**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

**FORM 10-Q**

 

| **(Mark  one)**                                                                                                                                                                                                                                    |   |                                                                                          |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                               |   |                                                                                          |   |   |
| **ý**                                                                                                                                                                                                                                         |   | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|                                                                                                                                                                                                                                               |   |                                                                                          |   |   |
| **For the quarterly period ended  March 31, 2003**                                                                                                                                                                                                 |
|                                                                                                                                                                                                                                               |   |                                                                                          |   |   |
| **OR**                                                                                                                                                                                                                                             |
|                                                                                                                                                                                                                                               |   |                                                                                          |   |   |
| **o**                                                                                                                                                                                                                                              |   | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                                                                               |   |                                                                                          |
| **For the transition period  from                 to                 .** |
|                                                                                                                                                                                                                                               |   |                                                                                          |   |   |
| **Commission file number:000-24207**                                                                                                                                                                                                               |

 

**ABGENIX, INC.**

(Exactname of registrant as specified 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) 608-6500**

(Registrant’stelephone 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 Act of1934 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 isan accelerated filer (as defined in Rule 12b-2 of the ExchangeAct. Yes ý No o

 

As of April 30, 2003 there were 87,914,308 sharesof the Registrant’s Common Stock outstanding.

 

 

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**TABLE OF CONTENTS**

 

** **
| **PART I. Financial Information**                                                                       |   |
|---------------------------------------------------------------------------------------------------------|--------|
|                                                                                                    |
| **ITEM  1. Financial Statements**                                                                       | 3      |
|                                                                                                    |
| Condensed  Consolidated Balance Sheets at March 31, 2003 and December 31,2002                           | 3      |
|                                                                                                    |
| Condensed Consolidated  Statements of Operations for the three monthsended March 31, 2003 and 2002      | 4      |
|                                                                                                    |
| Condensed  Consolidated Statements of Cash Flows for the three months endedMarch 31, 2003 and 2002      | 5      |
|                                                                                                    |
| Notes  to Condensed Consolidated Financial Statements                                                   | 6      |
|                                                                                                    |
| **ITEM 2. Management’s Discussion  and Analysis of Financial Condition and Results of Operations** | 10     |
|                                                                                                    |
| **ITEM  3. Quantitative and Qualitative Disclosures about Market Risk**                                 | 42     |
|                                                                                                    |
| **ITEM 4. Controls and Procedures**                                                                     | 43     |
|                                                                                                    |
| **PART II. Other Information**                                                                          |   |
|                                                                                                    |
| **ITEM 1. Legal Proceedings**                                                                           | 44     |
|                                                                                                    |
| **ITEM  2. Changes in Securities and Use of Proceeds**                                                  | 44     |
|                                                                                                    |
| **ITEM 3.  Defaults upon Senior Securities**                                                            | 44     |
|                                                                                                    |
| **ITEM  4. Submission of Matters to a Vote of Security Holders**                                        | 44     |
|                                                                                                    |
| **ITEM 5. Other Information**                                                                           | 44     |
|                                                                                                    |
| **ITEM 6.  Exhibits and Reports on Form 8-K**                                                      | 44     |
|                                                                                                    |
| **SIGNATURES**                                                                                          | 45     |
|                                                                                                    |
| **CERTIFICATIONS**                                                                                      | 46     |

 

2

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**PART I****.  FINANCIALINFORMATION**

 

**ITEM 1****.  FinancialStatements**

 

**ABGENIX, INC.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

(in thousands, except share and per share data)

(unaudited)

 
|                                                                                                                                                                            |   | **March 31,********2003** |    | **December 31,  2002** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------|---------|------------------------|--------|
|                                                                                                                                                                            |   |                      |    |                   |   |
| **ASSETS**                                                                                                                                                                      |   |                      |    |                   |   |
| Current assets:                                                                                                                                                                 |   |                      |    |                   |   |
| Cash and cash equivalents                                                                                                                                                       |   | $                         | 183,045 |                   | $      | 207,974 |   |
| Marketable securities                                                                                                                                                           |   | 162,702                   |    | 188,575                |   |
| Interest receivable                                                                                                                                                             |   | 1,821                     |    | 2,004                  |   |
| Accounts receivable, net                                                                                                                                                        |   | 1,439                     |    | 2,640                  |   |
| Prepaid expenses and other current assets                                                                                                                                       |   | 19,426                    |    | 16,538                 |   |
| Total current assets                                                                                                                                                            |   | 368,433                   |    | 417,731                |   |
| Property and equipment, net                                                                                                                                                     |   | 254,920                   |    | 244,419                |   |
| Long-term investments                                                                                                                                                           |   | 19,078                    |    | 20,939                 |   |
| Goodwill                                                                                                                                                                        |   | 34,780                    |    | 34,780                 |   |
| Identified intangible assets, net                                                                                                                                               |   | 89,091                    |    | 92,349                 |   |
| Deposits and other assets                                                                                                                                                       |   | 30,549                    |    | 31,779                 |   |
|                                                                                                                                                                            |   | $                         | 796,851 |                   | $      | 841,997 |   |
|                                                                                                                                                                            |   |                      |    |                   |   |
| **LIABILITIES AND  STOCKHOLDERS’ EQUITY**                                                                                                                                  |   |                      |    |                   |   |
| Current liabilities:                                                                                                                                                            |   |                      |    |                   |   |
| Accounts payable                                                                                                                                                                |   | $                         | 12,136  |                   | $      | 21,557 |   |
| Deferred revenue                                                                                                                                                                |   | 5,840                     |    | 3,416                  |   |
| Accrued liabilities                                                                                                                                                             |   | 7,578                     |    | 8,907                  |   |
| Accrued interest payable                                                                                                                                                        |   | 311                       |    | 2,061                  |   |
| Total current liabilities                                                                                                                                                       |   | 25,865                    |    | 35,941                 |   |
| Deferred rent                                                                                                                                                                   |   | 4,944                     |    | 4,417                  |   |
| Convertible subordinated notes                                                                                                                                                  |   | 200,000                   |    | 200,000                |   |
| Commitments                                                                                                                                                                     |   |                      |    |                   |   |
| Stockholders’ equity:                                                                                                                                                      |   |                      |    |                   |   |
| Preferred stock, $0.0001 par value; 5,000,000 shares authorized; none  issued or outstanding                                                                                    |   | —                    |    | —                 |   |
| Common stock, $0.0001 par value; 220,000,000 shares authorized;  87,756,470 and 87,655,342 shares issued and outstanding at March 31, 2003 and  December 31, 2002, respectively |   | 9                         |    | 9                      |   |
| Additional paid-in capital                                                                                                                                                      |   | 966,138                   |    | 965,821                |   |
| Accumulated other comprehensive income                                                                                                                                          |   | 1,406                     |    | 4,156                  |   |
| Accumulated deficit                                                                                                                                                             |   | (401,511                  | )       | (368,347               | )      |
| Total stockholders’ equity                                                                                                                                                 |   | 566,042                   |    | 601,639                |   |
|                                                                                                                                                                            |   | $                         | 796,851 |                   | $      | 841,997 |   |

 

See accompanying notes.

 

3

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**ABGENIX, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

(in thousands, except per share data)

(unaudited)

 
|                                                                               |   | **Three Months Ended March 31,** |    |
|------------------------------------------------------------------------------------|--------|----------------------------------|---------|
|                                                                               |   | **2003**                         |    | **2002** |   |
|                                                                               |   |                             |    |   |   |
| Revenues:                                                                          |   |                             |    |   |   |
| Contract revenue                                                                   |   | $                                | 6,156   |   | $ | 10,998 |   |
| Interest and other income                                                          |   | 3,195                            |    | 5,271 |   |
| Total revenues                                                                     |   | 9,351                            |    | 16,269 |   |
| Costs and expenses:                                                                |   |                             |    |   |   |
| Research and development                                                           |   | 21,187                           |    | 28,979 |   |
| Manufacturing start-up costs                                                       |   | 11,583                           |    | — |   |
| Amortization of identified intangible assets, related to research and  development |   | 1,815                            |    | 1,807 |   |
| General and administrative                                                         |   | 6,850                            |    | 6,707 |   |
| Impairment of investments                                                          |   | —                           |    | 34,653 |   |
| Interest expense                                                                   |   | 996                              |    | 574 |   |
| Total costs and expenses                                                           |   | 42,431                           |    | 72,720 |   |
| Loss before income tax expense                                                     |   | (33,080                          | )       | (56,451 | ) |
| Foreign income tax expense                                                         |   | 84                               |    | — |   |
| Net loss                                                                           |   | $                                | (33,164 | ) | $ | (56,451 | ) |
|                                                                               |   |                             |    |   |   |
| Basic and diluted net loss per share                                               |   | $                                | (0.38   | ) | $ | (0.65 | ) |
|                                                                               |   |                             |    |   |   |
| Shares used in computing basic and diluted net loss per share                      |   | 87,706                           |    | 86,725 |   |

 

See accompanying notes.

 

4

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**ABGENIX, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

(in thousands)

(unaudited)

 
|                                                                         |   | **Three Months Ended March 31,** |    |
|------------------------------------------------------------------------------|--------|----------------------------------|---------|
|                                                                         |   | **2003**                         |    | **2002** |   |
| **Operating activities**                                                     |   |                             |    |   |   |
| Net loss                                                                     |   | $                                | (33,164 | ) | $ | (56,451 | ) |
| Adjustments to reconcile net loss to net cash used in operating  activities: |   |                             |    |   |   |
| Depreciation                                                                 |   | 5,899                            |    | 2,066 |   |
| Amortization of identified intangible assets                                 |   | 1,815                            |    | 1,806 |   |
| Impairment of identified intangible asset                                    |   | 1,443                            |    | — |   |
| Amortization of debt issuance cost                                           |   | 296                              |    | 83 |   |
| Impairment of investments                                                    |   | —                           |    | 34,653 |   |
| Changes for certain assets and liabilities:                                  |   |                             |    |   |   |
| Interest receivable                                                          |   | 183                              |    | (421 | ) |
| Accounts receivable                                                          |   | 1,201                            |    | 523 |   |
| Prepaid expenses and other current assets                                    |   | (2,888                           | )       | (3,817 | ) |
| Deposits and other assets                                                    |   | 934                              |    | (1,528 | ) |
| Accounts payable                                                             |   | (9,421                           | )       | (5,014 | ) |
| Deferred revenue                                                             |   | 2,424                            |    | (8,248 | ) |
| Accrued liabilities                                                          |   | (1,329                           | )       | 638 |   |
| Accrued interest payable                                                     |   | (1,750                           | )       | 525 |   |
| Deferred rent                                                                |   | 527                              |    | 493 |   |
| Net cash used in operating activities                                        |   | (33,830                          | )       | (34,692 | ) |
|                                                                         |   |                             |    |   |   |
| **Investing activities**                                                     |   |                             |    |   |   |
| Purchases of marketable securities                                           |   | (18,986                          | )       | (25,755 | ) |
| Maturities of marketable securities                                          |   | 16,183                           |    | 30,353 |   |
| Sales of marketable securities                                               |   | 27,787                           |    | 27,833 |   |
| Purchases of property and equipment                                          |   | (16,400                          | )       | (34,882 | ) |
| Payments for acquisition liabilities                                         |   | —                           |    | (130 | ) |
| Net cash provided by (used in) investing activities                          |   | 8,584                            |    | (2,581 | ) |
|                                                                         |   |                             |    |   |   |
| **Financing activities**                                                     |   |                             |    |   |   |
| Net proceeds from issuance of convertible subordinated notes                 |   | —                           |    | 194,000 |   |
| Net proceeds from issuances of common stock                                  |   | 317                              |    | 452 |   |
| Net cash provided by financing activities                                    |   | 317                              |    | 194,452 |   |
| Net increase (decrease) in cash and cash equivalents                         |   | (24,929                          | )       | 157,179 |   |
| Cash and cash equivalents at beginning of period                             |   | 207,974                          |    | 99,663 |   |
| Cash and cash equivalents at end of period                                   |   | $                                | 183,045 |   | $ | 256,842 |   |

 

See accompanying notes.

 

5

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**ABGENIX, INC.**

**NOTES TO CONDENSED****CONSOLIDATED FINANCIALSTATEMENTS**

**March 31, 2003**

**(unaudited)**

 

**1.             Basis of Presentation and Summaryof Significant Accounting Policies**

 

**Basis ofPresentation -**The unaudited condensed consolidated financialstatements of Abgenix, Inc. (the “Company” or “Abgenix”) included herein havebeen prepared by the Company pursuant to the rules and regulations of theSecurities and Exchange Commission. Certain information or footnote disclosurenormally included in financial statements prepared in accordance with generallyaccepted accounting principles has been condensed or omitted pursuant to suchrules and regulations. In the opinion of the Company, the accompanyingunaudited condensed consolidated financial statements contain all adjustments,consisting only of normal recurring adjustments, necessary to present fairlythe financial information included therein. These financial statements shouldbe read in conjunction with the audited financial statements for the year endedDecember 31, 2002,****and accompanying notes included inthe Company’s Annual Report as filed on Form 10-K with the Securities andExchange Commission. The results of operations for the three months ended March31, 2003, are not necessarily indicative of the results to be expected for thefull year or for any other future period.

 

**Revenue Recognition** - The Company receivespayments from customers for license, option, service and milestone fees. Thesepayments are generally non-refundable but are reported as deferred revenueuntil they are recognizable as revenue. The Company has followed the followingprinciples in recognizing revenue:

 

•                                          Research license fees: Fees to license the use of theCompany’s proprietary technologies in research performed by the customer aregenerally recognized only after both the license period has commenced and thetechnology has been delivered. If Abgenix is obligated to provide significantassistance to enable the customer to practice the license, then the revenue isrecognized over the period of such obligation.

 

•                                            Product license fees: Fees to license theproduction, use and sale of an antibody generated by the Company’s proprietarytechnologies are generally recognized only after both the license period hascommenced and the technology has been delivered. If Abgenix is obligated toprovide significant assistance to enable the customer to practice the license,then the revenue is recognized over the period of such obligation.

 

•                                          Option fees: Fees for granting options to obtainproduct licenses to develop a product are recognized as revenue when the optionis exercised or when the option period expires, whichever occurs first.

 

•                                            Research services: Fees for research servicesperformed by Abgenix are recognized ratably over the entire period the servicesare performed. In the case of co-development arrangements, fees received forresearch services provided are recorded as contract revenues in the period theservices are rendered.

 

•                                            Milestones: Incentive milestone payments arerecognized as revenue when the milestone is achieved. Incentivemilestone payments are triggered either by the results of our research effortsor by events external to Abgenix, such as regulatory approval to market aproduct. Incentive milestone payments are substantially at risk at theinception of the contract, and the values assigned thereto are commensuratewith the type of milestone achieved. Upon achievement of an incentive milestoneevent, the Company has no future performance obligations related to thepayment.

 

6

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**Net Loss Per Share -**Basic net loss per share is calculated based onthe weighted average number of shares outstanding during the period. The impactof common stock options and warrants was excluded from the computation ofdiluted net loss per share, as their effect is antidilutive for the periodspresented.

 

**Reclassifications —**Certain prior period balances have been reclassifiedto conform to the current period presentation.

 

**2.             ComprehensiveIncome (Loss)**

 

Other comprehensiveincome (loss) consists of unrealized gains or losses on available-for-salesecurities. The components of comprehensive loss were as follows (in thousands):

 
|                                                                |   | **Three Months Ended March 31,** |    |
|---------------------------------------------------------------------|--------|----------------------------------|---------|
|                                                                |   | **2003**                         |    | **2002** |   |
|                                                                |   |                             |    |   |   |
| Net loss                                                            |   | $                                | (33,164 | ) | $ | (56,451 | ) |
| Other comprehensive income (loss):                                  |   |                             |    |   |   |
| Unrealized holding losses arising during period                     |   | (2,750                           | )       | (21,525 | ) |
| Less: reclassification adjustment for losses recognized in net loss |   | —                           |    | 34,653 |   |
| Net unrealized gains (losses) on securities                         |   | (2,750                           | )       | 13,128 |   |
| Comprehensive loss                                                  |   | $                                | (35,914 | ) | $ | (43,323 | ) |

 

**3.             Goodwilland Identified Intangible Assets**

 

During the threemonths ended March 31, 2003, no goodwill was recognized as a result ofacquisitions and no goodwill was impaired. During the three months ended March31, 2003, no identified intangible assets were acquired.

