**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

**(Markone)**

** **

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

 

**For the quarterly period ended June 30, 2003**

 

**OR**

 

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

** **

**For the transition period from                   to                   .**

 

**Commission file number:  000-24207**

 

**ABGENIX,INC.**

(Exact name 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) 284-6500**

(Registrant’s telephone number, including area code)

 

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

 

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

 

As of July 31,2003 there were 87,958,739 shares of the Registrant’s Common Stock outstanding.

 

 

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**TABLE OF CONTENTS**

** **
| **PART I. Financial Information** |
|-----------------------------------|
|                              |
| **ITEM 1.**                       |   | **Financial Statements** |
|                              |   |   |
|                              |   | Condensed  Consolidated Balance Sheets at June 30, 2003 and December 31, 2002 |
|                              |   |   |
|                              |   | Condensed  Consolidated Statements of Operations for the three and six months ended June  30, 2003 and 2002 |
|                              |   |   |
|                              |   | Condensed  Consolidated Statements of Cash Flows for the six months ended June 30, 2003  and 2002 |
|                              |   |   |
|                              |   | Notes  to Condensed Consolidated Financial Statements |
|                              |   |   |
| **ITEM  2.**                      |   | **Management’s  Discussion and Analysis of Financial Condition and Results of Operations** |
|                              |   |   |
| **ITEM  3.**                      |   | **Quantitative and Qualitative Disclosures about  Market Risk** |
|                              |   |   |
| **ITEM 4.**                       |   | **Controls and Procedures** |
|                              |   |   |
| **PART II. Other Information**    |
|                              |   |   |
| **ITEM 1.**                       |   | **Legal Proceedings** |
|                              |   |   |
| **ITEM  2.**                      |   | **Changes  in Securities and Use of Proceeds** |
|                              |   |   |
| **ITEM 3.**                       |   | **Defaults upon  Senior Securities** |
|                              |   |   |
| **ITEM  4.**                      |   | **Submission  of Matters to a Vote of Security Holders** |
|                              |   |   |
| **ITEM 5.**                       |   | **Other Information** |
|                              |   |   |
| **ITEM 6.**                       |   | **Exhibits and  Reports on Form 8-K** |
|                              |   |   |
| **SIGNATURES**                    |
|                              |
| **CERTIFICATIONS**                |

 

2

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**PART I.  FINANCIALINFORMATION**

** **

**ITEM 1.  Financial Statements**

 

**ABGENIX, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

(in thousands, except share and per share data)

(unaudited)

 
|                                                                                                                                                                                |   | **June 30,  2003** |    | **December 31,  2002** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|---------|------------------------|--------|
|                                                                                                                                                                                |   |               |    |                   |   |
| **ASSETS**                                                                                                                                                                          |   |               |    |                   |   |
| Current assets:                                                                                                                                                                     |   |               |    |                   |   |
| Cash and cash equivalents                                                                                                                                                           |   | $                  | 34,598  |                   | $      | 207,974 |   |
| Marketable securities                                                                                                                                                               |   | 272,811            |    | 188,575                |   |
| Interest receivable                                                                                                                                                                 |   | 2,616              |    | 2,004                  |   |
| Accounts receivable, net                                                                                                                                                            |   | 760                |    | 2,640                  |   |
| Prepaid expenses and other current assets                                                                                                                                           |   | 20,027             |    | 16,538                 |   |
| Total current assets                                                                                                                                                                |   | 330,812            |    | 417,731                |   |
| Property and equipment, net                                                                                                                                                         |   | 258,192            |    | 244,419                |   |
| Long-term investments                                                                                                                                                               |   | 23,367             |    | 20,939                 |   |
| Goodwill                                                                                                                                                                            |   | 34,780             |    | 34,780                 |   |
| Identified intangible assets, net                                                                                                                                                   |   | 87,299             |    | 92,349                 |   |
| Deposits and other assets                                                                                                                                                           |   | 30,026             |    | 31,779                 |   |
|                                                                                                                                                                                |   | $                  | 764,476 |                   | $      | 841,997 |   |
|                                                                                                                                                                                |   |               |    |                   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                      |   |               |    |                   |   |
| Current liabilities:                                                                                                                                                                |   |               |    |                   |   |
| Accounts payable                                                                                                                                                                    |   | $                  | 9,205   |                   | $      | 21,557 |   |
| Deferred revenue                                                                                                                                                                    |   | 5,092              |    | 3,416                  |   |
| Accrued liabilities                                                                                                                                                                 |   | 10,484             |    | 8,907                  |   |
| Contract cancellation obligation                                                                                                                                                    |   | 28,037             |    | —                 |   |
| Accrued interest payable                                                                                                                                                            |   | 2,061              |    | 2,061                  |   |
| Total current liabilities                                                                                                                                                           |   | 54,879             |    | 35,941                 |   |
| Deferred rent                                                                                                                                                                       |   | 5,454              |    | 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; 87,946,535 and 87,655,342 shares issued and outstanding at June  30, 2003 and December 31, 2002, respectively |   | 9                  |    | 9                      |   |
| Additional paid-in capital                                                                                                                                                          |   | 967,222            |    | 965,821                |   |
| Accumulated other comprehensive income                                                                                                                                              |   | 5,084              |    | 4,156                  |   |
| Accumulated deficit                                                                                                                                                                 |   | (468,172           | )       | (368,347               | )      |
| Total stockholders’ equity                                                                                                                                                     |   | 504,143            |    | 601,639                |   |
|                                                                                                                                                                                |   | $                  | 764,476 |                   | $      | 841,997 |   |

** **

See accompanying notes.

** **

3

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**ABGENIX, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

(in thousands, except per share data)

(unaudited)

 
|                                                                               |   | **Three Months Ended June 30,** |    | **Six Months Ended June 30,** |   |
|------------------------------------------------------------------------------------|--------|---------------------------------|---------|-------------------------------|--------|
|                                                                               |   | **2003**                        |    | **2002**                      |   | **2003** |   | **2002** |   |
|                                                                               |   |                            |    |                          |   |   |   |   |   |
| Revenues:                                                                          |   |                            |    |                          |   |   |   |   |   |
| Contract revenue                                                                   |   | $                               | 2,350   |                          | $      | 2,501 |   | $ | 8,506 |   | $ | 13,499 |   |
| Interest and other income                                                          |   | 2,779                           |    | 5,121                         |   | 5,974 |   | 10,392 |   |
| Total revenues                                                                     |   | 5,129                           |    | 7,622                         |   | 14,480 |   | 23,891 |   |
| Costs and expenses:                                                                |   |                            |    |                          |   |   |   |   |   |
| Research and development                                                           |   | 20,748                          |    | 38,940                        |   | 41,935 |   | 67,919 |   |
| Manufacturing start-up costs                                                       |   | 41,262                          |    | —                        |   | 52,845 |   | — |   |
| Amortization of identified intangible assets, related  to research and development |   | 1,791                           |    | 1,815                         |   | 3,606 |   | 3,622 |   |
| General and administrative                                                         |   | 6,504                           |    | 7,220                         |   | 13,354 |   | 13,927 |   |
| Impairment of investments                                                          |   | —                          |    | 37,498                        |   | — |   | 72,151 |   |
| Interest expense                                                                   |   | 1,485                           |    | 1,858                         |   | 2,481 |   | 2,432 |   |
| Total costs and expenses                                                           |   | 71,790                          |    | 87,331                        |   | 114,221 |   | 160,051 |   |
| Loss before income tax expense                                                     |   | (66,661                         | )       | (79,709                       | )      | (99,741 | ) | (136,160 | ) |
| Foreign income tax expense                                                         |   | —                          |    | —                        |   | 84 |   | — |   |
| Net loss                                                                           |   | $                               | (66,661 | )                             | $      | (79,709 | ) | $ | (99,825 | ) | $ | (136,160 | ) |
|                                                                               |   |                            |    |                          |   |   |   |   |   |
| Basic and diluted net loss per share                                               |   | $                               | (0.76   | )                             | $      | (0.92 | ) | $ | (1.14 | ) | $ | (1.57 | ) |
|                                                                               |   |                            |    |                          |   |   |   |   |   |
| Shares used in computing basic and diluted net loss per  share                     |   | 87,873                          |    | 87,063                        |   | 87,841 |   | 86,983 |   |

 

See accompanying notes.

 

4

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**ABGENIX, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

(in thousands)

(unaudited)

 
|                                                                         |   | **Six Months Ended June 30,** |    |
|------------------------------------------------------------------------------|--------|-------------------------------|---------|
|                                                                         |   | **2003**                      |    | **2002** |   |
| **Operating activities**                                                     |   |                          |    |   |   |
| Net loss                                                                     |   | $                             | (99,825 | ) | $ | (136,160 | ) |
| Adjustments to reconcile net loss to net cash used in  operating activities: |   |                          |    |   |   |
| Depreciation                                                                 |   | 12,554                        |    | 4,513 |   |
| Amortization of identified intangible assets                                 |   | 3,607                         |    | 3,622 |   |
| Impairment of identified intangible asset                                    |   | 1,443                         |    | — |   |
| Amortization of debt issuance cost                                           |   | 594                           |    | 372 |   |
| Impairment of investments                                                    |   | —                        |    | 72,151 |   |
| Loss on sale of equipment                                                    |   | 29                            |    | — |   |
| Changes for certain assets and liabilities:                                  |   |                          |    |   |   |
| Interest receivable                                                          |   | (612                          | )       | 463 |   |
| Accounts receivable                                                          |   | 1,880                         |    | 1,691 |   |
| Prepaid expenses and other current assets                                    |   | (3,489                        | )       | (2,116 | ) |
| Deposits and other assets                                                    |   | 1,159                         |    | (1,366 | ) |
| Accounts payable                                                             |   | (12,352                       | )       | 4,714 |   |
| Deferred revenue                                                             |   | 1,676                         |    | (8,252 | ) |
| Accrued liabilities                                                          |   | 1,577                         |    | 3,639 |   |
| Contract cancellation obligation                                             |   | 28,037                        |    | — |   |
| Deferred rent                                                                |   | 1,037                         |    | 1,227 |   |
| Net cash used in operating activities                                        |   | (62,685                       | )       | (55,502 | ) |
|                                                                         |   |                          |    |   |   |
| **Investing activities**                                                     |   |                          |    |   |   |
| Purchases of marketable securities                                           |   | (203,598                      | )       | (105,768 | ) |
| Maturities of marketable securities                                          |   | 30,744                        |    | 96,696 |   |
| Sales of marketable securities                                               |   | 87,118                        |    | 52,314 |   |
| Purchases of property and equipment                                          |   | (26,367                       | )       | (86,365 | ) |
| Sales of equipment                                                           |   | 11                            |    | — |   |
| Payments for acquisition liabilities                                         |   | —                        |    | (155 | ) |
| Net cash used in investing activities                                        |   | (112,092                      | )       | (43,278 | ) |
|                                                                         |   |                          |    |   |   |
| **Financing activities**                                                     |   |                          |    |   |   |
| Net proceeds from issuance of convertible subordinated  notes                |   | —                        |    | 194,000 |   |
| Net proceeds from issuances of common stock                                  |   | 1,401                         |    | 1,648 |   |
| Net cash provided by financing activities                                    |   | 1,401                         |    | 195,648 |   |
| Net increase (decrease) in cash and cash equivalents                         |   | (173,376                      | )       | 96,868 |   |
| Cash and cash equivalents at beginning of period                             |   | 207,974                       |    | 99,663 |   |
| Cash and cash equivalents at end of period                                   |   | $                             | 34,598  |   | $ | 196,531 |   |

 

See accompanying notes.

 

5

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**ABGENIX, INC.**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**June 30, 2003**

**(unaudited)**

 

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

 

**Basis of Presentation -**Theunaudited condensed consolidated financial statements of Abgenix, Inc. (the“Company” or “Abgenix”) included herein have been prepared pursuant to therules and regulations of the Securities and Exchange Commission. Certaininformation or footnote disclosure normally included in financial statementsprepared in accordance with generally accepted accounting principles has beencondensed or omitted pursuant to such rules and regulations. In the opinion ofthe Company, the accompanying unaudited condensed consolidated financialstatements contain all adjustments, consisting only of normal recurringadjustments, necessary to present fairly the financial information includedtherein. These financial statements should be read in conjunction with theaudited financial statements for the year ended December 31, 2002,****andaccompanying notes included in the Company’s Annual Report as filed on Form10-K with the Securities and Exchange Commission. The results of operations forthe three and six months ended June 30, 2003, are not necessarily indicative ofthe results to be expected for the full year or for any other future period.

