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UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





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FORM 10-K





ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF


THE SECURITIES EXCHANGE ACT OF 1934





For the fiscal year ended December 31, 2001





Commission file number 000-28401





MAXYGEN, INC.


(Exact name of registrant as specified in its charter)





Delaware (State or other jurisdiction of incorporation or organization)

77-0449487 (I.R.S. Employer Identification No.)





515 Galveston Drive


Redwood City, California 94063


(Address of principal executive offices)





(650) 298-5300


Registrants telephone number, including area code:





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Securities registered pursuant to Section 12(b) of the Act:





None





Securities registered pursuant to
Section 12(g) of the Act:





Common Stock, par value $0.0001 per share


(Title of Class)





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





Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.    Yes x     No  ̈





As of February 28, 2002 there were 34,130,918 shares of the registrants common stock outstanding, which is the only class of common or
voting stock of the registrant issued as of that date. The aggregate market value of the voting stock held by non-affiliates computed by reference to the closing price for the common stock as quoted by the Nasdaq Stock Market as of February 28, 2002
was approximately $286,032,774.





DOCUMENTS INCORPORATED BY REFERENCE





Designated portions of the registrants definitive proxy statement for its 2001 Annual Meeting of Stockholders are incorporated by reference into Part III hereof.





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TABLE OF CONTENTS





Part IItem 1:

Business

1Item 2:

Properties

39Item 3:

Legal Proceedings

39Item 4:

Submission of Matters to a Vote of Security Holders

39Part IIItem 5:

Market for the Registrants Common Equity and Related Stockholder Matters

40Item 6:

Selected Financial Data

42Item 7:

Managements Discussion and Analysis of Financial Condition and Results of Operations

44Item 7a:

Quantitative and Qualitative Disclosures About Market Risk

52Item 8:

Financial Statements and Supplementary Data

53Item 9:

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

80Part IIIItem 10:

Directors and Executive Officers of the Registrant

80Item 11:

Executive Compensation

80Item 12:

Security Ownership of Certain Beneficial Owners and Management

80Item 13:

Certain Relationships and Related Transactions

80Part IVItem 14:

Exhibits, Financial Statement Schedules and Reports on Form 8-K

81Signatures

84





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In this report Maxygen, the Company, we, us and our refer to Maxygen, Inc. and our wholly-owned subsidiaries.





Maxygen, MaxyScan, MolecularBreeding and the Maxygen logo are some of our trademarks. Other service marks, trademarks and trade names referred to in this report, and in the documents
incorporated by reference in this report, are the property of their respective owners. The use of the word partner and partnership does not mean a legal partner or legal partnership.




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Forward Looking Statements





This
report contains forward-looking statements about our research, business prospects and future financial performance. In some cases, you can identify forward-looking statements by terminology, such as may, can,
will, should, expect, plan, anticipate, believe, estimate, predict, intend, potential or continue or the negative of
these terms or other comparable words. Examples of these forward-looking statements include, but are not limited to, statements regarding the following:





| | · |  | our MolecularBreeding directed molecular evolution and other technologies and processes;
| | - |  | ----------------------------------------------------------------------------------------




| | · |  | our ability to realize commercially valuable discoveries in our programs;
| | - |  | -------------------------------------------------------------------------




| | · |  | the attributes of any products we may develop;
| | - |  | ----------------------------------------------




| | · |  | our future financial performance;
| | - |  | ---------------------------------




| | · |  | our intellectual property portfolio and rights;
| | - |  | -----------------------------------------------




| | · |  | our business strategies and plans; and
| | - |  | --------------------------------------




| | · |  | our ability to develop products suitable for commercialization.
| | - |  | ---------------------------------------------------------------




These statements are only predictions. Risks and uncertainties and the occurrence of other events could cause actual results to differ materially from these predictions. The risk factors set forth below at pages 28 to
39 should be considered carefully in evaluating us and our business.





Although we believe that the expectations reflected in the
forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of these statements.
Other than as required by applicable law, we disclaim any obligation to update or revise any forward-looking statement contained in this release as a result of new information or future events or developments.





PART I





Item 1    BUSINESS





Overview





We are a leader in the field of directed molecular evolution, a process by which genes are modified for specific commercial uses. We are focused on creating novel therapeutic and
industrial products using our integrated technologies. Our technologies bring together advances in molecular biology and protein modification to help create novel biotechnology products. Unlike conventional technologies, our approaches require
minimal understanding of complex underlying biological systems and can therefore help develop products more efficiently, faster and more cost-effectively. We have designed our technologies to rapidly improve existing biotechnology products as well
as to create products that would be difficult or impossible to develop through other processes.





