Novartis Pharma AG and
Genentech, Inc. In June 2000, our collaboration partners filed a Biologics
License Application (BLA) with the U. S. Food and Drug Administration (FDA) and
a submission for marketing approval with health authorities in the EU,
Switzerland, Australia, and New Zealand for allergic asthma and hay fever in
adults, adolescents and children. Following receipt of a Complete Response
Letter in July 2001, our collaboration partners are expected to submit an
amendment to the BLA in 2002 or early 2003, which will narrow the proposed
initial claim to allergic asthma in adults and adolescents.

Using our knowledge of the human immune system, we are building a diverse
pipeline of monoclonal antibody product candidates. We are conducting clinical
trials with three additional monoclonal antibodies. TNX-901, a humanized
anti-IgE monoclonal antibody distinct from Xolair, is currently in a Phase 2
trial to evaluate the potential of TNX-901 to reduce the sensitivity to peanut
allergen in patients suffering from severe peanut allergy. TNX-100 is an
anti-CD40 monoclonal antibody currently in a Phase 1 trial for treating Crohn's
disease. TNX-355, an anti-CD4 antibody, is in a Phase 1 trial for treating HIV.
We are also conducting preclinical and research studies with TNX-224, a
complement factor D inhibiting antibody for treating acute inflammatory
indications.

BACKGROUND

HUMAN IMMUNE SYSTEM

The human immune system has three general mechanisms that protect the body
against infections, toxins and cancer by responding to and clearing these agents
that have penetrated the body's protective barriers. These harmful agents
express molecules (antigens) that can be recognized as foreign by the host
immune system. These protective immune mechanisms are:

  .    Antibodies. The body produces proteins called antibodies that deactivate
       and help remove foreign antigens from the body. Each antibody matches an
       antigen much as a key matches a lock. Antibodies are made by specialized
       white blood cells called B cells. With the help of other white blood
       cells, such as antigen presenting cells and helper T cells, a B cell can
       manufacture millions of identical antibody molecules and releases them
       into the bloodstream.

  .    Cell-Mediated Immune Response. The second protective immune mechanism
       relies on cells to recognize and destroy pathogen-infected cells or
       cancer. This mechanism is known as cell-mediated immunity. T cells are
       important in cell-mediated immune responses. Some T cells, called killer
       T cells, seek out and kill cancer cells or virus-infected cells. Helper T
       cells also play a role in cell-mediated immune response by stimulating
       inflammatory cells called macrophages to actively destroy foreign
       antigens, microorganisms and cancer cells.

  .    Innate Immune Response. Innate immunity is the body's first line of
       defense against injury and infection and serves a surveillance and
       maintenance role. One part of the innate immune system involves white
       blood cells called phagocytes (literally, "cell-eaters") that can
       engulf and digest

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       foreign microorganisms and other antigens. Important phagocytes,
       including macrophages, rid the body of dead cells and other debris,
       and granulocytes, including neutrophils, which contain granules
       filled with potent chemicals, function to kill invading
       microorganisms. Natural killer cells, another component of this
       system, have the ability to recognize and kill foreign cells. Another
       part of the innate immune response is known as the complement system.
       The complement system includes a series of proteins that work to
       "complement" the activity of antibodies in destroying bacteria,
       either by stimulating the macrophages and neutrophils, or by
       puncturing the bacterial cell membrane to kill the cells. These
       proteins also cause the neutrophils to accumulate at the site of
       infection or tissue damage.

Most of the time, the immune system protects us from infections, cancer and some
toxic agents. However, the immune system may, under certain circumstances, cause
the disease or symptoms of disease. For example, in the case of allergic
diseases, such as asthma and hay fever, the immune system responds to the
antigen, or allergen in this case, by producing an IgE form of antibody. IgE is
instrumental in triggering the symptoms of the disease. In other cases, T and B
cells may recognize a part of the body as foreign, triggering an immune response
against the body resulting in an autoimmune disease with associated destruction
of healthy tissue or biochemical dysfunction.

MONOCLONAL ANTIBODIES AS THERAPEUTICS

Monoclonal antibodies represent an exciting new area of therapeutic product
development. Genetically engineered monoclonal antibodies are man-made
antibodies that target a specific antigen. Most monoclonal antibodies are
derived from animals such as mice. Advances in antibody design technologies have
enabled scientists to develop humanized (human-like) and fully human antibody
products that can be administered to patients on a chronic basis with reduced
concern for adverse responses by the human immune system. Advances in antibody
production technologies, such as high productivity fermentation and experimental
technologies such as transgenic plants and animals, have enabled manufacturers
to produce antibody products more cost-effectively. Because of these advances,
11 monoclonal antibodies have already been approved for marketing as
therapeutics by the FDA, and a large number of monoclonal antibodies are
currently undergoing clinical and preclinical investigation.

OUR STRATEGY

Our objective is to leverage our expertise in monoclonal antibodies and
understanding of the human immune system to advance our product pipeline and
become a profitable biopharmaceutical company. We intend to accomplish this
through the following strategic goals and initiatives:

..    Achieve a leadership position in developing innovative and effective
     therapies for treating asthma, allergies, inflammatory and immune system
     diseases, and advance those therapies into profitable products.

     1.  Advance our pipeline products as efficiently as possible. We hope to
         translate our expertise in developing innovative therapies into
         successfully marketed products. To this end we have significantly
         enhanced our in-house capability to shepherd products through clinical
         development and the FDA review process, and to manufacture clinical
         supplies. Also, for our second product in the development pipeline,
         TNX-901, we have completed enrollment for the Phase 2 trial in patients
         with severe peanut allergy. In addition, we are completing the Phase I
         clinical study of TNX-100 in patients with Crohn's disease.

     2.  Maximize the market opportunity for anti-IgE antibodies. Based on the
         favorable results of Phase 3 clinical trials of Xolair, we are
         interested in identifying diseases and conditions for which anti-IgE
         antibodies are likely to provide a safe and effective therapy. For
         Xolair, we intend to work with our partners, Novartis and Genentech, to
         pursue commercial opportunities in asthma and potential future
         indications, including allergic rhinitis. Concurrently, we are pursuing
         the

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         independent development of TNX-901, another anti-IgE, to treat
         patients suffering from food allergy.

     3.  Retain new SAB members who are leaders in immune system function.
         This year Drs.  John P.  Atkinson and Donald MacGlashen joined our
         Scientific Advisory Board (SAB).  Dr.  Atkinson is the Samuel Grant
         Professor of Medicine at the Washington University School of Medicine
         and is a leading authority on the complement system.  Dr. MacGlashen
         is an associate professor of Medicine at the Johns Hopkins Asthma and
         Allergy Center, where his laboratory is focused on understanding
         IgE-mediated signal transduction in human basophils and mast cells.
         We anticipate that these individuals will help guide our research
         efforts to develop possible treatment targets.

..    Become a profitable, fully integrated biopharmaceutical company with
     in-house capabilities from drug discovery and licensing through
     commercialization.

     1.  Expand our biologics manufacturing capability. Having enhanced our
         research and clinical development groups, we are evaluating
         alternatives for biologics manufacturing. In 2002, we expect to begin
         operation of our pilot plant for the production of Phase 3 clinical
         supplies of TNX-901. We are also investigating construction of a
         large-scale facility for commercial production of biological products.

     2.  Carefully control our costs, particularly pending regulatory review of
         Xolair. With the regulatory delays and developments we encountered in
         2001, one of our priorities in 2002 remains prudent budgeting and cost
         planning. While we are committed to moving our product pipeline
         forward, we are conscious of the need to preserve cash and control
         costs so that we can reach our goal of becoming profitable. As part of
         this effort, we are actively pursuing out-license opportunities, both
         exclusive and non-exclusive, for intellectual property that does not
         fit within our research and development plans for the foreseeable
         future.

     3.  Form strategic collaborations to support development and
         commercialization of our products. To enable us to develop a greater
         number of products, we may deem it advantageous to partner with large
         pharmaceutical and biotechnology companies. These partnerships allow us
         to obtain funding and marketing support for our development activities,
         reducing the substantial financial investment that is required of us to
         develop our products, and providing us with domestic and international
         marketing and sales expertise for our partnered products once approved.
         To the extent economically feasible, we expect to retain strategically
         important development, manufacturing or marketing rights in order to
         maximize the value of our drug development opportunities.

..    Build a technology platform for effective development of antibody-based
     products.

     1.  Continue to Identify and Develop Novel Monoclonal Antibodies. We have
         focused on the research and development of monoclonal antibodies since
         our inception and have successfully identified and obtained patents for
         novel monoclonal antibodies with potential therapeutic applications. We
         believe that monoclonal antibodies will be one of the primary areas of
         pharmaceutical development for the foreseeable future, particularly as
         genomic and proteomic research identifies novel disease targets. We
         will continue to apply our expertise in immunology and antibody
         development to generate new antibodies that bind to these novel targets
         and block the disease pathways. We will focus on diseases for which
         current therapies are substandard or unavailable and the market
         opportunities are large.

     2.  Identify Attractive Acquisition and In-licensing Candidates. In
         addition to our in-house research program, we identify and evaluate
         opportunities to acquire or in-license products and technologies that
         will supplement our product pipeline. We believe that we are well
         positioned to

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         continue to attract in-licensing and acquisition candidates as a result
         of our demonstrated expertise in immunology and monoclonal antibodies,
         and our manufacturing capabilities.

OUR PRODUCT DEVELOPMENT PROGRAMS

Our lead product, Xolair, has completed clinical development in several
indications and has been submitted for registration. We have three additional
products in clinical development and are evaluating several potential product
candidates in research and preclinical studies. Our drugs target various
elements or malfunctions of the immune system underlying the cause of disease.
We have designed drugs to deactivate or reduce the activity of the immune system
for diseases caused by over-activation or inappropriate activation of immune
responses, such as autoimmune and allergic diseases and acute inflammation. We
also have designed drugs to activate the immune system for treatment of diseases
where boosting immune protection is desirable, such as AIDS, infectious diseases
and cancer. Our products have either resulted from our internal research and
development activities or were in-licensed or acquired.

The table below summarizes the development status for our principal product
candidates.

<TABLE>
<CAPTION>
               Antibody
Product       Description               Indication                  Status             Partners
--------      -----------               -----------                 ------             ---------
<S>           <C>                <C>                           <C>                 <C>
Xolair        Anti-IgE              Allergic Asthma              Registration      Novartis/Genentech
                                 Seasonal Allergic Rhinitis    Phase 3 Completed   Novartis/Genentech
                                 Perennial Allergic Rhinitis   Phase 3 Completed   Novartis/Genentech

TNX-901/1/   Anti-IgE            Severe Peanut Allergy              Phase 2                --

TNX-100/2/   Anti-CD40             Crohn's Disease             Phase I Completed           --
TNX-335      Anti-CD4                HIV/AIDS                       Phase 1                --

TNX-224      Anti-complement       Acute Inflammation             Preclinical              --
             Factor D
</TABLE>

------------------------------
/1/      Novartis and Genentech are disputing our rights to independently
         develop TNX-901, as discussed under "Item 3. Legal Proceedings."
/2/      We have the right to develop and commercialize TNX-100 in Europe and
         Japan only.

ANTI-IGE DEVELOPMENT--XOLAIR

Xolair is a humanized anti-IgE monoclonal antibody designed to prevent symptoms
of allergic asthma and allergic rhinitis. In allergic diseases, the immune
system responds to the antigen, or allergen in this case, by producing IgE. IgE
binds to the surface of mast cells and basophils through high affinity IgE
receptors on the cell surface. These cells, which are found in tissue and also
circulate in the blood, contain chemicals such as histamine and leukotrienes,
which induce inflammation. The first time an allergy-prone person is exposed to
an allergen, he or she makes IgE antibodies specific to that allergen. These IgE
molecules circulate in the blood stream and find their way to attach to the mast
cells or basophils, thereby arming these cells. When a mast cell or basophil
armed with allergen specific IgE on its surface again comes in contact with its
specific allergen, the allergen will bind to the specific IgE molecules, with
resultant cross-linking of the underlying receptors on the cell surface. This
event signals the mast cell or basophil to release its powerful chemicals,
causing tissue inflammation and asthma and allergy symptoms, including wheezing,
coughing, sneezing, runny nose, watery eyes and itching. Xolair binds to
circulating IgE, preventing IgE from binding to and arming mast cells and
basophils, and thereby blocks or inhibits the allergic response.

We are developing Xolair in collaboration with Novartis and Genentech. Phase 3
clinical trials have been

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successfully completed in allergic asthma, seasonal allergic rhinitis and
perennial allergic rhinitis. We expect Xolair to be administered by
subcutaneous injections once or twice per month.

Market Opportunity

Allergic reactions triggered by IgE include allergic asthma and allergic
rhinitis.

Asthma. Asthma makes breathing difficult and is potentially life threatening.
According to a report by Decision Resources: Immune Disease, Asthma 1998,
approximately 35.6 million people in the top seven global markets (France,
Germany, Italy, Spain, the United Kingdom, Japan and the United States) suffer
from asthma. Approximately two-thirds of these patients have allergic asthma. In
the United States, there are 17 million asthmatics. Approximately 8.5 million of
these patients have moderate to severe asthma and depend on the use of
corticosteroids to control asthma symptoms. 5% of asthmatic patients with
disease symptoms are not adequately controlled by current medication.
Corticosteroids (primarily inhaled but also systemic) and beta-agonists, the
mainstay of asthma therapy, are usually effective, yet each is associated with
specific safety drawbacks. Particular side effects of even inhaled
corticosteroid treatment include osteoporosis, cataracts and growth retardation
in children. Beta-agonists offer only symptom relief and do not control the
underlying inflammation. Leukotriene modifiers, a new class of controller
medications with the potential to reduce steroid requirements, are modestly
effective for many patients. However, these modifiers have been associated with
drug interactions and adverse events including liver injury. Increasing use of
beta-agonists indicates inadequate control of the underlying inflammation that
causes asthma.

Allergic Rhinitis. Allergic rhinitis is a disease characterized by runny nose,
sneezing, congestion, itchy eyes and similar symptoms, and includes hay fever.
Allergic rhinitis afflicts approximately 39.5 million people in the United
States, most of whom have seasonal allergies and many of whom also suffer from
allergic asthma. Doctors commonly treat the symptoms of allergic rhinitis with
antihistamines, decongestants, nasal steroids and other drugs. They sometimes
prescribe allergy shots, called hyposensitization therapy, for severely allergic
persons, which can be effective if the treating health care professional knows
the allergen to which the patient is reacting. However, it is often difficult to
identify which allergen(s) causes the patient's allergy, and the frequent and
lengthy treatment protocols, coupled with limited effectiveness in many
patients, and the potential for serious adverse side effects, generally lessen
the desirability of hyposensitization.

Development Status and Clinical Data

Moderate to Severe Allergic Asthma.  Three Phase 3 clinical trials in patients
with moderate to severe allergic asthma have been completed in adults
(including adolescents) (12-75 years) or children (6-12 years).  The three
randomized, placebo-controlled, multicenter clinical trials included: 525
patients in the U.S. adult study; 546 patients in the European adult study; and
334 patients in the U.S. pediatric study.

In both adult trials, patients who were experiencing asthma symptoms, despite
taking inhaled corticosteroid therapy, were given either Xolair or placebo via
subcutaneous injection every two or four weeks. The pediatric study was designed
more as a steroid reduction and safety study, as only patients who were well
controlled but required inhaled corticosteroids for control were enrolled. The
pediatric study was otherwise similar to the adult studies.

Patients were monitored for asthma exacerbations, which were defined as symptoms
requiring a doubling of inhaled corticosteroids or initiation of oral or
parenteral corticosteroids to obtain adequate asthma control. These trials
included a 28-week core treatment period divided into two phases, which were
followed by a five-month treatment extension period, as follows:

   .     a 16-week stable treatment period that monitored patients taking either
         Xolair or placebo in addition to ongoing treatment with inhaled
         corticosteroids and rescue beta-agonists;

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   .     a 12-week steroid reduction period (immediately following the stable
         treatment period), where the dosage of inhaled corticosteroids was
         gradually reduced, if tolerated, in both the Xolair and placebo groups;
         and

   .     a treatment extension so that long term safety could be evaluated for a
         one-year period, blinded in the adult trials and open-label in the
         pediatric study .

In patients receiving Xolair as compared to placebo, the reduction in steroid
dosage, as assessed by both the median reduction and the percentage of patients
able to completely withdraw from inhaled steroids by the end of the steroid
reduction period, was greater in all three studies (p <= 0.001 for all
comparisons). In the adult studies, more than twice as many Xolair-treated
(approximately 40%) as placebo-treated patients (approximately 20%) were able to
completely withdraw from corticosteroids, and in the pediatric studies the
proportions were 69% vs. 39%, respectively.

The mean number of exacerbations per patient was significantly less in Xolair-
than in placebo-treated patients during both the stabilization and steroid
reduction phases in the adult trials (p <= 0.006 for all comparisons), and there
was a strong trend in this direction in the pediatric trial (p = 0.09 for both
phases). In the adult studies, Xolair-treated patients experienced approximately
half the number of exacerbations as did the placebo-treated patients, and in the
pediatric study, approximately 25% fewer exacerbations.

Results of the two adult trials for patients with moderate-to-severe allergic
asthma were pooled to measure the number of hospitalizations due to serious
asthma exacerbations. Over the full year of treatment, two Xolair-treated
patients (0.4%) were hospitalized as compared to 13 placebo patients (2.5%). The
children with moderate-to-severe allergic asthma participating in the pediatric
trial were monitored for hospitalizations during the 28-week core trial period.
None of the Xolair-treated patients were hospitalized due to serious asthma
exacerbations while five of the placebo-treated patients (4.6%) were
hospitalized.

Significant differences in favor of Xolair were also found in all three studies
in other secondary efficacy measures such as quality of life and use of rescue
medications.

Control of symptoms and steroid reduction was also maintained during the
five-month extension phase. In the adult U.S. study, at the end of one year of
treatment, 31% of Xolair-treated patients vs. 11% of placebo patients were
completely withdrawn from corticosteroids (p < 0.001), and the proportions of
patients experiencing no exacerbations were 67% and 36%, respectively (p <
0.001).

Data from the two adult trials were pooled, and the patients were grouped into
mild, moderate and severe according to asthma severity at baseline based upon
airway flow rates (FEV1). Significantly greater reductions in inhaled
corticosteroids in Xolair than placebo-treated patients were observed in all
three severity categories.

Xolair was well tolerated. The incidence of adverse events during the Phase 3
trials was similar in both the Xolair and placebo groups. Adverse events
suspected as being drug related that occurred more frequently in Xolair patients
than in placebo patients were fatigue (0.5% vs. 0.1%), rash (0.4% vs. 0%), and
urticaria (skin itching and hives) (0.4% vs. 0.1%). No anti-drug antibodies were
detected, and there was no evidence of immune complex disease. Furthermore,
there was no increase in the incidence of parasitic infections.

Severe Allergic Asthma. To confirm efficacy in the severe allergic asthma
patient, a separate Phase 3b study was conducted in 246 adolescents and adults.
The design and treatment regimens were similar to the previous studies in
moderate to severe patients, except patients required much higher doses of
inhaled steroids and had lower airway flow rates (FEV1) at baseline. As compared
to placebo-treated patients,

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Xolair-treated patients were able to achieve significantly better Asthma
Symptom and Quality of Life scores, and were able to more significantly reduce
their dosages of inhaled corticosteroids.

Seasonal Allergic Rhinitis. A Phase 3 clinical trial of Xolair for seasonal
allergic rhinitis was conducted in Scandinavia during the spring 1998 birch
season. The randomized, placebo-controlled, multicenter clinical trial examined
symptoms of rhinoconjunctivitis and rescue medication usage in 251 adult and
adolescent patients with a history of birch pollen allergy. Patients were
treated with 300 mg of Xolair or placebo via subcutaneous injection every three
or four weeks and treatment lasted eight or nine weeks. Patients received rescue
medications, such as antihistamines, when their symptoms were severe enough to
require additional medication. This Phase 3 clinical trial confirmed the
statistically significant results of an earlier pivotal Phase 2 trial in 536
patients conducted during the 1997 ragweed season in the United States.

Results from the Phase 3 seasonal allergic rhinitis trial showed that:

   .     Xolair decreased the severity of nasal and ocular allergy symptoms.
         Compared to placebo, Xolair treatment improved average daily nasal (p <
         0.001) and ocular (p = 0.031) symptom severity scores. Patients treated
         with placebo experienced recurring sneezing, itchy nose and similar
         symptoms that increased over the pollen season and were greatest during
         highest pollen exposure. In contrast, the average patient treated with
         Xolair experienced only a very modest increase in nasal symptoms over
         the whole Xolair treatment period compared to symptoms reported before
         the pollen season began and before treatment began. 21% of patients
         treated with Xolair reported complete control of symptoms and an
         additional 59% reported symptom control was improved compared to
         previous seasons.

   .     Xolair decreased use of rescue medication. Patients receiving Xolair
         used an average 0.5 antihistamine tablets per day versus 1.3 tablets
         per day in the placebo group (p < 0.001), and required rescue
         medication on half as many days (p < 0.001). Increased use of rescue
         medication by placebo group patients may have blunted the difference in
         symptom scores reported.

   .     Xolair improved patients' quality of life. Xolair treatment delivered
         clinically meaningful and statistically significant improvement over
         placebo in total rhinitis quality of life score (p < 0.001) and in the
         specific categories of activity limitations, nasal symptoms, non-nose
         and non-eye symptoms and practical problems. Xolair treated patients
         also experienced improvements in sleep, eye symptoms and emotional
         state.

   .     Xolair treatment was safe and well tolerated. In this and in the
         previous trials, no antibodies against Xolair were detected and no
         serum sickness, immune complex disease, severe allergic reactions or
         other allergy-related side effects were reported. Less than 2% of
         Xolair-treated patients experienced side effects of headache (1.8%) and
         upper respiratory infection (1.2%). Three subjects reported urticaria
         following Xolair injections (0.5% of all Xolair injections). The
         incidence of adverse events was similar for the Xolair and placebo
         groups.

Perennial Allergic Rhinitis. A Phase 3b clinical trial of Xolair for perennial
allergic rhinitis (PAR) was completed in adults (including adolescents) (12-75
years). The randomized, double-blinded, placebo-controlled, multicenter clinical
trial included 289 patients with moderate to severe PAR.

After a two-week run-in period (baseline), patients were treated with Xolair
(150-300 mg every four weeks or 225-375 mg every two weeks, depending on
baseline serum total IgE and body weight) or placebo, administered
subcutaneously for 16 weeks. Severity of nasal symptoms (sneezing, itchy nose,
runny nose and stuffy nose), post nasal drip, ocular symptoms (itchy eyes,
watery eyes and red eyes) and rescue medication requirement were significantly
lower in the Xolair group compared with placebo. Xolair also was found to be
effective in the subsets of patients who had previously failed to be adequately
controlled by nasal corticosteroids or specific immunotherapy (allergy shots).
There were no drug-related

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serious adverse events, and the incidence of adverse events was lower in the
Xolair group (77%) than in the placebo group (85%).

Additional Studies. To increase the safety database, Genentech and Novartis are
conducting a 900 patient study (ALTO) in difficult-to-treat allergic asthma.
Patients from 6-75 years of age are being enrolled and receiving treatment with
Xolair in open-label fashion for six months.

Regulatory Status

In June 2000, Novartis and Genentech filed a BLA with the FDA for both allergic
asthma and seasonal allergic rhinitis in both adults and children, and also
filed a submission for marketing approval with health authorities in the EU,
Switzerland, Australia, and New Zealand.

Our collaboration partners have advised that they received a Complete Response
Letter with respect to Xolair in July 2001, in which the FDA requested
additional preclinical and clinical data analyses, as well as information
confirming that the pharmacokinetics of the Xolair drug substance were
consistent throughout the development program. Based on subsequent discussions
with the FDA, Novartis and Genentech have reported that they expect to file an
amendment to the BLA in 2002 or early 2003. This amendment will respond to FDA's
request for additional information (which Genentech and Novartis expect to
satisfy with data from existing trials) and will limit the proposed initial
label claim to treatment of asthma in adults and adolescents at least 12 years
of age.

Novartis has announced that it will propose a label change in Europe from
patients with allergic asthma to "at risk" asthma patients, defined as persons
who, during the previous year, experienced an overnight hospitalization,
underwent an intensive care unit stay, were intubated, or needed to visit an
emergency room, in each case, due to asthma. Novartis has stated that it will
initiate new studies by early 2002 in this population and expects that the
results will be submitted to the European Medical Evaluations Agency by 2003.

E26. Genentech and Novartis also have begun early clinical studies on E26,
although they are primarily focussing on gaining marketing approval for Xolair.
While it may be several years behind the development of Xolair, E26 may require
lower doses to achieve the same clinical benefits as Xolair.