** **

**RevenueRecognition** - The Company receives payments from customers forlicense, option, service and milestone fees. These payments are generallynon-refundable but are reported as deferred revenue until they are recognizableas revenue. The Company has followed the following principles in recognizingrevenue:

 

•                                          Research license fees: Fees to license the use ofthe Company’s proprietary technologies in research performed by the customerare generally recognized only after both the license period has commenced andthe technology has been delivered. If Abgenix is obligated to providesignificant assistance to enable the customer to practice the license, then therevenue is recognized 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 the Company’sresearch efforts or by events external to Abgenix, such as regulatory approvalto market a product. Incentive milestone payments are substantially at risk atthe inception 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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**Stock-Based Compensation -**TheCompany accounts for stock-basedawards to employees and directors using the intrinsic value method in accordancewith Accounting Principles Board Opinion No. 25, “Accounting for Stock Issuedto Employees.” Accordingly, the Company does not recognize compensation expensefor employee stock options granted at fair market value. For purposes of disclosures pursuant to Statement of FinancialAccounting Standards (SFAS 123), as amended by SFAS 148, the estimated fairvalue of options is amortized to expense over the options’ vesting period. The following table illustrates what net losswould have been had the Company accounted for its stock-based awards under theprovisions of SFAS 123. Pro forma amounts may not be representative offuture periods.

 
|                                                                                                                                                                   |   | **Three Months Ended  June 30,**              |    | **Six Months Ended  June 30,** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------|---------|--------------------------------|--------|
|                                                                                                                                                                   |   | **2003**                                      |    | **2002**                       |   | **2003** |   | **2002** |   |
|                                                                                                                                                                   |   | **(in thousands, except per share  amounts)** |    |
|                                                                                                                                                                   |   |                                          |    |                           |   |   |   |   |   |
| Net loss as reported                                                                                                                                                   |   | $                                             | (66,661 | )                              | $      | (79,709 | ) | $ | (99,825 | ) | $ | (136,160 | ) |
| Stock-based employee compensation costs that would have  been included in the determination of net loss if the fair value based method  had been applied to all awards |   | (15,971                                       | )       | (21,130                        | )      | (31,892 | ) | (41,264 | ) |
| Pro forma net loss as if the fair value based method  had been applied to all awards                                                                                   |   | $                                             | (82,632 | )                              | $      | (100,839 | ) | $ | (131,717 | ) | $ | (177,424 | ) |
|                                                                                                                                                                   |   |                                          |    |                           |   |   |   |   |   |
| Basic and diluted net loss per share as reported                                                                                                                       |   | $                                             | (0.76   | )                              | $      | (0.92 | ) | $ | (1.14 | ) | $ | (1.57 | ) |
|                                                                                                                                                                   |   |                                          |    |                           |   |   |   |   |   |
| Pro forma basic and diluted loss per share                                                                                                                             |   | $                                             | (0.94   | )                              | $      | (1.16 | ) | $ | (1.50 | ) | $ | (2.04 | ) |

 

The fair value for these options was estimated at the date of grantusing a Black-Scholes option pricing model with the following assumptions forthe three and six months ended June 30, 2003 and 2002;

 
|                                                                 |   | **Three Months Ended  June 30,** |   | **Six Months Ended  June 30,** |   |
|----------------------------------------------------------------------|--------|----------------------------------|--------|--------------------------------|--------|
|                                                                 |   | **2003**                         |   | **2002**                       |   | **2003** |   | **2002** |   |
| Risk-free interest rate                                              |   | 2.75%                            |   | 3.07%                          |   | 2.91% |   | 3.07% |   |
| Dividend yield                                                       |   |  0.0%                       |   |  0.0%                     |   |  0.0% |   |  0.0% |   |
| Volatility factors of the expected market price of our  Common Stock |   | 1.01                             |   | 1.05                           |   | 1.04 |   | 1.05 |   |
| Weighted-average expected life of option (years)                     |   | 5.51                             |   | 5.54                           |   | 5.52 |   | 5.54 |   |

 

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

 

TheBlack-Scholes option valuation model was developed for use in estimating thefair value of traded options, which have no vesting restrictions and are fullytransferable. In addition, option valuation models require the input of highlysubjective assumptions, including the expected stock price volatility. Becausethe Company’s employee stock options have characteristics significantlydifferent from those of traded options, and because changes in the subjectiveinput assumptions can materially affect the fair value estimate, inmanagement’s opinion, the existing models do not necessarily provide a reliablesingle measure of the fair value of its employee stock options.

 

The weighted-average fair values of options granted during the threeand six months ended June 30, 2003 were $7.03 and $6.35 per share,respectively, and were $15.34 and $15.34 per share,

 

7

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respectively,for the three and six months ended June 30, 2002. All options granted were atexercise prices at the then current fair market value of the stock.

** **

**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 all periodspresented.

 

**Reclassifications –**Certain prior period balances have beenreclassified to conform to the current period presentation.

 

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

** **

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

** **
|                                                                 |   | **Three Months Ended  June 30,** |    | **Six Months Ended  June 30,** |   |
|----------------------------------------------------------------------|--------|----------------------------------|---------|--------------------------------|--------|
|                                                                 |   | **2003**                         |    | **2002**                       |   | **2003** |   | **2002** |   |
|                                                                 |   |                             |    |                           |   |   |   |   |   |
| Net loss                                                             |   | $                                | (66,661 | )                              | $      | (79,709 | ) | $ | (99,825 | ) | $ | (136,160 | ) |
| Other comprehensive income:                                          |   |                             |    |                           |   |   |   |   |   |
| Unrealized holding gains (losses) arising during period              |   | 3,678                            |    | (28,478                        | )      | 928 |   | (50,003 | ) |
| Less: reclassification adjustment for losses recognized  in net loss |   | —                           |    | 30,390                         |   | — |   | 65,043 |   |
| Net unrealized gains on securities                                   |   | 3,678                            |    | 1,912                          |   | 928 |   | 15,040 |   |
|                                                                 |   |                             |    |                           |   |   |   |   |   |
| Comprehensive loss                                                   |   | $                                | (62,983 | )                              | $      | (77,797 | ) | $ | (98,897 | ) | $ | (121,120 | ) |

** **

**3.****                                      Goodwilland Identified Intangible Assets**

 

During the quarter ended March 31, 2003, the Company made a decision to discontinue thedevelopment of therapeutic antibodies to the complement protein properdin.Accordingly, the Company recorded an impairment charge of approximately $1.4million related to the license to develop and commercialize antibodies toproperdin. The impairment charge was included in research and developmentexpenses on the Company’s statement of operations.

 

Identified intangible assets consisted of the following (in thousands):

 
|                                      |   | **Gross  Assets** |    | **Accumulated  Amortization** |   | **Net** |   |
|-------------------------------------------|--------|-------------------|---------|-------------------------------|--------|---------|--------|
| **As  of June 30, 2003:**                 |   |              |    |                          |   |    |   |
| Acquisition-related  developed technology |   | $                 | 106,183 |                          | $      | (20,151 | )      | $ | 86,032 |   |
| Other intangible  assets                  |   | 1,442             |    | (175                          | )      | 1,267   |   |
| Identified  intangible assets             |   | $                 | 107,625 |                          | $      | (20,326 | )      | $ | 87,299 |   |
|                                      |   |              |    |                          |   |    |   |
| **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 and $3.5 million, respectively, for each of the three and six monthperiods ended June 30, 2003 and 2002. Amortization of

 

8

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other intangible assets was $22,000 and $68,000, respectively, for thethree and six months ended June 30, 2003 and $46,000 and $93,000, respectively,for the three and six months ended June 30, 2002. All of the Company’s acquiredidentified intangibles other than goodwill are subject to amortization.

 

                                                Expectedamortization expense related to identified intangible assets for the six-monthperiod from July 1, 2003, to December 31, 2003, and each of the fiscal yearsthereafter is as follows (in thousands):

 
|                            |   | **Periods Ending December 31,** |   |     |   |     |   |
|---------------------------------|--------|---------------------------------|--------|----------|--------|----------|--------|
|                            |   | **2003**                        |   | **2004** |   | **2005** |   | **2006** |   | **2007** |   | **Thereafter** |   | **Total** |   |
| Acquisition-related intangibles |   | $                               | 3,538  |     | $      | 7,076    |   | $ | 7,077 |   | $ | 7,077 |   | $ | 7,076 |   | $ | 54,188 |   | $ | 86,032 |   |
| Other intangible assets         |   | $                               | 45     |     | $      | 90       |   | $ | 90 |   | $ | 90 |   | $ | 90 |   | $ | 862 |   | 1,267 |   |
|                                 |        |                                 |        |          |        |          |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**4. ****                                SegmentInformation**

** **

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

 

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

 
| **Period**                        |   | **Number  of customers and percentage of contract  revenues for each of the customers who provided   10% or more of contract revenues for the period.** |
|-----------------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------|
| Three months ended June  30, 2003 |   | 4 customers, 35%, 24%, 11%  and 11%, respectively                                                                                                       |
| Six months ended June 30,  2003   |   | 3 customers, 35%, 16%, and 13%,  respectively                                                                                                           |
| Three months ended June  30, 2002 |   | 3 customers, 38%, 32% and 15%, respectively                                                                                                             |
| Six months ended June 30,  2002   |   | 2 customers, 63% and 10%,  respectively                                                                                                                 |

 

**5. ****                                RestructuringCharges**

** **

In October 2002, theCompany announced a restructuring plan, which consisted primarily of a 15%reduction in employees. A restructuring charge of $1.8 million was recorded in2002 to account for severance, medical and other benefits associated with thisrestructuring. As of December 31, 2002, approximately $1.1 million of severancebenefits were accrued. During the three and six months ended June 30, 2003, theCompany made cash payments for severance benefits of approximately $85,000 and$1.0 million, respectively.  As of June30, 2003, approximately $102,000 of severance benefits were accrued and areexpected to be paid to terminated employees over the next three months.

 

**6.****                                      ContractCancellation Obligation**

** **

Effective June 30, 2003,the Company canceled its November 2000 agreement with Lonza Biologics plc(“Lonza”) for the exclusive use of a cell culture production suite, because theCompany determined that with the opening of its own manufacturing plant, it nolonger needed access to the Lonza facility. Upon canceling the agreement, the Company was obligated to pay Lonzafour equal installments of 4,250,000 British Pounds on October 1, 2003,February 1, 2004, May 1, 2004 and August 1, 2004, which eliminated theCompany’s commitment to pay approximately $46 million in total monthly feesthrough August 2006.  At June 30, 2003,the total value of this obligation was approximately $28.0 million UnitedStates dollars and was recorded as a component of Manufacturing start-up costsin the Company’s Statements of Operations.

** **

**7.****                                      CustomerIndemnification**

** **

The Company has certain agreements with customers andcollaborators that contain

 

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indemnification provisions. Insuch provisions, the Company typically agrees to indemnify the customer orcollaborator against certain types of third-party claims. The Company wouldaccrue for known indemnification issues if a loss were probable and could bereasonably estimated. TheCompany would also accrue for estimated incurred but unidentified issues basedon historical activity. There was no accrual for or expense related toindemnification issues as of June 30, 2003 and 2002 and, in each case, for thethree and six months then ended.

 

**8. ****                                RecentAccounting Pronouncements**

** **

In November 2002, the FASB issued Emerging Issues TaskForce (EITF) Issue No. 00-21, “Revenue Arrangements with MultipleDeliverables.” EITF Issue No. 00-21 addresses certain aspects of the accountingby a company for arrangements under which it will perform multiplerevenue-generating activities. EITF Issue No. 00-21 addresses when and how anarrangement involving multiple deliverables should be divided into separateunits of accounting. The provisions of EITF Issue No. 00-21 will apply torevenue arrangements entered into after June 30, 2003. The provisions of theEITF Issue No. 00-21 do not impact the accounting treatment of the Company’sexisting revenue arrangements. The Company believes that the adoption of EITFIssue No. 00-21 will not result in a material change to its existing revenuerecognition policy for prospective revenue arrangements. The Company does notexpect the adoption of EITF Issue No. 00-21 to have a material impact on itsconsolidated financial statements.

 

                InJanuary 2003, the FASB issued Interpretation No. 46 (the Interpretation),Consolidation of Variable Interest Entities. The Interpretation requires theconsolidation of entities in which an enterprise absorbs a majority of theentity’s expected losses, receives a majority of the entity’s expected residualreturns, or both, as a result of ownership, contractual or other financialinterests in the entity. Currently, entities are generally consolidated by anenterprise when it has controlling financial interest through ownership of amajority voting interest in the entity. The Interpretation will be implementedby Abgenix in the quarter ended September 30, 2003. The Company has performed apreliminary analysis of the Interpretation and does not believe that theadoption will result in a material impact on the results of operations orfinancial position. During the quarter ended September 30, 2003, the Companywill complete its evaluation of the implications of the Interpretation to allvariable interest entities with which it has involvement.