Our principal objective is to
commercialize multiple high-value products in a broad range of industries including human therapeutics, agriculture and chemicals. Our products will be developed and marketed either through corporate collaborations or independently by Maxygen. To
date, we have established strategic collaborations with leading companies including: Aventis Pasteur in novel vaccines; Celltech in antibodies; InterMune in next generation interferon gamma therapies; Lundbeck in interferon beta therapies for
central nervous system diseases and multiple sclerosis; ALK-Abelló in allergy; the International AIDS Vaccine Initiative in HIV; Pfizer and DSM in pharmaceutical manufacturing; and Shearwater Corporation in protein pharmaceutical PEGylation
technologies. Additionally, we have a range of other strategic alliances in industrial




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applications, including with Novozymes, DuPont, Syngenta, DSM, Rio Tinto, Chevron, Pfizer and Hercules. We also have received funding from U.S. government organizations including from the Defense
Advanced Research Projects Agency, the National Institute of Standards and Technology-Advanced Technology Program and the U.S. Agency for International Development.





We will continue to establish strategic collaborations with leaders in our target industries. We will also continue to retain rights in some of our collaborations to develop and market
products resulting from our alliances. In addition, we have invested, and will continue to invest, our own funds in specific areas and product opportunities. We have over 40 potential products in various stages of research, with fourteen potential
products in development and over 20 strategic alliances.





We began operations in 1997 to commercialize technologies originally
conceived at Affymax Research Institute, then a subsidiary of what is now GlaxoSmithKline plc. We were incorporated in Delaware on May 7, 1996 and began operations in March 1997. Our principal executive offices are located at 515 Galveston Drive,
Redwood City, CA 94063. Our telephone number is (650) 298-5300 and our website is located at www.maxygen.com. Information contained in our website is not a part of this report.





Market Opportunity





We have a platform of proprietary technologies that helps allow us to
integrate the powerful tools available in the biotechnology industry to efficiently develop novel and improved products for human therapeutics and industrial applications. We are currently working on over 40 different potential products, including
fourteen potential products that are in the development stage, either on our own or with companies that are leaders in their fields. Our target markets include protein pharmaceuticals, preventative and therapeutic vaccines, chemicals and
agriculture. Within these markets, we are focused on specific high-value opportunities.





Human
Therapeutics.    The human therapeutic protein pharmaceutical and vaccine markets represent a large opportunity for Maxygen. In 2000, worldwide sales of therapeutic proteins made using recombinant DNA technology exceeded $20
billion. Protein pharmaceutical products, such as erythropoietin and granulocyte colony stimulating factor, represent some of the worlds highest revenue pharmaceutical products. The protein therapeutics sector is one of the fastest growing
pharmaceutical markets, with an annual sales growth rate of 5 to 15%.





Worldwide sales of all vaccines in 1999 exceeded $6.5
billion and are expected to exceed approximately $10.9 billion by 2005. This dramatic growth in the vaccine market is expected to be driven by the anticipated success of therapeutic vaccines and the development of novel vaccines that address
significant unmet clinical needs.





In therapeutics, we are focused on developing products for a number of indications, including
multiple forms of cancer, infectious diseases such as HIV and hepatitis, hematology, allergies, and autoimmune diseases such as rheumatoid arthritis and multiple sclerosis.





Industrial Applications.    The industrial application markets of chemicals and agriculture also offer an attractive market opportunity for Maxygen. In 2000,
sales in the chemical industry exceeded $1.7 trillion, with approximately $50 billion in sales readily addressable by biological processing, for example, either by fermentation or through the use of enzyme catalysts. An additional $200 billion in
sales has been identified as potentially addressable by biological approaches within the next 10-20 years.





In chemicals, we are
focused on developing novel biocatalytic processes that could increase yields and decrease manufacturing costs for multiple known products. We believe that biocatalytic processes may also have utility for generating novel materials and molecules.





The agricultural biotechnology seed market was estimated at approximately $3 billion in sales in 2000. It is expected to grow
to approximately $5-8 billion in sales by 2005 and to approximately $20-25 billion in sales by




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2010. Biotechnology crops, first introduced to the market in 1996, have been adopted rapidly by farmers and were planted on approximately 110 million acres in 2000. In agriculture, we are
applying our technologies to potentially increase crop yield and qualities, such as enhancing nutritional value for human food or animal feed.





