**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

**(Mark one)**

 

**ý**   **QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thequarterly period ended September 30, 2004**

 

**OR**

** **

o   **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

** **

**For thetransition period from                 to                 ..**

 

Commission file number:**     000-24207**

 

**ABGENIX,INC.**

(Exact name of registrantas specified in its charter)

 
| **Delaware**                             | ** ** | **94-3248826**         |
|------------------------------------------|------------|------------------------|
| (State or other  jurisdiction of         |       | (IRS employer          |
| incorporation or  organization)          |       | Identification number) |
| ** **                               | ** ** | ** **             |
| **6701  Kaiser Drive, Fremont, CA**      | ** ** | **94555**              |
| (Address of principal  executive office) |       | (Zip Code)             |

 

**(510) 284-6500**

(Registrant’s telephonenumber, including area code)

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the precedingin 12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirements forthe past 90 days.  Yes ý  No o

 

Indicate by checkmark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Exchange Act. Yes ý  No o

 

As of October 29,2004 there were 89,072,158 shares of the Registrant’s Common Stock outstanding.

 

 

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**TABLE OFCONTENTS**

 
| **PART I. Financial  Information** | ** **                                                                                               |
|------------------------------------|----------------------------------------------------------------------------------------------------------|
|                               |                                                                                                     |   |   |
| ** **                         | **ITEM 1. Financial  Statements**                                                                        | ** ** |
| ** **                         | ** **                                                                                               | ** ** | ** ** |
|                               |                                                                                                     | Condensed  Consolidated Balance Sheets at September 30, 2004 and December 31, 2003 |   |
|                               |                                                                                                     | Condensed  Consolidated Statements of Operations for the three and nine months ended  September 30, 2004 and 2003 |   |
|                               |                                                                                                     | Condensed  Consolidated Statements of Cash Flows for the nine months ended September 30,  2004 and 2003 |   |
|                               |                                                                                                     | Notes  to Condensed Consolidated Financial Statements |   |
|                               |                                                                                                     |   |   |
|                               | **ITEM  2. Management’s Discussion and Analysis of Financial Condition and Results of  Operations** |   |
|                               | ** **                                                                                               |   |
| ** **                         | **ITEM  3. Quantitative and Qualitative Disclosures about Market Risk**                                  |   |
| ** **                         | ** **                                                                                               |   |
| ** **                         | **ITEM 4. Controls and  Procedures**                                                                     |   |
| ** **                         | ** **                                                                                               |   |
| **PART II. Other Information**     | ** **                                                                                               |
| ** **                         | ** **                                                                                               |
| ** **                         | **ITEM 1. Legal Proceedings**                                                                            |   |
| ** **                         | ** **                                                                                               |   |
| ** **                         | **ITEM  2. Unregistered Sales of Equity Securities and Use of Proceeds**                                 |   |
| ** **                         | ** **                                                                                               |   |
| ** **                         | **ITEM 3.  Defaults upon Senior Securities**                                                             |   |
| ** **                         | ** **                                                                                               |   |
| ** **                         | **ITEM  4. Submission of Matters to a Vote of Security Holders**                                         |   |
| ** **                         | ** **                                                                                               |   |
| ** **                         | **ITEM 5. Other Information**                                                                            |   |
| ** **                         | ** **                                                                                               |   |
| ** **                         | **ITEM 6. Exhibits**                                                                                     |   |
| ** **                         | ** **                                                                                               |   |
| **SIGNATURES**                     |                                                                                                     |
| ** **                         |                                                                                                     |
| **CERTIFICATIONS**                 |                                                                                                     |
|                                    |                                                                                                          |  |  |  |

 

2

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**PART I.  FINANCIAL INFORMATION**

 

**ITEM 1.  Financial Statements**

 

**ABGENIX, INC.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

(in thousands, exceptshare and per share data)

(unaudited)

 
| ** **                                                                                                                                                                                             | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| **ASSETS**                                                                                                                                                                                             |       |                    |       |                   |       |
| Current assets:                                                                                                                                                                                        |       |                    |       |                   |       |
| Cash and cash  equivalents                                                                                                                                                                             |       | $                       | 14,963     |                   | $          | 19,141 |   |
| Marketable  securities                                                                                                                                                                                 |       | 215,705                 |       | 328,622                |       |
| Interest  receivable                                                                                                                                                                                   |       | 1,436                   |       | 3,096                  |       |
| Accounts  receivable, net                                                                                                                                                                              |       | 835                     |       | 2,174                  |       |
| Inventories                                                                                                                                                                                            |       | 370                     |       | —                 |       |
| Prepaid expenses  and other current assets                                                                                                                                                             |       | 11,144                  |       | 12,546                 |       |
| Total current  assets                                                                                                                                                                                  |       | 244,453                 |       | 365,579                |       |
| Property and  equipment, net                                                                                                                                                                           |       | 229,914                 |       | 246,277                |       |
| Long-term  investments                                                                                                                                                                                 |       | 16,524                  |       | 20,695                 |       |
| Goodwill                                                                                                                                                                                               |       | 34,780                  |       | 34,780                 |       |
| Identified  intangible assets, net                                                                                                                                                                     |       | 61,451                  |       | 83,716                 |       |
| Deposits and  other assets                                                                                                                                                                             |       | 28,268                  |       | 29,146                 |       |
|                                                                                                                                                                                                   |       | $                       | 615,390    |                   | $          | 780,193 |   |
|                                                                                                                                                                                                   |       |                    |       |                   |       |
| **LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED  STOCK AND STOCKHOLDERS’ EQUITY**                                                                                                                 |       |                    |       |                   |       |
|                                                                                                                                                                                                   |       |                    |       |                   |       |
| Current  liabilities:                                                                                                                                                                                  |       |                    |       |                   |       |
| Accounts payable                                                                                                                                                                                       |       | $                       | 10,994     |                   | $          | 11,584 |   |
| Deferred revenue                                                                                                                                                                                       |       | 7,662                   |       | 10,919                 |       |
| Accrued  liabilities                                                                                                                                                                                   |       | 17,013                  |       | 13,974                 |       |
| Contract  cancellation obligation                                                                                                                                                                      |       | —                  |       | 22,749                 |       |
| Accrued interest  payable                                                                                                                                                                              |       | 311                     |       | 2,061                  |       |
| Total current  liabilities                                                                                                                                                                             |       | 35,980                  |       | 61,287                 |       |
| Deferred rent                                                                                                                                                                                          |       | 7,203                   |       | 6,153                  |       |
| Convertible  subordinated notes                                                                                                                                                                        |       | 249,876                 |       | 200,000                |       |
| Other long-term  liabilities                                                                                                                                                                           |       | 6,370                   |       | —                 |       |
| Redeemable  convertible preferred stock, $0.0001 par value; 5,000,000 shares authorized                                                                                                                |       |                    |       |                   |       |
| Series A-1  50,000 shares issued and outstanding at September 30, 2004 and December 31,  2003, respectively; liquidation preference $50,000 at September 30, 2004 and  December 31, 2003, respectively |       | 49,869                  |       | 49,869                 |       |
| Series A-2  50,000 shares issued and outstanding at December 31, 2003; liquidation  preference $50,000 at December 31, 2003; no shares outstanding at September  30, 2004                              |       | —                  |       | 49,868                 |       |
| Commitments                                                                                                                                                                                            |       |                    |       |                   |       |
| Stockholders’  equity:                                                                                                                                                                            |       |                    |       |                   |       |
| Common stock,  $0.0001 par value; 220,000,000 shares authorized; 88,858,422 and 88,262,457  shares issued and outstanding at September 30, 2004 and December 31, 2003,  respectively                   |       | 9                       |       | 9                      |       |
| Additional  paid-in capital                                                                                                                                                                            |       | 972,240                 |       | 968,922                |       |
| Accumulated  other comprehensive income                                                                                                                                                                |       | 3,228                   |       | 8,861                  |       |
| Accumulated  deficit                                                                                                                                                                                   |       | (709,385                | )          | (564,776               | )          |
| Total  stockholders’ equity                                                                                                                                                                       |       | 266,092                 |       | 413,016                |       |
|                                                                                                                                                                                                   |       | $                       | 615,390    |                   | $          | 780,193 |   |

 

See accompanying notes

 

3

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**ABGENIX, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

(in thousands, except pershare data)

(unaudited)

 
| ** **                                                                         | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                         | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenues:                                                                          |       |                                  |       |                                 |       |   |   |   |   |
| Contract revenue                                                                   |       | $                                     | 3,434      |                                 | $          | 1,957 |   | $ | 10,513 |   | $ | 10,463 |   |
| Contract  manufacturing revenue                                                    |       | —                                |       | —                               |       | 1,325 |   | — |   |
| Total revenue                                                                      |       | 3,434                                 |       | 1,957                                |       | 11,838 |   | 10,463 |   |
| Operating  expenses:                                                               |       |                                  |       |                                 |       |   |   |   |   |
| Cost of goods  manufactured                                                        |       | —                                |       | —                               |       | 1,857 |   | — |   |
| Research and  development                                                          |       | 29,978                                |       | 26,008                               |       | 94,583 |   | 66,500 |   |
| Manufacturing  start-up costs                                                      |       | 6,351                                 |       | 10,282                               |       | 16,487 |   | 63,127 |   |
| Amortization of  identified intangible assets, related to research and development |       | 1,441                                 |       | 1,792                                |       | 5,024 |   | 5,398 |   |
| General and  administrative                                                        |       | 7,673                                 |       | 7,828                                |       | 21,038 |   | 21,182 |   |
| Impairment of  intangible assets                                                   |       | —                                |       | —                               |       | 17,241 |   | 1,443 |   |
| Total operating  expenses                                                          |       | 45,443                                |       | 45,910                               |       | 156,230 |   | 157,650 |   |
| Loss from  operations                                                              |       | (42,009                               | )          | (43,953                              | )          | (144,392 | ) | (147,187 | ) |
| Other income  (expense):                                                           |       |                                  |       |                                 |       |   |   |   |   |
| Interest and  other income                                                         |       | 1,347                                 |       | 2,036                                |       | 4,831 |   | 8,010 |   |
| Interest expense                                                                   |       | (1,758                                | )          | (1,652                               | )          | (5,048 | ) | (4,133 | ) |
| Total other  income (expense)                                                      |       | (411                                  | )          | 384                                  |       | (217 | ) | 3,877 |   |
|                                                                               |       |                                  |       |                                 |       |   |   |   |   |
| Loss before  income tax expense                                                    |       | (42,420                               | )          | (43,569                              | )          | (144,609 | ) | (143,310 | ) |
| Foreign income  tax expense                                                        |       | —                                |       | —                               |       | — |   | 84 |   |
| Net loss                                                                           |       | $                                     | (42,420    | )                                    | $          | (43,569 | ) | $ | (144,609 | ) | $ | (143,394 | ) |
|                                                                               |       |                                  |       |                                 |       |   |   |   |   |
| Basic and  diluted net loss per share                                              |       | $                                     | (0.48      | )                                    | $          | (0.50 | ) | $ | (1.63 | ) | $ | (1.63 | ) |
|                                                                               |       |                                  |       |                                 |       |   |   |   |   |
| Shares used in  computing basic and diluted net loss per share                     |       | 88,845                                |       | 87,962                               |       | 88,609 |   | 87,865 |   |

 

See accompanying notes

 

4

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**ABGENIX, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

(in thousands)

(unaudited)

 
| ** **                                                                   | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                   | ** ** | **2004**                            | ** ** | **2003** | ** ** |
| **Operating  activities**                                                    |       |                                |       |   |   |
| Net loss                                                                     |       | $                                   | (144,609   | ) | $ | (143,394 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |                                |       |   |   |
| Depreciation                                                                 |       | 22,961                              |       | 20,489 |   |
| Amortization of  identified intangible assets                                |       | 5,024                               |       | 5,398 |   |
| Impairment of  identified intangible assets                                  |       | 17,241                              |       | 1,443 |   |
| Amortization of  debt issuance costs                                         |       | 943                                 |       | 896 |   |
| Loss on sale and  disposal of equipment                                      |       | 57                                  |       | 29 |   |
| Changes for  certain assets and liabilities:                                 |       |                                |       |   |   |
| Interest  receivable                                                         |       | 1,660                               |       | (132 | ) |
| Accounts  receivable                                                         |       | 1,339                               |       | 1,499 |   |
| Inventories                                                                  |       | (370                                | )          | — |   |
| Prepaid expenses  and other current assets                                   |       | 1,402                               |       | (5,854 | ) |
| Deposits and  other assets                                                   |       | (74                                 | )          | 1,358 |   |
| Accounts payable                                                             |       | (590                                | )          | (15,167 | ) |
| Deferred revenue                                                             |       | (3,257                              | )          | 3,827 |   |
| Accrued  liabilities                                                         |       | 3,266                               |       | 7,832 |   |
| Contract  cancellation obligation                                            |       | (22,749                             | )          | 21,191 |   |
| Accrued interest  payable                                                    |       | (1,750                              | )          | (1,765 | ) |
| Deferred rent                                                                |       | 1,050                               |       | 1,297 |   |
| Other long-term  liabilities                                                 |       | 6,370                               |       | — |   |
| Net cash used in  operating activities                                       |       | (112,086                            | )          | (101,053 | ) |
|                                                                         |       |                                |       |   |   |
| **Investing  activities**                                                    |       |                                |       |   |   |
| Purchases of  marketable securities                                          |       | (200,955                            | )          | (255,087 | ) |
| Maturities of  marketable securities                                         |       | 46,719                              |       | 40,533 |   |
| Sales of  marketable securities                                              |       | 265,708                             |       | 153,361 |   |
| Purchases of  property and equipment                                         |       | (6,885                              | )          | (27,636 | ) |
| Sale of  equipment                                                           |       | 3                                   |       | 11 |   |
| Net cash  provided by (used in) investing activities                         |       | 104,590                             |       | (88,818 | ) |
|                                                                         |       |                                |       |   |   |
| **Financing  activities**                                                    |       |                                |       |   |   |
| Net proceeds  from issuances of common stock                                 |       | 3,318                               |       | 1,728 |   |
| Net cash  provided by financing activities                                   |       | 3,318                               |       | 1,728 |   |
| Net decrease in  cash and cash equivalents                                   |       | (4,178                              | )          | (188,143 | ) |
| Cash and cash  equivalents at beginning of period                            |       | 19,141                              |       | 207,974 |   |
| Cash and cash  equivalents at end of period                                  |       | $                                   | 14,963     |   | $ | 19,831 |   |

 

See accompanying notes

 

5

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**ABGENIX, INC.**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**September30, 2004**

**(unaudited)**

 

**1.****             Basis ofPresentation and Summary of Significant Accounting Policies**

 

**Basis of Presentation -**Theunaudited condensed consolidated financial statements of Abgenix, Inc. (the “Company”or “Abgenix”) included herein have been prepared pursuant to the rules and regulationsof the Securities and Exchange Commission. Certain information or footnote disclosure normally included in annualfinancial statements prepared in accordance with generally accepted accountingprinciples has been condensed or omitted pursuant to such rules andregulations.  In the opinion of theCompany, the accompanying unaudited condensed consolidated financial statementscontain all adjustments, consisting only of normal recurring adjustments,necessary to present fairly the financial information included therein.  These financial statements should be read inconjunction with the audited financial statements for the year ended December31, 2003****and accompanying notesincluded in the Company’s annual report as filed on Form 10-K with theSecurities and Exchange Commission.  Theresults of operations for the three months and nine months ended September 30,2004 are not necessarily indicative of the results to be expected for the fullyear or for any other future period.

 

**ForeignExchange –**Accounts denominated in foreign currency have beenremeasured using the U.S. dollar as the functional currency.  The aggregate exchange gain/loss included indetermining net loss was an exchange loss of $304,000 and $758,000,respectively, in the three and nine months ended September 30, 2004 compared toan exchange loss of $256,000 and $82,000, respectively, in the three and ninemonths ended September 30, 2003.

 

**Consolidation** - In January 2003, theFASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities”(the “Interpretation”).  TheInterpretation requires the consolidation of entities in which an enterpriseabsorbs a majority of the entity’s expected losses, receives a majority of theentity’s expected residual returns, or both, as a result of ownership,contractual or other financial interests in the entity.  The Interpretation was effective immediatelyfor variable interests created after January 31, 2003.  The Company adopted the remaining provisionof the Interpretation, pertaining to variable interests existing prior toJanuary 31, 2003, in the quarter ended March 31, 2004.  The adoption of the Interpretation did nothave a material impact on the results of operations and the financial positionof the Company.  Significant intercompany accountsand transactions have been eliminated.

** **

**Revenue Recognition** – The Company receivespayments from customers for license, option, service and milestone fees, aswell as for contract manufacturing the Company performs.  These payments, which are generallynon-refundable, are recognized as revenue or reported as deferred revenue untilthey meet the criteria for revenue recognition. The Company recognizes revenue when (1) persuasive evidence of thearrangement exists; (2) delivery has occurred or services have been rendered;(3) the price is fixed or determinable and (4) the collectibility is reasonablyassured, in accordance with Securities and Exchange Commission Staff AccountingBulletin No. 104, “Revenue Recognition”. In addition, the Company has followed the following principles inrecognizing revenue:

** **

**•**      Abgenix enters into revenue arrangements withmultiple deliverables in order to meet its customer’s needs.  For example, the arrangements may include acombination of up-front fees, license payments, joint development revenue,research services, milestone payments, future royalties and manufacturingarrangements.  Multiple element revenueagreements entered into on or July 1, 2003 are evaluated under Emerging IssuesTask Force No. 00-21, “Revenue Arrangements with Multiple Deliverables,” todetermine whether the delivered 

 

6

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**item has value to the customer on a stand-alonebasis and whether objective and reliable evidence of the fair value of theundelivered item exists.  Deliverables inan arrangement that do not meet the separation criteria in Issue 00-21 must betreated as one unit of accounting for purposes of revenue recognition.  Generally, the revenue recognition guidanceapplicable to the last deliverable is followed for the combined unit ofaccounting.  For certain arrangements,the period of time over which certain deliverables will be provided is notcontractually defined.  Accordingly,management is required to make estimates and assumptions that affect theamounts reported in the financial statements and accompanying notes.**

** **

**•**      Abgenix has joint development arrangementsunder which Abgenix and its collaborative partners share the costs ofdeveloping and commercializing antibody therapeutic product candidatesequally.  In periods where Abgenix incursmore costs under the arrangement than the collaborative partner, Abgenixrecords contract revenue for the services rendered.  In periods where the collaborative partnerincurs more costs under the arrangement than Abgenix, Abgenix records expensefor the services received.

** **

**•**      Research and product license fees aregenerally recognized only after both the license period has commenced and thetechnology has been delivered.

** **

**•**      Option fees for granting options to obtainproduct licenses to develop a product are recognized when the option isexercised or when the option period expires, whichever occurs first.

** **

**•**      Fees the Company receives for researchservices the Company performs under its technology out-licensing agreements aregenerally recognized ratably over the entire period the Company performs theseservices.  Research services includeprocess sciences services the Company performs under its production services agreements,such as cell line development.

** **

**•**      Incentive milestone payments are recognizedas revenue when the specified milestone is achieved.  Incentive milestone payments are triggeredeither by the results of the Company’s research efforts or by events externalto Abgenix, such as regulatory approval to market a product.  Incentive milestone payments aresubstantially at risk at the inception of the contract, and the values assignedthereto are commensurate with the type of milestone achieved.  The Company has no future performanceobligations related to an incentive milestone that has been achieved.

** **

**•**      Contract manufacturing fees the Companyreceives under its production services agreements are recognized when themanufacture of an antibody product candidate is complete, and the antibodyproduct candidate is released and delivered, as defined in the relevantagreement.

** **

**Stock-BasedCompensation -**The Company accounts for stock-based awards toemployees and directors using the intrinsic value method in accordance withAccounting Principles Board Opinion No. 25, “Accounting for Stock Issued toEmployees.” Accordingly, the Company does not recognize compensation expensefor employee stock options granted at fair market value. For purposes ofdisclosures pursuant to Statement of Financial Accounting Standards No. 123, “Accountingfor Stock-Based Compensation” (“SFAS 123”), as amended by SFAS 148, theestimated fair value of options is amortized to expense on a straight-linebasis over the options’ vesting period. The following table illustrates what thenet loss would have been had the Company accounted for its stock-based awardsunder the provisions of SFAS 123. Pro forma amounts may not berepresentative of future periods.

