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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF

THE SECURITIES EXCHANGE
ACT OF 1934



For the quarterly period ended
September 30, 2005



Commission file number 000-28401



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MAXYGEN, INC.

(Exact name
of registrant as specified in its charter)



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|                         |  |                                     
|------------------------ |  | ------------------------------------
|Delaware                 |  | 77-0449487                          
|(State of incorporation) |  | (I.R.S. Employer Identification No.)



515 Galveston Drive

Redwood City, California 94063

(Address of principal executive offices, including zip code)



(650) 298-5300

(Registrants telephone number, including area code)



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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 the filing requirements for
at least the past 90 days.    Yes  xNo ̈



Indicate by check mark whether the registrant is an accelerated
filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  xNo ̈



Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes ̈Nox



As of November 1, 2005, there were 35,881,801 shares of the registrants common stock, $0.0001 par value per share, outstanding, which is the only class of common or voting stock of the registrant issued.



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##### Table of Contents

MAXYGEN, INC.

FORM 10-Q

QUARTER ENDED SEPTEMBER 30, 2005



INDEX



|           |  |                                                                                                                        |  |   
|---------- |  | ---------------------------------------------------------------------------------------------------------------------- |  | --
|Part I     |  | FINANCIAL INFORMATION                                                                                                  |  |   
|           |  |                                                                                                                       
|Item 1:    |  | Unaudited Condensed Consolidated Financial Statements and Notes:                                                       |  |   
|           |  |                                                                                                                       
|           |  | Condensed Consolidated Balance Sheets as of December 31, 2004 and September 30, 2005                                   |  | 3 
|           |  |                                                                                                                       
|           |  | Condensed Consolidated Statements of Operations for the three and nine month periods ended September 30, 2004 and 2005 |  | 4 
|           |  |                                                                                                                       
|           |  | Condensed Consolidated Statements of Cash Flows for the nine month periods ended September 30, 2004 and 2005           |  | 5 
|           |  |                                                                                                                       
|           |  | Notes to Condensed Consolidated Financial Statements                                                                   |  | 6 
|           |  |                                                                                                                       
|Item 2:    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                  |  | 16
|           |  |                                                                                                                       
|Item 3:    |  | Quantitative and Qualitative Disclosures About Market Risk                                                             |  | 31
|           |  |                                                                                                                       
|Item 4:    |  | Controls and Procedures                                                                                                |  | 31
|           |  |                                                                                                                       
|Part II    |  | OTHER INFORMATION                                                                                                      |  |   
|           |  |                                                                                                                       
|Item 1:    |  | Legal Proceedings                                                                                                      |  | 32
|           |  |                                                                                                                       
|Item 2:    |  | Unregistered Sales of Equity Securities and Use of Proceeds                                                            |  | 33
|           |  |                                                                                                                       
|Item 3:    |  | Defaults Upon Senior Securities                                                                                        |  | 33
|           |  |                                                                                                                       
|Item 4:    |  | Submission of Matters to a Vote of Security Holders                                                                    |  | 33
|           |  |                                                                                                                       
|Item 5:    |  | Other Information                                                                                                      |  | 33
|           |  |                                                                                                                       
|Item 6:    |  | Exhibits                                                                                                               |  | 33
|           | 
|SIGNATURES |  | 34                                                                                                                    



This report and the disclosures herein
include, on a consolidated basis, the business and operations of Maxygen, Inc. and its wholly-owned subsidiaries, Maxygen ApS and Maxygen Holdings Ltd. For the three and nine months ended September 30, 2004 and for the two months ended
February 28, 2005, the operations of Codexis, Inc. are also included. On February 28, 2005 Maxygens voting interests in Codexis fell below 50% and from such date the financial position and results of operations of Codexis were no
longer consolidated with the financial position and results of operations of Maxygen. The operations of Verdia, Inc. prior to its sale on July 1, 2004 are reflected as discontinued operations.



We make available on our website all reports filed with the Securities and Exchange
Commission, including our reports on Form 10-K, 10-Q and 8-K, as soon as reasonably practicable after they have been filed. Our website is located at www.maxygen.com. Information contained on our website is not a part of this report.



Maxygen is a registered trademark of Maxygen, Inc. Codexis is a trademark of Codexis, Inc.
The use of the word partner and partnership does not mean a legal partner or legal partnership.



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##### Table of Contents

PARTI  FINANCIAL INFORMATION

ITEM 1

FINANCIAL STATEMENTS



MAXYGEN, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)



|                                                                                                                                                                                  |  |                  |          |   |                   |   |          |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------- | -------- | - | ----------------- | - | -------- | -
|                                                                                                                                                                                  |  | December 31,2004 |          |   | September 30,2005 |  
|                                                                                                                                                                                  |  | (Note 1)         |          |   | (unaudited)       |  
|ASSETS                                                                                                                                                                            |  |                  |          |   |                   |   |          |  
|Current assets:                                                                                                                                                                   |  |                  |          |   |                   |   |          |  
|Cash and cash equivalents                                                                                                                                                         |  | $                | 40,415   |   |                   | $ | 35,065   |  
|Short-term investments                                                                                                                                                            |  |                  | 178,883  |   |                   |   | 119,965  |  
|Accounts receivable and other receivables                                                                                                                                         |  |                  | 1,735    |   |                   |   | 508      |  
|Prepaid expenses and other current assets                                                                                                                                         |  |                  | 7,046    |   |                   |   | 3,470    |  
|                                                                                                                                                                                  |  |                  |          |   |                   |   |          |  
|Total current assets                                                                                                                                                              |  |                  | 228,079  |   |                   |   | 159,008  |  
|Property and equipment, net                                                                                                                                                       |  |                  | 7,677    |   |                   |   | 3,343    |  
|Goodwill                                                                                                                                                                          |  |                  | 12,192   |   |                   |   | 12,192   |  
|Long-term investments                                                                                                                                                             |  |                  | 13,595   |   |                   |   | 34,597   |  
|Deposits and other long-term assets                                                                                                                                               |  |                  | 1,562    |   |                   |   | 357      |  
|                                                                                                                                                                                  |  |                  |          |   |                   |   |          |  
|Total assets                                                                                                                                                                      |  | $                | 263,105  |   |                   | $ | 209,497  |  
|                                                                                                                                                                                  |  |                  |          |   |                   |   |          |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                              |  |                  |          |   |                   |   |          |  
|Current liabilities:                                                                                                                                                              |  |                  |          |   |                   |   |          |  
|Accounts payable                                                                                                                                                                  |  | $                | 1,712    |   |                   | $ | 1,262    |  
|Accrued compensation                                                                                                                                                              |  |                  | 5,324    |   |                   |   | 3,756    |  
|Accrued program termination costs                                                                                                                                                 |  |                  | 2,209    |   |                   |   |         |  
|Other accrued liabilities                                                                                                                                                         |  |                  | 2,144    |   |                   |   | 2,358    |  
|Deferred revenue                                                                                                                                                                  |  |                  | 3,215    |   |                   |   | 185      |  
|Taxes payable                                                                                                                                                                     |  |                  | 921      |   |                   |   |         |  
|Current portion of equipment financing obligations                                                                                                                                |  |                  | 555      |   |                   |   |         |  
|                                                                                                                                                                                  |  |                  |          |   |                   |   |          |  
|Total current liabilities                                                                                                                                                         |  |                  | 16,080   |   |                   |   | 7,561    |  
|Non-current deferred revenue                                                                                                                                                      |  |                  | 1,718    |   |                   |   |         |  
|Non-current equipment financing obligations                                                                                                                                       |  |                  | 1,751    |   |                   |   |         |  
|Other long-term liabilities                                                                                                                                                       |  |                  | 35       |   |                   |   | 19       |  
|Minority interest                                                                                                                                                                 |  |                  | 32,180   |   |                   |   |         |  
|Commitments and contingencies                                                                                                                                                     |  |                  |          |   |                   |   |          |  
|Stockholders equity:                                                                                                                                                             |  |                  |          |   |                   |   |          |  
|Preferred stock, $0.0001 par value, 5,000,000 shares authorized, no shares issued and outstanding at December 31, 2004 and
September 30, 2005                                     |  |                  |         |   |                   |   |         |  
|Common stock, $0.0001 par value: 100,000,000 shares authorized, 35,636,333 and 35,872,593 shares issued and outstanding at December 31,
2004 and September 30, 2005, respectively |  |                  | 3        |   |                   |   | 3        |  
|Additional paid-in capital                                                                                                                                                        |  |                  | 399,314  |   |                   |   | 402,865  |  
|Accumulated other comprehensive loss                                                                                                                                              |  |                  | (2,190   | ) |                   |   | (2,585   | )
|Accumulated deficit                                                                                                                                                               |  |                  | (185,786 | ) |                   |   | (198,366 | )
|                                                                                                                                                                                  |  |                  |          |   |                   |   |          |  
|Total stockholders equity                                                                                                                                                        |  |                  | 211,341  |   |                   |   | 201,917  |  
|                                                                                                                                                                                  |  |                  |          |   |                   |   |          |  
|Total liabilities and stockholders equity                                                                                                                                        |  | $                | 263,105  |   |                   | $ | 209,497  |  
|                                                                                                                                                                                  |  |                  |          |   |                   |   |          |  



See accompanying notes.



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##### Table of Contents

MAXYGEN, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

(UNAUDITED)



|                                                                             |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|---------------------------------------------------------------------------- |  | -------------------------------- | ------- | - | ------------------------------- | - | ------- | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                             |  | Three months ended September 30, |         |   | Nine months ended September 30, |  
|                                                                             |  | 2004                             |         |   | 2005                            |   |         | 2004 |  |   | 2005    |  
|Collaborative research and development revenue                               |  | $                                | 3,451   |   |                                 | $ | 106     |      |  | $ | 11,087  |   |  | $ | 6,509   |  
|Grant revenue                                                                |  |                                  | 474     |   |                                 |   | 629     |      |  |   | 1,267   |   |  |   | 1,721   |  
|                                                                             |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Total revenues                                                               |  |                                  | 3,925   |   |                                 |   | 735     |      |  |   | 12,354  |   |  |   | 8,230   |  
|Operating expenses:                                                          |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Research and development                                                     |  |                                  | 14,428  |   |                                 |   | 9,982   |      |  |   | 37,041  |   |  |   | 30,975  |  
|General and administrative                                                   |  |                                  | 3,670   |   |                                 |   | 2,997   |      |  |   | 9,950   |   |  |   | 10,138  |  
|Stock compensation expense (1)                                               |  |                                  | 65      |   |                                 |   | 4       |      |  |   | 347     |   |  |   | 121     |  
|                                                                             |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Total operating expenses                                                     |  |                                  | 18,163  |   |                                 |   | 12,983  |      |  |   | 47,338  |   |  |   | 41,234  |  
|                                                                             |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Loss from operations                                                         |  |                                  | (14,238 | ) |                                 |   | (12,248 | )    |  |   | (34,984 | ) |  |   | (33,004 | )
|Interest income and other (expense), net                                     |  |                                  | 1,015   |   |                                 |   | 1,659   |      |  |   | 2,286   |   |  |   | 3,808   |  
|Equity in losses of minority investee                                        |  |                                  |        |   |                                 |   |        |      |  |   | (1,000  | ) |  |   |        |  
|                                                                             |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Loss from continuing operations                                              |  |                                  | (13,223 | ) |                                 |   | (10,589 | )    |  |   | (33,698 | ) |  |   | (29,196 | )
|Discontinued operations:                                                     |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Loss from discontinued operations                                            |  |                                  |        |   |                                 |   |        |      |  |   | (2,769  | ) |  |   |        |  
|Gain on sale of discontinued operations (net of taxes and transaction costs) |  |                                  | 61,197  |   |                                 |   |        |      |  |   | 61,197  |   |  |   |        |  
|                                                                             |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Net income (loss) from discontinued operations                               |  |                                  | 61,197  |   |                                 |   |        |      |  |   | 58,428  |   |  |   |        |  
|                                                                             |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Cumulative effect adjustment                                                 |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   | 16,616  |  
|                                                                             |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Net income (loss)                                                            |  |                                  | 47,974  |   |                                 |   | (10,589 | )    |  |   | 24,730  |   |  |   | (12,580 | )
|Subsidiary preferred stock accretion                                         |  |                                  | (250    | ) |                                 |   |        |      |  |   | (750    | ) |  |   | (167    | )
|                                                                             |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Income (loss) applicable to common stockholders                              |  | $                                | 47,724  |   |                                 | $ | (10,589 | )    |  | $ | 23,980  |   |  | $ | (12,747 | )
|                                                                             |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Basic and diluted earnings (loss) per share:                                 |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Continuing operations                                                        |  | $                                | (0.38   | ) |                                 | $ | (0.30   | )    |  | $ | (0.96   | ) |  | $ | (0.82   | )
|Discontinued operations                                                      |  | $                                | 1.74    |   |                                 | $ |        |      |  | $ | 1.67    |   |  | $ |        |  
|Cumulative effect adjustment                                                 |  | $                                |        |   |                                 | $ |        |      |  | $ |        |   |  | $ | 0.47    |  
|Applicable to common stockholders                                            |  | $                                | 1.35    |   |                                 | $ | (0.30   | )    |  | $ | 0.68    |   |  | $ | (0.36   | )
|Shares used in computing basic and diluted earnings (loss) per share         |  |                                  | 35,236  |   |                                 |   | 35,812  |      |  |   | 35,082  |   |  |   | 35,724  |  
|(1)      Stock
compensation expense related to the following:                |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Research and development                                                     |  | $                                | 50      |   |                                 | $ | 4       |      |  | $ | 288     |   |  | $ | 115     |  
|General and administrative                                                   |  |                                  | 15      |   |                                 |   |        |      |  |   | 59      |   |  |   | 6       |  
|                                                                             |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|                                                                             |  | $                                | 65      |   |                                 | $ | 4       |      |  | $ | 347     |   |  | $ | 121     |  
|                                                                             |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  



See accompanying notes.