Uses
and Limitations of Genes as Products





Genes and the protein products expressed by genes have significant value in multiple
commercial areas. The modern biotechnology industry was founded to capture this value, primarily through the isolation of genes from natural sources, and subsequent protein production from these genes for use in commercial production systems.
Despite some notable exceptions, the majority of proteins discovered by scientists and developed by the modern biotechnology industry have not been commercially successful. The lack of product success is due in part to the fact that the relevant
proteins have not been evolved for commercial purposes.





In recent years, significant research efforts in biotechnology have
focused on identifying genes and elucidating their function. These efforts, which are known as genomics, have been highly successful in identifying tens of thousands of genes, but to date have not lead to rapid product development. This results from
two primary causes. First, the genes identified by genomics have not been evolved for commercial purposes. Second, once a gene has been identified, a number of steps need to be completed before the genetic information can be used for the development
of products.





Typical deficiencies of naturally occurring genes and proteins that limit their commercial utility as therapeutic
products include inappropriate availability in the body, stability, difficulty and cost to manufacture, lack of specificity, toxicity and other side effects. Similarly, in applications such as agriculture and chemical processes using enzymes as
catalysts, problems include the levels at which proteins can be made, specificity, stability, efficiency of enzyme function under industrial manufacturing conditions and purity. In addition, potential products with the highest commercial value often
result from the action of multiple genes or multiple biological reactions and are difficult to optimize with modern biotechnology techniques. Many biotechnology companies have abandoned or never pursued development efforts with potential product
candidates as a result of the unsuitability of the native proteins for commercial uses.





The biotechnology industry has used two
other main approaches to attempt to adapt genes and their protein products for commercial uses. One approach, rational design, seeks to modify a gene to improve its properties based on knowledge regarding how the structure of the gene determines the
function of its resultant protein. Fundamental research on the mechanism of action of the relevant protein is pursued until the knowledge gained is used to try to make a rational prediction of how to change the gene for desired effect. This process
requires many simplifying assumptions, is costly, time intensive and has been generally unsuccessful.





A second approach,
directed molecular evolution, seeks to improve genes for commercial purposes by mimicking the natural events of evolution. There are two general approaches to directed molecular evolution, those utilizing targeted mutagenesis and those utilizing
recombination-based techniques. Targeted mutagenesis involves the mutation of genes at preselected sites, most of which are harmful to gene function. The mutated genes are then screened to determine which mutations have resulted in improved
attributes. Since targeted mutation has a low probability of improving a gene or sequence of complex biological reactions, screening for positive changes is expensive and time consuming. The second approach to directed molecular evolution involves
recombination-based techniques, which mimic naturally occurring sexual recombination, a process in which regions of DNA are exchanged between strands of DNA. As recombination-based techniques do not require an understanding of the underlying
biological process, and do not generate as many harmful changes as random mutagenesis, use of this approach is generally less costly and less time intensive than genomics, rational design or targeted mutagenesis approaches.





The Maxygen Solution





We have developed
proprietary technologies that help address the limitations of modern biotechnology, allow for the rapid identification of lead product candidates and increase the opportunities for developing




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characteristics optimally suited for specific commercial purposes. Our integrated technologies bring together advances in molecular biology and protein modification to help create novel
biotechnology products. Our technologies are faster and less expensive than conventional technologies. Our use of such technologies is commercially-focused and results-oriented, and unlike conventional approaches, requires minimal understanding of
complex underlying biological systems.





The most significant of our technologies are our MolecularBreeding directed molecular
evolution technologies, of which there are two components. The first is DNAShuffling, our proprietary process for recombining genes into a diverse high-quality library of novel DNA sequences known as gene variants. The second is MaxyScan, a series
of proprietary screening capabilities for the selection of desired commercial properties from the library of gene variants. The combination of DNAShuffling recombination technologies and MaxyScan specialized screening allows us to identify new
potential products in a more rapid, cost-effective manner than conventional techniques.





Virtually any product or process that
utilizes, or could utilize, DNA or proteins can potentially be improved for optimal function using our technologies. We are currently applying our technologies to adapt genes and proteins for use in fields as diverse as protein pharmaceuticals,
vaccines, chemicals and agriculture.





We believe that our technologies provide distinctive advantages over traditional
biotechnology, as summarized in the following table.





