**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

**FORM 10-Q**

 

**(Mark one)**

 

**ý****  QUARTERLY REPORT PURSUANT TO SECTION 13OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

 

**Forthe quarterly period ended March 31, 2004**

 

**OR**

 

**o****  TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934**

 

**Forthe transition period from               to               ..**

 

**Commissionfile number:        000-24207**

 

**ABGENIX,INC.**

(Exact name of registrant asspecified in its charter)

 

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

 

**(510)284-6500**

(Registrant’s telephone number,including area code)

 

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

 

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

 

As of April 30, 2004 there were 88,721,364 shares of theRegistrant’s Common Stock outstanding.

 

 

----

 

**TABLE OF CONTENTS**

 
| **PART I. Financial Information** |                                                                                                     |
|-----------------------------------|----------------------------------------------------------------------------------------------------------|
|                              |                                                                                                     |
| **ITEM 1.**                       | **Financial Statements**                                                                                 |   |
|                              |                                                                                                     |   |
|                              | Condensed Consolidated Balance Sheets at  March 31, 2004 and December 31, 2003                 |   |
|                              |                                                                                                     |   |
|                              | Condensed Consolidated Statements of  Operations for the three months ended March 31, 2004 and 2003 |   |
|                              |                                                                                                     |   |
|                              | Condensed Consolidated Statements of Cash  Flows for the three months ended March 31, 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.**                       | **Changes in 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 and Reports on Form 8-K**                                                                |   |
|                              |                                                                                                     |
| **SIGNATURES**                    |                                                                                                     |
|                              |                                                                                                     |
| **CERTIFICATIONS**                |                                                                                                     |

 

2

----

 

**PARTI.  FINANCIAL INFORMATION**

 

**ITEM1.  Financial Statements**

 

**ABGENIX, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

(in thousands, except share and per sharedata)

(unaudited)

 
|                                                                                                                                                                                                                   |   | **March 31,  2004** |    | **December 31,  2003** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|---------|-----------------------------|--------|
|                                                                                                                                                                                                                   |   |                     |    |                        |   |
| **ASSETS**                                                                                                                                                                                                             |   |                     |    |                        |   |
| Current assets:                                                                                                                                                                                                        |   |                     |    |                        |   |
| Cash and cash equivalents                                                                                                                                                                                              |   | $                        | 16,389  |                        | $      | 19,141 |   |
| Marketable securities                                                                                                                                                                                                  |   | 290,613                  |    | 328,622                     |   |
| Interest receivable                                                                                                                                                                                                    |   | 2,133                    |    | 3,096                       |   |
| Accounts receivable, net                                                                                                                                                                                               |   | 505                      |    | 2,174                       |   |
| Inventories                                                                                                                                                                                                            |   | 1,796                    |    | —                      |   |
| Prepaid expenses and other current assets                                                                                                                                                                              |   | 11,072                   |    | 12,546                      |   |
| Total current assets                                                                                                                                                                                                   |   | 322,508                  |    | 365,579                     |   |
| Property and equipment, net                                                                                                                                                                                            |   | 241,383                  |    | 246,277                     |   |
| Long-term investments                                                                                                                                                                                                  |   | 19,529                   |    | 20,695                      |   |
| Goodwill                                                                                                                                                                                                               |   | 34,780                   |    | 34,780                      |   |
| Identified intangible assets, net                                                                                                                                                                                      |   | 81,925                   |    | 83,716                      |   |
| Deposits and other assets                                                                                                                                                                                              |   | 28,864                   |    | 29,146                      |   |
|                                                                                                                                                                                                                   |   | $                        | 728,989 |                        | $      | 780,193 |   |
|                                                                                                                                                                                                                   |   |                     |    |                        |   |
| **LIABILITIES, REDEEMABLE CONVERTIBLE  PREFERRED STOCK AND STOCKHOLDERS’ EQUITY**                                                                                                                                 |   |                     |    |                        |   |
| Current liabilities:                                                                                                                                                                                                   |   |                     |    |                        |   |
| Accounts payable                                                                                                                                                                                                       |   | $                        | 9,143   |                        | $      | 11,584 |   |
| Deferred revenue                                                                                                                                                                                                       |   | 10,326                   |    | 10,919                      |   |
| Accrued liabilities                                                                                                                                                                                                    |   | 16,525                   |    | 13,974                      |   |
| Contract cancellation obligation                                                                                                                                                                                       |   | 15,640                   |    | 22,749                      |   |
| Accrued interest payable                                                                                                                                                                                               |   | 311                      |    | 2,061                       |   |
| Total current liabilities                                                                                                                                                                                              |   | 51,945                   |    | 61,287                      |   |
| Deferred rent                                                                                                                                                                                                          |   | 6,547                    |    | 6,153                       |   |
| Convertible subordinated notes                                                                                                                                                                                         |   | 249,870                  |    | 200,000                     |   |
| Redeemable convertible preferred stock,  $0.0001 par value; 5,000,000 shares authorized                                                                                                                                |   |                     |    |                        |   |
| Series A-1 50,000 shares issued and  outstanding at March 31, 2004 and December 31, 2003, respectively;  liquidation preference $50,000,000 at March 31, 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 $50,000,000 at  December 31, 2003; no shares outstanding at March 31, 2004                                |   | —                   |    | 49,868                      |   |
| Commitments                                                                                                                                                                                                            |   |                     |    |                        |   |
| Stockholders’ equity:                                                                                                                                                                                             |   |                     |    |                        |   |
| Common stock, $0.0001 par value; 220,000,000  shares authorized; 88,366,871 and 88,262,457 shares issued and outstanding at  March 31, 2004 and December 31, 2003, respectively                              |   | 9                        |    | 9                           |   |
| Additional paid-in capital                                                                                                                                                                                             |   | 969,335                  |    | 968,922                     |   |
| Accumulated other comprehensive income                                                                                                                                                                                 |   | 7,756                    |    | 8,861                       |   |
| Accumulated deficit                                                                                                                                                                                                    |   | (606,342                 | )       | (564,776                    | )      |
| Total stockholders’ equity                                                                                                                                                                                        |   | 370,758                  |    | 413,016                     |   |
|                                                                                                                                                                                                                   |   | $                        | 728,989 |                        | $      | 780,193 |   |

 

See accompanying notes

 

3

----

 

**ABGENIX, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS**

(in thousands, except per share data)

(unaudited)

 
|                                                                               |   | **Three  Months Ended March 31,** |    |
|------------------------------------------------------------------------------------|--------|----------------------------------------|---------|
|                                                                               |   | **2004**                               |    | **2003** |   |
|                                                                               |   |                                   |    |   |   |
| Revenues:                                                                          |   |                                   |    |   |   |
| Contract revenue                                                                   |   | $                                      | 2,890   |   | $ | 6,156 |   |
| Operating expenses:                                                                |   |                                   |    |   |   |
| Research and development                                                           |   | 28,457                                 |    | 21,187 |   |
| Manufacturing start-up costs                                                       |   | 7,346                                  |    | 11,583 |   |
| Amortization of identified intangible  assets, related to research and development |   | 1,792                                  |    | 1,815 |   |
| General and administrative                                                         |   | 6,888                                  |    | 6,850 |   |
| Total operating expenses                                                           |   | 44,483                                 |    | 41,435 |   |
| Loss from operations                                                               |   | (41,593                                | )       | (35,279 | ) |
| Other income (expense):                                                            |   |                                   |    |   |   |
| Interest and other income                                                          |   | 1,670                                  |    | 3,195 |   |
| Interest expense                                                                   |   | (1,643                                 | )       | (996 | ) |
| Total other income (expense)                                                       |   | 27                                     |    | 2,199 |   |
| Loss before income tax expense                                                     |   | (41,566                                | )       | (33,080 | ) |
| Foreign income tax expense                                                         |   | —                                 |    | 84 |   |
| Net loss                                                                           |   | $                                      | (41,566 | ) | $ | (33,164 | ) |
|                                                                               |   |                                   |    |   |   |
| Basic and diluted net loss per share                                               |   | $                                      | (0.47   | ) | $ | (0.38 | ) |
|                                                                               |   |                                   |    |   |   |
| Shares used in computing basic and diluted  net loss per share                     |   | 88,307                                 |    | 87,706 |   |

 

See accompanying notes

 

4

----

 

**ABGENIX, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASHFLOWS**

(in thousands)

(unaudited)

 
|                                                                         |   | **Three  Months Ended March 31,** |    |
|------------------------------------------------------------------------------|--------|----------------------------------------|---------|
|                                                                         |   | **2004**                               |    | **2003** |   |
| **Operating  activities**                                                    |   |                                   |    |   |   |
| Net loss                                                                     |   | $                                      | (41,566 | ) | $ | (33,164 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |   |                                   |    |   |   |
| Depreciation                                                                 |   | 7,799                                  |    | 5,899 |   |
| Amortization of identified intangible  assets                                |   | 1,791                                  |    | 1,815 |   |
| Impairment of identified intangible asset                                    |   | —                                 |    | 1,443 |   |
| Amortization of debt issuance cost                                           |   | 309                                    |    | 296 |   |
| Changes for certain assets and liabilities:                                  |   |                                   |    |   |   |
| Interest receivable                                                          |   | 963                                    |    | 183 |   |
| Accounts receivable                                                          |   | 1,669                                  |    | 1,201 |   |
| Inventories                                                                  |   | (1,796                                 | )       | — |   |
| Prepaid expenses and other current assets                                    |   | 1,474                                  |    | (2,888 | ) |
| Deposits and other assets                                                    |   | (15                                    | )       | 934 |   |
| Accounts payable                                                             |   | (2,441                                 | )       | (9,421 | ) |
| Deferred revenue                                                             |   | (593                                   | )       | 2,424 |   |
| Accrued liabilities                                                          |   | 2,627                                  |    | (1,329 | ) |
| Contract cancellation obligation                                             |   | (7,109                                 | )       | — |   |
| Accrued interest payable                                                     |   | (1,750                                 | )       | (1,750 | ) |
| Deferred rent                                                                |   | 394                                    |    | 527 |   |
| Net cash used in operating activities                                        |   | (38,244                                | )       | (33,830 | ) |
|                                                                         |   |                                   |    |   |   |
| **Investing  activities**                                                    |   |                                   |    |   |   |
| Purchases of marketable securities                                           |   | (65,810                                | )       | (18,986 | ) |
| Maturities of marketable securities                                          |   | 18,427                                 |    | 16,183 |   |
| Sales of marketable securities                                               |   | 85,442                                 |    | 27,787 |   |
| Purchases of property and equipment                                          |   | (2,980                                 | )       | (16,400 | ) |
| Net cash provided by investing activities                                    |   | 35,079                                 |    | 8,584 |   |
|                                                                         |   |                                   |    |   |   |
| **Financing  activities**                                                    |   |                                   |    |   |   |
| Net proceeds from issuances of common stock                                  |   | 413                                    |    | 317 |   |
| Net cash provided by financing activities                                    |   | 413                                    |    | 317 |   |
| Net decrease in cash and cash equivalents                                    |   | (2,752                                 | )       | (24,929 | ) |
| Cash and cash equivalents at beginning of  period                            |   | 19,141                                 |    | 207,974 |   |
| Cash and cash equivalents at end of period                                   |   | $                                      | 16,389  |   | $ | 183,045 |   |

 

See accompanying notes

 

5

----

 

**ABGENIX, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**March 31, 2004**

**(unaudited)**

 

**1.****                                      Basisof Presentation and Summary of Significant Accounting Policies**

 

**Basisof Presentation -**The unaudited condensed consolidatedfinancial statements of Abgenix, Inc. (the “Company” or “Abgenix”) includedherein have been prepared pursuant to the rules and regulations of theSecurities and Exchange Commission. Certain information or footnote disclosure normally included in financialstatements prepared in accordance with generally accepted accounting principleshas been condensed or omitted pursuant to such rules and regulations.  In the opinion of the Company, theaccompanying unaudited condensed consolidated financial statements contain alladjustments, consisting only of normal recurring adjustments, necessary topresent fairly the financial information included therein.  These financial statements should be read inconjunction with the audited financial statements for the year endedDecember 31, 2003,****andaccompanying notes included in the Company’s annual report as filed on Form10-K with the Securities and Exchange Commission.  The results of operations for the three months endedMarch 31, 2004, are not necessarily indicative of the results to beexpected for the full year or for any other future period.

 

**Foreign Exchange –**Accountsdenominated in foreign currency have been remeasured using the U.S. dollar asthe functional currency.  The aggregateexchange gain/loss included in determining net loss was a $0.7 million exchangeloss in the three months ended March 31, 2004 and a $0.04 million exchangegain in the three months ended March 31, 2003.

 

**Consolidation -**In January 2003, the FASB issuedInterpretation No. 46 (the “Interpretation”), Consolidation of VariableInterest Entities.  The Interpretationrequires the consolidation of entities in which an enterprise absorbs amajority of the entity’s expected losses, receives a majority of the entity’sexpected residual returns, or both, as a result of ownership, contractual orother financial interests in the entity. The interpretation was effective immediately for variable interestscreated after January 31, 2003. The Company adopted the remaining provision of the Interpretation,pertaining to variable interests existing prior to January 31, 2003, inthe quarter ending March 31, 2004. The adoption of the Interpretation did not have a material impact on theresults of operations and the financial position of the Company.  Significant intercompany accounts andtransactions have been eliminated.

 

**Stock-Based Compensation -**TheCompany accounts for stock-basedawards to employees and directors using the intrinsic value method inaccordance with Accounting Principles Board Opinion No. 25, “Accounting forStock Issued to Employees.” Accordingly, the Company does not recognizecompensation expense for employee stock options granted at fair market value. For purposes of disclosures pursuant toStatement of Financial Accounting Standards (SFAS 123), as amended by SFAS 148,the estimated fair value of options is amortized to expense straight-line overthe options’ vesting period. Thefollowing table illustrates what net loss would have been had the Companyaccounted for its stock-based awards under the provisions of SFAS 123. Proforma amounts may not be representative of future periods.