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MAXYGEN, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN THOUSANDS)

(UNAUDITED)



|                                                                                                                     |  |                                 |          |   |      |   |          |  
|-------------------------------------------------------------------------------------------------------------------- |  | ------------------------------- | -------- | - | ---- | - | -------- | -
|                                                                                                                     |  | Nine months ended September 30, |         
|                                                                                                                     |  | 2004                            |          |   | 2005 |  
|Operating activities                                                                                                 |  |                                 |          |   |      |   |          |  
|Net income (loss)                                                                                                    |  | $                               | 24,730   |   |      | $ | (12,580  | )
|Net income (loss) from discontinued operations                                                                       |  |                                 | 58,428   |   |      |   |         |  
|Cumulative effect adjustment                                                                                         |  |                                 |         |   |      |   | 16,616   |  
|                                                                                                                     |  |                                 |          |   |      |   |          |  
|Loss from continuing operations                                                                                      |  |                                 | (33,698  | ) |      |   | (29,196  | )
|Adjustments to reconcile loss from continuing operations to net cash used in operating activities:                   |  |                                 |          |   |      |   |          |  
|Depreciation and amortization                                                                                        |  |                                 | 4,636    |   |      |   | 2,829    |  
|Equity in losses of minority investee                                                                                |  |                                 | 1,000    |   |      |   |         |  
|Non-cash stock compensation                                                                                          |  |                                 | 538      |   |      |   | 11       |  
|Common stock issued and stock options granted to consultants for services rendered and for certain technology rights |  |                                 | 535      |   |      |   | 110      |  
|Changes in operating assets and liabilities:                                                                         |  |                                 |          |   |      |   |          |  
|Accounts receivable and other receivables                                                                            |  |                                 | (255     | ) |      |   | 565      |  
|Prepaid expenses and other current assets                                                                            |  |                                 | (333     | ) |      |   | 77       |  
|Deposits and other assets                                                                                            |  |                                 | (1,155   | ) |      |   | 2        |  
|Accounts payable                                                                                                     |  |                                 | 633      |   |      |   | 624      |  
|Accrued compensation                                                                                                 |  |                                 | 2,817    |   |      |   | (1,150   | )
|Accrued program termination costs                                                                                    |  |                                 |         |   |      |   | (2,209   | )
|Other accrued liabilities                                                                                            |  |                                 | 162      |   |      |   | 605      |  
|Taxes payable                                                                                                        |  |                                 |         |   |      |   | (921     | )
|Deferred revenue                                                                                                     |  |                                 | 132      |   |      |   | (458     | )
|                                                                                                                     |  |                                 |          |   |      |   |          |  
|Net cash used in operating activities                                                                                |  |                                 | (24,988  | ) |      |   | (29,111  | )
|                                                                                                                     |  |                                 |          |   |      |   |          |  
|Investing activities                                                                                                 |  |                                 |          |   |      |   |          |  
|Purchases of available-for-sale securities                                                                           |  |                                 | (104,678 | ) |      |   | (147,735 | )
|Maturities of available-for-sale securities                                                                          |  |                                 | 80,939   |   |      |   | 175,757  |  
|Investment in minority investee                                                                                      |  |                                 | (1,000   | ) |      |   |         |  
|Cash used in acquisition, net of cash acquired                                                                       |  |                                 |         |   |      |   | (2,617   | )
|Proceeds from sale of Verdia                                                                                         |  |                                 | 62,616   |   |      |   |         |  
|Acquisition of property and equipment                                                                                |  |                                 | (1,964   | ) |      |   | (1,954   | )
|                                                                                                                     |  |                                 |          |   |      |   |          |  
|Net cash provided by investing activities                                                                            |  |                                 | 35,913   |   |      |   | 23,451   |  
|                                                                                                                     |  |                                 |          |   |      |   |          |  
|Financing activities                                                                                                 |  |                                 |          |   |      |   |          |  
|Repayments under equipment financing obligations                                                                     |  |                                 | (299     | ) |      |   | (115     | )
|Borrowings under equipment financing obligations                                                                     |  |                                 | 2,187    |   |      |   | 1,229    |  
|Minority investment                                                                                                  |  |                                 | 9,972    |   |      |   |         |  
|Proceeds from issuance of common stock                                                                               |  |                                 | 2,254    |   |      |   | 1,259    |  
|                                                                                                                     |  |                                 |          |   |      |   |          |  
|Net cash provided by financing activities                                                                            |  |                                 | 14,114   |   |      |   | 2,373    |  
|                                                                                                                     |  |                                 |          |   |      |   |          |  
|Cash provided from discontinued operations                                                                           |  |                                 | 1,442    |   |      |   |         |  
|Codexis related net adjustment                                                                                       |  |                                 |         |   |      |   | (2,365   | )
|Effect of exchange rate changes on cash and cash equivalents                                                         |  |                                 | (8       | ) |      |   | 302      |  
|                                                                                                                     |  |                                 |          |   |      |   |          |  
|Net increase (decrease) in cash and cash equivalents                                                                 |  |                                 | 26,473   |   |      |   | (5,350   | )
|Cash and cash equivalents at beginning of period                                                                     |  |                                 | 21,353   |   |      |   | 40,415   |  
|                                                                                                                     |  |                                 |          |   |      |   |          |  
|Cash and cash equivalents at end of period                                                                           |  | $                               | 47,826   |   |      | $ | 35,065   |  
|                                                                                                                     |  |                                 |          |   |      |   |          |  
|Schedule of noncash transactions                                                                                     |  |                                 |          |   |      |   |          |  
|Shares of Codexis common stock issued in acquisition                                                                 |  |                                 |         |   |      | $ | (188     | )



See accompanying notes.



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##### Table of Contents

MAXYGEN, INC.



NOTES TO CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)



1. Basis of Presentation and Significant Accounting Policies



Basis of Presentation



The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information. The information as of
September 30, 2005, and for the three and nine months ended September 30, 2004 and September 30, 2005 includes all adjustments (consisting only of normal recurring adjustments) that the management of Maxygen, Inc. (Maxygen
or the Company) believes necessary for fair presentation of the results for the periods presented. The condensed consolidated balance sheet as of December 31, 2004 has been derived from the audited financial statements at that date.



Results for any interim period are not necessarily indicative of results for
any future interim period or for the entire year. The accompanying condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Companys Annual Report on Form 10-K
for the year ended December 31, 2004.



On June 2, 2004, the Company
agreed to sell Verdia, Inc. (its wholly-owned subsidiary) to Pioneer Hi-Bred International, Inc., a wholly-owned subsidiary of E.I. du Pont de Nemours and Company. This transaction closed on July 1, 2004 (see Note 7). The Company has
reclassified the operating results of Verdia to discontinued operations in the condensed consolidated financial statements for the three and nine months ended September 30, 2004 as a result of the Companys sale of Verdia.



On February 28, 2005, the Companys voting rights in Codexis, Inc. were reduced
below 50%. As of February 28, 2005, Codexis was no longer a consolidated subsidiary of the Company and the Companys ownership in Codexis is being accounted for under the equity method of accounting.



Principles of Consolidation



The consolidated financial statements include the amounts of the Company and its
wholly-owned subsidiaries, Maxygen ApS (Denmark) and Maxygen Holdings Ltd. (Cayman Islands). For the three and nine months ended September 30, 2004 and for the two months ended February 28, 2005, the results of operations of Codexis are
also included in the condensed consolidated financial statements. The condensed consolidated balance sheet at December 31, 2004 includes the financial position of Codexis as of that date. Subsequent to February 28, 2005, the Companys
investment in Codexis is reflected using the equity method of accounting.



In
accordance with EITF Consensus 96-16, Investor Accounting for an Investee When the Investor Has a Majority of the Voting Interest but the Minority Stockholder or Stockholders Have Certain Approval or Veto Rights and paragraph 1 of ARB
No. 51, Consolidated Financial Statements, the Company included 100% of the net losses of Codexis in the determination of the Companys consolidated net loss through February 28, 2005. As of February 28, 2005, the
Company controlled less than 50% of the voting rights of the issued and outstanding shares of Codexis common and preferred stock. In accordance with APB 18, The Equity Method of Accounting for Investments in Common Stock, the Company is
accounting for its investment in Codexis under the equity method of accounting after February 28, 2005.



Since the Company no longer consolidates the financial position of Codexis, the Company no longer reflects amounts as minority interest on the condensed consolidated balance sheet. It recorded a $2.4 million
adjustment to additional paid-in capital in the first quarter of 2005 to restore the negative additional paid-in capital that had resulted from Codexis preferred stock accretion prior to February 28, 2005.



Cumulative Effect Adjustment



Codexis was formed in January 2002 and financed by the Company and several other independent
investors. In accordance with EITF 96-16 and ARB 51, through February 28, 2005, the Company consolidated 100% of the operating results of Codexis even though it only owned a majority of the voting interests in Codexis. From March 2002 through
February 28, 2005, the Company had recorded losses of Codexis of $26.4 million, which was in



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excess of the Companys investment basis of $9.8 million. On February 28, 2005, the Companys voting
rights in Codexis were reduced below 50%. As a result, as of such date the Company no longer consolidates the financial position and results of operations of Codexis with the Companys financial results and instead accounts for Codexis under
the equity method of accounting. To reflect what the Companys basis in Codexis would have been under equity accounting, the Company recorded a one-time cumulative effect adjustment of $16.6 million in the first quarter of 2005 to bring its
investment basis in Codexis to zero. This cumulative effect adjustment does not have any tax consequences.



Reclassifications



Certain previously
reported amounts have been reclassified to conform with the current period presentation. These reclassifications, when made, did not have any effect on loss applicable to common stockholders, total assets or total liabilities and stockholders
equity.



Revenue Recognition



The Company recognizes revenue from multiple element arrangements under collaborative
research agreements that include license payments, research and development services, milestones, and royalties. Revenue arrangements with multiple deliverables are accounted for under the provisions of Emerging Issues Task Force Issue No. 00-21,
Revenue Arrangements with Multiple Deliverables, and are divided into separate units of accounting if certain criteria are met, including whether the delivered item has stand-alone value to the customer and whether there is objective and
reliable evidence of the fair value of the undelivered items in the arrangement. The consideration the Company receives is allocated among the separate units of accounting based on their respective fair values, and the applicable revenue recognition
criteria are considered separately for each of the separate units.



Non-refundable up-front payments received in connection with research and development collaboration agreements, including license fees, and technology advancement funding that is intended for the development of the Companys core
technologies, are deferred and recognized on a straight-line basis over the relevant periods specified in the agreement, generally the research term.



Revenue related to collaborative research payments with the Companys corporate collaborators are recognized as research services are performed over the related
funding periods for each contract. Under these agreements, the Company is typically required to perform research and development activities as specified in each respective agreement. Generally, the payments received are not refundable and are based
on a contractual cost per full-time equivalent employee working on the project. Research and development expenses under the collaborative research agreements approximate or exceed the research funding revenue recognized under such agreements over
the term of the respective agreements. Deferred revenue may result when the Company does not incur the required level of effort during a specific period in comparison to funds received under the respective contracts. Payments received relating to
substantive, at-risk incentive milestones, if any, are recognized as revenue upon achievement of the incentive milestone event because the Company has no future performance obligations related to the payment. Incentive milestone payments are
triggered either by the results of the Companys research efforts or by events external to the Company, such as regulatory approval to market a product.



The Company is eligible to receive royalties from licensees, which are typically based on sales to third parties of licensed products. Royalties are recorded as earned in
accordance with the contract terms when third-party results can be reliably measured and collectibility is reasonably assured.



The Company has been awarded grants from the Defense Advanced Research Projects Agency (DARPA), National Institute of Standards and Technology-Advanced
Technology Program, the U.S. Agency for International Development, the U.S. Army Medical Research and Materiel Command, National Institute of Health, and U.S. Army Space & Missile Defense Command for various research and development
projects. The terms of these grant agreements range from one to five years with various termination dates, the last of which is January 2010 for existing agreements. Revenue related to grant agreements is recognized as related research and
development expenses are incurred.



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##### Table of Contents

Earnings (Loss) per common share



Basic and diluted earnings (loss) per common share has been computed using the weighted-average number of shares of common stock outstanding
during the period, less shares subject to repurchase. The following table presents the calculation of basic and diluted earnings (loss) per common share (in thousands, except per share data):



|                                                                                      |  |                                  |        |      |                                 |         |      |  |   |        |   |  |   |         |  
|------------------------------------------------------------------------------------- |  | -------------------------------- | ------ | ---- | ------------------------------- | ------- | ---- |  | - | ------ | - |  | - | ------- | -
|                                                                                      |  | Three months ended September 30, |        |      | Nine months ended September 30, |        
|                                                                                      |  | 2004                             |        | 2005 |                                 |         | 2004 |  |   | 2005   |  
|Income (loss) applicable to common stockholders                                       |  | $                                | 47,724 |      | $                               | (10,589 | )    |  | $ | 23,980 |   |  | $ | (12,747 | )
|                                                                                      |  |                                  |        |      |                                 |         |      |  |   |        |   |  |   |         |  
|Basic and diluted:                                                                    |  |                                  |        |      |                                 |         |      |  |   |        |   |  |   |         |  
|Weighted-average shares of common stock outstanding                                   |  |                                  | 35,236 |      |                                 | 35,812  |      |  |   | 35,084 |   |  |   | 35,724  |  
|Less: weighted-average shares subject to repurchase                                   |  |                                  |       |      |                                 |        |      |  |   | (2     | ) |  |   |        |  
|                                                                                      |  |                                  |        |      |                                 |         |      |  |   |        |   |  |   |         |  
|Weighted-average shares used in computing basic and diluted earnings (loss) per share |  |                                  | 35,236 |      |                                 | 35,812  |      |  |   | 35,082 |   |  |   | 35,724  |  
|                                                                                      |  |                                  |        |      |                                 |         |      |  |   |        |   |  |   |         |  
|Basic and diluted earnings (loss) per common share                                    |  | $                                | 1.35   |      | $                               | (0.30   | )    |  | $ | 0.68   |   |  | $ | (0.36   | )
|                                                                                      |  |                                  |        |      |                                 |         |      |  |   |        |   |  |   |         |  



In accordance with paragraph 15 of FAS
128, Earnings Per Share, the Company has excluded all outstanding stock options, outstanding warrants and shares subject to repurchase from the calculation of diluted earnings (loss) per common share because all such securities are
antidilutive to loss from continuing operations for all applicable periods presented. The total number of shares excluded from the calculations of diluted earnings (loss) per share, prior to application of the treasury stock method for options, was
9,260,210 at September 30, 2004 and 9,824,735 at September 30, 2005.



Comprehensive Income (Loss)



Comprehensive income (loss) is
primarily comprised of net income (loss), net unrealized gains or losses on available-for-sale securities and foreign currency translation adjustments. Comprehensive income (loss) and its components for the three-month and nine-month periods ended
September 30, 2004 and September 30, 2005 were as follows (in thousands):



|                                                                   |  |                                  |        |      |                                 |         |      |  |   |        |   |  |   |         |  
|------------------------------------------------------------------ |  | -------------------------------- | ------ | ---- | ------------------------------- | ------- | ---- |  | - | ------ | - |  | - | ------- | -
|                                                                   |  | Three months ended September 30, |        |      | Nine months ended September 30, |        
|                                                                   |  | 2004                             |        | 2005 |                                 |         | 2004 |  |   | 2005   |  
|Net income (loss)                                                  |  | $                                | 47,974 |      | $                               | (10,589 | )    |  | $ | 24,730 |   |  | $ | (12,580 | )
|Changes in unrealized gain (loss) on securities available-for-sale |  |                                  | 194    |      |                                 | (134    | )    |  |   | (521   | ) |  |   | 57      |  
|Changes in foreign currency translation adjustments                |  |                                  | 60     |      |                                 | (24     | )    |  |   | 277    |   |  |   | (452    | )
|                                                                   |  |                                  |        |      |                                 |         |      |  |   |        |   |  |   |         |  
|Comprehensive income (loss)                                        |  | $                                | 48,228 |      | $                               | (10,747 | )    |  | $ | 24,486 |   |  | $ | (12,975 | )
|                                                                   |  |                                  |        |      |                                 |         |      |  |   |        |   |  |   |         |  



The
components of accumulated other comprehensive loss were as follows (in thousands):



|                                                   |  |                  |        |   |                   |   |        |  
|-------------------------------------------------- |  | ---------------- | ------ | - | ----------------- | - | ------ | -
|                                                   |  | December 31,2004 |        |   | September 30,2005 |  
|Unrealized gains on securities available-for-sale  |  | $                | 5      |   |                   | $ | 10     |  
|Unrealized losses on securities available-for-sale |  |                  | (585   | ) |                   |   | (533   | )
|Foreign currency translation adjustments           |  |                  | (2,306 | ) |                   |   | (1,693 | )
|Changes in foreign currency contracts              |  |                  | 696    |   |                   |   | (369   | )
|                                                   |  |                  |        |   |                   |   |        |  
|Accumulated other comprehensive loss               |  | $                | (2,190 | ) |                   | $ | (2,585 | )
|                                                   |  |                  |        |   |                   |   |        |  



Recent Accounting Pronouncements



In November 2004 the Financial Accountings Standards Board (FASB) delayed
the effective date for the measurement and recognition guidance contained in paragraphs 10-20 of EITF 03-01, The Meaning of Other-Than-Temporary Impairments and its Application to Certain Investments; this delay does not suspend the
requirement to recognize other-than-temporary impairments as required by existing authoritative literature. The disclosure requirement of this guidance remains in effect. The Company does not expect the adoption of the recognition and measurement
provisions of EITF 03-01 to significantly impact its results of operations or financial position but will reassess the impact once the rules are finalized.



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##### Table of Contents

On December 16, 2004, the FASB issued FASB Statement No. 123 (revised 2004), Share-Based Payment,
which is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation. Statement 123(R) supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and amends FASB Statement
No. 95, Statement of Cash Flows. Statement 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure
is no longer an alternative.