Advantages of Maxygens Technologies





Characteristic

Modern Biotechnology

Maxygens TechnologiesTime to generate lead product candidates

several years

weeks to monthsNecessary understanding of the biological processes underlying lead product candidates

yes

noAbility to optimally improve properties for commercial applications

no

yesCost to generate lead product candidates

high

lowAmount of resulting genetic diversity

limited

virtually unlimited





The Maxygen Strategy





Our goal is to be a world leader in the commercialization of biotechnology products. We believe our technologies have broad commercial application, including short-, medium- and
long-term commercial opportunities in human therapeutics and industrial applications (agriculture and chemicals). Our business strategy is built around two major efforts:





Commercialize Proprietary Products.    We will continue to strengthen our capabilities to develop high value products in each of our target markets through two
primary mechanisms:





Product Development Partnerships:    Our strategy in entering
into strategic collaborations is to work with leaders in their respective industries in specific areas of product focus. Our agreements grant to our strategic collaborators licenses under intellectual property developed by us in the collaboration
for specific products for specific uses. Generally, we retain the right to work independently or with others on products outside the scope of the areas that are the subject of our collaborations. In exchange for commercial licenses to the products
developed in specified fields, we typically seek up-front license fees, research funding, technology advancement funding, research and commercial milestone payments and royalties on product sales. Our goal is to benefit from the combined expertise
of Maxygen and our collaborators.





Independent Product Development:    We plan to
develop multiple products for a number of industries. We have invested and will continue to invest our own funds in specific, economically attractive, product opportunities.




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Expand Our Proprietary Technology Leadership.    To expand our
technology leadership, we will continue to develop our core technologies by investing significantly in research and development. We will continue to acquire and license technologies from third parties that complement our capabilities to more rapidly
develop products. We will protect and build upon our existing patent portfolio and also rely on trade secrets to protect our proprietary technologies. We will continue to recruit, and collaborate with, leaders in the field of directed molecular
evolution and complementary technologies and in various therapeutic indications and industrial segments.





We will continue to
support both elements of our business strategy by gaining access to complementary technologies, capabilities and expertise through in-licensing agreements, corporate partnerships and corporate acquisitions. We may also pursue additional grants from
U.S. government agencies in areas of commercial interest.





Since inception, we have entered into over 20 strategic
collaborations and several proof of principle collaborations with commercial entities and have received eight grants from U.S. government agencies. Assuming our research efforts for existing collaborations are expended for the full research term, we
have total committed funding of over $139 million, of which over $106 million is from our corporate collaborators and approximately $33 million is from the U.S. government. Of these committed funds, we have earned approximately $72 million;
additionally, we have received $15 million from our collaborators in consideration for purchases of our equity. Potential milestone payments from our existing collaborations could exceed $308 million based on the accomplishment of specific
performance goals. These payments are in addition to earned royalties on product sales.





In 2001, we were very successful in
achieving our goals. We advanced six potential products into development, two in human therapeutics and four in industrial applications. We currently have 14 potential products in development, including 11 with corporate collaborators and three that
are being funded by Maxygen. We entered into five new product development collaborations in 2001, with Aventis Pasteur in novel vaccines; Celltech in antibodies; InterMune in next generation interferon gamma therapies; with ALK-Abelló in
allergy and with the International AIDS Vaccine Initiative in HIV. We also received a grant from USAID in 2001 for malaria vaccine research. We had 14 additional U.S. patents issue and 29 additional foreign patents granted bringing the total number
of patents owned or licensed by us as of December 31, 2001 to 103. We also have over 500 patent applications worldwide.





Current Fields of Application





We are currently applying our technologies to high-value opportunities in the fields of human therapeutics (protein
pharmaceuticals and preventative and therapeutic vaccines) and industrial applications (agriculture and chemicals).





Human Therapeutics





Our human therapeutics business, consisting of protein pharmaceuticals and preventative and therapeutic vaccines, presents
us with opportunities in a wide variety of disease indications for which there is a significant unmet medical need for safe and effective treatments. The markets for many of these disease indications are very large and are summarized in the table
below.





Therapeutic Area/Market

Market ($US)*Cancer

$20 billionInfectious disease

$20 billionBlood Disorders

$9 billionArthritis

$8 billionMultiple sclerosis

$1.8 billion


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Source: *MedAdNews May 2001




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Protein Pharmaceuticals





We are dedicated to becoming one of the worlds leading providers of improved, proprietary, protein-based therapeutics.