 

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**Item 2.Management’s Discussion and Analysis of Financial Condition and Results ofOperations**

###  

*The following Management’sDiscussion and Analysis of Financial Condition and Results of Operationscontains forward*-*looking statementsbased upon current expectations that involve risks and uncertainties. In thisQuarterly Report on Form 10*-*Q, the words“intend,” “anticipate,” “believe,” “estimate,” “plan” and “expect” and similarexpressions as they relate to Abgenix are included to identify forward*-*looking statements. Our actual results and the timingof certain events could differ materially from those anticipated in theseforward*-*lookingstatements as a result of certain factors, including those set forth below andunder the heading “Additional Factors that Might Affect Future Results”.  In this Quarterly Report on Form 10-Q,references to “Abgenix,” we,” “us,” and “our” are to Abgenix, Inc. and itssubsidiaries.*

* *

##### **Overview**

** **

Weare a biopharmaceutical company that is focused on the discovery, developmentand manufacture of antibody therapeutic products for the treatment of a varietyof disease conditions, including cancer, inflammation, metabolic disease,transplant-related diseases, cardiovascular disease and infectious diseases.

 

Wehave proprietary technologies that facilitate rapid generation of highlyspecific, antibody therapeutic product candidates that contain fullyhuman protein sequences and thatbind to disease targets appropriate for antibody therapy. In this QuarterlyReport on Form 10-Q we refer to these candidates as fully human antibodytherapeutic product candidates.  Wedeveloped our XenoMouse® technology, a technology using genetically modifiedmice to generate fully human antibodies. We also own a technology that enablesthe rapid identification of antibodies with desired function andcharacteristics, referred to as SLAMTM technology. In our XenoMaxTM technology,we use SLAM technology to select and isolate antibodies with particularfunction and characteristics from antibody-producing cells generated byXenoMouse animals. We believe XenoMax technology enhances our capabilities inproduct development and flexibility in manufacturing. We have entered into avariety of contractual arrangements with multiple pharmaceutical, biotechnologyand genomics companies involving our XenoMouse and XenoMax technologies. Two ofour customers, Pfizer, Inc. and Amgen, Inc., have initiated clinicaltrials with fully human antibodies generated from XenoMouse animals. In addition,under a joint development and commercialization agreement, we are co-developingABX-EGF, our leading proprietary antibody product candidate, with Amgen andImmunex Corporation, a wholly-owned subsidiary of Amgen. We intend to build alarge and diversified product portfolio by using our XenoMouse and XenoMaxtechnologies to generate antibodies to antigen targets that we source, enteringinto additional 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 XenoMax technologyto assist our licensees and collaborators in isolating antibodies with desiredfunction and characteristics. These arrangements may involve sharing of costsand profits.

** **

Asof June 30, 2003, we had entered into contracts covering numerous antigentargets with over thirty customers to use our XenoMouse and XenoMaxtechnologies to generate and/or develop the resulting fully human antibodies.Also as of June 30, 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 antigensourcing contract. Pursuant to our XenoMouse contracts, we and our customersintend to generate antibody product candidates for the treatment of cancer,inflammation, autoimmune diseases, transplant rejection, cardiovasculardisease, growth factor modulation, neurological diseases and infectiousdiseases. We also plan to enter into additional contracts to provideantibody process sciences and manufacturing services. We expect that substantially all of ourrevenues for the foreseeable future will result from payments under these andother contracts. We have also licensed technology from third parties for use inconjunction with our proprietary technologies. The terms of our current contractualarrangements vary, 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 make equity investments incollaborators 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 human antibodywe created, with Amgen and Immunex. Under the agreement, Immunex paid us aninitial license fee at signing and a second license fee in May 2001. Weare obligated to pay 50% of the development costs and are entitled to receive50% of any 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 manufacturingservices related to an antibody product candidate that we developed and whichthe customer selected from a pool of antibodies generated pursuant to anexisting antigen sourcing agreement. Under this production services contract wewill deliver 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 to developand commercialize. The financial terms of these agreements may include licensefees, option fees and milestone payments paid to us by the customer. Based onour agreements, these payments and fees would average from approximately $7.0million to $10.0 million per antigen target if our customer takes theantibody into development and ultimately to commercialization. Additionally,our license agreements entitle us to receive royalties on any future productsales by 

 

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the customer. We may alsoagree to make equity investments in some of our customers, or they may agree tomake equity investments in us, in connection with these licensing arrangements.As of June 30, 2003, we hadentered into one agreement in which we licensed our SLAM technology to oneparty on a non-exclusive basis for the purpose of generating and usingantibodies other than antibodies derived from XenoMouse technology or othertechnology that involves the use of non-human animals, and on a co-exclusivebasis for the purpose of antigen discovery. We currently do not intend tolicense our SLAM technology for use by any other parties. In addition, as ofJune 30, 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 andcommercialize therapeutic antibodies to parathyroid hormone-related protein, orPTHrp.

 

•                  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, milestone paymentsand royalty fees to the counterparty upon the occurrence of specifiedconditions, including upon our sale of products derived from use of thelicensed technology. We may also agree to make an equity investment in theother party for strategic reasons in connection with these arrangements. Forexample, we purchased shares of common stock of ImmunoGen in connection withour agreement with that company.

 

Asof June 30, 2003, two of our antibody therapeutic product candidates were inongoing 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 and commercializationagreement.  The status of clinicaltrials 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 2 clinicaltrial evaluating the effect of ABX-EGF as monotherapy in patients with renalcell 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 chemotherapyalone, in July 2001, in which 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.  Enrollment in this studyis complete. Immunex initiated a separate Phase 2 clinical trial evaluating theeffect of ABX-EGF in combination with standard chemotherapy, as first-linetreatment in patients with metastatic colorectal cancer in January 2002, inwhich 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 Drug Application,or IND, in December 2001 and initiated a Phase 1 clinical trial for 

 

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ABX-MA1 in metastaticmelanoma in February 2002, in which enrollment is ongoing.

 

Wedeveloped ABX-CBL, an in-licensed mouse antibody, for the treatment of atransplant-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 to jointlydevelop and commercialize ABX-EGF.  Weintend to enter into additional joint development agreements for other productcandidates earlier in the product development lifecycle than when we enteredinto 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.

 

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

 

•                  Pfizer—We generated a XenoMouse-derived fullyhuman antibody therapeutic product candidate for treating cancer that Pfizerhas advanced into clinical trials.  Inaddition, Pfizer has recently filed an IND to initiate clinical testing of asecond XenoMouse-derived fully human antibody therapeutic product candidate.

 

•                  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 of Operations**

** **

*Three Months and Six Months Ended June 30, 2003 and 2002*

* *

*Contract Revenues.*

* *

Contractrevenues totaled $2.4 million and $8.5 million, respectively, in the three andsix months ended June 30, 2003, compared to $2.5 million and $13.5 million,respectively, in the comparable 2002 periods. Because contract revenues dependto a large extent on the success or failure of research and development effortsundertaken by our collaborators and licensees, our period-to-period contractrevenues can fluctuate significantly and are inherently difficult to predict. With our new manufacturing facility and ourexisting pilot plant, we now offer integrated process sciences andmanufacturing services, which we refer to as production services. In future periods we expect to generaterevenue from production services and for those revenues to increase over thenext few years.

 

The primary components ofcontract revenues for both periods were as follows:

 

•                        Technology Licensing

 

Werecognized a total of $2.3 million and $7.8 million, respectively, in thethree and six months ended June 30, 2003, compared to $1.5 million and $11.0million, respectively, in the comparable 2002 periods, from licensing ourproprietary technologies. Revenues consisted primarily of the following:

 

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•            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-PTHrp therapeuticantibodies.

 

•            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 our obligationsto provide Celltech with the applicable protocols, technical information andtraining to enable Celltech to effectively utilize the SLAM technology.

 

•            Additionally, in the three and six monthsended June 30, 2003 and 2002, we recognized various fees, such asresearch license and service fees, product license fees, product developmentand research milestone payments, and option fees, under agreements related tothe licensing of our XenoMouse technology. We recognized fees primarily from Pfizer, Amgen, and Abbott Laboratoriesin the three and six month periods ended June 30, 2003, and primarily fromPfizer and CuraGen in the three and six month periods ended June 30, 2002.

 

•                        Proprietary Product Development

 

Werecognized approximately $64,000 and $685,000, respectively in the three andsix months ended June 30, 2003, compared to $1.0 million and $2.5 million,respectively, in the comparable 2002 periods, pursuant to our joint developmentand commercialization agreements. In the three and six months ended June 30,2002 and 2003, the revenues included the reimbursement of developmentcosts from the development of ABX-CBL. In 2002, the revenue also included the reimbursement of development costsfrom the development of ABX-EGF.

 

*Interest and Other Income.*

 

Interestand other income consist primarily of interest from cash, cash equivalents andmarketable securities. Interest and other income decreased to $2.8 million and$6.0 million in the three and six months ended June 30, 2003, compared to $5.1million and $10.4 million, respectively, in the comparable 2002 periods. Thedecrease was due to lower interest rates and lower average cash, marketablesecurities and cash equivalent balances.

 

*Research and Development Expenses.*

 

Researchand development expenses were $20.7 million and $41.9 million, respectively, inthe three and six months ended June 30, 2003, compared to $38.9 million and$67.9 million, respectively, in the comparable 2002 periods. Managementseparates research and development expenditures into amounts related toresearch and amounts related to product development as follows:

 

•                        Research Costs

 

Researchcosts include costs associated withresearch and testing of our product candidates prior to reaching thedevelopment stage and costs associated with cell line development. Such costsinclude the costs of Abgenix personnel, facilities, including depreciation, andtechnology in-licensing.Research costs were $13.4 million and $28.9 million, respectively, in the threeand six months ended June 30, 2003,as compared to $20.8 million and $35.7 million, respectively, in the comparable 2002 periods. Major componentsof the changes in research 

 

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costsin the three and six months ended June 30, 2003 as compared to the same periodsin 2002 were as 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.

 

•                        Costs of Abgenix Personnel—Costs of Abgenixpersonnel to support research activities decreased 27% and 26% in the three and six months ended June 30, 2003,respectively, from the comparable 2002 periods. The decrease was a result of our restructuringplan implemented in October 2002, which resulted in an approximately 15%reduction in total employees overall. Personnel costs primarily include salary, fringe benefits, recruiting and relocation costs.

 

•                        Outside Contractors – Costs for outsidecontractors to support research activities decreased 70% and 49% in the threeand six months ended June 30, 2003, respectively, from the comparable 2002periods.  The decrease was a result ofthe reduction of activities performed by outside contractors related to thedevelopment of cell lines for our product candidates.

 

•                        ProductDevelopment Costs

 

Product development costsinclude costs of preclinical development andconducting clinical trials. Such costs include costs of Abgenix personnel, drugsupply costs, research fees charged by outside contractors and facilityexpenses including depreciation. Product development costs were $7.3 million and $13.0 million,respectively, in the threeand six months ended June 30, 2003 ascompared to$18.1 million and  $32.2 million, respectively, in the comparable 2002 periods. The decrease in the three and sixmonths ended June 30, 2003 was primarily related to the decrease in clinicaltrials being conducted for ABX-IL8. Major components of the changes in productdevelopment costs in the three and six months ended June 30, 2003 as compared to the same periods 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 79% and 81%, respectively, in the threeand six months ended June 30, 2003, as compared to the comparable 2002 periods.The decrease was primarily due to the decrease in clinical trials beingconducted for ABX-IL8 in the first and second quarters of 2003 as compared tothe same periods in 2002.

 

•                        Costs of Abgenix Personnel—Costs of Abgenixpersonnel to support clinical activities decreased 57% and 53%, respectively,in the three and six monthsended June 30, 2003, as compared to the comparable 2002 periods. The decrease was a result of our restructuring planimplemented in October 2002, which resulted in an approximate 15% reduction intotal employees overall, and the decrease in clinical trials being conductedfor ABX-IL8. Personnel costsprimarily include salary, fringe benefits, recruiting and relocation costs.