 

During the threemonths ended March 31, 2003, the Company made a decision to discontinue the development of therapeuticantibodies to the complement protein properdin. Accordingly, the Companyrecorded an impairment charge of approximately $1.4 million related to thelicense to develop and commercialize antibodies to properdin. The impairmentcharge was included in research and development expenses on the Company’sstatement of operations.

 

Identifiedintangible assets as of March 31, 2003 and December 31, 2002 consisted of thefollowing (in thousands):

 
|                                      |   | **Gross****Assets** |    | **Accumulated  Amortization** |   | **Net** |   |
|-------------------------------------------|--------|---------------------|---------|-------------------------------|--------|---------|--------|
| **As  of March 31, 2003:**                |   |                |    |                          |   |    |   |
| Acquisition-related  developed technology |   | $                   | 106,183 |                          | $      | (18,382 | )      | $ | 87,801 |   |
| Other intangible  assets                  |   | 1,442               |    | (152                          | )      | 1,290   |   |
| Identified  intangible assets             |   | $                   | 107,625 |                          | $      | (18,534 | )      | $ | 89,091 |   |
|                                      |   |                |    |                          |   |    |   |
| **As  of December 31, 2002:**             |   |                |    |                          |   |    |   |
| Acquisition-related  developed technology |   | $                   | 106,183 |                          | $      | (16,612 | )      | $ | 89,571 |   |
| Other intangible  assets                  |   | 3,016               |    | (238                          | )      | 2,778   |   |
| Identified  intangible assets             |   | $                   | 109,199 |                          | $      | (16,850 | )      | $ | 92,349 |   |

 

Amortization of acquisition-related intangibles was approximately $1.8million for each of the three-month periods ended March 31, 2003 and 2002.Amortization of other intangible assets was $46,000 and $48,000 for the threemonths ended March 31, 2003 and 2002, respectively. All of the Company’s

 

7

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acquired identified intangibles other than goodwill are subject toamortization.

 

Expected amortization expense related to identified intangible assetsfor the nine-month period from April 1, 2003, to December 31, 2003, and each ofthe fiscal years thereafter is as follows (in thousands):

 
|                             |   | **Periods  Ending December 31,** |   |     |   |     |   |
|----------------------------------|--------|----------------------------------|--------|----------|--------|----------|--------|
|                             |   | **2003**                         |   | **2004** |   | **2005** |   | **2006** |   | **2007** |   | **Thereafter** |   | **Total** |   |
| Acquisition-related  intangibles |   | $                                | 5,307  |     | $      | 7,076    |   | $ | 7,077 |   | $ | 7,077 |   | $ | 7,076 |   | $ | 54,188 |   | $ | 87,801 |   |
| Other intangible  assets         |   | $                                | 67     |     | $      | 90       |   | $ | 90 |   | $ | 90 |   | $ | 90 |   | $ | 863 |   | $ | 1,290 |   |

 

**4.             Stock-BasedCompensation**

 

The Companyaccounts 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 to Statementof Financial Accounting Standards (SFAS 123), as amended by SFAS 148, theestimated fair value of options is amortized to expense over the options’vesting period. The followingtable illustrates what net loss would have been had the Company accounted forits stock-based awards under the provisions of SFAS 123. Pro forma amountsmay not be representative of future periods.

 
|                                                                                                                                                                    |   | **Three Months Ended March 31,**              |    |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------|---------|
|                                                                                                                                                                    |   | **2003**                                      |    | **2002** |   |
|                                                                                                                                                                    |   | **(in thousands, except per share  amounts)** |    |
| Net loss                                                                                                                                                                |   | $                                             | (33,164 | ) | $ | (56,451 | ) |
| Stock-based employee compensation cost that would have been included  in the determination of net income if the fair value based method had been  applied to all awards |   | (15,921                                       | )       | (20,134 | ) |
| Pro forma net loss as if the fair value based method had been applied  to all awards                                                                                    |   | $                                             | (49,085 | ) | $ | (76,585 | ) |
|                                                                                                                                                                    |   |                                          |    |   |   |
| Basic and diluted net loss per share                                                                                                                                    |   | $                                             | (0.38   | ) | $ | (0.65 | ) |
|                                                                                                                                                                    |   |                                          |    |   |   |
| Pro forma basic and diluted loss per share as if the fair value based  method had been applied to all awards                                                            |   | $                                             | (0.56   | ) | $ | (0.88 | ) |

 

Pro forma information has been determined as if the Company hadaccounted for its employee stock options under the fair value method of SFAS123. The fair value for these options was estimated at the date of grant usinga Black-Scholes option pricing model with the following assumptions for thethree months ended March 31, 2003 and 2002, respectively: risk-free interestrate of 3.07% for both 2003 and 2002; no dividend yield in 2003 or 2002;volatility factor of 1.06 and 1.05; and an expected life of the option of 5.52years and 5.54 years. These same assumptions were applied in the determinationof the option values related to stock options granted to non-employees, exceptfor the option life for which the term of the consulting contracts, 1 to5 years, was used. The value of stock options granted to non-employees hasbeen recorded in the financial statements.

 

The Black-Scholes option valuation model was developed for use inestimating the fair value of traded options, which have no vesting restrictionsand are fully transferable. In addition, option valuation models require theinput of highly subjective assumptions, including the expected stock pricevolatility. Because the Company’s employee stock options have characteristicssignificantly different from those of traded options, and because changes inthe subjective input assumptions can materially affect the fair

 

8

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value estimate, in management’s opinion, the existing models do notnecessarily provide a reliable single measure of the fair value of its employeestock options.

 

The weighted-average fair values of options granted during the threemonths ended March 31, 2003 and 2002 were $5.67 and $15.34 per share,respectively. All options granted in 1997 and 1996 were granted at exerciseprices below the deemed fair value of the underlying common stock. All optionsgranted after 1997 were granted at exercise prices at the then current marketvalue of the stock.

 

**5.             SegmentInformation**

 

The operations of the Company and its wholly owned subsidiariesconstitute one business segment.

 

Revenues from three customers represented 49%, 12%, and 10%,respectively, of contract revenues for the three months ended March 31, 2003.Revenues from two customers represented 77% and 10%, respectively, of contractrevenues for the three months ended March 31, 2002.

 

**6.             RestructuringCharges**

 

InOctober 2002, the Company announced a restructuring plan, which consistedprimarily of a 15% reduction in employees. A restructuring charge of $1.8million was recorded in 2002 to account for severance, medical and otherbenefits associated with this restructuring. As of December 31, 2002,approximately $1.1 million of severance benefits were accrued. During the threemonths ended March 31, 2003, the Company made cash payments for severancebenefits of approximately $915,000.  Asof March 31, 2003, approximately $187,000 of severance benefits were accruedand are expected to be paid to terminated employees over the next six months.

 

**7.             CustomerIndemnification**

 

The Company has certain agreements with customers andcollaborators that contain indemnification provisions. In such provisions, theCompany typically agrees to indemnify the customer or collaborator againstcertain types of third-party claims. The Company would accrue for knownindemnification issues if a loss were probable and could be reasonablyestimated. The Company would accrue for estimated incurred but unidentifiedissues based on historical activity. There was no accrual for or expenserelated to indemnification issues as of March 31, 2003 and 2002 and, in eachcase, for the three months then ended.

 

**8.             RecentAccounting Pronouncements**

 

In November 2002, theFASB issued Emerging Issues Task Force (EITF) Issue No. 00-21, “Revenue Arrangementswith Multiple Deliverables.” EITF Issue No. 00-21 addresses certain aspects ofthe accounting by a company for arrangements under which it will performmultiple revenue-generating activities. EITF Issue No. 00-21 addresses when andhow an arrangement involving multiple deliverables should be divided intoseparate units of accounting. The provisions of EITF Issue No. 00-21 will applyto revenue arrangements entered into in fiscal periods beginning after June 15,2003. The provisions of the EITF Issue No. 00-21 do not impact the accountingtreatment of the Company’s existing revenue arrangements. The Company believesthat the adoption of EITF Issue No. 00-21 will not result in a material changeto its existing revenue recognition policy for prospective revenuearrangements. The Company does not expect the adoption of EITF Issue No. 00-21to have a material impact on its consolidated financial statements.

 

9

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

###  

*The following Management’sDiscussion and Analysis of Financial Condition and Results of Operationscontains forward*-*lookingstatements based upon current expectations that involve risks anduncertainties. 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**

 

We are a biopharmaceutical company that is focused on the discovery,development and manufacture of antibody therapeutic products for the treatmentof a variety of disease conditions, including cancer, inflammation, metabolicdisease, transplant-related diseases, cardiovascular disease and infectiousdiseases.

 

We have proprietary technologies that facilitate rapid generation ofhighly specific, antibody therapeutic product candidates that containfully human protein sequencesand that bind to disease targets appropriate for antibody therapy. In thisQuarterly Report on Form 10-Q we refer to these candidates as fully humanantibody therapeutic product candidates. We developed our XenoMouse® technology, a technology using geneticallymodified mice to generate fully human antibodies. We also own a technology thatenables the rapid identification of antibodies with desired function and characteristics,referred to as SLAMTM technology. In our XenoMaxTM technology, we use SLAMtechnology to select and isolate antibodies with particular function andcharacteristics from antibody-producing cells generated by XenoMouse animals.We believe XenoMax technology enhances our capabilities in product developmentand flexibility in manufacturing. We have entered into a variety of contractualarrangements with multiple pharmaceutical, biotechnology and genomics companiesinvolving our XenoMouse and XenoMax technologies. Two of our customers,Pfizer, Inc. and Amgen, Inc., have initiated clinical trials withfully human antibodies generated from XenoMouse animals. In addition, under ajoint development and commercialization agreement we are co-developing ABX-EGF,our leading proprietary antibody product candidate, with Amgen and ImmunexCorporation, a wholly-owned subsidiary of Amgen. We intend to build a large anddiversified product portfolio by using our XenoMouse and XenoMax technologiesto generate antibodies to antigen targets that we source, entering intoadditional joint development and commercialization agreements withpharmaceutical and biotechnology companies and, in some cases, self fundingclinical activities to determine preliminary safety and efficacy and carryingout additional internal product development. We also plan to enter into additional agreements to use our XenoMaxtechnology to assist our licensees and collaborators in isolating antibodieswith desired function and characteristics. These arrangements may involvesharing of costs and profits.

 

As of March 31, 2003, we had entered into contracts covering numerousantigen targets with over thirty customers to use our XenoMouse and XenoMaxtechnologies to generate and/or develop the resulting fully human antibodies.Also as of March 31, 2003, we had entered into a contract with one customer toprovide process sciences and manufacturing services related to an antibodyproduct candidate that we developed with the customer pursuant to an antigen sourcingcontract. Pursuant to our XenoMouse contracts, we and our customers intend togenerate antibody product candidates for the treatment of cancer, inflammation,autoimmune diseases, transplant rejection, cardiovascular disease, growthfactor modulation, neurological diseases and infectious diseases. Wealso plan to enter into additional contracts to provide antibody processsciences and manufacturing services. We expect that substantially all of our revenues for the foreseeablefuture will result from payments under these and other contracts. We have alsolicensed technology from third parties for use in conjunction with ourproprietary technologies. The terms of our current contractual arrangementsvary, but can generally be categorized as follows:

 

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•                                         Antigen Target Sourcing Contracts—We haveentered into several target sourcing contracts with genomics andbiopharmaceutical companies that may enable us to generate a pipeline ofproprietary fully human antibody product candidates. Typically, pursuant tothese contracts we generate fully human antibodies to the antigen targetsprovided or identified by our collaborators. The contracts typically containprovisions that allow either Abgenix or our collaborator to evaluate and selectparticular antibodies from the pool of generated antibodies for furtherdevelopment and commercialization. The party selecting an antibody for furtherdevelopment or commercialization will generally pay to the other party licensefees, milestone payments and royalty payments on any eventual product sales, inexchange for rights to develop and commercialize the product. In connectionwith these arrangements, we may also agree to purchase the common stock of acollaborator for strategic reasons. For example, we have made equityinvestments in CuraGen Corporation and MDS Proteomics Inc. in connection withour collaborations with these parties.

 

•                                         Proprietary Product Development—In each ofJuly and August 2000, we entered into a joint development andcommercialization agreement.  Pursuantto one of these agreements, we are co-developing ABX-EGF, a fully humanantibody we created, with Amgen and Immunex. Under the agreement, Immunex paidus an initial license fee at signing and a second license fee in May 2001.We are obligated to pay 50% of the development costs and are entitled to 50% ofany profits from sales of collaboration products. We also share responsibilityfor product development. We will be responsible for completing the ongoingPhase 1 trial and any additional Phase 1 trials that are initiated, and bothcompanies share responsibility for the execution of Phase 2 trials across avariety of indications. Amgen will have primary responsibility for Phase 3clinical trials and will market any potential products, while we will haveco-promotion rights. The other agreement is with SangStat Medical Corporationfor ABX-CBL, an in-licensed mouse antibody we developed. In February 2003, we and SangStat announcedthat because the Phase 2/3 clinical trial for ABX-CBL did not meet itsprimary endpoint, further development of ABX-CBL would not continue. Currentlywe are concluding all activities associated with the development of ABX-CBLincluding the Phase 2/3 clinical trial. Under that agreement, SangStat paid us certain license fees andmilestone payments, and we and SangStat have shared equally in all developmentcosts.

 

•                                         Production Services—We have entered into acontract with one customer to provide process sciences and manufacturing servicesrelated to an antibody product candidate that we developed and which thecustomer selected from a pool of antibodies generated pursuant to an existingantigen sourcing agreement. Under this production services contract we willdeliver a variety of process development, cell banking and manufacturingservices for the selected antibody product candidate. The agreement providesfor the customer to pay us certain fees in advance and upon completion of work,and we will be entitled to royalties on the sale of products subject to thiscontract. We also have the right of first offer with regard to productionservices for additional antibodies developed by this customer. We intend toenter into agreements to provide process sciences and manufacturing services toother existing and new customers.

 

•                                         Technology Out-Licensing—We have licensed ourXenoMouse technology to third parties for the purpose of generating antibodyproduct candidates to one or more specific antigen targets provided by thecustomer. In some cases in which we license XenoMouse technology, we provideour mice to the customer, which then carries out immunizations with itsspecific antigen targets. In other cases, we immunize the mice with thecustomer’s antigen targets for additional compensation. The customer generallyhas an option for a period of time to acquire a product license for anyantibody 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 customer.Based on our agreements, these payments and fees would average fromapproximately $7.0 million to $10.0 million per antigen target if ourcustomer takes the antibody into development and ultimately tocommercialization. Additionally, our license agreements entitle us to receiveroyalties on any future product sales by

 

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thecustomer. We may also agree to purchase the common stock of some of ourcustomers, or they may agree to purchase our common stock, in connection withthese licensing arrangements.Asof March 31, 2003, we had entered into one agreement in which we licensed ourSLAM technology to one party on a non-exclusive basis for the purpose ofgenerating and using antibodies other than antibodies derived from XenoMousetechnology or other technology that involves the use of non-human animals, andon a co-exclusive basis for the purpose of antigen discovery. We currently donot intend to license our SLAM technology for use by any other parties. Inaddition, as of March 31, 2003, we had also entered into an agreement in which we exclusively licensed to one partyrights under patent applications and patents held by us to develop and commercializetherapeutic antibodies to parathyroid hormone-related protein, or PTHrp..