Market Opportunity.    In 2000, worldwide sales of therapeutic proteins made using recombinant DNA technology exceeded $20 billion. Protein pharmaceutical
products, such as erythropoietin and granulocyte colony stimulating factor, represent some of the worlds highest revenue pharmaceutical products. The protein therapeutics sector is one of the fastest growing sectors of the pharmaceutical
market, with an annual sales growth rate of 5 to 15%. However, many presently marketed protein pharmaceuticals have limitations and harmful side effects. Most protein pharmaceuticals have short half-lives, which may result in the need for frequent
administration of expensive, painful injections or intravenous treatments. Proteins can also be immunogenic, potentially leading to adverse side effects or reduced therapeutic efficacy. Examples of therapeutic proteins made using recombinant DNA
technology, their 2000 worldwide sales and potential improvements that could be made to proteins currently being marketed are listed below:





Product

2000 Sales ($US)

Potential ImprovementErythropoietin

$
5.3 billion

Longer half lifeInterferons

$
3.4 billion

Fewer side effects, longer half lifeInsulin

$
3.1 billion

Lower manufacturing costHuman growth hormone

$
1.5 billion

Longer half lifeColony stimulating factors

$
1.6 billion

Longer half lifeClotting Factors

$
1.2 billion

Longer half life, reduced immunogenicityInterleukins

$
160 million

Fewer side effects





By applying our technologies we believe we will be able to develop potent and
safe protein pharmaceuticals that help address the limitations of current protein pharmaceuticals. Our technology offers a means both to develop new therapeutics, with better commercial and therapeutic attributes than naturally occurring proteins,
and to develop improved next-generation protein drugs.





Applying our technology to validated targets can potentially reduce
product development risk as well as accelerate the discovery and early-development phases of a drug candidate. While protein pharmaceuticals made from naturally occurring proteins can address large markets, they are often not well suited for
commercialization without modification. Our integrated platform of proprietary technologies, including our MolecularBreeding directed molecular evolution technologies and post-translational modification capabilities, can help transform proteins into
more potent, efficient and safer pharmaceuticals with suitable duration of action.





Business Strategy.    Our strategy for protein pharmaceuticals is to partner and independently develop new and improved therapeutic products. Biopharmaceuticals at all stages of
developmentresearch, clinical, marketed or failedare potential targets for improvement. We are currently building internal pre-clinical and clinical capabilities to allow us to move multiple products through the approval processes in the
United States, Europe, and other important markets. In parallel, we are working with pharmaceutical companies to develop, manufacture and commercialize biopharmaceutical candidates made using our technologies. By collaborating with leading
pharmaceutical companies and creating better versions of proven protein therapeutics we can maximize our return and decrease our development risk. Additionally, the speed of our technologies allows multiple potential products to be pursued
simultaneously, thus decreasing portfolio risk.





Our protein pharmaceuticals activities were expanded considerably in August
2000 by our acquisition of Maxygen ApS (then known as Profound Pharma A/S), a Danish company, which contributed protein modification technologies and capabilities, as well as strong additions to our management team with drug development expertise.
With the acquisition of Maxygen ApS, our research-stage protein pharmaceutical product pipeline was doubled. We have also benefited by additional expertise related to all stages of protein




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pharmaceutical development including molecular biology, protein chemistry, in vitro and in vivo pharmacology, immunology, and pre-clinical and
clinical development. Additionally, having a European presence may provide us European business opportunities that may not have been accessible otherwise.





Technology Platform.    We are capable of improving biopharmaceuticals in important parameters through the use of our integrated platform of proprietary technologies. In addition to our
MolecularBreeding directed molecular evolution technologies, our proprietary platform includes a number of significant technologies for structure-based molecular design, intelligent diversity generation, and directed PEGylation and glycosylation. We
have also designed and implemented proprietary expression systems, automated high-throughput fermentation capabilities, and protein purification and characterization techniques that are specific to proteins. Our technology platform is highly
flexible and enables us to apply a wide selection of technologies in an integrated fashion to improve proteins for a desired function. For example, we can use our MolecularBreeding directed molecular evolution technologies to modulate the receptor
specificity of a protein, and subsequently use directed PEGylation to modulate immunogenicity and pharmacokinetics.





In
addition, we have a broad strategic relationship with Shearwater Corporation (a subsidiary of Inhale Therapeutic Systems, Inc.), a leader in PEG-technology. This alliance provides us with access to Shearwaters proprietary PEGylation
chemistries, as well as PEG compound supply, for the development of our product candidates.