 

|                                                                                                                                                                   |   | **Three  Months Ended  March 31,**        |    |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------|---------|
|                                                                                                                                                                   |   | **2004**                                       |    | **2003** |   |
|                                                                                                                                                                   |   | **(in  thousands, except per  share amounts)** |    |
|                                                                                                                                                                   |   |                                           |    |
| Net loss                                                                                                                                                               |   | $                                              | (41,566 | ) | $ | (33,164 | ) |
| 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 |   | (12,355                                        | )       | (15,921 | ) |
| Pro forma net loss as if the fair value  based method had been applied to all awards                                                                                   |   | $                                              | (53,921 | ) | $ | (49,085 | ) |
|                                                                                                                                                                   |   |                                           |    |   |   |
| Basic and diluted net loss per share as  reported                                                                                                                      |   | $                                              | (0.47   | ) | $ | (0.38 | ) |
|                                                                                                                                                                   |   |                                           |    |   |   |
| Pro forma basic and diluted loss per share                                                                                                                             |   | $                                              | (0.61   | ) | $ | (0.56 | ) |

 

6

----

 

Thefair value for these options was estimated at the date of grant using aBlack-Scholes option pricing model with the following weighted-averageassumptions for the three months ended March 31, 2004 and 2003:

 

|                                                                 |   | **Three  Months Ended  March 31,** |   |
|----------------------------------------------------------------------|--------|-----------------------------------------|--------|
|                                                                 |   | **2004**                                |   | **2003** |   |
| Risk-free interest rate                                              |   | 3.07                                    | %      | 3.07 | % |
| Dividend yield                                                       |   | 0.00                                    | %      | 0.00 | % |
| Volatility factors of the expected market  price of our Common Stock |   | 0.90                                    |   | 1.06 |   |
| Weighted-average expected life of option  (years)                    |   | 5.55                                    |   | 5.52 |   |

 

Thesesame assumptions were applied in the determination of the option values relatedto stock options granted to non-employees, except the option life, for whichthe term of the consulting contracts, 1 to 5 years, were used. The valuehas been recorded in the financial statements.

 

**Net Loss Per Share -**Basicnet loss per share is calculated based on the weighted-average number of sharesoutstanding during the period. The impact of common stock options, warrants andshares issuable upon the conversion of convertible subordinated notes, and theredeemable convertible preferred stock was excluded from the computation ofdiluted net loss per share, as their effect is antidilutive for the periodspresented.

 

**Reclassifications -**Certainprior period balances have been reclassified to conform to the current periodpresentation.

 

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

 

Other comprehensive income/(losses) consist of unrealized gains orlosses on available-for-sale securities. The components of comprehensive loss,net of tax, were as follows:

 

|                                             |   | **Three  Months Ended  March 31,** |    |
|--------------------------------------------------|--------|-----------------------------------------|---------|
|                                             |   | **2004**                                |    | **2003** |   |
|                                             |   | **(in  thousands)**                     |    |
|                                             |   |                                    |    |
| Net loss                                         |   | $                                       | (41,566 | ) | $ | (33,164 | ) |
| Other comprehensive income (loss):               |   |                                    |    |   |   |
| Unrealized holding losses arising during  period |   | (1,105                                  | )       | (2,750 | ) |
|                                             |   |                                    |    |   |   |
| Comprehensive loss                               |   | $                                       | (42,671 | ) | $ | (35,914 | ) |

 

7

----

 

**3.****                                      SegmentInformation**

 

The operations of the Company and its whollyowned subsidiaries constitute one business segment.

 

Information about customers who provided 10%or more of contract revenues for the period is as follows:

 
| **Period**                              |   | **Number of  Customers and Percentage of  Contract Revenues for each of the Customers** |
|-----------------------------------------|--------|-----------------------------------------------------------------------------------------|
| Three months ended  March 31, 2004 |   | 4 customers, 42%, 16%, 15% and  12%, respectively                                       |
| Three months ended  March 31, 2003 |   | 3 customers, 49%, 12% and 10%,  respectively                                            |

 

**4.****                                      ConvertibleSubordinated Note**

 

In October 2003, in connection with a collaboration agreement, theCompany entered into a securities purchase agreement with AstraZeneca. Pursuantto the agreement, the Company issued to AstraZeneca $50.0 million of Series A-1 convertiblepreferred stock and $50.0 million of Series A-2 convertible preferredstock.  The net proceeds from thesecurities were $99.7 million.  Pursuant to its terms, the Series A-2preferred stock was redeemed at the option of AstraZeneca on February 19,2004 and the Company 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 the Company.

 

*Conversion rights*

 

The Company, subject to certain conditions, can convert the convertiblesubordinated note into shares of common stock at a conversion price equal tothe lower of (a) the average market price for the 10 days prior to the tradingday immediately preceding the conversion date (provided that the average marketprice shall in no event be higher than 101% of the market price on the tradingday immediately preceding the conversion date) or (b) $30.00 per share.

 

AstraZeneca may convert the convertiblesubordinated note into shares of common stock at a conversion price of $30.00per share, at any time prior to the repayment of the principal amount of thenote.

 

*Redemption rights and maturity*

 

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

 

AstraZeneca has the right to require Abgenix to repay the convertiblesubordinated note at its face amount, upon the occurrence of a change incontrol of Abgenix after the completion of a defined research period.  At its option, and subject to certainconditions, Abgenix may deliver shares of its common stock in lieu of cash uponsuch an event.

 

AstraZeneca has the right to require Abgenixto repay a specified portion of the convertible subordinated note upon theoccurrence of (a) a material breach by Abgenix of a materialobligation 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 all researchprograms and future programs under the

 

8

----

 

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, andsubject to certain conditions, Abgenix may deliver shares of its common stockin lieu of cash upon such events.

 

Upon the occurrence of certain events ofdefault, (1) the holders of the convertible subordinated note shall have theright to make the entire outstanding principal amount of the note due andpayable and (2) if the event of default is a payment default, quarterlyinterest payments shall begin to accrue on the convertible subordinated note ata default rate equal to the 10-year U.S. treasury rate plus three percent (3%)compounded annually.  Events of defaultfor purposes of this provision include, but are not limited to, the following(i) a failure to make a required payment, or a breach by the Company of any ofthe Company’s other obligations under, the Series A-1 preferred stock, theconvertible subordinated note or any subordinated promissory note that may beissued by the Company in the circumstances described below under “Aggregateownership limitation”; (ii) a breach of the Company of specified obligationsunder the securities purchase agreement with AstraZeneca; (iii) the securitiespurchase agreement, or any other agreement or instrument contemplated by thesecurities purchase agreement, is asserted by the Company not to be a legal,valid and binding instrument; (iv) certain bankruptcy and insolvency eventsinvolving the Company; and (v) a cross-acceleration of $25 million or more ofother indebtedness of the Company.

 

*Liquidation and Voting rights*

 

The convertible subordinated 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.

 

Theconvertible subordinated note is senior to the preferred stock and the commonstock and is junior to all senior indebtedness and to the Company’s 3.5% convertible subordinated notes due in2007.

 

*Aggregate ownership limitation*

 

Atno time may any holder of the convertible subordinated note beneficially own,following the conversion of the convertible subordinated note, more than 19.9%of the Company’s common stock then outstanding.  If any shares of common stock are issuable to a holder uponconversion of the convertible subordinated note that would result in any holder(together with its affiliates) owning common stock in excess of the ownershipthreshold described above, then the Company will be required to redeem theshares in excess of the ownership threshold for a price equal to (1) the numberof such excess shares times (2) the average market price of the common stockfor the 30 consecutive days ending on the 15th trading day prior tothe conversion date (such price, the “Excess Shares Redemption Price”).  Upon such a redemption of the sharesissuable upon conversion of the convertible subordinated note, the Company willhave the right, upon delivery of notice to the holder, to receive a loan fromthe holder in the form of interest-free subordinated promissory note.  The face amount of the promissory note shallbe the Excess Shares Redemption Price.

 

**5.****                                     ****Inventories**

 

Inventories consist of materials related to a production servicecontract with a collaborator.  Inventorycost is computed on a weighted-average cost basis.  Inventories at period end were as follows:

 

|            |   | **March 31,  2004** |   | **December 31,  2003** |   |
|-----------------|--------|--------------------------|--------|-----------------------------|--------|
|            |   | **(in  thousands)**      |   |
|            |   |                     |   |                        |   |
| Raw material    |   | $                        | 38     |                        | $      | — |   |
| Work in process |   | 78                       |   | —                      |   |
| Finished goods  |   | 1,680                    |   | —                      |   |
|            |   | $                        | 1,796  |                        | $      | — |   |

 

9

----

 

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

 

*The following Management’s Discussion and Analysis of FinancialCondition and Results of Operations contains forward*-*looking statements based upon current expectationsthat involve risks and uncertainties. In this quarterly report on Form 10*-*Q, the words “intend,” “anticipate,” “believe,”“estimate,” “plan” and “expect” and similar expressions as they relate toAbgenix are included to identify forward*-*looking statements. Our actual results and the timing of certain eventscould differ materially from those anticipated in these forward*-*looking statements as a result of certain factors,including those set forth below and under the heading “Additional Factors thatMight Affect Future Results”.  In thisquarterly report on Form 10-Q, references to “Abgenix,” we,” “us,” and “our”are to Abgenix, Inc. and its subsidiaries.*

 

##### **Overview**

##### ** **

Thefollowing Management’s Discussion and Analysis of Financial Condition andResults of Operations is intended to help the reader understand our company.

 

***Our Business***

 

Weare a biopharmaceutical company that is focused on the discovery, development and manufacture of humantherapeutic antibodies for thetreatment of a variety of diseases.   Weintend to use our proprietary technologies to build a large and diversifiedproduct portfolio that we expect to develop and commercialize largely throughjoint development and commercialization arrangements with pharmaceuticalcompanies and others.

 

We are co-developing our most advanced proprietary product candidate,panitumumab (formerly known as ABX-EGF), with Immunex.  Panitumumab is in pivotal trials, and wehave two product candidates in early stage clinical trials.  In addition, we have entered into a varietyof contractual arrangements with pharmaceutical, biotechnology and genomicscompanies involving our technologies. We use our closely integrated processsciences and manufacturing capabilities for the manufacture of our own proprietaryproduct candidates and also offer these services to our collaborators andothers.

 

We intend to enter into co-development agreements in addition to ouragreement for panitumumab.  We generallyexpect to self-fund preclinical and clinical activities to determine preliminary safety and efficacybefore entering into joint development and commercialization agreements.  In some cases we may conduct productdevelopment entirely on our own.  Wehave begun to implement our collaboration strategy through co-developmentarrangements with companies such as Chugai Pharmaceuticals Co., Ltd., U3 PharmaAG and Dendreon Corporation, and through a broad collaboration in oncology withAstraZeneca UK Limited.  Our strategy is designed to diversify therisks associated with our research and development spending and to continue tofocus our activities on product development and commercialization.

 

Under our collaboration with AstraZeneca, we are obligated to providepreclinical and clinical research support for the development of up to 36product candidates by AstraZeneca and have an opportunity to co-developproducts with AstraZeneca.

 

***Our Financial Position and Liquidity***

 

We derive our revenues from our technology out-licensing contracts, ourproprietary product development agreements, our target sourcing contracts andour production services contracts. We expect that substantially all of ourrevenues for the foreseeable future will result from payments under these andsimilar arrangements and that payments we receive under these arrangements willcontinue to be subject to significant fluctuation in both timing and amount.

 

We have incurred and expect to continue to incur substantial expensesin connection with our product development activities, both under contractualarrangements with third parties and related to our

 

10

----

 

independent research and development efforts.  Regulatory and business factors will require us to expendsubstantial funds in the course of completing required additional research,preclinical testing and clinical trials of, and attaining regulatory approvalsfor, product candidates. 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.

 

We have incurred net losses since we were organized as an independentcompany, including a net loss of $ 41.6 million for the three months endedMarch 31, 2004.  We expect to incuradditional losses for the foreseeable future as a result of our research anddevelopment costs and manufacturing start-up costs, including costs associatedwith conducting preclinical development and clinical trials, and chargesrelated to purchases of technology or other assets.   We expect that the amount of our operating losses will fluctuatesignificantly from quarter to quarter.

 

Asof March 31, 2004, we had cash, cash equivalents and marketable securitiesof $307.0 million.   The amounts ofthe expenditures that will be necessary to execute our business plan aresubject to numerous uncertainties that may adversely affect our liquidity andcapital resources to a significant extent. We plan to continue to make significant expenditures to establish, staffand operate our own manufacturing facility and support our research anddevelopment activities, including preclinical product development and clinicaltrials.  We expect that these activitieswill substantially increase our operating expenses over the next few years incomparison to prior periods.

 

***Summary of Contractual Arrangements***

 

Wehave entered into a variety of contractual arrangements covering numerousantigens with more thanthirty customers to use our XenoMouse and XenoMax technologies to generateand/or develop the resulting fully human antibodies.  Pursuant to our XenoMouse contracts, we and our customers intendto generate antibodies for development as product candidates for the treatmentof cancer, 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 ourcurrent contractual arrangements vary, but can generally be categorized asfollows:

 

•                                          Proprietary Product Development—In 2000, weentered into a joint development and commercialization agreement with Immunexfor the co-development of ABX-EGF, now known as panitumumab, a fully humanantibody we created.  We amended thisagreement in October 2003.  Underthe amended agreement, Immunex has decision-making authority for developmentand commercialization activities.  Asunder the original agreement, we are obligated to pay 50% of the developmentand commercialization 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 ofMarch 31, 2004, we had not received any advances from Immunex, but weexpect to take advantage of this credit facility when it becomes available tous.  The amount of any such advances,plus interest, may be repaid out of profits resulting from future productsales; however, we are not obligated to repay any portion of the advances ifpanitumumab does not reach commercialization. Under a separate agreement withImmunex, we will manufacture clinical supplies for the collaboration and, forthe first five years after commercial launch, commercial supplies withImmunex’s support and assistance.  Thecosts of manufacturing clinical and commercial supplies will also beshared.  We have entered intoco-development and commercialization arrangements for the development ofproprietary products that are in various early stages with other collaborators,including Microscience Limited, Sosei Co., Ltd., Dendreon and Chugai.  Development activities under theseagreements are in various early stages.

 

11

----

 

•                                          Oncology Alliance – We entered into acollaboration and license agreement with AstraZeneca in October 2003 forthe discovery, development and commercialization of fully human monoclonalantibodies to treat cancer.  Thisalliance involves the joint discovery and development of therapeutic antibodiesfor up to 36 cancer targets to be commercialized exclusively worldwide byAstraZeneca.  We will conduct earlystage preclinical research on behalf of AstraZeneca with respect to some or allof these targets.  For any resulting products,we may receive milestone payments at various stages of development and royaltieson future product sales.  AstraZenecamay make milestone payments to us of up to $51 million per candidate drug thatis developed under the agreement, and for any drug we choose to develop to atarget that is discontinued from the collaboration, we may pay AstraZeneca upto $15 million.  Under the agreement, wealso may conduct early clinical trials, process development and clinicalmanufacturing, as well as commercial manufacturing during the first five yearsof commercial sales, for which the agreement provides that AstraZeneca willcompensate us at competitive market rates. The collaboration also gives us the right to select and develop anadditional pool of antibodies against up to 18 targets, which the companies mayelect to further develop on an equal cost and profit sharing basis.  During the three-year period of selection oftargets for development we will work exclusively with AstraZeneca to generateand develop antibodies for therapeutic use directed against antigens in thefield of oncology, subject to various exceptions, including among others forantigens that are or become subject to existing collaborations, antigens thatwe and AstraZeneca decide not to pursue in the collaboration, and certainprocess development and manufacturing services.  In connection with this collaboration, AstraZeneca made a $100.0million investment in Abgenix securities. Upon the achievement of certain milestones, we may also requireAstraZeneca to invest up to an additional $60.0 million in our convertible preferredstock.