 

*Manufacturing Start-Up Costs.*

 

Manufacturing start-up costswere $41.3 million and $52.8 million, respectively, in the three and six monthsended June 30, 2003.  Manufacturingstart-up costs include costsassociated with our newantibody production facility,including quality assurance and quality control activities and the costs ofoutside contractors.  The primarycomponent of this expense in 2003 was a cancellation fee of 

 

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approximately $28.0 million inJune 2003 for the negotiated cancellation of an agreement with an outsidecontractor, Lonza Biologics plc. Effective June 30, 2003, we canceled our November 2000 agreement withLonza for the exclusive use of a cell culture production suite because wedetermined that with the opening of our own manufacturing facility we no longerneeded access to the Lonza facility. Excluding the cancellation fee, manufacturing start-up costs primarilyinclude facility expenses that include depreciation, outside contractor costs,and personnel costs. We began manufacturing antibodytherapeutic candidates in portions of the facility in the second quarter of2003, at which time we began to depreciate portions of the facility. We expectthe facility to be under-utilized for the remainder of the year and thereforemanufacturing start-up costs will continue for the remainder of 2003. These costs may decrease as a result ofutilization of the facility for the manufacture of ABX-EGF and potentiallyother product candidates under production services agreements; however, thisdecrease may be offset by an increase in additional depreciation.

 

*Amortization of Identified Intangible Assets.*

* *

Ouridentified intangible assets consist primarily of existing technology(including patents and certain royalty rights) that we acquired through ouracquisition 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 and $3.6 million, respectively, in each of the three andsix month periods ended June 30, 2003 and $1.8 million and $3.6 million for thethree and six months ended June 30, 2002.

 

*General and Administrative Expenses.*

* *

Generaland administrative expenses include compensation, professional services,consulting, facilities, including depreciation, and other expenses related tolegal, finance and information systems. General and administrative expensestotaled $6.5 million and $13.4 million, respectively, in the three and sixmonths ended June 30, 2003, as compared to $7.2 million and $13.9 million,respectively, in the comparable 2002 periods. The decrease in 2003 as comparedto 2002 was primarily due to a decrease in consulting related to the implementationof our new information systems in 2002 and in legal costs due to the timing ofactivities related to securities filings, licensing, financing activities andother contractual matters partially offset by an increase in personnel relatedcosts, facility costs and depreciation expense related to the enterpriseresource planning system, which was launched at the beginning of the thirdquarter of 2002. We expect general and administrative costs to approximate thesame levels in the third quarter of 2003 as they were in each of the first twoquarters of 2003.

 

*Impairment of Investments.*

* *

Wepurchased an aggregate amount of $80.0 million of common stock of CuraGen andImmunoGen as strategic investments at various times in 1999 and 2000.

 

In2002, during the first, second and fourth quarters, declines in the fair valueof the CuraGen and ImmunoGen common stock were deemed to be other thantemporary.  Accordingly, werecorded impairment charges of $34.7 million, $30.4 million and $2.2 million,in the first, second and fourth quarters of 2002, respectively.  The total impairment charge for the yearended December 31, 2002 was $67.3 million. As of June 30, 2003, these investments were recorded at fair value inlong-term investments on the balance sheet, and the net unrealized holdinggains 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.  As of June 30, 2002,we estimated 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 

 

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andour original cost basis. The investment is recorded in long-term investments onthe balance sheet.  If we deem theinvestment in MDS Proteomics further impaired at the end of any future period,we may incur an additional impairment charge on this investment.

 

*Interest Expense.*

 

Interest expense was primarily related to interest andamortization of issuance costs on our convertible debt. For the three months ended June 30, 2003 and 2002, interest expensedecreased to approximately $1.5 million from $1.9 million, respectively, as aresult of an increase in capitalized interest. Interest expense increased toapproximately $2.5 million from $2.4 million in the six months ended June 30,2003 and 2002, because our convertible debt was outstanding for only a portion ofthe relevant period in 2002.  Thisincrease was partially offset by an increase in capitalized interest.  The convertible debt was issued in March2002, accrues interest at an annual rate of 3.5%, and is payable semi-annually.Interest expense related to the convertible debt was capitalized in the amountof $0.6 million and $1.7 million, respectively, in the three and six monthsended June 30, 2003, as compared to $0.2 million and $0.3 million in the sameperiods in 2002. For each future quarterly period, we expect to accrueapproximately $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 was recorded reflecting anincome tax provision on foreign contract research projects of zero andapproximately $84,000, respectively, in the three and six months ended June 30,2003.

 

**Liquidity and Capital Resources**

** **

AtJune 30, 2003, we had cash, cash equivalents and marketable securities ofapproximately $307.4 million. We invest our cash equivalents andmarketable securities primarily in highly liquid, interest bearing, investmentgrade and government securities in order to preserve principal. We have alsoinvested in certain marketable equity securities of ImmunoGen and CuraGen forstrategic reasons. These securities had a fair value of $15.5 million at June30, 2003.

 

*Cash Used in Operating Activities.*  Netcash used in operating activities was $62.7 million and $55.5 million in the six months ended June 30, 2003 and 2002,respectively. The major components of the change in cash used in operating activities in thesix months ended June 30, 2003, compared to the same period in 2002, were primarily the following:

 

•                  A decrease of $31.1 million in research and development costs, net ofdepreciation and an impairment charge related to an identified intangibleasset, related to the development of new products.

 

•                  An increase of $21.4 million in manufacturing costs, net of the Lonzacontract cancellation obligation and depreciation, related to the start-up ofour new antibody production facility.

 

•                  An increase of$5.1 million in customer payments due primarily to the timing of paymentsreceived under our contracts offset by a decrease of $5.5 million in cash frominterest income due to lower interest rates and lower average cash balances.

 

•                  An increase of$17.1 million in vendor payments, which reduced accounts payable.

 

*Cash Used in Investing Activities.*  Netcash used in investing activities was $112.1 and $43.3 million in the six months ended June 30, 2003 and 2002,respectively. Cash was provided by and used in investing activities as follows:

 

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•                  Capitalexpenditures of $26.4 million and $86.4 million in the six months endedJune 30, 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.

 

•                  Purchases, netof maturities and sales, of marketable securities of $85.7 million during thesix months ended June 30, 2003 and maturities and sales, net of purchases,of marketable securities of $43.2million during the six months ended June 30, 2002.

 

*Cash Provided by Financing Activities.* During the six months ended June 30, 2003, net cash provided byfinancing activities was $1.4 million, consisting of proceeds from the exerciseof stock options and the issuance of stock under our employee stock purchaseplan. During the six months ended June 30, 2002, net cash provided by financingactivities was $195.6 million, consisting of $194.0 million net proceeds fromour issuance of convertible subordinated notes, as described below, and $1.6 million proceeds from the exerciseof stock options and the issuance of stock under our employee stock purchaseplan.

 

InMarch 2002, we issued $200.0 million principal amount of convertible subordinatednotes in a private placement. The notes are convertible into shares of ourcommon stock at a conversion price of $27.58 per share subject to certainadjustments. The notes accrue interest at an annual rate of 3.5% and we areobligated 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.

 

InMarch 2000 and February 2001, we obtained stand-by letters of creditfor $2.0 million and $3.0 million, respectively, from a commercial bank assecurity for our obligations under two facility leases. These were increased inJanuary 2002 to $2.5 and $3.2 million, respectively, in connection withamendments to our facility leases. In September 2001, we obtained a stand-byletter of credit for 1.0 million Canadian dollars from a commercial bankas security for our obligations under a facility lease in Canada while thefacility was under construction. The standby letter of credit for 1.0 millionCanadian dollars was terminated in January 2003. The outstanding stand-byletters of credit are secured by an investment account, in which we mustmaintain a balance of approximately $6.0 million.

 

*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 six months, we estimate that we will spend approximately$10.0 million on leasehold improvements and equipment for our newmanufacturing and our research and development facilities. Additionally, duringthe same period we expect to spend up to approximately $0.5 million on newcomputer hardware and software.

 

Wecurrently intend to use our available cash on hand to finance these projectsand business developments, but we might also pursue other financingalternatives, such as a bank line of credit, sale-lease back financing, fundingby one or more collaborators, equity or equity-related financing or a mortgagefinancing, that may become available to us. Whether we use cash on hand orchoose to obtain financing will depend on, among other things, the futuresuccess of our business, the prevailing interest rate environment and thecondition of financial markets generally.

 

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Theamounts of the expenditures that will be necessary to execute our business planare subject to numerous uncertainties that may adversely affect our liquidityand capital resources to a significant extent. As of June 30, 2003, four of our proprietary product candidates,ABX-EGF, ABX-MA1, ABX-CBL and ABX-IL8, were in various stages of clinicaltrials.  We are discontinuingdevelopment of two of them, ABX-IL8 and ABX-CBL. Completion of clinical trialsmay take several years or more, but the length of time generally variessubstantially according to the type, complexity, novelty and intended use of aproduct candidate. We estimate that clinical trials of the type we generallyconduct 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 of clinical trials may vary significantly over thelife of a project as a result of differences arising during the clinicaltrials, including, among others, the following:

 

•                                          the number of patients that ultimatelyparticipate in the trial;

 

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

 

•                                          the number of clinical sites included in thetrials; and

 

•                                          the length of time required to enrollsuitable patient subjects.

 

Wetest our potential product candidates in numerous pre-clinical studies toidentify disease indications for which they may be product candidates. We mayconduct multiple clinical trials on our own or with our collaborators to covera variety of indications for each product candidate. As we obtain results fromtrials, we may elect to discontinue clinical trials for certain productcandidates or for one or more indications for a given product candidate inorder to focus our resources on more promising product candidates orindications. For example, in January 2002 and May 2002, we announced thatclinical trials of our proprietary product candidate ABX-IL8 as a treatment forrheumatoid arthritis and psoriasis, respectively, did not support furtherclinical studies of that product candidate. Additionally in February 2003, we announced that the clinical trialof our proprietary product candidate ABX-CBL as a treatment for graft versushost disease, did not support further clinical studies of that productcandidate. The failure ofclinical trials can also result in additional research and development expensesand other costs.  For example, werecorded a charge of $6.7 million for the three months ended June 30, 2002,related to our decision in the second quarter of 2002 to wind down our clinicaltrials of ABX-IL8.

 

Animportant element of our business strategy is to pursue the research anddevelopment of a diverse range of product candidates for a variety of diseaseindications. We intend to enter co-development agreements, similar toour agreements with Amgen and Immunex for ABX-EGF and to enter into additionaljoint development 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 ofpotential product candidates we have in preclinical development. To the extent,however, that we are unable to maintain a diverse and broad range of productcandidates, our dependence on the success of one or a few product candidateswould increase.

 

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Ourproprietary product candidates also have not yet achieved FDA regulatoryapproval, which is required before we can market them as therapeutic products.In order to proceed to subsequent clinical trial stages and to ultimatelyachieve regulatory approval, the FDA must conclude that our clinical data establishsafety and efficacy. The number, size and type of clinical trials we conductfor a particular product candidate are also affected by the policies of the FDAand European regulatory agencies regarding the availability of possibleexpedited approval procedures, which we may seek to utilize.  These policies may change form time totime.  In addition, the results frompreclinical testing and early clinical trials have often not been predictive ofresults obtained in later clinical trials. A number of new drugs and biologicshave shown promising results in clinical trials, but subsequently failed toestablish sufficient safety and efficacy data to obtain necessary regulatoryapprovals.

 

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

 

Asa result of the uncertainties discussed above, among others, the duration andcompletion costs of our research and development projects are difficult toestimate and are subject to considerable variation. Our inability to completeour research and development projects in a timely manner or our failure toenter into collaborative agreements, when appropriate, could significantlyincrease our capital requirements and could adversely impact our liquidity.These uncertainties could force us to seek additional, external sources offinancing from time to time in order to continue with our business strategy.Our inability to raise additional capital, or to do so on terms reasonablyacceptable to us, would jeopardize the future success of our business.

 

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

 

•                  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 seekingregulatory approvals;

 

•                  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.

 

Webelieve that our current cash balances, cash equivalents, marketablesecurities, and the cash generated from our licensing and other agreements willbe sufficient to meet our operating and capital requirements for at least oneyear. However, because of the uncertainties in our business discussed above,

 

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among others, we cannotassure you that this will be the case. In addition, we may choose to, orprevailing business conditions may require us to, obtain additional financingfrom time to time. We may choose to raise additional funds through public orprivate financing, licensing and other agreements or other arrangements. Wecannot be sure that any additional funding, if needed, will be available onterms favorable to us or at all. Furthermore, any additional equity orequity-related financing may be dilutive to our stockholders, and debtfinancing, if available, may subject us to restrictive covenants. We may alsochoose to obtain funding through collaborations, licensing and othercontractual arrangements. Such agreements may require us to relinquish ourrights to certain of our technologies, products or marketing territories. Ourfailure to raise capital when needed would harm our business, financialcondition and results of operations.

 

*History of Net Losses.*  Wehave incurred net losses 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 $99.8 million in the six months ended June 30, 2003. As of June 30, 2003,our accumulated deficit was $468.2 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;

 

•                  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 in Xenotech;

 

•                  general and administrative costs relating toour operations;

 

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

 

•                  manufacturingstart-up costs, primarily those related to the cancellation of our agreementwith Lonza for the exclusive use of a cell culture production suite.