 

•                                         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 intolicense and options agreements with ImmunoGen, Inc. pursuant to which we maydevelop and commercialize products based upon certain proprietary immunotoxins.These agreements often also 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 purchase common stock of the otherparty for strategic reasons in connection with these arrangements. For example,we purchased shares of common stock of ImmunoGen in connection with ouragreement with that company.

 

As of March 31, 2003, two of our antibody therapeutic productcandidates were in ongoing clinical trials.

 

•                                         ABX-EGF—Generated using XenoMouse technologyfor development as a treatment for a variety of cancers, ABX-EGF is our leadingfully human antibody therapeutic product candidate. We are co-developing thiscandidate with Amgen and Immunex under a joint development andcommercialization agreement.  The statusof clinical trials for ABX-EGF is as follows:

 

•                                         Various cancers—We initiated a Phase 1clinical trial for ABX-EGF in cancer in July 1999, in which enrollment isongoing.

 

•                                         Renal cell cancer—We initiated a Phase 2clinical trial evaluating the effect of ABX-EGF as monotherapy in patients withrenal cell cancer in April 2001, in which enrollment is ongoing.

 

•                                         Non-small cell lung cancer— Immunex initiateda Phase 2 clinical trial for ABX-EGF in non-small cell lung cancer incombination with standard chemotherapy, compared to standard chemotherapy alone,in July 2001 and enrollment is ongoing.

 

•                                         Colorectal cancer— Immunex initiated a Phase2 clinical trial evaluating the effect of ABX-EGF as monotherapy in patientswith metastatic colorectal cancer who have previously failed chemotherapy inDecember 2001 and enrollment is ongoing. Immunex initiated a separate Phase 2clinical trial evaluating the effect of ABX-EGF in combination with standardchemotherapy, as first-line treatment in patients with metastatic colorectalcancer in January 2002, in which enrollment is ongoing.

 

•                                         Prostate cancer—We initiated a Phase 2clinical trial evaluating the effect of ABX-EGF in patients with hormoneresistant prostate cancer in January 2002, in which enrollment is ongoing.

 

•                                         ABX-MA1—Generated using XenoMouse technology,ABX-MA1 is a fully human antibody therapeutic product candidate for thetreatment of a variety of cancers. We filed an Investigational New DrugApplication, or IND, in December 2001 and initiated a Phase 1 clinical trialfor ABX-

 

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MA1 in metastatic melanoma in February 2002,in which enrollment is ongoing.

 

We developed ABX-CBL, an in-licensed mouse antibody, for the treatmentof a transplant-related disease known as graft versus host disease.  InFebruary 2003, we and our co-developer, SangStat, announced that thePhase 2/3 clinical trial for ABX-CBL did not meet its primary endpoint andthat we would discontinue further development. We are concluding all activities associated with the development ofABX-CBL. Also, in May 2002, after analyzing Phase 2b clinical trial results ofABX-IL8, a fully human antibody therapeutic product candidate generated usingXenoMouse technology, we decided to discontinue the clinical development ofABX-IL8 and wind down ongoing clinical trials, consistent with patient safetyand follow-up.

 

We agreed tojointly develop and commercialize ABX-EGF. We intend to enter into additional joint development agreements forother product candidates earlier in the product development lifecycle than whenwe entered into previous joint development agreements. We will expend significant capital to conductclinical trials or share in the costs of conducting clinical trials, for our proprietary product candidates. Weexpect that this will substantially increase our operating expenses over thenext few years in comparison to prior periods.

 

In addition to our proprietary antibody therapeutic product candidatesin clinical trials, there are two customer-developed antibodies generated with XenoMousetechnology in clinical trials as follows:

 

•                 Pfizer—We generated a XenoMouse-derived fullyhuman antibody therapeutic product candidate for treating cancer that Pfizerhas advanced into clinical trials.

 

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

 

**Results ofOperations**

 

*ThreeMonths Ended March 31, 2003 and 2002*

 

*Contract Revenues.*

 

Contract revenues totaled $6.2 million and $11.0 million in the threemonths ended March 31, 2003 and 2002, respectively. Because they depend to alarge 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. With our new manufacturing facility and ourexisting pilot plant, we now offer integrated process sciences andmanufacturing services, which we refer to as production services. Over the next few years, we expect revenuefrom production services to increase, and over the next several years we expectrevenue from product development to decrease.

 

The primary components of contract revenues for both periods were asfollows:

 

•                 Technology Licensing

 

We recognized a total of$5.5 million and $9.5 million in the three months ended March 31, 2003 and2002, respectively, from licensing our proprietary technologies. Revenuesconsisted primarily of the following:

 

•                  Chugai Pharmaceutical Co. Ltd.—In the threemonths ended March 31, 2003, we recognized $3.0 million under an agreement withChugai in which we exclusively licensed to Chugai rights under patentapplications and patents held by us to develop and commercialize anti-PTHrptherapeutic antibodies.

 

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•                  Celltech R&D Ltd.—In the three monthsended March 31, 2002, we recognized $8.4 million under an agreement withCelltech in which we granted a license of our SLAM technology. We receivedpayments totaling $16.8 million in the fourth quarter of 2001 representing aresearch license fee and service fees for the transfer of technology, net of$0.2 million in shared closing costs. We recognized these fees over thesix-month period ended March 31, 2002, during which we fulfilled ourobligations to provide Celltech with the applicable protocols, technicalinformation and training to enable Celltech to effectively utilize the SLAMtechnology.

 

•                  Additionally, in the three months ended March31, 2003 and 2002, we recognized various fees, such as research licenseand service fees, product license fees, product development and researchmilestone payments, and option fees, under agreements related to the licensingof our XenoMouse technology.  Werecognized fees from several collaborators, primarily from Pfizer, CuraGen,Abbott Laboratories and Amgen in the three months ended March 31, 2003, andprimarily from CuraGen and Pfizer in the three months ended March 31, 2002.

 

•                 Proprietary Product Development

 

We recognized a total of$0.6 million and $1.5 million in the three months ended March 31, 2003 and2002, respectively, pursuant to our joint development and commercializationagreements. In both periods the revenues included the reimbursement ofdevelopment costs from development of ABX-CBL. In 2002, the revenue also included thereimbursement of development costs from development of ABX-EGF.

 

*Interest and Other Income.*

 

Interest and other income consist primarily of interest from cash, cashequivalents and marketable securities. Interest and other income decreased to$3.2 million in the three months ended March 31, 2003, compared to $5.3 millionin the same period in 2002. The decrease was due to lower interest rates andlower average cash, marketable securities and cash equivalent balances.

 

*Research and Development Expenses.*

 

Research and development expenses were $21.2 million and $29.0 millionin the three months ended March 31, 2003 and 2002, respectively. Managementseparates research and development expenditures into amounts related toresearch and amounts related to product development as follows:

 

•                 Research Costs

 

Research costs include costs associated with research and testing of ourproduct candidates prior to reaching the development stage and costs associatedwith cell line development. Such costs include the costs of Abgenix personnel,facilities, including depreciation, and technology in-licensing. Research costs were $15.5 million in thethree months ended March 31, 2003, ascompared to $14.9 million in thesame period in 2002. Major components of the changes in research costs in thethree months ended March 31, 2003 as compared to the same period in 2002 wereas follows:

 

•                 Technology In-Licensing—In the first quarterof 2003 we made a decision to discontinue the development of therapeuticantibodies to the complement protein properdin. Accordingly, we recorded animpairment charge of $1.4 million of previously capitalized costs and $0.6million of other related costs related to the license to develop andcommercialize properdin.

 

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•                 Costs of Abgenix Personnel—Costs of Abgenixpersonnel to support research activities decreased 24% in the three months ended March 31, 2003 from thesame period in 2002. The decrease wasa result of our restructuring plan implemented in October 2002, which resultedin an approximately 15% reduction in total employees overall. Personnel costs primarily include salary, fringe benefits, recruiting and relocation costs.

 

•      Product Development Costs

 

Product development costs include costs of preclinical development and conductingclinical trials. Such costs include costs of Abgenix personnel, drug supplycosts, research fees charged by outside contractors and facility expensesincluding depreciation. Product development costs were $5.7 million in the three months ended March 31, 2003 as compared to$14.1 million in the same period in 2002. The decreasein the three months ended March 31, 2003 was primarily related to the decreasein clinical trials being conducted for ABX-IL8. Major components of the changesin product development costs in the three months ended March 31, 2003 as compared to the same period in 2002were as follows:

 

•                  Clinical Research Fees and Drug SupplyCosts—Clinical research fees, including clinical investigator site fees,monitoring costs, and data management costs, and drug supply costs decreased 84% in the threemonths ended March 31, 2003 from the same period in 2002. The decrease wasprimarily due to the decrease in clinical trials being conducted for ABX-IL8 inthe first quarter of 2003 as compared to the same period in 2002.

 

•                  Costs of Abgenix Personnel—Costs of Abgenixpersonnel to support clinical activities decreased 49% in the three months ended March 31, 2003 from thesame period in 2002. The decrease wasa result of our restructuring plan implemented in October 2002, which resultedin an approximately 15% reduction in total employees overall. Personnel costs primarily include salary,fringe benefits, recruiting and relocation costs.

 

*Manufacturing Start-Up Costs.*

 

Manufacturingstart-up costs include costsassociated with our newantibody production facility,including quality assurance and quality control activities. Such costsprimarily include facility expenses, including depreciation, outside contractorcosts and the costs of Abgenix personnel. The outside contractor costs includethe costs under a manufacturing supply agreement for a production suite heldexclusively for us, which is currently not being utilized. The total of themanufacturing start-up costs in the three months ended March 31, 2003 were$11.6 million. We expect to begin manufacturing antibodytherapeutic candidates in portions of the facility in the second quarter of2003, at which time we will begin depreciating those portions of the facility.We also expect the facility to be under-utilized for the remainder of the yearand therefore manufacturing start-up costs will continue for the remainder of2003. These costs may decrease as aresult of utilization of the facility for the manufacture of ABX-EGF andpotentially other product candidates under production services agreements;however, this decrease may be offset by an increase in depreciation.

 

*Amortization of Identified Intangible Assets.*

 

Our identified intangible assets consist primarily of existingtechnology (including patents and certain royalty rights) that we acquiredthrough our acquisition of Hesed Biomed Inc. in 2001, Abgenix Biopharma Inc. andIntraImmune Therapies, Inc. in 2000, and JT America’s interest in Xenotech in1999.  Amortization of intangible assetstotaled $1.8 million in each of the three-month periods ended March 31, 2003and 2002.

 

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*General and Administrative Expenses.*

 

General and administrative expenses include compensation, professionalservices, consulting, facilities, including depreciation, and other expensesrelated to legal, finance and information systems. General and administrativeexpenses totaled $6.9 million and $6.7 million in the three months ended March31, 2003 and 2002, respectively. The increase in 2003 as compared to 2002, wasprimarily due to an increase in facility costs and an increase in depreciationexpense related to the enterprise resource planning system, which was launchedat the beginning of the third quarter of 2002. The increase in 2003 waspartially offset by a decrease in consulting related to the implementation ofour new information systems in 2002 and a decrease in legal costs due to thetiming of activities related to securities filings, licensing, financingactivities and other contractual matters. We expect general and administrativecosts to approximate the same levels in the second quarter of 2003 as in thefirst quarter of 2003.

 

*Impairment of Investments.*

 

We purchased an aggregate amount of $80.0million of common stock of CuraGen and ImmunoGen as strategic investments atvarious times in 1999 and 2000. Under SFAS No. 115, “Accounting forCertain Investments in Debt and Equity Securities,” the CuraGen and ImmunoGeninvestments are designated as available-for-sale and arereported at fair value on our balance sheet. Unrealized holding gains andlosses for available-for-sale securities generally areexcluded from earnings and reported as a component of stockholders’equity. However, if a decline in the fair value of available-for-sale securities is judged to be other than temporary, the costbasis of the security is written down to fair value as a new cost basis and theamount of the write-down isincluded in earnings as an impairment charge.  Under our accountingpolicy, marketable equity securities are presumed to be impaired if their fairvalue is less than their cost basis for more than six months, absent compellingevidence to the contrary.  At March 31, 2002, our investments in CuraGenand ImmunoGen common stock had traded below their original cost basis for morethan six months, at which time we deemed that an impairment of these investmentshad occurred. Accordingly, we recorded an impairment charge of $34.7 million inthe three months ended March 31, 2002. In the year ended December 31, 2002, werecorded impairment charges totaling $67.3 million, which were based on thedifference between the market price and our original cost basis or new adjustedcost basis of these securities. We did notrecord further impairment charges in the three months ended March 31, 2003. Asof March 31, 2003, these investments were recorded at fair value in long-terminvestments on the balance sheet, and any net unrealized holding gains andlosses, to the extent not recognized as an impairment charge as discussedabove, are reported as a component of stockholders’ equity.  If wedeem these investments further impaired at the end of any future period, we mayincur an additional impairment charge on these investments.

 

In addition, in 2001, we invested $15.0 million inMDS Proteomics, a privately held company, in connection with the collaborationwith that company.  Because MDSProteomics is a private company and its securities are not publicly traded, thevalue of our investment is inherently more difficult to estimate than aninvestment in a publicly traded company. We did not record impairment chargesin the three months ended March 31, 2002. In the second quarter of 2002, weestimated that the value of our investment had declined to $7.9 million andthat an impairment of our investment had occurred. Accordingly, we recorded animpairment charge of $7.1 million in the second quarter of 2002. The amount ofthe charge was based on the difference between the estimated value asdetermined by our management and our original cost basis. We did not recordfurther impairment charges on this investment. As of March 31, 2003, there hasbeen no change in cost basis of this investment since June 30, 2002. Theinvestment is recorded in long-term investments on the balance sheet.  If we deem the investment in MDS Proteomicsfurther impaired at the end of any future period, we may incur an additionalimpairment charge on this investment.

 

*Interest Expense.*

 

Interest expense was primarily related to interest andamortization of issuance costs on our convertible debt. Interest expenseincreased to $996,000 in the three months ended March 31, 2003 compared to $574,000 in the sameperiod in 2002. The increase was primarily due to our issuance of $200.0million of convertible debt in March 2002, which accrues interest at an annualrate of 3.5%, payable semi-annually. Interest expense of $1.1 million and$38,000 related to the convertible debt was

 

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capitalized in the three months ended March 31,2003 and 2002, respectively. For each future quarterly period, we expect to payapproximately $1.8 million of interest expense related to our convertible debtuntil the debt matures, until we redeem or repurchase the debt or until all orpart of the debt is converted into shares of our common stock.

 

*Foreign Income Tax Expense.*

 

Foreign income tax expense of $84,000 in thethree months ended March 31, 2003 reflected an income tax provision on foreigncontract research projects.

 

**Liquidityand Capital Resources**

 

At March 31, 2003, we had cash, cash equivalents and marketablesecurities of approximately $345.7 million. We invest our cash equivalentsand marketable securities primarily in highly liquid, interest bearing,investment grade and government securities in order to preserve principal. Wehave also invested in certain marketable equity securities of ImmunoGen andCuraGen for strategic reasons. These securities had a fair value of $11.2million at March 31, 2003.

 

*Cash Used in Operating Activities.*  Netcash used in operating activities was $33.8 million and $34.7 million in the three months ended March 31, 2003 and 2002,respectively. The major components of the change in cash used in operating activities in thethree months ended March 31, 2003, compared to the same period in 2002, were primarily the following:

 

•                 A decrease of $11.3 million in research and development and manufacturingcosts, net of depreciation and an impairment charge related to an identifiedintangible asset, related to the development of new products.

 

•                 An increase of $10.2 million in manufacturing costs, net of depreciation,related to the start-up of our new antibody production facility.

 

•                 Anincrease of $6.5 million in customer payments due primarily to the timing ofpayments received under our contracts offset in part by a decrease of $1.5million in cash from interest income due to lower interest rates and loweraverage cash balances.

 

•                 Anincrease of $6.4 million in vendor payments, which reduced accounts payable andaccrued liabilities.