 

•                                          Antigen Sourcing Contracts—We have enteredinto several target sourcing contracts with genomics and biopharmaceuticalcompanies that may enable us to generate a pipeline of proprietary fully humanantibody therapeutic product candidates. Typically, pursuant to these contractswe generate fully human antibodies to the antigens provided or identified byour collaborators. The contracts typically contain provisions that allow eitherus or our collaborator to evaluate and select particular antibodies from thepool of generated antibodies for further development and commercialization. Theparty selecting an antibody for further development or commercialization willgenerally pay to the other party license fees, milestone payments and royalty paymentson any eventual product sales, in exchange for rights to develop andcommercialize the product. In connection with these arrangements, we may alsoagree to make equity investments in collaborators for strategic reasons. Forexample, we have made equity investments in CuraGen Corporation and MDSProteomics Inc. in connection with our collaborations with those entities.

 

•                                          Technology Out-Licensing—We have licensed ourXenoMouse technology to third parties for the purpose of generating antibodyproduct candidates to one or more specific antigens provided by thecustomer.  Pursuant to these contracts,we and our customers intend to generate antibody product candidates for thetreatment of cancer, inflammation, autoimmune diseases, cardiovascular disease,growth factor modulation, neurological diseases and infectious diseases.  In some cases in which we license XenoMousetechnology, we provide our mice to the customer, which then carries outimmunizations with its specific antigens. In other cases, we immunize the micewith the customer’s antigens for additional compensation.  We may also use our XenoMax technology onthe customer’s behalf.  The customergenerally has an option for a period of time to acquire a product license forany antibody identified using XenoMouse technology that the customer wishes todevelop and commercialize. The financial terms of these agreements may includelicense fees, option fees and milestone payments paid to us by the customers.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 any

 

12

----

 

futureproduct sales by the customer.  We alsohave the right of first offer with regard to production services for antibodiesdeveloped pursuant to certain of these agreements.  We may also agree to make equity investments in some of ourcustomers, or they may agree to make equity investments in us, in connectionwith these licensing arrangements. As of March 31, 2004, we hadentered 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 enteredinto an agreement in which we exclusively licensed to one party rights underpatent applications and patents held by us to develop and commercialize therapeuticantibodies to parathyroid hormone-related protein.

 

•                                          ProductionServices Contracts—We have entered into contracts with two customers underwhich we are currently providing process sciences and manufacturingservices.  One of these contracts is relatedto an antibody product candidate that we developed with the customer pursuantto an existing antigen sourcing contract. The other relates to an antibody the customer developed under aXenoMouse license agreement.  Underthese production services contracts we are delivering a variety of processdevelopment, cell banking and manufacturing services for selected antibodyproduct candidates. The agreements provide for the customer to pay us certainfees for production services.  Under oneof these agreements we will be entitled to royalties on the sale of productssubject to the agreement.  We also havethe right of first offer with regard to production services for additionalantibodies developed by one of these customers.  We intend to enter into agreements to provide process sciencesand manufacturing services to other existing and new customers to absorbproduction services capacity we are not using for our proprietary productcandidates.

 

•                                          Technology In-Licensing—We also licensetechnology from other parties that we use in conjunction with our proprietarytechnology to develop, manufacture and commercialize therapeutic antibodycandidates. The other party may also agree to produce antibody therapeuticcandidates for us using its own technology. For example, we have entered into license and options agreements withImmunoGen, Inc. pursuant to which we may develop and commercialize productsbased upon certain proprietary immunotoxins. These agreements often obligate us to pay license fees, and milestonepayments and royalty fees to the counterparty upon the occurrence of specifiedconditions, including upon our sale of products derived from use of thelicensed technology. We may also agree to make an equity investment in theother party for strategic reasons in connection with these arrangements. Forexample, we purchased shares of common stock of ImmunoGen in connection withour agreement with that company.

 

***Summary of Product Development***

 

Asof March 31, 2004, three of our antibody therapeutic product candidateswere in ongoing clinical trials.

 

•                  Panitumumab (ABX-EGF).  Our leading proprietary antibodytherapeutic product candidate is panitumumab. Generated using our technology, panitumumab is a fully human antibodytherapeutic product candidate for the treatment of a variety of cancers. We areco-developing this candidate with Immunex under a development andcommercialization agreement.  The statusof clinical trials of panitumumab is as follows:

 

•                  Various cancers—We initiated a Phase 1clinical trial for panitumumab in cancer in July 1999.  In 2003, we expanded enrollment toinvestigate additional dose levels. Enrollment is closed and treatment is ongoing.

 

•                  Renal cell cancer—We initiated a Phase 2clinical trial evaluating the effect of

 

13

----

 

panitumumabas monotherapy in patients with renal cell cancer in April 2001 andenrollment is ongoing.

 

•                  Non-small cell lung cancer— Immunex initiateda Phase 2 clinical trial for panitumumab in non-small cell lung cancer incombination with standard chemotherapy, compared to standard chemotherapyalone, in July 2001.  Enrollment isclosed and treatment is ongoing.

 

•                  Colorectal cancer— Immunex initiated a Phase2 clinical trial evaluating the effect of panitumumab as monotherapy inpatients with metastatic colorectal cancer who have previously failedchemotherapy in December 2001. Enrollment is closed and treatment is ongoing. Immunex initiated aseparate Phase 2 clinical trial evaluating the effect of panitumumab incombination with standard chemotherapy, as first-line treatment in patientswith metastatic colorectal cancer, in January 2002, in which enrollment isongoing.

 

InJanuary 2004 Immunex initiated a pivotal study of panitumumab as athird-line monotherapy in patients with colorectal cancer.  The trial initiation followed the receipt ofa 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.  At the same time Immunex initiated a secondpivotal study outside the United States in support of a global registrationprogram.

 

•                  Prostate cancer—We initiated a Phase 2clinical trial evaluating the effect of panitumumab in patients with hormoneresistant prostate cancer in January 2002, in which treatment isongoing.  Based on a preliminaryanalysis, we have recently closed enrollment in this trial.  The preliminary findings do not meet ourplanned threshold to support pursuing the drug as a monotherapy in thisindication.

 

•                  ABX-MA1. Generated using our technology, ABX-MA1 is a fully human antibodytherapeutic product candidate for the treatment of a variety of cancers.  We filed an investigational new drugapplication, or IND, in December 2001 and initiated a Phase 1 clinicaltrial evaluating the effect of ABX-MA1 in patients with metastatic melanoma inFebruary 2002.  Enrollment isclosed and treatment is ongoing.

 

•                  ABX-PTH. Generated using our technology, ABX-PTH is a fully human antibodytherapeutic product candidate for the treatment of a secondaryhyperparathyroidism.  We filed an IND inDecember 2003 and initiated a Phase 1 clinical trial evaluating the effectof ABX-PTH in patients with secondary hyperparathyroidism in February 2004.  Enrollment is ongoing.

 

“Phase 1” indicates safety and pharmacokinetics testing in a limitedpatient population. “Phase 2” indicates safety, dosing and efficacy testing ina limited patient population. “Phase 3” indicates efficacy and safety testingin a larger patient population.  A“pivotal study” is designed to meet registration requirements.  Phase 3 studies designed for registrationpurposes are considered pivotal studies. Certain Phase 2 studies can be pivotal studies.

 

We have entered into a broad collaboration with AstraZeneca for thedevelopment of antibody therapeutics for the treatment of oncology pursuant towhich we have an opportunity to co-develop products with AstraZeneca, as wellas provide preclinical and clinical research support for the development ofproduct candidates by AstraZeneca.  Inaddition, we have entered into co-development agreements for the jointdevelopment of antibody product candidates with a variety of companies includingChugai and Sosei.  We intend to enterinto additional joint development agreements for other product candidates.  We will expend significant capital to conduct clinical trials orshare in the costs of conducting clinical trials for our proprietary product candidates. We expect that this willsubstantially

 

14

----

 

increaseour operating expenses over the next few years in comparison to prior periods.

 

Inaddition to our proprietary antibody therapeutic product candidates in clinicaltrials, there are four customer-developed antibodies generated with XenoMousetechnology in clinical trials or the subject of an IND as follows:

 

•                                          Pfizer Inc.—We generated twoXenoMouse-derived fully human antibody therapeutic product candidates thatPfizer has advanced into clinical trials. In addition, Pfizer filed an IND to initiate clinical testing of a thirdXenoMouse-derived fully human antibody therapeutic product candidate inJanuary 2004.

 

•                                          Amgen—We generated a XenoMouse-derived fullyhuman antibody therapeutic product candidate that binds to an undisclosedantigen that Amgen has advanced into clinical trials as a potential treatmentfor bone loss.

 

**Results of Operations**

 

*Three Months Ended March 31, 2004 and 2003*

 

*Contract Revenues.*

 

Contractrevenues totaled $2.9 million and $6.2 million, respectively, in the threemonths ended March 31, 2004 and 2003. Because contract revenues depend toa large extent on the success or failure of research and development effortsundertaken by our collaborators and licensees, our period-to-period contractrevenues can fluctuate significantly and are inherently difficult to predict.

 

Theprimary components of contract revenues for both periods were as follows:

 

•                  Technology Licensing

 

Werecognized a total of $2.5 million and $5.5 million in the three monthsended March 31, 2004 and 2003, respectively, from licensing ourproprietary technologies. Revenues consisted primarily of the following:

 

•                  Pfizer – In the three months endedMarch 31, 2004, we recognized $1.2 million under a technology licenseagreement with Pfizer, consisting of a milestone for the filing of an IND,product license fees and research license and service fees.  In the three months ended March 31,2003, we recognized $0.8 million, which consisted of milestone and productlicense revenue.

 

•                  Chugai – In the three months endedMarch 31, 2003, we recognized $3.0 million under an agreement with Chugaiin which we exclusively licensed to Chugai rights to methods of treatment ofcertain diseases with an antibody.

 

•                  Additionally, in the three months endedMarch 31, 2004 and 2003, we recognized various fees, such asresearch license and service fees, product license fees, product developmentand research milestone payments and option fees, under technology license agreements.  We recognized fees from severalcollaborators, but primarily from PSMA Development Company, LLC and Amgen inthe three months ended March 31, 2004, and primarily from CuraGen, AbbottLaboratories and Amgen in the three months ended March 31, 2003.

 

•                  Proprietary Product Development

 

15

----

 

Werecognized zero and approximately $621,000, respectively in the three monthsended March 31, 2004 and 2003, respectively, pursuant to our jointdevelopment and commercialization agreements. In the three months ended March 31, 2003, the revenues consisted ofreimbursement of development costs from the development of ABX-CBL.  Revenue decreased in the three months endedMarch 31, 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 to be less in 2004 as compared to 2003 as weexpect our collaborator’s costs for the panitumumab development program toexceed our costs and because of the discontinuance of the ABX-CBL developmentprogram.

 

•                  Production Services

 

Werecognized a total of $432,000 in revenues during the three months endedMarch 31, 2004 for production services. These revenues consisted primarily of process sciences services and weregenerated from our manufacturing contract with CuraGen.  In the first quarter of 2003 we did notrecognize any revenues from production services.

 

*Research and Development Expenses.*

 

Researchand development expenses were $28.5 million and $21.2 million, respectively, inthe three months ended March 31, 2004 and 2003. The major components ofresearch and development expenses were as follows:

 

Researchand Development:

 
|                                 |   | **March 31,**  |   |
|--------------------------------------|--------|---------------------|--------|
|                                 |   | **2004**            |   | **2003** |   |
|                                 |   | **(in  thousands)** |   |
| Product development                  |   | $                   | 19,111 |   | $ | 9,680 |   |
| Research                             |   | 8,556               |   | 8,643 |   |
| In-licensing                         |   | 790                 |   | 2,864 |   |
| Total research and development costs |   | $                   | 28,457 |   | $ | 21,187 |   |

 

Productdevelopment costs include costs of preclinical development, cell linedevelopment and conducting clinical trials. Additionally, product development includes costs related to cell linedevelopment activities we perform under our production services contracts.  The primary components of productdevelopment include the costs of Abgenix personnel, drug supply costs, researchfees charged by outside contractors, co-development costs, and facilityexpenses, including depreciation.  Inthe three months ended March 31, 2004, our product development costsincreased in comparison to the same period in 2003, primarily due to asignificant increase in the development costs for the panitumumab program.  To a lesser extent the increase was due tocosts related to new product candidates including development costs under ourproduction services agreements. Offsetting some of the increase in product development costs weredecreases in development costs, primarily for ABX-CBL and ABX-IL8, for which wehave discontinued development, and ABX-PTH due to the timing of certain developmentcosts.  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.

 

Researchcosts include costs associated with research and testing of antibodieswe generate, whether for ourselves or for our customers, prior to thedevelopment stage which begins with the commencement of preclinicalactivities.  Research costs also includethe costs of research relating to proprietary technologies, includingenhancements to those technologies.  Theprimary components of

 

16

----

 

research costs include the costs of Abgenix personnel, facilities,including depreciation, and lab supplies.  Ourresearch costs in the three months ended March 31, 2004 were comparable tothose incurred in the same period of 2003 and resulted from the activitiesrelated to new target validation, including preclinical evaluation of severaltargets related to collaborations such as our collaboration with AstraZeneca,and bioinformatics activities.

 

In-licensingcosts include costs to acquire licenses to develop and commercialize varioustechnologies and molecules.  In thethree months ended March 31, 2004, the in-licensing costs decreasedsignificantly as compared to the same period in 2003.  The largest component of this cost in the three months endedMarch 31, 2003 was related to licenses and research funding for thedevelopment of therapeutic antibodies to the complement protein properdin,which we licensed from Gliatech Inc.  Inthe first quarter of 2003, we decided to discontinue the development ofproperdin and as a result we recorded an impairment charge of $1.4 million forpreviously capitalized costs and $600,000 of other related costs related to thelicense to develop and commercialize properdin.

 

Majorcomponents of research and development costs for the three months endedMarch 31, 2004 and 2003 were as follows:

 

•                  Costsof Abgenix Personnel — Costs of Abgenix personnel to support research anddevelopment activities increased 19% in the three months ended March 31,2004 as compared to the same period in 2003. Personnel costs primarilyinclude salary, fringe benefits, recruiting and relocation costs.  The increase was primarily due to increasedpersonnel costs for process sciences and preclinical research; and increased useof our manufacturing facility for development activities, including processvalidation for the manufacture of our conformance lots.