ANTI-IGE DEVELOPMENT--TNX-901

TNX-901 (formerly known as Hu-901) is a humanized anti-IgE monoclonal antibody
that we are developing to prevent symptoms of peanut-induced anaphylaxis, a
severe, potentially life-threatening allergic reaction. TNX-901 binds IgE in a
way similar to Xolair, and is designed to prevent allergic reactions. At the
initiation of our collaboration with Novartis and Genentech in 1996, Novartis
and we were developing TNX-901, and Genentech was developing Xolair. We agreed
with our collaboration partners to select Xolair for joint development primarily
because commercial-scale manufacturing capability was being built to accommodate
Xolair.

In July 1999, we initiated our first independent clinical trial with TNX-901. As
discussed under "Item 3. Legal Proceedings," Novartis and Genentech continue to
contest our right to develop TNX-901, despite an October 2001 favorable summary
judgement, confirming the existence of our contract rights to independent
development, and the parties are seeking resolution in arbitration. Regardless
of the outcome of the arbitration, we believe our development program will
highlight potential additional indications for the use of anti-IgE antibodies
and will encourage our partners to expand the development of anti-IgE more
rapidly into other indications. If we do not prevail in the arbitration and
other proceedings, we will terminate independent development of TNX-901.

Market Opportunity. We believe anti-IgE antibodies, such as TNX-901, have
potential applications beyond asthma and allergic rhinitis in treating other
allergic reactions and diseases, including peanut and

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other food allergies. For example, patients with severe peanut allergy suffer
gastrointestinal, skin and respiratory symptoms, and may also suffer
potentially life-threatening anaphylaxis in response to unintended ingestion of
peanuts. According to a recently published survey, peanut or tree nut (e.g.,
walnut, almond and cashew) allergy affects about 3 million people in the United
States, 1.1% of the U.S.  population. Current treatment is avoidance of peanuts
and peanut oil, which is used in the preparation of many food products.
Complete avoidance requires constant vigilance and is difficult because
prepared food labeling does not always identify peanut-derived ingredients.
Accidental exposures can result in serious allergic reactions and sometimes
death. Patients with severe peanut allergy take antihistamines for accidental
exposure and may require administration of epinephrine for severe anaphylactic
reactions.

Approximately six million children and adults in the United States suffer from
food allergies. If TNX-901 effectively reduces sensitivity to peanuts, we may
also investigate its use in other food allergies. There is no approved
preventive therapeutic for food allergies.

Development Status. We are currently conducting a randomized,
placebo-controlled, multicenter Phase 2 trial with TNX-901 in patients with
severe peanut allergy. We designed the trial to determine the extent to which
TNX-901 treatment of patients with histories of severe reactions to peanut
products decreases sensitivity to eating small amounts of a peanut preparation.
With enrollment completed, we currently expect to complete the trial in the
second half of 2002.

ANTI-CD40 DEVELOPMENT - TNX-100

TNX-100 (formerly known as 5D12) is an anti-CD40 monoclonal antibody that we are
developing for treatment of autoimmune diseases. TNX-100 blocks the CD40
pathway. The CD40 pathway enables B cells to produce antibodies and regulates
cellular immune responses, including activation of dendritic cells, macrophages
and killer T cells. T and B cells sometimes recognize a part of the body as
"non-self," triggering an immune response against the body that results in
tissue injury and autoimmune disease. We believe that TNX-100 is the only
antibody in clinical development that binds to CD40 and inhibits cellular
activation. We have exclusive rights to TNX-100 in Europe and Japan under a
license from Chiron.

Market Opportunity. Based on our research and preclinical studies with TNX-100,
we believe the product could reduce production of antibodies and the activation
of cellular immune responses that cause autoimmune diseases. Examples of such
diseases include: Crohn's disease; rheumatoid arthritis; multiple sclerosis;
lupus; and psoriasis.

Development Status. We are completing a Phase I clinical study with TNX-100 in
Crohn's disease in Europe. The trial is a single dose, dose-escalating study
designed to provide data regarding the safety of the product, its
pharmacokinetic behavior, including half-life and clearance characteristics, and
its biological activity using histological examination of biopsy tissue. After
we have had a chance to evaluate the study results, we will take into
consideration our development and manufacturing resources, in light of our
primary focus on developing TNX-901, and other commercial and economic factors
in determining our next steps with respect to TNX-100.

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ANTI-CD4 DEVELOPMENT - TNX-355

TNX-355 (formerly known as 5A8) is a humanized anti-CD4 monoclonal antibody that
we are developing for treatment of human immunodeficiency virus, or HIV. The
virus enters the host cell by binding to the CD4 receptors on these cells. In
lab studies, our TNX-355 antibody binds to the CD4 receptor on the cell surface
and prevents viral entry into the cell, thereby blocking infection. TNX-355
binds to a region of the CD4 molecule that is not involved with immune function.
TNX-355, therefore, does not suppress immune function in monkeys nor in human
blood cells in the laboratory. Furthermore, the antibody does not deplete CD4
cells in animal studies and studies of human blood cells in vitro. We have
exclusive worldwide rights to TNX-355 through a license with Biogen.

Market Opportunity. According to the World Health Organization, HIV infects
approximately 1.4 million people in North America and Western Europe. A number
of drugs targeting viral replication are being used, often in combination. About
30% of the patients treated with drug combinations, however, no longer respond
since their HIV has become drug resistant. In addition, many drug combinations
produce a variety of undesirable toxic side effects.

Development Status. We are conducting a Phase 1, dose-escalating clinical safety
study with TNX-355 directed at HIV patients who have failed two courses of
highly active anti-retroviral therapy (HAART). HAART typically involves a
combination of three to four drugs, chosen from the available pool of drugs
approved for HIV infection, that may reduce viral load to undetectable levels in
patients. The study's objectives include measurements of pharmacokinetic
parameters of TNX-355 after single-dose administration and its effects on viral
load and CD4+ cells.

ANTI-FACTOR D - TNX-224

TNX-224 (formerly known as 166-32) is a monoclonal antibody that binds to Factor
D, a component of the complement system, and is currently under investigation
for the treatment of acute inflammation. The complement system is the body's
first line of defense against infection.

While the complement system generally functions to protect the body, complement
system activation can become excessive and uncontrolled, resulting in
inflammation and tissue damage. This can occur in cases of acute tissue injury
or surgical procedures that reduce blood flow into a tissue. TNX-224 binds to
Factor D and inhibits complement activation.

Market Opportunity. During heart surgery involving cardiopulmonary bypass (CPB),
the shunting of blood outside the body for circulation through mechanical
devices has been shown to activate complement and is believed to result in
tissue injury. According to the American Heart Association there were 607,000
CPB (cardiac revascularization) procedures performed in the United States during
1997. Tanox believes that TNX-224 may also have potential application in
ischemia/reperfusion injury (e.g. stroke, burns, MI and organ transplantation).

Development Status. TNX-224 is in preclinical development to determine its
usefulness in treating activation of complement in coronary artery bypass graft
procedures. Research studies in laboratory animals showed that TNX-224 reduced
heart damage and inhibited complement activation in a model for CPB. Depending
on the results from preclinical and toxicity studies, we may initiate a Phase 1
study of TNX-224 in CPB patients.

COLLABORATION AND LICENSING AGREEMENTS

COLLABORATION WITH NOVARTIS AND GENENTECH

We are developing our lead product, Xolair, in collaboration with Novartis and
Genentech. In 1990, we established a collaboration with Novartis to jointly
develop anti-IgE antibodies to treat allergic diseases.

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In 1996, Genentech joined our collaboration with Novartis and we agreed to
combine our respective anti-IgE development programs in a three-party
collaboration. We and our collaboration partners selected Xolair as the lead
product for development and commercialization.

The collaboration agreements include, among others, the following terms:

   .     Development. Novartis and Genentech are responsible for completing the
         development of and obtaining the regulatory approval for Xolair and the
         other anti-IgE products developed through the collaboration. Novartis
         and Genentech share all development costs relating to Xolair and other
         anti-IgE products that the collaboration may select for development in
         the United States and Europe. We and Novartis equally share development
         costs relating to China, Hong Kong, Korea, Singapore and Taiwan.
         Novartis is responsible for development costs in the rest of the world.

   .     Manufacturing. Novartis and Genentech are responsible for manufacturing
         Xolair and other selected anti-IgE products worldwide, subject to our
         right to manufacture up to 50% of the worldwide requirements of those
         products.

   .     Marketing. Novartis and Genentech share U.S. marketing rights, and
         Novartis has marketing rights in Europe (with Roche retaining the
         option, subject to certain conditions, to participate in Europe) to
         products developed through the collaboration. Novartis is responsible
         for marketing these products in the rest of the world, including China,
         Hong Kong, Korea, Singapore and Taiwan.

   .     Payments. We may receive payments of up to $63.5 million based on
         completing development and marketing objectives for Xolair, $18.5
         million of which we have already received. We may also receive payments
         of up to $14.0 million based on completing development objectives for
         E26, $1.0 million of which we have already received.

   .     Royalties and Profit Sharing. We may receive royalties based on net
         sales of Xolair and other selected anti-IgE products in the United
         States and a share of Novartis' profits on these sales. We also may
         receive royalties on net sales of Xolair and other selected anti-IgE
         products in Europe and the rest of the world (except for China, Hong
         Kong, Korea, Singapore and Taiwan) and an equal share of Novartis'
         profits from sales of Xolair and other selected anti-IgE products in
         China, Hong Kong, Korea, Singapore and Taiwan.

         Our rights to the full amount of the milestone payments and royalties
         that we receive could be affected by the on-going legal proceedings
         with our former attorneys described under "Item 3. Legal Proceedings."

The collaboration agreements provide that we may independently develop, without
our collaboration partners, any anti-IgE product (other than products identified
and synthesized by Genentech) that the partners are not developing through the
collaboration. If we choose to independently develop a product, Novartis has a
right of first refusal on the licensing of that anti-IgE product. As described
under "Item 3. Legal Proceedings," we are currently involved in a dispute with
our collaboration partners regarding our rights to independently develop TNX-901
and our right to use certain know-how and other information in our independent
development efforts.

Roche has an option to participate in commercializing Xolair and other anti-IgE
products which the collaboration selects for development in Japan and Europe.
Roche may exercise this option if specified events relating to commercializing
the product occur. Roche has waived this option for Xolair in Japan. In
addition, Roche has an option to assume Genentech's position in the
collaboration if Genentech withdraws from the collaboration, as described below.

Either Novartis or Genentech may withdraw from the collaboration on short
notice. If either Novartis or Genentech withdraws, rights to Xolair and any
other products developed by the collaboration (including

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<PAGE>

by the withdrawing partner) revert to us and the remaining collaborator and, if
Genentech is the withdrawing party, to Roche if Roche exercises the option
described above. If the collaboration is dissolved in its entirety, we would
continue to retain rights to develop anti-IgE antibodies under the terms of
separate agreements with Novartis and Genentech.

In addition to the collaboration agreements, we and Genentech entered into a
cross-license agreement under which each party has an option to license the
other party's patents relating to the development of anti-IgE antibodies for use
in developing specific products. This option may be exercised at any time if
either party chooses to independently develop a product as permitted under the
collaboration agreements, if our collaboration with Novartis and Genentech
terminates or if we and Genentech may mutually agree.

OTHER COLLABORATIONS AND LICENSE AGREEMENTS

Chiron License. In 1995, our European subsidiary Tanox Pharma, B.V. entered into
an agreement to license from Chiron exclusive research and development rights
(except as to Chiron) to Chiron's murine monoclonal antibodies against CD40.
Subject to Tanox Pharma's obligations to develop an anti-CD40 product and, under
certain circumstances, pay maintenance fees, the agreement granted Tanox Pharma
an option to obtain a commercial license to Chiron's anti-CD40 antibodies,
patents and technology for Europe and Japan. Tanox Pharma exercised this option
in March 2000. Chiron retains its commercial rights in the United States and the
rest of the world. Additionally, Chiron has an option to obtain a commercial
license for the United States and the rest of the world outside Europe and Japan
to use anti-CD40 patents and technology that Tanox Pharma develops. Chiron has
four awarded U.S. patents relating to such anti-CD40 antibodies and has patents
pending in Europe, Japan and Canada.

Upon registering a product in Japan, the United Kingdom, France or Germany,
Tanox Pharma has agreed to pay Chiron a fee of $1.0 million and royalties based
on Tanox Pharma's European and Japanese sales. Chiron has agreed to pay Tanox
Pharma royalties based on Chiron's sales in the United States and the rest of
the world. The license terminates on the later of the expiration of 10 years
following the first commercial product sale or the expiration of the last to
expire of licensed patents (currently, 2017, subject to extensions).

Biogen. In 1998, we entered into an agreement to license from Biogen its
anti-CD4 monoclonal antibody and intellectual property on an exclusive worldwide
basis with limited sublicense rights. Biogen owns issued U.S., European and
Australian patents and has pending applications in Canada and Japan. We paid
Biogen a license fee and agreed to make additional development milestone
payments and royalty payments to Biogen based on annual net sales revenue
levels. Additionally, we agreed to make milestone payments to Biogen that
increase as product development continues and if specified corporate development
events occur. In addition to royalty payments, we may make up to an aggregate of
$10.4 million in product development milestone payments under this agreement, of
which we have paid $100,000. The license terminates on a country-by-country
basis on the later of the expiration of 12 years following the first commercial
product sale or the expiration or invalidity of applicable patents. The licensed
patents expire in Europe in 2011 and in the United States in 2016, subject to
extensions.

PATENTS AND PROPRIETARY RIGHTS

We pursue patent protection for our proprietary technology and products, and
have either been granted patents, have applications pending or are licensed
under patents and applications that relate to our current and certain potential
products. We file patents in the United States and other countries, including
Japan, Canada, Australia, countries of the European Union, other European
countries, and certain other Asian countries.

We have five U.S. patents that cover and/or relate to the use of anti-IgE and
other allergy/asthma products. We also hold patents in Europe, Canada, Japan,
Singapore, Hong Kong and Australia covering such products. We have additional
anti-IgE patents pending in the United States and internationally.

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Some of our patents are co-owned with Novartis. We also cross license
Genentech's patents covering anti-IgE products. Our issued patents covering
anti-IgE products expire between 2009 and 2013.

We also have filed U.S.  and corresponding national phase patent applications
relating to anti-Factor D antibodies.  We have a number of other U.S. and
foreign patents covering certain other proprietary technology and products,
with over fifty U.S. patents granted to date.

In September 2000, we purchased at auction from LXR Biotechnology, Inc. its
patent portfolio related to apoptosis. This portfolio includes the following
technologies: (i) Bak, a bcl-2 homologue and gene product, known to be a potent
inducer of apoptosis and cell death (5 U.S. patents, as well as several pending
applications in the U.S., Europe, Canada, and Japan); (ii) SARPs (secreted
apoptosis-regulating proteins), which constitute a family of proteins that
regulate the life and death of cells in the body (several pending applications
in the U.S., Europe, Canada, and Japan); (iii) Fas(DELTA)(TM), a
naturally-occurring soluble form of the death receptor protein also known as
Fax, CD95, or APO-1, which is believed to be involved in the signaling pathway
for apoptosis induction in many tissues and organs (2 U.S. patents); and (iv)
patents directed to in vitro apoptosis drug screening critical for future
discovery, diversification and optimization of apoptosis regulating drugs. The
patents expire between 2014 and 2019. In addition to the patents, we succeeded
to various related license agreements that LXR had executed, and we are involved
in negotiations with several other companies to out-license these technologies.

Patenting biotechnology-related products and processes can involve uncertain and
complex legal and factual questions and, to date, policies regarding the breadth
of claims allowed in biotechnology patents are not necessarily consistent.
Patents, if issued, may be challenged, invalidated, limited in their scope of
coverage, circumvented or held unenforceable. We cannot assure you that one or
more of the patents noted above would not be rescinded, held invalid,
successfully opposed or revoked or narrowed or held unenforceable. Thus, any
patents that we own or license from third parties may not provide any protection
against competitors. Our pending patent applications, those we may file in the
future, or those we may license from third parties, may not result in patents
being issued. Also, patent rights may not provide us with proprietary protection
or competitive advantages against competitors with similar technology or
different technology. Furthermore, others may independently develop similar
technologies or duplicate any technology that we have developed. Moreover, the
laws of certain foreign countries do not protect our intellectual property
rights to the same extent as do the laws of the United States.

Litigation may be necessary to enforce any patents issued or licensed to us or
to determine the scope and validity of these patents. We could incur substantial
costs and divert technical and management personnel's time and attention if we
must participate in litigation or if we must defend ourselves against patent
suits against us. If the outcome of litigation is adverse to us, third parties
may be able to use our patented invention without paying us. Moreover, we cannot
assure you that our patents will not be infringed or successfully avoided
through design innovation. Any of these events may materially and adversely
affect our business.

In addition, other companies, some of which may be our competitors, have filed
applications for or have been issued patents, and may obtain additional patents
and proprietary rights, relating to products or processes used in, necessary to,
competitive with or otherwise related to our patents and products. These
products and processes include, among other items, patents covering technology
relating to the type of humanized monoclonal antibodies that we anticipate
developing. Protein Design Labs, Inc. owns certain patents and patent
applications relating to these humanized antibodies. We acquired the right to
take non-exclusive licenses to these patents and patent applications for up to
four of our products, excluding Xolair, for which we paid $2.5 million in
license fees (in addition to $1.5 million that we paid Protein Design Labs under
a previous agreement). In addition, we will pay approximately $4.0 million if we
exercise our option to license all four antibodies, plus maintenance fees and
continuing royalties. We do not know if licenses from Protein Design Labs will
be available for our other antibody products. The Medical Research Council also
owns patents relating to humanized antibodies, for which we hold a non-exclusive

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<PAGE>

license. Our license permits us to humanize our murine monoclonal antibodies. In
addition to our obligation to pay royalties on net sales of our products
incorporating licensed technology, we paid a license fee of approximately
$50,000. We have also obtained licenses from other parties holding patents or
other intellectual property relating to technologies, which we deem necessary or
desirable for the manufacture, use or sale of our products. These licenses
generally require us to pay royalties on product sales, and may also require the
payment of milestones.

We may also develop products that are chimeric antibodies. Genentech owns a
patent (Cabilly 1) relating to chimeric antibodies and instituted suit against
us in 1994 claiming that we infringed this patent. We settled the lawsuit and,
pursuant to the settlement, we secured rights to acquire a non-exclusive license
to Cabilly 1, another patent relating to antibody co-expression (Cabilly 2) and
other Genentech patents (or patents to which Genentech has a license and is free
to grant a sublicense) for our anti-IgE antibody products. We also have certain
rights to acquire a non-exclusive license from Genentech for Cabilly 1, Cabilly
2 and certain other Genentech patents for products not exclusively or
co-exclusively licensed by Genentech to a third party for certain of our
products that do not compete with those of Genentech or its affiliates. In
addition, other parties also own patents covering chimeric and/or deimmunized
antibodies and/or processes applicable to making these antibodies.

The scope, enforceability and validity of these patents, the extent to which we
must obtain licenses under these patents or under other proprietary rights and
the cost and availability of licenses are unknown, but these factors may limit
our ability to market our products. Moreover, even if a license were available,
the payments that would be required could render uneconomic our efforts to
market certain of our products. If we elect to manufacture or market these
products without either a license or a favorable result in litigation, damages
could be assessed that could be materially adverse to us. Further, failure to
obtain a license could result in an injunction prohibiting us from manufacturing
or selling the affected lines of products.

In addition to patents, we rely on trade secrets and proprietary know-how. We
seek protection, in part, through confidentiality and proprietary information
agreements. These agreements may not provide meaningful protection or adequate
remedies for our technology if unauthorized use or disclosure of this
information occurs. Furthermore, our trade secrets may otherwise become known
to, or be independently developed by, our competitors.

We require our employees, consultants, advisors, outside scientific
collaborators and sponsored researchers and other advisors to execute
confidentiality agreements on commencing an employment, consulting or other
contractual relationship with us. These agreements provide that all confidential
information developed or made known to the individual during the course of the
relationship is to be kept confidential and not disclosed to third parties
except in specific circumstances. In the case of employees and certain other
parties, the agreements provide that all inventions conceived by the individual
shall be our exclusive property. We cannot assure you, however, that these
agreements will provide meaningful protection for our confidential information
or trade secrets against or in the event of unauthorized use or disclosure of
such information.

GOVERNMENT REGULATION

Producing and marketing our products and our research and development activities
are subject to regulations relating to product safety and efficacy by numerous
governmental authorities in the United States and other countries. In the United
States, drugs are subject to rigorous FDA regulation. The Federal Food, Drug and
Cosmetic Act and other federal and state statutes and regulations govern, among
other things, the testing, manufacture, safety, effectiveness, labeling,
storage, record keeping, approval, advertising and promotion of our products.

Before we may market a pharmaceutical product in the United States, the FDA
requires us to complete the following steps:

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<PAGE>

   .     preclinical laboratory and animal tests;

   .     submission to the FDA of an investigational new drug application
         (IND), which must become effective before human clinical trials may
         commence;

   .     adequate and well controlled human clinical trials conforming with good
         laboratory and clinical practices to establish the safety and efficacy
         of the product;

   .     submission to the FDA of a New Drug Application (NDA), with respect
         to drugs, and a BLA with respect to biological products; and

   .     FDA approval of the NDA or BLA before any commercial sale or shipment
         of the product.

In addition, the FDA requires the registration of each drug and approval of each
manufacturing establishment. Since any approval granted by the FDA is both site
and process specific, any material change in the manufacturing process,
equipment or location necessitates additional FDA review and approval. For our
monoclonal antibody products we are subject to the procedure for biological
products. Domestic manufacturing establishments are subject to FDA inspection
and must comply with current good manufacturing practices (cGMP), for
pharmaceutical products. To supply products for use in the United States,
foreign manufacturing establishments must comply with cGMP and are subject to
periodic FDA or other regulatory authority inspection under reciprocal
agreements with the FDA.

Preclinical tests include laboratory evaluation and animal studies to assess the
potential safety and biological and functional activities of the product and its
formulation. To comply with FDA regulations, laboratories must conduct these
preclinical safety tests according to Good Laboratory Practices. The results of
the preclinical tests are submitted to the FDA as part of an IND, and the FDA
reviews the results before the commencement of human clinical trials.

Human clinical trials involve the administration of the investigational compound
to patients or other volunteers under the supervision of a qualified principal
investigator. Clinical trials are conducted in accordance with protocols that
detail the objectives of the study, the parameters to be used to monitor safety
and the efficacy of the drug under evaluation. Each protocol must be submitted
to the FDA as part of the IND. Further, each clinical study must be conducted
under the auspices of an independent institutional review board (IRB), at the
institution where the study will be conducted. The IRB will consider, among
other things, ethical factors, the safety of human subjects and the possible
liability of the institution.

Clinical trials are typically conducted in four sequential phases, which may
overlap. In Phase 1, the initial introduction of the product into human
subjects, the product is tested for safety (adverse effects), dosage tolerance,
metabolism, distribution, excretion and clinical pharmacology. Phase 2 involves
studies in a limited patient population:

   .     to determine the efficacy of the product for specific, targeted
         indications;

   .     to determine dosage tolerance and optimal dosage; and

   .     to identify possible adverse effects and safety risks.

When a product is found to be effective and to have an acceptable safety profile
in Phase 2 evaluations, Phase 3 trials are undertaken:

   .     to continue to evaluate clinical efficacy; and

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<PAGE>

   .     to test further for safety within an expanded patient population at
         geographically dispersed clinical study sites.

In the case of agents for life-threatening diseases, the initial human testing
is generally done in patients rather than in healthy volunteers. Since these
patients already are afflicted with the target disease, it is possible that
these studies may provide results traditionally obtained in Phase 2 trials,
potentially expediting the approval process. These trials are frequently
referred to as "Phase 2/3" trials. Phase 4 studies are typically done post-FDA
approval to address safety issues not addressed in the Phase 1/2/3 programs, for
example, issues related to long term use of the product.

We cannot assure you that we will successfully complete clinical testing of our
products within any specified time period, if at all. Furthermore, the FDA or we
may suspend clinical trials at any time if it is felt that the subjects or
patients are being exposed to an unacceptable health risk.

The results of the pharmaceutical development, preclinical studies and clinical
studies are submitted to the FDA in the form of an NDA or BLA to approve
marketing and commercial shipment of the product. The testing and approval
process frequently requires substantial time and effort and we cannot assure you
that any approval will be granted on a timely basis, if at all. The FDA may
refuse to file an NDA or BLA if applicable regulatory criteria are not
satisfied, may require additional testing or information or may require
post-marketing testing and surveillance to monitor the safety and efficacy of
the product. Notwithstanding the submission of these data, the FDA may
ultimately decide that the application does not satisfy its regulatory criteria
for approval. Finally, product approvals may be withdrawn if compliance with
regulatory standards is not maintained or if problems occur following initial
marketing.