 

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, charges related to purchases oftechnology or other assets, and costs associated with establishing andoperating 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 Loss Carryforwards.*  Asof December 31, 2002, we had net operating loss carryforwards for federalincome tax purposes of approximately $314.0 million. Our net operatingloss carryforwards exclude losses incurred prior to our formation inJuly 1996. Further, we have capitalized the amounts associated with the1997 settlement and cross-license that have been expensed for financialstatement accounting purposes and we are amortizing those amounts over a periodof approximately 15 years for tax purposes. The net operating loss andcredit carryforwards will expire in the years 2006 through 2022, if notutilized. Utilization of the net operating losses and credits may be subject toa substantial annual limitation due to the “change in ownership” provisions ofthe Internal Revenue Code of 1986 and similar state provisions. The annuallimitation may result in the expiration of net operating losses and creditsbefore utilization.

** **

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****CriticalAccounting Policies****

** **

The financial resultsthat we report are impacted by the application of several accounting policiesthat require us to make subjective and complex judgments. We are required toestimate the effect of matters that are inherently uncertain. Changes in ourestimates or judgments could materially impact our results of operations,financial condition and cash flows in future years. We believe our mostcritical accounting policies include revenue recognition, accounting for ourequity investments,  accounting forgoodwill, and accounting for clinical trial supplies.

 

**RevenueRecognition.**

* *

We derive our contractrevenue 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 significant assistance tothe customer may not be contractually defined with an end date. In these circumstances,we must exercise 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.

** **

**Accountingfor Equity Investments.**

 

The Company records gains and losses on equity investments in accordancewith SFAS No. 115. Gains and losses that are deemed other than temporary arecharged to earnings, and any net unrealized holding gains and losses, to theextent not recognized as an impairment charge, are reported as a component ofstockholders’ equity.

 

In 2002, during the first, second and fourth quarters, declines in thefair value of our investment in CuraGen and ImmunoGen common stock were deemedto be other than temporary, primarily because the stock of each company tradedbelow our respective cost basis for more than six months.  Accordingly, 

 

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we recorded impairmentcharges of $34.7 million, $30.4 million and $2.2 million, in the first, secondand fourth quarters of 2002, respectively. The total impairment charge for the year ended December 31, 2002 was$67.3 million.

 

Inaddition, in 2001, we invested $15.0 million in MDS Proteomics, a privatelyheld company, in connection with our collaboration with that company. BecauseMDS Proteomics is a private company and its securities are not publicly traded,the value of our investment is inherently more difficult to estimate than aninvestment in a publicly traded company. As of June 30, 2002, we estimated thatthe value of our investment had declined to $7.9 million and that an impairmentof our investment had occurred. Accordingly, we recorded an impairment chargeof $7.1 million on our investment 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. This investment isrecorded 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.

 

*Accountingfor Goodwill***.**

 

On January 1, 2002, weadopted SFAS No. 142, “Goodwill and Other Intangible Assets,” which addressesthe financial accounting and reporting standards for goodwill and otherintangible assets subsequent to their acquisition. As a result, we no longeramortize goodwill but instead review goodwill for impairment on annual basis,or sooner if indications of impairment exist. Under our accounting policy, wehave adopted the beginning of the fourth quarter as an annual goodwillimpairment test date.  Following thisapproach, we compare the carrying values available as of September 30 with theestimated 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 duringthe first quarter of 2003, our common stock had traded at a price thatrepresented a market capitalization less than our book value. However thiscondition did not persist for a significant portion of the first quarter of2003 and as of June 30, 2003, our common stock was trading at a price thatrepresented a market capitalization higher than our book value. As of June 30,2003, we determined that the fair value of the reporting unit was higher thanits carrying value and an impairment charge was not recognized.

 

Ifwe were to determine in a future period that an impairment of goodwill existed,the impairment measurement procedures could result in a charge for theimpairment of goodwill.  Furthermore,a change in our determination of reporting units could result in a charge forthe impairment 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 June 30, 2003, the carrying value of our goodwill wasapproximately $34.8 million.

 

**Accountingfor Clinical Trial Supplies.**

* *

Thecosts associated with the manufacture of our antibody therapeutic productcandidates (clinical trial supplies) are capitalized as prepaid expense ifmanagement determines that the clinical trial supplies have alternative futureuses in clinical trials for multiple indications of a product candidate and areexpensed upon the use of the materials, primarily as they are used in clinicaltrials. We immediately expense previously capitalized costs if the asset is notexpected to have an alternative future use, such as use in a clinical trial. Asof June 30, 2003, the balance of prepaid clinical trial supplieswas $16.7 million and consisted of ABX-EGF. We may incur expenses related to clinical supply writedowns depending on theoutcome of ongoing clinical trials.

 

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****ContractualObligations and Commercial Commitments****

 

As of June 30, 2003,future minimum payments for certain contractual obligations for yearssubsequent to December 31, 2002 were as follows:

 
|                        |   | **Total**          |    | **2003** |   | **2004- 2005*** |   | **2006-  2007*** |   | **2008 and   Thereafter** |   |
|-----------------------------|--------|--------------------|---------|----------|--------|-----------------|--------|------------------|--------|---------------------------|--------|
|                        |   | **(in thousands)** |    |
| **Contractual Obligations** |   |               |    |     |   |            |   |             |   |                      |   |
| Operating leases            |   | $                  | 148,908 |     | $      | 6,401           |   | $                | 26,875 |                      | $      | 28,765 |   | $ | 86,867 |   |
| Convertible debt            |   | 200,000            |    | —   |   | —          |   | 200,000          |   | —                    |   |
| Total                       |   | $                  | 348,908 |     | $      | 6,401           |   | $                | 26,875 |                      | $      | 228,765 |   | $ | 86,867 |   |

 

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*Amounts represent total ofminimum payments for the entire period.

 

InMarch 2002, we issued $200.0 million principal amount of convertiblesubordinated notes in a private placement. The notes are convertible intoshares of our common stock at a conversion price of $27.58 per share subject tocertain adjustments. The notes accrue interest at an annual rate of 3.5%.  We areobligated to pay interest on March 15 and September 15 of each year,beginning on September 15, 2002. We expect to make interest payments on the notes of $7.0 million peryear, for years 2003 through 2006, and $1.2 million in 2007, assuming all thenotes remain outstanding until their maturity date. The notes will mature onMarch 15, 2007 and are redeemable at our option on or after March 20, 2005, orearlier if the price of our common stock exceeds specified levels. In addition,the holders of the notes may require us to repurchase the notes if we undergo achange in control.  Therefore, in March2007, or earlier if we undergo a change in control, we may use a significantportion of our cash balance to repay the $200.0 million principal amount of ourconvertible debt. If our cash balance at any time is insufficient to meet ourobligations under the notes, we would have to seek additional financing, ifavailable, to support our obligations under the notes.

 

Othersignificant commercial commitments include the following:

 

•                        Purchase commitments totaling $2.3 million tocontractors related to the purchase of equipment and design and construction ofour new manufacturing facility;

 

•                        EffectiveJune 30, 2003, the Company canceled its agreement with Lonza for the exclusiveuse of a cell culture production suite. Upon canceling the agreement, the Company is obligated to pay Lonza fourequal installments of 4,250,000 British Pounds on October 1, 2003, February 1,2004, May 1, 2004 and August 1, 2004.  The total value of this obligation was approximately $28.0 millionUnited States dollars on June 30, 2003. The cancellation arrangement eliminated the Company’s commitment to payapproximately $46 million in total monthly fees through August 2006;

 

•                        An annual maintenance fee of $50,000for our exclusive worldwide rights to commercialize ABX-CBL. In addition, we commit at least $1.0 million annually tothe development of ABX-CBL untilABX-CBL receives regulatoryapproval as a commercial product in any country and to pay royalties onpotential product sales. If we fail to fulfill this commitment, we would losethe CBL license and not be able to continue the development of ABX-CBL. Our obligations under the CBL license agreementare subject to our discretionary right to terminate the agreement. We and ourco-developer, SangStat, announced in February 2003 our decision to discontinuefurther development of ABX-CBL; and

 

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•                        Acommitment to share equally all development costs for ABX-EGF pursuant to ourjoint development and commercialization agreement with Amgen and Immunex.  Development costs are determined by thedevelopment plan agreed upon by a joint steering committee.  We share responsibility for productdevelopment with Amgen and Immunex.

 

**RecentAccounting Pronouncements**

 

In November 2002, the FASB issued Emerging Issues TaskForce (EITF) Issue No. 00-21, “Revenue Arrangements with MultipleDeliverables.” EITF Issue No. 00-21 addresses certain aspects of the accountingby a company for arrangements under which it will perform multiplerevenue-generating activities. EITF Issue No. 00-21 addresses when and how anarrangement involving multiple deliverables should be divided into separateunits of accounting. The provisions of EITF Issue No. 00-21 will apply torevenue arrangements entered into after June 30, 2003. The provisions of theEITF Issue No. 00-21 do not impact the accounting treatment of our existingrevenue arrangements. We believe that the adoption of EITF Issue No. 00-21 willnot result in a material change to our existing revenue recognition policy forprospective revenue arrangements. We do not expect the adoption of EITF IssueNo. 00-21 to have a material impact on our consolidated financial statements.

 

In January 2003, the FASB issuedInterpretation No. 46 (the Interpretation), Consolidation of Variable InterestEntities. The Interpretation requires the consolidation of entities in which anenterprise absorbs a majority of the entity’s expected losses, receives amajority of the entity’s expected residual returns, or both, as a result ofownership, contractual or other financial interests in the entity. Currently,entities are generally consolidated by an enterprise when it has controllingfinancial interest through ownership of a majority voting interest in the entity.The Interpretation will be implemented by Abgenix in the quarter endedSeptember 30, 2003. The Company has performed a preliminary analysis of theInterpretation and does not believe that the adoption will result in a materialimpact on the results of operations or financial position. During the quarterended September 30, 2003, the Company will complete its evaluation of theimplications of the Interpretation to all variable interest entities with whichit has involvement.

 

**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.*

* *

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

 

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

* *

We have incurred net losses in each of the last five years of operation,including net 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 $99.8 million in the six months ended June 30, 2003. As of June 30,2003, our accumulated deficit was $468.2 million. Our losses to date haveresulted principally from:

 

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

 

•                                          costs associated with certain agreements withJapan Tobacco and certain 1997 settlement 

 

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andcross-licensing agreements with GenPharm;

 

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

 

•                                          general and administrative costs relating to ouroperations;

 

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

 

•                                          manufacturing start-up costs, primarily thoserelated to the cancellation of our agreement with Lonza for the exclusive useof a cell culture production suite.

 

We expect to incur additional losses for the foreseeable future as aresult of our research and development costs and manufacturing start-up costs,including costs associated with conducting preclinical development and clinicaltrials, and charges related to purchases of technology or other assets. Weintend to invest significantly in our products prior to entering into licensingagreements. This will increase our need for capital and will result in lossesfor at least the next several years. We expect that the amount of operatinglosses will fluctuate significantly from quarter to quarter as a result ofincreases or decreases in our research and development efforts, the executionor termination of licensing, manufacturing and other contractual arrangements,and the initiation, success or failure of clinical trials.

 

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

* *

Prior to June 1996, Cell Genesys, Inc. owned our business andoperated it as a separate business unit. Since that time, we have funded ourresearch and development activities primarily from private placements andpublic offerings of our securities and from revenues generated by our licensingand other contractual arrangements.

 

We expect that substantially all of our revenues for the foreseeablefuture will result from payments under licensing and other contractualarrangements and from interest income. To date, payments under licensing andother agreements have been in the form of option fees, reimbursement forresearch and development expenses, license fees and milestone payments.Payments under our existing and any future customer agreements will be subjectto significant fluctuation in both timing and amount. Our revenues may not beindicative of our future performance or of our ability to continue to achievecontractual milestones. Our revenues and results of operations for any periodmay also not be comparable to the revenues or results of operations for anyother period. We may not be able to:

 

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

 

•                                          successfully complete preclinical development orclinical trials;

 

•                                          obtain required regulatory approvals;

 

•                                          successfully manufacture or market productcandidates; or

 

•                                          generate additional revenues or profitability.

 

Our failure to achieve any of the above goals would materially harm ourbusiness, financial condition and results of operations.