 

7

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| ** **                                                                                                                                                              | ** ** | **Three Months Ended  September 30,**        | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                                                                                              | ** ** | **2004**                                     | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                                                                                              | ** ** | **(in thousands, except per share amounts)** | ** ** |
| ** **                                                                                                                                                              | ** ** | ** **                                   | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net loss                                                                                                                                                                |       | $                                            | (42,420    | )                                    | $          | (43,569 | ) | $ | (144,609 | ) | $ | (143,394 | ) |
| Stock-based  employee compensation costs that would have been included in the  determination of net loss if the fair value based method had been applied to  all awards |       | (10,368                                      | )          | (15,058                              | )          | (34,778 | ) | (46,950 | ) |
| Pro forma net  loss as if the fair value based method had been applied to all awards                                                                                    |       | $                                            | (52,788    | )                                    | $          | (58,627 | ) | $ | (179,387 | ) | $ | (190,344 | ) |
|                                                                                                                                                                    |       |                                         |       |                                 |       |   |   |   |   |
| Basic and  diluted net loss per share as reported                                                                                                                       |       | $                                            | (0.48      | )                                    | $          | (0.50 | ) | $ | (1.63 | ) | $ | (1.63 | ) |
|                                                                                                                                                                    |       |                                         |       |                                 |       |   |   |   |   |
| Pro forma basic  and diluted loss per share                                                                                                                             |       | $                                            | (0.59      | )                                    | $          | (0.67 | ) | $ | (2.02 | ) | $ | (2.17 | ) |

 

The fair value forthese options was estimated at the date of grant using a Black-Scholes optionpricing model with the following weighted-average assumptions for the threemonths and nine months ended September 30, 2004 and 2003:

 
| ** **                                                           | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                           | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Risk-free  interest rate                                             |       | 3.59                                  | %          | 3.13                                 | %          | 3.39 | % | 2.98 | % |
| Dividend yield                                                       |       | 0.0                                   | %          | 0.0                                  | %          | 0.0 | % | 0.0 | % |
| Volatility  factors of the expected market price of our Common Stock |       | 0.90                                  |       | 0.96                                 |       | 0.90 |   | 1.01 |   |
| Weighted-average  expected life of option (years)                    |       | 5.71                                  |       | 5.55                                 |       | 5.63 |   | 5.53 |   |

 

These sameassumptions were applied in the determination of the option values related tostock options granted to non-employees, except the option life, for which theterm of the consulting contracts, 1 to 5 years, was used. The value hasbeen recorded in the financial statements.

 

**NetLoss Per Share -**Basic net loss per share is calculated basedon the weighted-average number of shares outstanding during the period. Theimpact of common stock options, warrants and shares issuable upon theconversion of convertible subordinated notes and the redeemable convertiblepreferred stock was excluded from the computation of diluted net loss pershare, as their effect is antidilutive for the periods presented.

 

**Reclassifications-**Certain prior period balances may have been reclassified toconform to the current period presentation.

 

**2.****             ComprehensiveIncome (Loss)**

 

Othercomprehensive income/(losses) consist of unrealized gains or losses onavailable-for-sale securities. The components of comprehensive loss, net oftax, were as follows (in thousands):

 

8

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| ** **                                       | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                       | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net loss                                         |       | $                                     | (42,420    | )                                    | $          | (43,569 | ) | $ | (144,609 | ) | $ | (143,394 | ) |
| Other  comprehensive income (loss):              |       |                                  |       |                                 |       |   |   |   |   |
| Unrealized  holding losses arising during period |       | (1,648                                | )          | (1,231                               | )          | (5,633 | ) | (303 | ) |
|                                             |       |                                  |       |                                 |       |   |   |   |   |
| Comprehensive  loss                              |       | $                                     | (44,068    | )                                    | $          | (44,800 | ) | $ | (150,242 | ) | $ | (143,697 | ) |

 

**3.**             Impairmentof Identified Intangible Assets and Balances

** **

**In thequarter ended June 30, 2004, management determined that an impairment of theCompany’s acquired technology in the field of catalytic antibodies had occurredand that the estimated value had declined to zero.  This technology, which includes intellectualproperty, was acquired in 2001 through the acquisition of Hesed Biomed,Inc.  The Company decided to focus itsresources on other research and development projects and decided to wind downits catalytic antibody program. Additionally, after assessing the associated patent position and thelikelihood of sale or license of the technology to a third party, managementfurther determined in the quarter ended June 30, 2004 that the possibility ofgenerating positive future cash flows from the technology was remote.  As a result of this determination, theCompany recorded an impairment charge of $17.2 million in the quarter endedJune 30, 2004.**

** **

**In thequarter ended March 31, 2003, the Company decided to discontinue thedevelopment of anti-properdin antibodies. As a result, the Company recorded an impairment charge of $1.4 millionfor previously capitalized costs related to licenses and research funding forthe development of therapeutic antibodies to the complement protein properdin,which the Company licensed from Gliatech, Inc. Such charge is included in the nine month period ended September 30,2003.**

** **

**Identifiedintangible assets consisted of the following (in thousands):**

** **
| ** **                                | ** ** | **Gross  Assets** | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** |
|-------------------------------------------|------------|-------------------|------------|-------------------------------|------------|---------|------------|
| **As of  September 30, 2004:**            |       |              |       |                          |       |    |       |
| Acquisition-related  developed technology |       | $                 | 85,143     |                          | $          | 24,847  |       | $ | 60,296 |   |
| Other intangible  assets                  |       | 1,442             |       | 287                           |       | 1,155   |       |
| Identified  intangible assets             |       | $                 | 86,585     |                          | $          | 25,134  |       | $ | 61,451 |   |
|                                      |       |              |       |                          |       |    |       |
| **As of  December 31, 2003:**             |       |              |       |                          |       |    |       |
| Acquisition-related  developed technology |       | $                 | 106,183    |                          | $          | 23,689  |       | $ | 82,494 |   |
| Other intangible  assets                  |       | 1,442             |       | 220                           |       | 1,222   |       |
| Identified  intangible assets             |       | $                 | 107,625    |                          | $          | 23,909  |       | $ | 83,716 |   |

 

Amortization ofacquisition-related intangibles was approximately $1.4 million and $5.0million, respectively, for the three and nine months ended September 30, 2004and $1.8 million and $5.3 million, respectively, for the three and nine monthsended September 30, 2003.  Amortizationof other intangible assets was approximately $22,000 and $67,000, respectively,for the three and nine months ended September 30, 2004 and $22,000 and $90,000,respectively, for the three and nine months ended September 30, 2003.

 

 

9

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** **

Expectedamortization expense related to identified intangible assets for thethree-month period from October 1, 2004 to December 31, 2004, and each of thefiscal years thereafter is as follows (in thousands):

 
| ** **                       | ** ** | **Periods Ending December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------------------|------------|---------------------------------|------------|------------|------------|------------|------------|
| ** **                       | ** ** | **2004**                        | ** ** | **2005**   | ** ** | **2006**   | ** ** | **2007** | ** ** | **2008** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
| Acquisition-related  intangibles |       | $                               | 1,418      |       | $          | 5,674      |       | $ | 5,674 |   | $ | 5,674 |   | $ | 5,676 |   | $ | 36,180 |   | $ | 60,296 |   |
| Other intangible  assets         |       | $                               | 23         |       | $          | 90         |       | $ | 90 |   | $ | 90 |   | $ | 90 |   | $ | 772 |   | $ | 1,155 |   |
|                                  |            |                                 |            |            |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**4.****            ****Convertible Subordinated Note**

 

In October 2003,in connection with a collaboration agreement, the Company entered into asecurities purchase agreement with AstraZeneca. Pursuant to the agreement, theCompany issued to AstraZeneca $50.0 million of Series A-1 convertible preferredstock and $50.0 million of Series A-2 convertible preferred stock.  The net proceeds from the securities were$99.7 million.  Pursuant to its terms,the Series A-2 preferred stock was redeemed at the option of AstraZeneca onFebruary 19, 2004 and the Company issued AstraZeneca a convertible subordinatednote with a principal amount of $50.0 million, which matures on October 29,2013.  No interest is payable on the noteexcept in the event of a payment default by the Company.

 

*Conversion rights*

 

The Company, subject to certain conditions, can convertthe convertible subordinated note into shares of common stock at a conversionprice equal to the lower of (a) the average market price for the 10 days priorto the trading day immediately preceding the conversion date (provided that theaverage market price shall in no event be higher than 101% of the market priceon the trading day immediately preceding the conversion date) or (b) $30.00 pershare.

 

AstraZeneca mayconvert the convertible subordinated note into shares of common stock at aconversion price of $30.00 per share, at any time prior to the repayment of theprincipal amount of the note.

 

*Redemptionrights and maturity*

 

The convertiblesubordinated note matures on October 29, 2013, if still outstanding.  The Company can, upon 15 days notice to theholder repay the principal amount of the convertible subordinated note in cash.

 

AstraZeneca hasthe right to require Abgenix to repay the convertible subordinated note at itsface amount, upon the occurrence of a change in control of Abgenix after thecompletion of a defined research period. At its option, and subject to certain conditions, Abgenix may delivershares of its common stock in lieu of cash upon such an event.

 

AstraZeneca hasthe right to require Abgenix to repay a specified portion of the convertiblesubordinated note upon the occurrence of (a) a material breach by Abgenix of amaterial obligation under the Collaboration Agreement between the Company andAstraZeneca or (b) a change in control of Abgenix or an acquisition by Abgenixin which the other party to the change in control or acquisition, as the casemay be, is a competitor of AstraZeneca, in each case that occurs during adefined research period and results in AstraZeneca’s termination of allresearch programs and future programs under the collaboration agreement. Theamount that AstraZeneca may require Abgenix to redeem will be based upon theextent of completion of the research programs that are the subject of thecollaboration between the Company and AstraZeneca.  At its option, and subject to certainconditions, Abgenix may deliver shares of its common stock in lieu of cash uponsuch events.

 

Upon theoccurrence of certain events of default, (1) the holder of the convertiblesubordinated note shall have the right to make the entire outstanding principalamount of the note due and payable and (2) if the event of default is a paymentdefault, quarterly interest payments shall begin to accrue on the convertiblesubordinated note at a default rate equal to the 10-year U.S. treasury rateplus three 

 

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percent (3%) compoundedannually.  Events of default for purposesof this provision include, but are not limited to, the following (i) a failureto make a required payment, or a breach by the Company of any of the Company’sother obligations under, the Series A-1 preferred stock, the convertiblesubordinated note or any subordinated promissory note that may be issued by theCompany in the circumstances described below under “Aggregate ownershiplimitation”; (ii) a breach of the Company of specified obligations under thesecurities purchase agreement with AstraZeneca; (iii) the securities purchase agreement,or any other agreement or instrument contemplated by the securities purchaseagreement, is asserted by the Company not to be a legal, valid and bindinginstrument; (iv) certain bankruptcy and insolvency events involving theCompany; and (v) a cross-acceleration of $25 million or more of otherindebtedness of the Company.

 

*Liquidationand Voting rights*

 

The convertiblesubordinated note has an aggregate principal amount of $50 million.  Theconvertible note does not have any voting rights unless it is converted intocommon stock and will not bear any interest unless there is an occurrence of adefault that is a payment default.  Uponan event of default that is a payment default, the convertible note will bearinterest at a rate equal to the 10-year U.S. treasury rate plus 3% compoundedannually.

 

The convertiblesubordinated note is senior to the preferred stock and the common stock and isjunior to all senior indebtedness and to the Company’s 3.5% convertiblesubordinated notes due in 2007.

 

*Aggregateownership limitation*

 

At no time may anyholder of the convertible subordinated note beneficially own, following theconversion of the convertible subordinated note, more than 19.9% of the Company’scommon stock then outstanding.  If anyshares of common stock are issuable to a holder upon conversion of theconvertible subordinated note that would result in any holder (together withits affiliates) owning common stock in excess of the ownership thresholddescribed above, then the Company will be required to redeem the shares inexcess of the ownership threshold for a price equal to (1) the number of suchexcess shares times (2) the average market price of the common stock for the 30consecutive days ending on the 15th trading day prior to the conversion date(such price, the “Excess Shares Redemption Price”).  Upon such a redemption of the shares issuableupon conversion of the convertible subordinated note, the Company will have theright, upon delivery of notice to the holder, to receive a loan from the holderin the form of interest-free subordinated promissory note.  The face amount of the promissory note shallbe the Excess Shares Redemption Price.

 

**5.****             Inventories**

 

Inventoriesconsist of materials related to a production service agreement with a collaborator.  Inventory cost is computed on aweighted-average cost basis and stated at lower of cost or market.  Inventories at period end were as follows (inthousands):

 

| ** **     | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|----------------|------------|-------------------------|------------|------------------------|------------|
| ** **     | ** ** | ** **              | ** ** | ** **             | ** ** |
| Raw material   |       | $                       | 42         |                   | $          | — |   |
| Finished goods |       | 328                     |       | —                 |       |
|           |       | $                       | 370        |                   | $          | — |   |

 

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**6.****             OtherLong-Term Liabilities**

 

In 2000, theCompany entered into a joint development and commercialization agreement withImmunex Corporation, a wholly-owned subsidiary of Amgen Inc., for theco-development of ABX-EGF, now known as panitumumab, a fully human antibody directedagainst epidermal growth factor receptor (EGFr) the Company created.  The parties amended this agreement in October2003.  Under the amended agreement,Immunex has decision-making authority for development and commercializationactivities.  As under the originalagreement, the Company is obligated to pay 50% of the development andcommercialization costs and is entitled to receive 50% of any profits fromsales of panitumumab.  Under the amendedagreement, Immunex is required to make available up to $60.0 million inadvances that the Company may use to fund a portion of its share of developmentand commercialization costs for panitumumab after the Company has contributed$20.0 million toward development costs in 2004. As of September 30, 2004, the Company has a carrying balance of $6.4million under this facility consisting of $6.3 million in advances and $104,000of interest accrued at the contract rate of 12% per annum.  The Company has notified Immunex of itsintent to draw a cash advance of an additional $13.3 million.  The Company expects to continue to make useof this credit facility in 2004 and thereafter up to the $60.0 millionlimit.  The amount and timing of the useof the facility is dependent on the development and related activities directedby Immunex and their cost.  The amount ofany such advances, plus interest, may be repaid out of profits resulting fromfuture product sales; however, the Company is not obligated to repay anyportion of the outstanding balance if panitumumab does not reachcommercialization.

 

**7.****             SegmentInformation**

 

The operations ofthe Company and its wholly owned subsidiaries constitute one business segment.

 

Information aboutcustomers who provided 10% or more of contract revenues for the period is asfollows:

 
| **Period**                             | ** ** | **Number of Customers and Percentage of   Contract Revenues for each of the Customers** | ** ** |
|----------------------------------------|------------|-----------------------------------------------------------------------------------------|------------|
| Three months ended  September 30, 2004 |       | 2 customers, 69% and  10%, respectively                                                 |       |
| Nine months ended  September 30, 2004  |       | 4 customers, 26%, 26%,  24% and 14%, respectively                                       |       |
| Three months ended  September 30, 2003 |       | 2 customers, 71% and  13%, respectively                                                 |       |
| Nine months ended  September 30, 2003  |       | 3 customers, 29%, 26%  and 12%, respectively                                            |       |

 

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**Item 2. Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

** **

*The following Management’sDiscussion and Analysis of Financial Condition and Results of Operationscontains forward*-*looking statements based upon current expectations that involve risksand uncertainties. In this quarterly report on Form 10*-*Q, the words “intend,” “anticipate,” “believe,” “estimate,” “plan” and “expect”and similar expressions as they relate to Abgenix are included to identifyforward*-*looking statements. Ouractual results and the timing of certain events could differ materially fromthose anticipated in these forward*-*lookingstatements as a result of certain factors, including those set forth below andunder the heading “Additional Factors that Might Affect Future Results”.  In this quarterly report on Form 10-Q,references to “Abgenix,” we,” “us,” and “our” are to Abgenix, Inc. and itssubsidiaries.*

 

##### **Overview**

##### ** **

The followingManagement’s Discussion and Analysis of Financial Condition and Results ofOperations is intended to help the reader understand our company.

 

***Our Business***

 

We are abiopharmaceutical company that is focused on the discovery, development andmanufacture of human therapeutic antibodies for the treatment of a variety ofdiseases.   We intend to use ourproprietary technologies to build a large and diversified product portfoliothat we expect to develop and commercialize largely through joint developmentand commercialization arrangements with pharmaceutical companies and others.

 

We areco-developing our most advanced proprietary product candidate, panitumumab(formerly known as ABX-EGF), with Immunex Corporation, a wholly-ownedsubsidiary of Amgen Inc.  Panitumumab isin pivotal trials, and we have two product candidates in early stage clinicaltrials.  In addition, we have enteredinto a variety of contractual arrangements with pharmaceutical, biotechnologyand genomics companies involving our technologies. We use our closelyintegrated process sciences and manufacturing capabilities for the manufactureof our own proprietary product candidates and also offer these services to ourcollaborators and others.

 

We intend to enterinto co-development agreements in addition to our agreement for panitumumab andour other co-development arrangements discussed below.  We generally expect to self-fund preclinicaland clinical activities to determine preliminary safety and efficacy beforeentering into joint development and commercialization agreements.  In some cases we may conduct productdevelopment entirely on our own.  We areimplementing our collaboration strategy through co-development arrangements withcompanies such as Chugai Pharmaceuticals Co., Ltd., U3 Pharma AG and DendreonCorporation, and through a broad collaboration in oncology with AstraZeneca UKLimited.  Our strategy is designed todiversify the risks associated with our research and development spending andto continue to focus our activities on product development andcommercialization.

 

Under ourcollaboration agreement with AstraZeneca, we are obligated to providepreclinical and clinical research support for the development of up to 36product candidates by AstraZeneca and have the opportunity to co-develop productswith AstraZeneca.

 

***Our Financial Position and Liquidity***

 

We derive our revenues from our technology out-licensingcontracts, our proprietary product development agreements, our target sourcingcontracts and our production services contracts. We expect that substantiallyall of our revenues for the foreseeable future will result from payments underthese and similar arrangements and that payments we receive under thesearrangements will continue to be subject to significant fluctuation in bothtiming and amount.

 

We have incurred and expect to continue to incursubstantial expenses in connection with our 

 

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product developmentactivities, both under contractual arrangements with third parties and relatedto our independent research and development efforts.  Regulatory and business factors will requireus to expend substantial funds in the course of completing required additionalresearch on, preclinical testing and clinical trials of, and attaining regulatoryapprovals for, product candidates. The amounts of the expenditures that will benecessary to execute our business plan are subject to numerous uncertaintiesthat may adversely affect our liquidity and capital resources.

 

We have incurred net losses since we were organized asan independent company, including a net loss of $144.6 million for the ninemonths ended September 30, 2004.  Weexpect to incur additional losses for the foreseeable future as a result of ourresearch and development costs and manufacturing start-up costs, includingcosts associated with conducting preclinical development and clinical trials,and charges related to purchases of technology or other assets.  We expect that the amount of our operatinglosses will fluctuate significantly from quarter to quarter.

 

As of September 30, 2004, we had cash, cashequivalents and marketable securities of $230.7 million.  The amounts of the expenditures that will benecessary to execute our business plan are subject to numerous uncertainties thatmay adversely affect our liquidity and capital resources to a significantextent.  We plan to continue to makesignificant expenditures to staff and operate our own manufacturing facilityand support our research and development activities, including preclinicalproduct development and clinical trials. These activities may result in increases in our operating expenses overthe next few years.