Among the conditions for NDA or BLA approval is that the prospective
manufacturer's quality control and manufacturing procedures conform to cGMP. In
complying with standards set forth in these regulations, manufacturers must
continue to expend time, monies and effort in the area of production and quality
control to ensure full compliance.

In addition to FDA regulations, we are subject to regulation under the
Occupational Safety and Health Act, the Environmental Protection Act, the Toxic
Substances Control Act, the Resource Conservation and Recovery Act and other
present and future federal, state or local regulations.

For marketing outside the United States, we also are subject to foreign
regulatory requirements governing human clinical trials and marketing approval
for pharmaceutical products. The requirements governing the conduct of clinical
trials, product licensing, pricing and reimbursement vary widely from country to
country. Whether or not we obtain FDA approval, we must obtain approval of a
product by the comparable regulatory authorities of foreign countries before
manufacturing or marketing the product in those countries. The approval process
varies from country to country and the time required for these approvals may
differ substantially from that required for FDA approval. We cannot assure you
that clinical trials conducted in one country will be accepted by other
countries or that approval in one country will result in approval in any other
country. For clinical trials conducted outside the United States, the clinical
stages are comparable to the phases of clinical development established by the
FDA.

COMPETITION

The pharmaceutical and biotechnology industries are characterized by rapidly
evolving technology and intense competition. Many companies, including major
pharmaceutical and chemical companies, as well as specialized biotechnology
companies, perform activities similar to ours. Many of these companies have
substantially greater financial and other resources, larger intellectual
property estates and larger research and development staffs than we do, and
greater capabilities and experience in preclinical testing, human clinical
trials, regulatory affairs, manufacturing and marketing. We chose to enter into
the collaboration agreements with Novartis and Genentech, in part, to secure the
benefit of their experience in these areas, as well as the contribution of their
greater financial resources. In addition, colleges,

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universities, governmental agencies and other public and private research
organizations conduct research and may market commercial products on their own
or through joint ventures. These institutions are becoming more active in
seeking patent protection and licensing arrangements to collect royalties for
using technology that they have developed.  We compete with these institutions
in recruiting and retaining highly qualified scientific personnel.

The diseases that we have targeted, including asthma/allergy, autoimmune,
inflammatory and other related diseases, are intensely competitive areas
targeted by both pharmaceutical companies and other biotechnology companies,
including our collaborators, Novartis and Genentech. All of these companies may
have competitive products on the market, may be testing their products in
clinical trials or may be focusing on product approaches that could prove to be
superior to our approaches. For instance, we are aware that some of these
companies, which may be our competitors, have filed applications for or have
been issued patents and may obtain additional patent and proprietary rights
relating to products or processes used in, necessary to, competitive with or
otherwise related to, our products or processes. These patents include, among
other items, patents relating to humanized monoclonal antibodies.

Our competition will be determined in part by the potential indications for
which our antibodies are developed and ultimately approved by regulatory
authorities. For some of our potential products, an important factor in
competition may be the timing of market introduction of our products or
competitive products. Accordingly, we expect the relative speed with which we
develop our products, complete the necessary approval processes and are able to
generate and market commercial quantities of the products to be important
competitive factors. We expect that competition among products approved for sale
will also be based, among other factors, on product efficacy and safety, timing
and scope of regulatory approval, product availability, advantages over
alternative treatment methods, price and cost-effectiveness, development,
distribution and marketing capabilities, third-party reimbursement and patent
position.

We are aware that several companies, including Novartis, have existing products
that will compete with Xolair, if it is approved for sale, including
corticosteriods, beta-agonists, antihistamines, leukotriene inhibitors and
allergen immunotherapy. In addition, several companies have products in
development that may compete with Xolair. These companies include, but are not
limited to, IDEC (Anti-CD23), Immunex (sIL-4R), CellTech/Schering-Plough
(Anti-IL5), Merck/Biogen (VLA-4 inhibitors), Protein Design Labs (Anti-IL4) and
American Home Products (IL-13 IgGFc).

Our competitive position also depends upon our ability to:

   .     attract and retain qualified personnel;

   .     obtain patent protection or otherwise develop proprietary products or
         processes;

   .     discover new therapeutic products that successfully treat human
         diseases;

   .     secure sufficient capital resources to complete product development and
         regulatory processes;

   .     build or secure manufacturing capacity and to manufacture efficiently;

   .     build or obtain a sales organization; and

   .     achieve profitable commercial production of our products.

MANUFACTURING

We have a small-scale production and purification facility in which we have
produced our products in compliance with cGMP standards for use in Phase 1 and
Phase 2 clinical trials. With funding from

                                      17
<PAGE>

Novartis, we constructed a pilot manufacturing facility that we may use for
larger-scale process development and cGMP production of culture derived
products. The facility includes a 1500L bioreactor and occupies approximately
14,000 square feet of space now under lease to us in Houston, Texas. The new
manufacturing facility is not yet operational; however, we have completed a
substantial portion of the required cGMP validation. Until the facility is
operational, we are not obligated to repay our $10.0 million loan from
Novartis, and Novartis has agreed to forgive our accrued interest obligations
under the loan. If the facility becomes operational, we will make interest and
principal payments on the loan in amounts equal to 75% of net cash flow from
the plant. The facility is available to both us and other companies for
production of monoclonal antibodies and other biologic products for large-scale
clinical trials and initial market launch.

Under our agreements with Novartis and Genentech, Novartis and Genentech must
manufacture Xolair and any other anti-IgE products selected by us and our
collaboration partners for development, although we have retained the right to
manufacture and supply up to 50% of the worldwide requirements for Xolair and
the other selected products. Novartis has announced that it intends to supply
Xolair from a facility now under construction that has a capacity of more than
one ton of active substance per year.

Our current facility will not be adequate for commercial scale manufacturing
requirements if we successfully develop our products. We are currently
evaluating alternatives for commercial manufacturing capacity, including the
possible construction of a plant. If we decide to establish a full-scale
manufacturing facility, we will require substantial additional funds and must
hire and train significant numbers of employees and comply with the extensive
FDA regulations applicable to that facility.

RESEARCH AND DEVELOPMENT

Company-sponsored research and development expenses were $17.2 million, $18.3
million and $21.7 million in 1999, 2000 and 2001, respectively. We expect that
research and development expenses will continue to increase as we seek to
identify new product opportunities and expand development of our current and
future product pipeline.

MARKETING AND SALES

Novartis and Genentech will market Xolair and the other products selected for
development by the collaboration. Novartis and Genentech share U.S. marketing
rights, and Novartis has marketing rights in Europe (with Roche retaining the
option to participate in Europe). Novartis can market these products in the rest
of the world, including China, Hong Kong, Korea, Singapore and Taiwan, where we
will share costs and profits with Novartis.

To effectively serve the worldwide markets, we intend to continue to collaborate
with major pharmaceutical companies or prominent pharmaceutical sales and
distribution organizations that can successfully market our products on a
worldwide basis or within specific geographic territories. As we pursue
strategic collaborations, we intend to reserve marketing rights for our
products, to the extent commercially reasonable, including rights in the United
States and selected Asian countries. We will focus initially on markets for
which our products have a clear advantage over other therapies or which we may
target using a relatively small sales force. We currently do not have an
internal sales and marketing capability. If we elect to retain marketing rights,
we will have to build a sales and marketing infrastructure.

EMPLOYEES

Including the employees of our subsidiaries, at December 31, 2001, we had 114
full-time employees, 110 of whom are based in the United States and 4 of whom
are based in Taiwan.  86 of our employees are engaged in, or directly support,
research and product development activities.  39 employees hold Ph.D.,

                                      18
<PAGE>

M.D. or Sc.D.  degrees, and 25 employees hold other advanced degrees.  We
consider our relations with employees to be good, and none of our employees is
covered by a collective bargaining agreement.  We enter into confidentiality
agreements with all of our employees and consultants.  We do not currently
maintain key employee life insurance on any of our personnel.

CORPORATE HISTORY

We were incorporated in Delaware in 2000 as the successor to a corporation
formed in 1986 under the laws of the State of Texas.

FORWARD-LOOKING STATEMENTS

Some of the information in this Annual Report on Form 10-K contains
forward-looking statements. We typically identify forward-looking statements by
using terms such as "may," "will," "should," "could," "expect," "plan,"
"anticipate," "believe," "estimate," "predict," "potential" or "continue" or
similar words, although we express some forward-looking statements differently.
You should be aware that actual events could differ materially from those
suggested in the forward-looking statements due to a number of factors,
including:

   .     our ability to develop safe and efficacious drugs;

   .     failure to achieve positive results in preclinical and toxicology
         studies in animals and clinical trials in humans;

   .     our ability to manufacture sufficient amounts of our products for
         clinical trials and commercialization activities;

   .     successful commercialization of our products, including market
         acceptance;

   .     relationships with our collaboration partners;

   .     our ability to obtain, maintain and successfully enforce patent and
         other proprietary rights protection of our products;

   .     the outcome of pending legal disputes;

   .     variability of royalty, license and other revenues;

   .     our ability to enter into future collaboration agreements to support
         our research and development activities;

   .     drug withdrawal from the market due to rare adverse reactions caused by
         the marketed drug;

   .     competition and technological change; and

   .     existing and future regulations affecting our business, including the
         content, timing of submissions and decisions made by the FDA and other
         regulatory agencies.

Factors that could cause our actual results to differ from those set forth in
the forward-looking statements include those set forth below, as well as those
discussed elsewhere in this Form 10-K.

                                      19
<PAGE>

FACTORS THAT MAY AFFECT OUR FUTURE RESULTS

REGULATORY RISKS

If We Do Not Receive Regulatory Approvals for Xolair, We Would Be Significantly
-------------------------------------------------------------------------------
Harmed and Our Stock Price Would Drop Sharply.
----------------------------------------------

Xolair is our lead product candidate, and our success will depend, to a great
degree, on the success of Xolair. To successfully commercialize Xolair, our
collaborators, Novartis and Genentech, must be able to obtain regulatory
approvals for Xolair.

Neither the FDA nor any European regulatory agency has approved Xolair. In June
2000, Novartis and Genentech filed a BLA with the FDA for both seasonal allergic
rhinitis and allergic asthma and also filed a submission for marketing approval
with health authorities in the EU, Switzerland, Australia, and New Zealand. In
August 2000, the FDA placed a partial clinical hold or clinical hold on certain
ongoing and planned Xolair clinical trials, based on observations in
then-ongoing safety studies in monkeys. These observations included cases of
abnormally lowered platelet counts, or thrombocytopenia, in cynomolgus monkeys
that received doses of Xolair ranging from approximately 3 to 27 times higher
than the maximum clinical dose tested. In an E26 toxicity study at the highest
dose, two monkeys died from bleeding. Following Genentech's agreement to revise
the trial protocols to provide for increased monitoring of, and more restrictive
admission criteria relating to, platelet levels in patients, the FDA removed the
clinical holds and partial clinical hold in November 2000. Genentech also
supplied the FDA with all the additional information it requested.

In July 2001, Genentech and Novartis announced that they had received a Complete
Response Letter with respect to Xolair, in which the FDA requested additional
preclinical and clinical data analyses, as well as information confirming that
the pharmacokinetics of the Xolair drug substance were consistent throughout the
development program. Based on subsequent discussions with the FDA, Novartis and
Genentech have reported that they expect to file an amendment to the BLA in 2002
or early 2003. This amendment will respond to FDA's request for additional
information (which Genentech and Novartis expect to satisfy with data from
existing trials) and will limit the proposed initial label claim to asthma in
adults and adolescents at least 12 years of age.

Additionally, Novartis has announced that it will propose a label change in
Europe from allergic asthma to "at risk" asthma patients, defined as persons
who, during the previous year, experienced an overnight hospitalization,
underwent an intensive care unit stay, were intubated, or needed to visit an
emergency room, in each case, due to asthma. Novartis has stated that it will
initiate new studies in late 2001 or early 2002 in this population and expects
that the results will be submitted to the European Medical Evaluations Agency by
2003.

We cannot assure you that Xolair will be approved by the FDA, the EMEA or any
other regulatory authorities in a timely manner or at all. If our collaborators
fail to successfully obtain regulatory approvals for Xolair, our business,
financial condition and results of operations will be materially harmed.
Moreover, a setback of this nature would cause a sharp drop in our stock price,
which would severely restrict our ability to raise additional funds through
secondary offerings or to enter into corporate transactions. Failure of our
Xolair program could also reflect adversely on our TNX-901 program, which is
also based on anti-IgE technology.

                                      20
<PAGE>

If We Do Not Receive and Maintain Regulatory Approvals, We Will Not Be Able to
------------------------------------------------------------------------------
Market Our Products.
--------------------

Neither the FDA, nor any regulatory authority, has approved any of our products.
We must receive FDA approval to manufacture and market our products in the
United States. The process that pharmaceutical products must undergo to receive
this approval is extensive, and includes preclinical testing and clinical trials
to demonstrate safety and efficacy and a review of the manufacturing process to
ensure compliance with good manufacturing practices. This process can last many
years, be very costly and still be unsuccessful. The FDA can delay, limit or not
grant approval for many reasons, including:

   .     their belief that a product candidate is not safe and effective;

   .     their interpretation of data from preclinical testing and clinical
         trials in different ways than we interpret it;

   .     the FDA might not approve our manufacturing processes or facilities or
         those of our collaboration partners;

   .     the FDA may change its approval policies and guidelines or adopt new
         regulations; and

   .     the FDA may approve a product candidate for fewer than all the
         indications requested.

The process of obtaining approvals in foreign countries to manufacture and
market our products there is subject to delay and failure for the same reasons.

Our products other than Xolair require significant additional laboratory
development and/or clinical trials before they can be commercialized. We have
limited experience in conducting and managing clinical trials and rely on third
parties, including our collaborative partners and contract research
organizations, to assist us in managing and monitoring clinical trials. Our
reliance on third parties may result in delays in completing, or failing to
complete, clinical trials if they fail to perform under our agreements with
them.

Continued approval of a product candidate could also depend on post-marketing
studies. In addition, any marketed product and its manufacturer continue to be
subject to strict regulation after approval. Any unforeseen problems with an
approved product or any violation of regulations could result in restrictions on
the product, including its withdrawal from the market.

Delays in receiving or failing to receive regulatory approvals, or losing
previously received approvals, would delay or prevent product commercialization,
which would adversely affect our business, financial condition and results of
operations.

Our Preclinical and Clinical Testing Results Are Uncertain.  If Trial Results
-----------------------------------------------------------------------------
Are Negative, We May Be Forced to Stop Developing Products Important to Our
---------------------------------------------------------------------------
Future.
-------

We must demonstrate through preclinical studies and clinical trials that our
products are safe and effective for use in each target indication before we can
obtain regulatory approvals to sell our products commercially. These studies and
trials may be very costly and time consuming. The results of preclinical studies
and initial clinical trials of our products do not necessarily predict the
results from later-stage clinical trials, which must demonstrate the desired
safety and efficacy traits. We cannot assure you that the data collected from
clinical trials of our products will be sufficient to support FDA or other
regulatory approval.

The speed with which we are able to enroll patients in clinical trials is an
important factor in determining how quickly we may complete clinical trials.
Many factors affect patient enrollment, including the size of the patient
population, the proximity of patients to clinical sites, the eligibility
criteria for the study and

                                      21
<PAGE>

other ongoing trials directed at the same indication.  We may target our
clinical trial protocols at indications that have small patient populations,
which may make it difficult for us to enroll enough patients to complete the
trials. Delays in patient enrollment in the trials will result in increased
costs and program delays, which could slow down our product development and
approval process, and could materially harm our business.

Administering any product we develop to humans may produce undesirable side
effects. These side effects could interrupt or delay clinical trials of products
and could result in the FDA or other regulatory authorities denying approval of
our products for any or all targeted indications. The FDA, other regulatory
authorities or we may suspend or terminate clinical trials at any time. Even if
we receive FDA and other regulatory approvals, our products may later exhibit
adverse effects that limit or prevent their widespread use or that force us to
withdraw those products from the market.

We Are Subject to the Uncertainty Related to Reimbursement Policies and
-----------------------------------------------------------------------
Healthcare Reform Measures.
---------------------------

In recent years, there have been numerous proposals to change the healthcare
system in the United States. Some of these proposals have included measures that
would limit or eliminate payments for medical procedures and treatments or
subject pharmaceutical product pricing to government control. In addition, as a
result of marketplace pressures, third-party payors are increasingly attempting
to contain healthcare costs by limiting both coverage and the level of
reimbursement of new drug products. Consequently, significant uncertainty exists
as to the reimbursement status of newly-approved healthcare products. If we or
any of our collaborators succeed in bringing one or more of our products to
market, we cannot assure you that third-party payors will establish and maintain
price levels sufficient for us to realize an appropriate return on our
investment in product development.

Significant changes in the healthcare system in the United States or elsewhere,
including changes resulting from adverse trends in third-party reimbursement
programs, could materially reduce our profitability. Such changes could also
significantly harm our ability to raise the capital we would need to continue
our operations. Furthermore, if these proposals affect our collaborators, the
proposals may harm our ability to commercialize the products we develop jointly
with them.

RISKS RELATING TO OUR INDUSTRY, BUSINESS AND STRATEGY

We May Experience Difficulties in Achieving or Managing Growth, Which Could
---------------------------------------------------------------------------
Materially Harm Our Business, Financial Condition and Results of Operations.
----------------------------------------------------------------------------

If our product development efforts and the product development efforts of our
collaborators succeed, our growth could strain our operations, product
development and other managerial and operating resources. Future growth will
impose significant added responsibilities on members of management, including
the need to identify, recruit, maintain and integrate additional employees,
including management. In the future, our financial performance and our ability
to compete effectively will depend, in part, on our ability to manage any future
growth effectively. To that end, we must be able to:

   .     manage our research and development efforts effectively;

   .     expand the capacity, scalability and performance of our product
         development infrastructure;

   .     enhance our administrative, accounting and management information
         systems and controls;

   .     improve coordination among our research, clinical development, process
         development, finance, manufacturing and other operations personnel; and

   .     hire and train additional qualified personnel.

                                      22
<PAGE>

Our failure to accomplish any of these tasks could materially harm our business,
financial condition and results of operations.

We Face Intense Competition and Rapid Technological Change That Could Result in
-------------------------------------------------------------------------------
Products That Are Superior to the Products We Are Developing.
-------------------------------------------------------------

The biotechnology and pharmaceutical industries are subject to rapid and
significant technological change. We have numerous competitors in the United
States and abroad, including, among others, major pharmaceutical and chemical
companies, specialized biotechnology firms, universities and other research
institutions. These competitors may develop technologies and products that are
more effective or less costly than any of our current or future products and
that could render our technologies and products obsolete or noncompetitive. Many
of these competitors have substantially more resources and product development,
production and marketing capabilities than we do. In addition, many of our
competitors have significantly greater experience than we do in undertaking
preclinical testing and clinical trials of new or improved pharmaceutical
products and obtaining FDA and other regulatory approvals of products for use in
health care. We also will be competing in manufacturing efficiency and, if we
succeed in achieving commercial sales of our products, marketing capability,
areas in which we have limited or no experience. Furthermore, our competitors
may obtain FDA approval for products sooner and/or be more successful in
manufacturing and marketing their products than are we or our collaborators.

Products currently exist in the market that will compete directly with the
products that we seek to develop. Any product candidate that we develop and that
obtains regulatory approval must then compete for market acceptance among
physicians, patients, healthcare payors and the medical community, as well as
for market share. Significant factors in determining whether we will be able to
compete successfully include:

   .     relative efficacy and safety of our products;

   .     timing and scope of regulatory approval;

   .     product availability;

   .     potential advantages over alternative treatment methods;

   .     development, marketing, distribution and manufacturing capabilities and
         support of our collaborators;

   .     reimbursement coverage from insurance companies and others;

   .     price and cost-effectiveness of our products; and

   .     patent protection.

If our products are not competitive based on these or other factors, our
business, financial condition and results of operations will be materially
harmed.

Failure By Our Future Collaboration Partners to Develop, Manufacture, Market or
-------------------------------------------------------------------------------
Distribute Our Other Products May Delay or Significantly Impair Our Ability to
------------------------------------------------------------------------------
Generate Revenues or Otherwise Materially Harm Our Profitability.
-----------------------------------------------------------------

We may rely on future collaboration partners to develop, manufacture,
commercialize, market and distribute our other products. Many of our competitors
are similarly seeking to develop or expand their collaboration and license
arrangements with pharmaceutical companies. The success of these efforts by our
competitors could have an adverse impact on our ability to form future
collaboration arrangements.

                                      23
<PAGE>

We cannot assure you that we will be able to negotiate acceptable collaboration
agreements in the future or that efforts under any collaboration agreements
will succeed. To the extent that we choose not to or are unable to enter into
future collaboration agreements, we would encounter increased capital
requirements to undertake research, development and marketing at our own
expense. In addition, we may experience significant delays in introducing our
product candidates or find that the absence of these collaboration agreements
adversely affects our ability to develop, manufacture or sell our product
candidates.

Our reliance on collaboration partners poses the following additional risks:

   .     disputes with our partners may arise, delaying or terminating our
         product candidates' research, development or commercialization or
         resulting in significant litigation or arbitration;

   .     contracts with our partners may fail to provide significant protection
         or may become unenforceable if one of these partners fails to perform;

   .     our partners may not commit enough capital or other resources to
         successfully develop, market or distribute our products; and

   .     our partners may not continue to develop and commercialize products
         resulting from our collaborations.

If any of these risks occur, our product development and productivity may
suffer, and our business, financial condition and results of operations would be
materially harmed.

We Are Involved in Litigation and Arbitration Proceedings With Novartis and
---------------------------------------------------------------------------
Genentech That May Be Very Costly to Us and Could Cause Us to Lose Our Rights to
--------------------------------------------------------------------------------
Independently Develop Products.
-------------------------------

We are a party to arbitrations and a related federal district court lawsuit with
our collaboration partners Novartis and Genentech, relating to our rights to
develop TNX-901 and other anti-IgE antibodies independently of our collaboration
with Novartis and Genentech. Novartis and Genentech are disputing our right to
pursue development of TNX-901 independently and are claiming that we are using
their unspecified confidential and proprietary information that we have no right
to use.

If we do not succeed in these proceedings, we could lose our rights to
independently develop TNX-901 and incur other substantial damages that would
harm our financial position. Even if we succeed, we expect these proceedings to
consume substantial amounts of our financial and managerial resources. Further,
because of the substantial amount of discovery required in connection with this
type of dispute, there is a risk that disclosure might compromise some of our
confidential information.

We are Involved in Legal Proceedings With Our Former Attorneys That May Be Very
-------------------------------------------------------------------------------
Costly to Us.
-------------

We have been involved in an arbitration regarding a fee dispute with our former
attorneys who represented us in our 1993 lawsuit against Genentech and F.
Hoffman-La Roche, Ltd. and its affiliates, and a 1994 lawsuit filed against us
by Genentech. The arbitration panel issued an award which entitled those
attorneys to receive (i) approximately $3.5 million, including interest, (ii)
payments ranging from 33 1/3% to 40% of any future milestone payments received
by us from Genentech following product approval and (iii) 10% of the royalties
that we receive on sales of anti-IgE products. We sought a court order vacating
the arbitration award. However, a judgment was entered confirming the award. We
are appealing that decision in the Court of Appeals and intend to pursue all
available remedies.

We may not be successful in this proceeding. If this proceeding continues to
result in decisions unfavorable to us, we could lose substantial value from our
collaboration with Novartis and Genentech by virtue of the legal fees awarded by
the panel, which could negatively affect our stock price and harm our business,
financial condition and results of operations. Whether or not we are successful
in this

                                      24
<PAGE>

proceeding, we expect it to consume substantial amounts of our financial and
managerial resources.

Failure to Attract and Retain Key Personnel and Principal Members of Our
------------------------------------------------------------------------
Scientific and Management Staff Could Materially Harm Our Business, Financial
-----------------------------------------------------------------------------
Condition and Results of Operations.
------------------------------------

Our success depends greatly on our ability to attract and retain qualified
scientific and technical personnel, as well as to retain the services of our
existing technical management staff. To pursue our research and development
programs and product development plans, we will be required to hire additional
qualified scientific and technical personnel. There is intense competition for
qualified staff, and we cannot assure you that we will be able to attract and
retain the necessary qualified staff to develop our business. The failure to
attract and retain key scientific and technical personnel and management staff
or the loss of any of our current management team could materially harm our
business and financial condition.