 

•                  Consulting and Outside Contractors — Costs ofconsulting and outside contractors to support research and development activitiesdecreased 15% in the three months ended March 31, 2004 as compared to thesame period in 2003.  The decrease wasprimarily due to a reduction of activities performed by outside contractorsrelated to toxicology studies.

 

•                  Clinical Research Fees – Clinical researchfees, including clinical investigator site fees, monitoring costs and datamanagement costs, increased 74% in the three months ended March 31, 2004as compared to the same period in 2003. The increase was primarily the result of increased clinical trialactivities for panitumumab and ABX-PTH.

 

•                  Drug Supply Costs – Drug supply costsincreased 169% in the three months ended March 31, 2004 as compared to thesame period in 2003.  The increase wasprimarily due to clinical drug supply costs for panitumumab.

 

•                  Co-development costs – Co-development costs,which primarily consist of reimbursement to Immunex for our share ofpanitumumab development costs, increased significantly in the three monthsended March 31, 2004 compared to the same period in 2003.  The increase was primarily related to costsharing for activities performed by Immunex associated with the co-developmentof panitumumab.  The increase was alsodue to our increased activities for clinical trials related to the developmentof panitumumab.

 

•                  Facility and Other Overhead Related Costs –These costs consist of depreciation, rent and other facility related costs andincreased 109%.  The increase wasprimarily related to increased use of our manufacturing facility fordevelopment activities, including process validation activities related to themanufacture of panitumumab conformance lots.

 

Theclinical trial status of product candidates included in product developmentcosts is as follows as of March 31 for each of the years indicated:

 

17

----

 
| **Proprietary Product** |   |                                  |   | **Clinical  Trial Status as of  March 31,** |       |
|-------------------------|--------|---------------------------------------|--------|--------------------------------------------------|------------|
| **Candidate**           |   | **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) |   |
|                    |   | Colorectal cancer                     |   |                                             | Phase 2(1) |   |   | Phase 2(1) |   |
|                    |   | Colorectal cancer (with chemotherapy) |   |                                             | Phase 2(1) |   |   | Phase 2(1) |   |
|                    |   | Prostate cancer                       |   |                                             | Phase 2    |   |   | Phase 2 |   |
|                    |   | Colorectal cancer (outside the US)    |   |                                             | Pivotal(1) |   |   |   |   |
|                    |   | Colorectal cancer                     |   |                                             | Pivotal(1) |   |   |   |   |
| ABX-MA1                 |   | Metastatic melanoma                   |   |                                             | Phase 1    |   |   | Phase 1 |   |
| ABX-PTH                 |   | Secondary hyperparathyroidism         |   |                                             | Phase 1    |   |   |   |   |

 

----

(1)          Clinicaltrial managed by Immunex.

 

*Manufacturing Start-Up Costs.*

 

Manufacturing start-up costswere $ 7.3 million and $11.6 million, respectively, in the three months endedMarch 31, 2004 and 2003, respectively. Manufacturing start-up costs include certain costs associated with ournew manufacturing facility, including depreciation, outside contractor costsand personnel costs for activities such as quality assurance and qualitycontrol.  The decrease in the threemonths ended March 31, 2004 as compared to the same period in 2003 wasprimarily due to the increased use of our manufacturing facility fordevelopment activities, including process validation for the manufacture of ourconformance lots.  The primary componentof this cost in the first quarter of 2003 consisted of costs under a manufacturingsupply agreement with Lonza Biologics plc for a production suite heldexclusively for us, which we were not using. We canceled the Lonza agreement in the second quarter of 2003 andexpensed the associated cancellation fee in that quarter.

 

We expect our manufacturingfacility to be under-utilized in 2004 and therefore we will continue to incurmanufacturing start-up costs in 2004. However, we expect manufacturing start-up costs to decrease in 2004compared to 2003 as a result of expensing the Lonza cancellation fee in 2003and the utilization of the facility in 2004 for the manufacture of panitumumaband potentially other product candidates under production services agreements.

 

*Amortization of Identified Intangible Assets.*

 

Ouridentified intangible assets consist primarily of existing technology(including patents and certain royalty rights) we acquired through theacquisitions of Hesed Biomed in 2001, Abgenix Biopharma and IntraImmune in2000, and JT America’s interest in Xenotech in 1999.  Amortization of intangible assets totaled $1.8 million in each ofthe three months ended March 31, 2004 and 2003.

 

*General and Administrative Expenses.*

 

Generaland administrative expenses include compensation, professional services,consulting, facilities, including depreciation, and other expenses related tolegal, finance and information systems. General and administrative expenses totaled $ 6.9 million, in each ofthe three month ended March 31, 2004 and 2003.  We expect general and administrative costs in the second quarterof 2004 to remain at the same level or slightly increase as compared to thefirst quarter.

 

*Interest and Other Income.*

 

Interestand other income consist primarily of interest from cash, cash equivalents andmarketable securities. Interest and other income decreased to $1.7 million inthe three months ended March 31, 2004, compared to $3.2 million in thethree month ended March 31, 2003. The decrease was primarily the

 

18

----

 

resultof lower interest, and to a lesser extent, to lower average cash, marketablesecurities and cash equivalent balances in the first quarter of 2004 ascompared to 2003.

 

*Interest Expense.*

 

Interest expense wasprimarily related to interest and amortization of issuance costs on ourconvertible subordinated notes due 2007. In the three months ended March 31, 2004, interest expenseincreased to $1.6 million, as compared to $996,000 in the same period in 2003,as a result of a decrease in the amount of capitalized interest. The amount ofinterest capitalized decreased in the first quarter of 2004 compared to thesame period 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 those portions of the facility.  Interest expense was capitalized in theamount of $0.4 million and $1.1 million, respectively, in the three monthsended March 31, 2004 and 2003.  Foreach future quarterly period, we expect to accrue approximately $1.8 million ofinterest expense related to our convertible subordinated notes due 2007 untilthe debt matures, until we redeem or repurchase the debt or until all or partof the debt is converted into shares of our common stock.

 

*Foreign Income Tax Expense.*

 

Foreignincome tax expense was recorded reflecting an income tax provision on foreigncontract research projects of zero and approximately $84,000, in the threemonths ended March 31, 2004 and 2003, respectively.

 

**Liquidity and Capital Resources**

 

AtMarch 31, 2004, we had cash, cash equivalents and marketable securities ofapproximately $307.0 million. We invest our cash equivalents and marketablesecurities primarily in highly liquid, interest bearing, investment grade andgovernment securities in order to preserve principal. We have also invested incertain marketable equity securities of ImmunoGen and CuraGen for strategicreasons. These securities had an aggregate fair value of $19.5 million atMarch 31, 2004.

 

*Cash Used in Operating Activities.*  Netcash used in operating activities was $38.2 million and $33.8 million in thethree months ended March 31, 2004 and 2003, respectively. The majorcomponents of the change in cash usedin operating activities in the three months ended March 31, 2004,compared to the same period in 2003, wereprimarily the following:

 

•                  An increase of $8.7 million in research and development costs, net ofdepreciation related to the development of new products.

 

•                  A decrease of $6.4 million in manufacturing start-up costs, net ofdepreciation.

 

•                  Apayment of approximately $7.8 million on the Lonza contract cancellationobligation in January 2004.

 

•                  Adecrease of $5.8 million in customer payments due primarily to the timing ofpayments received under our contracts.

 

•                  Adecrease of $10.6 million in the change in accounts payable and accruedliabilities, net.

 

•                  Adecrease of $4.4 million in the changes in prepaid expenses and other currentassets, net.

 

*Cash Provided by Investing Activities.*  Netcash provided by investing activities was $35.1 million and $8.6 million in thethree months ended March 31, 2004 and 2003, respectively. Cash wasprovided by and used in investingactivities primarily as follows:

 

19

----

 

•                  Capitalexpenditures of $3.0 million and $16.4 million in the three months endedMarch 31, 2004 and 2003, respectively. The investments reflect primarilyinvestment in construction in progress and equipment for our new manufacturingfacility.

 

•                  Maturitiesand sales, net of purchases, of marketable securities of $38.1 million and $25.0 million in the three months endedMarch 31, 2004 and 2003, respectively.

 

*Cash Provided by Financing Activities.* During the three months ended March 31, 2004 and 2003, net cashprovided by financing activities was $0.4 million and $0.3 million,respectively, consisting of proceeds from the exercise of stock options.

 

InOctober 2003, in connection with a collaboration agreement, we enteredinto a securities purchase agreement with AstraZeneca. Pursuant to theagreement, we issued to AstraZeneca $50.0 million of Series A-1 convertible preferred stock and $50.0million of Series A-2 convertible preferred stock.  The net proceeds from the securities were $99.7 million.  Pursuantto its terms, the Series A-2 preferred stock was redeemed at the option ofAstraZeneca in February 2004 and we issued AstraZeneca a convertiblesubordinated note with a principal amount of $50.0 million, which matures onOctober 29, 2013.  No interest ispayable on the note xcept in the event of a payment default by us.  The Series A-1 preferred stock matures 7years from the date of issuance.  Due tothe redemption feature, we do not record the redeemable convertible preferredstock in stockholders’ equity on our consolidated balance sheet.  Subjectto various terms and conditions, if a certain milestone event is reached, wewill have the option to issue toAstraZeneca up to $30.0 million of Series A-3 preferred stock and if a furthermilestone event is reached, we willhave the option to issue to AstraZeneca up to $30.0 million of Series A-4preferred stock.  Each of the Series A-3 preferred stock and the SeriesA-4 preferred stock will have a maturity date that is five years from issuance.

 

Subject tocertain conditions, we can convert the preferred stock and can convert theconvertible subordinated note into shares of our 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 may convert the preferred stock into shares of common stockat a conversion price of $30.00 per share, at any time prior to the earlier of(a) the redemption date or (b) the maturity date.  AstraZeneca may convert the convertible subordinated note intoshares of common stock at a conversion price of $30.00 per share, at any timeprior to the 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 mandatory redemptiondate. The note matures on October 29, 2013, if still outstanding. In addition, we can, upon at least 15 days’ notice to theholder, redeem the shares of Series A-1 preferred stock for cash in an amountequal to its liquidation preference at any time prior to maturity.  We can, upon at least 15 days’ notice to theholder, repay the principal amount of the convertible subordinated note incash, at any time prior to maturity.  In addition to the mandatory redemption andmaturity dates of these securities, certain events can give rise to an earlierredemption.   In certain circumstances,we have certain rights to convert the securities into common stock instead ofredeeming the securities for cash.

 

InMarch 2002, we issued $200.0 million principal amount of convertiblesubordinated notes in a private placement. The notes are convertible intoshares of our common stock at a conversion price of $27.58 per share subject tocertain adjustments. The notes accrue interest at an annual rate of 3.5% and weare obligated to pay interest on March 15 and September 15 of eachyear.  The notes will mature onMarch 15, 2007 and are redeemable at our option on or after March 20,2005, or earlier if the price of our common stock exceeds specifiedlevels.  In addition, the holders of thenotes may require us to repurchase the notes if we undergo a change incontrol.  Proceeds from the sale of thenotes, net of commissions payable to the initial purchasers of the notes butbefore subtracting other offering expenses payable by us, were $194.0 million.

 

20

----

 

InMarch 2000 and February 2001, we obtained stand-by letters of creditfor $2.0 million and $3.0 million, respectively, from a commercial bank assecurity for our obligations under two facility leases. These were increased inJanuary 2002 to $2.5 and $3.2 million, respectively, in connection withamendments to our facility leases. In 2003, the $3.2 million stand-by letter ofcredit increased to $3.5 million.  Theoutstanding stand-by letters of credit are secured by an investment account, inwhich we must maintain a balance of approximately $7.0 million.

 

*Financing Uncertainties Related to Our Business Plan.*  Weplan to continue to make significant expenditures to establish, staff andoperate our own manufacturing facility and support our research and developmentactivities, including preclinical product development and clinical trials. Wealso intend to look for opportunities to acquire new technology throughin-licensing, collaborations or acquisitions. Over the next nine months, we estimate that we will spendapproximately $17.0 to $22.0 million on leasehold improvements, equipment,computer hardware and software for our new manufacturing and our research anddevelopment facilities.  Additionally,we may spend additional amounts to support new production services contracts.

 

Wecurrently intend to use our available cash on hand to finance these projectsand business developments, but we might also pursue other financing alternatives,such as equity or equity-related financing, a bank line of credit, sale-leaseback financing, funding by one or more collaborators or a mortgage financing,that may become available to us. Whether we use cash on hand or choose toobtain financing will depend on, among other things, the future success of ourbusiness, the prevailing interest rate environment and the condition offinancial markets generally.

 

Theamounts of the expenditures that will be necessary to execute our business planare subject to numerous uncertainties that may adversely affect our liquidityand capital resources to a significant extent. As of March 31,2004, three of our proprietaryproduct candidates, panitumumab, ABX-MA1 and ABX-PTH were in various stages ofclinical trials.  The clinical trials ofpanitumumab, ABX-MA1 and ABX-PTH are expected to require significantexpenditures in the foreseeable future. In October 2003, we entered into an amendment of our jointdevelopment and commercialization agreement with Immunex for the co-developmentof panitumumab.  Under the agreement,Immunex is obligated to make available up to $60.0 million in advances that wemay use to fund a portion of our share of development and commercialization costsafter we have contributed $20.0 million toward development costs in 2004.  We expect to take advantage of this creditfacility when it becomes available. Completion of clinical trials may take several years or more, but thelength of time generally varies substantially according to the type,complexity, novelty and intended use of a product candidate. We estimate thatclinical trials of the type we generally conduct are typically completed overthe following timelines:

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

 

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

 

•                                          the number of patients that ultimatelyparticipate in the trial;

 

•                                          the duration of patient follow-up that seemsappropriate in view of the results;

 

•                                          the number of clinical sites included in thetrials; and

 

•                                          the length of time required to enroll suitablepatient subjects.

 

21

----

 

Wetest our potential product candidates in numerous preclinical studies toidentify disease indications for which they may be product candidates. We mayconduct multiple clinical trials on our own or with our collaborators to covera variety of indications for each product candidate. As we obtain results fromtrials, we may elect to discontinue clinical trials for certain productcandidates or for one or more indications for a given product candidate inorder to focus our resources on more promising product candidates orindications. For example, in January 2002 and May 2002, we announced thatclinical trials of our proprietary product candidate ABX-IL8 as a treatment forrheumatoid arthritis and psoriasis, respectively, did not support furtherclinical studies of that product candidate. Additionally in February 2003, we announced that theclinical trial of our proprietary product candidate ABX-CBL as a treatment forgraft versus host disease, did not support further clinical studies of thatproduct candidate.