 

***Summary of Contractual Arrangements***

 

We have entered into a variety of contractualarrangements covering numerous antigens with more than thirty customers to useour XenoMouse® and XenoMaxTM technologies to generate and/or develop theresulting fully human antibodies. Pursuant to our XenoMouse contracts, we and our customers intend togenerate antibodies for development as product candidates for the treatment ofcancer, inflammation, autoimmune diseases, cardiovascular disease, growthfactor modulation, neurological diseases, metabolic diseases and infectiousdiseases.  We have also entered intocontracts with two customers to provide process sciences and manufacturingservices.  We expect that substantiallyall of our revenues for the foreseeable future will result from payments underthese and other contracts. We have also licensed technology from third partiesfor use in conjunction with our proprietary technologies.  The terms of our current contractualarrangements vary, but can generally be categorized as follows:

 

•              ProprietaryProduct Development—In 2000, we entered into a joint development andcommercialization agreement with Immunex for the co-development of ABX-EGF, nowknown as panitumumab, a fully human antibody directed against EGFr wecreated.  We amended this agreement inOctober 2003.  Under the amendedagreement, Immunex has decision-making authority for development andcommercialization activities.  As underthe original agreement, we are obligated to pay 50% of the development andcommercialization costs and are entitled to receive 50% of any profits fromsales of panitumumab.  Under the amendedagreement, Immunex is required to make available up to $60.0 million inadvances that we may use to fund a portion of our share of development andcommercialization costs for panitumumab after we have contributed $20.0 milliontoward development costs in 2004.  As ofSeptember 30, 2004, we had a carrying balance of $6.4 million under thisfacility consisting of $6.3 million in advances and $104,000 of interestaccrued at the contract rate of 12% per annum. We have notified Immunex of our intent to draw a cash advance of anadditional $13.3 million and we intend to continue to make use of this creditfacility in 2004 and thereafter up to the $60.0 million limit.  The amount and timing of our use of thefacility is dependent on the development and related activities directed byImmunex and their cost.  The amount ofany such advances, plus interest, may be repaid out of profits resulting fromfuture product sales; however, we are not obligated to repay any portion of theoutstanding balance if panitumumab does not reach commercialization. Under aseparate agreement with Immunex, we are 

 

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manufacturing clinicalsupplies for the collaboration and will manufacture commercial supplies for thefirst five years after commercial launch, with Immunex’s support andassistance.  The costs of manufacturingclinical and commercial supplies are also shared.  We have entered into co-development andcommercialization arrangements for the development of proprietary products thatare in various early stages with other collaborators, including U3 Pharma, MicroscienceLimited, Sosei Co., Ltd., Dendreon and Chugai. Development activities under these agreements are in various earlystages.

 

•              OncologyAlliance—We entered into a collaboration and license agreement with AstraZenecain October 2003 for the discovery, development and commercialization of fullyhuman monoclonal antibodies to treat cancer. This alliance involves the joint discovery and development oftherapeutic antibodies for up to 36 cancer targets to be commercializedexclusively worldwide by AstraZeneca.  Wewill conduct early stage preclinical research on behalf of AstraZeneca withrespect to some or all of these targets, and have initiated research programsfor several of them.  To date, we andAstraZeneca have selected twelve targets for inclusion in the collaboration,including several for which we had pre-existing preclinical programs.  For any resulting products, we may receivemilestone payments at various stages of development and royalties on future productsales.  AstraZeneca may make milestonepayments to us of up to $51 million per candidate drug that is developed underthe agreement, and for any drug we choose to develop to a target that isdiscontinued from the collaboration, we may pay AstraZeneca up to $15 million.  Under the agreement, we also may conductearly clinical trials, process development and clinical manufacturing, as wellas commercial manufacturing during the first five years of commercial sales,and would be compensated for those activities at competitive market rates.  The collaboration also gives us the right toselect and develop an additional pool of antibodies against up to 18 targets,which the companies may elect to further develop on an equal cost and profitsharing basis.  Subject to a number ofexceptions, we will work exclusively with AstraZeneca to generate and developantibodies for therapeutic use in the field of oncology during a three-yeartarget selection period.  Theseexceptions include among others, work on antibodies directed at antigens thatare or become subject to existing collaborations and antigens that we andAstraZeneca decide not to pursue in the collaboration, and certain processdevelopment and manufacturing services. In connection with this collaboration, AstraZeneca made a $100.0 millioninvestment in Abgenix securities.  Uponthe achievement of certain milestones, we may also require AstraZeneca toinvest up to an additional $60.0 million in our convertible preferred stock.  In addition, AstraZeneca has the first rightto review the clinical data from our Phase 1 clinical trial of ABX-MA1 and tonegotiate terms for the development of this product candidate.

 

•              AntigenSourcing Contracts—We have entered into several target sourcing contracts withgenomics and biopharmaceutical companies that may enable us to generate apipeline of proprietary fully human antibody therapeutic product candidates.Typically, pursuant to these contracts we generate fully human antibodies tothe antigens provided or identified by our collaborators. The contracts typicallycontain provisions that allow either us or our collaborator to evaluate andselect particular antibodies from the pool of generated antibodies for furtherdevelopment and commercialization. The party selecting an antibody for furtherdevelopment or commercialization will generally pay to the other party licensefees, milestone payments and royalty payments on any eventual product sales, inexchange for rights to develop and commercialize the product. In connectionwith these arrangements, we may also agree to make an equity investment incollaborators for strategic reasons. For example, we have made equityinvestments in CuraGen Corporation in connection with our collaboration withCuraGen.

 

•              TechnologyOut-Licensing—We have licensed our XenoMouse technology to third parties forthe purpose of generating antibody product candidates to one or more specificantigens provided by the customer. Pursuant to these contracts, we and our customers intend to generate antibodyproduct candidates for the treatment of cancer, inflammation, autoimmune 

 

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diseases, cardiovascular disease, growth factormodulation, neurological diseases, metabolic diseases and infectiousdiseases.  In some cases in which welicense XenoMouse technology, we provide our mice to the customer, which thencarries out immunizations with its specific antigens. In other cases, weimmunize the mice with the customer’s antigens for additionalcompensation.  We may also use ourXenoMax technology on the customer’s behalf. The customer generally has an option for a period of time to acquire aproduct license for any antibody identified using XenoMouse technology that thecustomer wishes to develop and commercialize. The financial terms of these agreementsmay include license fees, option fees and milestone payments paid to us by thecustomers. Based on our agreements, these payments and fees would average fromapproximately $7.0 million to $10.0 million per antigen if our customertakes the antibody into development and ultimately to commercialization.Additionally, our license agreements entitle us to receive royalties on anyfuture product sales by the customer.  Wealso have the right of first offer with regard to production services forantibodies developed pursuant to certain of these agreements.  We may also agree to make equity investmentsin some of our customers, or they may agree to make equity investments in us,in connection with these licensing arrangements. As of September 30, 2004, wehad entered into one agreement in which we licensed our SLAM technology to oneparty on a non-exclusive basis for the purpose of generating and usingantibodies other than antibodies derived from XenoMouse technology or othertechnology that involves the use of non-human animals, and on a co-exclusivebasis for the purpose of antigen discovery. We currently do not intend to license our SLAM technology for use by anyother parties.  We have also entered intoan agreement in which we exclusively licensed to one party rights under patentapplications and patents held by us to develop and commercialize therapeuticantibodies to parathyroid hormone-related protein.

 

•              Production Services Contracts—We have enteredinto contracts with two customers for process sciences and manufacturingservices.  One of these contracts isrelated to an antibody product candidate that we developed with the customerpursuant to an existing antigen sourcing contract.  Under this contract we are delivering avariety of process development, cell banking and manufacturing services forselected antibody product candidates. The other contract related to an antibody the customer developed under aXenoMouse license agreement. The agreements provide for the customer to pay uscertain fees for production services. Under one of these agreements we will be entitled to royalties on thesale of products subject to the agreement. We also have the right of first offer with regard to production servicesfor additional antibodies developed by one of these customers.  We are seeking to enter into agreements toprovide process sciences and manufacturing services to other existing and newcustomers to absorb production services capacity we are not using for our proprietaryproduct candidates; however, we do not expect to enter into any such agreementsin the near term.

 

•              TechnologyIn-Licensing—We also license technology from other parties that we use inconjunction with our proprietary technology to develop, manufacture andcommercialize therapeutic antibody candidates. The other party may also agreeto produce antibody therapeutic candidates for us using its owntechnology.  For example, we have enteredinto license and option agreements with ImmunoGen, Inc. pursuant to which wemay develop and commercialize products based upon certain proprietaryimmunotoxins.  These agreements oftenobligate us to pay license fees, and milestone payments and royalty fees to thecounterparty upon the occurrence of specified conditions, including upon oursale of products derived from use of the licensed technology. We may also agreeto make an equity investment in the other party for strategic reasons inconnection with these arrangements. For example, we purchased shares of commonstock of ImmunoGen in connection with our agreement with that company.

 

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***Summary of Product Development***

 

As of September30, 2004, three of our antibody therapeutic product candidates were in ongoingclinical trials.

 

•              Panitumumab(ABX-EGF).  Our leading proprietaryantibody therapeutic product candidate is panitumumab.  Generated using our technology, panitumumabis a fully human antibody therapeutic product directed against EGFr and acandidate for the treatment of a variety of solid tumors. We are co-developingthis candidate with Immunex under a development and commercializationagreement.  The status of clinical trialsof panitumumab is as follows:

 

•              Variouscancers—We initiated a Phase 1 clinical trial for panitumumab in various solid tumorsin July 1999.  In 2003, we expandedenrollment to investigate additional panitumumab dose levels and schedules ofadministration.  Enrollment is closed andtreatment is ongoing.

 

•              Renalcell cancer—We initiated a Phase 2 clinical trial evaluating the effect ofpanitumumab as monotherapy in patients with renal cell cancer inApril 2001 and enrollment is closed and treatment is ongoing.

 

•              Non-smallcell lung cancer— Immunex initiated a Phase 2 clinical trial for panitumumab inadvanced non-small cell lung cancer in combination with standard chemotherapy,compared to standard chemotherapy alone, in July 2001.  Enrollment is closed and treatment isongoing.  Interim data from Part 1 ofthis Phase 2 study were presented at the conference of the American Society ofClinical Oncology on June 5, 2004 and demonstrated that frontline therapy withpanitumumab was generally well-tolerated in combination with paclitaxel andcarboplatin in patients with advanced non-small cell lung cancer.  Nineteen patients were enrolled into threegroups and were administered panitumumab weekly for up to eight 6-week cycles,in combination with paclitaxel and carboplatin administered every three weeks,for up to six 3-week cycles:  six subjectswere administered panitumumab at a dose of 1.0 mg/kg/week, seven subjects wereadministered panitumumab at a dose of 2.0 mg/kg/week, and six subjects wereadministered panitumumab at a dose of 2.5 mg/kg/week.  Five of 19 patients had objective responses(one complete, four partial).  In thissmall study of 19 patients, the observed median time to progression was sixmonths and the observed median overall survival was 17 months.  The most common adverse event seen in thisstudy was skin rash, but the incidence of grade 3 skin rash did not appear toincrease with panitumumab dose.  Part 2of this study, which is fully enrolled with 175 patients, compares time toprogression for patients receiving panitumumab plus chemotherapy to that forpatients receiving chemotherapy alone as frontline therapy for advancednon-small cell lung cancer.

 

•              Colorectalcancer— Immunex initiated a Phase 2 clinical trial evaluating the effect ofpanitumumab as monotherapy in patients with metastatic colorectal cancer whohave previously failed chemotherapy in December 2001.  Enrollment is closed and treatment isongoing.  Interim data from this Phase 2study were presented at the annual conference of the American Society forClinical Oncology on June 6, 2004 and demonstrated that panitumumab hasantitumor activity when administered as a single-agent treatment to patientswith metastatic colorectal cancer who have failed chemotherapy.  The interim analysis, which was an update ofresults announced in June 2003, showed that patients with measurable metastaticcolorectal cancer which expressed the epidermal growth factor receptorexperienced partial responses.  The studyincluded 148 patients who were previously treated with fluoropyrimidine (withor without leucovorin), and either irinotecan or oxaliplatin, or both.  Patients received 2.5 mg/kg of panitumumab byweekly intravenous infusion in 8-week treatment cycles until diseaseprogression or unacceptable toxicity. Tumor responses were confirmed at least four weeks after the initialresponse was observed.

 

Treatment with panitumumab resulted in a partialresponse in 15 of the 148 patients (10%) with a median duration of response of5.2 months, and no complete responses. Stabilization of disease was observed in 56 of the 148 patients (38%)with a median duration of stable disease of 3.8 months.  Median overall

 

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time to progression was two months and median overallsurvival time was 7.9 months. Exploratory subgroup analyses comparing patients who had received twoprior chemotherapy agents, (80 patients), versus those who had received threeprior chemotherapy agents (68 patients), demonstrated similar response rates of11% and 9%, respectively.

 

In the interim analysis, panitumumab was generally well-tolerated,with skin rash as the most common side effect: 95% experienced a skin rash and 4%experienced a grade 3 skin rash.  Otherside effects experienced by some patients were fatigue, nausea anddiarrhea.  One patient had a grade 3infusion-related reaction related to panitumumab, which did not result indiscontinuation of panitumumab.  Therewere no instances of anaphylaxis.  In the110 patients for which samples were available for testing, no human antihumanantibodies (HAHAs) were observed.

 

•              Immunexinitiated a separate Phase 2 clinical trial in January 2002 evaluating theeffect of panitumumab in combination with irinotecan-containing regimens, asfirst-line treatment in patients with metastatic colorectal cancer. Enrollmentis closed and treatment is ongoing.

 

In January 2004, Immunex initiated a pivotal study ofpanitumumab as third-line monotherapy in patients with metastatic colorectalcancer.  The trial initiation followedthe receipt of a Special Protocol Assessment letter from the U.S. Food and DrugAdministration, or FDA, endorsing the design of the trial to support aregulatory submission for potential accelerated approval.  Enrollment in this trial, which has begun, isproceeding more slowly than originally anticipated.  Immunex also initiated a second pivotal studyin Europe in support of a global registration program.  Enrollment in this study is proceeding asanticipated.

 

•              Prostatecancer—We initiated a Phase 2 clinical trial evaluating the effect ofpanitumumab in patients with hormone resistant prostate cancer in January 2002,in which treatment is ongoing.  Based ona preliminary analysis, we have closed enrollment in this trial.  The preliminary findings did not meet ourplanned threshold to support pursuing the drug as a monotherapy in thisindication.

 

•              Immunexhas initiated an additional study to evaluate panitumumab in varioussub-populations, including metastatic colorectal cancer patients with tumorshaving low or undetectable levels of EGFr. Enrollment is ongoing.

 

•              ABX-MA1.  Generated using our technology, ABX-MA1 is afully human antibody therapeutic product candidate for the treatment of avariety of cancers.  We filed aninvestigational new drug application, or IND, in December 2001 and initiated aPhase 1 clinical trial evaluating the safety and pharmacokinetics of ABX-MA1 inpatients with metastatic melanoma in February 2002.  Enrollment is closed and treatment iscomplete.

 

•              ABX-PTH.  Generated using our technology, ABX-PTH, orABX-10241, is a fully human antibody therapeutic product candidate for thetreatment of a secondary hyperparathyroidism. We filed an IND in December 2003 and initiated a Phase 1 clinical trialevaluating the safety and pharmacokinetics of ABX-PTH in patients withsecondary hyperparathyroidism in February 2004. Enrollment is ongoing.

 

Preliminary results from an interim analysis of thisongoing study were presented during a poster presentation at the 26th AnnualMeeting of the American Society for Bone and Mineral Research on October 3,2004.  In the Phase 1 study, fivepatients received a single dose of placebo, four patients received 30 mg ofABX-PTH and eight patients received 100 mg of ABX-PTH by intravenous bolusinjection.  At the 100 mg dose,suppression of parathyroid hormone was sustained below 300 pg/mL in 88 percentof patients one week after dosing. ABX-PTH treatment resulted in dose dependent suppression of parathyroid 

 

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hormone and a dose dependent reduction in serumcalcium.  Intravenous bolus administrationwas well tolerated and no drug-related adverse events were reported.  We expect to launch a multiple dose phase 1study of ABX-PTH by the first quarter of 2005.

 

“Phase 1” indicates safety and pharmacokineticstesting in a limited patient population. “Phase 2” indicates safety, dosing andefficacy testing in a limited patient population. “Phase 3” indicates efficacyand safety testing in a larger patient population.  A “pivotal study” is designed to meetregistration requirements.  Phase 3studies designed for registration purposes are considered pivotal studies.  Certain Phase 2 studies can be pivotalstudies.

 

We have entered into a broad collaboration withAstraZeneca for the development of antibody therapeutics for the treatment ofoncology pursuant to which we have an opportunity to co-develop products withAstraZeneca, as well as provide preclinical and clinical research support forthe development of product candidates by AstraZeneca.  In addition, we have entered intoco-development agreements for the joint development of antibody productcandidates with a variety of companies including U3, Microscience, Dendreon,Chugai and Sosei.  We intend to enterinto additional joint development agreements for other product candidates.

 

We will expend significant capital to conduct clinicaltrials or share in the costs of conducting clinical trials for our proprietaryproduct candidates.  These activities mayresult in increases in our operating expenses over the next few years.

 

In addition to our proprietary antibody therapeuticproduct candidates in clinical trials, there are four customer-developedantibodies generated with XenoMouse technology in clinical trials as follows:

 

•              PfizerInc.—We generated three XenoMouse-derived fully human antibody therapeuticproduct candidates that Pfizer has advanced into clinical trials, including onethat targets cytotoxic T lymphocyte-associated antigen 4 (CTLA-4) and one thattargets activated type 1 insulin-like growth factor receptors (IGF-1R).  The indication for the third productcandidate has not been disclosed.  Two ofthe product candidates are currently in phase 1 evaluation and one has advancedto phase 2 evaluation.

 

•              Amgen—Wegenerated a XenoMouse-derived fully human antibody therapeutic productcandidate that binds to the receptor activator of nuclear factor kappa B ligand(RANKL) that Amgen has advanced into a pivotal clinical trial as AMG162 as apotential treatment for bone loss.

 

**Results of Operations**

 

*Three Months and Nine Months EndedSeptember 30, 2004 and 2003*

 

*ContractRevenues.*

 

Contract revenues totaled $3.4 million and $10.5million, respectively, in the three months and nine months ended September 30,2004, compared to $2.0 million and $10.5 million, respectively, in thecomparable 2003 periods. Because contract revenues depend to a large extent onthe success or failure of research and development efforts undertaken by ourcollaborators and licensees, our period-to-period contract revenues canfluctuate significantly and are inherently difficult to predict.

 

The primarycomponents of contract revenues for both periods were as follows:

 

•              TechnologyLicensing

 

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We recognized a total of $2.8 million and $8.8million, respectively, in the three and nine months ended September 30, 2004,compared to $2.0 million and $9.7 million, respectively, in the comparable 2003periods, from licensing our proprietary technologies.  Technology licensing included various fees,such as research license and service fees, product license fees, productdevelopment and research milestone payments and option fees.  Revenue consisted primarily of the following:

 

•              Chugai– In the nine months ended September 30, 2003, we recognized $3.0 million underan agreement with Chugai in which we exclusively licensed to Chugai rights tomethods of treatment of certain diseases with an antibody.

 

•              Additionally,in the three and nine months ended September 30, 2004 and 2003, we recognizedvarious fees, such as research milestone payments, research license andservices fees, product license fees, product development and option fees, undertechnology license agreements.  Werecognized fees from several collaborators, primarily from: Amgen and Pfizer inthe three months ended September 30, 2004; Pfizer, Amgen and Abbott in the ninemonths ended September 30, 2004; and Pfizer and Amgen in the three and ninemonths ended September 30, 2003.

 

•              ProprietaryProduct Development

 

We recognized $318,000 in the three and nine monthsended September 30, 2004, compared to $38,000 and $723,000, respectively, inthe comparable 2003 periods, pursuant to our joint development andcommercialization agreements.  In thethree and nine months ended September 30, 2004, the revenues consisted ofreimbursement of development costs for the panitumumab program.  The revenue increase in the three monthsended September 30, 2004 as compared to the same period in 2003, was due to ourdevelopment costs exceeding the development costs of our collaborator,Immunex.  In the three and nine monthsended September 30, 2003, the revenues consisted of reimbursement ofdevelopment costs from the development of ABX-CBL.  Revenue decreased in the nine months endedSeptember 30, 2004 as compared to the same period in 2003 primarily due to thediscontinuation of the ABX-CBL program in 2003. We expect revenues pursuant to our joint development andcommercialization agreements will continue to be less in 2004 as compared to2003 as we expect our collaborator’s costs for the panitumumab developmentprogram to exceed our costs and because of the discontinuance of the ABX-CBLdevelopment program.