 

*Cash Used in Investing Activities.*  Netcash provided by investing activities was $8.6 million in the three months ended March 31, 2003. Net cashused in investing activities was $2.6 million in the threemonths ended March 31, 2002. Cash was provided by and used in investing activities as follows:

 

•                 Capitalexpenditures of $16.4 million and $34.9 million in the three months endedMarch 31, 2003 and 2002, respectively. The investments in 2003 and 2002 reflectprimarily investment in construction in progress and equipment for our newmanufacturing facility. The investments in 2002 also reflect investment inleasehold improvements in our new office facility and process sciencelaboratory and investments in computer hardware and software, including the acquisition of a newenterprise resource planning system.

 

•                 Maturitiesand sales, net of purchases, of marketable securities of $25.0 million and $32.4 million during the three months ended March31, 2003 and 2002, respectively.

 

*Cash Provided by Financing Activities.* During the three months ended March 31, 2003, net cash provided by financingactivities was $0.3 million, consisting of proceeds from the exercise of stockoptions. During the three months ended March 31, 2002, net cash provided byfinancing activities was

 

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$194.5million, consisting of $194.0 million net proceeds from our issuance ofconvertible subordinated notes, as described below, and $0.5 million proceedsfrom the exercise of stock options.

 

In March 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 by March 15 and September 15 of each year.  The notes will mature on March 15, 2007, andare redeemable at our option on or after March 20, 2005, or earlier if theprice of our common stock exceeds specified levels. In addition, the holders ofthe notes may require us to repurchase the notes if we undergo a change incontrol. Proceeds from the sale of the notes, net of commissions payableto the initial purchasers of the notes but before subtracting other offeringexpenses payable by us, were $194.0 million.

 

In March 2000 and February 2001, we obtained stand-by lettersof credit for $2.0 million and $3.0 million, respectively, from acommercial bank as security for our obligations under two facility leases.These were increased in January 2002 to $2.5 and $3.2 million, respectively, inconnection with amendments to our facility leases. In September 2001, weobtained a stand-by letter of credit for 1.0 million Canadian dollars froma commercial bank as security for our obligations under a facility lease inCanada while the facility was under construction. The standby letter of creditfor 1.0 million Canadian dollars was terminated in January 2003. The stand-byletters of credit outstanding are secured by an investment account.

 

*Financing Uncertainties Related to Our Business Plan.*  Weplan to continue to make significant expenditures to establish and staff ourown manufacturing facility and support our research and development activities,including pre-clinical product development and clinical trials. We also intendto look for opportunities to acquire new technology throughin-licensing, collaborations or acquisitions. Over the next nine months, we estimate that we will spendapproximately $17.6 million on leasehold improvements and equipment forour new manufacturing and research and development facilities. Additionally,during the same period we expect to spend up to approximately $0.5 millionon new computer hardware and software.

 

We currently intend to use our available cash on hand to finance theseprojects and business developments, but we might also pursue other financingalternatives, such as a bank line of credit, funding by one or morecollaborators or a mortgage financing, that may become available to us. Whetherwe use cash on hand or choose to obtain financing will depend on, among otherthings, the future success of our business, the prevailing interest rateenvironment and the condition of financial markets generally.

 

The amounts of the expenditures that will be necessary to execute ourbusiness plan are subject to numerous uncertainties that may adversely affectour liquidity and capital resources to a significant extent. As of March31, 2003, four of ourproprietary product candidates, ABX-EGF, ABX-MA1, ABX-CBL and ABX-IL8, were invarious stages of clinical trials.  Weare discontinuing development of two of them, ABX-IL8 and ABX-CBL. Completionof clinical trials may take several years or more, but the length of timegenerally varies substantially according to the type, complexity, novelty andintended use of a product candidate. We estimate that clinical trials of thetype we generally conduct are typically completed over the 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 ofclinical trials may vary significantly over the life of a project as a resultof differences arising during the clinical trials, including, among others, thefollowing:

 

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•              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; and

 

•              thelength of time required to enroll suitable patient subjects.

 

We test our potential product candidates innumerous pre-clinical studies to identify disease indications for which theymay be product candidates. We may conduct multiple clinical trials to cover avariety 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 further clinicalstudies of that product candidate. Additionallyin February 2003, we announced that the clinical trial of our proprietaryproduct candidate ABX-CBL as a treatment for graft versus host disease, did notsupport further clinical studies of that product candidate. The failure of clinical trials can alsoresult in additional research and development expenses.  For example, we recorded a charge of $6.7million for the three months ended June 30, 2002, related to our decision inthe second quarter of 2002 to wind down our clinical trials of ABX-IL8.

 

An important element of our business strategyis to pursue the research and development of a diverse range of productcandidates for a variety of disease indications. We intend to enterco-development agreements, similar to our agreements with Amgen and Immunex forABX-EGF and with SangStat for ABX-CBL, and to enter into additional jointdevelopment agreements earlier in the development lifecycle of productcandidates than we did in our existing co-development agreements. We have begunto implement our collaboration strategy through co-development arrangementswith companies such as Chugai Pharmaceutical, U3 Pharma AG and CorvasInternational, Inc. Our strategyis designed to diversify the risks associated with our research and developmentspending. The decisions to terminate or wind down our clinical programs fordeveloping ABX-IL8 and ABX-CBL have reduced the diversity of our productportfolio. We believe that this effect is temporary, in view of the number of potentialproduct candidates we have in preclinical development. To the extent, however,that we are unable to maintain a diverse and broad range of product candidates,our dependence on the success of one or a few product candidates wouldincrease.

 

Our proprietary product candidates also havenot yet achieved FDA regulatory approval, which is required before we canmarket them as therapeutic products. In order to proceed to subsequent clinicaltrial stages and to ultimately achieve regulatory approval, the FDA mustconclude that our clinical data establish safety and efficacy. Historically,the results from preclinical testing and early clinical trials have often notbeen predictive of results obtained in later clinical trials. A number of newdrugs and biologics have shown promising results in clinical trials, butsubsequently failed to establish sufficient safety and efficacy data to obtainnecessary regulatory approvals.

 

Furthermore, our business strategy includesthe option of entering into arrangements with third parties to collaborate inthe development and commercialization of our products. In the event that thirdparties take over the clinical trial process for one of our product candidates,the estimated completion date would largely be under the control of that thirdparty rather than us. We cannot forecast with any degree of certainty whichproprietary products or indications, if any, will be subject to futurecollaborative arrangements, in whole or in part, or the extent to which thirdparties may control clinical trials pursuant to such arrangements, and how sucharrangements would affect our capital requirements.

 

As a result of the uncertainties discussedabove, among others, the duration and completion costs of our research anddevelopment projects are difficult to estimate and are subject to considerable

 

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variation. Our inability to complete our research and developmentprojects in a timely manner or our failure to enter into collaborative agreements,when appropriate, could significantly increase our capital requirements andcould adversely impact our liquidity. These uncertainties could force us toseek additional, external sources of financing from time to time in order tocontinue with our business strategy. Our inability to raise additional capital,or to do so on terms reasonably acceptable to us, would jeopardize the futuresuccess of our business.

 

We also may be required to make furthersubstantial expenditures if unforeseen difficulties arise in other parts of ourbusiness. In particular, our future liquidity and capital requirements alsowill depend on many factors other than our research and development activities,including:

 

•                  the retention of existing and establishmentof further collaboration, licensing, manufacturing and other agreements, ifany;

 

•                  the cost of establishing and operating ourmanufacturing facility;

 

•                  the cost of conducting commercializationactivities and arrangements;

 

•                  the time and expense involved in seeking regulatoryapprovals;

 

•                  competing technological and marketdevelopments;

 

•                  the time and expense of filing andprosecuting patent applications and enforcing or defending against patentclaims;

 

•                  our investment in, or acquisition of, othercompanies;

 

•                  the amount of product in-licensing in whichwe engage; and

 

•                  other factors not within our control.

 

We believe that our current cash balances,cash equivalents, marketable securities, and the cash generated from ourlicensing and other agreements will be sufficient to meet our operating andcapital requirements for at least one year. However, because of theuncertainties in our business discussed above, among others, we cannot assureyou that this will be the case. In addition, we may choose to, or prevailingbusiness conditions may require us to, obtain additional financing from time totime. We may choose to raise additional funds through public or privatefinancing, licensing and other agreements or other arrangements. We cannot besure that any additional funding, if needed, will be available on termsfavorable to us or at all. Furthermore, any additional equity or equity-relatedfinancing may be dilutive to our stockholders, and debt financing, ifavailable, may subject us to restrictive covenants. We may also choose toobtain funding through collaborations, licensing and other contractualarrangements. Such agreements may require us to relinquish our rights tocertain of our technologies, products or marketing territories. Our failure toraise capital when needed would harm our business, financial condition andresults of operations.

 

*History of Net Losses.*  Wehave incurred net losses in each of the last five years of operation, includingnet losses of $16.8 million in 1998, $20.5 million in 1999,$8.8 million in 2000, $60.9 million in 2001, $208.9 million in 2002and $33.2 million in the three months ended March 31, 2003. As of March 31,2003, our accumulated deficit was $401.5 million. Our losses to date haveresulted principally from:

 

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

 

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•                  costs associated with certain agreements withJapan Tobacco, Inc. and certain 1997 settlement and cross-licensing agreementswith GenPharm International, Inc.;

 

•                  in-process research and development costs andamortization of intangible assets associated with our acquisitions of HesedBiomed, Abgenix Biopharma, IntraImmune and Japan Tobacco’s interest inXenotech;

 

•                  general and administrative costs relating toour operations; and

 

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

 

We expect to incur additional losses for the foreseeablefuture as a result of our research and development costs, including costsassociated with conducting preclinical development and clinical trials, chargesrelated to purchases of technology or other assets, and costs associated withestablishing our manufacturing facilities. We intend to invest significantly inour products prior to entering into licensing agreements. This will increaseour need for capital and will result in losses for at least the next severalyears. We expect that the amount of operating losses will fluctuatesignificantly from quarter to quarter as a result of increases or decreases inour research and development efforts, the execution or termination of licensingand other agreements, and the initiation, and success or failure, of clinicaltrials.

 

*Net Operating LossCarryforwards.*  As of December 31, 2002, we had netoperating loss carryforwards for federal income tax purposes of approximately$314.0 million. Our net operating loss carryforwards exclude lossesincurred prior to our formation in July 1996. Further, we have capitalizedthe amounts associated with the 1997 settlement and cross-license that havebeen expensed for financial statement accounting purposes and we are amortizingthose amounts over a period of approximately 15 years for tax purposes.The net operating loss and credit carryforwards will expire in the years 2006through 2022, if not utilized. Utilization of the net operating losses andcredits may be subject to a substantial annual limitation due to the “change inownership” provisions of the Internal Revenue Code of 1986 and similar stateprovisions. The annual limitation may result in the expiration of net operatinglosses and credits before utilization.

 

**Critical Accounting Policies**

 

The financialresults that we report are impacted by the application of several accountingpolicies that require us to make subjective and complex judgments. We arerequired to estimate the effect of matters that are inherently uncertain.Changes in our estimates or judgments could materially impact our results ofoperations, financial condition and cash flows in future years. We believe ourmost critical accounting policies include revenue recognition, accounting forour equity investments, accounting for goodwill, and accounting for clinicaltrial supplies.

 

*Revenue Recognition.*

 

We derive ourcontract revenue from license, option, service and milestone fees received fromcustomers. As described below, within the framework of generally acceptedaccounting principles, significant management judgments and estimates must bemade and applied in connection with the revenue recognized in any accountingperiod. If our management made different judgments or utilized differentestimates, material differences could result in the amount and timing of ourrevenue in any period.

 

•                                          Research andproduct license fees are generally recognized only after both the licenseperiod has commenced and the technology has been delivered. However, if we areobligated to provide significant assistance to enable the customer to practicethe license, then the revenue is recognized over the period of such obligation. Under some of our research and product licensearrangements, the period of our obligation to provide

 

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significant assistance to the customer may not becontractually defined with an end date. In these circumstances, we mustexercise judgment in estimating the period of time over which certaindeliverables, such as customer training, will be provided to enable thecustomer to practice the license.

 

**•**                                          Optionfees for granting options to obtain product licenses to develop a product arerecognized when the option is exercised or when the option period expires,whichever occurs first.

 

•                                          Feeswe receive for research services we perform are generally recognized ratablyover the entire period we perform these services. However, in the case ofco-development arrangements, fees we receive for research services we provideare recorded as revenue in the period they are rendered.

 

•                                          Incentivemilestone payments are recognized as revenue when the specified milestone isachieved. Incentive milestone payments are triggered either by the results ofour research efforts or by events external to Abgenix, such as regulatoryapproval to market a product. Incentive milestone payments are substantially atrisk at the inception of the contract, and the values assigned thereto arecommensurate with the type of milestone achieved. Upon achievement of anincentive milestone event, we have no future performance obligations related tothe payment.

 

*Accounting for Equity Investments.*

 

Weare exposed to equity price risk on our strategic investments in CuraGen,ImmunoGen and MDS Proteomics and we may elect to make additional similarinvestments in the future. As of March 31, 2003, we had a carrying value of$9.3 million in CuraGen common stock, which reflected the public trading priceon that date of $4.10 per share. We also had a carrying value on March 31,2003, of $1.8 million in ImmunoGen common stock, which reflected the publictrading price on that date of $2.33 per share. We typically do not attempt toreduce or eliminate our market exposure on these types of investments. UnderSFAS No. 115, “Accounting for Certain Investments in Debt and EquitySecurities,” the CuraGen and ImmunoGen investments are designated asavailable-for-sale and are reported at fair value on our balance sheet.Unrealized holding gains and losses on available-for-sale securities generallyare excluded from earnings and reported as a component of stockholders’ equity.However, if a decline in the fair value of available-for-sale securities isjudged to be other than temporary, the cost basis of the security is writtendown to fair value as a new cost basis and the amount of the write-down isincluded in earnings as an impairment charge. Under our accounting policy,marketable equity securities are presumed to be impaired if their fair value isless than their cost basis for more than six months, absent compelling evidenceto the contrary. We purchased $15.0 million of CuraGen common stock inDecember 1999 at price of $17.90 per share and $50.0 million ofCuraGen common stock in November 2000 at a price of $34.69 per share. Wepurchased $15.0 million of ImmunoGen common stock in September 2000at a price of $19.00 per share. During 2002, our investments in CuraGenand ImmunoGen common stock had traded below their original cost basis for morethan six months, and therefore we deemed that an impairment of theseinvestments had occurred. Accordingly, we recorded impairment charges totaling$67.3 million in the year ended December 31, 2002, which were based on thedifferences between the market price and cost basis or new adjusted cost basisof these securities. As of March 31, 2003,these investments were recorded at fair value in long-term investments on thebalance sheet, and any net unrealized holding gains and losses, to the extentnot recognized as an impairment charge as discussed above, were reported as a componentof stockholders’ equity. The public tradingprices of the shares of both companies have fluctuated significantly since wepurchased them and could continue to do so. If these shares continue to tradebelow their new cost bases in future periods, we may incur additionalimpairment charges relating to these investments. The amounts of these charges,if any, will equal our unrealized loss on these securities as of the end of therelevant periods.

 

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In addition, in 2001, we invested$15.0 million in MDS Proteomics, a privately held company, in connection withour collaboration with that company. Because MDS Proteomics is a privatecompany and its securities are not publicly traded, the value of our investmentis inherently more difficult to estimate than an investment in a publiclytraded company. In 2002, we estimated that the value of our investment haddeclined to $7.9 million and that an impairment of our investment had occurred.Accordingly, we recorded an impairment charge of $7.1 million on our investmentin the year ended December 31, 2002. The amount of the charge was based on thedifference between the estimated value as determined by our management and ouroriginal cost basis. As of March 31, 2003, there has been no change in costbasis of this investment since June 30, 2002. This investment is recorded inlong-term investments on the balance sheet. If we deem the investment in MDS Proteomics further impaired at the endof any future period, we may incur an additional impairment charge on thisinvestment.