We Are Exposed to Product Liability Claims, and It is Uncertain That We Can
---------------------------------------------------------------------------
Obtain Insurance Against These Claims at a Reasonable Rate in the Future.
-------------------------------------------------------------------------

Our business exposes us to potential product liability risks, which are inherent
in testing, manufacturing, marketing and selling pharmaceutical products. We may
be held liable if any product we develop, or any product that uses or
incorporates any of our technologies, causes injury or is found otherwise
unsuitable during product testing, manufacturing, marketing or sale. We cannot
assure you that we will be able to avoid product liability exposure.

Product liability insurance for the biopharmaceutical industry is generally
expensive, if available at all. We have obtained product liability insurance
coverage in the amount of $5.0 million per occurrence, subject to a $5.0 million
aggregate limitation. However, we cannot assure you that our present insurance
coverage is now or will continue to be adequate. In addition, some of our
license and collaboration agreements require us to obtain product liability
insurance. Future license and collaboration agreements may also include such a
requirement. We cannot assure you that we can obtain adequate insurance coverage
at a reasonable cost in the future. Our inability to obtain sufficient insurance
coverage at an acceptable cost or otherwise to protect against potential product
liability claims could prevent or inhibit us or our collaborators from
commercializing our products. If we are sued for any injury caused by our
products, our liability could exceed our total assets.

We Deal With Hazardous Materials and Must Comply With Environmental Laws and
----------------------------------------------------------------------------
Regulations, Which Can Be Expensive and Restrict How We Do Business.
--------------------------------------------------------------------

Our research and development work and manufacturing processes involve the
controlled use of hazardous materials, including chemical, radioactive and
biological materials. Our operations also produce hazardous waste products. We
are subject to federal, state and local laws and regulations governing how we
use, manufacture, store, handle and dispose of these materials. Although we
believe that we comply in all material respects with applicable environmental
laws and regulations, we cannot assure you that we will not incur significant
costs to comply with environmental laws and regulations in the future. In
addition, current or future environmental laws and regulations may impair our
research, development or production efforts.

                                      25
<PAGE>

We Could be Liable for Damages, Penalties or Other Forms of Censure If We Are
-----------------------------------------------------------------------------
Involved in a Hazardous Waste Spill or Other Accident.
------------------------------------------------------

Despite precautionary procedures that we implement for handling and disposing of
hazardous materials, we cannot eliminate the risk of accidental contamination or
discharge or any resultant injury from these materials. If a hazardous waste
spill or other accident occurs, we could be liable for damages, penalties or
other forms of censure. In addition, we may be sued for injury or contamination
that results from our use or the use by third parties of these materials, and
our liability could exceed our total assets.

RISKS ASSOCIATED WITH MANUFACTURING AND MARKETING

Failure to Receive Market Acceptance for and Successfully Commercialize Xolair
------------------------------------------------------------------------------
Would Have a Significant Adverse Effect on Us.
----------------------------------------------

Even if the FDA approves Xolair, we cannot be certain that physicians, patients,
insurers or other third-party payors will accept Xolair as a treatment for its
approved indications in the United States or in any foreign markets. A number of
factors may affect the rate and level of Xolair's market acceptance including:

   .     regulatory developments related to manufacturing or using Xolair;

   .     Xolair's price relative to other products or competing treatments;

   .     the effectiveness of Novartis' and Genentech's sales and marketing
         efforts;

   .     the perception by physicians and other members of the healthcare
         community of Xolair's safety, efficacy and benefits compared to those
         of competing products or therapies;

   .     the willingness of physicians to adopt a new asthma treatment regimen;

   .     the availability of third-party reimbursement; and

   .     unfavorable publicity concerning Xolair or comparable products or
         therapies.

If Xolair is not accepted as a safe and effective drug and we are unable to
successfully commercialize it, our business, financial condition and results of
operations will be materially harmed.

We Have Limited Experience and Capability in Manufacturing and May Encounter
----------------------------------------------------------------------------
Manufacturing Problems or Delays That Could Result in Lost Revenue.
-------------------------------------------------------------------

To commercialize our products successfully, we and our collaboration partners
must manufacture our products in commercial quantities in compliance with
regulatory requirements and at an acceptable cost. If the manufacturing
facilities used to produce our products cannot pass a pre-approval or periodic
plant inspection, the FDA may not approve our products or it may delay or bar
their sale. Although Novartis and Genentech have indicated that they wish to
manufacture and supply Xolair, we have reserved the right to manufacture up to
50% of the worldwide requirements. While we have successfully produced our
products for Phase 1 and Phase 2 clinical trials, we have no experience in
manufacturing commercial quantities of antibodies and currently have limited
manufacturing capacity.

In order to obtain regulatory approvals and to create capacity to produce our
products in sufficient quantities for commercial sale at an acceptable cost, we
will have to develop or acquire additional technology for commercial scale
manufacturing and build or otherwise obtain access to adequate facilities, which
will require substantial additional funds. We will also be required to
demonstrate to the FDA and corresponding foreign authorities our ability to
manufacture our products using controlled,

                                      26
<PAGE>

reproducible processes. We cannot assure you that we can develop the necessary
manufacturing technology or that we will be able to fund or build an adequate
commercial manufacturing facility necessary to obtain regulatory approvals and
to produce adequate commercial supplies of our potential products on a timely
basis.

We cannot assure you that we, operating alone or with the assistance of others,
will be able to successfully make the transition to commercial production. In
addition, as more of our products move into the clinic, we cannot assure you
that we will be able to continue to produce sufficient quantities of our product
to timely supply our clinical requirements. Any failure to produce these
clinical requirements, either as a result of our limited manufacturing capacity
or otherwise, can delay the commencement of, or ability to continue our ongoing,
clinical trials.

We Lack Sales and Marketing Experience, Which Makes Us Depend on Third Parties
------------------------------------------------------------------------------
for Their Expertise in this Area.
---------------------------------

Under our current collaboration agreement, Novartis and Genentech have exclusive
marketing rights to Xolair and other selected anti-IgE products. However,
commercialization rights may revert back to us if either we or our collaborators
terminate our relationship. We currently have no sales, marketing or
distribution capabilities. Any revenues we receive from our Xolair collaboration
will depend primarily on the efforts of our collaboration partners. We intend to
retain marketing rights in the United States and selected Asian countries for
products that we can develop and sell effectively with a small, targeted sales
force. If we elect to market products directly, we would require significant
additional expenditures and management resources to develop an internal
marketing and sales force. We cannot assure you that we would be able to
establish a successful sales force should we choose to do so.

RISKS RELATED TO FINANCIAL RESULTS AND NEED FOR FINANCING

We Have a History of Net Losses; We Expect to Continue to Incur Net Losses and
------------------------------------------------------------------------------
We May Never Achieve or Maintain Profitability.
-----------------------------------------------

We have incurred net losses since our inception. As of December 31, 2001, we had
an accumulated deficit of approximately $52.9 million, including a net loss of
approximately $21.4 million for the year ended December 31, 2001. Our losses
have primarily been the result of costs incurred in our research and development
programs and from our general and administrative costs.

We have not earned any revenues from commercial sales of any of our therapeutic
products, and such sales may not commence until 2003, if at all. We have funded
our operations principally from licensing fees and milestone payments under our
current or former collaborations, as well as with proceeds from private
placements and an initial public offering of our common stock. As we increase
our research and development, manufacturing, clinical trial and administrative
activities, we expect to continue to incur substantial operating losses until
such time, if ever, that we are able to generate sufficient revenue from
milestone payments and royalties on Xolair to cover our expenses.

Our ability to achieve and maintain long term profitability depends to a
significant extent on obtaining regulatory approval for and successfully
commercializing Xolair, and also on successfully completing preclinical and
clinical trials, obtaining required regulatory approvals and successfully
developing, manufacturing and marketing our other current and future product
candidates. We cannot assure you that we will be able to achieve any of the
foregoing or that we will be profitable even if we successfully commercialize
our products.

                                      27
<PAGE>

Failure by Novartis or Genentech to Obtain Regulatory Approval for, Manufacture,
--------------------------------------------------------------------------------
Market or Distribute, Xolair or Other Anti-IgE Products May Delay or
--------------------------------------------------------------------
Significantly Impair Our Ability to Generate Revenues.
------------------------------------------------------

Under the terms of our collaboration agreements, Novartis and Genentech are
responsible for developing, obtaining regulatory approval for, manufacturing,
marketing and distributing Xolair and other anti-IgE products that the
collaboration may select for development. We expect for the extended future that
Novartis and Genentech will manufacture, market and distribute Xolair and other
selected anti-IgE products, if the FDA approves any of these products. We also
rely on Novartis and Genentech for significant financial and technical
contributions to develop products covered by our collaboration agreements. Our
ability to profit from these products depends on Novartis' and Genentech's
performance under their agreements with us. We cannot control the amount and
timing of resources Novartis and Genentech will devote to any of our products.
If Novartis or Genentech experiences manufacturing or distribution difficulties,
does not actively market Xolair or other selected anti-IgE products or does not
otherwise perform under our collaboration agreements, our potential for revenue
from those products will be dramatically reduced. Novartis and Genentech may
terminate our collaboration agreements on short notice. If Novartis or Genentech
terminates our collaboration, we would experience increased capital requirements
to undertake development and marketing at our expense, and we cannot assure you
that we would be able to develop Xolair or our other anti-IgE products on our
own.

We May Need Additional Financing, But Our Access to Capital Funding is
-----------------------------------------------------------------------
Uncertain.
---------

Our current and anticipated development projects require substantial additional
capital. While we expect that our cash on hand, together with our revenue from
operations, will sufficiently fund our operations for the next four years, our
future capital needs will depend on many factors, including successfully
commercializing Xolair, receiving milestone payments from our collaboration
partners, and making progress in our research and development activities. Our
success may also depend on the magnitude and scope of these activities, the
progress and level of unreimbursed costs associated with preclinical studies and
clinical trials, the costs associated with acquisitions, the costs of preparing,
filing, prosecuting, maintaining and enforcing patent claims and other
intellectual property rights, competing technological and market developments,
changes in or terminations of existing collaboration and licensing arrangements,
the establishment of additional collaboration and licensing arrangements, and
the cost of manufacturing scale-up and development of marketing activities, if
undertaken by us. We do not have committed external sources of funding and we
cannot assure you that we will be able to obtain additional funds on acceptable
terms, if at all. If adequate funds are not available, we may be required to:

   .     delay, reduce the scope of or eliminate one or more of our development
         programs;

   .     obtain funds through arrangements with collaboration partners or others
         that may require us to relinquish rights to technologies, product
         candidates or products that we would otherwise seek to develop or
         commercialize ourselves; or

   .     license rights to technologies, product candidates or products on terms
         that are less favorable to us than might otherwise be available.

If we raise additional funds by issuing additional stock, further dilution to
our stockholders may result, and new investors could have rights superior to
existing stockholders. If funding is insufficient at any time in the future, we
may be unable to develop or commercialize our products, take advantage of
business opportunities or respond to competitive pressures.

                                      28
<PAGE>

RISKS RELATING TO INTELLECTUAL PROPERTY

We Depend on Our Patents And Proprietary Rights.  The Validity, Enforceability
------------------------------------------------------------------------------
and Commercial Value of These Rights Are Highly Uncertain.
----------------------------------------------------------

Our success depends in part on obtaining, maintaining and enforcing patents,
licensing the rights to patents and patent applications owned by others,
maintaining trade secrets and operating without infringing on the proprietary
rights of third parties. While we file and prosecute patent applications to
protect our inventions, our pending patent applications may not result in the
issuance of valid patents and our issued patents may not provide competitive
advantages. Also, our patent protection may not prevent others from developing
competitive products using related technology. We cannot assure you that pending
patent applications developed by or licensed to us will result in patents being
issued or that, if issued, the patents will give us an advantage over
competitors with similar technology.

We own and have licenses to certain issued patents. The patents we own that are
most material to our business are five U.S. patents and six foreign patents
relating to anti-IgE antibodies. However, the patent position of biotechnology
and pharmaceutical firms is highly uncertain and involves many complex legal and
technical issues. There is no clear policy involving the breadth of claims
allowed or the degree of protection afforded under such patents. Issued patents
can be challenged in litigation in the courts and in proceedings in the patent
and trademark office in the United States and in courts and patent offices in
foreign countries. Issuance of a patent is not conclusive as to its validity,
enforceability or the scope of its claim. We cannot assure you that our patents
will not be successfully challenged as to enforceability, invalidated or limited
in the scope of their coverage. Moreover, litigation to uphold the validity of
patents and to prevent infringement can be very costly and can result in
diverting technical and management personnel's time and attention, which may
materially harm our business, financial condition and results of operations. If
the outcome of litigation is adverse to us, third parties may be able to use our
patented technology without paying us. Moreover, we cannot assure you that our
patents will not be infringed or successfully avoided through design innovation.
Any of these events may materially and adversely affect our business.

There may be patent rights belonging to others that require us to alter our
products, pay licensing fees or cease certain activities. If our products
conflict with patent rights of others, the owners of those patent rights could
bring legal actions against us claiming damages and seeking to stop us from
manufacturing and marketing the affected products. If these legal actions are
successful, in addition to any potential liability for damages, we could be
required to obtain a license in order to continue to manufacture or market the
affected products. We cannot assure you that we would prevail in any such action
or that any license required under any such patent would be made available on
acceptable terms or at all. Any of these events may materially harm our
business, financial condition and results of operations.

Researching, developing and commercializing a biopharmaceutical product often
involves alternative development and optimization routes that are presented at
various stages in the development process. We cannot predict the preferred
routes at the outset of a research and development program, because they will
depend on subsequent discoveries and test results. There are numerous
third-party patents in our field, and it is possible that, to pursue the
preferred development route of one or more of our products, we will need to
obtain a license to a patent, which would decrease the ultimate profitability of
the applicable product. If we cannot negotiate a license, we might have to
pursue a less desirable development route or terminate the program altogether.

We are aware that other groups have claimed discoveries similar to those covered
by our patent applications. In addition, other companies, some of which may be
our competitors, have filed applications for or have been issued patents and may
obtain additional patents and proprietary rights relating to products or
processes used in, necessary to, competitive with or otherwise related to our
patents and products. These products and processes include, among other items,
patents covering technology relating to humanized monoclonal antibodies that we
anticipate developing. Protein Design

                                      29
<PAGE>

Labs, Inc. owns certain patents and patent applications relating to such
humanized antibodies. We have acquired the right to take non-exclusive licenses
to these patents for up to four of our products.  We do not know if we can
obtain licenses from Protein Design Labs for our other antibody products.

We must make substantial cash payments and achieve certain milestones and
satisfy certain conditions, including filing investigational new drug
applications, obtaining product approvals and introducing products, to maintain
our rights under certain of our licenses, including our licenses from Chiron and
Biogen, Inc. We cannot assure you that we will be able to maintain our rights
under these licenses. If any of these licenses terminate, we may be unable to
commercialize any related product.

In addition to the intellectual property rights described above, we also rely on
unpatented technology, trade secrets and confidential information. We cannot
assure you that others will not independently develop substantially equivalent
information and techniques or otherwise gain access to our technology or
disclose such technology, or that we can effectively protect our rights in
unpatented technology, trade secrets and confidential information. We require
each of our employees, consultants and advisors to execute a confidentiality
agreement at the commencement of an employment or consulting relationship with
us. We cannot assure you, however, that these agreements will provide effective
protection if an unauthorized use or disclosure of this confidential information
occurs.

EXECUTIVE OFFICERS OF TANOX

Our executive officers and their ages and positions with Tanox are:

Name                                     Age            Position
----                                     ---            --------
Nancy T. Chang, Ph.D..................   52    Chairman of the Board, President
                                                 and Chief Executive Officer
William R. Shanahan, Jr., M.D.........   53    Chief Medical Officer
Matthew Moyle, Ph.D...................   41    Vice President of Research
Michael A. Kelly......................   45    Vice President and Chief
                                                 Financial Officer
Joseph M. Welch.......................   61    Vice President of Business
                                                 Development
Seenu V. Srinivasan, Ph.D.............   48    Vice President of Manufacturing
                                                 Operations
Katie-Pat Bowman......................   47    Vice President, General Counsel
                                                 and Secretary
Gary M. Glandon.......................   43    Vice President of Human Resources

Nancy T. Chang, Ph.D.  is one of our co-founders and has served as our
President and Chairman of the Board of Directors since our organization in
March 1986. Dr. Chang has served as our Chief Executive Officer since June
1990.  From 1986 to 1992, Dr.  Chang served as an Associate Professor at Baylor
College of Medicine in the Division of Molecular Virology.  Between 1981 and
1986, Dr. Chang was employed by Centocor, Inc., serving as the Director of
Research, Molecular Biology Group, from 1984 to 1986.  From 1980 to 1981, she
was employed by Roche Institute of Molecular Biology.  Dr. Chang received her
Ph.D. in biological chemistry from Harvard University.

William R. Shanahan, Jr., M.D. has served as our Chief Medical Officer since
August 2000. From 1994 to August 2000, he served as Vice President, Drug
Development of Isis Pharmaceuticals, a leader in antisense technology, and,
prior to that, he was Director of Clinical Research at Pfizer Central Research
where he directed the clinical development of new anti-inflammatory
pharmacologic agents. At Searle Research and Development, he held Associate
Director and Director of Clinical Research positions where he developed and
monitored clinical studies related to anti-inflammatory, gastroprotective,
anti-HIV, and antineoplastic pharmacologic agents. In addition, at the
University of Connecticut School of Medicine he held various positions in the
Division of Rheumatology including Clinical Associate Professor. Dr. Shanahan
graduated from the University of California - San Francisco with a Doctorate in
Human

                                      30
<PAGE>

Medicine in 1974, and from Loyola University of Chicago with a Juris Doctorate
in 1992.

Matthew Moyle, Ph.D., joined us as Vice President of Research in January 2001.
Prior to that, he held various positions with Amgen, Inc., a biotechnology
company, since October 1995, including most recently Department Head of
Expression Profiling and Pharmacogenomics.  From July 1991 to September 1995 he
held senior research positions with Corvas, Inc.  where he was involved in the
discovery and development of two biological agents that are currently in
clinical testing.  While at Amgen and Corvas, Dr.  Moyle was actively involved
in recruiting scientists and establishing multi-disciplinary project teams. He
also participated in licensing transactions.  Dr. Moyle received both his Ph.D.
and B.Sc. degrees in Biochemistry from the University of Toronto.

Michael A. Kelly has served as our Vice President and Chief Financial Officer
since October 2000. Before joining Tanox, he was Vice President and Corporate
Controller of Biogen, Inc., a biopharmaceutical company, since August 1998,
where he was responsible for worldwide financial strategy and organizational
development and led a 75-person global team. While at Biogen, he was responsible
for an immediate improvement in the credibility of the Corporate Controller role
and reputation of the finance function through a service-oriented presence in
the business. Prior to that, he held numerous senior management positions with
Monsanto Life Sciences Company between 1981 and 1998, including Vice President,
Finance.

Joseph M. Welch became our Vice President of Business Development in June 2001.
From September 1993 to June 2001, Mr. Welch was Vice President of Business
Development for Texas Biotechnology Corporation in Houston, where he was
instrumental in effecting several alliances with major pharmaceutical and
biotechnology companies, including Schering Plough, GlaxoSmithKline and ICOS
Corporation. Prior to that, Mr. Welch spent 26 years with the Pharmaceutical
Division of DuPont and DuPont Merck Pharmaceutical Company. Mr. Welch holds an
MBA from Denver University.

Seenu V.  Srinivasan, Ph.D., joined Tanox as Vice President of Manufacturing
Operations in August 2001.  From August 2000 to July 2001, Dr.  Srinivasan was
Vice President of Pharmaceutical Development and Operations at Aronex
Pharmaceuticals, Inc., where he was responsible for all aspects of CMC
(Chemistry, Manufacturing and Controls) sections of pharmaceutical development,
including preformulation, formulation, scale up and manufacturing, and
regulatory document preparation.  From January 1998 to July 2000, he worked at
Boehringer Ingelheim Vetmedica, Inc. (BIV) as head of pharmaceutical research
and development, where he was in charge of preformulation, scale up, analytical
development, testing and technical support for manufacturing, and CMC document
preparation for regulatory submissions in the U.S. and Europe. Dr. Srinivasan
was Alza Pharmaceuticals' manager of OROS(R)Process Engineering from October
1996 to December 1997, and held various management positions at Mallinckrodt
Inc., a chemical and pharmaceutical company, from 1982-1996, including director
of research and development. Dr. Srinivasan received his Ph.D. in chemistry
from Purdue University.

Katie-Pat Bowman has served as our Vice President, General Counsel and Secretary
since July 2000. Prior to that she was Senior Corporate Counsel and Assistant
Secretary for Lyondell Chemical Company from September 1999 until July 2000. She
was Vice President and General Counsel for Daniel Industries Inc., a pipeline
equipment manufacturer, from September 1997 until September 1999, when it was
acquired by Emerson Electric Company. She practiced law with Houston-based law
firms Haynes & Boone LLP, from March 1997 until September 1997, and Fulbright &
Jaworski, L.L.P., from 1987 through February 1997. Ms. Bowman, a CPA, practiced
public accounting and worked in industry as an accountant from 1977 through
1987. She received both a Juris Doctorate and BBA from the University of
Houston.

Gary M. Glandon has served as our Vice President of Human Resources since August
2001. Prior to joining Tanox, Mr. Glandon was with Gateway, Inc., a manufacturer
and marketer of personal computers, most recently as Vice President of Corporate
Human Resources where he was responsible for all staff

                                      31
<PAGE>

human resources activities for Gateway. Prior to that, from February 1999 to
March 2001, Mr.  Glandon was Vice President of Human Resources with
responsibility for Gateway's consumer division (comprising about 10,000
employees), and from November 1997 to February 1999, he was responsible for the
global human resources function, which included Gateway's international
operations. From July 1996 until November 1997, Mr. Glandon had various HR
positions with Gateway, including Head of HR for Gateway's Country Store
division. From November 1989 to June 1996, Mr. Glandon worked for Abbott
Laboratories in the human resources function. He has also held human resources
positions at Magnavox and Phillips Petroleum. He received a BBA from Michigan
State University and has an MSBA from St. Francis College.

SCIENTIFIC ADVISORS

An important component of our scientific strategy is to establish collaborative
relationships with leading researchers in our fields of interest. Certain of our
scientific advisors attend periodic meetings and provide us with specific
expertise in both research and clinical development. In addition, we have
collaborative research relationships with certain individual advisors. We do not
employ our scientific advisors, and they may have commitments to or consulting
or advisory agreements with other entities that may limit their availability to
us. These companies may also compete with us. Several of our advisors have, from
time to time, devoted significant time and energy to our affairs. In general,
our scientific advisors may hold stock options, own our stock and/or receive
financial remuneration for their services.

Our scientific advisors are:

<TABLE>
<CAPTION>
Name                                                           Title and Affiliation
----                                                           ---------------------
<S>                                           <C>
John Atkinson, M.D..........................  Professor, Department of Medicine & Medical Microbiology,
                                              Washington University School of Medicine
K. Frank Austen, M.D.*......................  Director, Inflammation and Allergic Diseases, Brigham and
                                              Women's Hospital
Stanley J. Korsmeyer, M.D...................  Director, Program in Molecular Oncology, Sidney Farber
                                              Professor of Pathology and Medicine, Dana-Farber Cancer
                                              Institute
Donald MacGlashan Jr, MD, PhD...............  Associate Professor of Medicine, Johns Hopkins Asthma and
                                              Allergy Center
Robert T. Schooley, M.D.....................  Chief of Division of Infectious Diseases, University of
                                              Colorado Health Sciences Center
Ethan M. Shevach, M.D.......................  Chief, Cellular Immunology Section, National Institute of
                                              Allergy and Infectious Disease
</TABLE>
---------------------------------
*  Chairman

ITEM 2.  PROPERTIES

We currently lease 35,600 square feet of laboratory and manufacturing space
(including a biological product manufacturing facility) in a 42,100 square foot
industrial building in Houston, Texas. When the third party lease for the
remaining 6,500 square feet in the building expires in April 2002, we will
occupy the entire building. The lease expires in March 2007, and we have two
five-year renewal options. In January 2001, we acquired a 13.2-acre tract of
land near our present facility. Our corporate administrative offices currently
occupy approximately 13,100 square feet of leased space in Houston, Texas, under
a lease that expires in September 2003, with options for two six-month
extensions. We also lease approximately 6,500 square feet of space in the
Hsinchu Science Based Industrial Park in Taiwan. While we believe that our
existing facilities are adequate to meet our immediate needs, we are actively
evaluating alternatives for acquiring, building or leasing a research and
administration building in

                                      32
<PAGE>

Houston. We believe that suitable space, whether constructed and/or owned by us
or leased, will be available in the future on commercially reasonable terms.

ITEM 3.  LEGAL PROCEEDINGS

Dispute with Former Attorneys. We are arbitrating a fee dispute with the law
firms that represented us in connection with a lawsuit involving Genentech and
Roche relating to, among other things, the intellectual property rights of the
parties surrounding the development of anti-IgE technology. We settled the
lawsuit contemporaneously with the formation of our collaboration with
Genentech.