Statement 123(R) must be adopted no later than
the beginning of the first fiscal year beginning after June 15, 2005. The Company will adopt Statement 123(R) on January 1, 2006.



Statement 123(R) permits public companies to adopt its requirements using one of two methods:



| | 1. | A modified prospective method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of Statement 123(R) for all
share-based payments granted after the effective date and (b) based on the requirements of Statement 123 for all awards granted to employees prior to the effective date of Statement 123(R) that remain unvested on the effective date.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 2. | A modified retrospective method that includes the requirements of the modified prospective method described above, but also permits entities to restate, based on the
amounts previously recognized under Statement 123, for purposes of pro forma disclosures for all prior periods presented.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The Company plans to adopt Statement 123(R) using the modified prospective method.



As permitted by Statement 123, the Company currently accounts for share-based payments to employees using Opinion 25s intrinsic value
method and, as such, generally recognizes no compensation cost for employee stock options. Accordingly, the adoption of Statement 123(R)s fair value method will have a significant impact on the Companys result of operations, although it
will have no impact on the Companys overall financial position. The impact of adoption of Statement 123(R) cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had the
Company adopted Statement 123(R) in prior periods, the impact of that standard would have approximated the impact of Statement 123 as described in the disclosure of pro forma net income (loss) and earnings (loss) per share in Note 1 to the
Companys condensed consolidated financial statements (Stock-Based Compensation). Statement 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow,
rather than as an operating cash flow as required under current literature. This requirement may reduce net operating cash flows and increase net financing cash flows in periods after adoption. The Company cannot estimate what those amounts will be
in the future because they depend upon, among other things, levels of share-based payments granted in the future, when employees exercise stock options and if and when the Company becomes profitable.



In May 2005, the FASB issued Statement No. 154, Accounting Changes and Error
Corrections, a replacement of Accounting Principles Board Opinions No. 20, Accounting Changes, and Statement No. 3, Reporting Accounting Changes in Interim Financial Statements. Statement 154 changes the
requirements for the accounting for and reporting of a change in accounting principle. Previously, most voluntary changes in accounting principles were recognized by including in net income during the period of change the cumulative effect of
changing to the new accounting principle. Statement 154 requires retrospective application to prior periods financial statements, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the
change. Statement 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005; however, the Statement does not change the transition provisions of any existing accounting pronouncements. The Company believes
adoption of Statement 154 will not have a material effect on the Companys consolidated financial position, results of operations or cash flows.



Stock-Based Compensation



The Company accounts for common stock options granted to employees using the intrinsic value method and, thus, recognizes no compensation expense for options granted with
exercise prices equal to or greater than the fair value of the Companys common stock on the date of the grant. Options granted to consultants are periodically re-valued as they vest in accordance with SFAS Statement 123 and EITF 96-18 using
the Black-Scholes valuation model.



As permitted under SFAS No. 148, the
Company has elected to continue to follow the intrinsic value method in accounting for its stock-based employee compensation arrangement as defined by Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock
Issued to Employees, and related interpretations including Financial Accounting Standards Board Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB No. 25. The



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##### Table of Contents

following table illustrates the effect on net income (loss) and income (loss) per common share if the Company had applied
the fair value recognition provisions of SFAS No. 123, as amended by SFAS No. 148, using the Black-Scholes option-pricing model, to determine stock-based employee compensation (in thousands, except per share data):



|                                                                                                                    |  |                                  |        |   |                                 |   |         |      |  |   |        |   |  |   |         |  
|------------------------------------------------------------------------------------------------------------------- |  | -------------------------------- | ------ | - | ------------------------------- | - | ------- | ---- |  | - | ------ | - |  | - | ------- | -
|                                                                                                                    |  | Three months ended September 30, |        |   | Nine months ended September 30, |  
|                                                                                                                    |  | 2004                             |        |   | 2005                            |   |         | 2004 |  |   | 2005   |  
|Net income (loss), as reported                                                                                      |  | $                                | 47,974 |   |                                 | $ | (10,589 | )    |  | $ | 24,730 |   |  | $ | (12,580 | )
|Add: Stock based employee compensation cost included in the determination of net income (loss), as reported         |  |                                  | 59     |   |                                 |   |        |      |  |   | 237    |   |  |   |        |  
|Deduct: Total stock based employee compensation expense determined under the fair value-based method for all awards |  |                                  | (1,639 | ) |                                 |   | (2,136  | )    |  |   | (6,847 | ) |  |   | (4,782  | )
|                                                                                                                    |  |                                  |        |   |                                 |   |         |      |  |   |        |   |  |   |         |  
|Pro forma net income (loss)                                                                                         |  | $                                | 46,394 |   |                                 | $ | (12,725 | )    |  | $ | 18,120 |   |  | $ | (17,362 | )
|                                                                                                                    |  |                                  |        |   |                                 |   |         |      |  |   |        |   |  |   |         |  
|Net income (loss) per common share                                                                                  |  |                                  |        |   |                                 |   |         |      |  |   |        |   |  |   |         |  
|Basic and diluted                                                                                                   |  | $                                | 1.36   |   |                                 | $ | (0.30   | )    |  | $ | 0.70   |   |  | $ | (0.35   | )
|                                                                                                                    |  |                                  |        |   |                                 |   |         |      |  |   |        |   |  |   |         |  
|Basic and diluted  pro forma                                                                                       |  | $                                | 1.32   |   |                                 | $ | (0.36   | )    |  | $ | 0.52   |   |  | $ | (0.49   | )
|                                                                                                                    |  |                                  |        |   |                                 |   |         |      |  |   |        |   |  |   |         |  



The Black-Scholes weighted average
estimated fair values of stock options granted during the three months ended September 30, 2004 and 2005 were $4.72 and $3.87 per share, respectively and for the nine months ended September 30, 2004 and 2005 were $4.89 and $5.39 per share,
respectively.



2. Investments



Management determines the appropriate classification of debt securities at the time of
purchase and reevaluates such designation as of each balance sheet date. The Companys debt securities are classified as available-for-sale and are carried at estimated fair value in cash equivalents and investments. Unrealized gains and losses
are reported as accumulated other comprehensive loss in stockholders equity. The amortized cost of debt securities in this category is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included
in interest income. Realized gains and losses on available-for-sale securities and declines in value deemed to be other than temporary, if any, are included in interest income and expense. The cost of securities sold is based on the specific
identification method. Interest and dividends on securities classified as available-for-sale are included in interest income. The Companys cash equivalents and investments as of September 30, 2005 were as follows (in thousands):



|                                            |  |               |         |   |                      |   |    |                       |  |   |                     |   |  |   |         |  
|------------------------------------------- |  | ------------- | ------- | - | -------------------- | - | -- | --------------------- |  | - | ------------------- | - |  | - | ------- | -
|                                            |  | AmortizedCost |         |   | GrossUnrealizedGains |   |    | GrossUnrealizedLosses |  |   | EstimatedFair Value |  
|Money market funds                          |  | $             | 13,610  |   |                      | $ |   |                       |  | $ |                    |   |  | $ | 13,610  |  
|Commercial paper                            |  |               | 28,676  |   |                      |   | 10 |                       |  |   |                    |   |  |   | 28,686  |  
|Corporate bonds                             |  |               | 42,887  |   |                      |   |   |                       |  |   | (204                | ) |  |   | 42,683  |  
|U.S. government agency securities           |  |               | 104,977 |   |                      |   |   |                       |  |   | (329                | ) |  |   | 104,648 |  
|                                            |  |               |         |   |                      |   |    |                       |  |   |                     |   |  |   |         |  
|Total                                       |  |               | 190,150 |   |                      |   | 10 |                       |  |   | (533                | ) |  |   | 189,627 |  
|Less amounts classified as cash equivalents |  |               | (35,058 | ) |                      |   | (7 | )                     |  |   |                    |   |  |   | (35,065 | )
|                                            |  |               |         |   |                      |   |    |                       |  |   |                     |   |  |   |         |  
|Total investments                           |  | $             | 155,092 |   |                      | $ | 3  |                       |  | $ | (533                | ) |  | $ | 154,562 |  
|                                            |  |               |         |   |                      |   |    |                       |  |   |                     |   |  |   |         |  



There were no realized gains or losses
on the sale of available-for-sale securities for the three-month and nine-month periods ended September 30, 2004 and September 30, 2005. The change in unrealized holdings gains (losses) on available-for-sale securities included in
accumulated other comprehensive loss were unrealized losses of $521,000 for the nine months ended September 30, 2004, unrealized gains of $57,000 for the nine months ended September 30, 2005. The Company intends to hold the securities
until maturity and therefore does not believe the current unrealized losses of $533,000 are other than temporary.



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At September 30, 2005, the contractual maturities of investments were as follows (in thousands):



|                    |  |               |         |                     |   |        
|------------------- |  | ------------- | ------- | ------------------- | - | -------
|                    |  | AmortizedCost |         | EstimatedFair Value
|Due within one year |  | $             | 120,308 |                     | $ | 119,965
|Due after one year  |  |               | 34,784  |                     |   | 34,597 
|                    |  |               |         |                     |   |        
|                    |  | $             | 155,092 |                     | $ | 154,562
|                    |  |               |         |                     |   |        



3. Derivatives and Financial
Instruments



The Company addresses certain financial exposures through a
program of risk management that includes the use of derivative financial instruments. To date, the Company has only entered into foreign currency forward exchange contracts generally expiring within fifteen months to reduce the effects of
fluctuating foreign currency exchange rates on forecasted cash requirements.



All derivatives are recognized on the balance sheet at their fair value. The Company has designated its derivatives as foreign currency cash flow hedges. Changes in the fair value of derivatives that are highly effective as, and that are
designated and qualify as, foreign currency cash flow hedges are recorded in other comprehensive income until the associated hedged transaction impacts earnings.



The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and
strategy for undertaking various hedge transactions. The Company also formally assesses, both at the hedges inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting
changes in fair values or cash flows of hedged items. When it is determined that a derivative is not highly effective as a hedge or that it has ceased to be a highly effective hedge, the Company discontinues hedge accounting prospectively.



The purpose of the hedging activities is to minimize the effect of foreign
currency exchange rate movements on the cash flows related to the Companys funding of Maxygen ApS and payments to vendors in Europe. To date, foreign currency contracts are denominated in Danish kroner and Euros. At September 30, 2005,
the Company had foreign currency contracts outstanding in the form of forward exchange contracts totaling $12.3 million.



4. Litigation



In December 2001 a lawsuit was filed in the U.S. District Court for the Southern District of New York against Maxygen, Inc., its chief executive officer, Russell Howard and its then chief financial officer, Simba
Gill, together with certain underwriters of Maxygens initial public offering and secondary public offering of common stock. The complaint, which alleges claims under Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 and
Section 10(b) of the Securities Exchange Act of 1934, is among the so-called laddering cases that have been commenced against over 300 companies that had public offerings of securities in 1999 and 2000. The complaint has been
consolidated with other laddering claims in a proceeding styled In re Initial Public Offering Securities Litigation, No. 21 MC 92 (SAS), pending before the Honorable Shira A. Scheindlin. In February 2003, the court dismissed the
Section 10(b) claim against Drs. Howard and Gill; the remainder of the case remains pending.



In June 2003 the Company agreed to the terms of a tentative settlement agreement along with other defendant issuers in In re Initial Public Offering Securities Litigation. The tentative settlement provides that
the insurers of the 309 defendant issuers will pay to the plaintiffs $1 billion less any recovery of damages the plaintiffs receive from the defendant underwriters. If the plaintiffs receive over $5 billion in damages from the defendant
underwriters, the Company will be entitled to reimbursement of various expenses incurred by it as a result of the litigation. As part of the tentative settlement, the Company will assign to the plaintiffs excess compensation claims and
certain other of its claims against the defendant underwriters based on the alleged actions of the defendant underwriters. The settlement is subject to acceptance by a substantial majority of defendants and execution of a definitive settlement
agreement. The settlement is also subject to approval of the Court, which cannot be assured. On February 15, 2005 the Court tentatively approved the proposed settlement, conditioned upon the parties altering the proposed settlement to comply
with the Private Securities Litigation Reform Acts settlement discharge provision. The settlement does not contemplate any settlement payments by Maxygen.



If the settlement is not accepted by the requisite number of defendants or if it is not approved by the Court, the Company intends to defend the lawsuit vigorously.
The Company believes the lawsuit against Maxygen and its officers is without merit. However, the litigation is in the preliminary stage, and the Company cannot predict its outcome. The litigation process is inherently uncertain. If the outcome of
the litigation is adverse to the Company and if the Company is required to pay significant damages, the Companys business would be significantly harmed.



11



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##### Table of Contents

The Company is not currently a party to any other material pending legal proceedings.



From time to time, the Company becomes involved in claims and legal
proceedings that arise in the ordinary course of its business. The Company does not believe that the resolution of these claims will have a material adverse effect on its financial statements.



5. Segment Information



On July 1, 2004, the Company sold Verdia, the sole component of its agriculture segment, to Pioneer Hi-Bred International, Inc., a
wholly-owned subsidiary of E.I. du Pont de Nemours and Company. The operations of Verdia prior to its sale are reflected in the Companys financial statements for nine months ended September 30, 2004 as discontinued operations. Thus the
agriculture segment data provided in earlier reports is now reflected as discontinued operations (see Note 7). On February 28, 2005 the Companys voting interests in Codexis fell below 50% and from such time Codexis ceased to be a
consolidated subsidiary of the Company. Accordingly, the financial position of Codexis is included in the condensed consolidated balance sheet as of December 31, 2004 but excluded from the September 30, 2005 condensed consolidated balance
sheet, and the results of operations of Codexis are included in the consolidated results presented below only until February 28, 2005. Thereafter the Companys investment in Codexis is reflected under the equity method of accounting. The
Company has determined its reportable operating segments based upon how the business is managed and operated. The accounting policies of the segments described above are the same as those described in Note 1. Corporate administrative costs are
generally allocated based on headcount.