 

*Accounting for Goodwill*.

 

On January 1, 2002, we adopted SFAS No. 142, “Goodwilland Other Intangible Assets,” which addresses the financial accounting andreporting standards for goodwill and other intangible assets subsequent totheir acquisition. As a result, we no longer amortize goodwill but insteadreview goodwill for impairment on annual basis, or sooner if indications ofimpairment exist. Under our accounting policy, we have adopted the beginning ofthe fourth quarter as an annual goodwill impairment test date.  Followingthis approach, we compare the carrying values available as of September 30 withthe estimated fair value of the reporting unit to assess if there has been apotential impairment, and, if impairment is indicated, complete the measurementof impairment under the procedures established by SFAS 142. Because we havedetermined that we have one reporting unit under SFAS No. 142, our marketcapitalization is considered to be a reasonable proxy for the fair value of thereporting unit.  We also consider whether current business andgeneral market conditions suggest that the fair value of the reporting unit haslikely declined below its carrying value.

 

For a brief period during the first quarter of 2003,our common stock had traded at a price that represented a market capitalizationless than our book value. However this condition did not persist for asignificant portion of the first quarter of 2003 and as of March 31, 2003, ourcommon stock was trading at a price that represented a market capitalization higherthan our book value. As of March 31, 2003, we determined that the fair value ofthe reporting unit was higher than its carrying value and an impairment chargewas not recognized.

 

If we were to determine in afuture period that in impairment of goodwill existed, the impairmentmeasurement procedures could result in a charge for the impairment ofgoodwill.  Furthermore, a changein our determination of reporting units could result in a charge for theimpairment of goodwill in future periods. A change in the determination ofreporting units could occur should we reorganize into reporting units such thateach unit constitutes a business for which discrete financial information isavailable that is regularly reviewed by management to evaluate the performanceof that unit. As of March 31, 2003, the carrying value of our goodwill wasapproximately $34.8 million.

 

*Accounting for Clinical TrialSupplies.*

 

We pay fees to outside contractors for the manufactureof our antibody therapeutic product candidates. Such fees are capitalized asprepaid expense if management determines that the clinical trial supplies havealternative future uses in clinical trials for multiple indications of aproduct candidate and are expensed upon the use of the materials, primarily asthey are used in clinical trials. We immediately expense previously capitalizedcosts if the asset were not expected to have an alternative future use, such asuse in a clinical trial. As of March 31,2003, the balance of prepaid clinical trial supplies was $15.2million.  We may incur additional expenses related toclinical supply writedowns depending on the outcome of ongoing clinical trials.

 

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**Contractual Obligations andCommercial Commitments**

 

As of March 31, 2003, future minimum payments forcertain contractual obligations for years subsequent to December 31, 2002 wereas follows:

 
|                        |   | **Total**          |    | **2003** |   | **2004-  2005*** |   | **2006-  2007*** |   | **2008 and  Thereafter** |   |
|-----------------------------|--------|--------------------|---------|----------|--------|------------------|--------|------------------|--------|--------------------------|--------|
|                        |   | **(in thousands)** |    |
| **Contractual Obligations** |   |               |    |     |   |             |   |             |   |                     |   |
| Operating leases            |   | $                  | 154,978 |     | $      | 12,471           |   | $                | 26,875 |                     | $      | 28,765 |   | $ | 86,867 |   |
| Convertible debt            |   | 200,000            |    | —   |   | —           |   | 200,000          |   | —                   |   |
| Total                       |   | $                  | 354,978 |     | $      | 12,471           |   | $                | 26,875 |                     | $      | 228,765 |   | $ | 86,867 |   |

 

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*Amounts represent total of minimum payments forthe entire period.

 

In March 2002, we issued$200.0 million principal amount of convertible subordinated notes in a privateplacement. The notes are convertible into shares of our common stock at aconversion price of $27.58 per share subject to certain adjustments. The notesaccrue interest at an annual rate of 3.5%, and we are obligated to pay interest on March 15 andSeptember 15 of each year, beginning on September 15, 2002. The notes will mature on March 15, 2007 andare redeemable at our option on or after March 20, 2005, or earlier if theprice of our common stock exceeds specified levels. In addition, the holders ofthe notes may require us to repurchase the notes if we undergo a change in control.  Therefore, in March 2007, or earlier if weundergo a change in control, we may use a significant portion of our cashbalance to repay the $200.0 million principal amount of our convertible debt.If our cash balance at any time is insufficient to meet our obligations underthe notes, we would have to seek additional financing, if available, to supportour obligations under the notes.  Inaddition, we expect to make interest payments on the notes of  $7.0 million per year, for years 2003through 2006, and $1.2 million in 2007, assuming all the notes remainoutstanding until their maturity date.

 

Other significant commercialcommitments include the following:

 

•                                          Purchase commitments totaling $8.4 million tocontractors related to the purchase of equipment and design and construction ofour new manufacturing facility;

 

•                                          A monthly suite fee of approximately $1.2million plus a 15% raw material charge to Lonza for our exclusive use of a cellculture production suite within one of Lonza’s facilities over the five-yearcontract term, which ends August 2006;

 

•                                          An annual maintenance fee of $50,000 for ourexclusive worldwide rights to commercialize ABX-CBL. In addition, we commit atleast $1.0 million annually to the development of ABX-CBL until ABX-CBL receivesregulatory approval as a commercial product in any country and to pay royaltieson potential product sales. If we fail to fulfill this commitment, we wouldlose the CBL license and not be able to continue the development of ABX-CBL.Our obligations under the CBL license agreement are subject to ourdiscretionary right to terminate the agreement. We and our co-developer,SangStat, announced in February 2003 our decision to discontinue furtherdevelopment of ABX-CBL; and

 

•                                          A commitment to share equally all developmentcosts for ABX-EGF pursuant to our joint development and commercializationagreement with Amgen and Immunex. Development costs are determined by the development plan agreed upon bya joint steering committee.  We shareresponsibility for product development with Amgen and Immunex.

 

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**Recent Accounting Pronouncements**

 

In November 2002, the FASB issued Emerging Issues TaskForce (EITF) Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.”EITF Issue No. 00-21 addresses certain aspects of the accounting by a companyfor arrangements under which it will perform multiple revenue-generatingactivities. EITF Issue No. 00-21 addresses when and how an arrangementinvolving multiple deliverables should be divided into separate units ofaccounting. The provisions of EITF Issue No. 00-21 will apply to revenuearrangements entered into in fiscal periods beginning after June 15, 2003. Theprovisions of the EITF Issue No. 00-21 do not impact the accounting treatmentof our existing revenue arrangements. We believe that the adoption of EITFIssue No. 00-21 will not result in a material change to our existing revenuerecognition policy for prospective revenue arrangements. We do not expect the adoptionof EITF Issue No. 00-21 to have a material impact on our consolidated financialstatements.

 

**AdditionalFactors That Might Affect Future Results**

 

**Risks Related to our Finances**

 

*We are an early stage company without commercial therapeuticproducts, and we cannot assure you that we will develop sufficient revenues inthe future to sustain our business.*

 

Youmust evaluate us in light of the uncertainties and complexities present in anearly stage biopharmaceutical company. Our product candidates are in earlystages of development. We will need to make significant additional investmentsin research and development, preclinical testing and clinical trials, and inregulatory and sales and marketing activities, to commercialize current andfuture product candidates. Our product candidates, if successfully developed,may not generate sufficient or sustainable revenues to enable us to beprofitable.

 

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

 

Wehave incurred net losses in each of the last five years of operation, includingnet losses of $16.8 million in 1998, $20.5 million in 1999,$8.8 million in 2000, $60.9 million in 2001, $208.9 million in2002 and $33.2 million in the three months ended March 31, 2003. As of March31, 2003, our accumulated deficit was $401.5 million. Our losses to datehave resulted principally from:

 

•                                          research and development costs relating tothe development of our XenoMouse technology and antibody product candidates;

 

•                                          costs associated with certain agreements withJapan Tobacco and certain 1997 settlement and cross-licensing agreementswith GenPharm;

 

•                                          in-process research and development costs andamortization of intangible assets associated with our acquisitions of HesedBiomed, Inc., Abgenix Biopharma, Inc., IntraImmune Therapies, Inc. and JapanTobacco’s interest in Xenotech;

 

•                                          general and administrative costs relating toour operations; and

 

•                                          impairment charges related to our strategicinvestments in CuraGen, ImmunoGen, and MDS Proteomics.

 

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, and charges related to purchasesof technology or other assets. We intend to invest significantly in ourproducts prior to entering into licensing agreements. This will increase ourneed for capital and will result in losses for at least the next several years.We expect that the amount of operating losses will fluctuate significantly fromquarter to quarter as a result of increases or decreases in our research anddevelopment efforts, the execution or termination of licensing, manufacturingand other contractual arrangements, and the

 

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initiation, success or failure ofclinical trials.

 

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

 

Priorto June 1996, Cell Genesys owned our business and operated it as aseparate business unit. Since that time, we have funded our research anddevelopment activities primarily from private placements and public offeringsof our securities and from revenues generated by our licensing and other contractualarrangements.

 

Weexpect that substantially all of our revenues for the foreseeable future willresult from payments under licensing and other contractual arrangements andfrom interest income. To date, payments under licensing and other agreementshave been in the form of option fees, reimbursement for research anddevelopment expenses, license fees and milestone payments. Payments under ourexisting and any future customer agreements will be subject to significantfluctuation in both timing and amount. Our revenues may not be indicative ofour future 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 other period. Wemay not be able to:

 

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

 

•                                          successfully complete preclinical developmentor clinical trials;

 

•                                          obtain required regulatory approvals;

 

•                                          successfully manufacture or market productcandidates; or

 

•                                          generate additional revenues orprofitability.

 

Ourfailure to achieve any of the above goals would materially harm our business,financial condition and results of operations.

 

*We may require additional financing, and an inability toraise the necessary capital or to do so on acceptable terms would threaten thecontinued success of our business.*

 

Wewill continue to expend substantial resources to support research anddevelopment, including costs associated with preclinical development andclinical trials. In the years ended December 31, 2002, 2001, and 2000, weincurred expenses of $128.5 million, $96.2 million and $50.1 million,respectively, on research and development. For the three months ended March 31,2003, we spent $21.2 million on research and development. Regulatory andbusiness factors will require us to expend substantial funds in the course ofcompleting required additional development, preclinical testing and clinicaltrials of, and attaining regulatory approvals for, product candidates. 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. Our future liquidity and capital requirements willdepend on many factors, including:

 

•                                          the scope and results of preclinicaldevelopment and clinical trials;

 

•                                          the retention of existing and establishmentof further co-development, licensing, manufacturing and other agreements, ifany;

 

•                                          continued scientific progress in our researchand development programs;

 

•                                          the size and complexity of these programs;

 

•                                          the cost of establishing manufacturingcapabilities and meeting good manufacturing

 

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practice regulations;

 

•                                          the cost of conducting commercializationactivities and arrangements;

 

•                                          the time and expense involved in seekingregulatory approvals;

 

•                                          competing technological and marketdevelopments;

 

•                                          the time and expense of filing and prosecutingpatent applications, and enforcing and defending against patent claims;

 

•                                          our investment in, or acquisition of, othercompanies;

 

•                                          the amount of product or technologyin-licensing in which we engage; and

 

•                                          other factors not within our control.

 

Webelieve that our current cash balances, cash equivalents, marketablesecurities, and the cash generated from our licensing and other contractualarrangements, will be sufficient to meet our operating and capital requirementsfor at least one year. However, because of the uncertainties in our business,including the uncertainties listed above, we cannot assure you that this willbe the case. In addition, we may choose to obtain additional financing fromtime to time. We may choose to raise additional funds through public or privatefinancing, licensing and other agreements or arrangements. We cannot be surethat any additional funding, if needed, will be available on terms favorable tous or at all. Furthermore, any additional equity or equity-related financingmay be dilutive to our stockholders, and debt financing, if available, maysubject us to restrictive covenants. We may also choose to obtain fundingthrough licensing and other contractual arrangements. Such agreements mayrequire us to relinquish our rights to certain of our technologies, products ormarketing territories. Our failure to raise capital when needed would harm ourbusiness, financial condition and results of operations.

 

*Our strategic investments expose us to equity pricerisk and our investments in those companies may be deemed impaired, which wouldaffect our results of operations.*

 

Weare exposed to equity price risk on our strategic investments in CuraGen,ImmunoGen and MDS Proteomics and we may elect to make additional similar investmentsin the future. As of March 31, 2003, we had a carrying value of $9.3 million inCuraGen common stock, which reflected the public trading price on that date of$4.10 per share. We also had a carrying value on March 31, 2003, of $1.8million in ImmunoGen common stock, which reflected the public trading price onthat date of $2.33 per share. We typically do not attempt to reduce oreliminate our market exposure on these types of investments. Under SFASNo. 115, “Accounting for Certain Investments in Debt and EquitySecurities,” the CuraGen and ImmunoGen investments are designated asavailable-for-sale and are reported at fair value on our balance sheet.Unrealized holding gains and losses on available-for-sale securities generallyare excluded from earnings and reported as a component of stockholders’ equity.However, if a decline in the fair value of available-for-sale securities isjudged to be other than temporary, the cost basis of the security is writtendown to fair value as a new cost basis and the amount of the write-down isincluded in earnings as an impairment charge. Under our accounting policy,marketable equity securities are presumed to be impaired if their fair value isless than their cost basis for more than six months, absent compelling evidenceto the contrary. We purchased $15.0 million of CuraGen common stock inDecember 1999 at price of $17.90 per share and $50.0 million ofCuraGen common stock in November 2000 at a price of $34.69 per share. Wepurchased $15.0 million of ImmunoGen common stock in September 2000at a price of $19.00 per share. During 2002, our investments in CuraGenand ImmunoGen common stock had traded below their original cost basis for morethan six months, and therefore we deemed that an impairment of these investmentshad occurred. Accordingly, we recorded impairment charges totaling $67.3million in the year ended December 31, 2002, which were based on thedifferences between the market price and cost basis or new adjusted cost basisof these securities. As of March 31, 2003,these investments were recorded at fair

 

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value in long-term investments on the balance sheet,and any net unrealized holding gains and losses, to the extent not recognizedas an impairment charge as discussed above, were reported as a component ofstockholders’ equity.  The public trading prices of the shares of bothcompanies have fluctuated significantly since we purchased them and couldcontinue to do so. If these shares continue to trade below their new cost basesin future periods, we may incur additional impairment charges relating to theseinvestments.  The amounts of thesecharges, if any, will equal our unrealized loss on these securities as of theend of the relevant periods.

 

In addition,we invested $15.0 million in MDS Proteomics, a privately held company, inconnection with our collaboration with that company.  Because MDS Proteomics is a private company and its securitiesare not publicly traded, the value of our investment is inherently moredifficult to estimate than an investment in a publicly traded company.  In 2002, we estimated that the value of ourinvestment had declined to $7.9 million and that an impairment of ourinvestment had occurred. Accordingly, we recorded an impairment charge of $7.1million on our investment in the year ended December 31, 2002.  The amount of the charge was based on thedifference between the estimated value as determined by our management and ouroriginal cost basis. As of March 31, 2003, the cost basis of this investmentreflected the new estimated value at June 30, 2002, which is recorded inlong-term investments on the balance sheet. If we deem the investment in MDS Proteomics further impaired at the endof any future period, we may incur an additional impairment charge on thisinvestment.