 

•              Non-manufacturingProduction Services

 

We recognized a total of $326,000 and $1.4 million,respectively, in revenues during the three and nine months ended September 30,2004 for production services.  Theserevenues consisted primarily of process sciences services and were generatedfrom one of our product services agreements. We did not recognize any revenues from production services during thethree and nine months ended September 30, 2003.

 

*ContractManufacturing Revenues.*

 

Contract manufacturingrevenues totaled zero and $1.3 million, respectively, in the three and ninemonths ended September 30, 2004.  Theserevenues consisted primarily of manufacturing services for the manufacture ofan antibody product for a customer under a production services agreement.  In the three and nine months ended September30, 2003, we did not recognize any revenues from manufacturing services.

 

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*Costof Goods Manufactured.*

 

Cost of goodsmanufactured was zero and $1.9 million in the three and nine months endedSeptember 30, 2004.  Cost of goodsmanufactured included material, direct labor, outside testing and overheadcosts associated with manufacturing an antibody product for a customer under aproduction services agreement.  In thethree and nine months ended September 30, 2003, we did not have any cost ofgoods manufactured.

 

*Researchand Development Expenses.*

 

Research and development expenses were $30.0 millionand $94.6 million, respectively, in the three and nine months ended September30, 2004, compared to $26.0 million and $66.5 million, respectively, in thecomparable 2003 periods. The major components of research and developmentexpenses were as follows (in thousands):

 

Research and Development:

 
| ** **                            | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                            | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Product  development                  |       | $                                     | 21,961     |                                 | $          | 18,223 |   | $ | 67,112 |   | $ | 39,534 |   |
| Research                              |       | 7,939                                 |       | 7,593                                |       | 25,086 |   | 24,542 |   |
| In-licensing                          |       | 78                                    |       | 192                                  |       | 2,385 |   | 2,424 |   |
| Total research  and development costs |       | $                                     | 29,978     |                                 | $          | 26,008 |   | $ | 94,583 |   | $ | 66,500 |   |

 

Product development costs include costs of preclinicaldevelopment, cell line development, manufacturing and conducting clinicaltrials for our proprietary product candidates. Additionally, product development includes costs related to cell linedevelopment activities we perform under our production services contracts.  The primary components of product developmentinclude the costs of Abgenix personnel, drug supply costs, research feescharged by outside contractors, co-development costs, and facility expenses,including depreciation.  In the three andnine months ended September 30, 2004, our product development costs increasedin comparison to the same periods in 2003, primarily due to a significantincrease in the development costs for the panitumumab program.  To a lesser extent the increase was due tocosts related to new preclinical and clinical product candidates includingABX-PTH.  Product development costs canvary from period to period significantly depending on the developmentactivities in the period.  Overall, weexpect costs associated with product development in 2004 to be higher than 2003as we and our co-developer Immunex initiate new trials and add patients to ourexisting panitumumab clinical trials.

 

Research costs includecosts associated with research and testing of antibodies we generate, whetherfor ourselves or for our customers, prior to the development stage which beginswith the commencement of preclinical activities.  Research costs also include the costs ofresearch relating to proprietary technologies, including enhancements to thosetechnologies.  The primary components ofresearch costs include the costs of Abgenix personnel, facilities, includingdepreciation, and lab supplies.  Ourresearch costs have generally remained at the same levels in the three and ninemonths ended September 30, 2004 as compared to the same periods in 2003.

 

In-licensing costsinclude costs to acquire licenses to develop and commercialize varioustechnologies and molecules.  In the threemonths ended September 30, 2004, in-licensing costs decreased as compared tothe same period in 2003.  In-licensingcost can vary from period to period. In-licensing costs in the nine months ended September 30, 2004 werecomparable to the same period in 2003.

 

Major components ofresearch and development costs for the three and nine months ended September30, 2004 and 2003 were as follows:

 

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•              Costsof Abgenix Personnel—Costs of Abgenix personnel to support research anddevelopment activities increased 37% and 24%, respectively, in the three and ninemonths ended September 30, 2004 as compared to the same periods in 2003.  Personnel costs primarily include salary,fringe benefits, recruiting and relocation costs.  The increase was primarily due to increasedpersonnel costs for process sciences and preclinical research, and increaseduse of our manufacturing facility for development activities, including processvalidation for the manufacture of our conformance lots.

 

•              Consultingand Outside Contractors—Costs of consulting and outside contractors to supportresearch and development activities decreased 36% and 12%, respectively, in thethree and nine months ended September 30, 2004 as compared to the same periodsin 2003.  The decrease was primarily dueto a reduction of activities performed by outside contractors related totoxicology studies.  The decrease wasoffset in part by increased clinical trial activities for panitumumab.

 

•              ClinicalResearch Fees—Clinical research fees, including clinical investigator sitefees, monitoring costs and data management costs, increased 27% and 34%,respectively, in the three and nine months ended September 30, 2004 as comparedto the same periods in 2003.  Theincrease was primarily due to increased clinical trial activities forpanitumumab and ABX-PTH.

 

•              DrugSupply Costs—Drug supply costs increased 53% and 197%, respectively, in thethree and nine months ended September 30, 2004 as compared to the same periodin 2003.  The increase was primarily dueto the increased production of panitumumab resulting from the expansion of thepanitumumab clinical program.

 

•              Co-developmentcosts—Co-development costs, which primarily consist of reimbursement to Immunexfor our share of panitumumab development costs, decreased 100% in the threemonths ended September 30, 2004 and increased 14% in the nine months endedSeptember 30, 2004 as compared to the same periods in 2003.  In the three months ended September 30, 2004,we did not incur co-development costs associated with reimbursement to Immunexbecause our costs related to development of panitumumab exceeded thedevelopment costs incurred by Immunex. The increase in the nine months ended September 30, 2004 was primarilyrelated to cost sharing for activities performed by Immunex associated with theco-development of panitumumab.  Theincrease was also due to our increased activities for clinical trials relatedto the development of panitumumab.

 

•              Facilityand Other Overhead Related Costs—These costs, which primarily consist ofdepreciation, rent and other facility related costs, increased 50% and 52%,respectively, in the three and nine months ended September 30, 2004 as comparedto the same periods in 2003.  Theincrease was primarily related to increased use of our manufacturing facilityfor development activities, including process validation activities related tothe manufacture of panitumumab conformance lots.

 

The clinical trialstatus of product candidates included in product development costs is asfollows as of September 30 for each of the years indicated:

 
| **Proprietary Product  Candidate** | ** **     | ** **                                        | ** ** | **Clinical Trial Status as of  September 30,** | ** ** |
|------------------------------------|----------------|---------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                         | **Indication** | ** **                                        | **2004**   | ** **                                     | **2003**   | ** ** |
|                               |           |                                              |       |                                           |       |   |   |
| Panitumumab  (ABX-EGF)             |           | Various cancers                                   |       | Phase 1                                        |       | Phase 1 |   |
|                               |           | Renal cell  cancer                                |       | Phase 2                                        |       | Phase 2 |   |
|                               |           | Non-small cell  lung cancer                       |       | Phase 2(1)                                     |       | Phase 2(1) |   |
|                               |           | Metastatic Colorectal  cancer                     |       | Phase 2(1)                                     |       | Phase 2(1) |   |
|                               |           | Metastatic Colorectal  cancer (with chemotherapy) |       | Phase 2(1)                                     |       | Phase 2(1) |   |
|                               |           | Prostate cancer                                   |       | Phase 2                                        |       | Phase 2 |   |
|                               |           | Metastatic Colorectal  cancer (outside the US)    |       | Pivotal(1)                                     |       |   |   |
|                               |           | Metastatic Colorectal  cancer                     |       | Pivotal(1)                                     |       |   |   |
| ABX-MA1                            |           | Metastatic melanoma                               |       | Phase 1                                        |       | Phase 1 |   |
| ABX-PTH                            |           | Secondary hyperparathyroidism                     |       | Phase 1                                        |       |   |   |

----

(1)           Clinical trial managedby Immunex.

 

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*ManufacturingStart-Up Costs.*

 

Manufacturing start-up costs were $6.4 million and$16.5 million, respectively, in the three and nine months ended September 30,2004, compared to the $10.3 million and $63.1 million, respectively, in thecomparable 2003 periods.  Manufacturingstart-up costs include certain costs associated with our new manufacturingfacility, including depreciation, outside contractor costs and personnel costsfor activities such as quality assurance and quality control.  The primary component of this cost in the threeand nine months ended September 30, 2003 was a fee of approximately $28.0million for the negotiated cancellation of a manufacturing supply agreementwith an outside contractor, Lonza Biologics plc.  The manufacturing agreement was for aproduction suite held exclusively for us, which we were not using.  In addition to the absence of thecancellation fee in 2004, the decrease in the three and nine months endedSeptember 30, 2004 as compared to the same periods in 2003 was primarily due tothe increased use of our manufacturing facility for the manufacture ofpanitumumab and other development activities, including process validation forthe manufacture of panitumumab conformance lots.

 

We expect to continue to incur manufacturing start-upcosts until the facility is operating closer to full utilization.  For the year ending December 31, 2004, weexpect manufacturing start-up costs to decrease compared to 2003 as a result ofexpensing the Lonza cancellation fee in 2003 and the increased utilization ofthe facility in 2004.

 

*Amortization of Identified Intangible Assets.*

 

Our identified intangible assets consist primarily ofexisting technology (including patents and certain royalty rights) we acquiredthrough the acquisitions of Abgenix Biopharma and IntraImmune in 2000 and JTAmerica’s interest in Xenotech in 1999. Amortization of intangible assets totaled $1.4 million and $5.0 million,respectively, for the three and nine months ended September 30, 2004 and $1.8million and $5.4 million for the three and nine months ended September 30,2003.  The decrease in the three and ninemonths ended September 30, 2004 as compared to the same periods in 2003 was dueto a reduction in intangible assets due to the write-off in the second quarterof 2004 of the remaining value of the catalytic antibody technology that weacquired through the acquisition of Hesed Biomed Inc. in 2001.

 

*Generaland Administrative Expenses.*

 

General and administrative expenses includecompensation, professional services, consulting, facilities, includingdepreciation, and other expenses related to legal, finance and informationsystems.  General and administrativeexpenses totaled $7.7 million and $21.0 million, respectively, in the three andnine months ended September 30, 2004 and $7.8 million and $21.2 million,respectively, in the three and nine months ended September 30, 2003.  We expect general and administrative costs inthe fourth quarter of 2004 to remain at similar levels as compared to the firstthree quarters in 2004.

 

*Impairmentof Intangible Assets*

 

In the second quarter of 2004, we determined that animpairment of the Company’s acquired technology in the field of catalyticantibodies had occurred and that the estimated value had declined to zero.  This technology, which includes intellectualproperty, was acquired in 2001 through the acquisition of Hesed Biomed,Inc.  We decided to focus our resourceson other research and 

 

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development projects anddecided to wind down our catalytic antibody program.  Additionally, after assessing the associatedpatent position and the likelihood of sale or license of the technology to athird party, we further determined in the quarter ended June 30, 2004 that thepossibility of generating positive future cash flows from the technology wasremote.  As a result of thisdetermination, we recorded an impairment charge of $17.2 million.

 

In the first quarter of 2003, we decided todiscontinue the development of anti-properdin antibodies.  As a result, we recorded an impairment chargeof $1.4 million for previously capitalized costs related to licenses andresearch funding for the development of therapeutic antibodies to thecomplement protein properdin, which we licensed from Gliatech, Inc.

 

*Interestand Other Income.*

 

Interest and other income consist primarily ofinterest from cash, cash equivalents and marketable securities. Interest andother income decreased to $1.3 million and $4.8 million, respectively, in thethree and nine months ended September 30, 2004, compared to $2.0 million and$8.0 million, respectively, in the comparable 2003 periods.  The decrease was primarily the result oflower interest rates, and lower average cash, marketable securities and cashequivalent balances.

 

*InterestExpense.*

 

Interest expense was primarily related to interest andamortization of issuance costs on our convertible subordinated notes due2007.  In the three and nine months endedSeptember 30, 2004, interest expense increased to $1.8 million and $5.0million, respectively, as compared to $1.7 million and $4.1 million in the sameperiod in 2003, as a result of a decrease in the amount of capitalizedinterest.  The amount of interestcapitalized decreased in the three and nine months ended September 30, 2004 comparedto the same periods in 2003 because we placed into service a portion of ourmanufacturing facility in the second quarter of 2003 when we beganmanufacturing antibody therapeutic candidates in that portion of the facility.  Interest expense was capitalized in theamount of $0.4 million and $1.3 million, respectively, in the three and ninemonths ended September 30, 2004, compared to $0.4 million and $2.1 million,respectively, in the comparable 2003 periods. For each future quarterly period, we expect to record approximately $1.8million of interest expense related to our convertible subordinated notes due2007 until the debt matures, until we redeem or repurchase the debt or untilall or part of the debt is converted into shares of our common stock.  Additionally, we will record interest at 12%on the amounts we draw on our credit facility with Immunex until we repay thebalance in full.  For the quarter endedSeptember 30, 2004, the amount of interest expense recorded was $104,000.  The amount of any such advances, plusinterest, may be repaid out of profits resulting from future product sales;however, we are not obligated to repay any portion of the outstanding balanceif panitumumab does not reach commercialization.

 

*ForeignIncome Tax Expense.*

 

Foreign income tax expense was recorded reflecting anincome tax provision on foreign contract research projects of zero in both thethree and nine months ended September 30, 2004, compared to zero and $84,000,respectively, in comparable 2003 periods.

 

**Liquidity and Capital Resources**

 

At September 30, 2004, we had cash, cash equivalentsand marketable securities of approximately $230.7 million. We invest our cashequivalents and marketable securities primarily in highly liquid, interestbearing, investment grade and government securities in order to preserveprincipal. We have also invested in certain marketable equity securities ofImmunoGen and CuraGen for strategic reasons. These securities had an aggregatefair value of $16.5 million at September 30, 2004.

 

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*CashUsed in Operating Activities.* Net cash used in operating activities was $112.1 million and $101.1million in the nine months endedSeptember 30, 2004, and 2003, respectively. The major components of the changein cash used in operating activities in the nine months ended September 30,2004, compared to the same period in 2003, were primarily the following:

 

•      Anincrease of $16.4 million in payments pursuant to the Lonza contractcancellation obligation.  As of September30, 2004, we had no remaining obligations to Lonza.

 

•      Anincrease of $6.4 million in research and development and manufacturing start-upcosts, not including the Lonza contract cancellation charge in 2003,amortization of identified intangible assets and depreciation related to thedevelopment of new products.

 

•      Adecrease of $5.9 million in customer payments due primarily to the timing ofpayments received under our contracts.

 

•      Anincrease in our liability to Immunex of $6.4 million under the jointdevelopment agreement.

 

•      Accountspayable decreased $14.6 million less during the first nine months of 2004 thanduring the same period in 2003.

 

•      Prepaidexpenses and other current assets, net decreased $7.3 million more during the firstnine months of 2004 than during the same period in 2003.

 

*CashProvided by and Used in Investing Activities.*  Net cash provided by investing activities was$104.6 million in the nine months ended September 30, 2004, compared to $88.8million of net cash used in investing activities in the nine months ended September 30, 2003. Net cash provided by andused in investing activities consisted primarily of the following:

 

•      Capitalexpenditures of $6.9 million and $27.6 million in the nine months endedSeptember 30, 2004 and 2003, respectively. The investments in 2004 reflectprimarily investment in construction in progress and equipment for ourmanufacturing facility and investments in lab equipment.  The investments in 2003 reflect primarilyinvestment in construction in progress and equipment for our new manufacturingfacility.

 

•      Salesand maturities, net of purchases, of marketable securities of $111.5 millionduring the nine months ended September 30, 2004, compared to purchases, net ofsales and maturities of marketable securities of $61.2 million during the sameperiod in 2003.

 

*CashProvided by Financing Activities.*  During the nine months ended September 30,2004 and 2003, net cash provided by financing activities was $3.3 million and$1.7 million, respectively, consisting of proceeds from the issuance of ourcommon stock upon exercise of stock options and pursuant to our employee stockpurchase plan.

 

InOctober 2003, in connection with a collaboration agreement, we entered into asecurities purchase agreement with AstraZeneca. Pursuant to the agreement, weissued to AstraZeneca $50.0 million of Series A-1 convertible preferred stockand $50.0 million of Series A-2 convertible preferred stock.  The net proceeds from the securities were$99.7 million.  Pursuant to its terms,the Series A-2 preferred stock was redeemed at the option of AstraZeneca inFebruary 2004 and we issued AstraZeneca a convertible subordinated note with aprincipal amount of $50.0 million, which matures on October 29, 2013.  No interest is payable on the note except inthe event of a payment default by us. The Series A-1 preferred stock matures seven years from the date ofissuance.  Due to the redemption feature,we do not record the redeemable convertible preferred stock in stockholders’equity on our consolidated balance sheet. Subject to various terms and conditions, if a certain milestone event isreached, we will have the option to issue to AstraZeneca up to $30.0 million ofSeries A-3 preferred

 

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stockand if a further milestone event is reached, we will have the option to issueto AstraZeneca up to $30.0 million of Series A-4 preferred stock.  Each ofthe Series A-3 preferred stock and the Series A-4 preferred stock will have amaturity date that is five years from issuance.

 

Subject to certain conditions, we canconvert the preferred stock and can convert the convertible subordinated noteinto shares of our common stock at a conversion price equal to the lower of (a)the average market price for the 10 days prior to the trading day immediatelypreceding the conversion date (provided that the average market price shall inno event be higher than 101% of the market price on the trading day immediatelypreceding the conversion date) or (b) $30.00 per share.  AstraZenecamay convert the preferred stock into shares of common stock at a conversionprice of $30.00 per share, at any time prior to the earlier of (a) theredemption date or (b) the maturity date. AstraZeneca may convert the convertible subordinated note into shares ofcommon stock at a conversion price of $30.00 per share, at any time prior tothe repayment of the principal amount of the note.  We must redeem all outstanding sharesof the Series A-1 preferred stock, if any, at a cash redemption price per shareequal to the liquidation preference by October 29, 2010, the mandatoryredemption date. The note matures on October 29, 2013, if still outstanding.  Inaddition, we can, upon at least 15 days’notice to the holder, redeem the shares of Series A-1 preferred stock for cashin an amount equal to its liquidation preference at any time prior tomaturity.  We can, upon at least 15 days’notice to the holder, repay the principal amount of the convertiblesubordinated note in cash, at any time prior to maturity.  In addition to the mandatoryredemption and maturity dates of these securities, certain events can give riseto an earlier redemption.  In certaincircumstances, we have certain rights to convert the securities into commonstock instead of redeeming the securities for cash.

 

In March 2002, weissued $200.0 million principal amount of convertible subordinated notes in aprivate placement. The notes are convertible into shares of our common stock ata conversion price of $27.58 per share subject to certain adjustments.  The notes accrue interest at an annual rateof 3.5% and we are obligated to pay interest on March 15 and September 15 ofeach year.  The notes will mature onMarch 15, 2007 and are redeemable at our option on or after March 20, 2005, orearlier if the price of our common stock exceeds specified levels.  In addition, the holders of the notes mayrequire us to repurchase the notes if we undergo a change in control.  Proceeds from the sale of the notes, net ofcommissions payable to the initial purchasers of the notes but beforesubtracting other offering expenses payable by us, were $194.0 million.

 

In March 2000 and February 2001, we obtainedstand-by letters of credit for $2.0 million and $3.0 million, respectively,from a commercial bank as security for our obligations under two facilityleases. These were increased in January 2002 to $2.5 and $3.2 million,respectively, in connection with amendments to our facility leases. In 2003,the $3.2 million stand-by letter of credit increased to $3.5 million.  The outstanding stand-by letters of creditare secured by an investment account, in which we must maintain a balance ofapproximately $7.0 million.

 

*FinancingUncertainties Related to Our Business Plan.*  We plan to continue to make significantexpenditures to staff and operate our own manufacturing facility and supportour research and development activities, including preclinical productdevelopment and clinical trials. We also intend to look for opportunities toacquire new technology through in-licensing, collaborations oracquisitions.  For the full year 2004 weestimate that we will spend no more than $12 million on leasehold improvements,equipment, computer hardware and software for our new manufacturing and ourresearch and development facilities. Additionally, we may spend additional amounts to support new productionservices contracts.