We initiated the arbitration proceeding in August 1996, after we and our
attorneys, Akin, Gump, Strauss, Hauer and Feld, L.L.P., The Robinson Law Firm
and Williams, Birnberg & Anderson, could not reach agreement on the fee owed
pursuant to the terms of our written fee agreement. The arbitration panel issued
an award entitling the attorneys to receive (i) approximately $3.5 million,
including interest, (ii) payments ranging from 33 1/3% to 40% of the future
milestone payments received by us from Genentech under the collaboration
following product approval and (iii) 10% of the royalties that we receive on
sales of anti-IgE products.

We sought a court order vacating the arbitration award, but a judgment was
entered confirming the award. We have appealed the District Court's decision to
the Court of Appeals, 14/th/ District of Texas, on the basis that the panel
manifestly disregarded the law and the facts in arriving at the award, the award
is against public policy, and the award fails to draw its essence from the
underlying fee agreement. The appeal was argued on February 7, 2002, and we
currently await the Court's ruling.

If this proceeding continues to result in decisions unfavorable to us, we could
lose substantial value from our collaboration with Novartis and Genentech by
virtue of the legal fees awarded by the panel, which could negatively affect our
stock price and harm our business, financial condition and results of
operations.

Dispute Over Independent Development Rights. We are currently pursuing clinical
development of TNX-901 to determine its potential in treating peanut induced
anaphylaxis independently of Novartis and Genentech. Novartis and Genentech have
disputed our right to pursue development of TNX-901 independently, but we
believe our agreements with Novartis and Genentech permit this activity.

In an effort to resolve this dispute, we initiated an arbitration with Novartis
in March 1999 pursuant to our Development and Licensing Agreement (D&L
Agreement) with Novartis. In the arbitration, we are seeking, among other
things, to confirm our rights to independently develop certain anti-IgE
products, including TNX-901, and to use know-how we received from Novartis in
our development activities. Novartis initially claimed that the dispute was not
subject to arbitration and that our claimed rights to independently develop
TNX-901 do not exist. Novartis also claimed damages arising from our actions.

In response to the arbitration we initiated against Novartis, Novartis and
Genentech jointly filed suit against us in April 1999 in the U.S. District Court
for the Northern District of California. In the lawsuit, Novartis and Genentech
seek declarations that we cannot develop TNX-901 independently, that we cannot
use confidential and proprietary information obtained from Novartis or Genentech
for independent product development, and that we cannot pursue separate
arbitrations on these matters against both Novartis and Genentech. Novartis and
Genentech also claim undetermined actual and punitive damages resulting from our
independent development of TNX-901, and seek a permanent injunction stopping our
TNX-901 development and preventing us from continuing with our arbitrations on
these matters.

In July 1999, we initiated an arbitration proceeding against Genentech, seeking,
among other things, confirmation that Genentech expressly acknowledged our
independent development rights in our agreement with them and that Genentech
agreed to allow us to use and disclose their confidential and proprietary
information for purposes contemplated by our separate agreement with Novartis.
Genentech

                                      33
<PAGE>

asserted that their disputes with us are not subject to arbitration and should
remain in Federal court and, further, that our arbitration with Novartis should
be joined with Genentech's arbitration.

In September 1999, the U.S. District Court Judge issued an order staying
virtually all proceedings in the lawsuit and both arbitrations, and ordered the
parties to mediation. The mediation took place in November 1999, and concluded
unsuccessfully. In September 2000, and without lifting the stay on the
arbitrations, the U.S. District Court Judge indicated that the litigation should
continue and that discovery be had on an accelerated basis to determine certain
contractual issues. In October 2001, the Court ruled on motions for summary
judgment filed by each of the parties and granted summary judgment in our favor,
finding that, pursuant to the D&L Agreement with Novartis, we have independent
development rights, and that nothing in the Outline of Terms among Tanox,
Genentech and Novartis superseded those rights. In addition, the Court noted
that we may proceed with the development of TNX-901 and that we may use
information acquired under our tripartite agreement with Genentech and Novartis
in connection with our development of TNX-901. The Court also lifted the stays
on the two arbitration proceedings.

Thereafter, Novartis and Genentech continued to dispute Tanox's right to
independently develop TNX-901 and, on December 10, 2001, the Court stayed the
litigation and directed the parties to return to the arbitrations originally
initiated by Tanox, Inc. to resolve remaining issues with respect to TNX-901.

We intend to continue to pursue independent development of TNX-901 during the
pendency of the above-described actions. If we are unsuccessful in these
actions, we could be required to cease development of TNX-901 and other anti-IgE
products covered by the collaboration with Novartis and Genentech and could be
required to pay damages.

Dispute Regarding Contingent Payment for Tanox Pharma.  In March 1998, we
acquired all of the outstanding shares of Tanox Pharma B.V.  (formerly known as
Pangenetics B.V.) The purchase price was payable in three installments of cash
and Tanox common stock, and payment of the total consideration was contingent
on the satisfaction of certain conditions.  One of the conditions to be
satisfied was the origination of three new projects prior to March 8, 2001, by
the former shareholders of Tanox Pharma (Pan Resources International N.V.,
Andries deNooij B.V., M. deBoer, J.W. Larrick, J.S. Price, R.F. Balint, M.T.
denHartog, L. Boon (Former Shareholders)).  Based on a determination that only
one project was originated, we reduced the total consideration payable to the
Former Shareholders by 20%, and the third installment of cash and stock was
accordingly reduced.

We have sought a declaratory judgement from the District Court of Harris County
that we fulfilled our obligations under the agreement. The Former Shareholders
claim that the total consideration should not have been reduced and, further,
that Tanox should issue additional shares of common stock to the Former
Shareholders because we declared a stock dividend on February 1, 2000. Thus, the
Former Shareholders claim that they are entitled to an additional $200,000 and
181,552 shares of common stock. The Former Shareholders also claim that, because
of the alleged failure by Tanox to tender the third installment, we must
transfer a sufficient number of shares of Tanox Pharma to the Former
Shareholders as would reduce our interest in Tanox Pharma to 49%. Messrs.
DeBoer, Larrick and Price make similar claims against Tanox and Tanox Pharma in
an action brought by them in Haarlem, the Netherlands.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders of the Company, through
solicitation of proxies or otherwise, during the last quarter of 2001.

                                      34
<PAGE>

PART II

ITEM 5.  MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

MARKET PRICE AND DIVIDENDS

Our common stock trades on The Nasdaq Stock Market under the symbol TNOX. Public
trading of our stock began on April 7, 2000. The table below provides the high
and low sales prices of our common stock for the periods indicated, as reported
by The Nasdaq Stock Market.

                                                         High          Low
                                                         ----          ---
Year Ended December 31, 2000:
Second quarter (beginning April 7)...........           $54.31       $24.75
Third quarter................................            50.50        33.88
Fourth quarter...............................            41.00        26.88

Year Ended December 31, 2001:
First quarter................................            40.00        17.25
Second quarter................................           34.09        16.75
Third quarter................................            30.91        12.00
Fourth quarter...............................            22.24        13.18

On March 8, 2002, the last reported sale price of our common stock on the Nasdaq
National Market was $15.42. As of March 8, 2002, there were 44,077,881 shares of
common stock outstanding and 172 shareholders of record of our common stock.

We have never declared or paid any cash dividends on our common stock and do not
anticipate paying such cash dividends in the foreseeable future. We currently
anticipate that we will retain all of our future earnings for use in our
research and product development activities and for general corporate purposes.
Any determination to pay dividends in the future will be at the discretion of
our Board of Directors and will depend upon our results of operations, financial
condition and other factors as the Board of Directors, in its discretion, deems
relevant.

USE OF IPO PROCEEDS

On April 6, 2000, the Securities and Exchange Commission declared effective our
Registration Statement on Form S-1, Commission File No. 333-96025, registering
the sale of 8,568,000 shares of our Common Stock (including the over-allotment
option) for net proceeds of $225,837,000. None of the proceeds from the initial
public offering were used during the period beginning with the closing of that
offering and ending on December 31, 2001; however, we continue to expect that
our use of these proceeds will be as described in the prospectus to our
Registration Statement. Pending such use, the net proceeds are being invested in
interest-bearing investment-grade securities.

                                      35
<PAGE>

ITEM 6.  SELECTED FINANCIAL DATA

       We derived the following data from the consolidated financial statements
that Arthur Andersen LLP, independent public accountants, audited. This data
should be read in conjunction with the consolidated financial statements.

<TABLE>
<CAPTION>
                                                                                  Year Ended December 31,
                                                         =========================================================================
                                                            1997           1998            1999             2000          2001
                                                         ===========    ===========     ===========     ===========    ===========
                                                                             (In thousands, except per share data)
<S>                                                      <C>            <C>             <C>             <C>            <C>

STATEMENT OF OPERATIONS DATA:
Revenues..................................               $  8,939       $  2,422        $   1,405       $   12,748     $    419
                                                         -----------    -----------     -----------     -----------    -----------

Research and development..................                  6,926         11,933           17,163           18,325       21,683
General and administrative................                  2,230          3,431            8,582            7,683        8,349
Restructuring charge......................                     --             --               --               --        3,860
                                                         -----------    -----------     -----------     -----------    -----------
Total operating costs and expenses........                  9,156         15,364           25,745           26,008       33,892
                                                         -----------    -----------     -----------     -----------    -----------
Loss from operations......................                   (217)       (12,942)         (24,340)         (13,260)     (33,473)

Other income, net.........................                  1,045          1,240            1,028           13,128       12,096
                                                         -----------    -----------     -----------     -----------    -----------
Income (loss) before income taxes.........                    828        (11,702)         (23,312)            (132)     (21,377)
(Provision) benefit of income taxes.......                   (198)         1,533              (34)            (915)          --
                                                         -----------    -----------     -----------     -----------    -----------

Net income (loss).........................               $    630       $ (10,169)      $ (23,346)      $   (1,047)    $(21,377)
                                                         ===========    ===========     ===========     ===========    ===========

Earnings (loss) per share:
     Basic................................               $   0.02       $  (0.35)       $   (0.75)      $    (0.03)    $  (0.49)
                                                         ===========    ===========     ===========     ===========    ===========
     Diluted..............................               $   0.02       $  (0.35)       $   (0.75)      $    (0.03)    $  (0.49)
                                                         ===========    ===========     ===========     ===========    ===========
Shares used in computing earnings (loss) per share:
     Basic................................                 27,909         29,105           31,113           40,258       44,010
     Diluted..............................                 31,190         29,105           31,113           40,258       44,010

                                                                                       December 31,
                                                        ==========================================================================
                                                            1997           1998            1999            2000           2001
                                                        =============   ============    ============    ============   ============
                                                                                      (In thousands)
BALANCE SHEET DATA:

Cash, cash equivalents and investments....               $  36,857      $ 33,735        $  47,254       $ 275,921      $261,102
Working capital...........................                  35,871        34,323           42,718         175,309       198,092
Total assets..............................                  44,831        43,422           55,328         290,978       277,534
Long term debt............................                   9,000        10,000           10,000          10,000        10,000
Accumulated deficit.......................                   3,054        (7,115)         (30,461)        (31,508)      (52,885)
Total stockholders' equity................                  34,428        31,540           40,007         272,774       256,441
</TABLE>

ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS

OVERVIEW

       Tanox identifies and develops therapeutic monoclonal antibodies to
address significant unmet medical needs in the areas of asthma, allergy,
autoimmune, inflammation and other related diseases. Tanox's products are
genetically engineered antibodies that target a specific substance, or antigen.
In 1987, we discovered a novel approach for treating allergies and asthma by
using anti-immunoglobulin E, or anti-IgE, antibodies capable of blocking IgE, a
causative agent of the allergy pathway, thus preventing the onset of disease
symptoms. Xolair, our most advanced product in development, is a humanized
monoclonal antibody that blocks IgE. Its therapeutic effect has been validated
through clinical trials in patients suffering from allergic asthma, seasonal
allergic rhinitis (hay fever) and perennial allergic rhinitis. We are developing
Xolair in collaboration with Novartis Pharma AG and Genentech, Inc. In June
2000, our collaboration partners filed a BLA with the FDA and a submission for
marketing approval with health authorities in the EU, Switzerland, Australia,
and New Zealand for allergic asthma and hay fever in adults, adolescents and
children. Following receipt of a Complete Response Letter in July 2001, our
collaboration partners are expected to submit an amendment to the BLA in 2002 or
early 2003, which will narrow the proposed initial claim to allergic asthma in
adults and adolescents.

       Using our knowledge of the human immune system, we are building a diverse
pipeline of

                                      36
<PAGE>

monoclonal antibody product candidates. We are conducting clinical trials with
three additional monoclonal antibodies. TNX-901, a humanized anti-IgE
monoclonal antibody distinct from Xolair, is currently in a Phase 2 trial to
evaluate the potential of TNX-901 to reduce the sensitivity to peanut allergen
in patients suffering from severe peanut allergy. TNX-100 is an anti-CD40
monoclonal antibody currently in a Phase 1 trial for treating Crohn's disease.
TNX-355, an anti-CD4 antibody, is in a Phase 1 trial for treating HIV.  We are
also conducting preclinical and research studies with TNX-224, a complement
factor D inhibiting antibody for treating acute inflammatory indications.

       We currently have no products available for sale. We are focusing our
efforts on research and product development activities necessary to advance our
product opportunities, including process development and clinical trialA
activities for products that are currently in the clinic or will commence
clinical development in the next several months. We have incurred substantial
losses since inception and incurred an accumulated deficit through December 31,
2001, of $52.9 million. We expect to continue to incur substantial operating
losses for the foreseeable future, particularly as we expand our research and
development activities, produce clinical material and initiate additional
clinical trials, as well as provide additional administrative support for these
and other activities. We expect that losses will continue until such time, if
ever, that we generate sufficient revenue from Xolair or our other products to
cover our expenses.

       Historically, we have earned revenues primarily from milestone payments,
license fees and sponsored research under our collaboration agreements. In the
future, we expect our principal revenues will be milestone payments, royalties
and profit-sharing payments from Novartis and Genentech. We may also receive
royalties from Hoffman-La Roche Ltd. should it participate in selling Xolair in
Europe. Our revenues will depend particularly on the success of our
collaboration partners in developing, manufacturing, obtaining regulatory
approvals for and marketing Xolair. Because a substantial portion of our
revenues for the foreseeable future will depend on achieving development and
commercialization milestones, we anticipate that our results of operations will
vary substantially from year to year and even quarter to quarter.

CRITICAL ACCOUNTING POLICIES

Use of Estimates

       The preparation of financial statements in conformity with generally
accepted accounting principles in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of expenses during the
reporting period. The actual results could differ from those estimates, and any
adjustment will be reflected in future results.

Cash, Cash Equivalents and Investments

       Cash equivalents consist of highly liquid investments with an original
maturity of three months or less when purchased. Investments consist of
investment grade corporate bonds and commercial paper with maturity dates of
less than two years. Tanox's policy is to hold all investments until maturity,
therefore, all investments are classified as held-to-maturity and carried at
amortized cost.

       At December 31, 2001, Tanox held investments with a net carrying value of
$118.2 million and a fair market value of $118.9 million. At any point in time,
amortized cost may be greater or less than fair market value. If investments are
sold prior to maturity we could incur a realized gain or loss based on the fair
market value of the investments at the date of sale. Additionally, Tanox could
incur future losses on investments if the investment issuer becomes impaired or
the investment is down graded.

                                      37
<PAGE>

Research & Development

        Research and development costs, including incidental patent costs, are
expensed as incurred. Research and development costs include estimates for
clinical trial costs. These estimates are based on patient enrollment and
clinical trial progress. Actual costs may differ from estimates, and any
adjustment will be reflected in future results.

Contingent Liabilities

       We are currently involved in certain legal proceedings as discussed in
the "Commitments and Contingencies" note in the Notes to Consolidated Financial
Statements.

RESULTS OF OPERATIONS

Year Ended December 31, 2001 Compared to Year Ended December 31, 2000

       Revenues. Revenues decreased to $419,000 in 2001 from $12.7 million in
2000. The $12.3 million decrease in revenues in 2001 resulted primarily from
$12.0 million in milestone revenues earned in June 2000 under our collaborative
agreements with Novartis and Genentech when the BLA for Xolair was submitted to
the FDA. The collaborative agreements with Novartis and Genentech accounted for
none of the revenues in 2001 and 95% of total revenues in 2000. Other revenues
in both years consisted of grants, government subsidies and technology licensing
revenue.

       Research and Development Expenses. Research and development expenses
increased to $21.7 million in 2001 from $18.3 million in 2000. In 2001, we
incurred higher salary and related costs from increased staffing, increased
expenses related to process development and manufacturing feasibility studies,
and an in-process research and development charge of $1.1 million related to the
1998 acquisition of Tanox Pharma B.V. (formerly known as PanGenetics B.V.). The
increase was partially offset by a reduction in 2001 operating expenses due to
the closure of Tanox Pharma B.V., a $2.5 million charge in 2000 to acquire the
right to non-exclusive licenses to patents and patent applications owned by
Protein Design Labs, Inc. and a $0.6 million charge in 2000 to acquire certain
technologies from LXR Biotechnology, Inc.

       General and Administrative Expenses. General and administrative expenses
increased to $8.3 million in 2001 from $7.7 million in 2000, an increase of
$666,000. The increase relates primarily to higher legal costs associated with
increased litigation activity and increased infrastructure costs.

       Restructuring Charge. In June 2001, we implemented a plan to consolidate
our research operations in Houston, Texas. In connection with the plan, we
closed our facility in Amsterdam, and recorded a restructuring charge of $3.9
million. The restructuring charge primarily consisted of $624,000 for severance
and related costs, $886,000 of goodwill impairment, $778,000 for the write-down
of assets, $1.1 million for agreement terminations and $458,000 for other exit
costs.

       Other Income. Other income decreased to $12.1 million in 2001 from $13.1
in 2000. This $1.0 million decrease was principally due to a decrease in
interest income in 2001 resulting from lower interest rates.

                                      38
<PAGE>

       Income Taxes.  There was no provision for income taxes in 2001, due to
the pre-tax loss of $21.4 million.  This pre-tax loss generated a tax benefit,
which was fully offset by an increase in Tanox's valuation allowance.  Our
effective tax rate in 2000 significantly differed from the U.S.  federal
statutory rate.  The provision for income taxes was $915,000, due to income
generated in the U.S. and losses from foreign subsidiaries that were not tax
deductible in the U.S., and did not offset the U.S. tax provision.  In
addition, we generated a tax benefit from non-qualified stock option exercises
in 2000.  The benefit was reflected as a reduction to additional paid-in
capital in the accompanying financial statements.

       Net Loss. As a result of the above factors, the net loss for the year
ended December 31, 2001 was $21.4 million or $0.49 per share on both a basic and
fully diluted basis, compared with a net loss in 2000 of $1.0 million or $0.03
per share on both a basic and fully diluted basis.

Year Ended December 31, 2000 Compared to Year Ended December 31, 1999

       Revenues. Revenues increased to $12.7 million in 2000 from $1.4 million
in 1999. The $11.3 million increase in revenues in 2000 resulted from the $12.0
million in milestone revenues earned in the second quarter under the Company's
agreements with Novartis and Genentech when the BLA for Xolair was submitted to
the FDA. The collaborative agreements with Novartis and Genentech accounted for
95% of total revenues in 2000 and 76% of total revenues in 1999. Other revenues
in both years consisted of grants, governmental subsidies and technology
licensing revenue.

       Research and Development Expenses. Research and development expenses
increased to $18.3 million in 2000 from $17.2 million in 1999, an increase of
$1.1 million. Research and development expenses in 1999 were adversely affected
by two charges. We incurred a non-cash charge for stock-based compensation of
$2.7 million in 1999 to extend the exercise period of certain stock options for
certain research and development employees and consultants. Additionally, a
charge to in-process research and development of $3.4 million was incurred in
1999 for the second payment related to the 1998 acquisition of Tanox Pharma B.V.
Excluding the two charges in 1999, research and development expenses in 2000
increased by $7.2 million. In 2000, we incurred increased personnel costs
associated with the addition of research personnel, as well as increased costs
due to our expanded pre-clinical and clinical development activities. In
addition, we acquired the right to certain licenses from Protein Design Labs,
Inc. for $2.5 million and acquired certain technologies from LXR Biotechnology,
Inc. for $0.6 million.

       General and Administrative Expenses. General and administrative expenses
decreased to $7.7 million in 2000 from $8.6 million in 1999, a decrease of
$899,000. We incurred a non-cash charge for stock-based compensation of $1.9
million in 1999 to extend the exercise period of certain employee stock options.
Additionally, we incurred a charge of $3.5 million to record a September 1999
arbitration award in favor of the attorneys who represented us in litigation
against Genentech. Excluding the two charges in 1999, general and administrative
expenses in 2000 increased by $4.5 million. This increase was primarily
attributable to increased personnel costs, investor relations and other expenses
associated with becoming a public company, franchise taxes associated with
reincorporating in Delaware, and increased litigation costs.

       Other Income. Other income increased to $13.1 million in 2000 from $1.0
million in 1999, an increase of $12.1 million. This increase was principally due
to an increase in interest income resulting from higher cash and investment
balances in 2000, as a result of the proceeds from our initial public offering
(IPO) in April 2000.

       Income Taxes.  The provision for income taxes increased to $915,000 in
2000 from $34,000 in 1999.  This increase was due principally to increased U.S.
pretax income, due to revenues and increased interest income, combined with
non-deductible foreign tax operating expenses and U.S. tax benefits arising
from the exercise of stock options.  The tax benefit related to the exercises
of options was recorded to additional paid-in capital.

                                      39
<PAGE>

       Net Loss. As a result of the above factors, net loss for the year ended
December 31, 2000 was $1.0 million or $0.03 per share on both a basic and
diluted basis, compared with a net loss in 1999 of $23.3 million or $0.75 per
share on both a basic and diluted basis. The improved earnings in 2000 primarily
were due to higher revenues from milestone payments and higher interest income
earned on the cash received in the IPO.

LIQUIDITY AND CAPITAL RESOURCES

       We have financed our operations since inception primarily through
collaboration and grant revenues, sales of equity securities, interest income
and equipment financing agreements. As of December 31, 2001, we had $261.1
million in cash, cash equivalents and investments, of which $205.6 million were
classified as current assets.

       During the year ended 2001, we used $12.1 million of cash for operating
activities. Investing activities provided $123.4 million of cash in 2001, from
the maturity of short-term and long-term investments, slightly offset by the
purchase of investments and capital expenditures. Financing activities generated
$2.4 million of cash during 2001, from the exercise of stock options and
repayment of employee loans, slightly offset by the purchase of 80,000 shares of
treasury stock. The combination of the above items resulted in an increase in
cash and cash equivalents of $113.6 million during 2001.

       On April 12, 2000, we sold 7,500,000 shares of common stock in an initial
public offering at a price of $28.50 per share and, on May 11, 2000, sold an
additional 1,068,000 shares pursuant to the exercise by the underwriters of
their over-allotment option. In total, we received gross proceeds of $244.2
million and net proceeds of $225.8 million.

       From 1994 through 1998, Novartis advanced us $10.0 million, pursuant to a
loan agreement, to finance our pilot manufacturing facility. Tanox has pledged
all of the assets of the pilot manufacturing facility as security for the loan.
The loan bears interest at the London Interbank Offered Rate, or LIBOR, plus 2%.
For 2000 and 2001, the loan interest rate approximated 8.4% and 5.6%,
respectively. Through December 31, 2001, Novartis has agreed to forgive interest
on the loan. For the years 1999, 2000 and 2001, the interest Novartis has
forgiven has been reflected as interest expense and a contribution to capital.
Subject to modifications agreed to in principle concurrent with completion of
the Three-Party Collaboration, the principal and future interest payments may be
partially or totally forgiven by Novartis based on the future use of the
facility. When the facility becomes operational, Tanox will make interest and
principal payments on the loan in amounts equal to 75% of net cash flow from the
facility. If the net cash flow payments during the ten years following the date
the facility first becomes operational are not sufficient to repay the principal
and accrued interest on the loan, Novartis has agreed to forgive the remaining
principal and accrued interest.

      Tanox has future minimum lease obligations of $2.8 million under
noncancelabe leases at December 31, 2001, of which approximately $1.0 million
will be paid in 2002.

       During 2001, we invested approximately $5.0 million in property and
equipment, primarily to support the expansion of our research and product
development activities.

       At December 31, 2001 we had accrued restructuring expenses of
approximately $1.7 million. We expect to pay these expenses in 2002.

       We loaned certain employees an aggregate of $1.2 million in April 2000 to
pay tax obligations resulting from their stock option exercises in 1999. These
loans were repaid in 2001, and at December 31, 2001, there were no loan balances
outstanding.