 

**Risks Related to the Development and Commercializationof our Products**

 

*Our XenoMouse and XenoMax technologies may not producesafe, efficacious or commercially viable products, which will be critical toour ability to generate revenues from our products.*

 

OurXenoMouse and XenoMax technologies are new approaches to developing antibodiesas products for the treatment of diseases and medical disorders. We have notcommercialized any antibody therapeutic products based on our technologies.Moreover, we are not aware of any commercialized, fully human antibodytherapeutic products that have been generated from any technologies similar toours. Our antibody therapeutic product candidates are still in early stages ofdevelopment. We have initiated clinical trials with respect to threeproprietary fully human antibody therapeutic product candidates, and ourcollaborators have initiated clinical trials with respect to two other fullyhuman antibody therapeutic product candidates generated by XenoMousetechnology. We cannot be certain that either XenoMouse technology or XenoMaxtechnology will generate antibodies against every antigen to which they areexposed in an efficient and timely manner, if at all. Furthermore, XenoMousetechnology and XenoMax technology may not result in any meaningful benefits toour current or potential customers or in product candidates that are safe andefficacious for patients. Our failure to generate antibody therapeutic productcandidates that lead to the successful commercialization of products wouldmaterially harm our business, financial condition and results of operations.

 

*If we do not successfully develop our products, or ifthey do not achieve commercial success, our business will be materially harmed.*

 

Ourdevelopment of current and future product candidates, either alone or inconjunction with collaborators, is subject to the risks of failure inherent inthe development of new pharmaceutical products and products based on new technologies.These risks include:

 

•                                          delays in product development, clinicaltesting or manufacturing;

 

•                                          unplanned expenditures in productdevelopment, clinical testing or manufacturing;

 

•                                          failure in clinical trials or failure toreceive regulatory approvals;

 

•                                          emergence of superior or equivalent productdevelopment technologies or products;

 

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•                                          inability to manufacture on our own, orthrough others, product candidates on a clinical or commercial scale;

 

•                                          inability to market products due to third-partyproprietary rights;

 

•                                          election by our customers not to pursueproduct development;

 

•                                          failure by our customers to develop productssuccessfully; and

 

•                                          failure to achieve market acceptance.

 

Becauseof these risks, our research and development efforts and those of our customersand collaborators may not result in any commercially viable products. Ourfailure to successfully complete a significant portion of these developmentefforts, to obtain required regulatory approvals or to achieve commercialsuccess with any approved products would materially harm our business,financial condition and results of operations.

 

Inaddition, our decisions to terminate or wind down our clinical programs fordeveloping ABX-IL8 and ABX-CBL have reduced the diversity of our productportfolio. We hope to be able to make up for this loss of diversity through thenumber of potential new product candidates we have in preclinical development.However, to the extent that we are unable to maintain a broad and diverse rangeof product candidates, our success would depend more heavily on one or a fewproduct candidates.

 

*Before we commercialize and sell any of our productcandidates, we must conduct clinical trials, which are expensive and haveuncertain outcomes.*

 

Conductingclinical trials is a lengthy, time-consuming and expensive process. Beforeobtaining regulatory approvals for the commercial sale of any products, we mustdemonstrate through preclinical testing and clinical trials that our productcandidates are safe and effective for use in humans. We have incurred and willcontinue to incur substantial expense for, and we have devoted and expect tocontinue to devote a significant amount of time to, preclinical testing andclinical trials.

 

Historically,the results from preclinical testing and early clinical trials have often notbeen predictive of results obtained in later clinical trials. A number of newdrugs and biologics have shown promising results in clinical trials, but subsequentlyfailed to establish sufficient safety and efficacy data to obtain necessaryregulatory approvals. Data obtained from preclinical and clinical activitiesare susceptible 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.

 

Completionof clinical trials may take several years or more. The length of time generallyvaries substantially according to the type, complexity, novelty and intendeduse of the product candidate. However, we estimate that clinical trials of thetype we generally conduct are typically completed over the following timelines:

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

 

Manyfactors may delay our commencement and rate of completion of clinical trials,including:

 

•                                          the number of patients that ultimately participatein the trial;

 

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•                                          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 enrollsuitable patient subjects.

 

Wehave limited experience in conducting and managing clinical trials. We rely onthird parties, including our collaborators, to assist us in managing andmonitoring clinical trials. Our reliance on these third parties may result indelays in completing, or in failure to complete, these trials if the thirdparties fail to perform under our agreements with them.

 

Inaddition, we have ongoing research projects that may lead to productcandidates, but we have not submitted INDs nor begun clinical trials for theseprojects. Our preclinical or clinical development efforts may not besuccessfully completed, we may not file further INDs and clinical trials maynot commence as planned.

 

Fourof our proprietary product candidates, ABX-EGF, ABX-MA1, ABX-CBL and ABX-IL8,are in various stages of clinical trials, some of which are being would down orterminated. To date, data obtained from these clinical trials have beeninsufficient to demonstrate safety and efficacy under applicable Food and DrugAdministration, or FDA, guidelines. As a result, these data will not support anapplication for regulatory approval without further clinical trials. Clinicaltrials that we conduct or that third parties conduct on our behalf may notdemonstrate sufficient safety and efficacy to obtain the requisite regulatoryapprovals for any of our product candidates. We expect to commence new clinicaltrials from time to time in the course of our business as our productdevelopment work continues. However, regulatory authorities may not permit usto undertake any additional clinical trials for our product candidates.

 

Ourproduct candidates may fail to demonstrate safety or efficacy in clinicaltrials. For example, we completed analysis of the Phase 2b clinical trials ofABX-IL8 in psoriasis and concluded that the results did not warrant continueddevelopment in psoriasis and decided not to proceed with studies in otherdisease indications. Similarly we completed a preliminary analysis ofthe Phase 2/3 clinical trial of ABX-CBL and concluded that the study did notmeet its primary endpoint.  Therefore,we and SangStat do not plan any further development of ABX-CBL. Such failure could delay the development of otherproduct candidates or hinder our ability to obtain additional financing. Inaddition, failures in our clinical trials can lead to additional research anddevelopment charges. Any delays in, or termination of, our clinical trialscould materially harm our business, financial condition and results of operations.

 

*We currently rely on third-party manufacturers, and wemay have difficulty conducting clinical trials of our product candidates if amanufacturer does not perform in accordance with our expectations.*

 

Todate we have relied on a single contract manufacturer, Lonza Biologics, toproduce ABX-CBL, ABX-IL8 and ABX-EGF under good manufacturing practiceregulations, for use in our clinical trials. We have also relied on othercontract manufacturers from time to time to produce our product candidates foruse in our clinical trials. For example, Fred Hutchinson Cancer Research Centerhas produced ABX-MA1 for use in our clinical trials. While portions of ourFremont manufacturing facility are now operational, creating additionalcapacity, which we control, we cannot assure you that we will be able toqualify this facility for regulatory compliance as expected. InNovember 2000, we entered into a manufacturing supply agreement withLonza, under which Lonza is making available exclusively to us, for a period offive years, a cell culture production suite, with associated purificationcapacity, within Lonza’s facility. The agreement includes an option to extendthe initial five-year term. The dedicated cell culture production suite isoperational and became available to us in the third quarter of 2001. Althoughwe have gained access through this agreement to production capacity andscheduling flexibility similar to owning the production capability, Lonzaretains responsibility for, and control over, staffing and operating thefacility.

 

Lonzahas limited experience in manufacturing our product candidates in quantitiessufficient for conducting clinical trials or for commercialization.

 

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Third-partymanufacturers may encounter difficulties in scaling up production, includingproblems involving production yields, quality control and assurance, shortageof qualified personnel, compliance with FDA and other applicable regulations,production costs, and development of advanced manufacturing techniques andprocess controls. If we continue to use third-party manufacturers, theymay not perform as agreed or may not remain in the contract manufacturingbusiness for the time required by us to successfully produce and market our productcandidates. Any failure of third-party manufacturers to deliver therequired quantities of our product candidates for clinical use on a timelybasis and at commercially reasonable prices, and our failure to findreplacement manufacturers or successfully implement our own manufacturingcapabilities, would materially harm our business, financial condition andresults of operations.

 

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

 

Weare establishing our own manufacturing facility for the manufacture of productcandidates for clinical trials and to support the potential early commerciallaunch of a limited number of products, in each case, in compliance with FDAand European good manufacturing practices. In May 2000, we signed along-term lease for the building that contains this manufacturing facility.Construction is substantially complete and portions of the facility areoperational. We are also conducting validation of the facility and expect tocomplete a significant stage of validation in the second quarter of 2003. Thetotal costs of this facility, including design fees, permits, validation,leasehold improvements and equipment, will be approximately$148.0 million. Completion of this facility may take longer than expected,and the planned and actual construction costs of building and qualifying thefacility for regulatory compliance may be higher than expected. In addition, ifthe commercial launch of one or more of our product candidates provessuccessful, we will likely need to use one or more third-party facilitiesto produce these products in sufficient quantities. The process ofmanufacturing antibody therapeutic products is complex. While the managers ofthe facility have gained extensive manufacturing experience in prior positionswith other companies, we have no experience in the clinical or commercial scalemanufacturing of our existing product candidates, or any other antibodytherapeutic products. Also, we will need to manufacture such antibodytherapeutic products in a facility and by a process that comply with FDA,European and other regulations. It may take a substantial period of time tobegin producing antibodies in compliance with those regulations. Our manufacturingoperations will be subject to ongoing, periodic unannounced inspection by theFDA and state agencies to ensure compliance with good manufacturing practices.Our inability to complete and maintain a manufacturing facility within ourplanned time and cost parameters could materially harm the development andsales of our products and our financial performance.

 

Wealso may encounter problems with the following:

 

•                                          production yields;

 

•                                          quality control and assurance;

 

•                                          availability of qualified personnel;

 

•                                          on-going compliance with FDA regulations;

 

•                                          production costs; and

 

•                                          development of advanced manufacturingtechniques and process controls.

 

Wecontinually evaluate our options for commercial production of our antibodytherapeutic products, which include use of third-party manufacturers, useof our own commercial scale manufacturing facility or entering into amanufacturing joint venture relationship with a third party. We are aware ofonly a limited number of companies on a worldwide basis that operatemanufacturing facilities in which our product candidates can be manufacturedunder good manufacturing practice regulations, a requirement for

 

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all pharmaceutical products. Itmay take a substantial period of time for a contract manufacturing facilitythat has not been producing antibodies to begin producing antibodies under goodmanufacturing practice regulations. We may not be able to contract with any ofthese companies on acceptable terms, if at all.

 

Inaddition, the FDA and other regulatory authorities will require us to registerany manufacturing facilities in which our antibody therapeutic products aremanufactured. The FDA and other regulatory authorities will then subject thefacilities to inspections confirming compliance with FDA good manufacturingpractice or other regulations. Our failure or the failure of our third-partymanufacturers to maintain regulatory compliance would materially harm ourbusiness, financial condition and results of operations.

 

*The successful growth of revenues from our manufacturingservices depends to a large extent on our ability to find third parties toagree to use our services and our ability to provide those servicessuccessfully.*

 

Ourstrategy for enhancing contract revenues depends, in part on entering intoagreements to provide antibody production services to third parties. Potentialthird parties include our existing collaborators, as well as otherpharmaceutical and biotechnology companies, technology companies, academicinstitutions and other entities. We must enter into these agreements tosuccessfully develop this aspect of our business. To date, we have entered intoone production services agreement and we cannot assure you that we will be ableto enter into additional agreements.

 

Wemay not be able to secure manufacturing agreements on favorable terms. If we doobtain such agreements, we may encounter difficulties in performing asagreed.   We may encounter difficultiesin scaling up production, including problems involving production yields,quality control and assurance, shortage of qualified personnel, compliance withFDA and other applicable regulations, production costs, and development ofadvanced manufacturing techniques and process controls.  The failure to deliver the 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 depends to a largeextent on our ability to find third-party collaborators to develop andcommercialize many of our product candidates.*

 

Ourstrategy for the development and commercialization of antibody therapeuticproducts depends, in large part, upon the formation of collaboration agreementswith third parties. Potential third parties include pharmaceutical andbiotechnology companies, technology companies, academic institutions and otherentities. We must enter into these agreements to successfully develop andcommercialize product candidates. These agreements are necessary in order forus to:

 

•                                          access proprietary antigens for which we cangenerate fully human antibody products;

 

•                                          fund our research and development activities;

 

•                                          fund preclinical development, clinical trialsand manufacturing;

 

•                                          seek and obtain regulatory approvals; and

 

•                                          successfully commercialize existing andfuture product candidates.

 

Ourability to continue our current collaborations and to enter into additionalthird party collaborations is dependent in large part on our ability tosuccessfully demonstrate that our XenoMouse technology is an attractive methodof developing fully human antibody therapeutic products. We have generated onlya limited number of fully human antibody therapeutic product candidatespursuant to our collaboration agreements and only five fully human antibodytherapeutic product candidates generated with XenoMouse technology have enteredclinical testing. We have announced that one of these product candidates hasnot met our expectations. Our failure to maintain our existing collaborationagreements or to

 

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enter into additional agreementscould materially harm our business, financial condition and results ofoperations.

 

Ourdependence on licensing, collaboration, manufacturing and other agreements withthird parties subjects us to a number of risks. These agreements may not be onterms that prove favorable to us, and we typically afford our collaboratorssignificant discretion in electing whether to pursue any of the plannedactivities. Licensing and other contractual arrangements may require us torelinquish our rights to certain of our technologies, products or marketingterritories. We cannot control the amount or timing of resources ourcollaborators may devote to the product candidates, and collaborators may notperform their obligations as expected. Additionally, business combinations orsignificant changes in a collaborator’s business strategy may adversely affecta collaborator’s willingness or ability to complete its obligations under thearrangement. Even if we fulfill our obligations under an agreement, typicallyour collaborators can terminate the agreement at any time following properwritten notice. The termination or breach of agreements by our collaborators,or the failure of our collaborators to complete their obligations in a timelymanner, could materially harm our business, financial condition and results ofoperations. If we are not able to establish further collaboration agreements orany or all of our existing agreements are terminated, we may be required toseek new collaborators or to undertake product development andcommercialization at our own expense. Such an undertaking may:

 

•                                          limit the number of product candidates thatwe will be able to develop and commercialize;

 

•                                          reduce the likelihood of successful productintroduction;

 

•                                          significantly increase our capitalrequirements; and

 

•                                          place additional strain on our management’stime.

 

Existingor potential collaborators may pursue alternative technologies, including thoseof our competitors, or enter into other transactions that could make acollaboration with us less attractive to them. For example, if an existingcollaborator purchases a company that is one of our competitors, that companycould be less willing to continue its collaboration with us. In addition, acompany that has a strategy of purchasing companies with attractivetechnologies might have less incentive to enter into a collaboration agreementwith us. Moreover, disputes may arise with respect to the ownership of rightsto any technology or products developed with any current or futurecollaborator. Lengthy negotiations with potential new collaborators ordisagreements between us and our collaborators may lead to delays in ortermination of the research, development or commercialization of productcandidates or result in time-consuming and expensive litigation or arbitration.The decision by our collaborators to pursue alternative technologies or thefailure of our collaborators to develop or commercialize successfully anyproduct candidate to which they have obtained rights from us could materiallyharm our business, financial condition and results of operations.

 

*We are subject to extensive government regulation, whichwill require us to spend significant amounts of money, and we may not be ableto obtain regulatory approvals, which are required for us to conduct clinicaltesting and commercialize our products.*

 

Ourproduct candidates under development are subject to extensive and rigorousdomestic government regulation. The FDA regulates, among other things, thedevelopment, 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

 

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resources, involvespost-marketing surveillance, and may involve ongoing requirements forpost-marketing studies. Regulatory requirements are subject to frequent change.Delays in obtaining regulatory approvals may:

 

•                                          adversely affect the successfulcommercialization of any drugs that we or our customers develop;

 

•                                          impose costly procedures on us or ourcustomers;

 

•                                          diminish any competitive advantages that weor our customers may attain; and

 

•                                          adversely affect our receipt of revenues orroyalties.