 

We currently intend to use our available cash on handto finance these projects and business developments, but we might also pursueother financing alternatives, such as equity, equity-linked debt or debtfinancing, a bank line of credit, sale-lease back financing, asset sales,funding by one or more collaborators or a mortgage financing, that may becomeavailable to us.  We have a currentlyeffective shelf registration that allows us to issue from time to time up to$250 million in equity or debt securities. Whether we use cash on hand or choose to obtain financing will dependon, among other 

 

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things, the futuresuccess of our business, the prevailing interest rate environment and thecondition of financial markets generally.

 

The amounts of the expenditures that will be necessaryto execute our business plan are subject to numerous uncertainties that mayadversely affect our liquidity and capital resources to a significant extent.As of September 30, 2004, three of our proprietary product candidates,panitumumab, ABX-MA1 and ABX-PTH were in various stages of clinical trials.  The clinical trials of panitumumab, ABX-MA1and ABX-PTH are expected to require significant expenditures for theforeseeable future.  In October 2003, weentered into an amendment of our joint development and commercializationagreement with Immunex for the co-development of panitumumab.  Under the amended agreement, Immunex isobligated to make available up to $60.0 million in advances that we may use tofund a portion of our share of development and commercialization costs after wehave contributed $20.0 million toward development costs in 2004.  We have drawn $6.3 million under this creditfacility and have notified Immunex of our intent to draw a cash advance of anadditional $13.3 million.  We expect tocontinue to make use of this credit facility in 2004 and thereafter up to the$60.0 million limit.  The amount andtiming of our use of the facility is dependent on the development and relatedactivities directed by Immunex and their cost.

 

Completion of clinical trials may take several yearsor more, but the length of time generally varies substantially according to thetype, complexity, novelty and intended use of a product candidate. We estimatethat clinical trials of the type we generally conduct are typically completedover the following timelines:

 

| **Clinical  Phase** |   | **Estimated  Completion Period** |
|---------------------|--------|----------------------------------|
| Phase 1             |   | 1-2 Years                        |
| Phase 2             |   | 1-2 Years                        |
| Phase 3             |   | 2-4 Years                        |

 

However, theduration and the cost of clinical trials may vary significantly over the lifeof a project as a result of differences arising during the clinical trials,including, among others, the following:

 

•              thenumber of patients that ultimately participate in the trial, which may beaffected by the availability of competing therapeutic alternatives;

 

•              theduration of patient follow-up that seems appropriate in view of the results;

 

•              thenumber of clinical sites included in the trials; and

 

•              thelength of time required to enroll suitable patient subjects.

 

We test our potential product candidates in numerouspreclinical studies to identify disease indications for which they may beproduct candidates. We may conduct multiple clinical trials on our own or withour collaborators to cover a variety of indications for each product candidate.As we obtain results from trials, we may elect to discontinue clinical trialsfor certain product candidates or for one or more indications for a givenproduct candidate in order to focus our resources on more promising productcandidates or indications. For example, in January 2002 and May 2002, weannounced that clinical trials of our proprietary product candidate ABX-IL8 asa treatment for rheumatoid arthritis and psoriasis, respectively, did notsupport further clinical studies of that product candidate.  Additionally in February 2003, weannounced that the clinical trial of our proprietary product candidate ABX-CBLas a treatment for graft versus host disease, did not support further clinicalstudies of that product candidate.

 

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An importantelement of our business strategy is to pursue the research and development of adiverse range of product candidates for a variety of disease indications. Wemay enter co-development agreements, similar to our agreement with Immunex forpanitumumab, and may enter into additional joint development agreements earlierin the development life cycle of product candidates. We are implementing ourcollaboration strategy through co-development arrangements with companies suchas Chugai, U3 and Dendreon. Our strategy is designed to diversify the risksassociated with our research and development spending. The decisions toterminate or wind down our clinical programs for developing ABX-IL8 and ABX-CBLhave reduced the diversity of our product portfolio. We believe that thiseffect is temporary in view of the number and diversity of potential productcandidates we have in preclinical development. For example, we advanced ABX-PTH from the preclinical stage into aclinical study in patients with secondary hyperparathyrodism.  To the extent, however, that we are unable tomaintain a diverse and broad range of product candidates, our success woulddepend to a greater extent on the success of one or a few product candidates.

 

Our proprietaryproduct candidates also have not yet achieved FDA regulatory approval, which isrequired before we can market them as therapeutic products. In order to proceedto subsequent clinical trial stages and to ultimately achieve regulatoryapproval, the FDA must conclude that our clinical data establish safety andefficacy. The number, size and type of clinical trials we conduct for aparticular product candidate are also affected by the policies of the FDA andEuropean regulatory agencies, including their policies regarding clinical trialdesign and the availability of possible expedited approval procedures, which wemay seek to utilize.  These policies maychange from time to time.  As we conductclinical trials for a given product candidate, we may decide or the FDA mayrequire us to make changes in our plans and protocols.  Such changes may relate to, for example,changes in the standard of care for a particular disease indication,comparability of efficacy and toxicity of materials where a change in materialsis proposed, or competitive developments foreclosing the availability ofexpedited approval procedures.  We may berequired to support proposed changes with additional preclinical or clinicaltesting, which could delay the expected time line for concluding clinicaltrials.  In addition, the results from preclinicaltesting and early clinical trials have often not been predictive of resultsobtained in later clinical trials. A number of new drugs and biologics haveshown promising results in clinical trials, but subsequently failed toestablish sufficient safety and efficacy data to obtain necessary regulatoryapprovals.

 

Furthermore, ourbusiness strategy includes the option of entering into arrangements with thirdparties to collaborate in the development and commercialization of ourproducts. In the event that third parties take over the clinical trial processfor one of our product candidates, the estimated completion date would largelybe under the control of that third party rather than us. We cannot forecastwith any degree of certainty which proprietary products or indications, if any,will be subject to future collaborative arrangements, in whole or in part, orthe extent to which third parties may control clinical trials pursuant to sucharrangements, and how such arrangements would affect our capital requirements.

 

As a result of theuncertainties discussed above, among others, the duration and completion costsof our research and development projects are difficult to estimate and aresubject to considerable variation. Our inability to complete our research anddevelopment projects in a timely manner or our failure to enter intocollaborative agreements when appropriate, could significantly increase ourcapital requirements and could adversely impact our liquidity. Theseuncertainties could force us to seek additional sources of financing from timeto time in order to continue with our business strategy. Our inability to raiseadditional capital, or to do so on terms reasonably acceptable to us, wouldjeopardize the future success of our business.

 

We also may berequired to make further substantial expenditures if unforeseen difficultiesarise in other parts of our business. In particular, our future liquidity andcapital requirements also will depend on many factors including:

 

•              thescope and results of preclinical development and clinical trials;

 

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•              theretention of existing and establishment of further co-development, licensing,manufacturing and other agreements, if any;

 

•              continuedscientific progress in our research and development programs;

 

•              thesize and complexity of these programs;

 

•              thecost of operating our manufacturing facility and complying with goodmanufacturing practice regulations;

 

•              thecost of conducting commercialization activities and arrangements;

 

•              thetime and expense involved in seeking regulatory approvals;

 

•              competingtechnological and market developments;

 

•              thetime and expense of filing and prosecuting patent applications, and enforcingand defending against patent claims;

 

•              ourinvestment in, or acquisition of, other companies;

 

•              theamount of product or technology in-licensing in which we engage; and

 

•              otherfactors not within our control.

 

We believe thatour current cash balances, cash equivalents, marketable securities, and thecash generated from our licensing and other agreements will be sufficient tomeet our operating and capital requirements for at least one year. However,because of the uncertainties in our business discussed above, among others, wecannot assure you that this will be the case. In addition, we may choose to, orprevailing business conditions may require us to, obtain additional financingfrom time to time. We may choose to raise additional funds through public orprivate financing, licensing and other agreements, asset sales or otherarrangements. We cannot be sure that any additional funding, if needed, will beavailable on terms favorable to us or at all. Furthermore, any additionalequity or equity-related financing may be dilutive to our stockholders, anddebt financing, if available, may subject us to restrictive covenants andsignificant interest costs. We may also choose to obtain funding throughcollaborations, licensing and other contractual arrangements. Such agreementsmay require us to relinquish our rights to certain of our technologies,products or marketing territories. Our failure to raise capital when neededwould harm our business, financial condition and results of operations.

 

*Historyof Net Losses.*  We haveincurred net losses since our organization as an independent company, includingin the last five years net losses of $20.5 million in 1999,$8.8 million in 2000, $60.9 million in 2001, $208.9 million in2002, $196.4 million in 2003 and $144.6 million in the nine months endedSeptember 30, 2004. As of September 30, 2004, our accumulated deficit was$709.4 million. Our losses to date have resulted principally from:

 

•      research and developmentcosts relating to the development of our XenoMouse and XenoMax technologies andantibody therapeutic product candidates;

 

•      generaland administrative costs relating to our operations;

 

•      impairmentcharges relating to our strategic investments in CuraGen, ImmunoGen and MDSProteomics;

 

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•      impairmentcharges relating to technology in the field of catalytic antibodies, whichincludes intellectual property that was acquired through the acquisition ofHesed Biomed; and

 

•      manufacturingstart-up costs relating to our new manufacturing facility includingdepreciation, outside contractor costs and personnel costs for activities suchas quality assurance and quality control.

 

We expect to incur additional losses for theforeseeable future as a result of our research and development costs, includingcosts associated with conducting preclinical development and clinical trials,which will continue to be substantial, charges related to purchases oftechnology or other assets, and costs associated with operating ourmanufacturing facilities. We intend to invest significantly in our productsprior to entering into licensing agreements. This will increase our need forcapital and will result in losses for at least the next several years. Weexpect that the amount of operating losses will fluctuate significantly fromquarter to quarter as a result of increases or decreases in our research anddevelopment efforts, the execution or termination of licensing and otheragreements, and the initiation, and success or failure, of clinical trials.

 

*NetOperating Loss Carryforwards.* As of December 31, 2003, we had net operating loss carryforwards forfederal and state income tax purposes of approximately $469.0 million and$102.0 million, respectively.  Our netoperating loss carryforwards exclude losses incurred prior to our formation inJuly 1996. Further, we have capitalized the amounts associated with a 1997settlement and cross-license with GenPharm International, Inc. that we haveexpensed for financial statement accounting purposes and we are amortizing thoseamounts over a period of approximately 15 years for tax purposes. Thefederal and state net operating loss and credit carryforwards will expire inthe years 2006 through 2023, if not utilized. Utilization of the net operatinglosses and credits may be subject to a substantial annual limitation due to the“change in ownership” provisions of the Internal Revenue Code of 1986 andsimilar state provisions. The annual limitation may result in the expiration ofnet operating losses and credits before utilization.

 

****Critical Accounting Estimates****

 

Several estimates and judgments involved in theapplication of accounting principles impacts the financial results that wereport. We are required to estimate the effect of matters that are inherentlyuncertain. Changes in our estimates or judgments could materially impact ourresults of operations, financial condition and cash flows in future years. Webelieve our most critical accounting estimates include revenue recognition,accounting for our equity investments, and accounting for goodwill, intangibleassets and income taxes.  There have beenno significant changes to our critical accounting estimates as reported in ourannual report on Form 10-K for the year ended December 31, 2003 with respect tothe accounting for revenue recognition, equity investments, goodwill or incometaxes.  We have made a significant changeto our estimate of the value of certain intangible assets as described below.

 

***Accounting for Intangible Assets***

 

As a result of the adoption of SFAS No. 144 “Accountingfor the Impairment or Disposal of Long-Lived Assets”, intangible assets heldand used must be tested for impairment when events or changes in circumstancesindicate that its carrying amount may not be recoverable.  Factors that are considered important indetermining whether impairment might exist include a significant change in themanner in which an asset is being used, a significant adverse change in legalfactors or the business climate that could affect the value of an asset,including an adverse action or assessment by a regulator, and a currentexpectation that, more likely that not, an asset will be sold or otherwisedisposed of before the end of its previously estimated useful life.

 

In the quarter ended June 30, 2004, we determined thatan impairment of the Company’s acquired technology in the field of catalyticantibodies had occurred and that the estimated value had 

 

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declined to zero.  This technology, which includes intellectualproperty, was acquired in 2001 through the acquisition of Hesed Biomed,Inc.  We decided to focus our resourceson other research and development projects and decided to wind down ourcatalytic antibody program. Additionally, after assessing the associated patent position and thelikelihood of sale or license of the technology to a third party, we furtherdetermined in the quarter ended June 30, 2004 that the possibility ofgenerating positive future cash flows from the technology was remote.  As a result of this determination, werecorded an impairment charge of $17.2 million.

 

****Contractual Obligationsand Commercial Commitments****

 

As of September 30, 2004, future minimum payments forcertain contractual obligations for years subsequent to December 31, 2003 wereas follows:

 
| ** **                                              | ** ** | **Total**          | ** ** | **Less than  1 year(3)** | ** ** | **1 – 3  years** | ** ** | **3 – 5  years** | ** ** | **After 5  years(1)** | ** ** |
|---------------------------------------------------------|------------|--------------------|------------|--------------------------|------------|-----------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                              | ** ** | **(in thousands)** | ** ** |
| **Contractual  Obligations**                            |       |               |       |                     |       |                  |       |                  |       |                  |       |
| Operating leases                                        |       | $                  | 132,624    |                     | $          | 3,332                 |       | $                     | 27,782     |                  | $          | 29,793 |   | $ | 71,717 |   |
| Convertible  subordinated notes due 2007 & interest |       | 217,519            |       | —                   |       | 14,000                |       | 203,519               |       | —                |       |
| Convertible  subordinated note due 2013                 |       | 50,000             |       | —                   |       | —                |       | —                |       | 50,000                |       |
| Redeemable  convertible preferred stock                 |       | 50,000             |       | —                   |       | —                |       | —                |       | 50,000                |       |
| Immunex                                                 |       | 6,370              | (2)        | —                   |       | —                |       | —                |       | —                |       |
| Purchase orders                                         |       | 1,851              |       | 1,851                    |       | —                |       | —                |       | —                |       |
| Total                                                   |       | $                  | 458,364    | (2)                      | $          | 5,183                 |       | $                     | 41,782     |                  | $          | 233,312 |   | $ | 171,717 |   |

 

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(1)  Amounts represent total of minimum paymentsfor the entire period.

(2)  The $6.4 million long termobligation to Immunex consists of $6.3 million in advances under the creditfacility and $104,000 of interest accrued at the rate of 12% compoundedannually and is repayable out of profits resulting from future sales ofpanitumumab, the timing of which are uncertain. We are not obligated to repayany portion of the loan if panitumumab does not reach commercialization.

(3)  This represents the periodof October 1, 2004 through December 31, 2004.

 

In March 2002, we issued $200.0 million principalamount of convertible subordinated notes in a private placement. The notes areconvertible into shares of our common stock at a conversion price of $27.58 pershare subject to certain adjustments. The notes accrue interest at an annualrate of 3.5%.  We are obligated to payinterest on March 15 and September 15 of each year. We expect to makeinterest payments on the notes of $7.0 million per year, for years 2003 through2006, and $3.5 million in 2007, assuming all the notes remain outstanding untiltheir maturity date. The notes will mature on March 15, 2007 and are redeemableat our option on or after March 20, 2005, or earlier if the price of our commonstock exceeds specified levels. In addition, the holders of the notes mayrequire us to repurchase the notes if we undergo a change in control.  Therefore, in March 2007, or earlier if weundergo a change in control, we may use a significant portion of our cash, cashequivalents and marketable securities to repay the $200.0 million principalamount of our convertible debt. If our balance of cash, cash equivalents andmarketable securities at any time is insufficient to meet our obligations underthe notes, we would have to seek additional financing, if available, to supportour obligations under the notes.

 

In connection with a collaboration agreement, we haveissued to AstraZeneca $50.0 million of Series A-1 convertible preferred stockand a convertible subordinated note with a principal amount of $50.0 million.The total net proceeds were $99.7 million. The Company, subjectto certain conditions,

 

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can convert theSeries A-1 convertible preferred stock and can convert the convertible noteinto shares of common stock at a conversion price equal to the lower of (a) theaverage market price for the 10 days prior to the trading day immediatelypreceding the conversion date (provided that the average market price shall inno event be higher than 101% of the market price on the trading day immediatelypreceding the conversion date) or (b) $30.00 per share.  AstraZenecamay convert the Series A-1 convertible preferred stock and the convertible noteinto shares of common stock at a conversion price of $30.00 per share, at anytime prior to the earlier of (a) the redemption date or (b) the maturity date,as applicable. The Company must redeem all outstanding shares, if any,at a cash redemption price per share equal to the liquidation preference byOctober 29, 2010, the mandatory redemption date. The note matures on October29, 2013, if still outstanding. In addition, we can, upon at least 15 days’ notice to the holder, redeem the Series A-1convertible preferred stock for cash in an amount equal to its liquidationpreference and pre-pay the convertible note for its face amount, at any timeprior to maturity. In addition to the mandatory redemption and maturitydates of these securities, certain events can give rise to an earlierredemption.  In such circumstances, wehave certain rights to convert the securities into common stock instead ofredeeming the securities for cash.

 

Effective June 30, 2003, we canceled our agreementwith Lonza for the exclusive use of a cell culture production suite.  Upon canceling the agreement, we becameobligated to pay Lonza four equal installments of 4,250,000 British pounds onOctober 1, 2003, February 1, 2004, May 1, 2004 and August 1, 2004, whicheliminated our commitment to pay approximately $46.0 million in total monthlyfees through August 2006.  The value ofthe cancellation fee obligation on the effective date of June 30, 2003 wasapproximately $28.0 million.  In July2004, we made the final installment payment to Lonza.  As of September 30, 2004 we had no remainingobligations to Lonza.

 

We have a commitment toshare equally all development and commercialization costs for panitumumabpursuant to our development and commercialization agreement with Immunex.  As amended in October 2003, that agreementprovides that Immunex will have decision-making authority for development andcommercialization activities and will make available to us $60.0 million inadvances that we may use to fund our share of development and commercializationcosts for panitumumab after we have contributed $20.0 million towarddevelopment costs in 2004.  As ofSeptember 30, 2004, we have a carrying balance of $6.4 million under thisfacility consisting of $6.3 million in advances and $104,000 of interestaccrued at the contract rate of 12% per annum. We have notified Immunex of our intent to draw a cash advance of anadditional $13.3 million.  We expect tocontinue to make use of this credit facility in 2004 and thereafter up to the$60.0 million limit.  The amount andtiming of our use of the facility is dependent on the development and relatedactivities directed by Immunex and their cost. The amount of any such advances, plus interest, may be repaid out ofprofits resulting from future product sales and we are not obligated to repayany portion of the loan if panitumumab does not reach commercialization.

 

We have outstanding purchase orders totaling $1.9million to contractors related to the purchase of equipment and design andconstruction of our new manufacturing facility.

 

**Additional Factors That Might Affect FutureResults**

 

**Risks Related to our Finances**

 

*We are an early stage companywithout commercial therapeutic products, and we cannot assure you that we willdevelop sufficient revenues in the future to sustain our business.*

 

You must evaluate us in light of the uncertainties andcomplexities present in an early stage biopharmaceutical company. Our productcandidates are in early stages of development. We will need to make significantadditional investments in research and development, preclinical testing andclinical trials, and in regulatory and sales and marketing activities, tocommercialize current and future product candidates. Our product candidates, ifsuccessfully developed, may not generate sufficient or sustainable 

 

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revenues to enable us to be profitable.

 

*We have a history of losses and weexpect to continue to incur losses for the foreseeable future.*

 

We have incurred net losses since we were organized asan independent company, including in the last five years net losses of$20.5 million in 1999, $8.8 million in 2000, $60.9 million in2001, $208.9 million in 2002, $196.4 million in 2003 and $144.6 million inthe nine months ended September 30, 2004. As of September 30, 2004, ouraccumulated deficit was $709.4 million. Our losses to date have resulted principally from:

 

•              researchand development costs relating to the development of our XenoMouse and XenoMaxtechnologies and antibody product candidates;

 

•              generaland administrative costs relating to our operations;

 

•              impairmentcharges related to our strategic investments in CuraGen, ImmunoGen, and MDSProteomics;

 

•              impairmentcharges relating to technology in the field of catalytic antibodies, whichincludes intellectual property that was acquired through the acquisition ofHesed Biomed; and

 

•              manufacturingstart-up costs related to our new manufacturing facility includingdepreciation, outside contractor costs and personnel costs for activities suchas quality assurance and quality control.