 

Animportant element of our business strategy is to pursue the research anddevelopment of a diverse range of product candidates for a variety of diseaseindications. We may enter co-development agreements, similar to ouragreement with Immunex for panitumumab, and may enter into additional jointdevelopment agreements earlier in the development life cycle of productcandidates. We have begun to implement our collaboration strategy throughco-development arrangements with companies such as Chugai, U3 and Dendreon. Our strategy is designed to diversify therisks associated 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 recently advanced ABX-PTH from the preclinical stageinto a clinical study in patients with secondary hyperparathyrodism.  To the extent, however, that we are unableto maintain 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.

 

Ourproprietary product candidates also have not yet achieved FDA regulatoryapproval, which is required before we can market them as therapeutic products.In order to proceed to subsequent clinical trial stages and to ultimatelyachieve regulatory approval, the FDA must conclude that our clinical dataestablish safety and efficacy. The number, size and type of clinical trials weconduct for a particular product candidate are also affected by the policies ofthe FDA and European regulatory agencies regarding the availability of possibleexpedited approval procedures, which we may seek to utilize.  These policies may change from time to time.  As we conduct clinical trials for a givenproduct candidate, we may decide or the FDA may require us to make changes inour plans and protocols.  Such changesmay relate 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 support proposed changes with additionalpreclinical or clinical testing, which could delay the expected time line forconcluding clinical trials.  Inaddition, the results from preclinical testing and early clinical trials haveoften not been predictive of results obtained in later clinical trials. Anumber of new drugs and biologics have shown promising results in clinicaltrials, but subsequently failed to establish sufficient safety and efficacydata to obtain necessary regulatory approvals.

 

Furthermore,our business strategy includes the option of entering into arrangements withthird parties 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.

 

Asa result of the uncertainties discussed above, among others, the duration andcompletion costs of our research and development projects are difficult toestimate and are subject to considerable variation. Our inability to completeour research and development projects in a timely manner or our failure toenter into collaborative agreements when appropriate, could significantlyincrease our capital requirements and could adversely impact our liquidity.These uncertainties could force us to seek

 

22

----

 

additionalsources of financing from time to time in order to continue with our businessstrategy. Our inability to raise additional capital, or to do so on termsreasonably acceptable to us, would jeopardize the future success of ourbusiness.

 

Wealso may be required to make further substantial expenditures if unforeseendifficulties arise in other parts of our business. In particular, our futureliquidity and capital requirements also will depend on many factors other thanour research and development activities, 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;

 

•                                          continuedscientific progress in our research and development programs;

 

•                                          thesize and complexity of these programs;

 

•                                          thecost of establishing our manufacturing capabilities 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.

 

Webelieve that our current cash balances, cash equivalents, marketablesecurities, and the cash generated from our licensing and other agreements willbe sufficient to meet our operating and capital requirements for at least oneyear. However, because of the uncertainties in our business discussed above,among others, we cannot assure you that this will be the case. In addition, wemay choose to, or prevailing business conditions may require us to, obtainadditional financing from time to time. We may choose to raise additional fundsthrough public or private financing, licensing and other agreements 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. We mayalso choose to obtain funding through collaborations, licensing and othercontractual arrangements. Such agreements may require us to relinquish ourrights to certain of our technologies, products or marketing territories. Ourfailure to raise capital when needed would harm our business, financialcondition and results of operations.

 

*History of Net Losses.*  Wehave incurred net losses since our organization as an independent company,including in 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 $41.6 million in the three months endedMarch 31, 2004. As of March 31, 2004, our accumulated deficit was$606.3 million. Our losses to date have resulted principally from:

 

23

----

 

•                  research and development costs relating tothe development of our XenoMouse and XenoMax technologies and antibodytherapeutic product candidates;

 

•                  general and administrative costs relating toour operations;

 

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

 

Weexpect to incur additional losses for the foreseeable future as a result of ourresearch and development costs, including costs associated with conductingpreclinical development and clinical trials, which will continue to besubstantial, charges related to purchases of technology or other assets, andcosts associated with establishing and operating our manufacturing facilities.We intend to invest significantly in our products prior to entering intolicensing agreements. This will increase our need for capital and will resultin losses for at least the next several years. We expect that the amount ofoperating losses will fluctuate significantly from quarter to quarter as aresult of increases or decreases in our research and development efforts, theexecution or termination of licensing and other agreements, and the initiation,and success or failure, of clinical trials.

 

*Net Operating Loss Carryforwards.*  Asof December 31, 2003, we had net operating loss carryforwards for federaland state income tax purposes of approximately $469.0 million and $102.0million, respectively.  Our netoperating loss carryforwards exclude losses incurred prior to our formation inJuly 1996. Further, we have capitalized the amounts associated with the1997 settlement and cross-license that we have expensed for financial statementaccounting purposes and we are amortizing those amounts over a period ofapproximately 15 years for tax purposes. The federal and state netoperating loss and credit carryforwards will expire in the years 2006 through2023, if not utilized. Utilization of the net operating losses and credits maybe subject to a substantial annual limitation due to the “change in ownership”provisions of the Internal Revenue Code of 1986 and similar state provisions.The annual limitation may result in the expiration of net operating losses andcredits before utilization.

 

**Critical Accounting Estimates**

 

The application of several accounting estimates that require us to makesubjective and complex judgments impacts the financial results that we report.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, accounting for goodwill and intangibleassets and income taxes.  There havebeen no significant changes to our critical accounting estimates as reported inour annual report on Form 10-K for the year ended December 31, 2003.

 

**Contractual Obligations and CommercialCommitments**

 

As of March 31, 2004, future minimum payments for certaincontractual obligations for years subsequent to December 31, 2003 were asfollows:

 
|                                                    |   | **Total**           |    | **Less than  1 year** |   | **1 – 3  years** |   | **4 – 5  years** |   | **After 5  years*** |   |
|---------------------------------------------------------|--------|---------------------|---------|-----------------------|--------|-----------------------|--------|-----------------------|--------|---------------------|--------|
|                                                    |   | **(in  thousands)** |    |
| **Contractual  Obligations**                            |   |                |    |                  |   |                  |   |                  |   |                |   |
| Operating leases                                        |   | $                   | 139,177 |                  | $      | 9,885                 |   | $                     | 27,782 |                | $      | 29,793 |   | $ | 71,717 |   |
| Convertible subordinated notes due 2007  & interest |   | 220,708             |    | 3,500                 |   | 14,000                |   | 203,208               |   | —              |   |
| Convertible subordinated note due 2013                  |   | 50,000              |    | —                |   | —                |   | —                |   | 50,000              |   |
| Redeemable convertible preferred stock                  |   | 50,000              |    | —                |   | —                |   | —                |   | 50,000              |   |
| Lonza                                                   |   | 15,640              |    | 15,640                |   | —                |   | —                |   | —              |   |
| Purchase orders                                         |   | 1,800               |    | 1,800                 |   | —                |   | —                |   | —              |   |
| Total                                                   |   | $                   | 477,325 |                  | $      | 30,825                |   | $                     | 41,782 |                | $      | 233,001 |   | $ | 171,717 |   |

 

24

----

 

----

*                 Amountsrepresent total of minimum payments for the entire period.

 

InMarch 2002, we issued $200.0 million principal amount of convertiblesubordinated notes in a private placement. The notes are convertible intoshares of our common stock at a conversion price of $27.58 per share subject tocertain adjustments. The notes accrue interest at an annual rate of 3.5%.  We are obligated to pay interest onMarch 15 and September 15 of each year. We expect to make interest payments on the notes of $7.0 million peryear, for years 2003 through 2006, and $3.2 million in 2007, assuming all thenotes remain outstanding until their maturity date. The notes will mature onMarch 15, 2007 and are redeemable at our option on or after March 20,2005, or earlier if the price of our common stock exceeds specified levels. Inaddition, the holders of the notes may require us to repurchase the notes if weundergo a change in control.  Therefore,in March 2007, or earlier if we undergo a change in control, we may use asignificant portion of our cash, cash equivalents and marketable securities torepay the $200.0 million principal amount of our convertible debt. If ourbalance of cash, cash equivalents and marketable securities at any time isinsufficient to meet our obligations under the notes, we would have to seekadditional financing, if available, to support our obligations under the notes.

 

We issued to AstraZeneca as of February 19, 2004, in connectionwith a collaboration agreement, $50.0 million of Series A-1 convertible preferred stock and a convertible subordinated note with aprincipal amount of $50.0 million. The total net proceeds were $99.7million.  The Company, subject tocertain conditions, can convert the Series A-1 convertible preferred stock andcan convert the convertible 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 may convert the Series A-1 convertible preferred stock andthe convertible note into shares of common stock at a conversion price of$30.00 per share, at any time prior to the earlier of (a) the redemption dateor (b) the maturity date, as applicable. The Company must redeem alloutstanding shares, if any, at a cash redemption price per share equal to theliquidation preference by October 29, 2010, the mandatory redemption date.The note matures on October 29, 2013, if still outstanding. In addition, we can, upon at least 15 days’ notice to theholder, redeem the Series A-1 convertible preferred stock for cash in an amountequal to its liquidation preference and pre-pay the convertible note for itsface amount, at any time prior to maturity. In addition to the mandatory redemption and maturity dates of thesesecurities, certain events can give rise to an earlier redemption.  In such circumstances, we have certainrights to convert the securities into common stock instead of redeeming thesecurities for cash.

 

Effective June 30, 2003, we canceled our agreement with Lonza forthe exclusive use of a cell culture production suite.  Upon canceling the agreement, we became obligated to pay Lonzafour equal installments of 4,250,000 British pounds on October 1, 2003,February 1, 2004, May 1, 2004 and August 1, 2004, which eliminatedour commitment to pay approximately $46.0 million in total monthly fees throughAugust 2006.  The value of thecancellation fee obligation on the effective date of June 30, 2003 wasapproximately $28.0 million.  InSeptember 2003 and January 2004, we made the first and second of fourinstallment payments to Lonza.  Thebalance of the obligation as of March 31, 2004 was approximately $15.6million.

 

25

----

 

Wehave outstanding purchase orders totaling $1.8 million to contractors relatedto the purchase of equipment and design and construction of our new manufacturingfacility.

 

Othersignificant commercial commitments include the following:

 

•                  Acommitment to share equally all development and commercialization costs forpanitumumab pursuant to our development and commercialization agreement withImmunex.  As amended inOctober 2003, that agreement provides that Immunex will havedecision-making authority for development and commercialization 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.  The amountof any such advances, plus interest, may be repaid out of profits resultingfrom future product sales and we are not obligated to repay any portion of theloan if panitumumab does not reach commercialization.

 

**Additional FactorsThat Might Affect Future Results**

 

**Risks Related to our Finances**

 

*We are an early stage company withoutcommercial therapeutic products, and we cannot assure you that we will developsufficient revenues in the future to sustain our business.*

 

You must evaluate us in light of the uncertainties and complexitiespresent in an early stage biopharmaceutical company. Our product candidates arein early stages of development. We will need to make significant additionalinvestments in research and development, preclinical testing and clinicaltrials, and in regulatory and sales and marketing activities, to commercializecurrent and future product candidates. Our product candidates, if successfullydeveloped, may not generate sufficient or sustainable revenues to enable us tobe profitable.

 

*We have a history of losses and we expect tocontinue to incur losses for the foreseeable future.*

 

We have incurred net losses since we were organized as an independentcompany, including in the last five years net losses of $20.5 million in1999, $8.8 million in 2000, $60.9 million in 2001,$208.9 million in 2002, $196.4 million in 2003 and $41.6 million in thethree months ended March 31, 2004. As of March 31, 2004, ouraccumulated deficit was $606.3 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; 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 the foreseeable future as aresult of our research and development costs and manufacturing start-up costs,including costs associated with conducting preclinical development and clinicaltrials, which will continue to be substantial, and charges related to purchasesof technology or other assets. 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

 

26

----

 

of increases or decreases in our research and development efforts, theexecution or termination of licensing, manufacturing and other contractualarrangements, the progress or lack of progress of product developmentcandidates in our collaboration with AstraZeneca and the initiation, success orfailure of clinical trials.

 

*We are currently unprofitable and may neverbe profitable, and our future revenues could fluctuate significantly.*

 

Since our founding, we have funded our research and developmentactivities primarily from private placements and public offerings of oursecurities and from revenues generated by our licensing and other contractualarrangements.

 

We expect that substantially all of our revenues for the foreseeablefuture will result from payments under licensing and other contractualarrangements and from interest income. To date, payments under licensing and other agreements have been in theform of option fees, reimbursement for research and development expenses,license fees and milestone payments. Payments under our existing and any future customer agreements will besubject to significant fluctuation in both timing and amount.  Our revenues may not be indicative of ourfuture performance or of our ability to continue to achieve contractualmilestones. Our revenues and results of operations for any period may also notbe comparable to the revenues or results of operations for any otherperiod.  Our revenues for any period maynot be sufficient to cover our operating costs, including the costs ofoperating our manufacturing plant.  Wemay not be able to:

 

•                                          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 would materially harm ourbusiness, financial condition and results of operations.

 

*We may require additional financing, and aninability to raise the necessary capital or to do so on acceptable terms wouldthreaten the continued success of our business.*

 

We will continue to expend substantialresources to support research and development and establish 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 three months ended March 31,2004, we spent $28.5 million on research and development.  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;

 

•                                          continuedscientific progress in our research and development programs;

 

27

----

 

•                                          thesize and complexity of these programs;

 

•                                          thecost of establishing, validating and implementing our manufacturingcapabilities and processes and complying with good manufacturing practiceregulations;

 

•                                          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 that our current cash balances,cash equivalents, marketable securities, and the cash generated from ourlicensing and other contractual arrangements, will be sufficient to meet ouroperating and capital requirements for at least one year. However, because ofthe uncertainties in our business, including the uncertainties listed above, wecannot 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 or other arrangements. We cannot be sure that any additionalfunding, if needed, will be available on terms favorable to us or at all.Furthermore, any additional equity or equity-related financing may be dilutiveto our stockholders, and debt financing, if available, may subject us torestrictive covenants. We may also choose to obtain funding through licensingand other contractual arrangements. Such agreements may require us torelinquish our rights to certain of our technologies, products or marketingterritories. Our failure to raise capital when needed would harm our business,financial condition and results of operations.

 

*Our indebtedness may harm our financialcondition and results of operations.*

 

We have $200 million of convertible debt convertible subordinated notesdue March 15, 2007 and debt service obligations related thereto.  In February 2004, we incurred anadditional $50.0 million of indebtedness to AstraZeneca, in the form of aconvertible subordinated note, which we issued to AstraZeneca in connectionwith our redemption of the shares of our Series A-2 preferred stock we issuedto AstraZeneca in October 2003. There is no interest payable on the note except in the event of apayment default.  Our level ofindebtedness will have several important 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.