 

Certainmaterial changes affecting an approved product such as manufacturing changes oradditional labeling claims are subject to further FDA review and approval. TheFDA may withdraw any required approvals after we obtain them. We may not maintaincompliance with other regulatory requirements. Further, if we fail to complywith applicable FDA and other regulatory requirements at any stage during theregulatory process, we or our third-party manufacturers may be subject tosanctions, including:

 

•                                          delays;

 

•                                          warning letters;

 

•                                          fines;

 

•                                          product recalls or seizures;

 

•                                          injunctions;

 

•                                          refusal of the FDA to review pending marketapproval applications or supplements to approval applications;

 

•                                          total or partial suspension of production;

 

•                                          civil penalties;

 

•                                          withdrawals of previously approved marketingapplications; and

 

•                                          criminal prosecutions.

 

Inmany instances we expect to rely on our customers and co-developers to fileINDs and generally direct the regulatory approval process for products derivedfrom our technologies. These customers and co-developers may not be able toconduct clinical testing or obtain necessary approvals from the FDA or otherregulatory authorities for any product candidates. If they fail to obtainrequired governmental approvals, we will experience delays in or be precludedfrom marketing or realizing the commercial benefits from the marketing ofproducts derived from our technologies. In addition, our failure to obtain therequired approvals would preclude the commercial use of our products. Any suchdelays and limitations may materially harm our business, financial conditionand results of operations.

 

Weand our third-party manufacturers also are required to comply with theapplicable 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. Manufacturing facilitiesare subject to inspection by the FDA and the facilities must pass an inspectionby the FDA before we can use them in commercial

 

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manufacturing of any product.Manufacturing facilities in California, including our facility, are alsosubject to the licensing requirements of and inspection by the CaliforniaDepartment of Health Services. We or our third-party manufacturers maynot be able to comply with the applicable good manufacturing practice requirementsand other regulatory requirements. The failure of us or our third-partymanufacturers to comply with these requirements would materially harm ourbusiness, financial condition and results of operations.

 

*If our products do not gain market acceptance among themedical community, our revenues would greatly decline.*

 

Ourproduct candidates may not gain market acceptance among physicians, patients,third-party payors and the medical community. We may not achieve marketacceptance even if clinical trials demonstrate safety and efficacy, and thenecessary regulatory and reimbursement approvals are obtained. The degree ofmarket acceptance of any product candidates that we develop will depend on anumber of factors, including:

 

•                                          establishment and demonstration of clinicalefficacy and safety;

 

•                                          cost-effectiveness of our product candidates;

 

•                                          their potential advantage over alternativetreatment methods;

 

•                                          reimbursement policies of government andthird-party payors; and

 

•                                          marketing and distribution support for ourproduct candidates, including the efforts of our collaborators where they havemarketing and distribution responsibilities.

 

Physicianswill not recommend therapies using our products until such time as clinicaldata or other factors demonstrate the safety and efficacy of such procedures ascompared to conventional drug and other treatments. Even if we establish theclinical safety and efficacy of therapies using our antibody productcandidates, physicians may elect not to recommend the therapies for any numberof other reasons, including whether the mode of administration of our antibodyproducts is effective for certain indications. Antibody products, including ourproduct candidates as they would be used for certain disease indications, aretypically administered by infusion or injection, which requires substantialcost and inconvenience to patients. Our product candidates, if successfullydeveloped, will compete with a number of drugs and therapies manufactured andmarketed by major pharmaceutical and other biotechnology companies. Ourproducts may also compete with new products currently under development byothers. Physicians, patients, third-party payors and the medicalcommunity may not accept or utilize any product candidates that we or our customersdevelop. The failure of our products to achieve significant market acceptancewould materially harm our business, financial condition and results ofoperations.

 

*We do not have marketing and sales experience, which mayrequire us to rely on others to market and sell our products and may make itmore challenging for us to commercialize our product candidates.*

 

Althoughwe have been marketing our XenoMouse technology to potential customers andcollaborators for several years, we do not have marketing, sales ordistribution experience or capability with respect to our therapeutic productcandidates. We intend to enter into arrangements with third parties to marketand sell most of our therapeutic product candidates when we commercialize them,which may be as early as 2005. We may not be able to enter into these marketingand sales arrangements with others on acceptable terms, if at all. To theextent that we enter into marketing and sales arrangements with othercompanies, our revenues, if any, will depend on the efforts of others. Theseefforts 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 have

 

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experienced and well-fundedmarketing and sales operations. Our failure to enter into successful marketingarrangements with third parties and our inability to conduct such activitiesourselves would materially harm our business, financial condition and resultsof operations.

 

**Risks Related to Our Intellectual Property**

 

*Our ability to protect our intellectual property rights willbe critically important to the success of our business, and we may not be ableto protect these rights in the United States or abroad.*

 

Oursuccess depends in part on our ability to:

 

•                                          obtain patents;

 

•                                          protect trade secrets;

 

•                                          operate without infringing the proprietaryrights of others; and

 

•                                          prevent others from infringing ourproprietary rights.

 

Wewill be able to protect our proprietary rights from unauthorized use by thirdparties only to the extent that our proprietary rights are covered by valid andenforceable patents or are effectively maintained as trade secrets. We attemptto protect our proprietary position by filing U.S. and foreign patentapplications related to our proprietary technology, inventions and improvementsthat are important to the development of our business. However, the patentposition of biopharmaceutical companies involves complex legal and factualquestions, and, therefore, we cannot predict with certainty whether our patentapplications will be approved or any resulting patents will be enforced. Inaddition, third parties may challenge, invalidate or circumvent any of ourpatents, once they are issued. Thus, any patents that we own or license fromthird parties may not provide any protection against competitors. Our pendingpatent applications, those we may file in the future, or those we may licensefrom third parties, may not result in patents being issued. Also, patent rightsmay not provide us with adequate proprietary protection or competitiveadvantages against competitors with similar technologies. The laws of certainforeign countries do not protect our intellectual property rights to the sameextent as do the laws of the United States.

 

Inaddition to patents, we rely on trade secrets and proprietary know-how. We seekprotection, in part, through confidentiality and proprietary informationagreements. These agreements may not provide meaningful protection for ourtechnology or adequate remedies in the event of unauthorized use or disclosureof confidential and proprietary information, and, in addition, the parties maybreach such agreements. Also, our trade secrets may otherwise become known to,or be independently developed by, our competitors. Furthermore, others mayindependently develop similar technologies or duplicate any technology that wehave developed.

 

*We may face challenges from third parties regarding thevalidity of our patents and proprietary rights, or from third parties assertingthat we are infringing their patents or proprietary rights, which could resultin litigation that would be costly to defend and could deprive us of valuablerights.*

 

Partieshave conducted research for many years in the antibody and transgenic animalfields. The term “transgenic”, when applied to an animal, such as a mouse,refers to an animal that has chromosomes into which human genes have beenincorporated. This research has resulted in a substantial number of issuedpatents and an even larger number of pending patent applications. Thepublication of discoveries in the scientific or patent literature frequentlyoccurs substantially later than the date on which the underlying discoverieswere made. Our commercial success depends significantly on our ability tooperate without infringing the patents and other proprietary rights of thirdparties. Our technologies may unintentionally infringe the patents or violateother proprietary rights of third parties. Such infringement or violation mayprevent us and our customers from pursuing product development orcommercialization. Such a result could materially harm our business, financialcondition and results of operations.

 

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InMarch 1997, we entered into a cross-license and settlement agreementwith GenPharm to avoid protracted litigation. Under the cross-license, welicensed on a non-exclusive basis certain patents, patent applications, third-partylicenses and inventions pertaining to the development and use of certaintransgenic rodents, including mice, that produce fully human antibodies thatare integral to our products and business. Our business, financial conditionand results of operations could be materially harmed if any of the partiesbreaches the cross-license agreement.

 

GlaxoSmithKline,plc, or Glaxo has a family of patents relating to certain methods forgenerating monoclonal antibodies that Glaxo is asserting against Genentech,Inc. in litigation that was commenced in 1999. On May 4, 2001, Genentechannounced that a jury had determined that Genentech had not infringed Glaxo’spatents and that all of the patent claims asserted against Genentech areinvalid. We understand that Glaxo has filed a notice of appeal with the Courtof Appeals for the Federal Circuit. If any of the claims of these patents arefinally determined in the litigation to be valid, and if we were to usemanufacturing processes covered by the patents to make our products, we maythen need to obtain a license should one be available. Should a license bedenied or unavailable on commercially reasonable terms, we may have difficultycommercializing one or more of our products in any territories in which theseclaims were in force.

 

Genentech,Johnson & Johnson, Glaxo and Transkaryotic Therapics, Inc. each owns orcontrols a U.S. patent that relates to recombinant cell lines or methods ofgenerating recombinant cell lines for the production of antibodies. If we wereto use a production system covered by any of these patents, we may then need toobtain a license should one be available. Under these circumstances, ourfailure to obtain a license at all or on commercially reasonable terms couldimpede commercialization of one or more of our products in any territories inwhich these patent claims were in force.

 

Genentechowns a U.S. patent that issued in June 1998 relating to inhibiting thegrowth of tumor cells that involves an antibody that binds to an epidermalgrowth factor receptor, or an anti-EGF receptor antibody, in combination with acytotoxic factor, which is a substance having a toxic effect on cells. ImCloneSystems, Inc. owns or is licensed under a U.S. patent that issued inApril 2001, relating to inhibiting the growth of tumor cells that involvesan anti-EGF receptor antibody in combination with an anti-neoplastic, oranti-tumor, agent. We do not believe based on our review that either theGenentech or ImClone patent would be successfully asserted against any plannedcommercial sales of ABX-EGF. We believe that currently all of our activitiesrelating to anti-EGF receptor monoclonal antibodies are within the exemptionprovided by the U.S. patent laws for uses reasonably related to obtaining FDAapproval of a drug. We do not expect the scope of our product development plansto change in the future prior to filing an application for a biologic licensewith the FDA. If a court determines that the claims of either the Genentechpatent or the ImClone patent cover our activities with ABX-EGF and are valid,such a decision may require us to obtain a license to Genentech’s or ImClone’spatent, as the case may be, to label and sell ABX-EGF for certain combinationtherapies. Our failure to obtain a license, or to obtain a license oncommercially reasonable terms, could impede our commercialization of ABX-EGF inthe United States.

 

In2000, the Japanese Patent Office granted a patent to Kirin Beer KabushikiKaisha, one of our competitors, relating to non-human transgenic mammals. Kirinhas filed corresponding patent applications in Europe and Australia. Kirin mayalso have filed a corresponding patent application in the United States. Ourlicensee, Japan Tobacco, has filed opposition proceedings against the Kirin patent.We cannot predict the outcome of those opposition proceedings, which may takeyears to be resolved.

 

Extensivelitigation regarding patents and other intellectual property rights has beencommon in the biotechnology and pharmaceutical industries. The defense andprosecution of intellectual property suits, United States Patent and TrademarkOffice interference proceedings, and related legal and administrativeproceedings in the United States and internationally involve complex legal andfactual questions. As a result, such proceedings are costly and time-consumingto pursue and their outcome is uncertain. Litigation may be necessary to:

 

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•                                          enforce patents that we own or license;

 

•                                          protect trade secrets or know-how that we ownor license; or

 

•                                          determine the enforceability, scope andvalidity of the proprietary rights of others.

 

Ourinvolvement in any litigation, interference or other administrative proceedingscould cause us to incur substantial expense and could significantly divert theefforts of our technical and management personnel. An adverse determination maysubject us to loss of our proprietary position or to significant liabilities,or require 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 rapid technological change,and if we fail to develop products that keep pace with new technologies andthat gain market acceptance, our product candidates or technologies couldbecome obsolete.*

 

Thebiotechnology and pharmaceutical industries are highly competitive and subjectto significant and rapid technological change. We are aware of severalpharmaceutical 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. Many of thesecompanies are addressing the same diseases and disease indications as we or ourcustomers are. Also, we compete with companies that offer antibody generationservices to companies that have antigens. These competitors have specificexpertise or technology related to antibody development and introduce new or modifiedtechnologies from time to time. These companies include GenPharm, a whollyowned subsidiary of Medarex, Inc., Medarex’s collaborator, Kirin Brewing Co.Ltd.; GenMab A/S; Cambridge Antibody Technology Group plc; Protein DesignLabs, Inc.; MorphoSys AG; Xenerex Biosciences Inc., a subsidiary of AvanirPharmaceuticals; XLT Biopharmaceuticals Ltd.; and Alexion Pharmaceuticals,Inc.  Finally, we compete with companiesthat currently offer antibody production services, and may compete withcompanies that currently only manufacture their own antibodies but could offerantibody production services to third parties.

 

Someof our competitors have received regulatory approval of or are developing ortesting product candidates that may compete directly with our productcandidates. ImClone, 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 withABX-EGF, which is also in clinical trials. In September 2002, an FDA advisory panel voted to recommend for approvalAstraZeneca’s small molecule product candidate Iressa, which may compete withABX-EGF.  Furthermore, we are also awarethat AstraZeneca has received approval for Iressa in the United States, Japanand Australia for the treatment of advanced non-small cell lung cancer.

 

Manyof these companies and institutions, either alone or together with theircustomers, have substantially greater financial resources and larger researchand development staffs than we do. In addition, many of these competitors,either alone or together with their customers, have significantly greaterexperience than we do in:

 

•                                          developing products;

 

•                                          undertaking preclinical testing and humanclinical trials;

 

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•                                          obtaining FDA and other regulatory approvalsof products; and

 

•                                          manufacturing and marketing products.

 

Accordingly,our competitors may succeed in obtaining patent protection, receiving FDA approvalor commercializing products before we do. If we commence commercial productsales, we will be competing against companies with greater marketing andmanufacturing capabilities, areas in which we have limited or no experience.

 

Wealso face, and will continue to face, competition from academic institutions,government agencies and research institutions. There are numerous competitorsworking on products to treat each of the diseases for which we are seeking todevelop therapeutic products. In addition, any product candidate that wesuccessfully develop may compete with existing therapies that have longhistories of safe and effective use. Competition may also arise from:

 

•                                          other drug development technologies andmethods of preventing or reducing the incidence of disease;

 

•                                          new small molecules; or

 

•                                          other classes of therapeutic agents.

 

Developmentsby competitors may render our product candidates or technologies obsolete ornon-competitive. We face and will continue to face intense competition from othercompanies for agreements with pharmaceutical and biotechnology companies, forestablishing relationships with academic and research institutions, and forlicenses to proprietary technology. These competitors, either alone or withtheir customers, may succeed in developing technologies or products that aremore effective than ours.

 

*We face uncertainty over reimbursement and healthcarereform, which, if determined adversely to us, could seriously hinder the marketacceptance of our products.*

 

Inboth domestic and foreign markets, sales of our product candidates will dependin part upon the availability of reimbursement from third-party payors,such as government health administration authorities, managed care providersand 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 governments continue to proposeand pass legislation designed to reduce the cost of healthcare, which couldfurther limit reimbursement for pharmaceuticals. The failure of the governmentand third-party payors to provide adequate coverage and reimbursementrates for our product candidates could adversely affect the market acceptanceof our products. The failure of our products to receive market acceptance wouldmaterially harm our business, financial condition and results of operations.

 

**Other Risks Related to Our Company**

 

*Our restructuring plan may notachieve the results we intend and may harm our business.*

 

In October 2002, we announced a restructuringplan, which includes a reduction in headcount of approximately 15%. Theplanning and implementation of our restructuring has placed, and may continueto place, a significant strain on our managerial, operational and otherresources. The restructuring may negatively affect our employee turnover,recruiting and retention, and may not enable us to reduce our costs to theextent expected.

 

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*We may experience difficulty in the integration of anyfuture acquisition with the operations of our business.*

 

Wemay 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:

 

•                                          the potential inability to identify targetcompanies best suited to our business plan;

 

•                                          the potential inability to successfullyintegrate acquired operations and businesses and to realize anticipatedsynergies, economies of scale or other expected value;

 

•                                          incurrence of expenses attendant totransactions that may or may not be consummated; and

 

•                                          difficulties in managing and coordinatingoperations at multiple venues, which, among other things, could divert ourmanagement’s attention from other important business matters.

 

Inaddition, our acquisition of companies and businesses and expansion ofoperations may result in dilutive issuances of equity securities, theincurrence of additional debt, large one-time write-offs and the creation ofgoodwill or other intangible assets that could result in amortization expenseor other charges to expense.