Segment Earnings

(in thousands)



|                                                               |  |                   |         |   |                    |   |        |                           |  |   |         |  
|-------------------------------------------------------------- |  | ----------------- | ------- | - | ------------------ | - | ------ | ------------------------- |  | - | ------- | -
|                                                               |  | HumanTherapeutics |         |   | Chemicals(Codexis) |   |        | Maxygen, Inc.Consolidated | 
|Three months ended September 30, 2004                          |  |                   |         |   |                    |   |        |                           |  |   |         |  
|Segment loss                                                   |  | $                 | (10,941 | ) |                    | $ | (3,232 | )                         |  | $ | (14,173 | )
|Stock compensation                                             |  |                   | (58     | ) |                    |   | (7     | )                         |  |   | (65     | )
|Interest income and other (expense), net                       |  |                   | 982     |   |                    |   | 33     |                           |  |   | 1,015   |  
|                                                               |  |                   |         |   |                    |   |        |                           |  |   |         |  
|Loss from continuing operations                                |  |                   | (10,017 | ) |                    |   | (3,206 | )                         |  |   | (13,223 | )
|Subsidiary preferred stock accretion                           |  |                   |        |   |                    |   | (250   | )                         |  |   | (250    | )
|                                                               |  |                   |         |   |                    |   |        |                           |  |   |         |  
|Loss applicable to common stockholders  continuing operations |  | $                 | (10,017 | ) |                    | $ | (3,456 | )                         |  | $ | (13,473 | )
|                                                               |  |                   |         |   |                    |   |        |                           |  |   |         |  



The operations of Codexis are not
included in the consolidated operations of Maxygen for the three months ended September 30, 2005.



|                                                               |  |                   |         |   |                    |   |         |                           |  |   |         |  
|-------------------------------------------------------------- |  | ----------------- | ------- | - | ------------------ | - | ------- | ------------------------- |  | - | ------- | -
|                                                               |  | HumanTherapeutics |         |   | Chemicals(Codexis) |   |         | Maxygen, Inc.Consolidated | 
|Nine months ended September 30, 2004                           |  |                   |         |   |                    |   |         |                           |  |   |         |  
|Segment loss                                                   |  | $                 | (24,977 | ) |                    | $ | (9,660  | )                         |  | $ | (34,637 | )
|Stock compensation                                             |  |                   | (324    | ) |                    |   | (23     | )                         |  |   | (347    | )
|Interest income and other (expense), net                       |  |                   | 2,209   |   |                    |   | 77      |                           |  |   | 2,286   |  
|Equity in minority interests                                   |  |                   | (1,000  | ) |                    |   |        |                           |  |   | (1,000  | )
|                                                               |  |                   |         |   |                    |   |         |                           |  |   |         |  
|Loss from continuing operations                                |  |                   | (24,092 | ) |                    |   | (9,606  | )                         |  |   | (33,698 | )
|Subsidiary preferred stock accretion                           |  |                   |        |   |                    |   | (750    | )                         |  |   | (750    | )
|                                                               |  |                   |         |   |                    |   |         |                           |  |   |         |  
|Loss applicable to common stockholders  continuing operations |  | $                 | (24,092 | ) |                    | $ | (10,356 | )                         |  | $ | (34,448 | )
|                                                               |  |                   |         |   |                    |   |         |                           |  |   |         |  
|Nine months ended September 30, 2005                           |  |                   |         |   |                    |   |         |                           |  |   |         |  
|Segment loss                                                   |  | $                 | (31,558 | ) |                    | $ | (1,325  | )                         |  | $ | (32,883 | )
|Stock compensation                                             |  |                   | (121    | ) |                    |   |        |                           |  |   | (121    | )
|Interest income and other (expense), net                       |  |                   | 3,788   |   |                    |   | 20      |                           |  |   | 3,808   |  
|                                                               |  |                   |         |   |                    |   |         |                           |  |   |         |  
|Loss from continuing operations                                |  |                   | (27,891 | ) |                    |   | (1,305  | )                         |  |   | (29,196 | )
|Cumulative effect adjustment                                   |  |                   | 16,616  |   |                    |   |         |                           |  |   | 16,616  |  
|Subsidiary preferred stock accretion                           |  |                   |        |   |                    |   | (167    | )                         |  |   | (167    | )
|                                                               |  |                   |         |   |                    |   |         |                           |  |   |         |  
|Income (loss) applicable to common stockholders                |  | $                 | (11,275 | ) |                    | $ | (1,472  | )                         |  | $ | (12,747 | )
|                                                               |  |                   |         |   |                    |   |         |                           |  |   |         |  



12



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##### Table of Contents

The operations of Codexis are not included in the consolidated operations of Maxygen
after February 28, 2005.



Segment Revenue



Revenues for each operating segment are derived from the Companys research
collaboration agreements and government grants and are categorized based on the industry of the product or technology under development. On February 28, 2005 the Companys voting interests in Codexis fell below 50% and from such time
Codexis ceased to be a consolidated subsidiary of the Company. Thus the revenues of Codexis are included in the consolidated results presented below only until February 28, 2005 and thereafter the Companys investment in Codexis is
reflected under the equity method of accounting. The following table presents revenues for each reporting segment (in thousands):



|                   |  |                                  |       |                                 |   |      |  |      |        |  |   |      
|------------------ |  | -------------------------------- | ----- | ------------------------------- | - | ---- |  | ---- | ------ |  | - | -----
|                   |  | Three months ended September 30, |       | Nine months ended September 30,
|                   |  | 2004                             |       | 2005                            |   | 2004 |  | 2005
|Human therapeutics |  | $                                | 2,575 |                                 | $ | 735  |  | $    | 8,968  |  | $ | 6,720
|Chemicals          |  |                                  | 1,350 |                                 |   |     |  |      | 3,386  |  |   | 1,510
|                   |  |                                  |       |                                 |   |      |  |      |        |  |   |      
|Total revenue      |  | $                                | 3,925 |                                 | $ | 735  |  | $    | 12,354 |  | $ | 8,230
|                   |  |                                  |       |                                 |   |      |  |      |        |  |   |      



Identifiable Assets



The following table presents identifiable assets for each reporting segment (in
thousands):



|                   |  |                   |         |                    |   |        
|------------------ |  | ----------------- | ------- | ------------------ | - | -------
|                   |  | December 31, 2004 |         | September 30, 2005
|Human therapeutics |  | $                 | 240,372 |                    | $ | 209,497
|Chemicals          |  |                   | 22,733  |                    |   |       
|                   |  |                   |         |                    |   |        
|Total assets       |  | $                 | 263,105 |                    | $ | 209,497
|                   |  |                   |         |                    |   |        



6. Human Therapeutics



On February 28, 2005 the Companys voting interests in Codexis
fell below 50% and from such time Codexis ceased to be a consolidated subsidiary of the Company. Accordingly, the results of operations of Codexis are included in the consolidated results presented in the condensed consolidated statements of
operations only until February 28, 2005. Presented below are the results of operations for the three and nine months ended September 30, 2004 and September 30, 2005 for the Human Therapeutics business on a stand-alone basis:



|                                               |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|---------------------------------------------- |  | -------------------------------- | ------- | - | ------------------------------- | - | ------- | ---- |  | - | ------- | - |  | - | ------- | -
|                                               |  | Three months ended September 30, |         |   | Nine months ended September 30, |  
|(In thousands)                                 |  | 2004                             |         |   | 2005                            |   |         | 2004 |  |   | 2005    |  
|Revenues:                                      |  |                                  |         |   |                                 |   |         |      |  |   |         |  
|Collaborative research and development revenue |  | $                                | 2,101   |   |                                 | $ | 106     |      |  | $ | 7,701   |   |  | $ | 4,999   |  
|Grant revenue                                  |  |                                  | 474     |   |                                 |   | 629     |      |  |   | 1,267   |   |  |   | 1,721   |  
|                                               |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Total revenues                                 |  |                                  | 2,575   |   |                                 |   | 735     |      |  |   | 8,968   |   |  |   | 6,720   |  
|                                               |  |                                  |         |  
|Operating Expenses:                            |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Research and development                       |  |                                  | 10,453  |   |                                 |   | 9,982   |      |  |   | 25,685  |   |  |   | 28,441  |  
|General and administrative                     |  |                                  | 3,062   |   |                                 |   | 2,997   |      |  |   | 8,259   |   |  |   | 9,837   |  
|Stock compensation expense                     |  |                                  | 59      |   |                                 |   | 4       |      |  |   | 325     |   |  |   | 121     |  
|                                               |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Total operating expenses                       |  |                                  | 13,574  |   |                                 |   | 12,983  |      |  |   | 34,269  |   |  |   | 38,399  |  
|                                               |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Loss from operations                           |  |                                  | (10,999 | ) |                                 |   | (12,248 | )    |  |   | (25,301 | ) |  |   | (31,679 | )
|                                               |  |                                  |         |  
|Interest income and other (expense), net       |  |                                  | 982     |   |                                 |   | 1,659   |      |  |   | 2,209   |   |  |   | 3,788   |  
|Equity in losses of minority investee          |  |                                  |        |   |                                 |   |        |      |  |   | (1,000  | ) |  |   |        |  
|                                               |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Loss from continuing operations                |  |                                  | (10,017 | ) |                                 |   | (10,589 | )    |  |   | (24,092 | ) |  |   | (27,891 | )
|Income (loss) from discontinued operations     |  |                                  | 61,197  |   |                                 |   |        |      |  |   | 58,428  |   |  |   |        |  
|Cumulative effect adjustment                   |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   | 16,616  |  
|                                               |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Net income (loss)                              |  | $                                | 51,180  |   |                                 | $ | (10,589 | )    |  | $ | 34,336  |   |  | $ | (11,275 | )
|                                               |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  



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##### Table of Contents

7. Discontinued Operations



On July 1, 2004 the Company completed the sale of Verdia, its agriculture subsidiary and sole component of its agriculture segment, to
Pioneer Hi-Bred International, Inc., a wholly-owned subsidiary of E.I. du Pont de Nemours and Company, for $64 million in cash, less estimated income taxes and transaction costs of $1.4 million. The operating results of Verdia have been reclassified
as discontinued operations for all periods presented. Results of discontinued operations provided below reflect the results of Verdia prior to its sale.



Summary operating results for the discontinued operations through the date of disposition are as follows (in thousands):



|                                                                  |  |   |        |  
|----------------------------------------------------------------- |  | - | ------ | -
|Nine months ended September 30, 2004:                             |  |   |        |  
|                                                                  | 
|Collaborative research and development revenue                    |  | $ | 2,721  |  
|Collaborative research and development revenue from related party |  |   | 2,454  |  
|Grant revenue                                                     |  |   | 311    |  
|                                                                  |  |   |        |  
|Total revenues                                                    |  |   | 5,486  |  
|Operating expenses:                                               |  |   |        |  
|Research and development                                          |  |   | 6,165  |  
|General and administrative                                        |  |   | 616    |  
|                                                                  |  |   |        |  
|Total operating expenses                                          |  |   | 6,781  |  
|                                                                  |  |   |        |  
|Loss from operations of discontinued operations                   |  |   | (1,295 | )
|Interest income and other, net                                    |  |   | 32     |  
|Equity in net loss of joint venture                               |  |   | (1,506 | )
|                                                                  |  |   |        |  
|Loss from discontinued operations                                 |  | $ | (2,769 | )
|                                                                  |  |   |        |  



Verdias investment in its joint
venture with Delta and Pine Land Company called DeltaMax Cotton LLC in which Verdia had an equity interest of 50% as of June 30, 2004 was accounted for under the equity method of accounting. As a result of the Companys sale of Verdia on
July 1, 2004, Verdias portion of the DeltaMax loss as of June 30, 2004 is included in the loss from discontinued operations on the condensed consolidated statement of operations for the nine months ended September 30, 2004.



8. Commitments



The Company has entered into various operating leases for its facilities and certain
computer equipment and material contracts. The leases expire on various dates in 2005 through 2007. The facilities leases also include scheduled rent increases. The scheduled rent increases are recognized on a straight-line basis over the term of
the leases. The material contracts expire on various dates in 2006 through 2008.



Minimum annual commitments under operating leases and material contracts are as follows (in thousands):



|                          |  |   |      
|------------------------- |  | - | -----
|For the remainder of 2005 |  | $ | 1,964
|                          | 
|Year ending December 31,  |  |  
|2006                      |  | $ | 3,297
|2007                      |  |   | 514  
|2008                      |  |   | 181  
|                          |  |   |      
|                          |  | $ | 3,992
|                          |  |   |      



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##### Table of Contents

9. Guarantees and Indemnifications



In November 2002, the FASB issued Interpretation No. 45, Guarantors Accounting and Disclosure Requirements for
Guarantees, including Indirect Guarantees of Indebtedness of Others(FIN 45). FIN 45 requires that upon issuance of a guarantee, the guarantor must recognize a liability for the fair value of the obligations it assumes under
that guarantee.



As permitted under Delaware law and in accordance with the
Companys Bylaws, the Company indemnifies its officers and directors for certain events or occurrences, subject to certain limits, while the officer or director is or was serving at the Companys request in such capacity. The
indemnification agreements with the Companys officers and directors terminate upon termination of their employment, but the termination does not affect claims for indemnification relating to events occurring prior to the effective date of
termination. The maximum amount of potential future indemnification is unlimited; however, the Companys officer and director insurance policy reduces the Companys exposure and may enable the Company to recover a portion of any future
amounts paid. The Company believes that the fair value of these indemnification agreements is minimal. Accordingly, the Company has not recorded any liabilities for these agreements as of September 30, 2005.



10. Restructuring Charges



During the three months ended June 30, 2005, Maxygen implemented a plan to consolidate
its organization to increase focus on development of its pharmaceutical product candidates. The consolidation reflected the Companys strategic shift from early discovery research and collaborative partner funding to an increased focus on
internal product development. The restructuring plan included a reduction of approximately 16% of the Companys personnel over the following four months. The Company recorded severance charges of $710,000 during the three months ended
June 30, 2005 relating to 19 employees who ceased employment with the Company on or prior to August 29, 2005 and $97,000 during the three months ended September 30, 2005 relating to three employees whose charges were expensed as
incurred as they ceased employment with the Company after August 29, 2005, or their termination was uncertain at June 30, 2005. The restructuring balances are comprised entirely of cash charges.



These charges are included in operating expenses on the condensed consolidated statements of
operations as follows (in thousands):



|                           |  |         |     |                                                          |   |                                                                |  |                             |     |  |   |   
|-------------------------- |  | ------- | --- | -------------------------------------------------------- | - | -------------------------------------------------------------- |  | --------------------------- | --- |  | - | --
|                           |  | Charges |     | Amounts paid inthe three monthsended June 30,2005
(Cash) |   | Amounts paid inthe three monthsended September 30, 2005 (Cash) |  | Accrued atSeptember 30,2005
|Severance costs            |  |         |     |                                                          |   |                                                                |  |                             |     |  |   |   
|Research and development   |  | $       | 471 |                                                          | $ | 230                                                            |  | $                           | 222 |  | $ | 19
|General and administrative |  |         | 336 |                                                          |   | 188                                                            |  |                             | 139 |  |   | 9 
|                           |  |         |     |                                                          |   |                                                                |  |                             |     |  |   |   
|Total                      |  | $       | 807 |                                                          | $ | 418                                                            |  | $                           | 361 |  | $ | 28
|                           |  |         |     |                                                          |   |                                                                |  |                             |     |  |   |   



15



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##### Table of Contents

Forward-Looking Statements



This report contains forward-looking statements within the meaning of federal securities laws that relate to future events or our future
financial performance. In some cases, you can identify forward-looking statements by terminology such as may, can, will, should, expect, plan, anticipate,
believe, estimate, predict, intend, potential or continue or the negative of these terms or other comparable terminology. Risks and uncertainties and the occurrence of other
events could cause actual results to differ materially from these predictions. Factors that could cause or contribute to such differences include those discussed below under Risk Factors That May Affect Results of Operations and Financial
Condition, as well as those discussed in our Annual Report on Form 10-K for the year ended December 31, 2004.



Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance
or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of these statements. We are under no duty to update any of the forward-looking statements after the date of this report or to conform
these statements to actual results.



ITEM 2

MANAGEMENTS DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS



Executive Summary



We are a leader in the application of directed molecular evolution, a process by which genes and related proteins are modified for specific
commercial uses. Maxygen began operations in March 1997 with the mission to develop important commercial products through the use of biotechnology. Since then, we have established a focus in human therapeutics, particularly optimized protein
pharmaceuticals.



Our business model focuses on developing next-generation
protein pharmaceuticals that address significant markets, on our own or with partners. We currently have four next-generation protein therapeutic leads in pre-clinical development. The four lead product candidates seek to address significant
opportunities and deficiencies in first-generation marketed protein products. The four product candidates are: an optimized alpha interferon for the treatment of hepatitis C virus infection, partnered with Roche; an optimized gamma interferon for
the treatment of idiopathic pulmonary fibrosis and other indications, partnered with InterMune; an optimized G-CSF for the treatment of neutropenia, and an optimized Factor VII to treat uncontrolled bleeding. We currently expect that Investigational
New Drug Applications (INDs) will be filed on two of these programs in 2006.



The successful development of our product candidates is highly uncertain. Product development costs and timelines can vary significantly for each product candidate and are difficult to accurately predict. Various
statutes and regulations also govern or influence the manufacturing, safety, labeling, storage, record keeping and marketing of each product. The lengthy process of seeking these approvals, and the subsequent compliance with applicable statutes and
regulations, require the expenditure of substantial resources. Any failure by us to obtain, or any delay in obtaining, regulatory approvals could materially adversely affect our business.