 

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

* *

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We will continue to expend substantial resources to support research anddevelopment and establish and operate our manufacturing facility, includingcosts associated with preclinical development and clinical trials. In the yearsended December 31, 2002, 2001, and 2000, we incurred expenses of $128.5million, $96.2 million and $50.1 million, respectively, on researchand development. For the six months ended June 30, 2003, we spent $41.9 millionon research and development. Regulatory and business factors will require us toexpend substantial funds in the course of completing required additionaldevelopment, preclinical testing and clinical trials of, and attainingregulatory approvals for, product candidates. The amounts of the expendituresthat will be necessary to execute our business plan are subject to numerousuncertainties that may adversely affect our liquidity and capital resources.Our future liquidity and capital requirements will depend on many factors,including:

 

•                                          the scope and results of preclinical developmentand clinical trials;

 

•                                          the retention of existing and establishment offurther co-development, licensing, manufacturing and other agreements, if any;

 

•                                          continued scientific progress in our research anddevelopment programs;

 

•                                          the size and complexity of these programs;

 

•                                          the cost of establishing manufacturingcapabilities and meeting good manufacturing practice regulations;

 

•                                          the cost of conducting commercializationactivities and arrangements;

 

•                                          the time and expense involved in seeking regulatoryapprovals;

 

•                                          competing technological and market developments;

 

•                                          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 technology in-licensingin which we engage; and

 

•                                          other factors not within our control.

 

We believe 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 indebtedness may harm ourfinancial condition and results of operations.*

* *

We have asignificant amount of convertible debt and debt service obligations.  Our level of

 

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indebtedness will haveseveral important effects on our future operations, including, withoutlimitation:

 

•                                          we will have additional cash requirementsto support the payment of any interest or amortization required with respect tooutstanding indebtedness;

 

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

 

•                                          depending onthe levels of our outstanding debt, our ability to obtain additional financingfor working capital, capital expenditures, general corporate and other purposesmay be limited.

 

Our ability to makepayment of principal and interest on our indebtedness depends upon our futureperformance, which will be subject to general economic conditions, industrycycles and financial, business and other factors affecting our operations, manyof which are beyond our control.  If weare unable to generate sufficient cash flow from operations in the future toservice our debt, we may be required, among other things:

 

•                                    to seek additionalfinancing in the debt or equity markets;

 

•                                    to refinance orrestructure all or a portion of our indebtedness, including our convertiblesubordinated notes;

 

•                                    to sell selectedassets; or

 

•                                    to reduce or delayplanned capital expenditures.

 

Such measuresmight not be sufficient to enable us to service our debt. In addition, any suchfinancing, refinancing or sale of assets might not be available on economicallyfavorable terms.

 

*Our strategic investments expose us to equity price risk andour investments in those companies may be deemed impaired, which would affectour results of operations.*

* *

We are exposed to equity price risk on our strategic investments inCuraGen, ImmunoGen and MDS Proteomics and we may elect to make additionalsimilar investments in the future.  In1999 and 2000, the Company purchased an aggregate amount of $80.0 million ofthe common stock of CuraGen and ImmunoGen as strategic investments.  In 2002, during the first, second and fourth quarters, declines in thefair value of the CuraGen and ImmunoGen common stock were deemed to be otherthan temporary, primarily because the stock of each company traded below ourrespective cost basis for more than six months.  Accordingly, we recorded impairment chargesof $34.7 million, $30.4 million and $2.2 million, in the first, second andfourth quarters of 2002, respectively. The total impairment charge for the year ended December 31, 2002 was$67.3 million.  The public trading prices of the shares of both companies havefluctuated significantly since we purchased them and could continue to do so.If these shares continue to trade below their new cost bases in future periods,we may incur additional impairment charges relating to these investments.  As of June 30, 2003, theseinvestments were recorded at fair value in long-term investments on the balancesheet, and any net unrealized holding gains and losses are reported as acomponent of stockholders’ equity.

 

In addition, in 2001, we invested $15.0 million in MDS Proteomics, aprivately held company, in connection with our collaboration with thatcompany.  Because MDS Proteomics is aprivate company and its securities are not publicly traded, the value of ourinvestment is inherently more difficult to estimate than an investment in apublicly traded company.  As of June 30,2002, we estimated that the value of our investment had declined to $7.9million and that an impairment of our investment had occurred. Accordingly, werecorded an impairment charge of $7.1 million on our investment in the secondquarter of 2002.  The amount of thecharge was based on the difference between the estimated value as determined byour management and our original cost basis. The investment is record inlong-term investments on the 

 

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balancesheet.  If we deem the investment in MDSProteomics further impaired at the end of any future period, we may incur anadditional impairment charge on this investment.

 

**Risks Related to the Development and Commercialization of ourProducts**

 

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

* *

Our XenoMouse and XenoMax technologies are new approaches to developingantibodies as products for the treatment of diseases and medical disorders. Wehave not commercialized any antibody therapeutic products based on ourtechnologies. Moreover, we are not aware of any commercialized, fully humanantibody therapeutic products that have been generated from any technologiessimilar to ours. Our antibody therapeutic product candidates are still in earlystages of development. We have initiated clinical trials with respect to threeproprietary fully human antibody therapeutic product candidates, and ourcollaborators have initiated clinical trials with respect to three 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 if theydo not achieve commercial success, our business will be materially harmed.*

* *

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

 

•                                          delays in product development, clinical testing ormanufacturing;

 

•                                          unplanned expenditures in product development,clinical testing or manufacturing;

 

•                                          failure in clinical trials or failure to receiveregulatory approvals;

 

•                                          emergence of superior or equivalent productdevelopment technologies or products;

 

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

 

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

 

•                                          election by our customers not to pursue productdevelopment;

 

•                                          failure by our customers to develop productssuccessfully; and

 

•                                          failure to achieve market acceptance.

 

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

 

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In addition, our decisions to terminate or wind down our clinicalprograms for developing ABX-IL8 and ABX-CBL have reduced the diversity of ourproduct portfolio. We hope to be able to make up for this loss of diversitythrough the number and variety of potential new product candidates we have inpreclinical development. However, to the extent that we are unable to maintaina broad and diverse range of product candidates, our success would depend moreheavily on one or a few product candidates.

 

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

* *

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

 

Historically, the results from preclinical testing and early clinicaltrials have often not been predictive of results obtained in later clinicaltrials. A number of new drugs and biologics have shown promising results inclinical trials, but subsequently failed to establish sufficient safety andefficacy data to obtain necessary regulatory approvals. Data obtained frompreclinical and clinical activities are susceptible to varying interpretations,which may delay, limit or prevent regulatory approval. In addition, we mayencounter regulatory delays or rejections as a result of many factors,including changes in regulatory policy during the period of productdevelopment.

 

Completion of clinical trials may take several years or more. The lengthof time generally varies substantially according to the type, complexity,novelty and intended use of the product candidate. However, we estimate thatclinical trials of the type we generally conduct are typically completed overthe following timelines:

 

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

 

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

 

•                                          the number of patients that ultimately participatein the trial;

 

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

 

•                                          the number of clinical sites included in thetrials; and

 

•                                          the length of time required to enroll suitablepatient subjects.

 

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

 

In addition, we have ongoing research projects that may lead to productcandidates, but we have not submitted INDs nor begun clinical trials for theseprojects. Our preclinical or clinical development efforts

 

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maynot be successfully completed, we may not file further INDs and clinical trialsmay not commence as planned.

 

Four of our proprietary product candidates, ABX-EGF, ABX-MA1, ABX-CBL andABX-IL8, are in various stages of clinical trials, some of which are beingwound down or terminated. To date, data obtained from these clinical trialshave been insufficient to demonstrate safety and efficacy under applicable Foodand Drug Administration, or FDA, guidelines. As a result, these data will notsupport an application for regulatory approval without further clinical trials.Clinical trials that we conduct or that third parties conduct on our behalf maynot demonstrate sufficient safety and efficacy to obtain the requisiteregulatory approvals for any of our product candidates. We expect to commencenew clinical trials from time to time in the course of our business as ourproduct development work continues. However, regulatory authorities may notpermit us to undertake any additional clinical trials for our productcandidates.

 

Our product candidates may fail to demonstrate safety or efficacy inclinical trials. For example, we completed analysis of the Phase 2b clinicaltrials of ABX-IL8 in psoriasis and concluded that the results did not warrantcontinued development in psoriasis and decided not to proceed with studies inother disease indications. Similarly we completed a preliminary analysisof the 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. Failures of clinical trials of any productcandidate could delay the development of other product candidates or hinder ourability to obtain additional financing. In addition, failures in our clinicaltrials can lead to additional research and development charges. Any delays in,or termination of, our clinical trials could materially harm our business,financial condition and results of operations.

 

*We may rely on third-party manufacturers, and we may havedifficulty conducting clinical trials of our product candidates if amanufacturer does not perform in accordance with our expectations.*

* *

To date we have relied on a single contract manufacturer, Lonza, toproduce ABX-CBL, ABX-IL8 and ABX-EGF under good manufacturing practiceregulations, for use in our clinical trials. In June 2003, we canceled ourmanufacturing supply agreement with Lonza, pursuant to which we had exclusive accessto a cell culture production suite, because we determined that with the openingof our own manufacturing plant, we no longer needed access to the Lonzafacility.  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 additional capacity,which we control, we cannot assure you that we will be able to qualify thisfacility for regulatory compliance as expected and we may use Lonza or anotherthird-party manufacturer if necessary in the future.

 

Third-party manufacturers may encounter difficulties in scaling upproduction, including problems involving production yields, quality control andassurance, shortage of qualified personnel, compliance with FDA and otherapplicable regulations, production costs, and development of advanced manufacturingtechniques and process controls. If we continue to use third-partymanufacturers, they may not perform as agreed or may not remain in the contractmanufacturing business for the time required by us to successfully produce andmarket our product candidates. Any failure of third-party manufacturers todeliver the required quantities of our product candidates for clinical use on atimely basis 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.*

* *

We are establishing our own manufacturing facility for the manufactureof product candidates for clinical trials and to support the potential earlycommercial launch of a limited number of products, in each case, in compliancewith FDA and European good manufacturing practices. In May 2000, we signeda long-

 

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termlease for the building that contains this manufacturing facility. Constructionis substantially complete and portions of the facility are operational. We arealso conducting validation of the facility and completed a significant stage ofvalidation in the second quarter of 2003. We expect to complete additionalsignificant stages of validation in each of the remaining quarters of 2003.  Inspection of the facility by the State ofCalifornia, a precondition for the use of the facility for the production ofclinical trial supplies and commercial products, is scheduled for the thirdquarter of 2003.  The total costs ofthis facility, including design fees, permits, validation, leaseholdimprovements and equipment, will be approximately $148.0 million.Completion of this facility may take longer than expected, and the planned andactual construction costs of building and qualifying the facility forregulatory compliance may be higher than expected. In addition, if thecommercial launch of one or more of our product candidates proves successful,we will likely need to use one or more third-party facilities to produce theseproducts in sufficient quantities. The process of manufacturing antibodytherapeutic products is complex. While the managers of the facility have gainedextensive manufacturing experience in prior positions with other companies, wehave no experience in the clinical or commercial scale manufacturing of ourexisting product candidates, or any other antibody therapeutic products. Also,we will need to manufacture such antibody therapeutic products in a facilityand by a process that comply with FDA, European and other regulations. Althoughwe are currently manufacturing an antibody product candidate in this facilityin compliance with those regulations, we may not be able to maintain compliancewith those regulations. Our manufacturing operations will be subject toongoing, periodic unannounced inspection by the FDA and state agencies toensure compliance with good manufacturing practices. Our inability to completeand maintain a manufacturing facility within our planned time and costparameters could materially harm the development and sales of our products andour financial performance.

 

We also 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 manufacturing techniquesand process controls.

 

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

 

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

 

*The successful growth of revenues from our manufacturingservices depends to a large extent on our ability*

* *

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*to find third parties to agree to use our services and ourability to provide those services successfully.*

* *

Our strategy for enhancing contract revenues depends, to a significantextent on entering into agreements to provide antibody production services tothird parties. Potential third parties include our existing collaborators, aswell as other pharmaceutical and biotechnology companies, technology companies,academic institutions and other entities. We must enter into these agreementsto successfully develop this aspect of our business. To date, we have enteredinto one production services agreement and we cannot assure you that we will beable to enter into additional agreements.

 

We may not be able to secure manufacturing agreements on favorableterms. If we do obtain such agreements, we may encounter difficulties inperforming as agreed.   We may encounterdifficulties in scaling up production, including problems involving productionyields, quality control and assurance, shortage of qualified personnel,compliance with FDA and other applicable regulations, production costs, anddevelopment of advanced manufacturing techniques and process controls.  The failure to deliver the required quantitiesof product on a timely basis and at commercially reasonable prices couldmaterially harm our business, financial condition and results of operations.

 

*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.*

* *

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

 

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

 

•                                          fund our research and development activities;

 

•                                          fund preclinical development, clinical trials andmanufacturing;

 

•                                          seek and obtain regulatory approvals; and

 

•                                          successfully commercialize existing and futureproduct candidates.