 

28

----

 

Our ability to make payments of principal and interest on ourindebtedness depends upon our future performance, which will be subject togeneral economic conditions, industry cycles and financial, business and otherfactors affecting our operations, many of which are beyond our control. If weare unable to generate sufficient cash flow from operations in the future toservice 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.

 

Such measures might not be sufficient to enable us to service our debt.In addition, any such financing, refinancing or sale of assets might not beavailable on economically favorable terms.

 

*Our strategic investments expose us to equityprice risk and our investments in those companies may be deemed impaired, whichwould affect our results of operations.*

 

We are exposed to equity price risk on our strategic investments inCuraGen and ImmunoGen and we may elect to make additional similar investmentsin the future. In 1999 and 2000, we purchased an aggregate amount of$80.0 million of the common stock of CuraGen and ImmunoGen as strategicinvestments. In 2002, declines in the fair value of the CuraGen and ImmunoGencommon stock were deemed to be other than temporary, primarily because thestock 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 March 31, 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.

 

**Risks Related to the Development andCommercialization of our Products**

 

*Our XenoMouse and XenoMax technologies maynot produce safe, efficacious or commercially viable products, which will becritical to our ability to generate revenues from our products.*

 

Our XenoMouse and XenoMax technologies are new approaches to developingantibodies as products for the treatment of diseases and medical disorders. Wehave not commercialized any antibody therapeutic products based on ourtechnologies. Moreover, we are not aware of any commercialized, fully humanantibody therapeutic products that have been generated from any technologiessimilar to ours. Our antibody therapeutic product candidates are still invarious stages of development and many are in an early development stage. Wehave initiated clinical trials with respect to four proprietary fully humanantibody therapeutic product candidates, and our collaborators have initiatedclinical trials with respect to three other fully human antibody therapeuticproduct candidates generated by XenoMouse technology and filed an IND toinitiate clinical testing of a fourth. We cannot be certain that either XenoMousetechnology or XenoMax technology will generate antibodies against every antigento which they are exposed in an efficient and timely manner, if at all.Furthermore, XenoMouse technology and XenoMax technology may not result in anymeaningful benefits to our current or potential customers or in productcandidates that are safe and efficacious for patients. Our failure to generateantibody therapeutic product candidates that lead to the successfulcommercialization of products would materially harm our business, financialcondition and results of operations.

 

29

----

 

*If we do not successfully develop ourproducts, or if they do not achieve commercial success, our business will bematerially harmed.*

 

Our development of current and future product candidates, either aloneor in conjunction with collaborators, is subject to the risks of failureinherent in the development of new pharmaceutical products and products basedon new technologies. These risks 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;

 

•                                          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 development efforts and thoseof our customers and collaborators may not result in any commercially viableproducts. Our failure to successfully complete a significant portion of thesedevelopment efforts, to obtain required regulatory approvals or to achievecommercial success with any approved products would materially harm ourbusiness, financial condition and results of operations.

 

In addition, our decisions to terminate our clinical programs fordeveloping ABX-IL8, a fully human antibody product candidate for inflammatorydisorders, and ABX-CBL, an in-licensed antibody product candidate for graftversus host disease, have reduced the diversity of our product portfolio. Wehope to be able to make up for this loss of diversity through the number andvariety of potential new product candidates we have in preclinical development.For example, ABX-PTH, which targets the action of parathyroid hormone inpatients with chronic renal disease, is a new product candidate that we movedfrom the preclinical stage into a clinical study in 2004 in patients withsecondary hyperparathyroidism. However, to the extent that we are unable tomaintain 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 any of ourproduct candidates, we must conduct clinical trials, which are expensive andhave uncertain outcomes.*

 

Conducting clinical trials is a lengthy, time-consuming and expensiveprocess. Before obtaining regulatory approvals for the commercial sale of anyproducts, we must demonstrate through preclinical testing and clinical trialsthat our product candidates are safe and effective for use in humans. We haveincurred and will continue to incur substantial expense for, and we havedevoted and expect to continue to devote a significant amount of time to,preclinical testing and clinical trials.

 

Historically, the results from preclinical testing and early clinicaltrials have often not been predictive of results obtained in later clinicaltrials. A number of new drugs and biologics have shown promising results inclinical trials, but subsequently failed to establish sufficient safety andefficacy data to obtain necessary regulatory approvals. Data obtained frompreclinical and clinical activities are susceptible

 

30

----

 

to varying interpretations, which may delay, limit or preventregulatory approval. In addition, we may encounter regulatory delays orrejections as a result of many factors, including changes in regulatory policyduring the period of product development.

 

Completion of clinical trials may take several years or more. Thelength of time generally varies substantially according to the type,complexity, novelty and intended use of the product candidate. However, weestimate 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                        |

 

Many factors may delay our commencement and rate of completion ofclinical trials, including:

 

•                                          thenumber of patients that ultimately participate in the trial;

 

•                                          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 managing clinical trials.We rely on third parties, including our collaborators, to assist us in managingand monitoring clinical trials. Our reliance on these third parties may resultin delays in completing, or in failure to complete, these trials if the thirdparties fail to perform under our agreements with them.

 

In addition, we have ongoing research projects that may lead to productcandidates, but we have not submitted INDs nor begun clinical trials for theseprojects.  Our ability to fileadditional INDs, and to build diversity and scale in our product portfolio,depends to a significant extent on our ability to identify additional potentialproduct candidates through our preclinical research and to conduct preclinicalresearch efficiently.  Our preclinicalor clinical development efforts may not be successfully completed, we may notfile further INDs and clinical trials may not commence as planned.

 

Three of our proprietary product candidates, panitumumab, ABX-MA1 andABX-PTH, are in various stages of clinical trials. We have discontinueddevelopment of two proprietary product candidates, ABX-CBL and ABX-IL8. Todate, data obtained from these clinical trials have been insufficient todemonstrate safety and efficacy under applicable FDA guidelines. As a result,these data will not support an application for regulatory approval withoutfurther clinical trials. Clinical trials that we conduct or that third partiesconduct on our behalf may not demonstrate sufficient safety and efficacy toobtain the requisite regulatory approvals for any of our product candidates. Weexpect to commence new clinical trials from time to time in the course of ourbusiness as our product development work continues. However, regulatoryauthorities may not permit us to undertake any additional clinical trials forour product candidates.

 

Our product candidates may fail to demonstrate safety or efficacy inclinical trials. For example, in 2002 we completed analysis of a Phase 2bclinical trial of ABX-IL8 in psoriasis, concluded that the results did notwarrant continued development in psoriasis and decided not to proceed withstudies in other disease indications. Similarly, in February 2003, wecompleted a preliminary analysis of the results from the Phase 2/3 clinicaltrial of ABX-CBL and concluded that the study did not meet its primaryendpoint. Therefore, we and our co-developer, SangStat (now a subsidiary ofGenzyme Corporation) do not plan any further

 

31

----

 

development of ABX-CBL. Failures of clinical trials of any productcandidate could delay the development of other product candidates or hinder ourability to obtain additional financing. In addition, failures in our clinicaltrials can lead to additional research and development charges. Any delays in,or termination of, our clinical trials could materially harm our business,financial condition and results of operations.

 

*We may rely on third-party manufacturers, andwe may have difficulty conducting clinical trials of our product candidates ifa manufacturer does not perform in accordance with our expectations.*

 

Until recently, we relied on a single contract manufacturer, Lonza, toproduce ABX-CBL, ABX-IL8 and panitumumab under good manufacturing practiceregulations for use in our clinical trials. In June 2003, we canceled ourmanufacturing supply agreement with Lonza, pursuant to which we had exclusiveaccess to a cell culture production suite, because we determined that with theopening of our own manufacturing plant and changes in our product candidateportfolio, we no longer needed access to the Lonza facility. We have alsorelied on other contract manufacturers from time to time to produce our productcandidates for use in our clinical trials. For example, Fred Hutchinson CancerResearch Center has produced ABX-MA1 for use in our clinical trials. Whileportions of our Fremont manufacturing facility are now operational and we aremanufacturing material that we intend to use in clinical trials, we cannotassure you that we will be able to qualify this facility for regulatory compliance.  For that reason or others, we may use Lonzaor another third-party manufacturer if necessary in the future.

 

Third-party manufacturers may encounter difficulties in scaling upproduction, including problems involving production yields, quality control andassurance, shortage of qualified personnel, shortage of capacity, compliancewith FDA and other applicable regulations, production costs, and development ofadvanced manufacturing techniques and process controls. If we continue to usethird-party manufacturers, they may not perform as agreed or may not remain inthe contract manufacturing business for the time required by us to successfullyproduce and market our product candidates. 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.

 

*Our own ability to manufacture is uncertain,which may make it more difficult for us to develop and sell our products.*

 

We are establishing our own manufacturing facility for the manufactureof product candidates for clinical trials and to support the potential earlycommercial launch of a limited number of products, in each case, in compliancewith FDA and European good manufacturing practices. In 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 operational.We are also conducting validation of the facility and completed significantstages of validation in 2003. In October 2003, following an inspection bythe California State Department of Health Services, we received a State DrugManufacturing License. The license permits us to manufacture and ship clinicalmaterial from our manufacturing facility. We expect the total cost of thefacility, including design fees, permits, validation, construction, leaseholdimprovements and equipment, to be approximately $155.0 million. Validationof this facility may take longer than expected, and the planned and actualconstruction costs of building and qualifying the facility for regulatorycompliance may be higher than expected. We currently have excess production services capacity and this conditionmay persist for an extended period. However, if the commercial launch of one or more of our productcandidates proves successful, we will likely experience capacity shortages andmay need to use one or more third-party facilities to produce these products insufficient quantities.

 

The process of manufacturing antibody therapeutic products is complex.While the managers of the facility have gained extensive manufacturingexperience in prior positions with other companies, we have limited experiencein the clinical or commercial scale manufacturing of our existing productcandidates, or any other antibody therapeutic products.  We will need to hire, train and retainadditional qualified manufacturing, quality control and quality assurancepersonnel. Also, we will need to manufacture such

 

32

----

 

antibody therapeutic products in a facility and by an appropriatelyvalidated process that comply with FDA, European and other regulations. Ourmanufacturing operations will be subject to ongoing, periodic unannouncedinspection by the FDA and state agencies to ensure compliance with goodmanufacturing practices. Our inability to complete the establishment of ourmanufacturing operations and maintain them in compliance with applicableregulations within our planned time and cost parameters could materially harmour business, financial condition and results of operations.

 

We also may encounter problems with the following:

 

•                                          productionyields;

 

•                                          qualitycontrol and assurance;

 

•                                          availabilityof qualified personnel;

 

•                                          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.

 

We continually evaluate our options for commercial production of ourantibody therapeutic products, which include use of third-party manufacturers,establishing a commercial scale manufacturing facility or entering into amanufacturing joint venture relationship with a collaborator or other thirdparty. We are aware of only a limited number of companies on a worldwide basisthat operate manufacturing facilities in which our product candidates can bemanufactured under good manufacturing practice regulations, a requirement forall pharmaceutical products. It may take a substantial period of time for acontract manufacturing facility that has not been producing antibodies to beginproducing antibodies under good manufacturing practice regulations. We may notbe able to contract with any of these companies on acceptable terms, if at all.

 

In addition, the FDA and other regulatory authorities will require usto register any manufacturing facilities in which our antibody therapeuticproducts are manufactured. The FDA and other regulatory authorities will thensubject the facilities to inspections to confirm compliance with FDA goodmanufacturing practice or other regulations. Our failure or the failure of ourthird-party manufacturers to maintain regulatory compliance would materiallyharm our business, financial condition and results of operations.

 

*The successful growth of revenues from ourmanufacturing services depends to a large extent on our ability to find thirdparties who agree to use our services and our ability to provide those servicessuccessfully.*

 

Enhancing our contract revenues depends to a significant extent onentering into agreements to provide antibody production services to thirdparties. Potential third parties include our existing collaborators, as well asother pharmaceutical and biotechnology companies, technology companies,academic institutions and other entities. We must enter into these agreementsto successfully develop this aspect of our business. To date, we have enteredinto two production services agreements and we cannot assure you that we will beable to enter into additional agreements.

 

We may not be able to secure manufacturing agreements on favorableterms. If we do obtain such agreements, we may encounter difficulties inperforming as agreed. We may encounter difficulties in scaling up production,including problems involving production yields, quality control and assurance,shortage of

 

33

----

 

qualified personnel, training of personnel, compliance with FDA andother applicable regulations, production costs, and development of advancedmanufacturing techniques and process controls. The failure to deliver requiredquantities of product on a timely basis and at commercially reasonable pricescould materially harm our business, financial condition and results ofoperations.

 

*The successful growth of our business dependsto a large extent on our ability to find third-party collaborators to developand commercialize many of our product candidates.*

 

Our strategy for the development and commercialization of antibodytherapeutic 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 and to enter intoadditional third party collaborations is dependent in large part on our abilityto successfully demonstrate that our XenoMouse technology is an attractivemethod of developing antibody therapeutic products. We have generated only alimited number of fully human antibody therapeutic product candidates pursuantto our collaboration agreements and only eight fully human antibody therapeuticproduct candidates generated with XenoMouse technology have entered theclinical stage. We have announced that one of these product candidates has notmet our expectations. Our failure to maintain our existing collaborationagreements or to enter into additional agreements could materially harm ourbusiness, financial condition and results of operations.

 

Our dependence on licensing, collaboration, manufacturing and otheragreements with third parties subjects us to a number of risks. Theseagreements may not be on terms that prove favorable to us, and we typicallyafford our collaborators significant discretion in electing whether to pursueany of the planned activities. Licensing and other contractual arrangements mayrequire us to relinquish our rights to certain of our technologies, products ormarketing territories. To the extent we agree to work exclusively with onecollaborator in a given therapeutic area, our opportunities to collaborate withother entities could be curtailed.  Forexample, our collaboration with AstraZeneca for the identification anddevelopment of therapeutic antibodies in oncology contains exclusivity provisionsthat significantly restrict our ability to enter into arrangements with thirdparties in the field of oncology as well as our ability to conduct research anddevelopment activities in that field. To the extent that our collaboration with AstraZeneca is not successful,our ability to develop antibodies for use in oncology applications throughother collaborations will be severely curtailed.  Our collaboration with AstraZeneca also limits our ability todevelop such antibodies through our own independent development.

 

We cannot control the amount or timing of resources our collaboratorsmay devote to the collaboration, and collaborators may not perform theirobligations as expected. Additionally, business combinations or significantchanges in a collaborator’s business strategy may adversely affect acollaborator’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:

 

34

----

 

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

 

•                                          reducethe likelihood of successful product introduction;

 

•                                          significantlyincrease our capital requirements; and

 

•                                          placeadditional strain on our management’s time.