In addition to our focus in human therapeutics, we established two industrial subsidiaries. Codexis focuses on the development of
biocatalysis and fermentation processes and products for the pharmaceutical industry. On February 28, 2005, our voting rights in Codexis were reduced below 50%. As a result, as of such date we no longer consolidated the financial position and
results of operations of Codexis with our financial results and instead we account for Codexis under the equity method of accounting. To reflect what our basis in Codexis would have been under equity accounting, we recorded a one-time positive
adjustment as a cumulative effect adjustment of $16.6 million for the nine months ended September 30, 2005 to bring our investment basis in Codexis to zero. On July 1, 2004 we completed the sale of Verdia, our agriculture subsidiary, to
Pioneer Hi-Bred International, Inc., a wholly-owned subsidiary of E.I. du Pont de Nemours and Company, for cash proceeds of $64 million. The discussion in this section reflects the results of Verdia as a discontinued operation for the nine months
ended September 30, 2004.



To date, we have generated revenues from
research collaborations with pharmaceutical, chemical and petroleum companies and from government grants. Moving forward, we anticipate establishing additional strategic alliances. However, as our internal resources and expertise have evolved, we
have strategically shifted our focus to pharmaceutical products and internal product development in order to capture more of the potential value resulting from our efforts. We believe this is an important step in building long-term value in Maxygen.
However, in the immediate term this will mean reduced revenues and increased operating losses. Consistent with our strategic shift, revenue from collaborative research agreements and government grants decreased from $22.9 million in 2003



16



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##### Table of Contents

to $16.3 million in 2004. Our revenues were $12.4 million in the nine months ended September 30, 2004, compared to
$8.2 million for the nine months ended September 30, 2005. Due to our continuing shift to internal product development and the deconsolidation of Codexis, our revenue is expected to drop accordingly during the remainder of 2005.



For the purposes of this report, our continuing operations consist of the results of Maxygen,
Inc. and our wholly-owned subsidiaries, Maxygen ApS (Denmark) and Maxygen Holdings Ltd. (Cayman Islands), as well as the results of Codexis through February 28, 2005.



We continue to maintain a strong cash position to fund our expanded internal product development, with cash, cash equivalents and marketable
securities totaling $189.6 million as of September 30, 2005.



We have
incurred significant operating losses since our inception. As of September 30, 2005, our accumulated deficit was $198.4 million. We have invested heavily in establishing our proprietary technologies. Our research and development expenses from
continuing operations for the three months ended September 30, 2005 were $10.0 million compared to $14.4 million for comparable period in 2004. Our research and development expenses from continuing operations for the nine months ended
September 30, 2005 were $31.0 million compared to $37.0 million for comparable period in 2004. We expect to incur additional operating losses over at least the next several years.



Critical Accounting Policies and Estimates



The preparation of financial statements in conformity with generally accepted accounting principles requires management to make judgments, estimates and assumptions in
the preparation of our consolidated financial statements and accompanying notes. Actual results could differ from those estimates.



Except as supplemented below, we believe there have been no significant changes in our critical accounting policies during the three months ended September 30, 2005,
as compared to what was previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2004.



Consolidation



The consolidated financial statements presented in this report include the amounts of Maxygen and our wholly-owned subsidiaries, Maxygen ApS (Denmark) and Maxygen Holdings Ltd. (Cayman Islands). For the three months
and nine months ended September 30, 2004 and for the two months ended February 28, 2005, 100% of the results of operations of Codexis are also included as well as the financial position of Codexis at December 31, 2004.



In accordance with EITF Consensus 96-16, Investor Accounting for an Investee When the
Investor Has a Majority of the Voting Interest but the Minority Stockholder or Stockholders Have Certain Approval or Veto Rights and paragraph 1 of ARB No. 51, Consolidated Financial Statements, Maxygen has included 100% of
the net losses of Codexis in the determination of its net loss through February 28, 2005. As of February 28, 2005, Maxygen controlled less than 50% of the voting rights of the issued and outstanding shares of Codexis common and preferred
stock. In accordance with APB 18, The Equity Method of Accounting for Investments in Common Stock, Maxygen is accounting for its investment in Codexis under the equity method of accounting after February 28, 2005. The operations of
Verdia, Inc. prior to its sale on July 1, 2004 are reflected as discontinued operations. All significant intercompany balances and transactions have been eliminated in consolidation.



Results of Operations



Revenues



Our total revenues from continuing operations were $3.9 million and $12.4 million in the three and nine months ended September 30, 2004 and were $735,000 and $8.2
million in the three and nine months ended September 30, 2005. The decrease in collaborative research and development revenue of $3.3 million for the three months ended September 30, 2005 as compared to the three months ended
September 30, 2004, was primarily due to the completion of the research and development funding terms of several collaborations during 2004 and 2005 and the change to the equity method of accounting for our investment in Codexis as of
February 28, 2005. The decrease in collaborative research and development revenue of $4.6 million for the nine months ended September 30, 2005 as compared to the nine months ended September 30, 2004, was primarily due to the
completion of the research and development funding terms of several collaborations during 2004 and 2005 and the change to the equity method of accounting for our investment in Codexis as of February 28, 2005, partially offset by a significant
milestone from Roche in the first quarter of 2005. The increase in grant revenue of $155,000 for the three months ended



17



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##### Table of Contents

September 30, 2005 compared to the three months ended September 30, 2004 and the increase in grant revenue of
$454,000 for the nine months ended September 30, 2005 compared to the nine months ended September 30, 2004 primarily reflects an increase in activity on our existing grant projects and the beginning of three new grant projects in the third
quarter of 2005. For 2005, we expect our consolidated revenues to be approximately $10.0 million. This reduced level of revenues as compared to 2004 reflects the fact that Codexis revenues are not included in Maxygens consolidated financial
results after February 28, 2005 and that Maxygens focus has intensified on the internal development of its product candidates as opposed to conducting funded research and development for the benefit of third party collaborations.



Due to the nature of our research and our dependence on our collaborative
partners to commercialize certain results of the research, we cannot predict with any certainty whether any particular collaboration or research effort will ultimately result in a commercial product and therefore whether we will receive future
milestone payments or royalty payments under our various collaborations.



Revenues for each operating segment are derived from our research collaboration agreements and government research grants and are categorized based on the industry of the product or technology under development. Results of Codexis through
February 28, 2005 are shown as Maxygens chemicals segment. After February 28, 2005 we have operated as one segment. The following table presents revenues for each operating segment (in thousands):



|                   |  |                                  |       |                                 |   |      |  |      |        |  |   |      
|------------------ |  | -------------------------------- | ----- | ------------------------------- | - | ---- |  | ---- | ------ |  | - | -----
|                   |  | Three months ended September 30, |       | Nine months ended September 30,
|                   |  | 2004                             |       | 2005                            |   | 2004 |  | 2005
|Human therapeutics |  | $                                | 2,575 |                                 | $ | 735  |  | $    | 8,968  |  | $ | 6,720
|Chemicals          |  |                                  | 1,350 |                                 |   |     |  |      | 3,386  |  |   | 1,510
|                   |  |                                  |       |                                 |   |      |  |      |        |  |   |      
|Total revenue      |  | $                                | 3,925 |                                 | $ | 735  |  | $    | 12,354 |  | $ | 8,230
|                   |  |                                  |       |                                 |   |      |  |      |        |  |   |      



The decrease in revenues for our human
therapeutics segment for the three month periods primarily reflects the shift in focus of our product development strategy towards internal development of product candidates and away from third-party funded research collaborations as several of our
collaborations came to completion during 2004 and 2005. The decrease in revenues for our human therapeutics segment for the nine month periods primarily reflects the shift in focus of our product development strategy towards internal development of
product candidates and away from third party funded research collaborations as several of our collaborations came to completion during 2004 and 2005, partially offset by the achievement of a significant milestone from Roche in the first quarter of
2005. Revenues for our human therapeutics segment for the next several quarters are expected to be higher than revenues for our human therapeutics segment in the three months ended September 30, 2005, primarily due to the work that began on
three new grants in the third quarter of 2005.



Research and
Development Expenses



We have entered into a number of research and
development collaborations to perform research for our collaborators. The major collaborative agreements have similar contractual terms. The agreements generally require us to devote a specified number of full-time equivalent employees to the
research efforts over defined terms, generally ranging from three to five years.



We do not track fully burdened research and development costs by project. However, we do estimate, based on full-time equivalent personnel effort, the percentage of research and development efforts (as measured in hours incurred, which
approximates costs) undertaken for projects funded by, on the one hand, our collaborators and government grants and, on the other hand, projects funded by Maxygen. We believe that presenting our research and development expenses in these categories
will provide our investors with meaningful information on how our resources are being used.



The following table presents our approximate research and development expenses by funding category (in thousands):



|                                               |  |                                  |        |                                 |   |       |  |      |        |  |   |       
|---------------------------------------------- |  | -------------------------------- | ------ | ------------------------------- | - | ----- |  | ---- | ------ |  | - | ------
|                                               |  | Three months ended September 30, |        | Nine months ended September 30,
|                                               |  | 2004                             |        | 2005                            |   | 2004  |  | 2005
|Collaborative projects funded by third parties |  | $                                | 2,922  |                                 | $ | 1,526 |  | $    | 8,239  |  | $ | 5,644 
|Internal projects                              |  |                                  | 11,506 |                                 |   | 8,456 |  |      | 28,802 |  |   | 25,331
|                                               |  |                                  |        |                                 |   |       |  |      |        |  |   |       
|Total                                          |  | $                                | 14,428 |                                 | $ | 9,982 |  | $    | 37,041 |  | $ | 30,975
|                                               |  |                                  |        |                                 |   |       |  |      |        |  |   |       



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As we do not track fully burdened research and development costs by project, the expense figures provided above are
comprised of the number of hours expended in each category multiplied by the approximate cost per hour of research and development effort. In addition, project-specific external costs are added to these costs.



Most of our product development programs are at an early stage and may not result in any
marketed products. Product candidates that may appear promising at early stages of development may not reach the market for a number of reasons. Product candidates may be found ineffective or cause harmful side effects during clinical trials, may
take longer to pass through clinical trials than had been anticipated, may fail to receive necessary regulatory approvals and may prove impracticable to manufacture in commercial quantities at reasonable costs and with acceptable quality. In
addition, competitors may develop superior competing products. Furthermore, it is uncertain which of our internally developed product candidates will be subject to future collaborative arrangements. The participation of a collaborative partner may
accelerate the time to completion and reduce the cost to us of a product candidate or it may delay the time and increase the cost to us due to the alteration of our existing strategy. The risks and uncertainties associated with our research and
development projects are discussed more fully in the section of this report titled Risk Factors That May Affect Results of Operations and Financial Condition. Because of these risks and uncertainties, we cannot predict when or whether we
will successfully complete the development of our product candidates or the ultimate product development cost in any particular case.



Our research and development expenses consist primarily of salaries and other personnel-related expenses, research consultants and external collaborative research
expenses (including contract manufacturing and research), facility costs, supplies and depreciation of facilities, and expensed laboratory equipment. Research and development expenses decreased from $14.4 million and $37.0 million in the three
months and nine months ended September 30, 2004 to $10.0 million and $31.0 million in the comparable periods of 2005. The decreases are primarily due to the change from consolidation to the equity method of accounting for our investment in
Codexis as of February 28, 2005, offset in part by increased external collaborative research expenses associated with the development of our product candidates, including the manufacture of product candidates in preparation for clinical trials
and termination charges of $440,000 in the three months ended June 30, 2005 and $31,000 in the three months ended September 30, 2005 related to a reduction in force of research and development personnel announced on June 16, 2005.
Excluding Codexis, research and development expenses decreased from $10.5 million in the three months ended September 30, 2004 to $10.0 million in the three months ended September 30, 2005 primarily due to decreased facility costs, supply
costs and decreased salary and other personnel-related expenses related to the reduction in force announced on June 16, 2005. Excluding Codexis, research and development expenses increased from $25.7 million in the nine months ended
September 30, 2004 to $28.4 million in the nine months ended September 30, 2005 primarily due to increased external collaborative research expenses associated with the development of our product candidates, including the manufacture of
product candidates in preparation for clinical trials and termination charges related to the reduction in force of research and development personnel announced on June 16, 2005. Stock compensation expenses included in research and development
expenses were $50,000 during the three months ended September 30, 2004 compared to $4,000 in the three months ended September 30, 2005 and were $288,000 in the nine months ended September 30, 2004 compared to $115,000 during the nine
months ended September 30, 2005. The decreases in stock compensation expenses were primarily related to the amortization of deferred compensation relating to the grant of stock options to employees before our initial public offering, which was
fully amortized to expense by August 2004.



We expect that our research and
development costs may decrease modestly in 2005 over 2004, due primarily to the change to the equity method of accounting for our investment in Codexis as of February 28, 2005, offset by an increase in research and development costs for the
remainder of our consolidated operations as we increase our efforts on internally funded projects. We expect to continue to devote substantial resources to research and development and we expect research and development expenses to increase over the
next several years if we are successful in advancing our product candidates into clinical trials. To the extent we out-license our product candidates prior to commencement of clinical trials or collaborate with others with respect to clinical
trials, increases in research and development expenses may be reduced or avoided. We intend to manage the level of our expenditures for research and development, including clinical trials, to balance advancing our product candidates against
maintaining adequate cash resources for our operations. Stock compensation expense related to research and development will increase considerably upon our implementation of Financial Accounting Standards Board Statement No. 123(R). We are
currently evaluating the requirements of SFAS 123(R) as well as option valuation methodologies related to our employee and director stock options and employee stock purchase plan. Although we have not yet determined the method of adoption or the
effect of adopting SFAS 123(R), we expect that the adoption of SFAS 123(R) could have a material impact on our consolidated results of operations and net loss per share. The impact of adoption of SFAS 123(R) will depend on, among other things, the
levels of share-based payments granted in the future, the method of adoption and the option valuation method used. We will adopt SFAS 123(R) on January 1, 2006.



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General and Administrative Expenses



Our general and administrative expenses consist primarily of personnel costs for finance, human resources, business development, legal and
general management, as well as insurance premiums and professional expenses, such as external expenditures for legal, accounting and commercial assessment of potential products. General and administrative expenses decreased from $3.7 million in the
three months ended September 30, 2004 to $3.0 million in the three months ended September 30, 2005. General and administrative expenses increased from $10.0 million in the nine months ended September 30, 2004 to $10.1 million in the
nine months ended September 30, 2005. The decrease in the three-month periods was primarily due to the change to the equity method of accounting for our investment in Codexis as of February 28, 2005 and the reduction in force of general
and administrative personnel announced June 16, 2005. The increase in the nine-month periods was primarily due to professional fees related to an increase in market research and product profile development activity and regulatory compliance
costs as well as termination charges of $336,000 related to a reduction in force announced on June 16, 2005, offset in part by the change to the equity method of accounting for our investment in Codexis as of February 28, 2005. Excluding
Codexis, general and administrative expenses decreased from $3.1 million in the three months ended September 30, 2004 to $3.0 million in the three months ended September 30, 2005 primarily due to the reduction in force announced
June 16, 2005. Excluding Codexis, general and administrative expenses increased from $8.3 million in the nine months ended September 30, 2004 to $9.8 million in the nine months ended September 30, 2005 primarily due to professional
fees related to an increase in market research and product profile development activity and regulatory compliance costs as well as termination charges of $336,000 related to a reduction in force announced on June 16, 2005. Stock compensation
expenses included in general and administrative expenses were $15,000 in the three months ended September 30, 2004. There were no stock compensation expenses included in general and administrative expenses in the three months ended
September 30, 2005. Stock compensation expenses included in general and administrative expenses were $59,000 in the nine months ended September 30, 2004 and $6,000 in the nine months ended September 30, 2005. The decreases in general
and administrative stock compensation expenses were primarily related to the amortization of deferred compensation relating to the grant of stock options to employees before our initial public offering, which was fully amortized to expense by August
2004.



We expect that our quarterly general and administrative expenses will
decrease in the remainder of 2005, due primarily to reduced personnel costs and the change to the equity method of accounting for our investment in Codexis, offset in part by increased professional fees and product assessment costs. Stock
compensation expense related to general and administration will increase considerably upon our implementation of Financial Accounting Standards Board Statement No. 123(R). We are currently evaluating the requirements of SFAS 123(R) as well as
option valuation methodologies related to our employee and director stock options and employee stock purchase plan. Although we have not yet determined the method of adoption or the effect of adopting SFAS 123(R), we expect that the adoption of SFAS
123(R) could have a material impact on our consolidated results of operations and net loss per share. The impact of adoption of SFAS 123(R) will depend on, among other things, the levels of share-based payments granted in the future, the method of
adoption and the option valuation method used. We will adopt SFAS 123(R) on January 1, 2006.