       Our current and anticipated development projects will require substantial
additional capital to complete. We anticipate that the amount of cash we need to
fund operations, including research and development, manufacturing and other
costs, and for capital expenditures, will grow substantially in the

                                      40
<PAGE>

future as our projects move from research to pre-clinical and clinical
development. We also expect that we will need to expand our administrative,
clinical development, facilities and business development activities to support
the future development of our programs. In 2002, we expect research and
development expenses to be between $30 million and $35 million, depending on the
advances in our clinical trials. We expect that cash on hand and revenue from
operations will be sufficient to fund our operations for approximately the next
five years. However, our future capital needs will depend on many factors,
including successfully commercializing Xolair, receiving payments from our
collaboration partners, progress in our research and development activities, the
magnitude and scope of these activities, the progress and level of unreimbursed
costs associated with pre-clinical studies and clinical trials, the costs and
magnitude of product or technology acquisitions, the cost of preparing, filing,
prosecuting, maintaining and enforcing patent claims and other intellectual
property rights, competing technological and market developments, changes in or
terminations of existing collaboration and licensing arrangements, establishing
additional collaboration and licensing arrangements, and manufacturing scale-up
costs and marketing activities, if we undertake those activities. Consequently,
we may need to raise substantial additional funds. We do not have committed
external sources of funding and we cannot assure that we will be able to obtain
additional funds on acceptable terms, if at all. If adequate funds are not
available, we may be required to :

   .     delay, reduce the scope of or eliminate one or more of our programs;
   .     obtain funds through arrangements with collaboration partners or others
         that may require us to relinquish rights to technologies, product
         candidates or products that we would otherwise seek to develop or
         commercialize ourselves; or
   .     license rights to technologies, product candidates or products on terms
         that are less favorable to us than might otherwise be available.

We are currently engaged in litigation and arbitration relating to a fee dispute
with the law firms that represented us in litigation with Genentech relating to,
among other things, the intellectual property rights surrounding the development
of anti-IgE technology. An arbitration panel issued an award entitling the
attorneys to receive (i) approximately $3.5 million (including interest), (ii)
payments ranging from 33-1/3% to 40% of the future milestone payments we would
receive from Genentech following product approval, and (iii) 10% of the
royalties that we would receive on all sales of anti-IgE products. Tanox sought
a court order vacating this arbitration award. However, a judgment was entered
confirming the award. Tanox intends to pursue all available remedies, including
appealing the decision. During the appeals process, we are required to post a
bond or place amounts in escrow to secure payment of the award. We posted a $4.1
million supersedeas bond with the Court to continue the appeals process and to
secure payment of the award.

       If Tanox is ultimately required to pay all or part of the award to the
attorneys, Tanox could be required to pay up to $3.5 million, plus accrued
interest that would become due, and the award would effectively reduce future
milestone payments from Genentech by up to 40% and reduce future royalties from
the Three-Party Collaboration by 10%. Accordingly, Tanox's future revenues,
result of operations, cash flow and financial condition could be materially
adversely affected.

RECENT ACCOUNTING DEVELOPMENTS

       In August 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". SFAS No. 144 addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
Under this Statement, the FASB established a single accounting model for the
valuation of long-lived assets. The provisions of SFAS No. 144 are required to
be applied by Tanox for the 2002 fiscal year, and as such, we will adopt the
Statement on January 1, 2002. We believe that our valuation of long-lived assets
is in accordance with SFAS No. 144.

                                      41
<PAGE>

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

       We are exposed to a variety of risks, including foreign currency exchange
fluctuations and changes in interest rates. In the normal course of business, we
have established policies and procedures to manage these risks.

       Foreign Currency Exchange Rates. For the year ended December 31, 2001,
operating results reflect foreign exchange gains of $39,000 and our balance
sheet reflects a cumulative foreign currency translation adjustment of $84,000.
We are subject to foreign currency exchange risk because:

   .     we invest in our foreign subsidiaries;
   .     we incur a portion of our revenues and expenses in the local currencies
         of the countries where we do business; and
   .     we finance part of the cost of our subsidiaries' operations through
         dollar denominated inter-company loans and equity investments that are
         recorded on their books in the respective local currencies.

       Fluctuations in exchange rates have not had a material impact on our
revenues or costs and expenses, but have affected the value of our equity
investments and intercompany loans. As a result of our international operations
and our current financing approach, fluctuations in exchange rates of the local
currencies versus the U.S. dollar impact our operating results. We are primarily
exposed to gains and losses with respect to Euros, Dutch guilders and Taiwan
dollars because our subsidiaries conduct business or have conducted business in
these currencies. To date, we have not implemented a program to hedge our
foreign currency risk, but we may do so in the future.

       Interest Rate Risk. Cash, cash equivalents and investments were
approximately $261.1 million at December 31, 2001. These assets were primarily
invested in investment grade corporate bonds and commercial paper with
maturities of less than two years, which we have the ability and intent to hold
to maturity. We do not invest in derivative securities. Although our portfolio
is subject to fluctuations in interest rates and market conditions, no gain or
loss on any security would actually be recognized in earnings unless we sell the
asset. In addition, our loan from Novartis is based on a premium over LIBOR. As
such, if general interest rates increase, our interest costs will increase.

                                      42
<PAGE>

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                                   Tanox, Inc.
                   Index to Consolidated Financial Statements

<TABLE>
<CAPTION>
                                                                                               PAGE
                                                                                               ----
<S>                                                                                             <C>
Report of Independent Public Accountants......................................................  44
Consolidated Balance Sheets as of December 31, 2000 and 2001..................................  45
Consolidated Statements of Operations and Comprehensive Loss for the years ended
   December 31, 1999, 2000 and 2001...........................................................  46
Consolidated Statements of Stockholders' Equity for the years ended December 31, 1999, 2000
   and 2001...................................................................................  47
Consolidated Statements of Cash Flows for the years ended December 31, 1999, 2000 and 2001....  49
Notes to Consolidated Financial Statements....................................................  50
</TABLE>

                                      43
<PAGE>

                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Board of Directors of
Tanox, Inc.:

       We have audited the accompanying consolidated balance sheets of Tanox,
Inc., a Delaware corporation, and subsidiaries as of December 31, 2000 and 2001,
and the related consolidated statements of operations and comprehensive loss,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 2001. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.

       We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the consolidated
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the consolidated financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

       In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Tanox, Inc.,
and subsidiaries as of December 31, 2000 and 2001, and the results of their
operations and their cash flows for each of the three years in the period
December 31, 2001, in conformity with accounting principles generally accepted
in the United States.

ARTHUR ANDERSEN LLP

Houston, Texas
March 8, 2002

                                      44
<PAGE>

                          TANOX, INC. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                                           December 31,
                                                                             =========================================
                                                                                   2000                   2001
                                                                             ================       ==================
                                ASSETS
<S>                                                                          <C>                    <C>
CURRENT ASSETS:
  Cash and cash equivalents.....................................             $  29,264,000          $   142,883,000
  Short-term investments........................................               149,020,000               62,720,000
  Interest receivable...........................................                 4,156,000                2,722,000
  Other receivables.............................................                   567,000                  110,000
  Prepaid and other.............................................                   506,000                  750,000
                                                                             ----------------       ------------------
       Total current assets.....................................               183,513,000              209,185,000
LONG-TERM INVESTMENTS...........................................                97,637,000               55,499,000

PROPERTY AND EQUIPMENT:
  Land..........................................................                        --                1,619,000
  Laboratory and office equipment...............................                11,388,000               12,089,000
  Leasehold improvements........................................                 2,711,000                4,135,000
  Furniture and fixtures........................................                   230,000                  779,000
                                                                             ----------------       ------------------
                                                                                14,329,000               18,622,000
   Less-Accumulated depreciation and amortization...............                (5,717,000)              (7,024,000)
                                                                             ----------------       ------------------
       Net property and equipment...............................                 8,612,000               11,598,000
OTHER ASSETS, net of accumulated amortization
  of $92,000 and $178,000.......................................                 1,216,000                1,252,000
                                                                             ----------------       ------------------
       Total assets.............................................             $ 290,978,000          $   277,534,000
                                                                             ================       ==================
       LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
  Accounts payable and accrued liabilities......................             $   4,453,000          $     7,190,000
  Accrued arbitration award.....................................                 3,751,000                3,903,000
                                                                             ----------------       ------------------
       Total current liabilities................................                 8,204,000               11,093,000
NOTE PAYABLE TO RELATED PARTY...................................                10,000,000               10,000,000

COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS' EQUITY:

  Preferred stock, $.01 par value; 10,000,000 shares authorized;
    none outstanding............................................                        --                       --
  Common stock, $.01 par value; 120,000,000 shares authorized;
    43,603,955 and 44,156,601 shares issued; 43,603,955 shares
    and 44,076,601 shares outstanding...........................                   436,000                  442,000
  Additional paid-in capital....................................               304,647,000              309,892,000
  Treasury stock, at cost; - and 80,000 shares..................                        --               (1,009,000)
  Deferred compensation.........................................                  (555,000)                 (83,000)
  Loans receivable from employees...............................                  (442,000)                      --
  Accumulated other comprehensive loss, cumulative translation
    adjustment..................................................                   196,000                   84,000
  Accumulated deficit...........................................               (31,508,000)             (52,885,000)
                                                                             -----------------      ------------------
       Total stockholders' equity...............................               272,774,000              256,441,000
                                                                             -----------------      ------------------
       Total liabilities and stockholders' equity...............             $ 290,978,000          $   277,534,000
                                                                             =================      ==================
</TABLE>

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

                                      45
<PAGE>

                          TANOX, INC. AND SUBSIDIARIES
          CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

<TABLE>
<CAPTION>
                                                                       For the Year Ended December 31,
                                                           --------------------------------------------------
                                                                1999                2000             2001
                                                           ---------------    --------------    -------------
<S>                                                         <C>                <C>              <C>
REVENUES:
  Development agreement with related party.............     $  1,063,000       $  2,010,000     $         --
  Other development agreements and licensing fees......          342,000         10,738,000          419,000
                                                          ---------------    ---------------   --------------
        Total revenues.................................        1,405,000         12,748,000          419,000
OPERATING COSTS AND EXPENSES:
     Research and development..........................       17,163,000         18,325,000       21,683,000
     General and administrative........................        8,582,000          7,683,000        8,349,000
     Restructuring charge..............................               --                 --        3,860,000
                                                          ---------------    ---------------   --------------
        Total operating costs and expenses.............       25,745,000         26,008,000       33,892,000
                                                          ---------------    ---------------   --------------
LOSS FROM OPERATIONS...................................      (24,340,000)       (13,260,000)     (33,473,000)
OTHER INCOME (EXPENSES):
     Interest income...................................        1,884,000         14,050,000       12,769,000
     Interest expense..................................         (741,000)          (846,000)        (714,000)
     Other, net........................................         (115,000)           (76,000)          41,000
                                                          ---------------    ---------------   --------------
        Total other income.............................        1,028,000         13,128,000       12,096,000
                                                          ---------------    ---------------   --------------
LOSS BEFORE INCOME TAXES...............................      (23,312,000)          (132,000)     (21,377,000)
        Income tax provision...........................          (34,000)          (915,000)              --
                                                          ---------------    ---------------   --------------
NET LOSS...............................................     $(23,346,000)      $(1,047,000)     $(21,377,000)
                                                          ===============    ===============   ==============
LOSS PER SHARE - Basic and diluted.....................     $      (0.75)      $     (0.03)     $      (0.49)
                                                          ---------------    ---------------   --------------
SHARES USED IN COMPUTING LOSS PER SHARE -
     Basic and diluted.................................       31,113,000        40,258,000        44,010,000
                                                          ---------------    ---------------   --------------
COMPREHENSIVE LOSS:
     Net loss..........................................     $(23,346,000)      $(1,047,000)     $(21,377,000)
     Foreign currency translation adjustment...........          173,000            25,000          (112,000)
                                                          ---------------    ---------------   --------------
TOTAL COMPREHENSIVE LOSS...............................     $(23,173,000)      $(1,022,000)     $(21,489,000)
                                                          ===============    ===============   ==============
</TABLE>

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

                                      46
<PAGE>

                          TANOX, INC. AND SUBSIDIARIES
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
              For the Years Ended December 31, 1999, 2000, and 2001

<TABLE>
<CAPTION>

                                                                                 Common Stock             Additional
                                                                           =========================       Paid-in
                                                                              Shares       Par Value       Capital
                                                                           =============  ===========   ==============
<S>                                                                          <C>           <C>          <C>
BALANCES, December 31, 1998..............................................    29,310,175    $ 293,000    $  39,266,000
  Issuance of common stock for cash, $12.50 per share, net of issuance
    costs................................................................     1,896,000       19,000       22,907,000
  Exercise of stock options, net.........................................     1,789,520       18,000        1,131,000
  Issuance of common stock on a net issuance basis upon exercise of
    warrants ............................................................        86,632           --               --
  Issuance of common stock for acquisition...............................       242,075        3,000        3,023,000
  Capital contribution from forgiveness of interest by related party.....            --           --          738,000
  Deferred compensation related to stock options.........................            --           --        4,636,000
  Amortization of deferred compensation related to stock options.........            --           --               --
  Loans receivable from employees........................................            --           --               --
  Foreign currency translation adjustment................................            --           --               --
  Net loss...............................................................            --           --               --
                                                                           -------------  -----------   --------------
BALANCES, December 31, 1999..............................................    33,324,402      333,000       71,701,000
  Issuance of common stock for cash, $28.50 per share, net of issuance
    costs................................................................     8,568,000       86,000      225,752,000
  Exercise of stock options, net.........................................     1,711,553       17,000        4,732,000
  Income tax benefit from stock options exercised........................            --           --          915,000
  Capital contribution from forgiveness of interest by related party.....            --           --          845,000
  Deferred compensation related to stock options.........................            --           --          702,000
  Amortization of deferred compensation related to stock options.........            --           --               --
  Loans receivable from employees........................................            --           --               --
  Repayment of employee loans............................................            --           --               --
  Foreign currency translation adjustment................................            --           --               --
  Net loss...............................................................            --           --               --
                                                                           -------------  -----------   --------------
BALANCES, December 31, 2000..............................................    43,603,955      436,000      304,647,000
  Exercise of stock options, net.........................................       492,128        5,000        2,929,000
  Issuance of common stock for acquisition...............................        60,518        1,000        1,817,000
  Repurchase of 80,000 shares of common stock at cost....................            --           --               --
  Capital contribution from forgiveness of interest by related party.....            --           --          556,000
  Cancelled stock options................................................            --           --         (335,000)
  Amortization of deferred compensation related to stock options.........            --           --               --
  Stock option compensation to non-employees.............................            --           --          278,000
  Repayment of employee loans............................................            --           --               --
  Foreign currency translation adjustment................................            --           --               --
  Net loss...............................................................            --           --               --
                                                                           -------------  -----------   --------------
BALANCES, December 31, 2001..............................................    44,156,601    $ 442,000     $309,892,000
                                                                           =============  ===========   ==============
</TABLE>

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

                                      47
<PAGE>

<TABLE>
<CAPTION>
                                                             Accumulated
                                                                Other
                                                            Comprehensive
                                             Loans             Loss -
                                          Receivable         Cumulative                                 Total
    Treasury            Deferred             From            Translation          Accumulated        Stockholders'
     Stock            Compensation         Employees         Adjustment            Deficit              Equity
-----------------    -----------------   --------------   ------------------   -----------------   -----------------
<S>                  <C>                  <C>              <C>                  <C>                 <C>
 $        --         $    (902,000)       $       --       $      (2,000)       $   (7,115,000)     $    31,540,000

          --                    --                --                  --                    --           22,926,000
          --                    --                --                  --                    --            1,149,000

          --                    --                --                  --                    --                   --
          --                    --                --                  --                    --            3,026,000
          --                    --                --                  --                    --              738,000
          --               (60,000)               --                  --                    --            4,576,000
          --               311,000                --                  --                    --              311,000
          --                    --        (1,086,000)                 --                    --           (1,086,000)
          --                    --                --             173,000                    --              173,000
          --                    --                --                  --           (23,346,000)         (23,346,000)
-----------------    -----------------   --------------      ---------------   -----------------   -----------------
          --              (651,000)       (1,086,000)            171,000           (30,461,000)          40,007,000
          --                    --                --                  --                    --          225,838,000
          --                    --                --                  --                    --            4,749,000
          --                    --                --                  --                    --              915,000
          --                    --                --                  --                    --              845,000
          --              (496,000)               --                  --                    --              206,000
          --               592,000                --                  --                    --              592,000
          --                    --        (1,188,000)                 --                    --           (1,188,000)
          --                    --         1,832,000                  --                    --            1,832,000
          --                    --                --              25,000                    --               25,000
          --                    --                --                  --            (1,047,000)          (1,047,000)
-----------------    -----------------   --------------      ---------------   -----------------   -----------------
          --              (555,000)         (442,000)            196,000           (31,508,000)         272,774,000
          --                    --                --                  --                    --            2,934,000
          --                    --                --                  --                    --            1,818,000
  (1,009,000)                   --                --                  --                    --           (1,009,000)
          --                    --                --                  --                    --              556,000
          --               335,000                --                  --                    --                   --
          --               137,000                --                  --                    --              137,000
          --                    --                --                  --                    --              278,000
          --                    --           442,000                  --                    --              442,000
          --                    --                --            (112,000)                   --             (112,000)
          --                    --                --                  --           (21,377,000)         (21,377,000)
-----------------    -----------------   --------------      ---------------   -----------------   -----------------
 $(1,009,000)        $     (83,000)        $      --          $   84,000         $ (52,885,000)      $  256,441,000
=================    =================   ==============      ===============   =================   =================
</TABLE>

                                      48
<PAGE>

                          TANOX, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                                   For the Year Ended December 31,
                                                                   -------------------------------------------------------------
                                                                         1999                 2000                   2001
                                                                   -----------------    -----------------     ------------------
<S>                                                                 <C>                  <C>                   <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net loss....................................................      $  (23,346,000)       $  (1,047,000)       $  (21,377,000)
  Adjustments to reconcile net loss to net cash
    provided by (used in) operating activities-
    Depreciation and amortization.............................           1,034,000            1,173,000             1,585,000
    Interest expense forgiven by related party................             738,000              845,000               556,000
    Non-cash portion of restructuring charge..................                  --                   --             1,664,000
    Compensation expense related to stock options                        4,887,000              798,000               415,000
    Non-cash income tax provision.............................                  --              915,000                    --
    In-process research and development.......................           3,359,000                   --             1,066,000
    Changes in operating assets and liabilities
      Decrease (increase) in receivables and other
        operating assets......................................           1,685,000           (4,444,000)            1,260,000
      Increase in current liabilities.........................           3,439,000            2,883,000             2,755,000
                                                                    -----------------    -----------------     ------------------
        Net cash provided by (used in) operating activities...          (8,204,000)           1,123,000           (12,076,000)
                                                                    -----------------    -----------------     ------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
  Purchase of investments.....................................         (12,082,000)        (559,645,000)          (79,349,000)
  Maturity of investments.....................................          14,453,000          316,001,000           207,787,000
  Purchases of property and equipment.........................            (887,000)          (2,740,000)           (4,998,000)
  Decrease (increase) in other assets.........................            (219,000)            (973,000)                   --
  Purchase of acquisition (net  of cash acquired).............            (333,000)                  --                    --
                                                                    -----------------    -----------------     -----------------
        Net cash provided by (used in) investing activities                932,000         (247,357,000)          123,440,000
                                                                    -----------------    -----------------     -----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
  Proceeds from issuance of common stock......................          24,075,000          230,587,000             2,934,000
  (Issuance) repayments of employee loans, net................          (1,086,000)             644,000               442,000
  Purchase of treasury stock..................................                  --                   --            (1,009,000)
                                                                    -----------------    -----------------     -----------------
        Net cash provided by financing activities                       22,989,000          231,231,000             2,367,000

IMPACT OF EXCHANGE RATES ON CASH..............................             173,000               25,000              (112,000)
                                                                    -----------------    -----------------     -----------------
INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS...................................................          15,890,000          (14,978,000)          113,619,000
CASH AND CASH EQUIVALENTS, beginning of
  year........................................................          28,352,000           44,242,000            29,264,000
                                                                    -----------------    -----------------     -----------------
CASH AND CASH EQUIVALENTS, end of year........................      $   44,242,000        $  29,264,000        $  142,883,000
                                                                    =================    =================     =================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
  Cash paid during the year for taxes.........................      $      137,000        $          --        $           --
  Non-cash investing and financing activities -
    Capital contribution from forgiveness of interest by a
      related party...........................................             738,000              845,000               556,000
    Common stock issued for acquisition.......................           3,026,000                   --             1,818,000
</TABLE>

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

                                      49
<PAGE>

                          TANOX, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.  ORGANIZATION, BUSINESS AND RISK FACTORS:

       Tanox, Inc. (Tanox), was formerly known as Tanox Biosystems, Inc. and was
originally incorporated as a Texas corporation on March 19, 1986. Tanox was
reincorporated in Delaware in January 2000. Tanox is engaged in the
identification and development of therapeutic monoclonal antibodies to address
significant unmet medical needs in the area of asthma, allergy, autoimmune,
inflammation and other related diseases.

       Tanox has not yet generated any significant revenues from product sales,
nor is there any assurance of significant future revenues from product sales.
The research and development activities engaged in by Tanox involve a high
degree of risk and uncertainty. The ability of Tanox to successfully develop,
manufacture and market its proprietary products is dependent upon many factors.
These factors could include, but are not limited to, the need for additional
financing, the reliance on collaborative arrangements for research and
development, marketing and product commercialization and the ability to develop
or obtain manufacturing, sales and marketing capabilities. Additional factors
could include resolution of ongoing contingencies, including legal proceedings,
changes in the level of sponsored research revenue, uncertainties as to patents
and proprietary technologies, technological change and risk of obsolescence,
efficacy and safety of its products, competition, governmental regulations and
regulatory approval, and product liability exposure. As a result of the
aforementioned factors and related uncertainties, there can be no assurance of
Tanox's future success.

       Tanox entered into a development and licensing agreement with Novartis
Pharma AG (Novartis) in May 1990. Under this agreement, Tanox and Novartis
agreed to jointly develop certain products for IgE-mediated diseases, including
asthma and allergies. Tanox received a contract payment upon signing the
agreement and has received additional contract payments and reimbursement
payments upon the occurrence of specified events. Under a separate agreement
(the Stock Agreement), Tanox and Novartis also agreed to the sale and purchase
of shares of Tanox's common stock. Sales of these shares were completed in May
1990, May 1992 and June 1994. Tanox notified Novartis of the termination of the
Stock Agreement as provided therein, and the termination was effective as of May
10, 1997. Novartis owned approximately 14.4% of Tanox's outstanding common stock
at December 31, 2001.

       On December 22, 1993, Tanox sued Genentech, Inc. (Genentech), F.
Hoffman-La Roche, Ltd., Roche Holdings, Inc., Roche Holding Ltd. and Hoffman-La
Roche, Inc. (collectively referred to as "Roche"), in Harris County District
Court in Houston, Texas. The action arose from collaboration discussions between
Tanox and Genentech in 1989 and 1990 relating to Tanox's anti-IgE product as a
treatment for IgE-mediated diseases, including allergy and asthma. In response,
Genentech filed suit against Tanox for patent infringement and subsequently
named Novartis in the suit. Tanox's litigation against Genentech and Roche and
Genentech's litigation against Tanox and Novartis were settled in July 1996.
Contemporaneously with the settlement, Genentech, Novartis and Tanox also
entered into a binding agreement in principle to combine their existing anti-IgE
antibody programs into a cooperative effort to develop and commercialize
selected anti-IgE antibodies (the Three-Party Collaboration). Tanox also entered
into additional licensing arrangements with Genentech. Tanox received an initial
payment upon entering into the Three-Party Collaboration and settling the
litigation. Tanox received and will receive additional milestone and royalty
payments upon the occurrence of specified subsequent events. Novartis or
Genentech may terminate their participation in the Three-Party Collaboration on
short notice, subject to reversion of product rights to Tanox and the remaining
collaborator.

                                      50
<PAGE>

                          TANOX, INC. AND SUBSIDIARIES
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

Basis of Presentation

       The accompanying consolidated financial statements include the accounts
of Tanox and its wholly owned subsidiaries, Tanox Pharma International, Inc.,
Tanox Pharma B.V.  and TanAsia Pharma, Ltd.  Intercompany transactions and
balances are eliminated in consolidation.

       Certain amounts previously reported have been reclassified in order to
ensure comparability among years reported.

Use of Estimates

       The preparation of consolidated financial statements in conformity with
generally accepted accounting principles in the United States requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the consolidated financial statements and the reported amounts of
expenses during the reporting period. Actual results could differ from those
estimates.