 

Our ability to continue our current collaborations and to enter intoadditional third party collaborations is dependent in large part on our abilityto successfully demonstrate that our XenoMouse technology is an attractivemethod of developing antibody therapeutic products. We have generated only alimited number of fully human antibody therapeutic product candidates pursuantto our collaboration agreements and only six fully human antibody therapeuticproduct candidates generated with XenoMouse technology have entered clinicaltesting. We have announced that one of these product candidates has not met ourexpectations. Our failure to maintain our existing collaboration agreements orto enter into additional agreements could materially harm our business,financial condition and results of operations.

 

Our dependence on licensing, collaboration, manufacturing and otheragreements with third parties subjects us to a number of risks. Theseagreements may not be on terms that prove favorable to us, and we typicallyafford our collaborators significant discretion in electing whether to pursueany of the planned activities. Licensing and other contractual arrangements mayrequire us to relinquish our rights to certain of our technologies, products ormarketing territories. 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

 

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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 that wewill be able to develop and commercialize;

 

•                                          reduce the likelihood of successful productintroduction;

 

•                                          significantly increase our capital requirements;and

 

•                                          place additional strain on our management’s time.

 

Existing or potential collaborators may pursue alternative technologies,including those of our competitors, or enter into other transactions that couldmake a collaboration with us less attractive to them. For example, if anexisting collaborator purchases a company that is one of our competitors, thatcompany could be less willing to continue its collaboration with us. Inaddition, a company 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.*

* *

Our product candidates under development are subject to extensive andrigorous domestic government regulation. The FDA regulates, among other things,the development, testing, manufacture, safety, efficacy, record-keeping,labeling, storage, approval, advertising, promotion, sale and distribution ofbiopharmaceutical products. If we market our products abroad, they will also besubject to extensive regulation by foreign governments. Neither the FDA nor anyother regulatory agency has approved any of our product candidates for sale inthe United States or any foreign market. The regulatory review and approvalprocess, which includes preclinical studies and clinical trials of each productcandidate, is lengthy, expensive and uncertain. Securing FDA approval requiresthe submission of extensive preclinical and clinical data and supporting informationto the FDA for each indication to establish the product candidate’s safety andefficacy. The approval process takes many years, requires the expenditure ofsubstantial resources, involves post-marketing surveillance, and may involveongoing requirements for post-marketing studies. Regulatory requirements aresubject to frequent change. Delays in obtaining regulatory approvals may:

 

•                                          adversely affect the successful commercializationof any drugs that we or our customers develop;

 

•                                          impose costly procedures on us or our customers;

 

•                                          diminish any competitive advantages that we or ourcustomers may attain; and

 

•                                          adversely affect our receipt of revenues orroyalties.

 

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Certain material changes affecting an approved product such asmanufacturing changes or additional labeling claims are subject to further FDAreview and approval. The FDA may withdraw any required approvals after weobtain them. We may not maintain compliance with other regulatory requirements.Further, if we fail to comply with applicable FDA and other regulatoryrequirements at any stage during the regulatory process, we or our third-partymanufacturers may be subject to sanctions, 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.

 

In many instances we expect to rely on our customers and co-developersto file INDs and generally direct the regulatory approval process for productsderived from our technologies. These customers and co-developers may not beable to or may choose not to conduct clinical testing or obtain necessaryapprovals from the FDA or other regulatory authorities for any productcandidates. If they fail to obtain required governmental approvals, we willexperience delays in or be precluded from marketing or realizing the commercialbenefits from the marketing of products derived from our technologies. Inaddition, our failure to obtain the required approvals would preclude thecommercial use of our products. Any such delays and limitations may materiallyharm our business, financial condition and results of operations.

 

We and our third-party manufacturers also are required to comply withthe applicable FDA current good manufacturing practice regulations and otherregulatory requirements. Good manufacturing practice regulations includerequirements relating to quality control and quality assurance as well as thecorresponding maintenance of records and documentation. Manufacturingfacilities are subject to inspection by the FDA and the facilities must pass aninspection by the FDA before we can use them in commercial manufacturing of anyproduct. Manufacturing facilities in California, including our facility, arealso subject to the licensing requirements of and inspection by the State ofCalifornia Department of Health Services. We or our third-party manufacturersmay not be able to comply with the applicable good manufacturing practicerequirements and 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.*

* *

Our product candidates may not gain market acceptance among physicians,patients, third-party payors and the medical community. We may not achievemarket acceptance even if clinical trials demonstrate safety and efficacy, andthe necessary regulatory and reimbursement approvals are obtained. 

 

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Thedegree of market acceptance of any product candidates that we develop willdepend on a number of factors, including:

 

•                                          establishment and demonstration of clinical efficacyand 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 our productcandidates, including the efforts of our collaborators where they havemarketing and distribution responsibilities.

 

Physicians will not recommend therapies using our products until suchtime as clinical data or other factors demonstrate the safety and efficacy ofsuch procedures as compared to conventional drug and other treatments. Even ifwe establish the clinical safety and efficacy of therapies using our antibodyproduct candidates, physicians may elect not to recommend the therapies for anynumber of other reasons, including whether the mode of administration of ourantibody products is effective for certain indications. Antibody products,including our product candidates as they would be used for certain diseaseindications, are typically administered by infusion or injection, whichrequires substantial cost and inconvenience to patients. Our productcandidates, if successfully developed, will compete with a number of drugs andtherapies manufactured and marketed by major pharmaceutical and other biotechnologycompanies. Our products may also compete with new products currently underdevelopment by others. Physicians, patients, third-party payors and the medicalcommunity may not accept or utilize any product candidates that we or ourcustomers develop. The failure of our products to achieve significant marketacceptance would materially harm our business, financial condition and resultsof operations.

 

*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.*

* *

Although we have been marketing our XenoMouse technology to potentialcustomers and collaborators for several years, we do not have marketing, salesor distribution experience or capability with respect to our therapeuticproduct candidates. We intend to enter into arrangements with third parties tomarket and sell most of our therapeutic product candidates when wecommercialize them, which may be as early as 2005. We may not be able to enterinto these marketing and sales arrangements with others on acceptable terms, ifat all. To the extent that we enter into marketing and sales arrangements withother companies, our revenues, if any, will depend on the efforts of others.These efforts may not be successful. If we are unable to enter into third-partyarrangements, we will need to develop a marketing and sales force, which mayneed to be substantial in size, in order to achieve commercial success for anyproduct candidate approved by the FDA. We may not successfully developmarketing and sales capabilities or have sufficient resources to do so. If wedo develop such capabilities, we will compete with other companies that haveexperienced and well-funded marketing and sales operations. Our failure toenter into successful marketing arrangements with third parties and ourinability to conduct such activities ourselves would materially harm ourbusiness, financial condition and results of operations.

 

**Risks Related to 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.*

* *

Our success depends in part on our ability to:

 

•                                          obtain patents;

 

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•                                          protect trade secrets;

 

•                                          operate without infringing the proprietary rightsof others; and

 

•                                          prevent others from infringing our proprietaryrights.

 

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

 

In addition to patents, we rely on trade secrets and proprietaryknow-how. We seek protection, in part, through confidentiality and proprietaryinformation agreements. These agreements may not provide meaningful protectionfor our technology or adequate remedies in the event of unauthorized use ordisclosure of confidential and proprietary information, and, in addition, theparties may breach such agreements. Also, our trade secrets may otherwisebecome known to, or be independently developed by, our competitors.Furthermore, others may independently develop similar technologies or duplicateany technology that we have developed.

 

*We may face challenges from third 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.*

* *

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

 

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

 

GlaxoSmithKline, plc, or Glaxo has a family of patents relating tocertain methods for generating monoclonal antibodies that Glaxo is assertingagainst Genentech, Inc. in litigation that was commenced in 1999. On May 4,2001, Genentech announced that a jury had determined that Genentech had notinfringed Glaxo’s patents and that all of the patent claims asserted againstGenentech are invalid. We understand that Glaxo has filed a notice of appealwith the Court of Appeals for the Federal Circuit. If any of the claims of

 

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thesepatents are finally determined in the litigation to be valid, and if we were touse manufacturing 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 Therapies,Inc. each owns or controls a U.S. patent that relates to recombinant cell linesor methods of generating recombinant cell lines for the production ofantibodies. If we were to use a production system covered by any of thesepatents, we may then need to obtain a license should one be available. Underthese circumstances, our failure to obtain a license at all or on commerciallyreasonable terms could impede commercialization of one or more of our productsin any territories in which these patent claims were in force.

 

Genentech owns a U.S. patent that issued in June 1998 relating toinhibiting the growth of tumor cells that involves an antibody that binds to anepidermal growth factor receptor, or an anti-EGF receptor antibody, incombination with a cytotoxic factor, which is a substance having a toxic effecton cells. ImClone Systems, Inc. owns or is licensed under a U.S. patentthat issued in April 2001, relating to inhibiting the growth of tumorcells that involves an anti-EGF receptor antibody in combination with ananti-neoplastic, or anti-tumor, agent. We do not believe based on our reviewthat either the Genentech or ImClone patent would be successfully assertedagainst any planned commercial sales of ABX-EGF. We believe that currently allof our activities relating to anti-EGF receptor monoclonal antibodies arewithin the exemption provided by the U.S. patent laws for uses reasonablyrelated to obtaining FDA approval of a drug. We do not expect the scope of ourproduct development plans to change in the future prior to filing anapplication for a biologic license with the FDA. If a court determines that theclaims of either the Genentech patent or the ImClone patent cover ouractivities with ABX-EGF and are valid, such a decision may require us to obtaina license to Genentech’s or ImClone’s patent, as the case may be, to label andsell ABX-EGF for certain combination therapies. Our failure to obtain alicense, or to obtain a license on commercially reasonable terms, could impedeour commercialization of ABX-EGF in the United States.

 

In 2000, the Japanese Patent Office granted a patent to Kirin BeerKabushiki Kaisha, one of our competitors, relating to non-human transgenic mammals.Kirin has filed corresponding patent applications in Europe and Australia.Kirin may also have filed a corresponding patent application in the UnitedStates. Our licensee, Japan Tobacco, has filed opposition proceedings againstthe Kirin patent. We cannot predict the outcome of those oppositionproceedings, which may take years to be resolved.

 

Extensive litigation regarding patents and other intellectual propertyrights has been common in the biotechnology and pharmaceutical industries. Thedefense and prosecution of intellectual property suits, United States Patentand Trademark Office interference proceedings, and related legal andadministrative proceedings in the United States and internationally involvecomplex legal and factual questions. As a result, such proceedings are costlyand time-consuming to pursue and their outcome is uncertain. Litigation may benecessary to:

 

•                                          enforce patents that we own or license;

 

•                                          protect trade secrets or know-how that we own orlicense; or

 

•                                          determine the enforceability, scope and validityof the proprietary rights of others.

 

Our involvement in any litigation, interference or other administrativeproceedings could cause us to incur substantial expense and could significantlydivert the efforts of our technical and management personnel. An adversedetermination may subject us to loss of our proprietary position or tosignificant liabilities, or require us to seek licenses that may not beavailable from third parties. An adverse determination in a judicial or administrativeproceeding, or a failure to obtain necessary licenses, may restrict or preventus from manufacturing and selling our products, if any. Costs associated withthese arrangements may be substantial and may include ongoing royalties.Furthermore, we may not be able to

 

39

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obtainthe necessary licenses on satisfactory terms, if at all. These outcomes couldmaterially harm our business, financial condition and results of operations.

 

**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.*

* *

The biotechnology and pharmaceutical industries are highly competitiveand subject to significant and rapid technological change. We are aware ofseveral pharmaceutical and biotechnology companies that are actively engaged inresearch and development in areas related to antibody therapy. These companieshave commenced clinical trials of antibody therapeutic product candidates orhave successfully commercialized antibody therapeutic products. Many of thesecompanies are addressing the same diseases and disease indications as we or ourcustomers are. Also, we compete with companies that offer antibody generationservices to companies that have antigens. These competitors have specificexpertise or technology related to antibody development and introduce new ormodified technologies from time to time. These companies include GenPharm, awholly owned subsidiary of Medarex, Inc., Medarex’s collaborator, Kirin BrewingCo. 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.

 

Some of our competitors have received regulatory approval of or aredeveloping or testing product candidates that may compete directly with ourproduct candidates. ImClone, in collaborations with Bristol-Meyers SquibCompany and Merck KgAa; AstraZeneca, plc; Glaxo; and a collaboration of OSIPharmaceuticals, Inc., Genentech and Roche have potential antibody andsmall molecule product candidates in clinical development that may compete withABX-EGF, which is also in clinical trials. AstraZeneca has received approval for Iressa, a small molecule productcandidate that may compete with ABX-EGF, in the United States, Japan andAustralia for the treatment of advanced non-small cell lung cancer.  Furthermore, we are also aware that MerckKgAa has submitted applications for the authorization to market Erbitux,ImClone’s antibody product candidate, for the treatment of metastaticcolorectal cancer in the European Union and Switzerland.