Interest Income and Other (Expense), net



Interest income and other (expense), net represents income earned on our cash, cash equivalents and marketable securities, net of interest expense on our equipment leases
and currency transaction gains or losses related to the funding of our Danish subsidiary Maxygen ApS. Interest income and other (expense), net increased from $1.0 million in the three months ended September 30, 2004 to $1.7 million in the three
months ended September 30, 2005. Included in these amounts are foreign exchange gains of $93,000 in the three months ended September 30, 2004 and foreign exchange losses of $17,000 in the three months ended September 30, 2005. The
increase in interest income was primarily due to higher interest rates. Interest income and other (expense), net increased from $2.3 million in the nine months ended September 30, 2004 to $3.8 million in the nine months ended September 30,
2005. Included in these amounts are foreign exchange losses of $84,000 in the nine months ended September 30, 2004 and $542,000 in the nine months ended September 30, 2005. The net increase in interest income and other (expense), net was
primarily due to higher average balances of cash, cash equivalents and marketable securities, and higher interest rates, offset in part by an increase in foreign exchange losses.



Cumulative Effect Adjustment



Codexis was formed in January 2002 and independently financed by Maxygen and several other investors in September and October of 2002. In
August 2004 Codexis received additional equity funding from Pfizer. Until February 28, 2005, Maxygen recognized 100% of the operating results of Codexis even though we only owned a majority of the voting interests in Codexis. At such time we
had recorded losses of Codexis in the amount of $26.4 million, which was in excess of our investment basis of $9.8 million. On February 28, 2005, our voting rights in Codexis were reduced below 50%. As a result, as of such date we no longer
consolidate the financial position and



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results of operations of Codexis with Maxygens financial results and instead we account for Codexis under the
equity method of accounting. To reflect what our basis in Codexis would have been under equity accounting, we recorded a non-recurring cumulative effect adjustment of $16.6 million for the nine months ended September 30, 2005 to bring our
investment basis in Codexis to zero. This cumulative effect adjustment does not have any tax consequences.



Subsidiary Preferred Stock Accretion



In 2002, Codexis sold $25 million of Codexis series B convertible preferred stock to investors, of which $5 million was purchased by Maxygen and $20 million was purchased
by several unrelated investors. The series B convertible preferred stock includes a redemption provision, which provides that the holders of at least a majority of the outstanding shares of series B convertible preferred stock (excluding the series
B convertible preferred stock held by Maxygen and its affiliates), voting together as a separate class, may require Codexis to redeem the series B convertible preferred stock. The redemption price for each share will be payable in cash in exchange
for the shares of series B convertible preferred stock to be redeemed at a sum equal to the applicable original issue price per share plus five percent (5%) of the original issue price per year from the original issue date until the applicable
redemption date, plus declared and unpaid dividends. Notice of redemption can be given at any time on or after the fifth anniversary of the original issue date. In connection with these redemption rights, we recorded accretion of the redemption
premium for the series B convertible preferred stock, excluding the shares owned by Maxygen, in the amount of $250,000 and $750,000 in the three and nine months ended September 30, 2004 and zero and $167,000 in the nine months ended
September 30, 2005. There was no accretion in the three months ended September 30, 2005. The accretion was recorded as subsidiary preferred stock accretion on the condensed consolidated statement of operations through February 28,
2005 and as a reduction of additional paid-in capital and an increase to minority interest on the condensed consolidated balance sheets. Any obligation to make redemption payments is solely an obligation of Codexis and any payments are to be made
solely from assets of Codexis. Since we no longer consolidate the financial position of Codexis, as of February 28, 2005 we no longer recognized accretion for the Codexis redemption premium. We also no longer reflect amounts as minority
interest on our condensed consolidated balance sheets. We have recorded a $2.4 million adjustment to additional paid-in capital to eliminate the reduction of additional paid-in capital that had resulted from Codexis preferred stock accretion
prior to February 28, 2005.



New Accounting Pronouncements



In November 2004 the Financial Accounting Standards Board (FASB) delayed
the effective date for the measurement and recognition guidance contained in paragraphs 10-20 of EITF 03-01, The Meaning of Other-Than-Temporary Impairments and its Application to Certain Investments; this delay does not suspend the
requirement to recognize other-than-temporary impairments as required by existing authoritative literature. The disclosure requirement of this guidance remains in effect. We do not expect the adoption of the recognition and measurement provisions of
EITF 03-01 to significantly impact our results of operations or financial position but will reassess the impact once the rules are finalized.



On December 16, 2004, the FASB issued FASB Statement No. 123 (revised 2004), Share-Based Payment, which is a revision of FASB Statement
No. 123, Accounting for Stock-Based Compensation. Statement 123(R) supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and amends FASB Statement No. 95, Statement of Cash Flows.
Statement 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative.



Statement 123(R) must be adopted no later than the beginning of the first fiscal year
beginning after June 15, 2005. We will adopt Statement 123(R) on January 1, 2006.



Statement 123(R) permits public companies to adopt its requirements using one of two methods:



| | 1. | A modified prospective method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of Statement 123(R) for all
share-based payments granted after the effective date and (b) based on the requirements of Statement 123 for all awards granted to employees prior to the effective date of Statement 123(R) that remain unvested on the effective date.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 2. | A modified retrospective method that includes the requirements of the modified prospective method described above, but also permits entities to restate, based on the
amounts previously recognized under Statement 123, for purposes of pro forma disclosures for all prior periods presented.
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We plan to adopt Statement 123(R) using the modified prospective method.



As permitted by Statement 123, we currently account for share-based payments to employees
using Opinion 25s intrinsic value method and, as such, generally recognize no compensation cost for employee stock options. Accordingly, the adoption of Statement 123(R)s fair value method will have a significant impact on our result of
operations, although it will have no impact on our overall cash position. The impact of adoption of Statement 123(R) cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had we
adopted Statement 123(R) in prior periods, the impact of that standard would have approximated the impact of Statement 123 as described in the disclosure of pro forma net income (loss) and earnings (loss) per share in Note 1 to our Notes to
condensed consolidated financial statements (Stock-Based Compensation). Statement 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an
operating cash flow as required under current literature. This requirement may reduce net operating cash flows and increase net financing cash flows in periods after adoption. We cannot estimate what those amounts will be in the future because they
depend upon, among other things, levels of share-based payments granted in the future, when employees exercise stock options and if and when we become profitable.



In May 2005, the FASB issued Statement No. 154, Accounting Changes and Error Corrections, a replacement of Accounting
Principles Board Opinions No. 20, Accounting Changes, and Statement No. 3, Reporting Accounting Changes in Interim Financial Statements. Statement 154 changes the requirements for the accounting for and reporting of
a change in accounting principle. Previously, most voluntary changes in accounting principles were recognized by including in net income during the period of change the cumulative effect of changing to the new accounting principle. Statement 154
requires retrospective application to prior periods financial statements, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. Statement 154 is effective for accounting changes made
in fiscal years beginning after December 15, 2005; however, the Statement does not change the transition provisions of any existing accounting pronouncements. We do not believe adoption of Statement 154 will have a material effect on our
consolidated financial position, results of operations or cash flows.



Liquidity and Capital Resources



Since inception, we have
financed our continuing operations primarily through private placements and public offerings of equity securities, research and development funding from collaborators and government grants. In addition, on July 1, 2004 we received $64.0 million
in cash as proceeds, before estimated income taxes and transaction costs of $1.4 million, from the sale of our agriculture segment, Verdia. As of September 30, 2005, we had $189.6 million in cash, cash equivalents and marketable securities.



Net cash used in operating activities was $25.0 million for the nine months
ended September 30, 2004 and $29.1 million in the nine months ended September 30, 2005. Uses of cash in operating activities were primarily to fund losses from continuing operations. The increase in cash used in operating activities for
the nine months ended September 30, 2005 primarily relates to payment of accrued expenses relating to annual bonuses for 2004 and program termination costs during the nine months ended September 30, 2005 that were not paid during the nine
months ended September 30, 2004.



Net cash provided by investing
activities was $35.9 million in the nine months ended September 30, 2004 and $23.5 million in the nine months ended September 30, 2005. The cash provided during the nine months ended September 30, 2004 was primarily related to the
cash received from the sale of Verdia of $62.6 million offset by purchases of available-for-sale securities. The cash provided during the nine months ended September 30, 2005 was primarily related to maturities of available-for-sale securities
in excess of purchases offset by the $2.6 million used by Codexis to acquire Julich Fine Chemicals GmbH in February 2005. The majority of additions of property and equipment in 2004 and 2005 relate to Codexis investment in its bioprocessing
facility. We expect to continue to make investments in the purchase of property and equipment to support our human therapeutics operations. We may use a portion of our cash to acquire or invest in businesses, products or technologies, or to obtain
the right to use such technologies.



Net cash provided by financing activities
was $14.1 million in the nine months ended September 30, 2004 and $2.4 million in the nine months ended September 30, 2005. The cash provided during the nine months ended September 30, 2004 was primarily related to Codexis
receipt of $10 million from a private placement of its equity securities by Pfizer, the proceeds of $2.2 million from equipment loans entered into by Codexis and the proceeds of $2.3 million from the sale of common stock in connection with our
Employee Stock Purchase Plan and the exercise of stock options by employees. The cash provided during the nine months ended September 30, 2005 was primarily the proceeds of the sale of common stock in connection with our Employee Stock Purchase
Plan and the exercise of stock options by employees, from the proceeds of equipment loans entered into by Codexis net of repayments of such loans, and Codexis assumption of loans upon the acquisition of Julich.



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Cash provided by discontinued operations was $1.4 million in the nine months ended September 30, 2004. The cash
provided by discontinued operations in 2004 relates to Verdias final payment for services provided by Maxygen and reimbursement to Maxygen for payments made on behalf of Verdia prior to the sale of Verdia to Pioneer Hi-Bred International, Inc.



The $2.4 million cash decrease due to the Codexis related net adjustment in
the nine months ended September 30, 2005 reflects the net impact on cash and cash equivalents due to Maxygen no longer consolidating Codexis after February 28, 2005.



In accordance with FAS No. 52, the functional currency for our Danish operations is its local currency. The effects of foreign exchange
rate changes on the translation of the local currency financial statements into U.S. dollars are reported as a component of accumulated other comprehensives loss on the Consolidated Balance Sheets. The effect of exchange rate changes on cash and
cash equivalents was a decrease of $8,000 in the nine months ended September 30, 2004 and an increase of $302,000 in the nine months ended September 30, 2005.



Assuming our research efforts for existing collaborations and grants continue for their full research terms, as of September 30, 2005
we had total committed funding of approximately $14.9 million remaining to be received over the next year. Potential milestone payments from our existing collaborations could exceed $280 million based on the accomplishment of specific performance
criteria. We may also earn royalties on product sales. In general, the obligation of our corporate collaborators to provide research funding cannot be terminated by either party before the end of the research term unless there has been a material
breach of contract or either party has become bankrupt or insolvent. In the case of such an event, the agreement specifies the rights, if any, that each party will retain.



We believe that our current cash, cash equivalents, short-term investments and long-term investments, together with funding received from
collaborators and government grants, will be sufficient to satisfy our anticipated cash needs for working capital and capital expenditures for at least the next twelve months. However, it is possible that we will seek additional financing within
this timeframe. We may raise additional funds through public or private financing, collaborative relationships or other arrangements. Additional funding, if sought, may not be available on terms favorable to us. Further, any additional equity
financing may be dilutive to stockholders, and debt financing, if available, may involve restrictive covenants. Our failure to raise capital when needed may harm our business and operating results.



Discontinued Operations



The results of discontinued operations reflect the results of Verdia until it was sold on July 1, 2004. Our loss from discontinued
operations was $2.8 million for the nine months ended September 30, 2004.



Collaborative research and development revenue from discontinued operations was $2.7 million in the nine months ended September 30, 2004. There was no collaborative research and development revenue from discontinued operations in the
three months ended September 30, 2004 and the three and nine months ended September 30, 2005. Collaborative research and development revenue from related party from discontinued operations was $2.5 million in the nine months ended
September 30, 2004. There was no collaborative research and development revenue from related party from discontinued operations in the three months ended September 30, 2004 and the three and nine months ended September 30, 2005. Grant
revenue from discontinued operations was $311,000 in the nine months ended September 30, 2004. There was no grant revenue from discontinued operations in the three months ended September 30, 2004 and the three and nine months ended
September 30, 2005.



Research and development expenses from discontinued
operations were $6.2 million in the nine months ended September 30, 2004. There were no research and development expenses from discontinued operations in the three months ended September 30, 2004 and the three and nine months ended
September 30, 2005. General and administrative expenses from discontinued operations were $616,000 in the nine months ended September 30, 2004. There were no general and administrative expenses from discontinued operations in the three
months ended September 30, 2004 and the three and nine months ended September 30, 2005.



Interest income and other, net from discontinued operations was $32,000 in the three and nine months ended September 30, 2004. There was no interest income and other, net from discontinued operations in the three
months ended September 30, 2004 and the three and nine months ended September 30, 2005. Equity in net loss of joint venture from discontinued operations was $1.5 million in the nine months ended September 30, 2004. There was no equity
in net loss of joint venture from discontinued operations in the three months ended September 30, 2004 and the three and nine months ended September 30, 2005.



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RISK FACTORS THAT MAY AFFECT RESULTS OF OPERATIONS AND FINANCIAL CONDITION



You should carefully consider the risks described below, together with all of the other
information included in this report, in considering our business and prospects. The risks and uncertainties described below are not the only ones facing Maxygen. Additional risks and uncertainties not presently known to us or that we currently deem
immaterial also may impair our business operations. If any of the following risks actually occur, our business could be harmed. In such case, the trading price of our common stock could decline, and you may lose all or part of your investment.



We Have a History of Net Losses. We Expect to Continue to Incur Net Losses
and We May Not Achieve or Maintain Profitability.



We have incurred losses
since our inception, including a loss applicable to common stockholders of $33.9 million in 2002 and $33.7 million in 2003. During 2004 we recognized income applicable to common stockholders, primarily due to the sale of Verdia, of $8.3 million, but
our loss from continuing operations was $49.1 million. For the nine months ended September 30, 2005 we recognized a loss applicable to common stockholders of $12.7 million, primarily due to a positive non-recurring adjustment of $16.6 million
resulting from the cumulative effect adjustment recorded as a result of the change to the equity method of accounting for our investment in Codexis. Our loss from continuing operations for the nine months ended September 30, 2005 was $29.2
million. As of September 30, 2005, we had an accumulated deficit of $198.4 million. We expect to incur net losses and negative cash flow from operating activities for at least the next several years. To date, we have derived substantially all
our revenues from collaborations and grants and expect to derive a substantial majority of our revenue from such sources for at least the next several years. The funded research portion of our primary collaboration, with Roche, wound down on
schedule in the third quarter of 2005. Revenues from collaborations and grants are uncertain because our existing agreements have fixed terms and because our ability to secure future agreements will depend upon our ability to address the needs of
current and potential future collaborators. We expect to spend significant amounts to fund the development of our product candidates. As a result, we expect that our operating expenses will exceed revenues in the near term and we do not expect to
achieve profitability during the next several years. If the time required for us to achieve profitability is longer than we anticipate, we may not be able to continue our business.



We Need to Contain Costs in Order to Achieve Profitability.