 

Existing or potential collaborators may pursue alternativetechnologies, including those of our competitors, or enter into othertransactions that could make a collaboration with us less attractive to them.For example, if an existing collaborator purchases a company that is one of ourcompetitors, 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 us couldmaterially harm our business, financial condition and results of operations.

 

*We are subject to extensive governmentregulation, which will require us to spend significant amounts of money, and wemay not be able to obtain regulatory approvals, which are required for us toconduct clinical testing and commercialize our products.*

 

Our product candidates under development are subject to extensive andrigorous domestic government regulation. The FDA regulates, among other things,the development, testing, manufacture, safety, efficacy, record-keeping,labeling, storage, approval, advertising, promotion, sale and distribution ofbiopharmaceutical products. If we market our products abroad, they will also besubject to extensive regulation by foreign governments. Neither the FDA nor anyother regulatory agency has approved any of our product candidates for sale inthe United States or any foreign market. The regulatory review and approvalprocess, which includes preclinical studies and clinical trials of each productcandidate, is lengthy, expensive and uncertain. Securing FDA approval requiresthe submission of extensive preclinical and clinical data and supportinginformation to the FDA for each indication to establish the product candidate’ssafety and efficacy. The approval process takes many years, requires theexpenditure of substantial resources, and may involve post-marketingsurveillance and requirements for post-marketing studies. 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 relateto, for example, changes in the standard of care for a particular diseaseindication, comparability of efficacy and toxicity of materials where a changein 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. 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.

 

35

----

 

Our product candidates may not be approved or may be approved withlimitations or for indications that differ from those we initially target. Ifapproved, certain material changes affecting a product such as manufacturingchanges or additional labeling claims are subject to further FDA review and approval.The FDA may withdraw any required approvals after we obtain them. We may notmaintain compliance with other regulatory requirements. Further, if we fail tocomply with applicable FDA and other regulatory requirements at any stageduring the regulatory process, we or our third-party manufacturers may besubject 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 customers and co-developersto file INDs and generally direct the regulatory approval process for productsderived from our technologies. These customers and co-developers may not beable to or may choose not to conduct clinical testing or obtain necessary approvalsfrom the FDA or other regulatory authorities for any product candidates. Ifthey fail to obtain required governmental approvals, we will experience delaysin or be precluded from marketing or realizing the commercial benefits from themarketing of products derived from our technologies. In addition, our failureto obtain the required approvals would preclude the commercial use of ourproducts. Any such delays and limitations may materially harm our business,financial condition and results of operations.

 

We and our third-party manufacturers also are required to comply withthe applicable FDA current good manufacturing practice regulations and otherregulatory requirements. Good manufacturing practice regulations includerequirements relating to quality control and quality assurance as well as thecorresponding maintenance of records and documentation. Manufacturingfacilities are subject to inspection by the FDA and the facilities must pass aninspection by the FDA before we can use them in commercial manufacturing of anyproduct. Manufacturing facilities in California, including our facility, arealso subject to the licensing requirements of and inspection by the State ofCalifornia Department of Health Services. In October 2003, following aninspection, we received a Drug Manufacturing License from the State ofCalifornia. The license, which must be renewed annually, permits us tomanufacture and ship clinical material. We or our third-party manufacturers maynot be able to comply with the applicable good manufacturing practicerequirements and other regulatory requirements. The failure of us or ourthird-party manufacturers to comply with these requirements would materiallyharm our business, financial condition and results of operations.

 

*If our products do not gain market acceptanceamong the medical community, our revenues would greatly*

 

36

----

 

*decline and might not be sufficient tosupport our operations.*

 

Our product candidates may not gain market acceptance among physicians,patients, third-party payors and the medical community. We may not achievemarket acceptance even if clinical trials demonstrate safety and efficacy, andthe necessary regulatory and reimbursement approvals are obtained. The degreeof market acceptance of any product candidates that we develop will depend on anumber 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 our products until suchtime as clinical data or other factors demonstrate the safety and efficacy ofsuch procedures as compared to conventional drug and other treatments. Even ifwe establish the clinical safety and efficacy of therapies using our antibodyproduct candidates, physicians may elect not to recommend the therapies for anynumber of other reasons, including whether the mode of administration of ourantibody products is effective for certain indications. Antibody products,including our product candidates as they would be used for certain diseaseindications, are typically administered by infusion or injection, whichrequires substantial cost and inconvenience to patients. Our productcandidates, if successfully developed, will compete with a number of drugs andtherapies manufactured and marketed by major pharmaceutical and otherbiotechnology companies. Our products may also compete with new productscurrently under development by others. Physicians, patients, third-party payorsand 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 XenoMouse technology to potentialcustomers and collaborators for several years, we do not have marketing, salesor distribution experience or capability with respect to our therapeuticproduct candidates. We intend to enter into arrangements with third parties tomarket and sell most of our therapeutic product candidates when wecommercialize them, which may be as early as 2005. We may not be able to enterinto these marketing and sales arrangements with others on acceptable terms, ifat all. To the extent that we enter into marketing and sales arrangements withother companies, our revenues, if any, will depend on the efforts of others.These efforts may not be successful. If we are unable to enter into third-partyarrangements, we will need to develop a marketing and sales force, which mayneed to be substantial in size, in order to achieve commercial success for anyproduct candidate approved by the FDA. We may not successfully developmarketing and sales capabilities or have sufficient resources to do so. If wedo develop such capabilities, we will compete with other companies that haveexperienced and well-funded marketing and sales operations. Our failure toenter into successful marketing arrangements with third parties and ourinability to conduct such activities ourselves would materially harm ourbusiness, financial condition and results of operations.

 

**Risks Related to Intellectual Property**

 

*Our ability to protect our intellectualproperty rights will be critically important to the success of our business,and we may not be able to protect these rights in the United States or abroad.*

 

37

----

 

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 from unauthorized useby third parties only to the extent that our proprietary rights are covered byvalid and enforceable patents or are effectively maintained as trade secrets.We attempt to protect our proprietary position by filing U.S. and foreignpatent applications related to our proprietary technology, inventions andimprovements that are important to the development of our business. However,the patent position of biopharmaceutical companies involves complex legal andfactual questions, and, therefore, we cannot predict with certainty whether ourpatent applications will be approved or any resulting patents will be enforced.In addition, third parties may challenge, seek to invalidate or circumvent anyof our patents, once they are issued. Thus, any patents that we own or licensefrom third parties may not provide any protection against competitors. Ourpending patent applications, those we may file in the future, or those we maylicense from third parties, may not result in patents being issued. Also,patent rights may not provide us with adequate proprietary protection orcompetitive advantages against competitors with similar technologies. The lawsof certain foreign countries do not protect our intellectual property rights tothe same extent as do the laws of the United States.

 

In addition to patents, we rely on trade secrets and proprietaryknow-how. We seek protection, in part, through confidentiality and proprietaryinformation agreements. These agreements may not provide meaningful protectionfor our technology or adequate remedies in the event of unauthorized use ordisclosure of confidential and proprietary information, and, in addition, theparties may breach such agreements. Also, our trade secrets may otherwisebecome 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 third partiesregarding the validity of our patents and proprietary rights, or from thirdparties asserting that we are infringing their patents or proprietary rights,which could result in litigation that would be costly to defend and coulddeprive us of valuable rights.*

 

Parties have conducted research for many years in the antibody andtransgenic animal fields. The term “transgenic”, when applied to an animal,such as a mouse, refers to an animal that has chromosomes into which humangenes have been incorporated. This research has resulted in a substantialnumber of issued patents and an even larger number of pending patent applications.The publication of discoveries in the scientific or patent literaturefrequently occurs substantially later than the date on which the underlyingdiscoveries were made. Our commercial success depends significantly on ourability to operate without infringing the patents and other proprietary rightsof third parties. Our technologies may unintentionally infringe the patents orviolate other proprietary rights of third parties. Such infringement orviolation may prevent us and our customers from pursuing product development orcommercialization. Such a result could materially harm our business, financialcondition and results of operations.

 

In March 1997, we entered into a cross-license and settlementagreement with GenPharm to avoid protracted litigation. Under thecross-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.

 

38

----

 

GlaxoSmithKline, plc, or Glaxo, has a family of patents relating tocertain methods for generating monoclonal antibodies that Glaxo is assertingagainst Genentech, Inc. in litigation that was commenced in 1999. OnMay 4, 2001, Genentech announced that a jury had determined that Genentechhad not infringed Glaxo’s patents and that all of the patent claims assertedagainst Genentech are invalid. We understand that Glaxo has filed a notice ofappeal with the Court of Appeals for the Federal Circuit. If any of the claimsof these patents are finally determined in the litigation to be valid, and ifwe were to use manufacturing processes covered by the patents to make ourproducts, we may then need to obtain a license should one be available. Shoulda license be denied or unavailable on commercially reasonable terms, we mayhave difficulty commercializing one or more of our products in any territoriesin which these claims were in force.

 

Genentech, Johnson & Johnson, Glaxo, TranskaryoticTherapies, Inc. and the Trustees of Columbia University in the City of NewYork each owns or controls a U.S. patent that relates to recombinant cell linesor methods of generating recombinant cell lines for the production ofantibodies. If we were to use a production system covered by any of thesepatents, we may then need to obtain a license should one be available. Underthese circumstances, our failure to obtain a license at all or on commerciallyreasonable terms could impede commercialization of one or more of our productsin any territories in which these patent claims were in force.

 

Genentech owns a U.S. patent that issued in June 1998 relating toinhibiting the growth of tumor cells that involves an antibody that binds to anepidermal growth factor receptor, or an anti-EGF receptor antibody, incombination with a cytotoxic factor, which is a substance having a toxic effecton cells. ImClone Systems, Inc. owns or is licensed under a U.S. patentthat issued in April 2001, relating to inhibiting the growth of tumor cellsthat involves an anti-EGF receptor antibody in combination with ananti-neoplastic, or anti-tumor, agent. A corresponding European patent was published for grant inMarch 2002 and Abgenix and others are opposing that patent in the EuropeanPatent Office.  A corresponding patenthas also issued in Canada.  We do notbelieve based on our review that either the Genentech patent or any of theImClone patents would be successfully asserted against any of our current orplanned activities relating to panitumumab or future commercial sales ofpanitumumab. If a court determines that the claims of either the Genentechpatent or the ImClone patent cover our activities with panitumumab and arevalid, such a decision may require us to obtain a license to Genentech’s patentor ImClone’s patents, as the case may be, to label and sell panitumumab forcertain combination therapies. Our failure to obtain a license, or to obtain alicense on commercially reasonable terms, could impede our commercialization ofpanitumumab.

 

In 2000, the Japan Patent Office granted a patent to Kirin BeerKabushiki Kaisha, one of our competitors, relating to non-human transgenicmammals.  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 other intellectual propertyrights has been common in the biotechnology and pharmaceutical industries. Thedefense and prosecution of intellectual property suits, United States Patentand Trademark Office interference proceedings, and related legal andadministrative proceedings in the United States and internationally involvecomplex legal and factual questions. As a result, such proceedings are costlyand time-consuming to pursue and their outcome is uncertain. Litigation may benecessary to:

 

•                                          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 or other administrativeproceedings could cause us

 

39

----

 

to incur substantial expense and could significantly divert the effortsof our technical and management personnel. An adverse determination may subjectus to loss of our proprietary position or to significant liabilities, orrequire us to seek licenses that may not be available from third parties. Anadverse determination in a judicial or administrative proceeding, or a failureto obtain necessary licenses, may restrict or prevent us from manufacturing andselling our products, if any. Costs associated with these arrangements may besubstantial and may include ongoing royalties. Furthermore, we may not be ableto obtain the necessary licenses on satisfactory terms, if at all. Theseoutcomes could materially harm our business, financial condition and results ofoperations.

 

**Risks Related to Our Industry**

 

*We face intense competition and rapidtechnological change, and if we fail to develop products that keep pace withnew technologies and that gain market acceptance, our product candidates ortechnologies could become obsolete.*

 

The biotechnology and pharmaceutical industries are highly competitiveand subject to significant and rapid technological change. We are aware ofseveral pharmaceutical and biotechnology companies that are actively engaged inresearch and development in areas related to antibody therapy. These companieshave commenced clinical trials of antibody therapeutic product candidates orhave successfully commercialized antibody therapeutic products for use on theirown or in combination therapies. Many of these companies are addressing thesame diseases and disease indications as we or our customers are. Also, wecompete with companies that offer antibody generation services to companiesthat have antigens. These competitors have specific expertise or technologyrelated to antibody development and introduce new or modified technologies fromtime to time. These companies include GenPharm, a wholly owned subsidiary ofMedarex, Inc., Medarex’s collaborator, Kirin Brewing Co. Ltd.; GenMabA/S; Cambridge Antibody Technology Group plc; Genentech; Protein DesignLabs, Inc.; MorphoSys AG; Xenerex Biosciences Inc., a subsidiary ofAvanir Pharmaceuticals; XLT Biopharmaceuticals Ltd.; and AlexionPharmaceuticals, Inc. Finally, we compete with companies that currentlyoffer antibody production services, and may compete with companies thatcurrently only manufacture their own antibodies but could offer antibodyproduction services to third parties.

 

Some of our competitors have received regulatory approval of or aredeveloping or testing product candidates that may compete directly with ourproduct candidates. ImClone, in collaborations with Bristol-Meyers SquibCompany and Merck KgAa; AstraZeneca, plc; Glaxo; and a collaboration of OSIPharmaceuticals, Inc., Genentech and Roche have potential antibody andsmall molecule product candidates in clinical development that may compete withpanitumumab, which is also in clinical trials.

 

ImCloneand Bristol-Myers Squibb have received approval to market Erbitux, ImClone’santibody product candidate for the treatment of metastatic colorectal cancer,in the United States.  ImCloneand Bristol-Myers Squibb have also announced the submission of an applicationfor approval to market Erbitux in Canada. Merck KgAa has announced that it has received approval to market Erbituxfor the treatment of metastatic colorectal cancer in the European Union andthat it has received approval to market Erbitux in Switzerland for treatment ofmetastatic colorectal cancer.

 

Genentech has received approval to market Avastin for use withchemotherapy as a first-line treatment for colorectal cancer.

 

AstraZeneca has received approval to market Iressa, a small moleculeproduct candidate that may compete with panitumumab, in many markets in theworld, including the United States, Japan, Australia and Canada, for thetreatment of advanced non-small cell lung cancer.

 

Genentech and OSI have initiated the rolling submission of an NDA forTarceva in the United States for the treatment of advanced non-small cell lungcancer.

 

In addition, Amgen has received approval to market Sensipar, orcinacalcet HCI, a small molecule

 

40

----

 

product candidate for the treatment of secondary hyperparathyroidism,which may compete with ABX-PTH.