 

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

 

•                                          developing products;

 

•                                          undertaking preclinical testing and human clinicaltrials;

 

•                                          obtaining FDA and other regulatory approvals ofproducts; and

 

•                                          manufacturing and marketing products.

 

Accordingly, our competitors may succeed in obtaining patent protection,receiving FDA approval or commercializing products before we do. If we commencecommercial product sales, we will be competing against companies with greatermarketing and manufacturing capabilities, areas in which we have limited or noexperience.

 

We also face, and will continue to face, competition from academicinstitutions, government agencies and research institutions. There are numerouscompetitors working on products to treat each of the

 

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diseasesfor which we are seeking to develop therapeutic products. In addition, anyproduct candidate that we successfully develop may compete with existingtherapies that have long histories of safe and effective use. Competition mayalso arise from:

 

•                                          other drug development technologies and methods ofpreventing or reducing the incidence of disease;

 

•                                          new small molecules; or

 

•                                          other classes of therapeutic agents.

 

Developments by competitors may render our product candidates ortechnologies obsolete or non-competitive. We face and will continue to faceintense competition from other companies for agreements with pharmaceutical andbiotechnology companies, for establishing relationships with academic andresearch institutions, and for licenses to proprietary technology. Thesecompetitors, either alone or with their customers, may succeed in developingtechnologies or products that are more effective than ours.

 

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

* *

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

 

**Other Risks Related to Our Company**

*** ***

*Ourrestructuring plan may not achieve the results we intend and may harm ourbusiness.*

 

In October 2002, weannounced a restructuring plan, which included a reduction in headcount ofapproximately 15%. The planning and implementation of our restructuring hasplaced, and may continue to place, a significant strain on our managerial, operationaland other resources. The restructuring may negatively affect our employeeturnover, recruiting and retention, and may not enable us to reduce our coststo the extent expected.

 

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

* *

For us to pursue product development, marketing and commercializationplans, we may need to hire additional qualified scientific personnel. We willalso need to hire personnel with expertise in clinical testing, governmentregulation, manufacturing, marketing, law and finance. Attracting and retainingqualified personnel will be critical to our success. We may not be able toattract and retain personnel on acceptable terms given the competition for suchpersonnel among biotechnology, pharmaceutical and healthcare companies,universities and non-profit research institutions.

 

We grant stockoptions as a method of attracting and retaining employees, to motivateperformance and to align the interests of management with those of ourstockholders. Due to the decline

 

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in the trading price ofour common stock during 2001 and 2002, a substantial portion of the stockoptions held by our employees have an exercise price that is higher than thecurrent trading price of our common stock. We may elect to reprice or otherwiseadjust the terms of these stock options, grant additional stock options at thecurrent lower market price, pay higher cash compensation, or provide somecombination of these alternatives to retain and attract qualified employees,but we cannot be sure that any of these actions would be successful. If weissue 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 may experience difficulty in the integration of anyfuture acquisition with the operations of our business.*

* *

We may from time to time seek to expand our business through corporateacquisitions. Our acquisition of companies and businesses and expansion ofoperations, involve risks such as the following:

 

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

 

•                                          the potential inability to successfully integrateacquired operations and businesses and to realize anticipated synergies,economies of scale or other expected value;

 

•                                          incurrence of expenses attendant to transactionsthat 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.

 

In addition, our acquisition of companies and businesses and expansionof operations 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.

 

*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.*

* *

In June 1999, our board of directors adopted a stockholder rightsplan, which we amended and restated in November 1999 and May 2002.The stockholder 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 or furtheraction by the stockholders;

 

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

 

•                                          specify procedures for director nominations bystockholders and submission of other proposals for consideration at stockholdermeetings; and

 

•                                          eliminate cumulative voting in the election ofdirectors.

 

We are subject to certain provisions of Delaware law which could alsodelay or make more difficult a merger, tender offer or proxy contest involvingus. In particular, Section 203 of the Delaware General Corporation Lawprohibits a Delaware corporation from engaging in any business combination withany interested stockholder for a period of three years unless the transactionmeets certain conditions. The

 

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stockholderrights plan, the possible issuance of preferred stock, the procedures requiredfor director nominations and stockholder proposals and Delaware law could havethe effect of delaying, deferring or preventing a change in control of us,including, without limitation, discouraging a proxy contest or making moredifficult the acquisition of a substantial block of our common stock. Theprovisions also could limit the price that investors might be willing to pay inthe future for shares 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.*

* *

The use of any of our product candidates, or of any productsmanufactured in our facility,  inclinical trials, and the sale of any approved products, may expose us toliability claims resulting from such use or sale. Consumers, healthcare providers,pharmaceutical companies or others selling such products might make claims ofthis kind. We may experience financial losses in the future due to productliability claims. We have obtained limited product liability insurance coveragefor our clinical trials, under which the coverage limits are $10.0 millionper occurrence and $10.0 million in the aggregate. We intend to expand ourinsurance coverage to include the sale of commercial products if we obtainmarketing approval for product candidates in development. We also intend toexpand our insurance coverage to include production services activities.  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.*

* *

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

 

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

* *

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

 

*Our stock price is highly volatile, and 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.*

* *

The market price and trading volume of our common stock are volatile,and we expect such volatility to continue for the foreseeable future. Forexample, during the period between June 30, 2002 and June 30, 2003, our commonstock closed as high as $12.28 per share and as low as $4.58 per share. Thismay impact your decision to buy or sell our common stock. Factors affecting ourstock price include:

 

•                                          our financial results;

 

•                                          fluctuations in our operating results;

 

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

 

•                                          published reports by securities analysts;

 

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•                                          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 with customers;

 

•                                          public concern as to the safety and efficacy ofour 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.*

* *

Acompany is required to register as an investment company under the InvestmentCompany Act of 1940, or the 1940 Act, if, among other things, and subject tovarious exceptions:

 

•                                          it is or holds itself out to be engaged primarily,or proposes to engage primarily, in the business of investing, reinvesting ortrading 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.

 

Amajor portion of our assets has been invested in investment gradeinterest-bearing securities. Such investments could in some circumstancesrequire us to register as an investment company under the 1940 Act.Registration under the 1940 Act, or a determination that we failed to registerwhen required to do so, could have a material adverse impact on us. We believethat we are and will remain exempt from the registration requirements, butabsent interpretation by the courts or the SEC of the relevant exemption asapplied to companies engaged in research and development, this result cannot beassured. In addition, a change in our allocation of assets on account of 1940Act concerns could reduce the rate of return on our liquid assets.

 

##### **Item3**. Quantitative and Qualitative Disclosures About Market Risk

 

*Interest Rate Risk.*  We are exposed tointerest rate sensitivity on our investments in debt securities and ouroutstanding fixed rate debt. Theobjective of our investment activities is to preserve principal, while at thesame time maximizing yields without significantly increasing risk. To achievethis objective, we invest in highly liquid, investment grade and governmentdebt securities. Our investments in debt securities are subject to interestrate risk. To minimize the exposure due to an adverse shift in interest rates,we invest in short-term securities and our goal is to maintain an averagematurity of approximately one year. In addition, as of June 30, 2003, wehad $200.0 million of outstanding 3.5% convertible subordinated notes due in2007. The fair value of these convertible subordinated notes may fluctuate withchanges in market interest rates, as well as changes in the market price of ourcommon stock.  A hypothetical 1.0% per annum decrease in interest rates as ofJune 30, 2003 would result in anadverse net change in the fair value of our interest rate sensitive assets andliabilities of approximately $5.4million. A hypothetical 1.0% per annum decrease in interest rates as ofDecember 31, 2002 would result in an adverse net change in the fair value ofour interest rate sensitive assets and liabilities of****approximately $6.3million.

 

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*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 aggregate market value of ourinvestments in these securities was approximately $15.5 million and$13.0 million as of June 30, 2003 and December 31, 2002, respectively. Due todecreases in the market prices of the shares of CuraGen and ImmunoGen, werecorded impairment charges of $67.3 million in 2002 related to theseinvestments. The trading prices of shares of CuraGen and ImmunoGen havefluctuated significantly since we purchased these securities. Each additional10% decrease in market value of these securities would result in a decrease invalue of approximately $1.6 million and $1.3 million from the fair value ofthose investments at June 30, 2003 and December 31, 2002, respectively.  Additional price declines could cause us torecord additional impairment charges in future periods.

 

An adverse movement of equity market prices generallywould also have an impact on the valuation of our strategic investment in MDSProteomics, a privately held company. 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 ourbeing able 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 write-downs of these securities. At June 30, 2003, our strategicinvestment in MDS Proteomics had a carrying amount of $7.9 million.

* *

*Foreign Currency Risk.*A substantial majority of our revenue, expense,and capital purchasing activities are transacted in U.S. dollars. However, wedo enter into transactions in other currencies, primarily the British pound. Asof June 30, 2003, we had a contract cancellation obligation to Lonza ofapproximately $28.0 million, which is payable in British pounds. A hypothetical10% adverse change in exchange rates as of June 30, 2003 would result in anincrease in the U.S. dollar value of this obligation of approximately $2.8million.

 

# **Item 4. Controls and Procedures**

 

#### **Evaluationof Disclosure Controls and Procedures**

 

Based on their evaluationof our disclosure controls and procedures, as that term is defined by Rule13a-15(e) promulgated under the Securities Exchange Act of 1934, as of the endof the period covered by this report, our chief executive officer and our chieffinancial officer have concluded that our disclosure controls and proceduresare effective in ensuring that all material information required to be includedin this quarterly report on Form 10-Q has been made known to them in a timelyfashion.

 

**Changes in Internal Controls Over Financial Reporting**

 

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

 

 

**PARTII.  OTHER INFORMATION**

 

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

 

Not applicable.

 

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

** **

Notapplicable.

 

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

 

Not applicable.

 

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

 

At our Annual Meeting ofStockholders, held on June 27, 2003, onematter, the election of directors, was voted upon. The following is tabulationof votes with respect to each nominee:

 
|                 |   | **Votes**  |   |
|----------------------|--------|------------|--------|
| **Nominee**          |   | **For**    |   | **Withheld** |   |
|                 |   |       |   |   |   |
| R. Scott Greer       |   | 60,894,854 |   | 97,445 |   |
| M. Kathleen Behrens  |   | 59,335,857 |   | 1,656,442 |   |
| Raju S. Kucherlapati |   | 59,342,722 |   | 1,649,577 |   |
| Kenneth B. Lee Jr.   |   | 60,774,245 |   | 218,054 |   |
| Mark B. Logan        |   | 60,775,395 |   | 216,904 |   |
| Thomas G. Wiggans    |   | 59,340,563 |   | 1,651,736 |   |
| Raymond M. Withy     |   | 60,892,754 |   | 99,545 |   |

 

#### **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.                                                                                                    |
| 10.82      |   | Letter Agreement dated  June 27, 2003, between Lonza Biologics plc and Abgenix, Inc.                                                                                |
| 10.83      |   | Form of Change of Control  Severance Agreement between Abgenix, Inc. and its officers                                                                               |
| 10.84      |   | Amended and Restated  Change of Control Severance Agreement, dated as of April 24, 2003, between  Abgenix, Inc. and Raymond M. Withy, Ph.D.                         |
| 31.1       |   | Certification of Raymond  M. Withy, Ph.D. Pursuant to Rule 13a-14(a), as Adopted Pursuant to Section  302 of the Sarbanes-Oxley Act of 2002                         |
| 31.2       |   | Certification of Kurt  Leutzinger Pursuant to Rule 13a-14(a), as Adopted Pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002                                 |
| 32.1       |   | Certification of Raymond M. Withy, Ph.D. Pursuant to  18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002. |
| 32.2       |   | Certification of 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 exhibit filed with Abgenix’sAnnual Report on Form 10-K for the year ended December 31, 2002.

 

(2)          Incorporated by reference to the same exhibit filed with Abgenix’sAnnual Report on Form 10-K for the year ended December 31, 2001.

 

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**(b) Reports on Form 8-K**

** **

We filed a Form 8-K on April 23, 2003,furnishing under “Item 12. Disclosure of Results of Operations and FinancialCondition” a press release we issuedon that date to report our financial results for the quarter ended March 31,2003.

** **

We filed a Form 8-Kon July 22, 2003, furnishing under “Item 12. Disclosure of Results ofOperations and Financial Condition” a press release we issued on that date toreport our financial results for the quarter ended June 30, 2003.

 

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 

 
| Dated:  August 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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