We are continuing our efforts to contain costs. On June 16, 2005 we announced a reduction in force of approximately 16% of our
personnel, across both our research and administrative functions. This reduction in force was a part of our efforts to focus our resources on product development. As a result of the reduction in force we recorded termination costs of $97,000 during
the three months ended September 30, 2005 and $807,000 during the nine months ended September 30, 2005, comprised primarily of involuntary termination benefits. We continue to believe strict cost containment in the near term is essential
if our current funds are to be sufficient to allow us to achieve future profitability. We assess market conditions on an ongoing basis and plan to take appropriate actions as required. If we are not able to effectively contain our costs and achieve
an expense structure commensurate with our business activities and revenues, we may have inadequate levels of cash for future operations or for future capital requirements, which could significantly harm our ability to operate the business.



We Are an Early Stage Company Deploying Unproven Technologies. If We Do Not
Develop Commercially Successful Products, We May Be Forced to Cease Operations.



You must evaluate us in light of the uncertainties and complexities affecting an early stage biotechnology company. We may not be successful in the commercial development of products. Successful products will require significant development
and investment, including testing, to demonstrate their safety and effectiveness before their commercialization. To date, companies in the biotechnology industry have developed and commercialized only a limited number of products. We have not proven
our ability to develop and commercialize products. We must conduct a substantial amount of additional research and development before any regulatory authority will approve any of our potential products. Our research and development may not indicate
that our products are safe and effective, in which case regulatory authorities may not approve them. Problems frequently encountered in connection with the development and utilization of new and unproven technologies and the competitive environment
in which we operate might limit our ability to develop commercially successful products.



Acquisitions Could Result in Dilution, Operating Difficulties and Other Harmful Consequences.



If appropriate opportunities present themselves, we will acquire businesses and technologies that complement our capabilities. The process of integrating any acquisition
may create unforeseen operating difficulties and expenditures and is itself risky. The areas where we may face difficulties include:



| |  |  | diversion of management time (both ours and that of the acquired company) from focus on operating the businesses to issues of integration during the period of negotiation through
closing and further diversion of such time after closing;
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| |  |  | decline in employee morale and retention issues resulting from changes in compensation, reporting relationships, future prospects, or the direction of the business;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the need to integrate each companys accounting, management information, human resource and other administrative systems to permit effective management and the lack of control
if such integration is delayed or not implemented; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the need to implement controls, procedures and policies appropriate for a larger public company in companies that before acquisition had been smaller, private companies.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------



We do not have extensive experience in managing this integration
process. Moreover, the anticipated benefits of any or all of these acquisitions may not be realized.



Future acquisitions could result in potentially dilutive issuances of equity securities, the incurrence of debt, contingent liabilities or amortization expenses related to intangible assets, any of which could harm
our business. Future acquisitions may require us to obtain additional equity or debt financing, which may not be available on favorable terms or at all. Even if available, this financing may be dilutive.



Legislative Actions, Pending and Potential New Accounting Pronouncements and Higher
Compliance Costs are Likely to Adversely Impact Our Future Financial Position and Results of Operations.



Future changes in financial accounting standards, including the requirement that we expense all stock option grants and other stock-based compensation to employees beginning in January 2006, may cause adverse,
unexpected earnings fluctuations and will adversely affect our financial position and results of operations. The magnitude of the impact of expensing stock-based compensation will depend in part upon the timing and amount of future equity
compensation awards. New accounting pronouncements and varying interpretations of such pronouncements have occurred with frequency in the recent past and may occur in the future. In addition we may make changes in our accounting policies in the
future. Compliance with changing regulation of corporate governance and public disclosure will also result in additional expenses. Changing laws, regulations and standards relating to corporate governance and public disclosure, including the
Sarbanes-Oxley Act of 2002, new SEC regulations and Nasdaq National Market listing requirements, are creating uncertainty for companies such as ours and compliance costs are increasing as a result of this uncertainty and other factors. We are
committed to maintaining high standards of corporate governance and public disclosure. As a result, we intend to invest all reasonably necessary resources to comply with evolving standards, and this investment will result in increased general and
administrative expenses and may cause a diversion of management time and attention from revenue-generating activities to compliance activities.



Accounting for Employee Stock Options Using the Fair Value Method Will Significantly Increase Our Net Loss.



On December 16, 2004, the Financial Accounting Standards Board (FASB) issued FASB
Statement No. 123 (revised 2004), Share-Based Payment. Statement 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based at their fair values.
Statement 123(R) must be adopted no later than the beginning of the first fiscal year beginning after June 15, 2005. We will adopt Statement 123(R) on January 1, 2006. The adoption of Statement 123(R)s fair value method will have a
significant impact on our results of operations. Such charges will significantly increase our net loss and will delay our ability to achieve profitability.



We Conduct Proprietary Research Programs, and Any Conflicts With Our Collaborators or Any Inability to Commercialize Products Resulting from This Research Could Harm
Our Business.



An important part of our strategy involves conducting
proprietary research programs. We may pursue opportunities in fields that could conflict with those of our collaborators. Moreover, disagreements with our collaborators could develop over rights to our intellectual property. Any conflict with our
collaborators could reduce our ability to obtain future collaboration agreements and negatively impact our relationship with existing collaborators, which could reduce our revenues.



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Certain of our collaborators could become our competitors in the future. Our collaborators could develop competing
products, preclude us from entering into collaborations with their competitors, fail to obtain timely regulatory approvals, terminate their agreements with us prematurely or fail to devote sufficient resources to allow the development and
commercialization of products. Any of these developments could harm our product development efforts.



In some cases our collaborators already market a product that could be competitive with the product(s) that we are collaborating with them on for an improved version, and could conduct their operations in a manner
that discriminates against the product that we developed.



We will either
commercialize products resulting from our proprietary programs directly or through licensing to other companies. We have no experience in manufacturing and marketing, and we currently do not have the resources or capability to manufacture products
on a commercial scale. In order for us to commercialize these products directly, we would need to develop, or obtain through outsourcing arrangements, the capability to manufacture, market and sell products. We do not have these capabilities, and we
may not be able to develop or otherwise obtain the requisite manufacturing, marketing and sales capabilities. If we are unable to successfully commercialize products resulting from our proprietary research efforts, we will continue to incur losses.



Litigation or Other Proceedings or Third Party Claims of Intellectual
Property Infringement Could Require Us to Spend Time and Money and Could Require Us to Shut Down Some of Our Operations.



Our ability to develop products depends in part on not infringing patents nor other proprietary rights of third parties, and not breaching any licenses that we have
entered into with regard to our technologies and products. Others have filed, and in the future are likely to file, patent applications covering genes or gene fragments or corresponding proteins or peptides that we may wish to utilize with our
proprietary technologies, or products that are similar to products developed with the use of our technologies or alternative methods of generating gene diversity. If these patent applications result in issued patents and we wish to use the patented
technology, we would need to obtain a license from the third party, which may not be available on acceptable terms, if at all.



Third parties may assert that we are employing their proprietary technology without authorization. In addition, third parties may obtain patents in the future and claim
that use of our technologies infringes these patents. We could incur substantial costs and diversion of the time and attention of management and technical personnel in defending ourselves against any of these claims or enforcing our patents or other
intellectual property rights against others. Furthermore, parties making claims against us may be able to obtain injunctive or other equitable relief that could effectively block our ability to further develop, commercialize and sell products, and
such claims could result in the award of substantial damages against us. In the event of a successful claim of infringement against us, we may be required to pay damages and obtain one or more licenses from third parties. We may not be able to
obtain these licenses at a reasonable cost, if at all. In that event, we could encounter delays in product introductions while we attempt to develop alternative methods or products or be required to cease commercializing affected products.



We monitor the public disclosures of other companies operating in our industry
regarding their technological development efforts. If we determine that these efforts violate our intellectual property or other rights, we intend to take appropriate action, which could include litigation. Any action we take could result in
substantial costs and diversion of management and technical personnel. Furthermore, the outcome of any action we take to protect our rights may not be resolved in our favor.



We May Need Additional Capital in the Future. If Additional Capital is Not Available, We May Have to Curtail or Cease Operations.



Our future capital requirements will depend on many factors including
payments received under collaborative agreements, joint ventures and government grants, the progress and scope of our collaborative and independent research and development projects, the extent to which we advance products into clinical trials with
our own resources, the effect of any acquisitions, and the filing, prosecution and enforcement of patent claims.



Changes may also occur that would consume available capital resources significantly sooner than we expect. We may be unable to raise sufficient additional capital. In
difficult economic periods the ability of biotechnology companies to raise capital is severely limited, particularly companies such as Maxygen without human therapeutic products in late clinical development. If we fail to raise sufficient funds, we
may need to curtail or cease operations. We anticipate that existing cash and cash equivalents and income earned thereon, together with anticipated revenues from collaborations, joint ventures and grants, will enable us to maintain our currently
planned operations for at least the next twelve months. If our capital resources are insufficient to meet future capital requirements, we will have to raise additional funds to continue the development of our technologies and complete the
commercialization of products, if any, resulting from our technologies. If adequate funds are not available, we will not be able to successfully execute our business plan.



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The Operation of International Locations May Increase Operating Expenses and Divert Management Attention.



We conduct certain of our operations through a Danish subsidiary, Maxygen
ApS. Operation as an international entity requires additional management attention and resources. We have limited experience in operating internationally and in conforming our operations to local cultures, standards and policies. The costs of
operating internationally are expected to continue to exceed our international revenues for at least the next several years. As we continue to operate internationally, we are subject to risks of doing business internationally, including the
following:



| |  |  | regulatory requirements that may limit or prevent the offering of our products in local jurisdictions;
| | - |  | ------------------------------------------------------------------------------------------------------



| |  |  | local legal and governmental limitations on company-wide employee benefit practices, such as the operation of our employee stock option plan in local jurisdictions;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | government limitations on research and/or research involving genetically engineered products or processes;
| | - |  | ----------------------------------------------------------------------------------------------------------



| |  |  | difficulties in staffing and managing foreign operations;
| | - |  | ---------------------------------------------------------



| |  |  | currency exchange risks; and
| | - |  | ----------------------------



| |  |  | potentially adverse tax consequences.
| | - |  | -------------------------------------



The Manufacturing of our Products Candidates Present Technological, Logistical and Regulatory Risks, Each of Which May Adversely Affect our Potential Revenues.



The manufacturing and manufacturing development of pharmaceuticals, and,
in particular, biologicals, are technologically and logistically complex and heavily regulated by the FDA and other governmental authorities. The manufacturing and manufacturing development of our products and product candidates present many risks,
including, but not limited to, the following:



| |  |  | before we can obtain approval of any of our products or product candidates for the treatment of a particular disease, we must demonstrate to the satisfaction of the FDA and other
governmental authorities that the drug manufactured for the clinical trials is comparable to the drug manufactured for commercial use and that the manufacturing facility complies with applicable laws and regulations;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | it may not be technically feasible to scale-up an existing manufacturing process to meet demand or such scale-up may take longer than anticipated; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | failure to comply with strictly enforced good manufacturing practices regulations and similar foreign standards may result in delays in product approval or withdrawal of an approved
product from the market.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Any of these factors could delay
clinical trials, regulatory submissions and/or commercialization of our products, entail higher costs and result in our being unable to effectively sell our products.



Our Manufacturing Strategy, Which Relies on Third-Party Manufacturers, Exposes us to Additional Risks as a Result of Which We May Lose
Potential Revenues.



We do not currently have the resources, facilities or
experience to manufacture any product candidates or potential products ourselves. Completion of our clinical trials and commercialization of our products will require access to, or development of, manufacturing facilities that meet FDA standards to
manufacture a sufficient supply of our potential products. We currently depend on third parties for the scale-up and manufacture of our product candidates for preclinical and clinical purposes. If our third party manufacturers are unable to
manufacture preclinical or clinical supplies in a timely manner or are unable or unwilling to satisfy our needs or FDA requirements, it could delay clinical trials, regulatory submissions or commercialization of our potential products, entail higher
costs and result in our being unable to sell our products. In addition, technical problems or other manufacturing delays could delay the advancement of potential products into preclinical or clinical trials or result in the termination of
development of particular product candidates, adversely affecting our product development timetable, which in turn could adversely affect our stock price.



Substantial Sales of Shares May Adversely Impact the Market Price of our Common Stock.



If our stockholders sell substantial amounts of our common stock, including shares issued upon the exercise of outstanding options, the
market price of our common stock may decline. Our common stock trading volume is low



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and thus the market price of our common stock is particularly sensitive to trading volume. Our low trading volume may
also make it more difficult for us to sell equity or equity related securities in the future at a time and price that we deem appropriate. Significant sales of our common stock may adversely impact the then-prevailing market price of our common
stock.



Many Potential Competitors Who Have Greater Resources and Experience
Than We Do May Develop Products and Technologies That Make Ours Obsolete.



The biotechnology industry is characterized by rapid technological change, and the area of gene research is a rapidly evolving field. Our future success will depend on our ability to maintain a competitive position with respect to
technological advances. Rapid technological development by others may result in our products and technologies becoming obsolete.



We face, and will continue to face, intense competition from organizations such as large and small biotechnology companies, as well as academic and research institutions
and government agencies that are pursuing competing technologies for modifying DNA and proteins. These organizations may develop technologies that are alternatives to our technologies. Further, our competitors in the protein optimization field may
be more effective at implementing their technologies to develop commercial products. Some of these competitors have entered into collaborations with leading companies within our target markets to produce commercial products.



Any products that we develop through our technologies will compete in multiple, highly
competitive markets. Most of the organizations competing with us in the markets for such products have greater capital resources, research and development and marketing staffs and facilities and capabilities, and greater experience in modifying DNA
and proteins, obtaining regulatory approvals, manufacturing products and marketing.



Accordingly, our competitors may be able to develop technologies and products more easily, which would render our technologies and products and those of our collaborators obsolete and noncompetitive.



Since Our Voting Control of Codexis Has Recently Fallen Below 50%, We No Longer
Consolidate Codexis, Which Will Significantly Reduce Our Revenue and Could Reduce our Stock Price.



Our voting rights in Codexis have been reduced below 50%. As a result, as of February 28, 2005 (the date upon which such rights fell below 50%), we no longer consolidate the financial results of Codexis with the
financial results of Maxygen. This has resulted in a significant reduction in the revenue (and expenses) of Maxygen in its consolidated financial statements. This reduction in revenue could lead to a reduction in the share price of our stock.



Any Inability to Adequately Protect Our Proprietary Technologies Could Harm
Our Competitive Position.



Our success will depend in part on our ability
to obtain patents and maintain adequate protection of our intellectual property for our technologies and products in the U.S. and other countries. If we do not adequately protect our intellectual property, competitors may be able to practice our
technologies and erode our competitive advantage. The laws of some foreign countries do not protect proprietary rights to the same extent as the laws of the U.S., and many companies have encountered significant problems in protecting their
proprietary rights in these foreign countries. These problems can be caused by, for example, a lack of rules and processes allowing for meaningfully defending intellectual property rights.



We will be able to protect our proprietary rights from unauthorized use by third parties only
to the extent that our proprietary technologies are covered by valid and enforceable patents or are effectively maintained as trade secrets. The patent positions of biopharmaceutical and biotechnology companies, including our patent positions, are
often uncertain and involve complex legal and factual questions. We apply for patents covering our technologies and potential products as we deem appropriate. However, we may not obtain patents on all inventions for which we seek patents, and any
patents we obtain may be challenged and may be narrowed in scope or extinguished as a result of such challenges. Our existing patents and any future patents we obtain may not be sufficiently broad to prevent others from practicing our technologies
or from developing competing products. Enforcement of our patents against infringers could require us to expend significant amounts with no assurance that we would be successful in any litigation. Others may independently develop similar or
alternative technologies or design around our patented technologies or products. In addition, others may challenge or invalidate our patents, or our patents may fail to provide us with any competitive advantages.



In July 2005, our European Patent 0752008, covering our first generation directed molecular
evolution technologies, was the subject of an opposition proceeding before the European Patent Office. Despite arguments raised by four



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opponents to the patent, all claims of the patent were upheld as valid with minor amendments. In October 2005, the
Australian Patent Office found, in an opposition proceeding regarding our Australian patent application No. 703264 that corresponds to European Patent 0752008, 89 of our claims to be patentable as presented.