 

Many of these companies and institutions, either alone or together withtheir customers or collaborators, have substantially greater financialresources and larger research and development staffs than we do. In addition,many of these competitors, either alone or together with their customers orcollaborators, have significantly greater experience than we do in:

 

•                                          developingproducts;

 

•                                          undertakingpreclinical testing and human clinical trials;

 

•                                          obtainingFDA and other regulatory approvals of products; and

 

•                                          manufacturingand marketing products.

 

Accordingly, our competitors may succeed in obtaining patentprotection, receiving FDA approval or commercializing products before we do. Ifwe commence commercial product sales, we will be competing against companieswith greater marketing and manufacturing capabilities, areas in which we havelimited or no experience.

 

We also face, and will continue to face, competition from academicinstitutions, government agencies and research institutions. There are numerouscompetitors working on products to treat each of the diseases for which we areseeking to develop therapeutic products. In addition, any product candidatethat we successfully develop may compete with existing therapies that have longhistories of safe and effective use. Competition may also 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 product candidates ortechnologies obsolete or non-competitive. We face and will continue to faceintense competition from other companies for agreements with pharmaceutical andbiotechnology companies, for establishing relationships with academic andresearch institutions, and for licenses to proprietary technology. Thesecompetitors, either alone or with their customers, may succeed in developingtechnologies or products that are more effective than ours.

 

We also face competition from companies that provide productionservices.  These include contractmanufacturers, such as Lonza, Avid Bioservices, Inc., Diosynth Biotechnology,DSM N.V. and Goodwin Biotechnology Inc., and other pharmaceutical andbiotechnology companies that manufacture their own product candidates but canmake extra capacity available to collaborators and customers, such asBoehringer Ingelheim GmbH, Biogen Idec Inc., Cangene Corporation, ICOSCorporation, Abbott and Novartis AG.

 

*We face uncertainty over reimbursement andhealthcare reform, which, if determined adversely to us, could seriously hinderthe market acceptance of our products.*

 

In both domestic and foreign markets, sales of our product candidateswill depend in part upon the availability of reimbursement from third-partypayors, such as government health administration authorities, managed careproviders and private health insurers. Third-party payors are increasinglychallenging the price and examining the cost effectiveness of medical productsand services. In addition, significant uncertainty exists as to thereimbursement status of newly approved healthcare products. Adequate third-partyreimbursement may not be available to enable us to maintain price levelssufficient to realize an appropriate return on our investment in productdevelopment. In addition, domestic and foreign

 

41

----

 

governments continue to propose and pass legislation designed to reducethe cost of healthcare, which could further limit reimbursement forpharmaceuticals. The failure of the government and third-party payors toprovide adequate coverage and reimbursement rates for our product candidatescould adversely affect the market acceptance of our products. The failure ofour products to receive market acceptance would materially harm our business,financial condition and results of operations.

 

**Other Risks Related to Our Company**

 

*The future growth and success of our businesswill depend on our ability to continue to attract and retain our employees andconsultants.*

 

For us to pursue product development, manufacturing, marketing andcommercialization plans, we will need to hire additional qualified scientific,manufacturing, quality control and quality assurance personnel. We may alsoneed to hire personnel with expertise in clinical testing, governmentregulation, manufacturing, marketing, law and finance. Attracting and retainingqualified personnel will be critical to our success. We may not be able toattract and 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 increased attrition rates in2003.  Further attrition couldmaterially harm our business, financial condition and results of operations.

 

We grant stock options as a method of attracting and retainingemployees, to motivate performance and to align the interests of managementwith those of our stockholders. Due to the decline in the trading price of ourcommon stock during 2001 and 2002, a substantial portion of the stock optionsheld by our employees have an exercise price that is higher than the currenttrading price of our common stock. We may elect to reprice or otherwise adjustthe terms of these stock options, grant additional stock options at the currentlower market price, pay higher cash compensation, or provide some combinationof these alternatives to retain and attract qualified employees, but we cannotbe sure that any of these actions would be successful. If we issue additionalstock options, this would dilute existing stockholders.

 

As a result of these factors, we may have difficulty attracting andretaining qualified personnel, which could materially harm our business,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 business through corporateacquisitions. Our acquisition of companies and businesses and expansion ofoperations, 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;

 

•                                          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 of companies andbusinesses and expansion of operations may result in dilutive issuances ofequity securities, the incurrence of additional debt, U.S. or foreign taxliabilities, large one-time write-offs and the creation of goodwill or otherintangible assets that could result in amortization expense or other charges toexpense.

 

*We have implemented a stockholder rights planand are subject to other anti-takeover provisions, which could deter a partyfrom effecting a takeover of us at a premium to our then-current stock price.*

 

42

----

 

In June 1999, our board of directors adopted a stockholder rightsplan, which we amended and restated in November 1999 and May 2002,and amended in October 2003. The stockholder rights plan and certainprovisions of our amended and restated certificate of incorporation and amendedand restated bylaws may have the effect of making it more difficult for a thirdparty to acquire, or of discouraging a third party from attempting to acquire,control of us. This could limit the price that certain investors might bewilling to pay in the future for our common stock. Certain provisions of ouramended and restated certificate of incorporation and amended and restatedbylaws 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 and licenseagreement with AstraZeneca for the purpose of identifying and developingantibody products for use in oncology therapeutics.  The collaboration agreement includes provisions that would allowAstraZeneca to accelerate its selection of target antigens and, in certainsituations, terminate the collaboration agreement, or specific programs oractivities conducted under it, in the event of a change in control in us,particularly if we were acquired by a competitor of AstraZeneca.  In the event of a change in control of us,AstraZeneca could also acquire control over the development programs andvarious intellectual property rights in respect of antigens that are thesubject 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 provisions contained in thecollaboration agreement would apply to an acquirer of our company and would restrictthe acquirer’s ability to operate its business in the oncology field after theacquisition, except with respect to pre-existing development programs.  These and other provisions of thecollaboration agreement could make our company less attractive to a potentialacquirer, particularly an acquirer that conducts or expects to conductsignificant operations in the field of oncology therapeutics.

 

We are also subject to certain provisions of Delaware law which couldalso delay or make more difficult a merger, tender offer or proxy contestinvolving us. In particular, Section 203 of the Delaware GeneralCorporation Law prohibits a Delaware corporation from engaging in any businesscombination with any interested stockholder for a period of three years unlessthe transaction meets certain conditions. The stockholder rights plan, thepossible issuance of preferred stock, the procedures required for directornominations and stockholder proposals, our collaboration agreement withAstraZeneca and Delaware law could have the effect of delaying, deferring orpreventing 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 and may notbe 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 any productsmanufactured in our facility, in clinical trials, and the sale of any approvedproducts, may expose us to liability claims resulting from such use or sale.Consumers, healthcare providers, pharmaceutical companies or others sellingsuch products might make claims of this kind. We may experience financiallosses in the future due to product liability claims. We have obtained limitedproduct liability insurance coverage for our clinical trials and productionservices activities, under which the coverage limits are $15.0 million peroccurrence and $15.0 million in the

 

43

----

 

aggregate. We may not be able to maintain insurance coverage at areasonable cost or in sufficient amounts to protect us against losses. If thirdparties bring a successful product liability claim or series of claims againstus for uninsured liabilities or in excess of insured liabilities, our business,financial condition and results of operations may be materially harmed.

 

*Our operations involve hazardous materials,and we could be held responsible for any damages caused by such materials.*

 

Our research and manufacturing activities involve the controlled use ofhazardous materials. In addition, although we maintain insurance for harm toemployees and to our facilities caused by hazardous materials, we do not insureagainst any other harm (including harm to the environment) caused by the use ofhazardous materials on our premises. We cannot eliminate the risk of accidentalcontamination or injury from these materials. In the event of an accident orenvironmental discharge, we may be held liable for any resulting damages, whichmay exceed our financial resources and may materially harm our business,financial condition and results of operations.

 

*We do not intend to pay cash dividends on ourcommon stock.*

 

We intend to retain any future earnings to finance the growth anddevelopment of our business and we do not plan to pay cash dividends on ourcommon stock in the foreseeable future.

 

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

 

The market price and trading volume of our common stock are volatile,and we expect such volatility to continue for the foreseeable future. Forexample, during the period between March 31, 2003 and March 31, 2004,our common stock closed as high as $16.58 per share and as low as $7.80 pershare.  This may impact your decision tobuy or sell our common stock. Factors affecting our stock price include:

 

•                                          ourfinancial results;

 

•                                          fluctuationsin our operating results;

 

•                                          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 competitiveproduct candidates;

 

•                                          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

 

44

----

 

•                                          generalmarket conditions.

 

*If we were deemed to be an investmentcompany, we would become subject to provisions of the Investment Company Actthat likely would have a material adverse impact on our business.*

 

A company is required to register as an investment company under theInvestment Company Act of 1940, or the 1940 Act, if, among other things, andsubject 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 in investment gradeinterest-bearing securities. Such investments could in some circumstancesrequire us to register as an investment company under the 1940 Act.Registration under the 1940 Act, or a determination that we failed to registerwhen required to do so, could have a material adverse impact on us. We believethat we are and will remain exempt from the registration requirements, butabsent 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 QualitativeDisclosures About Market Risk

 

*Interest Rate Risk.*  We are exposed tointerest rate sensitivity on our investments in debt securities and ouroutstanding fixed rate debt. Theobjective of our investment activities is to preserve principal, while at thesame time maximizing yields without significantly increasing risk. To achievethis objective, we invest in highly liquid, investment grade and governmentdebt securities. Our investments in debt securities are subject to interestrate risk. To minimize the exposure due to an adverse shift in interest rates,we invest in short-term securities and our goal is to maintain an averagematurity of approximately one year. In addition, as of March 31,2004, 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.  A hypothetical 1.0% per annum decrease ininterest rates would result in an adverse net change in the fair valueof our interest rate sensitive assets and liabilities of approximately $3.2 million at March 31, 2004 andDecember 31, 2003.

 

*Equity Price Risk.*  We are exposed to equity pricerisk on strategic investments, such as those we have made in CuraGen andImmunoGen. We typically do not attempt to reduce or eliminate our marketexposure on these securities. With respect to CuraGen and ImmunoGen, each ofwhose common stock is publicly traded, the aggregate market value of ourinvestments in these securities was approximately $19.5 million and$20.7 million as of March 31, 2004 and December 31, 2003,respectively. Due to decreases in the market prices of the shares of CuraGenand ImmunoGen, we recorded impairment charges of $67.3 million in 2002 relatedto these investments. The trading prices of shares of CuraGen and ImmunoGenhave fluctuated significantly since we purchased these securities. Eachadditional 10% decrease in market value of these securities would result in adecrease in value of approximately $2.0 million and $2.1 million from the fairvalue of those investments at March 31, 2004 and December 31, 2003,respectively.  Additional price declinescould cause us to record additional impairment charges in future periods.

 

*Foreign Currency Risk.*Asubstantial majority of our revenue, expense, and capital purchasing activitiesare transacted in U.S. dollars. However, we do enter into transactions in othercurrencies,

 

45

----

 

primarily the British pound. As of March 31, 2004, we had acontract cancellation obligation to Lonza of approximately $15.6 million ascompared to $22.7 million as of December 31, 2003, which is payable inBritish pounds. A hypothetical 10% adverse change in exchange rates wouldresult in an increase in the U.S. dollar value of this obligation ofapproximately $1.6 million at March 31, 2004 as compared to $2.3 millionat December 31, 2003.

 

# **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 Senior Director, Finance, 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**

 

Therehas been no change in our internal control over financial reporting during ourlast fiscal quarter that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting.

 

**PART II. OTHER INFORMATION**

 

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

 

Not applicable.

 

#### **ITEM2**. Changes inSecurities, Use of Proceeds and Issuer Purchases of Equity Securities

#### ** **

On February 19, 2004, we issued to AstraZeneca UK Limited aconvertible subordinated promissory note with a face amount of $50 million anda maturity date of October 29, 2013. The convertible subordinated note was issued to AstraZeneca inconnection with the redemption by the Company of shares of the Company’s SeriesA-2 Convertible Preferred Stock with an aggregate liquidation preference of $50million that were previously held by AstraZeneca.  The offer and sale of securities in the transaction describedabove was deemed to be exempt from registration under the Securities Act inreliance upon Section 4(2) of the Securities Act, as a transaction by anissuer not involving any public offering. In addition, appropriate legends were affixed to the securities issuedin the transaction described above.

 

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

 

Not applicable.

 

#### **ITEM 4. Submission of Matters to Vote ofSecurity Holders**

 

Not applicable.

 

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

 

Not applicable.

 

#### **ITEM 6. Exhibits and Reports on Form 8-K**

 

(a) Exhibits

 

46

----

 
| **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.                                                                                                     |
| 10.87++    |   | Amendment  No. 1 to Collaboration and License Agreement, between Abgenix, Inc. and  AstraZeneca UK Ltd., dated March 19, 2004.                                  |
| 31.1       |   | Certification  of Raymond M. Withy, Ph.D. Pursuant to Rule 13a-14(a), as Adopted Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                    |
| 31.2       |   | Certification  of Barbara Riching Pursuant to Rule 13a-14(a), as Adopted Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                            |
| 32.1       |   | Certification  of Raymond M. Withy, Ph.D. 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 Barbara Riching Pursuant  to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906  of the Sarbanes-Oxley Act of 2002.          |

 

----

++                                  Confidential treatment has been requested forportions of the exhibit.  Omittedportions have been filed separately with the Commission.

 

(1)                                  Incorporated by reference to the same exhibitfiled with Abgenix’s Annual Report on Form 10-K for the year endedDecember 31, 2002.

 

(2)                                  Incorporated by reference to the same exhibitfiled with Abgenix’s Annual Report on Form 10-K for the year endedDecember 31, 2001.

 

(b) Reports on Form 8-K

 

We filed a Form 8-K on February 24,2004, furnishing under “Item 12. Disclosure of Results of Operations andFinancial Condition” a press release we issued on that date to report ourfinancial results for the year ended December 31, 2003.

 

We filed a Form 8-K on April 27,2004, furnishing under “Item 12. Disclosure of Results of Operations andFinancial Condition” a press release we issued on that date to report ourfinancial results for the quarter ended March 31, 2004.

 

47

----

 

**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 

 

Dated: May 10, 2004

 

 
|   | **ABGENIX, INC.**                                 |
|--------|---------------------------------------------------|
|   | (Registrant)                                      |
|   |                                              |
|   |                                              |
|   |   /s/   RAYMOND M. WITHY |   |
|   | Raymond M. Withy, Ph.D.                           |
|   | President and Chief Executive Officer             |
|   | (Principal Executive Officer)                     |
|   |                                              |
|   |                                              |
|   |   /s/   BARBARA  RICHING |   |
|   | Barbara Riching                                   |
|   | Senior Director, Finance                          |
|   | (Principal Financial and Accounting Officer)      |

 

48

----