Revenue Recognition

       Revenues associated with development agreements, which include rights to
license or sublicense Tanox's technology or product rights, are recognized when
payments are earned. Revenues earned under development agreements include
payments for milestone achievements and payments for sponsored research.
Milestone payments are received under best efforts contracts, and such revenues
are not refundable. Any revenue from milestones is recognized when the
milestones are achieved and there are no remaining performance obligations.
Revenues earned in connection with sponsored research are recognized as Tanox
performs its obligations related to such research. Any revenue contingent upon
future performance by Tanox is deferred and recognized as the performance is
completed.

       Tanox recognized revenues of $1.1 million and $12.0 million during 1999
and 2000, respectively, under the Three-Party Collaboration described in Note 1.
No revenues were recognized in 2001 under the Three-Party Collaboration.
Included in these revenues are milestone payments of $1.0 million and $12.0
million in 1999 and 2000, respectively. No milestone payments were recognized in
2001. The remainder of the revenues related to sponsored research and license
fees unrelated to the Three-Party Collaboration. Expenses incurred related to
these agreements were approximately $0.1 million in 1999. There were no expenses
incurred in 2000 or 2001. Revenues from collaborative agreements with Novartis
accounted for 76% of 1999 revenues and 16% of 2000 revenues. Revenues from
collaborative agreements with Genentech accounted for none of 1999 revenues and
79% of 2000 revenues.

Cash and Cash Equivalents

       Cash equivalents consist of highly liquid investments with an original
maturity of three months or less when purchased. Tanox has restricted cash of
approximately $370,000 at December 31, 2001 related to estimated obligations
associated with the closure of its Amsterdam facility.

                                      51
<PAGE>

                          TANOX, INC. AND SUBSIDIARIES
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

Short-Term and Long-Term Investments

       Investments consist of investment grade corporate bonds and commercial
paper with maturities of less than two years from the balance sheet date.
Tanox's policy is to hold all investments until maturity; therefore, all
investments are classified as held-to-maturity and carried at amortized cost.
Tanox has no available-for-sale or trading securities.

       At December 31, 2000, the amortized cost amounts approximated fair value.
Tanox's net carrying value of investments at December 31, 2001, was
$118,219,000. The fair value of these investments at December 31, 2001, was
$118,857,000. Unrealized gains and losses on these investments totaled $926,000
and $288,000, respectively.

       During the year ended December 31, 2001, Tanox sold $14.6 million of
held-to-maturity investments prior to the maturity date, due to the
deterioration in the investment issuers' credit worthiness. A realized gain of
$49,000 was recognized in the accompanying consolidated statement of operations
and comprehensive loss. Realized gains and losses from sales prior to maturity
are classified as interest income.

Property and Equipment

       Property and equipment is carried at cost and depreciated on a
straight-line basis over the estimated useful economic lives of the assets or,
in the case of leasehold improvements, over the remaining term of the lease. The
estimated useful lives used in computing depreciation are three to seven years
for laboratory and office equipment, five to seven years for furniture and
fixtures, and the lesser of nine years or the remaining lease term for leasehold
improvements. When property is retired or otherwise disposed of, the cost and
accumulated depreciation are removed from the accounts and any resulting gain or
loss is included in income. Maintenance and repairs are charged to expense when
incurred. Depreciation and amortization expense related to property and
equipment was $1.0 million, $1.1 million and $1.6 million for 1999, 2000 and
2001, respectively.

       Management periodically reviews long-lived assets and certain
identifiable intangibles whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. If factors indicate
that an asset should be evaluated for possible impairment, management compares
estimated undiscounted future operating cash flow from the related asset to the
carrying amount of the asset. If the carrying amount of the asset is greater
than undiscounted future operating cash flow, an impairment loss would be
recognized.

       In August 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". SFAS No. 144 addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
Under this Statement, the FASB established a single accounting model for the
valuation of long-lived assets. The provisions of SFAS No. 144 are required to
be applied by Tanox for the 2002 fiscal year, and as such, we will adopt the
Statement on January 1, 2002. We believe that our valuation of long-lived assets
is in accordance with SFAS No. 144.

Other Assets

       Other assets include the cost of a $1.0 million investment in a
privately held biotechnology company, which management believes approximates
the fair market value.

                                      52
<PAGE>

                          TANOX, INC. AND SUBSIDIARIES
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

Research and Development

       Research and development costs, including incidental patent costs, are
expensed as incurred. Research and development costs include estimates for
clinical trial costs. These estimates are based on patient enrollment and
clinical trial progress. Actual costs may differ from estimates, and any
adjustment will be reflected in future results.

Accrued Liabilities

       Accrued liabilities at December 31, 2000 and 2001, consist of the
following:

                                                  2000              2001
                                             --------------   --------------
Accounts payable...........................     $1,590,000       $1,624,000
Accrued restructuring......................             --        1,684,000
Accrued payroll............................        193,000          547,000
Accrued vacation...........................        182,000          370,000
Accrued taxes..............................        424,000          400,000
Accrued professional fees..................        276,000          590,000
Accrued clinical trial costs...............        832,000        1,463,000
Accrued construction/work in progress......        538,000               --
Other......................................        418,000          512,000
                                             --------------   --------------
                                                $4,453,000       $7,190,000
                                             ==============   ==============

       See Notes 10 and 4, respectively, for a discussion of the accrued
arbitration award and the accrued restructuring as of December 31, 2001.

Income Taxes

       Tanox accounts for income taxes using the liability method prescribed by
SFAS No. 109, "Accounting for Income Taxes." Under this method, deferred income
tax assets and liabilities reflect the impact of temporary differences between
the financial accounting and tax bases of assets and liabilities and are
measured using the enacted tax rates and laws that will be in effect when the
differences are expected to reverse.

Foreign Currency Transactions and Translations

       The balance sheet accounts of Tanox are translated into U.S. dollars at
exchange rates in effect on reporting dates. Foreign currency translation
adjustments are reflected in other comprehensive loss. Income statement items
are translated at average exchange rates in effect during the financial
statement period. Gains and losses resulting from foreign currency transactions
denominated in currency other than the functional currency are classified as
other income (expenses).

Loss Per Share

       SFAS No. 128, "Earnings Per Share," requires dual presentation of basic
and diluted earnings per share (EPS). Basic EPS is computed by dividing net
income (loss) by the weighted average number of shares of common stock
outstanding during the year. Diluted EPS is computed in the same manner as

                                      53
<PAGE>

                          TANOX, INC. AND SUBSIDIARIES
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

basic EPS, except that diluted EPS reflects the potential dilution that would
occur if outstanding options and warrants were exercised. Tanox incurred net
losses for the years ended December 31, 1999, 2000 and 2001; therefore, all
options outstanding for each of the years were excluded from the computation of
diluted EPS because they would have been antidilutive (see Note 9). Due to the
antidilutive effect of the stock options, basic and diluted EPS are the same
for the years ended December 31, 1999, 2000 and 2001.

Concentration of Credit Risk

       Tanox's other receivables are primarily associated with research
collaborations with pharmaceutical and biotechnology companies and grants from
foreign government entities. Tanox does not believe this concentration of credit
risk presents a material risk to Tanox. Tanox does not require collateral from
these entities. Tanox has invested its excess cash generally in high-quality
corporate bonds and commercial paper. As of December 31, 2001, management
believes that these investments bear minimal risk.

3.  ACQUISITION OF TANOX PHARMA B.V.:

       In March 1998, Tanox acquired the common stock of Tanox Pharma B.V.
(formerly PanGenetics B.V.), a biotechnology company located in Amsterdam, The
Netherlands. Tanox recorded the transaction for accounting purposes as a
purchase, and the consolidated financial statements include the operations of
Tanox Pharma subsequent to the acquisition date. Under the terms of the
agreement, Tanox purchased Tanox Pharma for an initial cash payment of $508,000
and 226,409 shares of common stock, valued at $11.25 per share, for a total
initial consideration of $3.1 million. In addition, Tanox agreed to pay future
consideration, in two installments, upon occurrence of specified future events.
These events include originating at least three additional research projects
within a three-year period, retaining the services of two individuals for 36
months and maintaining a certain level of government grants and subsidies. Any
additional consideration would be paid to all former shareholders in proportion
to their ownership at the acquisition date. In September 1999, Tanox made the
second installment payment of $333,000 in cash and 242,075 shares of common
stock valued at $12.50 per share, for a total additional consideration of $3.4
million.

       Tanox management believes that certain events upon which full payment of
the third installment was dependent did not occur and, in accordance with the
stock purchase agreement, the total consideration should be reduced by 20%. The
third installment payment was recorded in the second quarter of 2001 and
consisted of $133,000 in cash and 60,518 shares of common stock, totaling $2.0
million, which reflects a 20% reduction in total consideration. As discussed in
Note 10, the former shareholders are disputing the sufficiency of the amount
paid in the third installment. Due to the dispute, the cash portion of the
payment was returned and is included in accrued liabilities at December 31,
2001.

       Tanox engaged an independent firm to perform an appraisal of the assets
acquired in the transaction. The appraisal was completed and the report issued
in 1998. Under the purchase method of accounting, the aggregate purchase price
was allocated to tangible and intangible assets acquired based on their relative
fair values as of the date of the transactions. At the time of the acquisition,
the total current and future consideration of the acquisition was valued for
accounting purposes at $9.2 million, based on the total of the cash and then
fair value of common stock to be paid to Tanox Pharma shareholders. Of this
amount, Tanox allocated approximately $0.2 million to tangible fixed assets,
$0.1 million to intangible assets, $7.2 million to in-process research and
development and $1.7 million to goodwill.

                                      54
<PAGE>

                          TANOX, INC. AND SUBSIDIARIES
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

       The valuation of acquired in-process research and development considered:

   .     the current technological feasibility, scientific and development
         states of the anti-CD40 research project;
   .     the expected amount of time and resources required to complete the
         projects;
   .     the alternative future use of the acquired research and development;
         and
   .     valuation and allocation approaches.

       Tanox's ability to commercialize the acquired anti-CD40 research project
is affected by several risks. These risks include:

   .     Tanox's ability to construct low cost versions of the antibody;
   .     successful preclinical testing;
   .     successful completion of Phase I, II
         and III clinical testing;
   .     successful filing and acceptance of European and Japanese regulatory
         submissions;
   .     Tanox's ability to successfully commercialize the anti-CD40 monoclonal
         antibody by itself or in connection with a collaborative partner; and
   .     Tanox's ability to manufacture the anti-CD40 monoclonal antibody at a
         competitive cost.

       At the time of the acquisition, the anti-CD40 monoclonal antibody
required additional development work and preclinical testing to enter clinical
trials. In order for anti-CD40 to become a marketable product, it was necessary
to conduct several clinical trials and to improve the manufacturing of the
product. Tanox estimated at the time of the acquisition that it would take from
seven to nine years and cost at least $50 million to complete the development of
the anti-CD40 product.

       The purchase price installments were allocated as follows:

<TABLE>
<CAPTION>
                                              Initial               Second              Third
                                            Installment          Installment         Installment
                                               (1998)               (1999)              (2001)             Total
                                           ===============    ===================   ===============    ==============
<S>                                            <C>                    <C>               <C>               <C>
In-process research and development.....       $2,798,000             $3,359,000        $1,066,000        $7,223,000
Net working capital.....................          125,000                     --                --           125,000
Intangible assets.......................          100,000                     --                --           100,000
Tangible fixed assets...................           22,000                     --                --            22,000
Goodwill and other non-current assets...           10,000                     --           886,000           896,000
                                           ---------------    -------------------   ---------------    --------------
   Total................................       $3,055,000             $3,359,000        $1,952,000        $8,366,000
                                           ===============    ===================   ===============    ==============
</TABLE>

       Accordingly, Tanox's financial statements for the years ended December
31, 1998, 1999 and 2001 included a charge of $2,798,000, $3,359,000 and
$1,066,000, respectively, for expensing the cost of the in-process research and
development.

       If Tanox had acquired Tanox Pharma prior to January 1, 1999, the
unaudited pro forma financial results would have been as follows:

<TABLE>
<CAPTION>
                                              1999                2000               2001
                                         ================   ================   =================
<S>                                      <C>                <C>                <C>
Total assets...........................  $   55,328,000     $  290,978,000     $   277,534,000
Total revenues.........................       1,405,000         12,748,000             419,000
Net loss...............................     (19,988,000)        (1,047,000)        (20,311,000)

Basic and diluted loss per share.......           (0.64)             (0.03)              (0.46)
</TABLE>

                                      55
<PAGE>

                          TANOX, INC. AND SUBSIDIARIES
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

4.  RESTRUCTURING CHARGE:

       In connection with a periodic review and assessment of Tanox's research
programs, management made the decision to streamline its research activities and
to consolidate the Taiwan, Dutch and U.S. research operations into a single site
at the Company's headquarters in Houston. In June 2001, management approved a
formal restructuring plan (the Plan) to close Tanox's research facility in
Amsterdam. Tanox recorded a restructuring charge for the Plan of $3.9 million or
$0.09 per share in June 2001, which includes a restructuring accrual for cash
expenses of $2.2 million and non-cash charges of $1.7 million for impairment of
goodwill and write-down of assets.

       The Plan's activity, as it relates to cash expenses for the year ended
December 31, 2001, was as follows:

<TABLE>
<CAPTION>
                                      Balance           Estimate                                 Balance at
                                   June 30, 2001        Revision         Amount Paid         December 31, 2001
                                  ----------------    -------------    ----------------     --------------------
<S>                                <C>                  <C>              <C>                 <C>
Severance and related costs...     $     450,000        $  174,000       $   (324,000)       $        300,000
Termination of government
    grants and subsidies......           646,000                --                 --                 646,000
Termination of leases and
    research agreements.......           969,000          (501,000)           (24,000)                444,000
Other exit costs..............           187,000           271,000           (164,000)                294,000
                                 ================    ==============    ================     ===================
    Total.....................     $   2,252,000        $  (56,000)      $   (512,000)       $      1,684,000
                                 ================    ==============    ================     ===================
</TABLE>

       Included in the restructuring charge are incremental costs to terminate
17 employees and exit licensing, research and office lease arrangements. As of
December 31, 2001, all employees have been terminated.

       The Company expects to substantially complete the Plan by June 30, 2002.
As of December 31, 2001, $512,000 of the restructuring expenses had been paid,
and a restructuring liability of $1.7 million is reflected in the accompanying
balance sheet. The remainder of the accrual represents management's best
estimate, based on available information as of December 31, 2001, of
identifiable and quantifiable costs that the Company will incur as a result of
the Plan. The actual expenses may differ from the estimates, and any adjustments
will be reflected in future results.

5.  NOTE PAYABLE TO RELATED PARTY:

        Novartis has advanced Tanox $10.0 million pursuant to a loan agreement
to finance a pilot manufacturing facility. Tanox has pledged all of the assets
of the pilot manufacturing facility as security for the loan. The loan bears
interest at LIBOR plus 2%. For 2000 and 2001, the loan interest rate
approximated 8.4% and 5.6%, respectively. Through December 31, 2001, Novartis
has agreed to forgive interest on the loan. For the years ended December 31,
1999, 2000 and 2001, the interest forgiven by Novartis has been reflected as
interest expense and a capital contribution. These amounts totaled $738,000,
$845,000 and $556,000, respectively, for 1999, 2000 and 2001. Subject to
modifications agreed to in principle concurrent with completion of the
Three-Party Collaboration, the principal and future interest payments may be
partially or totally forgiven by Novartis based on the future use of the
facility. When the facility becomes operational, Tanox will make interest and
principal payments on the loan in amounts equal to 75% of net cash flow from the
facility. If the net cash flow payments during the ten years following the date
the facility first becomes operational are not sufficient to repay the principal
and accrued interest on the loan, Novartis has agreed to forgive the remaining
principal and accrued interest.

                                      56
<PAGE>

                          TANOX, INC. AND SUBSIDIARIES
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

6.  LICENSE AGREEMENT WITH PROTEIN DESIGN LABS, INC.:

       During March 2000, Tanox entered into an agreement with Protein Design
Labs, Inc. (PDL) to acquire the right to non-exclusive licenses to patents and
patent applications owned by PDL for up to four of the Company's antibodies.
Under the agreement, Tanox agreed to pay initial license fees to PDL of $2.5
million, in addition to $1.5 million that was paid to PDL in 1998 under a prior
licensing agreement. Tanox also agreed to pay up to $4.0 million ($1.0 million
per antibody), plus maintenance fees, to PDL if Tanox exercises its options to
license all four antibodies. In addition, Tanox agreed to pay royalties on
future sales if a product using the PDL technology is successfully
commercialized. During the first quarter of 2000, Tanox recorded a research and
development expense of $2.5 million, representing the cost of the initial option
payment.

7.  INCOME TAXES:

       Tanox's pretax income (loss) consists of the following:

                           1999               2000               2001
                      ===============   ================    ===============
U.S................    $(16,505,000)     $   5,742,000       $(24,451,000)
Foreign............      (6,807,000)        (5,874,000)         3,074,000
                      ---------------   ----------------    ---------------
                       $(23,312,000)     $    (132,000)      $(21,377,000)
                      ===============   ================    ===============

       The components of the provision for income taxes are as follows:

                                1999               2000               2001
                           ==============    ================    ===============
     Current............    $     34,000      $     915,000       $        ---
     Deferred...........             ---                ---                ---
                           --------------    ----------------    ---------------
                            $     34,000      $     915,000       $        ---
                           ==============    ================    ===============

       For 1999, 2000 and 2001 the effective income tax provision varied from
that computed at the statutory federal income tax rate of 35% primarily due to
an increase in the valuation allowance and nondeductible foreign losses.

       During 2000 and 2001, a significant number of non-qualified options were
exercised creating an excess income tax benefit for Tanox. This benefit was
utilized to the extent that Tanox had tax basis income that was not offset by
net operating loss (NOL) carryforwards. The benefits recognized in 2000 of
$915,000 were recorded as an expense and additional paid-in capital. At December
31, 2001, approximately $19.1 million of the valuation allowance has been
attributed to "excess benefit due to options." The company will use this portion
only when the valuation allowance has been reduced by $10.5 million. Any tax
benefit that is realized in subsequent years from the reduction of the valuation
allowance established related to these options will also be recorded as an
expense and additional paid-in capital.

                                      57
<PAGE>

                          TANOX, INC. AND SUBSIDIARIES
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

       Significant components of Tanox's deferred tax assets at December 31 are
as follows:

<TABLE>
<CAPTION>
                                                         2000             2001
                                                     ==============    ===============
<S>                                                  <C>               <C>
Federal NOL carryforwards.........................    $  9,005,000      $ 19,482,000
In-process research and development...............       2,038,000         1,335,000
Foreign NOL carryforwards.........................       2,412,000         2,412,000
Deferred compensation related to stock options....       2,189,000         2,268,000
Research and development tax credit...............       1,289,000         1,713,000
Alternative minimum tax credit....................         186,000           248,000
Accruals not currently deductible.................       1,456,000         1,550,000
Capitalized research..............................         656,000           875,000
Other, net........................................         140,000           223,000
                                                     --------------    ---------------
     Total deferred tax assets....................      19,371,000        30,106,000
Differences in book and tax depreciation..........        (488,000)         (474,000)
Deferred tax valuation allowance..................     (18,883,000)      (29,632,000)
                                                     --------------    ---------------
     Net deferred taxes                               $        ---      $        ---
                                                     ==============    ===============
</TABLE>

        At December 31, 2001, Tanox had federal regular tax NOL carryforwards
and alternative minimum tax NOL carryforwards of approximately $55,663,000 and
53,729,000, respectively, which will begin to expire in 2019. Tanox also had a
foreign NOL carryforward of approximately $6,891,000, which will be available to
offset the separate company taxable income of certain foreign subsidiaries.
Additionally, Tanox has an unused U.S. research and development tax credit
carryforward at December 31, 2001, of approximately $1,713,000, which will begin
to expire in 2002. Tanox also has alternative minimum tax NOL carryforwards of
approximately $57,490,000 and alternative minimum tax credit carryforwards, of
approximately $248,000 as of December 31, 2001. As Tanox has incurred cumulative
losses to date and there is no assurance of future taxable income, a valuation
allowance has been established to fully offset the net deferred tax asset at
December 31, 2000 and 2001. Tanox's valuation allowance increased from
$18,883,000 at December 31, 2000, to $29,632,000 at December 31, 2001, primarily
due to Tanox's increase in NOL carryforwards.

8.  LEASE OBLIGATIONS:

       Tanox leases its facilities pursuant to various operating leases that
expire at various dates through March 2007. Future minimum lease obligations
under noncancelable leases at December 31, 2001, are as follows:

Year ending December 31-
      2002..........................................       $  967,000
      2003..........................................          671,000
      2004..........................................          365,000
      2005..........................................          359,000
      2006..........................................          359,000
      Thereafter....................................           90,000
                                                          ------------
           Total....................................       $2,811,000
                                                          ============

       Tanox incurred rent expense of $331,000, $425,000 and $572,000 in 1999,
2000 and 2001, respectively. Certain of the facility leases include escalation
clauses for operating expenses and real estate taxes.

                                      58
<PAGE>

                          TANOX, INC. AND SUBSIDIARIES
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

9.  CAPITAL STOCK:

Preferred Stock

       Tanox is authorized to issue up to 10,000,000 shares of $.01 par value
preferred stock. The board of directors has the authority to issue these shares
in one or more series and to establish the rights, preferences and dividends. No
shares of preferred stock have been issued.

Stock Split

       On February 1, 2000, Tanox declared a stock dividend to effect a stock
split that provided 0.6 of a share of Tanox common stock for every one share of
Tanox common stock held by stockholders of record as of January 31, 2000. The
aggregate par value of the dividend was transferred from additional paid-in
capital to common stock. The stock split has been retroactively reflected in the
accompanying consolidated financial statements.

Stockholder Rights Agreement

       On July 27, 2001, the board of directors of Tanox declared a dividend of
one right for each outstanding share of the common stock of record at the close
of business on August 10, 2001. Each right entitles the registered holder to
purchase a unit consisting of one one-hundredth of a share (a Fractional Share)
of Series A Junior Participating Preferred Stock, par value $0.01 per share, at
a purchase price of $140 per Fractional Share, subject to adjustment. The rights
generally become exercisable if an acquiring party accumulates 20% or more of
the common stock and, in such event, the holders of the rights (other than the
acquiring person) would be entitled to purchase either Tanox's stock or shares
in an acquiring entity at half of market value. Tanox is generally entitled to
redeem the rights at $0.01 per right at any time until the tenth day following
the time the rights become exercisable. The rights will expire on August 10,
2011.

Treasury Stock

       In September 2001, the board of directors of Tanox authorized the
repurchase, at management's discretion, of up to $4.0 million of Tanox's common
stock, and in September 2001 the Company purchased 80,000 shares for an
aggregate cost of $1.0 million.

Stock Options

       During 1987, Tanox established the 1987 Stock Option Plan (the 1987 Plan)
covering key employees, officers and directors of Tanox. Under the terms of the
1987 Plan, as amended, the number of shares of common stock eligible for
issuance was 4,320,000. Options issued under the 1987 Plan were generally
granted at a purchase price equal to the fair market value at the date of grant
and are generally exercisable beginning two years after the date of grant for
40% of the shares, with the balance to become exercisable cumulatively in three
installments of 20% each year thereafter. Options expire ten years after the
date of grant. At December 31, 2001, options to purchase 344,960 shares of
common stock were outstanding under the 1987 Plan. The 1987 Plan expired June
24, 1997, and no more shares may be granted under this plan.

                                      59
<PAGE>

                          TANOX, INC. AND SUBSIDIARIES
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

       Tanox established the 1997 Stock Plan (the 1997 Plan) in November 1997.
Under the terms of the 1997 Plan, Tanox may grant options to purchase up to
8,000,000 shares of common stock to employees, directors, advisors and
consultants. The 1997 Plan also provides for several types of grants including
incentive stock options, non-qualified stock options, stock appreciation rights,
stock awards, stock purchases and performance units. Incentive stock options
provide the right to purchase common stock at a price not less than 100% of the
fair value of common stock on the date of the grant. Non-qualified stock options
provide the right to purchase common stock at a price not less than 50% of the
fair value of the common stock on the date of the grant. The options granted
under the 1997 Plan generally expire ten years after date of grant and are
generally completely exercisable five years after the grant date. At December
31, 2001, options to purchase 1,405,236 shares of common stock were outstanding
under the 1997 Plan, and 6,289,533 shares were available for future grants. The
1997 Plan will expire on October 31, 2007.