 

*The future growth and success of our business will depend onour ability to continue to attract and retain our employees and consultants.*

 

Forus to pursue product development, marketing and commercialization plans, we mayneed to hire additional qualified scientific personnel. We will also need tohire personnel with expertise in clinical testing, government regulation,manufacturing, marketing, law and finance. Attracting and retaining qualifiedpersonnel will be critical to our success. We may not be able to attract andretain personnel on acceptable terms given the competition for such personnelamong biotechnology, pharmaceutical and healthcare companies, universities andnon-profit research institutions.

 

We grant stock options as a method of attracting andretaining employees, to motivate performance and to align the interests ofmanagement with those of our stockholders. Due to the decline in the tradingprice of our common stock during 2001 and 2002, a substantial portion of thestock options held by our employees have an exercise price that is higher thanthe current trading price of our common stock. We may elect to reprice orotherwise adjust the terms of these stock options, grant additional stockoptions at the current lower market price, pay higher cash compensation, orsome combination of these alternatives to retain and attract qualifiedemployees, but we cannot be sure that any of these actions would be successful.If we issue additional stock options, this would dilute existing stockholders.

 

As a result of these factors, we may have difficultyattracting and retaining qualified personnel, whichcould materially harm our business, financial condition and results ofoperations.

 

*We have implemented a stockholder rights plan and aresubject to other anti-takeover provisions, which could deter a party fromeffecting a takeover of us at a premium to our then-current stock price.*

 

InJune 1999, our board of directors adopted a stockholder rights plan, whichwe amended and restated in November 1999 and May 2002. Thestockholder rights plan and certain provisions of our amended and restatedcertificate of incorporation and amended and restated bylaws may have theeffect of making it more difficult for a third party to acquire, or ofdiscouraging a third party from attempting to acquire, control of us. Thiscould limit the price that certain investors might be willing to pay in thefuture for our common stock. Certain provisions of our amended and restatedcertificate of incorporation and amended and restated bylaws allow us to:

 

•                                          issue preferred stock without any vote orfurther action by the stockholders;

 

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•                                          eliminate the right of stockholders to act bywritten consent without a meeting;

 

•                                          specify procedures for director nominationsby stockholders and submission of other proposals for consideration atstockholder meetings; and

 

•                                            eliminate cumulative voting in the electionof directors.

 

Weare subject to certain provisions of Delaware law which could also delay ormake more difficult a merger, tender offer or proxy contest involving us. Inparticular, Section 203 of the Delaware General Corporation Law prohibitsa Delaware corporation from engaging in any business combination with anyinterested stockholder for a period of three years unless the transaction meetscertain conditions. The stockholder rights plan, the possible issuance ofpreferred stock, the procedures required for director nominations andstockholder proposals and Delaware law could have the effect of delaying,deferring or preventing a change in control of us, including, withoutlimitation, discouraging a proxy contest or making more difficult theacquisition of a substantial block of our common stock. The provisions alsocould limit the price that investors might be willing to pay in the future forshares of our common stock.

 

*We face product liability risks and may not be able toobtain adequate insurance, and if we are held liable for an uninsured claim ora claim in excess of our insurance limits, our business, financial conditionand results of operations may be harmed.*

 

Theuse of any of our product candidates, or of any products manufactured in ourfacility,  in clinical trials, and thesale of any approved products, may expose us to liability claims resulting fromsuch use or sale. Consumers, healthcare providers, pharmaceutical companies orothers selling such products might make claims of this kind. We may experiencefinancial losses in the future due to product liability claims. We haveobtained limited product liability insurance coverage for our clinical trials,under which the coverage limits are $10.0 million per occurrence and$10.0 million in the aggregate. We intend to expand our insurance coverageto include the sale of commercial products if we obtain marketing approval forproduct candidates in development. We may not be able to maintain insurancecoverage at a reasonable cost or in sufficient amounts to protect us againstlosses. If third parties bring a successful product liability claim or seriesof claims against us for uninsured liabilities or in excess of insuredliabilities, our business, financial condition and results of operations may bematerially harmed.

 

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

 

Ourresearch and manufacturing activities involve the controlled use of hazardousmaterials. In addition, although we maintain insurance for harm to employeesand to our facilities caused by hazardous materials, we do not insure againstany 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 our common stock.*

 

Weintend to retain any future earnings to finance the growth and development ofour business and we do not plan to pay cash dividends on our common stock inthe foreseeable future.

 

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

 

Themarket price and trading volume of our common stock are volatile, and we expectsuch volatility to continue for the foreseeable future. For example, during theperiod between March 31, 2002 and March 31, 2003, our common stock closed ashigh as $18.98 per share and as low as $4.58 per share. This

 

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may impact your decision to buyor sell our common stock. Factors affecting our stock price include:

 

•                                          our financial results;

 

•                                          fluctuations in our operating results;

 

•                                          announcements of technological innovations ornew commercial therapeutic products by us or our competitors;

 

•                                          published reports by securities analysts;

 

•                                          developments in our clinical trials and inclinical trials for potentially competitive product candidates;

 

•                                          government regulation;

 

•                                          changes in reimbursement policies;

 

•                                          developments in patent or other proprietaryrights;

 

•                                          developments in our relationship withcustomers;

 

•                                          public concern as to the safety and efficacyof our products; and

 

•                                          general market conditions.

 

*If we were deemed to be an investment company, we wouldbecome subject to provisions of the Investment Company Act that likely wouldhave a material adverse impact on our business.*

 

A company is required to registeras an investment company under the Investment Company Act of 1940, or the 1940Act, if, among other things, and subject to various exceptions:

 

•                                          it is or holds itself out to be engagedprimarily, or proposes to engage primarily, in the business of investing,reinvesting or trading in securities; or

 

•                                          it is engaged or proposes to engage in thebusiness of investing, reinvesting, owning, holding or trading in securities,and owns or proposes to acquire investment securities having a value exceeding40 percent of the value of such company’s total assets (exclusive of Governmentsecurities and cash items) on an unconsolidated basis.

 

A major portion of our assets hasbeen invested in investment grade interest-bearing securities. Suchinvestments could in some circumstances require us to register as an investmentcompany under the 1940 Act. Registration under the 1940 Act, or a determinationthat we failed to register when required to do so, could have a materialadverse impact on us. We believe that we are and will remain exempt from theregistration requirements, but absent interpretation by the courts or the SECof the relevant exemption as applied to companies engaged in research anddevelopment, this result cannot be assured. In addition, a change in ourallocation of assets on account of 1940 Act concerns could reduce the rate ofreturn on our liquid assets.

 

 

**Item 3.Quantitative and Qualitative Disclosures About Market Risk**

 

*Interest Rate Risk.*  We are exposed tointerest rate sensitivity on our investments in debt securities and itsoutstanding fixed rate debt. Theobjective of our investment activities is to preserve principal, while at thesame time maximizing yields without significantly increasing risk. To achievethis

 

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objective, we invest in highly liquid,investment grade and government debt securities. Our investments in debtsecurities are subject to interest rate risk. To minimize the exposure due toan adverse shift in interest rates, we invest in short-term securities and ourgoal is to maintain an average maturity of approximately one year. Inaddition, as of March 31, 2003, we had $200.0 million of outstanding 3.5%convertible subordinated notes due in 2007. The fair value of these convertiblesubordinated notes may fluctuate with changes in market interest rates, as wellas changes in the market price of our common stock.  A hypothetical1.0% per annum decrease in interest rates as of March 31, 2003 would have an adverse net change inthe fair value of our interest rate sensitive assets and liabilities of approximately $6.0 million. Ahypothetical 1.0% per annum decrease in interest rates as of December 31, 2002would have an adverse net change in the fair value of our interest ratesensitive assets and liabilities of****approximately $6.3 million.

 

*Equity Price Risk.*  We are exposed to equity pricerisk on strategic investments, such as those we have made in CuraGen, ImmunoGenand MDS Proteomics. We typically do not attempt to reduce or eliminate ourmarket exposure on these securities. With respect to CuraGen and ImmunoGen,each of whose common stock is publicly traded, the market price of thesesecurities was approximately $11.2 million and $13.0 million as of March31, 2003 and December 31, 2002, respectively. Due to decreases in the marketprice, we recorded impairment charges of $67.3 million in 2002 related to ourinvestments in CuraGen and ImmunoGen. The trading prices of shares of CuraGenand ImmunoGen have fluctuated significantly since we purchased thesesecurities. Each additional 10% decrease in market value of these securitieswould result in a decrease in value of approximately $1.1 million and $1.3million from the fair value of those investments at March 31, 2003 and December31, 2002, respectively.  Additionalprice declines could cause us to record additional impairment charges in futureperiods.

 

An adverse movement of equity market prices generallywould also have an impact on the valuation of our non-publicly traded strategicequity securities, such as MDS Proteomics. Such a movement and the relatedunderlying economic conditions would negatively impact the prospects of anycompany we invest in, its ability to raise capital and the likelihood of our beingable to realize our investment through liquidity events such as a publicoffering, merger or private sale. In 2002, we incurred a $7.1 million chargerelated to a write-down of our investment in MDS Proteomics, and we may incurfuture writedowns of these securities. At March 31, 2003, our strategicinvestment in MDS Proteomics had a carrying amount of $7.9 million.

 

 

**Item 4. Controls and Procedures**

 

**Evaluationof Disclosure Controls and Procedures**

 

Based on their evaluation of our disclosure controls andprocedures, as that term is defined by Rule 13a-14(c) promulgated under theSecurities Exchange Act of 1934, within 90 days of the filing date of thisreport, our chief executive officer and our chief financial officer haveconcluded that our disclosure controls and procedures are effective in ensuringthat all material information required to be included in this quarterly reporton Form 10-Q has been made known to them in a timely fashion.

 

**Changes in Internal Controls**

 

                There have been nosignificant changes in our internal controls or in other factors that couldsignificantly affect these controls subsequent to the date of their evaluation,nor were any corrective actions required with regard to significantdeficiencies and material weaknesses subsequent to that date.

 

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**PARTII.  OTHER INFORMATION**

 

#### **ITEM 1. LegalProceedings**

 

Not applicable.

 

#### **ITEM 2. Changes inSecurities and Use of Proceeds**

 

Not applicable.

 

#### **ITEM 3. Defaultsupon Senior Securities**

 

Not applicable.

 

#### **ITEM 4. Submissionof Matters to Vote of Security Holders**

 

Not applicable.

 

#### **ITEM 5. OtherInformation**

 

Not applicable.

 

#### **ITEM 6. Exhibitsand Reports on Form 8-K**

 

(a) Exhibits

 
| **Number** |   | **Description**                                                                                                                                                     |
|------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |   |                                                                                                                                                                |
| 3.1(1)     |   | Amended and Restated  Certificate of Incorporation of Abgenix, as currently in effect.                                                                              |
| 3.2(2)     |   | Amended and Restated  Bylaws of Abgenix, as currently in effect.                                                                                                    |
| 99.1       |   | 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. |
| 99.2       |   | Certification of Kurt  Leutzinger Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002.         |

 

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(1)                                  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

 

Wefiled a Form 8-K on April 23, 2003, furnishing under “Item 12. Disclosureof Results of Operations and Financial Condition” a press release we issued on that date to report ourfinancial results for the quarter ended March 31, 2003.

 

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**SIGNATURES**

 

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

 
| Dated:  May 14, 2003 |                                         |
|----------------------|----------------------------------------------|
|                 |                                         |
|                 | **ABGENIX,  INC.**                           |
|                 | (Registrant)                                 |
|                 |                                         |
|                 |                                         |
|                 | /s/ RAYMOND M. WITHY                         |   |
|                 | Raymond M. Withy, Ph.D.                      |
|                 | President and Chief Executive Officer        |
|                 | (Principal Executive Officer)                |
|                 |                                         |
|                 |                                         |
|                 | /s/ KURT LEUTZINGER                          |   |
|                 | Kurt Leutzinger                              |
|                 | Chief Financial Officer                      |
|                 | (Principal Financial and Accounting Officer) |

 

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**CERTIFICATIONS**

 

I, Raymond M. Withy, Ph.D., certify that:

 

1.             I have reviewedthis quarterly report on Form 10-Q of Abgenix, Inc.;

 

2.             Based on myknowledge, this quarterly report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this quarterly report;

 

3.             Based on my knowledge,the financial statements, and other financial information included in thisquarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4.             The registrant’sother certifying officers and I are responsible for establishing andmaintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a) designed such disclosure controls and procedures to ensure thatmaterial information relating to the registrant, including its consolidatedsubsidiaries, is made known to us by others within those entities, particularlyduring the period in which this quarterly report is being prepared;

 

b) evaluated the effectiveness of the registrant’s disclosure controlsand procedures as of a date within 90 days prior to the filing date ofthis quarterly report (the “Evaluation Date”); and

 

c) presented in this quarterly report our conclusions about theeffectiveness of the disclosure controls and procedures based on our evaluationas of the Evaluation Date;

 

5.             The registrant’sother certifying officers and I have disclosed, based on our most recentevaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a) all significant deficiencies in the design or operation of internalcontrols which could adversely affect the registrant’s ability to record,process, summarize and report financial data and have identified for theregistrant’s auditors any material weaknesses in internal controls; and

 

b) any fraud, whether or not material, that involves management orother employees who have a significant role in the registrant’s internalcontrols; and

 

6.             The registrant’sother certifying officers and I have indicated in this quarterly report whetheror not there were significant changes in internal controls or in other factorsthat could significantly affect internal controls subsequent to the date of ourmost recent evaluation, including any corrective actions with regard tosignificant deficiencies and material weaknesses.

 
| Dated: May 14, 2003 |                                                                 |
|--------------------------|----------------------------------------------------------------------|
|                     |                                                                 |
|                     |                                                                 |
|                     | /s/ Raymond  M. Withy                                                |   |
|                     | Raymond M. Withy, Ph.D.                                              |
|                     | President and Chief Executive Officer  (Principal Executive Officer) |

 

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**CERTIFICATIONS**

 

I, Kurt Leutzinger, certify that:

 

1.             I have reviewedthis quarterly report on Form 10-Q of Abgenix, Inc.;

 

2.             Based on myknowledge, this quarterly report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this quarterly report;

 

3.             Based on myknowledge, the financial statements, and other financial information includedin this quarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4.             The registrant’sother certifying officers and I are responsible for establishing andmaintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a) designed such disclosure controls and procedures to ensure thatmaterial information relating to the registrant, including its consolidatedsubsidiaries, is made known to us by others within those entities, particularlyduring the period in which this quarterly report is being prepared;

 

b) evaluated the effectiveness of the registrant’s disclosure controlsand procedures as of a date within 90 days prior to the filing date ofthis quarterly report (the “Evaluation Date”); and

 

c) presented in this quarterly report our conclusions about theeffectiveness of the disclosure controls and procedures based on our evaluationas of the Evaluation Date;

 

5.             The registrant’sother certifying officers and I have disclosed, based on our most recentevaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a) all significant deficiencies in the design or operation of internalcontrols which could adversely affect the registrant’s ability to record,process, summarize and report financial data and have identified for theregistrant’s auditors any material weaknesses in internal controls; and

 

b) any fraud, whether or not material, that involves management orother employees who have a significant role in the registrant’s internalcontrols; and

 

6.             The registrant’sother certifying officers and I have indicated in this quarterly report whetheror not there were significant changes in internal controls or in other factorsthat could significantly affect internal controls subsequent to the date of ourmost recent evaluation, including any corrective actions with regard tosignificant deficiencies and material weaknesses.

 
| Dated: May 14, 2003 |                                                                  |
|--------------------------|-----------------------------------------------------------------------|
|                     |                                                                  |
|                     |                                                                  |
|                     | /s/  Kurt Leutzinger                                             |   |
|                     | Kurt Leutzinger                                                       |
|                     | Chief Financial Officer  (Principal Financial and Accounting Officer) |

 

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