 

We expect to incur additional losses for theforeseeable future as a result of our research and development costs and manufacturingstart-up costs, including costs associated with conducting preclinicaldevelopment and clinical trials, which will continue to be substantial, andcharges related to purchases of technology or other assets. We intend to investsignificantly in our products prior to entering into licensing agreements. Thiswill increase our need for capital and will result in losses for at least thenext several years. We expect that the amount of operating losses willfluctuate significantly from quarter to quarter as a result of increases ordecreases in our research and development efforts, the execution or terminationof licensing, manufacturing and other contractual arrangements, the progress orlack of progress of product development candidates in our collaboration withAstraZeneca and the initiation, success or failure of clinical trials.

 

*We are currently unprofitable andmay never be profitable, and our future revenues could fluctuate significantly.*

 

Since our founding, we have funded our research anddevelopment activities primarily from private placements and public offeringsof our securities and from revenues generated by our licensing and othercontractual arrangements.

 

We expect that substantially all of our revenues forthe foreseeable future will result from payments under licensing and othercontractual arrangements.  To date,payments under licensing and other agreements have been in the form of licensefees, milestone payments, reimbursement for research and development expenses,option fees, and payments for manufacturing services.  Payments under our existing and any futurecustomer agreements will be subject to significant fluctuation in both timingand amount.  Our revenues may not beindicative of our future performance or of our ability to continue to achievecontractual milestones. Our revenues and results of operations for any periodmay also not be comparable to the revenues or results of operations for anyother period.  Our revenues for anyperiod may not be sufficient to cover our operating costs, including the costsof operating our manufacturing plant.  Wemay not be able to:

 

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•              enterinto further co-development, licensing, manufacturing or other agreements;

 

•              successfullycomplete preclinical development or clinical trials;

 

•              obtainrequired regulatory approvals;

 

•              successfullymanufacture or market product candidates; or

 

•              generateadditional revenues or profitability.

 

Our failure to achieve any of the above goals wouldmaterially harm our business, financial condition and results of operations.

 

*We may require additional financing,and an inability to raise the necessary capital or to do so on acceptable termswould threaten the continued success of our business.*

 

We will continue to expendsubstantial resources to support research and development and operate ourmanufacturing facility, including costs associated with preclinical developmentand clinical trials. In the years ended December 31, 2003, 2002, and 2001,we incurred expenses of $99.6 million, $128.5 million and$96.2 million, respectively, on research and development.  For the nine months ended September 30, 2004,we incurred $94.6 million of research and development expenses.  Regulatory and business factors will requireus to expend substantial funds in the course of completing required additionaldevelopment, preclinical testing and clinical trials of, and attainingregulatory approvals for, product candidates. The amounts of the expendituresthat will be necessary to execute our business plan are subject to numerousuncertainties that may adversely affect our liquidity and capital resources.Our future liquidity and capital requirements will depend on many factors,including:

 

•              thescope and results of preclinical development and clinical trials;

 

•              theretention of existing and establishment of further co-development, licensing,manufacturing and other agreements, if any;

 

•              thedecisions of our collaborator, Immunex, under our co-development agreement forpanitumumab, which provides Immunex decision-making authority for developmentand commercialization activities and obligates us to share 50% of thedevelopment and commercialization costs;

 

•              continuedscientific progress in our research and development programs;

 

•              thesize and complexity of these programs;

 

•              thecost of operating our manufacturing facility, validating our processes andcomplying with good manufacturing practice regulations;

 

•              thecost of conducting commercialization activities and arrangements;

 

•              thetime and expense involved in seeking regulatory approvals;

 

•              competingtechnological and market developments;

 

•              thetime and expense of filing and prosecuting patent applications, and enforcingand defending against patent claims;

 

•              ourinvestment in, or acquisition of, other companies;

 

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•              theamount of product or technology in-licensing in which we engage; and

 

•              otherfactors not within our control.

 

We believe that our current cashbalances, cash equivalents, marketable securities, and the cash generated fromour licensing and other contractual arrangements, will be sufficient to meetour operating and capital requirements for at least one year. However, becauseof the uncertainties in our business, including the uncertainties listed above,we cannot assure you that this will be the case. In addition, we may choose toobtain additional financing from time to time. We may choose to raiseadditional funds through public or private equity or debt financing, licensingand other agreements, a bank line of credit, sale-lease back financing,mortgage financing, asset sales or other arrangements. We cannot be sure thatany additional funding, if needed, will be available on terms favorable to usor at all. Furthermore, any additional equity or equity-related financing maybe dilutive to our stockholders, and debt financing, if available, may subjectus to restrictive covenants and significant interest costs. We may also chooseto obtain funding through licensing and other contractual arrangements. Suchagreements may require us to relinquish our rights to certain of ourtechnologies, products or marketing territories. Our failure to raise capitalwhen needed would harm our business, financial condition and results ofoperations.

 

*Our indebtedness may harm ourfinancial condition and results of operations.*

 

We have $200 million of convertible subordinated notesdue March 15, 2007 and debt service obligations related thereto.  In February 2004, we incurred an additional$50.0 million of indebtedness to AstraZeneca, in the form of a convertiblesubordinated note due 2013, which we issued to AstraZeneca in connection withour redemption of the shares of our Series A-2 preferred stock we issued toAstraZeneca in October 2003.  There is nointerest payable on the note except in the event of a payment default.  Our level of indebtedness will have severalimportant effects on our future operations, including, without limitation:

 

•              wewill have additional cash requirements to support the payment of any interestor amortization required with respect to outstanding indebtedness;

 

•              increasesin our outstanding indebtedness and leverage will increase our vulnerability toadverse changes in general economic and industry conditions, as well as tocompetitive pressure; and

 

•              dependingon the levels of our outstanding debt, our ability to obtain additionalfinancing for working capital, capital expenditures, general corporate andother purposes may be limited.

 

Our ability to make payments of principal and intereston our indebtedness depends upon our future performance, which will be subjectto general economic conditions, industry cycles and financial, business andother factors affecting our operations, many of which are beyond our control.If we are unable to generate sufficient cash flow from operations in the futureto service our debt, we may be required, among other things:

 

•              toseek additional financing in the debt or equity markets;

 

•              torefinance or restructure all or a portion of our indebtedness, including ourconvertible subordinated notes due 2007;

 

•              tosell selected assets; or

 

•              toreduce or delay planned capital expenditures.

 

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Such measures might not be sufficient to enable us toservice our debt. In addition, any such financing, refinancing or sale ofassets might not be available on economically favorable terms.

 

*Our strategic investments expose usto equity price risk and our investments in those companies may be deemedimpaired, which would affect our results of operations.*

 

We are exposed to equity price risk on our strategicinvestments in CuraGen and ImmunoGen and we may elect to make additionalsimilar investments in the future. In 1999 and 2000, we purchased an aggregateamount of $80.0 million of the common stock of CuraGen and ImmunoGen asstrategic investments. In 2002, declines in the fair value of the CuraGen andImmunoGen common stock were deemed to be other than temporary, primarily becausethe stock of each company traded below our cost basis for more than six months.Accordingly, we recorded a total impairment charge for the year endedDecember 31, 2002 of $67.3 million. The public trading prices of theshares of both companies have fluctuated significantly since we purchased themand could continue to do so. If these shares trade below their new cost basesin future periods, we may incur additional impairment charges relating to theseinvestments. As of September 30, 2004, these investments were recorded at fairvalue in long-term investments on the balance sheet, and any net unrealizedholding gains and losses are reported as a component of stockholders’ equity.

 

**RisksRelated to the Development and Commercialization of our Products**

 

*OurXenoMouse and XenoMax technologies may not produce safe, efficacious orcommercially viable products, which will be critical to our ability to generaterevenues from our products.*

 

Our XenoMouse andXenoMax technologies are new approaches to developing antibodies as productsfor the treatment of diseases and medical disorders. We have not commercializedany antibody therapeutic products based on our technologies. Moreover, we arenot aware of any commercialized, fully human antibody therapeutic products thathave been generated from any technologies similar to ours. Our antibodytherapeutic product candidates are still in various stages of development andmany are in an early development stage. We have initiated clinical trials withrespect to four proprietary fully human antibody therapeutic productcandidates, and our collaborators have initiated clinical trials with respectto four other fully human antibody therapeutic product candidates generated byXenoMouse technology. We cannot be certain that either XenoMouse technology orXenoMax technology will generate antibodies against every antigen to which theyare exposed in an efficient and timely manner, if at all. Furthermore,XenoMouse technology and XenoMax technology may not result in any meaningfulbenefits to our current or potential customers or in product candidates thatare safe and efficacious for patients. Our failure to generate antibodytherapeutic product candidates that lead to the successful commercialization ofproducts would materially harm our business, financial condition and results ofoperations.

 

*If wedo not successfully develop our products, or if they do not achieve commercialsuccess, our business will be materially harmed.*

 

Our development ofcurrent and future product candidates, either alone or in conjunction withcollaborators, is subject to the risks of failure inherent in the developmentof new pharmaceutical products and products based on new technologies. Theserisks include:

 

•              delaysin product development, clinical testing or manufacturing;

 

•              unplannedexpenditures in product development, clinical testing or manufacturing;

 

•              failurein clinical trials or failure to receive regulatory approvals;

 

•              emergenceof superior or equivalent product development technologies or products;

 

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•              inabilityto manufacture on our own, or through others, product candidates on a clinicalor commercial scale;

 

•              inabilityto market products due to third-party proprietary rights;

 

•              electionby our customers not to pursue product development;

 

•              failureby our customers to develop products successfully; and

 

•              failureto achieve market acceptance.

 

Because of these risks, our research and developmentefforts and those of our customers and collaborators may not result in anycommercially viable products. Our failure to successfully complete asignificant portion of these development efforts, to obtain required regulatoryapprovals or to achieve commercial success with any approved products would materiallyharm our business, financial condition and results of operations.

 

In addition, our decisions to terminate our clinicalprograms for developing ABX-IL8, a fully human antibody product candidate forinflammatory disorders, and ABX-CBL, an in-licensed antibody product candidatefor graft versus host disease, have reduced the diversity of our productportfolio. We hope to be able to make up for this loss of diversity through thenumber and variety of potential new product candidates we have in preclinicaldevelopment. For example, ABX-PTH, which targets the action of parathyroidhormone in patients with chronic renal disease, is a new product candidate thatwe moved from the preclinical stage into a clinical study in 2004 in patientswith secondary hyperparathyroidism. However, to the extent that we are unableto maintain a broad and diverse range of product candidates, our success woulddepend more heavily on one or a few product candidates.

 

*Before we commercialize and sell anyof our product candidates, we must conduct clinical trials, which are expensiveand have uncertain outcomes.*

 

Conducting clinical trials is a lengthy,time-consuming and expensive process. Before obtaining regulatory approvals forthe commercial sale of any products, we must demonstrate through preclinicaltesting and clinical trials that our product candidates are safe and effectivefor use in humans. We have incurred and will continue to incur substantialexpense for, and we have devoted and expect to continue to devote a significantamount of time to, preclinical testing and clinical trials.

 

Historically, the results from preclinical testing andearly clinical trials have often not been predictive of results obtained inlater clinical trials. A number of new drugs and biologics have shown promisingresults in clinical trials, but subsequently failed to establish sufficientsafety and efficacy data to obtain necessary regulatory approvals. Dataobtained from preclinical and clinical activities are susceptible to varyinginterpretations, which may delay, limit or prevent regulatory approval. Inaddition, we may encounter regulatory delays or rejections as a result of manyfactors, including changes in regulatory policy during the period of productdevelopment.

 

Completion of clinical trials may take several yearsor more. The length of time generally varies substantially according to thetype, complexity, novelty and intended use of the product candidate. However,we estimate that clinical trials of the type we generally conduct are typicallycompleted over the following timelines: 

 
| **Clinical  Phase** | ** ** | **Estimated  Completion Period** | ** ** |
|---------------------|------------|----------------------------------|------------|
| Phase 1             |       | 1-2 Years                        |       |
| Phase 2             |       | 1-2 Years                        |       |
| Phase 3             |       | 2-4 Years                        |       |

 

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Many factors maydelay our commencement and rate of completion of clinical trials, including:

 

•              thenumber of patients that ultimately participate in the trial, which may beaffected by the availability of competing therapeutic alternatives;

 

•              theduration of patient follow-up that seems appropriate in view of the results;

 

•              thenumber of clinical sites included in the trials;

 

•              thelength of time required to enroll suitable patient subjects; and

 

•              theavailability of adequate supplies of the product candidate being tested.

 

We have limited experience in conducting and managingclinical trials. We rely on third parties, including our collaborators, toassist us in managing and monitoring clinical trials. Our reliance on thesethird parties may result in delays in completing, or in failure to complete,these trials if the third parties fail to perform under our agreements withthem.

 

In addition, we have ongoing research projects thatmay lead to product candidates, but we have not submitted INDs nor begunclinical trials for these projects.  Ourability to file additional INDs, and to build diversity and scale in ourproduct portfolio, depends to a significant extent on our ability to identifyadditional potential product candidates through our preclinical research and toconduct preclinical research efficiently. Our preclinical or clinical development efforts may not be successfullycompleted, we may not file further INDs and clinical trials may not commence asplanned.

 

Three of our proprietary product candidates,panitumumab, ABX-MA1 and ABX-PTH, are in various stages of clinical trials. Wehave discontinued development of two proprietary product candidates, ABX-CBLand ABX-IL8. To date, data obtained from these clinical trials have beeninsufficient to demonstrate safety and efficacy under applicable FDAguidelines. As a result, these data will not support an application forregulatory approval without further clinical trials. Clinical trials that weconduct or that third parties conduct on our behalf may not demonstratesufficient safety and efficacy to obtain the requisite regulatory approvals forany of our product candidates. We expect to commence new clinical trials fromtime to time in the course of our business as our product development workcontinues. However, regulatory authorities may not permit us to undertake anyadditional clinical trials for our product candidates.

 

Our product candidates may fail to demonstrate safetyor efficacy in clinical trials. For example, in 2002 we completed analysis of aPhase 2b clinical trial of ABX-IL8 in psoriasis, concluded that the results didnot warrant continued development in psoriasis and decided not to proceed withstudies in other disease indications. Similarly, in February 2003, we completeda preliminary analysis of the results from the Phase 2/3 clinical trial ofABX-CBL and concluded that the study did not meet its primary endpoint.Therefore, we and our co-developer, SangStat (now a subsidiary of GenzymeCorporation) do not plan any further development of ABX-CBL. Failures ofclinical trials of any product candidate could delay the development of otherproduct candidates or hinder our ability to obtain additional financing. Inaddition, failures in our clinical trials can lead to additional research anddevelopment charges. Any delays in, or termination of, our clinical trialscould materially harm our business, financial condition and results ofoperations.

 

*Our own ability to manufacture isuncertain, which may make it more difficult for us to develop and sell ourproducts.*

 

We have limited experience manufacturing antibodytherapeutic product candidates in our manufacturing facility. We intend to useour manufacturing facility for the manufacture of product candidates forclinical trials and to support the potential early commercial launch of alimited number of products, in each case, in compliance with FDA and Europeangood manufacturing practices. In 

 

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May 2000, we signeda long-term lease for the building that contains this manufacturing facility.Construction has been completed and portions of the facility are operationaland validated.  In October 2003,following an inspection by the California State Department of Health Services,we received a State Drug Manufacturing License. The license permits us tomanufacture and ship clinical material from our manufacturing facility.  The total cost of the facility to date,including design fees, permits, validation, construction, leaseholdimprovements and equipment, is approximately $150 million.  The costs of completing validation of thisfacility, making the remaining portions of the facility operational andqualifying the facility for regulatory compliance may be higher than expected.  We currently have excess production servicescapacity and this condition may persist for an extended period.  However, if the commercial launch of one ormore of our product candidates proves successful, we will likely experiencecapacity shortages and may need to use one or more third-party facilities toproduce these products in sufficient quantities.

 

The process of manufacturing antibody therapeuticproducts is complex. While the managers of the facility have gained extensivemanufacturing experience in prior positions with other companies, we havelimited experience in the clinical or commercial scale manufacturing of ourexisting product candidates, or any other antibody therapeutic products.  We will need to hire, train and retainadditional qualified manufacturing, quality control and quality assurance personnel.Also, we will need to manufacture such antibody therapeutic products in afacility and by an appropriately validated process that comply with FDA,European and other regulations. Our manufacturing operations will be subject toongoing, periodic unannounced inspection by the FDA and state agencies toensure compliance with good manufacturing practices.  Our inability to manufacture in accordancewith FDA and European good manufacturing practices could affect our ability toobtain regulatory approval for our products and to supply our clinical trialneeds.  Any significant manufacturingchanges for the production of our product candidates could result in delays indevelopment or regulatory approval or in the reduction or interruption ofcommercial sales of our product candidates. Our inability to maintain our manufacturing operations in compliancewith applicable regulations within our planned time and cost parameters couldmaterially harm our business, financial condition and results of operations.

 

We also mayencounter problems with the following:

 

•              productionyields;

 

•              qualitycontrol and assurance;

 

•              availabilityof qualified personnel;

 

•              availabilityof raw materials;

 

•              adequatetraining of new and existing personnel;

 

•              on-goingcompliance with our standard operating procedures;

 

•              on-goingcompliance with FDA regulations;

 

•              productioncosts; and

 

•              developmentof advanced manufacturing techniques and process controls.

 

In addition, theFDA and other regulatory authorities will require us to register anymanufacturing facilities in which our antibody therapeutic products aremanufactured and subject the facilities to inspections to confirm compliancewith FDA good manufacturing practices or other equivalent regulations.  The FDA or foreign regulatory bodies will notgrant pre-market approval of our product candidates if our facilities cannotpass a pre-approval plant inspection.  Incomplying with these regulations and foreign regulatory requirements, we willbe obligated to expend time, money and effort 

 

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in production, recordkeeping and quality control in an effort to ensure that our product candidatesmeet applicable specifications and other requirements.  Our failure to maintain regulatory compliancewould materially harm our business, financial condition and results ofoperations.

 

*We may rely on third-partymanufacturers, and we may have difficulty conducting clinical trials orcommercializing product candidates if a manufacturer does not perform inaccordance with our expectations.*

 

Previously, we relied on contract manufacturers toproduce candidates under good manufacturing practice regulations for use in ourclinical trials.  While we haveestablished our own manufacturing facility, we cannot assure you that we willbe able to qualify this facility for compliance with FDA and European goodmanufacturing practices or manufacture sufficient quantities of our productcandidates for clinical trials or a potential early commercial launch.

 

We continually evaluate our options for commercialproduction of our product candidates, including use of third-partymanufacturers or entering into a manufacturing joint venture relationship witha collaborator or other third party.  Weare aware of only a limited number of companies on a worldwide basis thatoperate manufacturing facilities in which our product candidates can bemanufactured under good manufacturing practice regulations, a requirement forall pharmaceutical products.  It may takea substantial period of time for a contract manufacturing facility that has notbeen producing antibodies to begin producing antibodies under goodmanufacturing practice regulations.  Wemay not be able to contract with any of these companies on acceptable terms, ifat all.

 

Third-party manufacturers may encounter difficultiesin scaling up production, including problems involving production yields,quality control and assurance, shortage of qualified personnel, shortage ofcapacity, compliance with FDA and other applicable regulations, productioncosts, and development of advanced manufacturing techniques and processcontrols.  They may not perform as agreedor may not remain in the contract manufacturing business for the time requiredby us to successfully produce and market our product candidates.  Also, third-party manufacturers may havedifficulty maintaining compliance with FDA good manufacturing practices orequivalent regulations, or having their facilities pass a pre-approvalinspection.  Any failure of third-partymanufacturers to deliver the required quantities of our product candidates forclinical use on a timely basis and at commercially reasonable prices, and ourfailure to find replacement manufacturers or successfully implement our ownmanufacturing capabilities, would materially harm our business, financialcondition and results of operations.

 

*The successful growth of revenuesfrom our manufacturing services depends to a large extent on our ability tofind third parties who agree to use our services and our ability to providethose services successfully.*

 

Enhancing our contract revenues depends to asignificant extent on entering into agreements to provide antibody productionservices to third parties. Potential third parties include our existing collaborators,as well as other pharmaceutical and biotechnology companies, technologycompanies, academic institutions and other entities. We must enter into theseagreements to successfully develop this aspect of our business. To date, wehave entered into two production services agreements and we cannot assure youthat we will be able to enter into additional agreements.