       In January 1992, Tanox established the 1992 Non-Employee Directors Stock
Options Plan (the Directors Plan) and reserved 480,000 shares of common stock
for issuance upon the exercise of options granted pursuant to the Directors
Plan. Unless otherwise provided, options granted under the Directors Plan will
vest one-third annually from the date of grant. The exercise price of the
options granted will be determined by a committee appointed by Tanox's board of
directors. At December 31, 2001, options to purchase 129,800 shares of common
stock were outstanding under the Directors Plan, and 330,000 shares were
available for future grants. The Directors Plan expired on January 10, 2002.

       In February 2000, Tanox established the 2000 Non-Employee Directors'
Stock Option Plan (the 2000 Directors Plan) and reserved 500,000 shares of
common stock for issuance under the plan. Non-employee directors joining the
board after April 6, 2000, automatically receive a stock option to purchase
15,000 shares upon initial election or appointment. Each such director also
receives a stock option to purchase an additional 5,000 shares upon their
re-election to the board. In May 2001, the board of directors of Tanox approved,
subject to stockholder approval, an amendment to the 2000 Directors Plan. As
amended, the plan provides that non-employee directors joining the board after
May 31, 2001, automatically receive an option to purchase an equivalent number
of shares of common stock having a Black-Scholes model value of $200,000.
Non-employee directors also receive, immediately following any annual meeting of
stockholders at which directors are elected (beginning with the 2002 annual
meeting), an option to purchase an equivalent number of shares of common stock
having a Black-Scholes model value of $80,000, provided that the director did
not receive an initial grant under the plan within the prior six months. All
grants under the 2000 Directors Plan are issued at fair market value and vest
1/36 per month from the date of grant over three years. The term of each stock
option is ten years. The board of directors administers the 2000 Directors Plan.
At December 31, 2001, options to purchase 15,000 shares of common stock were
outstanding under the 2000 Directors Plan, and 485,000 shares were available for
future grants.

       In addition to the plans discussed above, Tanox has entered into various
stock option agreements with certain outside consultants and advisors. At
December 31, 2001, options to purchase 117,600 shares of Tanox's common stock
were outstanding under such agreements. All of the outstanding options issued
under these agreements were issued prior to 1996, are currently exercisable and
expire in either 2002 or 2003.

                                      60
<PAGE>

                          TANOX, INC. AND SUBSIDIARIES
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

       The following table summarizes stock option transactions since December
31, 1998:

<TABLE>
<CAPTION>
                                            Number of                                  Weighted Average
                                             Shares         Exercise Price              Exercise Price
                                          ---------------  ----------------           -------------------
<S>                                       <C>              <C>                        <C>
Outstanding, December 31, 1998....           4,881,120      $ 0.21 - 11.25                      $ 2.88
Granted...........................             137,120        4.06 - 12.50                       10.27
Exercised.........................          (1,789,520)       0.63 -  5.63                        0.64
Cancelled.........................             (44,800)       2.29 - 11.25                        7.61
                                          ---------------  ----------------           -------------------
Outstanding, December 31, 1999....           3,183,920        0.21 - 12.50                        4.39
Granted...........................             686,500       12.50 - 48.00                       36.14
Exercised.........................          (1,720,742)       0.21 - 12.50                        2.86
Cancelled.........................            (169,041)       7.50 - 12.50                        8.52
                                          ---------------  ----------------           -------------------
Outstanding, December 31, 2000....           1,980,637        0.63 - 48.00                       16.38
Granted...........................             750,800       12.74 - 36.31                       22.25
Exercised.........................            (492,128)       0.63 - 12.50                        5.96
Cancelled.........................            (226,713)       3.75 - 38.50                        9.59
                                          ---------------  ----------------           -------------------
Outstanding, December 31, 2001....           2,012,596      $ 0.83 - 48.00                      $21.88
                                          ===============  ================           ===================
Exercisable, December 31, 2001....             651,859      $ 0.83 - 48.00                      $14.29
                                          ===============  ================           ===================
</TABLE>

       Tanox follows SFAS No. 123, which permits one of two methods of
accounting for stock options. Tanox adopted Accounting Principles Board Opinion
(APB) No. 25, "Accounting for Stock Issued to Employees," and related
interpretations in accounting for its employee stock options. SFAS No. 123,
however, requires Tanox to disclose the income statement effect of the
alternative fair value method assuming Tanox was required to record compensation
expense for stock options equal to the assumed fair value on the grant date.

       Under APB No. 25, Tanox recognizes as compensation expense the excess of
the estimated fair value of the common stock issuable upon exercise of such
options over the aggregate exercise price of such options on the measurement
date. This compensation expense is amortized ratably over the vesting period of
each option. Amortization expense for such options, net of reversals for
terminations, was $311,000, $592,000 and $137,000 during the years ended
December 31, 1999, 2000 and 2001, respectively.

       The fair value of each option grant is estimated using the Black-Scholes
option pricing model. The Black-Scholes model uses grant prices, as stated in
the option agreements, market price as established by stock sales in 1999 and
deemed market prices established by the Compensation Committee of Tanox's board
of directors prior to Tanox's initial public offering (IPO) and fair market
value established by closing prices on the Nasdaq Stock Market following the
IPO. The following assumptions were used in the Black-Scholes option pricing
model:

                                          1999         2000         2001
                                      ----------   -----------  -----------
Expected dividend yield...........           --            --           --
Expected price volatility.........        42.0%         46.0%         51.O%
Risk-free interest rate...........         6.0%         4.25%          3.0%
Expected life of option...........      6 years       5 years       5 years
Expected turnover.................        20.0%          2.0%          5.0%

                                      61
<PAGE>

                          TANOX, INC. AND SUBSIDIARIES
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

       Assuming the compensation cost for the stock option plans had been
determined pursuant to the fair value method under SFAS No. 123, Tanox's pro
forma net loss would have been as follows:

<TABLE>
<CAPTION>
                                        1999             2000               2001
                                -----------------   -----------------   -----------------
<S>                              <C>                  <C>                 <C>
Net loss -
   As reported...............    $ (23,346,000)       $ (1,047,000)       $ (21,377,000)
   Pro forma.................      (24,551,000)         (2,322,000)         (26,086,000)
Basic and diluted EPS -
   As reported...............            (0.75)              (0.03)               (0.49)
   Pro forma.................            (0.79)              (0.06)               (0.59)
</TABLE>

       Because the SFAS No. 123 method of accounting has not been applied to
options granted prior to January 1, 1996, the resulting pro forma compensation
cost may not be representative of the expense to be expected in future years.

        The number and weighted average fair value of options granted in 1999,
2000 and 2001 is as follows:

<TABLE>
<CAPTION>
                                             1999                           2000                           2001
                                 -----------------------------  -----------------------------  -----------------------------
                                                  Weighted                       Weighted                       Weighted
                                                   Average                        Average                        Average
                                    Shares        Fair Value       Shares        Fair Value       Shares        Fair Value
                                 ------------   --------------  ------------   --------------  ------------   --------------
<S>                                <C>                 <C>        <C>               <C>           <C>               <C>
Option price equals fair market
  Value........................    129,120             $5.24      627,000           $17.43        727,072           $10.59
Option piice greater than fair
  market value.................         --                --           --               --         22,828             7.83
Option price less than fair
  market value.................      8,000              5.65       59,500            17.65             --               --
</TABLE>

       The following table summarizes information about fixed-price stock
options outstanding at December 31, 2001:

<TABLE>
<CAPTION>
                                      Options Outstanding at                   Options Exercisable at
                                        December 31,2001                         December 31,2001
                            ---------------------------------------------  ------------------------------
                                             Weighted                           No. of
                               No. of        Average          Weighted          Shares         Weighted
                              Shares        Remaining         Average         Subject to       Average
                             Subject to    Contractual        Exercise        Exercisable      Exercise
Kanpe of Exercise Prices     Options      Life(in Yrs)        Price           Options          Price
-------------------------  -----------  ----------------  --------------  --------------- --------------
<S>                           <C>              <C>                <C>           <C>                <C>
$0.83 - 9.60..............     593,400         4.1                $5.31         420,653            $4.41
$9.60 -  19.20............     482,468         9.2                15.28          36,811            12.50
$19.20 - 28.80............     102,128         5.2                23.29          14,246            24.39
$28.80 - 38.40............     637,600         8.8                34.45         140,000            34.31
$38.40 - 48.00............     197,000         7.9                46.47          40,149            45.97
                            -----------                                    ---------------
                              2,012,596        7.2                21.88         651,859            14.29
                            ===========                                    ===============
</TABLE>

       In April 1999, Tanox loaned 12 employees approximately $1,086,000 to
enable the employees to exercise options to purchase 1,738,320 shares of Tanox
common stock. All of the loans were full-recourse, secured by shares of Tanox
common stock owned by the employees, bore interest at a rate of 8.5%, and were
due and payable in full in September 2001. In March 2000, Tanox loaned an
additional

                                      62
<PAGE>

                          TANOX, INC. AND SUBSIDIARIES
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

$1,188,000, payable in full in September 2001, to eight of the employees to
enable them to pay federal income tax associated with the 1999 exercise of
stock options. At December 31, 2001, the loans have been paid in full.

       Also during 1999, Tanox agreed to extend, for an additional three-year
period, the term of 524,400 stock options held by certain employees and
consultants that were scheduled to expire. In connection with this extension,
Tanox expensed, for accounting purposes, approximately $4,576,000 of
compensation expense representing the fair value of the options as of the
remeasurement date. For employees, compensation expense was recorded equal to
the difference between the fair value of the underlying stock on the date of the
extension and the exercise price of the option. For consultants, compensation
expense was calculated using the Black-Scholes valuation model on the date of
the extension.

Warrants

       In connection with the issuance of notes payable to an unrelated company
for equipment financing in 1989, Tanox issued warrants to purchase 93,053 shares
of Tanox's common stock at $0.86 per share. All of the warrants were exercised
on a net issuance basis in 1999 and converted into 86,632 shares of common
stock. As of December 31, 2001, there were no outstanding warrants.

10.  COMMITMENTS AND CONTINGENCIES

Arbitrations and Litigation

       Following settlement of Tanox's lawsuit against Genentech and Roche
referred to in Note 1, Tanox filed a demand for arbitration against the
attorneys who represented Tanox in the litigation in order to resolve a dispute
over the amount of attorneys' fees due by Tanox. On September 29, 1999, the
arbitration panel issued an award entitling the attorneys to receive (i)
approximately $3.5 million, including interest, (ii) payments ranging from
33-1/3% to 40% of the future payments that Tanox may receive from Genentech
following product approval and (iii) 10% of the royalties that Tanox may receive
on sales of anti-IgE products. Tanox sought a court order vacating this
arbitration award. However, a judgment was entered confirming the award. Tanox
intends to pursue all available remedies, including appealing the decision.
During the appeals process, we are required to post a bond or place amounts in
escrow to secure payment of the award. We posted a $4.1 million supersedeas bond
with the Court to continue the appeals process and to secure payment of the
award.

       If Tanox is ultimately required to pay all or part of the award to the
attorneys, Tanox could be required to pay up to 3.5 million, plus accrued
interest that would become due, and the award would effectively reduce future
milestone payments from Genentech by up to 40% and reduce future royalties from
the Three-Party Collaboration by 10%. Accordingly, Tanox's future revenues,
result of operations, cash flow and financial condition could be materially
adversely affected.

       Tanox is also engaged in a dispute with Novartis and Genentech over
Tanox's right to independently develop certain of its anti-IgE monoclonal
antibodies, which are not being developed in connection with the Three-Party
Collaboration. Following a favorable summary judgment from a Federal district
court regarding certain key issues, Tanox and Novartis will submit remaining
issues to an arbitration panel, following which, Tanox may pursue arbitration
with Genentech. If Tanox ultimately loses its right to independently develop the
anti-IgE monoclonal antibodies, Tanox would be required to discontinue
development of its TNX-901 product.

       In connection with Tanox's acquisition of Tanox Pharma in March 1998,
Tanox paid initial consideration of $508,000 and 226,409 shares of its common
stock, and agreed to pay future

                                      63
<PAGE>

                          TANOX, INC. AND SUBSIDIARIES
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

consideration, in two installments, subject to the occurrence of specified
events. Tanox believes that certain events did not occur, and, in accordance
with the terms of the stock purchase agreement, the total consideration payable
was reduced by 20%. The former stockholders of Tanox Pharma have disputed this
position, and Tanox sought a declaratory judgment in state court in Harris
County, Texas to resolve the dispute. The former stockholders have brought
counter claims in the Texas lawsuit, as well as claims in a parallel litigation
in the Netherlands, which assert that the total consideration should not have
been reduced, therefore requesting payment of the full amount of the third
installment, as well as return of 51% of the stock of Tanox Pharma. The full
amount of the third installment under the stock purchase agreement is $333,336
in cash and 151,294 shares of common stock. In addition, the former
stockholders have asserted that they are entitled to additional shares because
Tanox declared a stock dividend in February, 2000. Tanox also disagrees with
this assertion. Tanox does not believe that the outcome of this litigation will
have a material adverse effect on its financial position or liquidity.

       From time to time Tanox is a defendant in lawsuits incidental to its
business. Management believes that the outcome of these lawsuits will not be
material to Tanox's financial statements.

Milestones and Royalties

       Tanox has agreements with various companies and institutions that call
for payments upon the achievement of milestones by Tanox and royalty payments
based upon a percentage of product sales.

Registration Rights

       Some of Tanox's stockholders including founders, some early investors and
persons who hold 15% or more of our stock, have certain registration rights.

401(k) Plan

       Effective January 1, 1992, Tanox adopted a qualified retirement plan (the
401(k) Plan) covering all of Tanox's U.S. employees who are at least 21 years of
age and have completed at least 90 days of service with Tanox. Pursuant to the
401(k) Plan, employees may elect to reduce their current compensation by up to
the statutorily prescribed annual limit and have the amount of such reduction
contributed to the 401(k) Plan. The 401(k) Plan permits, but does not require,
additional matching contributions by Tanox on behalf of all participants in the
401(k) Plan. Tanox's matching contributions to the 401(k) Plan totaled
approximately $66,000, $83,000 and $208,000 in 1999, 2000 and 2001,
respectively.

                                      64
<PAGE>

                          TANOX, INC. AND SUBSIDIARIES
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

11.  GEOGRAPHIC AREAS:

       Tanox operates in a single business segment. Tanox's operations by
geographic area for the years ended December 31, 1999, 2000 and 2001, are
presented below:

<TABLE>
<CAPTION>
                                         Total             Net Income       Identifiable
                                        Revenues             (Loss)           Assets
                                     ==============    ===============     ===============
<S>                                   <C>              <C>                 <C>
Year Ended December 31, 1999-
   Americas.....................      $  3,865,000     $  (19,242,000)     $   58,522,000
   Europe.......................           244,000         (4,039,000)            754,000
   Asia.........................                --            (65,000)          1,534,000
   Interarea eliminations.......        (2,704,000)                --          (5,482,000)
                                    ---------------    ---------------     ---------------
                                      $  1,405,000     $  (23,346,000)     $   55,328,000
                                    ===============    ===============     ===============
Year Ended December 31, 2000-
   Americas.....................      $ 14,502,000     $    3,127,000      $  298,027,000
   Europe.......................           666,000         (3,746,000)          1,358,000
   Asia.........................                --           (428,000)          1,178,000
   Interarea eliminations.......        (2,420,000)                --          (9,585,000)
                                    ---------------    ---------------     ---------------
                                      $ 12,748,000     $   (1,047,000)     $  290,978,000
                                     ==============    ===============     ===============
Year Ended December 31, 2001-
   Americas.....................      $    235,000     $  (16,409,000)     $  288,259,000
   Europe.......................           184,000         (4,670,000)            636,000
   Asia.........................                --           (298,000)            788,000
   Interarea eliminations.......                --                 --         (12,149,000)
                                     --------------    ---------------     ---------------
                                       $    419,000    $  (21,377,000)     $  277,534,000
                                    ===============    ===============     ===============
</TABLE>

12.  QUARTERLY FINANCIAL DATA (UNAUDITED) (IN THOUSANDS EXCEPT PER SHARE DATA):

<TABLE>
<CAPTION>
                                                       Three Months Ended
                                   ========================================================
2000                                March 31        June 30    September 30    December 31
                                   ==========      =========   ============    ============
<S>                                <C>            <C>            <C>            <C>
Revenues.........................  $      149     $   12,112     $      203     $      284
Income (loss) from operations....      (6,445)         6,769         (5,774)        (7,810)
Net income (loss)................      (5,967)         8,449         (1,739)        (1,790)
Income (loss) per share:
     Basic.......................       (0.18)          0.21          (0.04)         (0.04)
     Diluted.....................       (0.18)          0.20          (0.04)         (0.04)
</TABLE>

<TABLE>
<CAPTION>
                                                       Three Months Ended
                                   ========================================================
2001                                March 31        June 30    September 30    December 31
                                   ==========      =========   ============    ============
<S>                                 <C>             <C>         <C>             <C>
Revenues.........................   $    121        $    163    $      3        $     132
Loss from operations.............    (6,855)         (12,119)     (6,710)          (7,789)
Net loss.........................    (2,971)          (8,315)     (3,698)          (6,393)
Loss per share:
      Basic and diluted..........     (0.07)           (0.19)      (0.08)           (0.15)
</TABLE>

                                      65
<PAGE>

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE

None

PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information regarding directors that is required by this item is
incorporated by reference from the discussion in the Proxy Statement captioned
"Proposal 1--Election of Directors" and "Beneficial Ownership Table".
Information concerning our executive officers is set forth under Part I of this
Form 10-K.

ITEM 11.  EXECUTIVE COMPENSATION

The information that is required by this item is incorporated by reference from
the discussion in the Proxy Statement captioned "Executive Compensation".

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information that is required by this item is incorporated by reference from
the discussion in the Proxy Statement captioned "Beneficial Ownership Table".

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information that is required by this item is incorporated by reference from
the discussion in the Proxy Statement captioned "Executive Compensation".

                                     PART IV

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a)   1. Index to Financial Statements.

         Report of Independent Public Accountants
         Consolidated Balance Sheets as of December 31, 2000 and 2001
         Consolidated Statements of Operations and Comprehensive Loss for the
           years ended December 31, 1999, 2001 and 2001
         Consolidated Statements of Stockholders' Equity for the years ended
           December 31, 1999, 2000 and 2001
         Consolidated Statements of Cash Flows for the years ended December 31,
           1999, 2000 and 2001
         Notes to Consolidated Financial Statements

      2. Financial Statement Schedules.

         All schedules are omitted because they are not applicable or not
         required, or because the required information is included in the
         consolidated financial statements or notes thereto.

      3. Exhibits.

        3.1-- Amended and Restated Certificate of Incorporation of the
              Registrant, as amended. (1)
        3.2-- Bylaws of the Registrant, as currently in effect. (1)
        4.1-- Specimen of Common Stock Certificate, $.01 par value, of the
              Registrant. (1)

                                      66
<PAGE>

      10.1-- Form of Indemnification Agreement between the Registrant and its
             officers and directors. (1) (5)
      10.2-- 1987 Stock Option Plan of the Registrant, as amended. (1) (5)
      10.3-- 1992 Non-employee Directors Stock Option Plan of the Registrant.
             (1) (5)
      10.4-- 1997 Stock Plan of the Registrant. (1) (5)
      10.5-- Lease of premises at 10301 Stella Link, Suite 110, Houston, Texas,
             dated December 3, 1986, as amended. (1)
      10.6-- Stock Purchase Agreement, dated July 14, 1987, by and among the
             Registrant and Tse Wen Chang, Nancy T. Chang, Alafi Capital
             Company, Shireen Alafi, Joseph Heskel, Trustee for Christopher
             Alafi, and Invitron Corporation. (1)
      10.7-- License for Winter Patent, dated June 26, 1989, by and between
             Medical Research Council and the Registrant. (1)
      10.8-- Amendment to the License for Winter Patent, dated February 9,
             1990, by and between Medical Research Council and the Registrant.
             (1)
      10.9-- Development and Licensing Agreement, dated May 11, 1990, by and
             between the Registrant and Ciba-Geigy Limited. (1)
      10.10--Term Sheet for Secured Loan, dated December 14, 1994, by and
             between the Registrant and Ciba-Geigy Limited. (1)
      10.11--Chiron-PanGenetics Research and Development License and Options
             for Commercial License, dated September 25, 1995, by and between
             PanGenetics, B.V., Panorama Research, Inc. and Chiron
             Corporation. (1)
      10.12--Stock Purchase Agreement, dated as of March 12, 1998, by and
             between the Registrant and the holders of shares of PanGenetics,
             B.V. (1)
      10.13--License Agreement, dated June 1, 1998, by and between Biogen, Inc.
             and the Registrant. (1)
      10.14--Outline of Terms for Settlement of the Litigations Among
             Genentech, Inc., Genentech International, Ltd., the Registrant and
             Ciba-Geigy Limited Relating to Anti-IgE Inhibiting Monoclonal
             Antibodies, dated July 8, 1996. (1)
      10.15--Supplemental Agreement between the Registrant and Ciba-Geigy
             Limited, dated July 8, 1996. (1)
      10.16--Settlement and Cross-Licensing Agreement, dated July 8, 1996, by
             and between the Registrant and Genentech, Inc. and Genentech
             International Limited. (1)
      10.17--Settlement and Participation Agreement, dated July 8, 1996, by and
             between the Registrant and F.  Hoffman-La Roche, Ltd., Hoffman-La
             Roche, Inc., Roche Holding Ltd. and Roche Holdings, Inc. (1)
      10.18--Patent License Agreement, dated June 30, 1998, by and between
             Protein Design Labs, Inc. and the Registrant. (1)
      10.19--Amendment to Patent License Agreement, dated June 28, 1999, by and
             between Protein Design Labs, Inc.  and the Registrant. (1)
      10.20--Research and License Agreement, dated April 21, 1999, by and
             between the Registrant and Biovation Limited. (1)
      10.21--Material Transfer and Commercial Evaluation Agreement, dated March
             9, 1999, by and between Tanox, Inc. and Biovation Limited. (1)
      10.22--G-CSF Receptor Non-exclusive License Agreement, dated January 11,
             2000, by and between Immunex Corporation and the Registrant. (1)
      10.23--2000 Non-Employee Directors' Stock Option Plan. (1) (5)
      10.24--Master Agreement, dated March 17, 2000, by and between the
             Registrant and Protein Design Labs, Inc. (1)
      10.25--First Amendment to the Tanox, Inc. 1997 Stock Plan. (2) (5)
      10.26--First Amendment to the 2000 Non-Employee Directors' Stock Option
             Plan. (3) (5)
      10.27--Rights Agreement dated as of July 27, 2001 between Tanox, Inc. and
             American Stock Transfer & Trust Company, as Rights Agent, which
             includes as Exhibit A the form of Rights Certificate and as
             Exhibit B the Summary of Rights to Purchase Common Stock. (4)
      10.28--Amendment 10, dated October 22, 2001, to Lease of premises at 10301
             Stella Link, Suite 110, Houston, Texas, dated December 3, 1986.

                                      67
<PAGE>

      21.1-- List of Subsidiaries of the Registrant.
      23.1-- Consent of Arthur Andersen LLP
      23.2-- Consent of KPMG Consulting Inc.
      -----------------------------
      (1)    Filed as an exhibit to our Registration Statement on Form S-1 (no.
             333-90625) and incorporated herein by reference.
      (2)    Filed as an exhibit to our Quarterly Report on Form 10-Q for the
             quarter ended September 30, 2000, and incorporated herein by
             reference.
      (3)    Filed as an exhibit to our Quarterly Report on Form 10-Q for the
             quarter ended June 30, 2001, and incorporated herein by reference.
      (4)    Filed as an exhibit to our Current Report on Form 8-K dated
             August 2, 2001.
      (5)    Management contract or compensatory plan.

(b)   Reports on Form 8-K

      No reports on Form 8-K were filed during the quarter ended December 31,
2001.

                                      68
<PAGE>

                                   SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.

                                      TANOX, INC.

                                      By:     Nancy T. Chang
                                          --------------------------------
                                              Nancy T. Chang
                                        President and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act, this report has
been signed by the following persons on behalf of the registrant in the
capacities and on the dates indicated:

Signature                      Title                               Date

  Nancy T. Chang               President, Chief Executive Officer  March 8, 2002
------------------
  Nancy T. Chang               and Chairman of the Board

  Michael A. Kelly             Vice President and Chief            March 8, 2002
------------------
  Michael A. Kelly             Financial Officer
                               (Principal Financial Officer)

  Pamela Thompson              Director of Financial Reporting     March 8, 2002
------------------------
  Pamela Thompson              (Principal Accounting Officer)

  Heinz W. Bull                 Director                           March 8, 2002
------------------------
  Heinz T. Bull

  Txe Wen Chang                 Director                           March 8, 2002
------------------------
  Tse Wen Chang

  William J. Jenkins            Director                           March 8, 2002
------------------------
  William J. Jenkins

  Osama Mikhail                 Director                           March 8, 2002
------------------------
  Osama Mikhail

                                      69