We rely upon trade secret protection for our confidential and proprietary information. We
have taken security measures to protect our proprietary information. These measures may not provide adequate protection for our trade secrets or other proprietary information. We seek to protect our proprietary information by entering into
confidentiality agreements with employees, collaborators and consultants. Nevertheless, employees, collaborators or consultants may still disclose or misuse our proprietary information, and we may not be able to meaningfully protect our trade
secrets. In addition, others may independently develop substantially equivalent proprietary information or techniques or otherwise gain access to our trade secrets.



Our Potential Therapeutic Products Are Subject to a Lengthy and Uncertain Regulatory Process. If Our Potential Products Are Not Approved,
We Will Not Be Able to Commercialize Those Products.



The Food and Drug
Administration must approve any vaccine or therapeutic product before it can be marketed in the U.S. Before we can file a new drug application or biologic license application with the FDA, the product candidate must undergo extensive testing,
including animal and human clinical trials, which can take many years and require substantial expenditures. Data obtained from such testing are susceptible to varying interpretations that could delay, limit or prevent regulatory approval. In
addition, changes in regulatory policy for product approval during the period of product development and regulatory agency review of each submitted new application or product license application may cause delays or rejections. The regulatory process
is expensive and time consuming. The regulatory agencies of foreign governments must also approve our therapeutic products before the products can be sold in those other countries.



Because our potential products involve the application of new technologies and may be based upon new therapeutic approaches, they may be
subject to substantial review by government regulatory authorities and government regulatory authorities may grant regulatory approvals more slowly for our products than for products using more conventional technologies. We have not submitted an
application to the FDA or any other regulatory authority for any product candidate, and neither the FDA nor any other regulatory authority has approved any therapeutic product candidate developed with our MolecularBreeding directed evolution
platform for commercialization in the U.S. or elsewhere. We may not be able to, or our collaborators may not be able to, conduct clinical testing or obtain the necessary approvals from the FDA or other regulatory authorities for our products.



Even if we receive regulatory approval, this approval may entail limitations
on the indicated uses for which we can market a product. Further, once regulatory approval is obtained, a marketed product and its manufacturer are subject to continual review, and discovery of previously unknown problems with a product or
manufacturer may result in restrictions on the product, manufacturer or manufacturing facility, including withdrawal of the product from the market. In certain countries, regulatory agencies also set or approve prices.



If Approval of Our Potential Products Is Delayed or Our Potential Products Do Not Perform
as Expected, Our Stock Price and Ability to Raise Capital Will be Reduced.



The development and regulatory process for human therapeutic products is long and uncertain. Most product candidates fail before entering clinical trials and most clinical trials do not result in a marketed product. In addition, due to the
nature of human therapeutic research and development, the expected timing of product development and initiation of clinical trials and the results of such development and clinical trials are uncertain and subject to change at any point. This
uncertainty may result in research delays; product candidate failures and clinical trial delays and failures. Such delays and failures could drastically reduce the price of our stock and our ability to raise capital. Without sufficient capital, we
would need to reduce operations and could be forced to cease operations.



Preclinical Development is a Long, Expensive and Uncertain Process, and We May Terminate One or More of our Current Preclinical Development Programs.



We may determine that certain preclinical product candidates or programs do not have sufficient potential to warrant further funding.
Accordingly, we may elect to terminate our programs for such product candidates or programs at any time. If we terminate a preclinical program in which we have invested significant resources, our financial condition and results of operations may be
adversely affected, as we will have expended resources on a program that will not provide a return on our investment and we will have missed the opportunity to have allocated those resources to potentially more productive uses. Termination of such
programs could cause the price of our stock to drop drastically.



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Commercialization of Our Technologies Depends on Collaborations With Other Companies. If We Are Unable to Find
Collaborators in the Future, We May Not Be Able to Develop Our Technologies or Products.



Since we do not currently possess the resources necessary to develop and commercialize potential products that may result from our technologies, or the resources to complete any approval processes that may be required
for these potential products, we must enter into collaborative arrangements, including joint ventures, to develop and commercialize potential products. We have entered into collaborative agreements and joint ventures with other companies to fund the
development of new products for specific purposes. We have also entered into agreements to manufacture certain of our product candidates for use in clinical trials. These contracts expire after a fixed period of time. If they are not renewed or if
we do not enter into new collaborative agreements or joint ventures, our revenues will be reduced and our potential products may not be commercialized.



We have limited or no control over the resources that any collaborator may devote to our potential products. Any of our present or future collaborators may not perform
their obligations as expected. These collaborators may breach or terminate their agreement with us or otherwise fail to conduct their collaborative activities successfully and in a timely manner. Further, our collaborators may elect not to develop
potential products arising out of our collaborative arrangements or devote sufficient resources to the development, manufacture, marketing or sale of these products. If any of these events occur, we may not be able to develop our technologies or
commercialize our potential products.



Our Stock Price Has Been, and May
Continue to Be, Extremely Volatile, and an Investment in Our Stock Could Decline in Value.



The trading prices of life science company stocks in general, and ours in particular, have experienced significant price fluctuations in the last several years. During the twelve-month period ended September 30,
2005, the price of our common stock on the Nasdaq National Market ranged from $6.49 to $12.79. The valuations of many life science companies without product revenues and earnings, including ours, are high based on valuation standards such as price
to sales ratios and progress in product development and/or clinical trials. Trading prices based on these valuations may not be sustained. Any negative change in the publics perception of the prospects of biotechnology or life science
companies could depress our stock price regardless of our results of operations. Other broad market and industry factors may decrease the trading price of our common stock, regardless of our performance. In addition, our stock price could be subject
to wide fluctuations in response to factors including the following:



| |  |  | our failure to meet our publicly announce revenue and/or expense projections and/or product development timetables;
| | - |  | -------------------------------------------------------------------------------------------------------------------



| |  |  | adverse results or delays in preclinical development or clinical trials;
| | - |  | ------------------------------------------------------------------------



| |  |  | any decisions to discontinue or delay development programs or clinical trials;
| | - |  | ------------------------------------------------------------------------------



| |  |  | announcements of new technological innovations or new products by us or our competitors;
| | - |  | ----------------------------------------------------------------------------------------



| |  |  | conditions or trends in the biotechnology and life science industries;
| | - |  | ----------------------------------------------------------------------



| |  |  | changes in the market valuations of other biotechnology or life science companies;
| | - |  | ----------------------------------------------------------------------------------



| |  |  | developments in domestic and international governmental policy or regulations;
| | - |  | ------------------------------------------------------------------------------



| |  |  | announcements by us or our competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------



| |  |  | developments in or challenges relating to patent or other proprietary rights; and
| | - |  | ---------------------------------------------------------------------------------



| |  |  | sales of our common stock or other securities in the open market.
| | - |  | -----------------------------------------------------------------



In the past, stockholders have often instituted securities class action litigation after periods of volatility in the market price of a companys securities. If a
stockholder files a securities class action suit against us, we would incur substantial legal fees and our managements attention and resources would be diverted from operating our business to respond to the litigation.



Some of Our Existing Stockholders Can Exert Control Over Us, and May Not Make Decisions
that Are in the Best Interests of All Stockholders.



As of
September 30, 2005, our executive officers, directors and principal stockholders together controlled approximately 28% of our outstanding common stock, including GlaxoSmithKline plc, which owned approximately 18% of our outstanding common
stock. As a result, these stockholders, if they act together, and GlaxoSmithKline plc by itself, could exert a significant degree of influence over our management and affairs and over matters requiring stockholder approval, including the election of
directors and approval of significant corporate transactions. In addition, this concentration of ownership may delay or prevent a change in control of Maxygen and might affect the market price of our common stock, even when a change may be in the
best interests of all stockholders. In



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addition, the interests of this concentration of ownership may not always coincide with our interests or the interests of
other stockholders and accordingly, they could cause us to enter into transactions or agreements that we would not otherwise consider. This concentration of ownership could also depress our stock price.



ITEM 3

QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK



Market risk management



Our cash flow
and earnings are subject to fluctuations due to changes in foreign currency exchange rates, interest rates, the fair value of equity securities held and our stock price. We attempt to limit our exposure to some or all of these market risks through
the use of various financial instruments. There were no significant changes in our market risk exposures during the nine months ended September 30, 2005. These activities are discussed in further detail in Part II, Item 7A,
Quantitative and Qualitative Disclosures About Market Risk of our Annual Report on Form 10-K for the year ended December 31, 2004.



ITEM 4

CONTROLS AND PROCEDURES



Company management is required to perform two evaluations each quarter in
connection with its disclosure controls and procedures (Disclosure Controls) and its internal control over financial reporting (Internal Control). This Controls and Procedures section describes those evaluations, their
limitations and the conclusions of Company management based on such evaluations.



Controls Evaluations. Company management, with the participation of our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), has (i) evaluated the effectiveness of our Disclosure Controls as
of September 30, 2005, and (ii) evaluated whether any change in Internal Control that occurred in the most recently completed fiscal quarter has materially affected, or is reasonably likely to materially affect, our Internal Control.



CEO and CFO Certifications. Appearing as Exhibits 31.1 and 31.2 of this
report are the certifications of our CEO and CFO that are required in accordance with Rule 13a-14 of the Exchange Act. This Controls and Procedures section includes the information concerning the controls evaluation referred to in the certifications
and it should be read in conjunction with the certifications for a more complete understanding of the topics presented.



Definition of Disclosure Controls. Disclosure Controls are controls and procedures designed to ensure that information required to be disclosed in our reports
filed under the Exchange Act, such as this report, is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms. Disclosure Controls are also designed to ensure that such information is
accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.



Definition of Internal Control. Internal Control consists of the control processes designed with the objective of providing reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles (GAAP) and includes those policies and procedures that (1) pertain to
the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets, (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial
statements in accordance with GAAP, and that receipts and expenditures are being made only in accordance with authorizations of management and directors and (3) provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements.



Limitations on the Effectiveness of Controls.Our management, including our CEO and CFO, does not expect that our Disclosure Controls and Internal Control will
prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system will be met. Further, the design of a control system must
reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, within Maxygen have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake.
Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls also is based in part upon certain assumptions
about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or
deterioration in the degree of compliance with the policies or procedures.



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Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and
not be detected.



Scope of the Controls Evaluation.The CEO/CFO
evaluation of our Disclosure Controls included a review of the controls objectives and design, the controls implementation by Maxygen and the effect of the controls on the information generated for use in this report. In the course of
the controls evaluation, we sought to identify errors, controls problems or acts of fraud. Elements of our controls are also evaluated on an ongoing basis by personnel in our Finance department. The overall goals of these various evaluation
activities are to monitor our Disclosure Controls and to make modifications as necessary. Our intent in this regard is that the Disclosure Controls will be maintained as dynamic systems that change (including with improvements and corrections) as
conditions warrant.



Among other matters, we sought in our evaluation to
determine whether there were any significant deficiencies or material weaknesses in our Internal Control, or whether we had identified any acts of fraud involving personnel who have a significant role in our Internal Control. This information was
important both for the controls evaluation generally and because item 5 in the certifications of our CEO and CFO require that the CEO and CFO disclose that information to our Audit Committee and to our independent registered public accounting firm.



Quarterly Reports



Quarterly Evaluation of Disclosure Controls.Based upon the controls evaluation, our
CEO and CFO have concluded that our Disclosure Controls were effective as of September 30, 2005 to ensure that material information relating to Maxygen and its consolidated subsidiaries is made known to management, including the CEO and CFO,
particularly during the period when our periodic reports are being prepared.



Quarterly Evaluation of Changes in Internal Control. During the most recently completed fiscal quarter there have been no significant changes in our Internal Control that has materially affected, or is reasonably likely to materially
affect, our Internal Control.



PART II  OTHER INFORMATION



ITEM 1

Legal Proceedings



In December 2001 a lawsuit was filed in the U.S. District Court for the Southern District of
New York against Maxygen, Inc., its chief executive officer, Russell Howard and its then chief financial officer, Simba Gill, together with certain underwriters of Maxygens initial public offering and secondary public offering of common stock.
The complaint, which alleges claims under Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934, is among the so-called laddering cases that have been commenced against
over 300 companies that had public offerings of securities in 1999 and 2000. The complaint has been consolidated with other laddering claims in a proceeding styled In re Initial Public Offering Securities Litigation, No. 21 MC 92 (SAS),
pending before the Honorable Shira A. Scheindlin. In February 2003, the court dismissed the Section 10(b) claim against Drs. Howard and Gill; the remainder of the case remains pending.



In June 2003 the Company agreed to the terms of a tentative settlement agreement along with
other defendant issuers in In re Initial Public Offering Securities Litigation. The tentative settlement provides that the insurers of the 309 defendant issuers will pay to the plaintiffs $1 billion less any recovery of damages the plaintiffs
receive from the defendant underwriters. If the plaintiffs receive over $5 billion in damages from the defendant underwriters, we will be entitled to reimbursement of various expenses incurred by us as a result of the litigation. As part of the
tentative settlement, the Company will assign to the plaintiffs excess compensation claims and certain other of its claims against the defendant underwriters based on the alleged actions of the defendant underwriters. The settlement is
subject to acceptance by a substantial majority of defendants and execution of a definitive settlement agreement. The settlement is also subject to approval of the Court, which cannot be assured. On February 15, 2005 the Court tentatively
approved the proposed settlement, conditioned upon the parties altering the proposed settlement to comply with the Private Securities Litigation Reform Acts settlement discharge provision. The settlement does not contemplate any settlement
payments by Maxygen.



If the settlement is not accepted by the requisite number
of defendants or if it is not approved by the Court, the Company intends to defend the lawsuit vigorously. The Company believes the lawsuit against Maxygen and its officers is without merit. However, the litigation is in the preliminary stage, and
the Company cannot predict its outcome. The litigation process is inherently uncertain. If the outcome of the litigation is adverse to the Company and if the Company is required to pay significant damages, the Companys business would be
significantly harmed.



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The Company is not currently a party to any other material pending legal proceedings.



From time to time, the Company becomes involved in claims and legal proceedings that arise in
the ordinary course of its business. The Company does not believe that the resolution of these claims will have a material adverse effect on its financial statements.



ITEM 2

UNREGISTERED SALES OF
EQUITY SECURITIES AND USE OF PROCEEDS



Not applicable.



ITEM3

DEFAULTS UPON SENIOR
SECURITIES



Not applicable.



ITEM 4

SUBMISSION OF MATTERS
TO A VOTE OF SECURITY HOLDERS



Not applicable.



ITEM 5

OTHER INFORMATION



Pre-Approval of Audit and Non-Audit Services



During the three month period ended September 30, 2005, the Audit Committee of the
Board of Directors approved the following services to be performed by Ernst & Young LLP: (i) audit consultations regarding 2005 audit planning, (ii) audit-related renewal of an online accounting information service,
(iii) audit-related consultations regarding 2005 internal controls compliance planning and (iv) audit-related consultations regarding accounting for a potential strategic transaction.



The Audit Committee has determined that the rendering of the audit and audit-related services
described above by Ernst & Young LLP is compatible with maintaining the independence of the registered public accounting firm.



ITEM 6

EXHIBITS



The following exhibits are filed as part of this report:



|     |  |                                                                                                                               
|---- |  | ------------------------------------------------------------------------------------------------------------------------------
|31.1 |  | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                            
|     | 
|31.2 |  | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                            
|     | 
|32.1 |  | Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002



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SIGNATURES



Pursuant to the
requirements 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.



|                 |  |               |  |                        
|---------------- |  | ------------- |  | -----------------------
|                 |  | MAXYGEN, INC.
|                 |  |              
|November 4, 2005 |  | By:           |  | /s/ Russell J. Howard  
|                 |  |               |  | Russell J. Howard      
|                 |  |               |  | Chief Executive Officer
|                 |  |              
|November 4, 2005 |  | By:           |  | /s/ Lawrence W. Briscoe
|                 |  |               |  | Lawrence W. Briscoe    
|                 |  |               |  | Chief Financial Officer



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