 

We may not be able to secure manufacturing agreementson favorable terms. If we do obtain such agreements, we may encounterdifficulties in performing as agreed. We may encounter difficulties in scalingup production, including problems involving production yields, quality controland assurance, shortage of qualified personnel, training of personnel,compliance with FDA and other applicable regulations, production costs, anddevelopment of advanced manufacturing techniques and process controls. Thefailure to deliver required quantities of product on a timely basis and atcommercially reasonable prices could materially harm our business, financialcondition and results of operations.

 

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*The successful growth of ourbusiness depends to a large extent on our ability to find third-partycollaborators to develop and commercialize many of our product candidates.*

 

Our strategy for the development and commercializationof antibody therapeutic products depends, in large part, upon the formation ofcollaboration agreements with third parties. Potential third parties includepharmaceutical and biotechnology companies, technology companies, academicinstitutions and other entities. We must enter into these agreements tosuccessfully develop and commercialize product candidates. These agreements arenecessary in order for us to:

 

•              accessproprietary antigens for which we can generate fully human antibody products;

 

•              fundresearch, preclinical development, clinical trials and manufacturing;

 

•              seekand obtain regulatory approvals; and

 

•              successfullycommercialize existing and future product candidates.

 

Our ability to continue our current collaborations andto enter into additional third party collaborations is dependent in large parton our ability to successfully demonstrate that our XenoMouse technology is anattractive method of developing antibody therapeutic products. We havegenerated only a limited number of fully human antibody therapeutic productcandidates pursuant to our collaboration agreements and only eight fully humanantibody therapeutic product candidates generated with XenoMouse technologyhave entered the clinical stage. We have announced that one of these productcandidates has not met our expectations. Our failure to maintain our existingcollaboration agreements or to enter into additional agreements couldmaterially harm our business, financial condition and results of operations.

 

Our dependence on licensing, collaboration,manufacturing and other agreements with third parties subjects us to a numberof risks. These agreements may not be on terms that prove favorable to us, andwe typically afford our collaborators significant discretion in electingwhether to pursue any of the planned activities. Licensing and othercontractual arrangements may require us to relinquish our rights to certain ofour technologies, products or marketing territories. To the extent we agree towork exclusively with one collaborator in a given therapeutic area, ouropportunities to collaborate with other entities could be curtailed.  For example, our collaboration withAstraZeneca for the identification and development of therapeutic antibodies inoncology contains exclusivity provisions that significantly restrict ourability to enter into arrangements with third parties in the field of oncologyas well as our ability to conduct research and development activities in thatfield.  To the extent that ourcollaboration with AstraZeneca is not successful, our ability to developantibodies for use in oncology applications through other collaborations willbe severely curtailed.  Our collaborationwith AstraZeneca also limits our ability to develop such antibodies through ourown independent development.

 

We cannot control the amount or timing of resourcesour collaborators may devote to a collaboration, and collaborators may notperform their obligations as expected. Additionally, business combinations orsignificant changes in a collaborator’s business strategy may adversely affecta collaborator’s willingness or ability to complete its obligations under thearrangement. Even if we fulfill our obligations under an agreement, typicallyour collaborators can terminate the agreement at any time following properwritten notice. The termination or breach of agreements by our collaborators,or the failure of our collaborators to complete their obligations in a timelymanner, could materially harm our business, financial condition and results ofoperations. If we are not able to establish further collaboration agreements orany or all of our existing agreements are terminated, we may be required toseek new collaborators or to undertake product development andcommercialization at our own expense. Such an undertaking may:

 

•              limitthe number of product candidates that we will be able to develop andcommercialize;

 

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•              reducethe likelihood of successful product introduction;

 

•              significantlyincrease our capital requirements; and

 

•              placeadditional strain on our management’s time.

 

Existing or potential collaborators may pursuealternative technologies, including those of our competitors, or enter intoother transactions that could make a collaboration with us less attractive tothem. For example, if an existing collaborator purchases a company that is oneof our competitors, that company could be less willing to continue its collaborationwith us. In addition, a company that has a strategy of purchasing companieswith attractive technologies might have less incentive to enter into acollaboration agreement with us. Moreover, disputes may arise with respect tothe ownership of rights to any technology or products developed with anycurrent or future collaborator. Lengthy negotiations with potential newcollaborators or disagreements between us and our collaborators may lead todelays in or termination of the research, development or commercialization ofproduct candidates or result in time-consuming and expensive litigation orarbitration. The decision by our collaborators to pursue alternativetechnologies or the failure of our collaborators to develop or commercializesuccessfully any product candidate to which they have obtained rights from uscould materially harm our business, financial condition and results ofoperations.

 

*We aresubject to extensive government regulation, which will require us to spendsignificant amounts of money, and we may not be able to obtain regulatoryapprovals, which are required for us to conduct clinical testing andcommercialize our products.*

 

Our product candidates under development are subjectto extensive and rigorous domestic government regulation. The FDA regulates,among other things, the development, testing, manufacture, safety, efficacy,record-keeping, labeling, storage, approval, advertising, promotion, sale anddistribution of biopharmaceutical products. If we market our products abroad,they will also be subject to extensive regulation by foreign governments.Neither the FDA nor any other regulatory agency has approved any of our productcandidates for sale in the United States or any foreign market. The regulatoryreview and approval process, which includes preclinical studies and clinicaltrials of each product candidate, is lengthy, expensive and uncertain. SecuringFDA approval requires the submission of extensive preclinical and clinical dataand supporting information to the FDA for each indication to establish theproduct candidate’s safety and efficacy. The approval process takes many years,requires the expenditure of substantial resources, and may involvepost-marketing surveillance and requirements for post-marketing studies. As weconduct clinical trials for a given product candidate, we may decide or the FDAmay require us to make changes in our plans and protocols. Such changes mayrelate to, for example, changes in the standard of care for a particulardisease indication, comparability of efficacy and toxicity of materials where achange in materials is proposed, or competitive developments foreclosing theavailability of expedited approval procedures. We may be required to supportproposed changes with additional preclinical or clinical testing, which coulddelay the expected time line for concluding clinical trials.  The approval of a product candidate maydepend on the acceptability to the FDA of data from clinical trials conductedoutside the United States.  Regulatoryrequirements are subject to frequent change. Delays in obtaining regulatoryapprovals may:

 

•              adverselyaffect the successful commercialization of any drugs that we or our customersdevelop;

 

•              imposecostly procedures on us or our customers;

 

•              diminishany competitive advantages that we or our customers may attain; and

 

•              adverselyaffect our receipt of revenues or royalties.

 

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Our product candidates may not be approved or may beapproved with limitations or for indications that differ from those weinitially target. If approved, certain material changes affecting a productsuch as manufacturing changes or additional labeling claims are subject tofurther FDA review and approval. The FDA may withdraw any required approvalsafter we obtain them. We may not maintain compliance with other regulatoryrequirements. Further, if we fail to comply with applicable FDA and otherregulatory requirements at any stage during the regulatory process, we or ourthird-party manufacturers may be subject to sanctions, including:

 

•              delays;

 

•              warningletters;

 

•              fines;

 

•              clinicalholds;

 

•              productrecalls or seizures;

 

•              injunctions;

 

•              refusalof the FDA to review pending market approval applications or supplements toapproval applications;

 

•              totalor partial suspension of production;

 

•              civilpenalties;

 

•              withdrawalsof previously approved marketing applications; and

 

•              criminalprosecutions.

 

In many instances we expect to rely on our customersand co-developers to file INDs and generally direct the regulatory approvalprocess for products derived from our technologies. These customers andco-developers may not be able to or may choose not to conduct clinical testingor obtain necessary approvals from the FDA or other regulatory authorities forany product candidates. If they fail to obtain required governmental approvals,we will experience delays in or be precluded from marketing or realizing thecommercial benefits from the marketing of products derived from our technologies.In addition, our failure to obtain the required approvals would preclude thecommercial use of our products. Any such delays and limitations may materiallyharm our business, financial condition and results of operations.

 

We and our third-party manufacturers also are requiredto comply with the applicable FDA current good manufacturing practiceregulations and other regulatory requirements. Good manufacturing practiceregulations include requirements relating to quality control and qualityassurance as well as the corresponding maintenance of records anddocumentation. Manufacturing facilities are subject to inspection by the FDAand the facilities must pass an inspection by the FDA before we can use them incommercial manufacturing of any product. Manufacturing facilities inCalifornia, including our facility, are also subject to the licensingrequirements of and inspection by the State of California Department of HealthServices. In October 2003, following an inspection, we received a DrugManufacturing License from the State of California. The license, which must berenewed annually, permits us to manufacture and ship clinical material. We orour third-party manufacturers may not be able to comply with the applicablegood manufacturing practice requirements and other regulatory requirements. Thefailure of us or our third-party manufacturers to comply with theserequirements would materially harm our business, financial condition andresults of operations.

 

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*If our products do not gain marketacceptance among the medical community, our revenues would greatly decline andmight not be sufficient to support our operations.*

 

Our product candidates may not gain market acceptanceamong physicians, patients, third-party payors and the medical community. Wemay not achieve market acceptance even if clinical trials demonstrate safetyand efficacy, and the necessary regulatory and reimbursement approvals areobtained. The degree of market acceptance of any product candidates that wedevelop will depend on a number of factors, including:

 

•              establishmentand demonstration of clinical efficacy and safety;

 

•              cost-effectivenessof our product candidates;

 

•              theirpotential advantage over alternative treatment methods;

 

•              reimbursementpolicies of government and third-party payors; and

 

•              marketingand distribution support for our product candidates, including the efforts ofour collaborators where they have marketing and distribution responsibilities.

 

Physicians will not recommend therapies using ourproducts until such time as clinical data or other factors demonstrate thesafety and efficacy of such procedures as compared to conventional drug andother treatments. Even if we establish the clinical safety and efficacy oftherapies using our antibody product candidates, physicians may elect not torecommend the therapies for any number of other reasons, including whether themode of administration of our antibody products is effective for certainindications. Antibody products, including our product candidates as they wouldbe used for certain disease indications, are typically administered by infusionor injection, which requires substantial cost and inconvenience to patients.Our product candidates, if successfully developed, will compete with a numberof drugs and therapies manufactured and marketed by major pharmaceutical andother biotechnology companies. Our products may also compete with new productscurrently under development by others. Physicians, patients, third-party payersand the medical community may not accept or utilize any product candidates thatwe or our customers develop. The failure of our products to achieve significantmarket acceptance would materially harm our business, financial condition andresults of operations.

 

*We do not have marketing and salesexperience, which may require us to rely on others to market and sell ourproducts and may make it more challenging for us to commercialize our productcandidates.*

 

Although we have been marketing our XenoMousetechnology to potential customers and collaborators for several years, we donot have marketing, sales or distribution experience or capability with respectto our therapeutic product candidates. We intend to enter into arrangementswith third parties to market and sell most of our therapeutic productcandidates when we commercialize them, which may be as early as 2005.  For example, pursuant to our amended jointdevelopment agreement with Immunex, we have granted to Immunex decision-makingauthority for development and commercialization activities relating to anyproducts developed under the collaboration. We may not be able to enter into these marketing and sales arrangementswith others on acceptable terms, if at all. To the extent that we enter intomarketing and sales arrangements with other companies, our revenues, if any,will depend on the efforts of others. These efforts may not be successful. Ifwe are unable to enter into third-party arrangements, we will need to develop amarketing and sales force, which may need to be substantial in size, in orderto achieve commercial success for any product candidate approved by the FDA. Wemay not successfully develop marketing and sales capabilities or havesufficient resources to do so. If we do develop such capabilities, we willcompete with other companies that have experienced and well-funded marketingand sales operations. Our failure to enter into successful marketingarrangements with third parties and our inability to conduct such activities ourselveswould materially harm our business, financial condition and results ofoperations.

 

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**Risks Related to IntellectualProperty**

 

*Our ability to protect ourintellectual property rights will be critically important to the success of ourbusiness, and we may not be able to protect these rights in the United Statesor abroad.*

 

Our success depends in part on our ability to:

 

•              obtainpatents;

 

•              protecttrade secrets;

 

•              operatewithout infringing the proprietary rights of others; and

 

•              preventothers from infringing our proprietary rights.

 

We will be able to protect our proprietary rights fromunauthorized use by third parties only to the extent that our proprietaryrights are covered by valid and enforceable patents or are effectivelymaintained as trade secrets. We attempt to protect our proprietary position byfiling U.S. and foreign patent applications related to our proprietarytechnology, inventions and improvements that are important to the developmentof our business. However, the patent position of biopharmaceutical companiesinvolves complex legal and factual questions, and, therefore, we cannot predictwith certainty whether our patent applications will be approved or anyresulting patents will be enforced. In addition, third parties may challenge,seek to invalidate or circumvent any of our patents, once they are issued.Thus, any patents that we own or license from third parties may not provide anyprotection against competitors. Our pending patent applications, those we mayfile in the future, or those we may license from third parties, may not resultin patents being issued. Also, patent rights may not provide us with adequateproprietary protection or competitive advantages against competitors withsimilar technologies. The laws of certain foreign countries do not protect ourintellectual property rights to the same extent as do the laws of the UnitedStates.

 

In addition to patents, we rely on trade secrets andproprietary know-how. We seek protection, in part, through confidentiality andproprietary information agreements. These agreements may not provide meaningfulprotection for our technology or adequate remedies in the event of unauthorizeduse or disclosure of confidential and proprietary information, and, inaddition, the parties may breach such agreements. Also, our trade secrets mayotherwise become known to, or be independently developed by, our competitors.Furthermore, others may independently develop similar technologies or duplicateany technology that we have developed.

 

*We may face challenges from thirdparties regarding the validity of our patents and proprietary rights, or fromthird parties asserting that we are infringing their patents or proprietaryrights, which could result in litigation that would be costly to defend andcould deprive us of valuable rights.*

 

Parties have conducted research for many years in theantibody and transgenic animal fields. The term “transgenic”, when applied toan animal, such as a mouse, refers to an animal that has chromosomes into whichhuman genes have been incorporated. This research has resulted in a substantialnumber of issued patents and an even larger number of pending patentapplications. The publication of discoveries in the scientific or patentliterature frequently occurs substantially later than the date on which theunderlying discoveries were made. Our commercial success depends significantlyon our ability to operate without infringing the patents and other proprietaryrights of third parties. Our technologies may unintentionally infringe thepatents or violate other proprietary rights of third parties. Such infringementor violation may prevent us and our customers from pursuing product developmentor commercialization. Such a result could materially harm our business,financial condition and results of operations.

 

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In March 1997, we entered into a cross-licenseand settlement agreement with GenPharm to avoid protracted litigation. Underthe cross-license, we licensed on a non-exclusive basis certain patents, patentapplications, third-party licenses and inventions pertaining to the developmentand use of certain transgenic rodents, including mice, that produce fully humanantibodies that are integral to our products and business. Our business,financial condition and results of operations could be materially harmed if anyof the parties breaches the cross-license agreement.

 

GlaxoSmithKline, plc, or Glaxo, has a family ofpatents relating to certain methods for generating monoclonal antibodies thatGlaxo is asserting against Genentech, Inc. in litigation that wascommenced in 1999. On May 4, 2001, Genentech announced that a jury haddetermined that Genentech had not infringed Glaxo’s patents and that all of thepatent claims asserted against Genentech are invalid. We understand that Glaxohas filed a notice of appeal with the Court of Appeals for the Federal Circuit.If any of the claims of these patents are finally determined in the litigationto be valid, and if we were to use manufacturing processes covered by thepatents to make our products, we may then need to obtain a license should onebe available. Should a license be denied or unavailable on commerciallyreasonable terms, we may have difficulty commercializing one or more of ourproducts in any territories in which these claims were in force.

 

Genentech, Johnson & Johnson, Glaxo,Transkaryotic Therapies, Inc. and the Trustees of Columbia University inthe City of New York each owns or controls a U.S. patent that relates torecombinant cell lines or methods of generating recombinant cell lines for theproduction of antibodies. If we were to use a production system covered by anyof these patents, we may then need to obtain a license should one be available.Under these circumstances, our failure to obtain a license at all or oncommercially reasonable terms could impede commercialization of one or more ofour products in any territories in which these patent claims were in force.

 

Genentech owns a U.S. patent that issued inJune 1998 relating to inhibiting the growth of tumor cells that involvesan antibody that binds to an epidermal growth factor receptor, or an anti-EGFreceptor antibody, in combination with a cytotoxic factor, which is a substancehaving a toxic effect on cells. ImClone Systems, Inc. owns or is licensedunder a U.S. patent that issued in April 2001, relating to inhibiting thegrowth of tumor cells that involves an anti-EGF receptor antibody in combinationwith an anti-neoplastic, or anti-tumor, agent. A corresponding European patent was published for grant in March 2002and Abgenix and others are opposing that patent in the European Patent Office.  A corresponding patent has also been issuedin Canada.  We do not believe based onour review that either the Genentech patent or any of the ImClone patents wouldbe successfully asserted against any of our current or planned activitiesrelating to panitumumab or future commercial sales of panitumumab. If a courtdetermines that the claims of either the Genentech patent or the ImClonepatents cover our activities with panitumumab and are valid, such a decisionmay require us to obtain a license to Genentech’s patent or ImClone’s patents,as the case may be, to label and sell panitumumab for certain combinationtherapies. Our failure to obtain a license, or to obtain a license oncommercially reasonable terms, could impede our commercialization ofpanitumumab.

 

In 2000, the Japan Patent Office granted a patent toKirin Beer Kabushiki Kaisha, one of our competitors, relating to non-humantransgenic mammals.  In October 2003, theUnited States Patent and Trademark Office issued a corresponding patent toKirin.  Kirin has filed correspondingpatent applications in Europe and Australia. Our licensee, Japan Tobacco, hasfiled opposition proceedings against the Kirin patent. We cannot predict theoutcome of those opposition proceedings, which may take years to be resolved.

 

Extensive litigation regarding patents and otherintellectual property rights has been common in the biotechnology andpharmaceutical industries. The defense and prosecution of intellectual propertysuits, United States Patent and Trademark Office interference proceedings, andrelated legal and administrative proceedings in the United States andinternationally involve complex legal and factual questions. As a result, suchproceedings are costly and time-consuming to pursue and their outcome isuncertain. Litigation may be necessary to:

 

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•              enforcepatents that we own or license;

 

•              protecttrade secrets or know-how that we own or license; or

 

•              determinethe enforceability, scope and validity of the proprietary rights of others.

 

Our involvement in any litigation, interference orother administrative proceedings could cause us to incur substantial expenseand could significantly divert the efforts of our technical and managementpersonnel. An adverse determination may subject us to loss of our proprietaryposition or to significant liabilities, or require us to seek licenses that maynot be available from third parties. An adverse determination in a judicial oradministrative proceeding, or a failure to obtain necessary licenses, mayrestrict or prevent us from manufacturing and selling our products, if any.Costs associated with these arrangements may be substantial and may includeongoing royalties. Furthermore, we may not be able to obtain the necessarylicenses on satisfactory terms, if at all. These outcomes could materially harmour business, financial condition and results of operations.

 

**Risks Related to Our Industry**

 

*We face intense competition andrapid technological change, and if we fail to develop products that keep pacewith new technologies and that gain market acceptance, our product candidatesor technologies could become obsolete.*

 

The biotechnology and pharmaceutical industries arehighly competitive and subject to significant and rapid technological change.We are aware of several pharmaceutical and biotechnology companies that areactively engaged in research and development in areas related to antibodytherapy. These companies have commenced clinical trials of antibody therapeuticproduct candidates or have successfully commercialized antibody therapeuticproducts for use on their own or in combination therapies. Many of thesecompanies are addressing the same diseases and disease indications as we or ourcustomers are. Also, we compete with companies that offer antibody generationservices to companies that have antigens. These competitors have specificexpertise or technology related to antibody development and introduce new ormodified technologies from time to time. These companies include GenPharm, awholly owned subsidiary of Medarex, Inc., Medarex’s collaborator, KirinBrewing Co. Ltd.; GenMab A/S; Cambridge Antibody Technology Group plc;Genentech; Protein Design Labs, Inc.; MorphoSys AG; XenerexBiosciences Inc., a subsidiary of Avanir Pharmaceuticals; XLTBiopharmaceuticals Ltd.; and Alexion Pharmaceuticals, Inc. Finally,we compete with companies that currently offer antibody production services,and may compete with companies that currently only manufacture their ownantibodies but could offer antibody production services to third parties.

 

Some of our competitors have received regulatoryapproval of or are developing or testing product candidates that may competedirectly with our product candidates. ImClone, in collaborations with Bristol-MeyersSquib Company and Merck KgAa; AstraZeneca, plc; Glaxo; and a collaboration ofOSI Pharmaceuticals, Inc., Genentech and Roche have potential antibody andsmall molecule product candidates in clinical development that may compete withpanitumumab, which is also in clinical trials.

 

ImClone and Bristol-Myers Squibb have receivedapproval to market Erbitux, ImClone’s antibody product candidate for thetreatment of metastatic colorectal cancer, in the United States.  ImClone and Bristol-Myers Squibb have alsoannounced the submission of an application for approval to market Erbitux inCanada.  Merck KgAa has announced that ithas received approval to market Erbitux for the treatment of metastaticcolorectal cancer in the European Union and that it has received approval tomarket Erbitux in Switzerland for treatment of metastatic colorectal cancer.

 

Genentech has received approval to market Avastin foruse with chemotherapy as a first-line treatment for colorectal cancer.

 

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AstraZeneca has received approval to market Iressa, asmall molecule product candidate that may compete with panitumumab, in manymarkets in the world, including the United States, Japan, Australia and Canada,for the treatment of advanced non-small cell lung cancer.

 

The FDA has accepted an NDA submitted by Genentech andOSI for Tarceva for the treatment of advanced non-small cell lung cancer.

 

In addition, Amgen has received approval to marketSensipar, or cinacalcet HCI, a small molecule product candidate for thetreatment of secondary hyperparathyroidism, which may compete with ABX-PTH.

 

Many of these companies and institutions, either aloneor together with their customers or collaborators, have substantially greaterfinancial resources and larger research and development staffs than we do. Inaddition, many of these competitors, either alone or together with theircustomers or collaborators, have significantly greater experience than we doin:

 

•              developingproducts;

 

•              undertakingpreclinical testing and human clinical trials;

 

•              obtainingFDA and other regulatory approvals of products; and

 

•              manufacturingand marketing products.

 

Accordingly, our competitors may succeed in obtainingpatent protection, receiving FDA approval or commercializing products before wedo. If we commence commercial product sales, we will be competing againstcompanies with greater marketing and manufacturing capabilities, areas in whichwe have limited or no experience.

 

We also face, and will continue to face, competitionfrom academic institutions, government agencies and research institutions.There are numerous competitors working on products to treat each of thediseases for which we are seeking to develop therapeutic products. In addition,any product candidate that we successfully develop may compete with existingtherapies that have long histories of safe and effective use. Competition mayalso arise from:

 

•              otherdrug development technologies and methods of preventing or reducing theincidence of disease;

 

•              newsmall molecules; or

 

•              otherclasses of therapeutic agents.

 

Developments by competitors may render our productcandidates or technologies obsolete or non-competitive. We face and willcontinue to face intense competition from other companies for agreements withpharmaceutical and biotechnology companies, for establishing relationships withacademic and research institutions, and for licenses to proprietary technology.These competitors, either alone or with their customers, may succeed indeveloping technologies or products that are more effective than ours.

 

We also face competition from companies that provideproduction services.  These includecontract manufacturers, such as Lonza, Avid Bioservices, Inc., DiosynthBiotechnology, DSM N.V., Cangene Corporation and Goodwin Biotechnology Inc., andother pharmaceutical and biotechnology companies that manufacture their ownproduct candidates but can make extra capacity available to collaborators andcustomers, such as Boehringer Ingelheim GmbH, Biogen Idec Inc., ICOSCorporation, Abbott and Novartis AG.

 

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*We face uncertainty overreimbursement and healthcare reform, which, if determined adversely to us,could seriously hinder the market acceptance of our products.*

 

In both domestic and foreign markets, sales of ourproduct candidates will depend in part upon the availability of reimbursementfrom third-party payors, such as government health administration authorities,managed care providers and private health insurers. Third-party payors areincreasingly challenging the price and examining the cost effectiveness ofmedical products and services. In addition, significant uncertainty exists asto the reimbursement status of newly approved healthcare products. Adequatethird-party reimbursement may not be available to enable us to maintain pricelevels sufficient to realize an appropriate return on our investment in productdevelopment. In addition, domestic and foreign governments continue to proposeand pass legislation designed to reduce the cost of healthcare, which couldfurther limit reimbursement for pharmaceuticals. The failure of the governmentand third-party payors to provide adequate coverage and reimbursement rates forour product candidates could adversely affect the market acceptance of ourproducts. The failure of our products to receive market acceptance wouldmaterially harm our business, financial condition and results of operations.

 

**Other Risks Related to Our Company**

 

*The future growth and success of ourbusiness will depend on our ability to continue to attract and retain ouremployees and consultants.*

 

For us to pursue product development, manufacturing,marketing and commercialization plans, we will need to hire additionalqualified scientific, manufacturing, quality control, quality assurance, andkey management personnel, including a vice president of quality and a vicepresident of process science.  We mayalso need to hire personnel with expertise in clinical testing, governmentregulation, marketing, law and finance. Attracting and retaining qualified personnel will be critical to oursuccess.  We may not be able to attractand retain personnel on acceptable terms given the competition for suchpersonnel among biotechnology, pharmaceutical and healthcare companies,universities and non-profit research institutions.  In addition, we experienced increasedattrition rates in 2003.  Furtherattrition could materially harm our business, financial condition and resultsof operations.

 

We grant stock options as a method of attracting andretaining employees, to motivate performance and to align the interests ofmanagement with those of our stockholders. Due to the decline in the tradingprice of our common stock during 2001, 2002 and in recent months, a substantialportion of the stock options held by our employees have an exercise price thatis higher than the current trading price of our common stock. We may elect togrant additional stock options at the current lower market price, pay highercash compensation, or provide some combination of these alternatives to retainand attract qualified employees, but we cannot be sure that any of theseactions would be successful. If we issue additional stock options, this woulddilute existing stockholders.

 

As a result of these factors, we may have difficultyattracting and retaining qualified personnel, which could materially harm ourbusiness, financial condition and results of operations.

 

*We may experience difficulty in theintegration of any future acquisition with the operations of our business.*

 

We may from time to time seek to expand our businessthrough corporate acquisitions. Our acquisition of companies and businesses andexpansion of operations, involve risks such as the following:

 

•              thepotential inability to identify target companies best suited to our businessplan;

 

•              thepotential inability to successfully integrate acquired operations andbusinesses and to realize anticipated synergies, economies of scale or otherexpected value;

 

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•              incurrenceof expenses attendant to transactions that may or may not be consummated; and

 

•              difficultiesin managing and coordinating operations at multiple venues, which, among otherthings, could divert our management’s attention from other important businessmatters.

 

In addition, our past and future acquisitions ofcompanies and businesses and expansion of operations may result in dilutiveissuances of equity securities, the incurrence of additional debt, U.S. orforeign tax liabilities, large one-time write-offs and the creation of goodwillor other intangible assets that could result in amortization expense or othercharges to expense.  For example, werecorded a one-time charge of $17.2 million in the quarter ended June 30, 2004,as a result of our determination that an impairment of our acquired technologyin the field of catalytic antibodies had occurred and that the estimated valuehad declined to zero.  This technologywas acquired in 2001 through the acquisition of Hesed Biomed, Inc.  After assessing the associated patentposition and the likelihood of sale or license of the technology to a thirdparty, we further determined that the possibility of generating positive futurecash flows from the technology was remote. We continue to evaluate our internal programs and assets.  Further changes in our plans or strategycould result in additional one-time charges.

 

*We have implemented a stockholderrights plan and are subject to other anti-takeover provisions, which coulddeter a party from effecting a takeover of us at a premium to our then-currentstock price.*

 

In June 1999, our board of directors adopted astockholder rights plan, which we amended and restated in November 1999and May 2002, and amended in October 2003. The stockholder rightsplan and certain provisions of our amended and restated certificate ofincorporation and amended and restated bylaws may have the effect of making itmore difficult for a third party to acquire, or of discouraging a third partyfrom attempting to acquire, control of us. This could limit the price thatcertain investors might be willing to pay in the future for our common stock.Certain provisions of our amended and restated certificate of incorporation andamended and restated bylaws allow us to:

 

•              issuepreferred stock without any vote or further action by the stockholders;

 

•              eliminatethe right of stockholders to act by written consent without a meeting;

 

•              specifyprocedures for director nominations by stockholders and submission of otherproposals for consideration at stockholder meetings; and

 

•              eliminatecumulative voting in the election of directors.

 

In October 2003, we entered into a collaboration andlicense agreement with AstraZeneca for the purpose of identifying anddeveloping antibody products for use in oncology therapeutics.  The collaboration agreement includesprovisions that would allow AstraZeneca to accelerate its selection of targetantigens and, in certain situations, terminate the collaboration agreement, orspecific programs or activities conducted under it, in the event of a change incontrol in us, particularly if we were acquired by a competitor ofAstraZeneca.  In the event of a change incontrol of us, AstraZeneca could also acquire control over the developmentprograms and various intellectual property rights in respect of antigens thatare the subject of the collaboration agreement. This would result in a reduction in the royalties and milestones to bepaid by AstraZeneca to us under the collaboration agreement and the release ofAstraZeneca from certain exclusivity provisions.  In addition, certain exclusivity provisionscontained in the collaboration agreement would apply to an acquirer of ourcompany and would restrict the acquirer’s ability to operate its business inthe oncology field after the acquisition, except with respect to pre-existingdevelopment programs.  These and otherprovisions of the collaboration agreement could make our company lessattractive to a potential acquirer, particularly an acquirer that conducts orexpects to conduct significant operations in the field of oncologytherapeutics.

 

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We are also subject to certain provisions of Delawarelaw which could also delay or make more difficult a merger, tender offer orproxy contest involving us. In particular, Section 203 of the DelawareGeneral Corporation Law prohibits a Delaware corporation from engaging in anybusiness combination with any interested stockholder for a period of threeyears unless the transaction meets certain conditions. The stockholder rightsplan, the possible issuance of preferred stock, the procedures required fordirector nominations and stockholder proposals, our collaboration agreementwith AstraZeneca and Delaware law could have the effect of delaying, deferringor preventing a change in control of us, including, without limitation,discouraging a proxy contest or making more difficult the acquisition of asubstantial block of our common stock. The provisions also could limit theprice that investors might be willing to pay in the future for shares of ourcommon stock.

 

*We face product liability risks andmay not be able to obtain adequate insurance, and if we are held liable for anuninsured claim or a claim in excess of our insurance limits, our business,financial condition and results of operations may be harmed.*

 

The use of any of our product candidates, or of anyproducts manufactured in our facility, in clinical trials, and the sale of anyapproved products, may expose us to liability claims resulting from such use orsale. Consumers, healthcare providers, pharmaceutical companies or othersselling such products might make claims of this kind. We may experiencefinancial losses in the future due to product liability claims. We have obtainedlimited product liability insurance coverage for our clinical trials andproduction services activities, under which the coverage limits are$15.0 million per occurrence and $15.0 million in the aggregate. Wemay not be able to maintain insurance coverage at a reasonable cost or insufficient amounts to protect us against losses. If third parties bring asuccessful product liability claim or series of claims against us for uninsuredliabilities or in excess of insured liabilities, our business, financialcondition and results of operations may be materially harmed.

 

*Our operations involve hazardousmaterials, and we could be held responsible for any damages caused by suchmaterials.*

 

Our research and manufacturing activities involve thecontrolled use of hazardous materials. In addition, although we maintaininsurance for harm to employees and to our facilities caused by hazardousmaterials, we do not insure against any other harm (including harm to theenvironment) caused by the use of hazardous materials on our premises. Wecannot eliminate the risk of accidental contamination or injury from thesematerials. In the event of an accident or environmental discharge, we may beheld liable for any resulting damages, which may exceed our financial resourcesand may materially harm our business, financial condition and results ofoperations.

 

*We do not intend to pay cashdividends on our common stock.*

 

We intend to retain any future earnings to finance thegrowth and development of our business and we do not plan to pay cash dividendson our common stock in the foreseeable future.

 

*Our stock price is highly volatile,and you may not be able to sell your shares of our common stock at a pricegreater than or equal to the price you paid for them.*

 

The market price and trading volume of our commonstock are volatile, and we expect such volatility to continue for theforeseeable future. For example, during the period between September 30, 2003and September 30, 2004, our common stock closed as high as $18.55 per share andas low as $7.77 per share.  This mayimpact your decision to buy or sell our common stock. Factors affecting ourstock price include:

 

•              ourfinancial results;

 

•              fluctuationsin our operating results;

 

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•              announcementsof technological innovations or new commercial therapeutic products by us orour competitors;

 

•              publishedreports by securities analysts;

 

•              developmentsin our clinical trials and in clinical trials for potentially competitive productcandidates;

 

•              governmentregulation;

 

•              changesin reimbursement policies;

 

•              developmentsin patent or other proprietary rights;

 

•              announcementsthat we have entered into new collaboration, licensing or similar arrangementswith new collaborators, or amendments of the terms of our existingcollaborations;

 

•              developmentsin our relationship with customers;

 

•              publicconcern as to the safety and efficacy of our products; and

 

•              generalmarket conditions.

 

*If we were deemed to be aninvestment company, we would become subject to provisions of the InvestmentCompany Act that likely would have a material adverse impact on our business.*

 

A company is required to register as an investmentcompany under the Investment Company Act of 1940, or the 1940 Act, if, amongother things, and subject to various exceptions:

 

•              itis or holds itself out to be engaged primarily, or proposes to engageprimarily, in the business of investing, reinvesting or trading in securities;or

 

•              itis engaged or proposes to engage in the business of investing, reinvesting,owning, holding or trading in securities, and owns or proposes to acquireinvestment securities having a value exceeding 40 percent of the value ofsuch company’s total assets (exclusive of Government securities and cash items)on an unconsolidated basis.

 

A major portion of our assets has been invested ininvestment grade interest-bearing securities. Such investments could in somecircumstances require us to register as an investment company under the 1940Act. Registration under the 1940 Act, or a determination that we failed toregister when required to do so, could have a material adverse impact on us. Webelieve that we are and will remain exempt from the registration requirements,but absent interpretation by the courts or the SEC of the relevant exemption asapplied to companies engaged in research and development, this result cannot beassured. In addition, a change in our allocation of assets on account of 1940Act concerns could reduce the rate of return on our liquid assets.

 

##### **Item 3. Quantitative and Qualitative Disclosures AboutMarket Risk**

##### ** **

*InterestRate Risk.*  We areexposed to interest rate sensitivity on our investments in debt securities andour outstanding fixed rate debt. The objective of our investment activities isto preserve principal, while at the same time maximizing yields withoutsignificantly increasing risk. To achieve this objective, we invest in highlyliquid, investment grade and government debt securities. Our investments indebt securities are subject to interest rate risk. To minimize the exposure dueto an 

 

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adverse shift in interestrates, we invest in short-term securities and our goal is to maintain anaverage maturity of approximately one year. In addition, as of September 30,2004, we had $200.0 million of outstanding 3.5% convertible subordinated notesdue in 2007. The fair value of these convertible subordinated notes mayfluctuate with changes in market interest rates, as well as changes in themarket price of our common stock.  Ahypothetical 1.0% per annum decrease in interest rates would result in anadverse net change in the fair value of our interest rate sensitive assets andliabilities of approximately $2.6 million at September 30, 2004 and December31, 2003.

 

*EquityPrice Risk.*  We areexposed to equity price risk on strategic investments, such as those we havemade in CuraGen and ImmunoGen. We typically do not attempt to reduce oreliminate our market exposure on these securities. With respect to CuraGen andImmunoGen, each of whose common stock is publicly traded, the aggregate marketvalue of our investments in these securities was approximately $16.5 millionand $20.7 million as of September 30, 2004 and December 31, 2003, respectively.Due to decreases in the market prices of the shares of CuraGen and ImmunoGen,we recorded impairment charges of $67.3 million in 2002 related to theseinvestments. The trading prices of shares of CuraGen and ImmunoGen havefluctuated significantly since we purchased these securities. Each additional10% decrease in market value of these securities would result in a decrease invalue of approximately $1.7 million and $2.1 million from the fair value ofthose investments at September 30, 2004 and December 31, 2003,respectively.  Additional price declinescould cause us to record additional impairment charges in future periods.

 

*Foreign Currency Risk.*A substantial majority of our revenue, expense,and capital purchasing activities are transacted in U.S. dollars. However, wedid enter into transactions in other currencies, primarily the Britishpound.  As of December 31, 2003, we had acontract cancellation obligation to Lonza of $22.7 million, which was payablein British pounds.  As of September 30,2004, we had no remaining obligations to Lonza.

 

# **Item 4. Controls and Procedures**

#  

#### **Evaluation of DisclosureControls and Procedures**

#### ** **

                Basedon their evaluation of our disclosure controls and procedures, as that term isdefined by Rule 13a-15(e) promulgated under the Securities Exchange Act of1934, as of the end of the period covered by this report, our chief executiveofficer and our chief financial officer, have concluded that our disclosurecontrols and procedures are effective in ensuring that all material informationrequired to be included in this quarterly report on Form 10-Q has been madeknown to them in a timely fashion.

 

**Changes in Internal Controls Over Financial Reporting**

 

There has been no change in our internal controlover financial reporting during our last fiscal quarter that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

 

**PARTII.  OTHER INFORMATION**

 

#### **ITEM 1. Legal Proceedings**

#### ** **

Not applicable.

 

#### **ITEM 2. Unregistered Sales of Equity Securities andUse of Proceeds.**

#### ** **

Not applicable.

 

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#### **ITEM 3. Defaults upon Senior Securities**

#### ** **

Not applicable.

 

#### **ITEM 4. Submission of Matters to a Vote of SecurityHolders**

#### ** **

#### **Not applicable.**

#### ** **

#### **ITEM 5. Other Information**

#### ** **

Not applicable.

 

**ITEM6. Exhibits**

 
| **Number** | ** ** | **Description**                                                                                                                                              |
|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                         |
| 3.1(1)     |       | Amended and Restated Certificate of Incorporation of  Abgenix, as currently in effect.                                                                       |
| 3.2(2)     |       | Amended and Restated Bylaws of Abgenix, as currently  in effect.                                                                                             |
| 10.88      |       | Employment Agreement, dated July 20, 2004, between  Abgenix, Inc. and William R. Ringo.                                                                      |
| 10.89      |       | Change of Control Severance Agreement, dated August  30, 2004, between Abgenix, Inc. and William R. Ringo.                                                   |
| 10.90      |       | Resignation and Transition Agreement, dated August  30, 2004, between Abgenix, Inc. and Raymond M. Withy, Ph.D.                                              |
| 31.1       |       | Certification of William R. Ringo Pursuant to Rule  13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                        |
| 31.2       |       | Certification of H. Ward Wolff Pursuant to Rule  13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                           |
| 32.1       |       | Certification of William R. Ringo Pursuant to  18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002. |
| 32.2       |       | Certification  of H. Ward Wolff Pursuant to 18 U.S.C. Section 1350, as Adopted  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.    |

 

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(1)           Incorporatedby reference to the same exhibit filed with Abgenix’s Annual Report onForm 10-K for the year ended December 31, 2002.

 

(2)           Incorporatedby reference to the same exhibit filed with Abgenix’s Annual Report onForm 10-K for the year ended December 31, 2001.

 

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** **

**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 
| Dated:  November 5, 2004 |                                                        |
|--------------------------|-------------------------------------------------------------|
|                     |                                                        |
|                     | **ABGENIX, INC.**                                           |
|                     | (Registrant)                                                |
|                     |                                                        |
|                     |                                                        |
|                     |   /s/ WILLIAM R. RINGO                            |   |
|                     | William R. Ringo                                            |   |
|                     | President and Chief Executive Officer                       |   |
|                     | (Principal Executive Officer)                               |   |
|                     |                                                        |
|                     |                                                        |
|                     |   /s/ H. WARD WOLFF                               |   |
|                     | H. Ward Wolff                                               |
|                     | Chief Financial Officer and Senior Vice President,  Finance |
|                     | (Principal Financial and Accounting Officer)                |

 

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