Products/Pipeline.    Our protein pharmaceuticals activities are focused on the development of second-generation, tailor made, and novel protein
therapeutics. At present, we have over ten active programs aimed at improving therapeutic proteins, many of which are second-generation versions of successfully marketed products. Two of those potential products are in pre-clinical development.





Examples of Potential Products in Protein Pharmaceutical Pipeline





Product

Disease Indication

Estimated Potential Market ($US)

Partner/Maxygen Retained Rights

StatusMaxy-10

CNS, including MS

$
3 billion

Lundbeck

Pre-clinicalMaxy-50

Fibrosis and Oncology

$
2.5 billion

InterMune

Pre-clinicalMaxy-12

Inflammatory disease

$
700 million

Maxygen

ResearchMaxy-14

Cancer

$
1 billion

NCI/Maxygen

ResearchMaxy-20

Allergy

$
1.6 billion

ALK-Abelló

ResearchMaxy-30

Autoimmune disease

$
1 billion

Maxygen

Research





| | · |  | Research means the discovery or creation of prototype products, including their characterization.
| | - |  | ---------------------------------------------------------------------------------------------------




| | · |  | Pre-clinical means product scale-up, formulation and further testing in animals, including toxicology.
| | - |  | --------------------------------------------------------------------------------------------------------




Protein Pharmaceutical Alliances.





Celltech.    In December 2001, we entered into a technology collaboration agreement with Celltech Group plc, whereby Maxygen will potentially apply its MolecularBreeding directed evolution
technologies to four of Celltechs therapeutic monoclonal antibody programs. Under the terms of the agreement, Maxygen may receive license and option fees, full research and development funding, milestone payments, and royalties on product
sales. Celltech retains exclusive worldwide rights to commercialize antibody therapeutics developed in the collaboration. Maxygens previous therapeutic collaborations focus on use of our technologies to improve cytokines, immunostimulatory
factors and vaccines. By applying our capabilities to the field of antibodies, we have significantly expanded the therapeutic markets that we are addressing.





InterMune.    In September 2001, we granted a license to, and established a three-year collaboration with, InterMune, Inc. to develop and commercialize novel, next-generation interferon
gamma products. The main




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purpose of the collaboration is to develop a next-generation Actimmune ® with enhanced pharmacokinetics and a less-frequent dosing regime. Actimmune ® (Interferon
gamma-1b), is currently being marketed by InterMune in the United States for the treatment of chronic granulomatous disease (CGD) and severe, malignant osteopetrosis. InterMune is continuing the development of Actimmune ® by conducting several advanced stage clinical trials, including a Phase III trial for the treatment of idiopathic pulmonary
fibrosis (IPF) and a Phase III trial for ovarian cancer. Under the terms of the agreement, InterMune will take forward into clinical development product candidates created by Maxygen. InterMune will fund optimization and development of the
next-generation interferon gamma products, and will retain exclusive worldwide commercialization rights for all human therapeutic indications. Maxygen will receive up-front license fees, full research funding, and development and commercialization
milestone payments based on clinical development, regulatory approvals and commercial sales. In addition, Maxygen will receive royalties on product sales.





Lundbeck.    In September 2000, we established a three-year strategic alliance with H. Lundbeck A/S, a Danish pharmaceutical company, to develop an interferon beta pharmaceutical product to
address central nervous system diseases including multiple sclerosis. Treatments for these diseases may provide Lundbeck with access to a market with a potential value of $3.0 billion. Lundbeck specializes in the development of pharmaceuticals to
treat psychiatric and neurological disorders. We will receive research and development funding as well as license fees, milestone payments based on clinical trials, regulatory approval and commercial sales and royalties on product sales. We also
retain development and marketing rights to the product in key Asian markets and global rights for all indications outside of central nervous system diseases, including inflammatory disease and cancer. In February 2002 we announced that Lundbeck
intended to move an optimized interferon beta lead compound from the collaboration forward into pre-clinical development. The lead compound has been engineered by us to have an improved drug profile for therapy, with reduced immunogenicity,
increased bioavailablility and substantially improved half life, to minimize side effects and maximize therapeutic efficacy.





National Cancer Institute.    In February 2000, we entered into a cooperative research and development agreement (CRADA) with the National Cancer Institute, National Institute of Health. The CRADA is a three-year
research agreement under which we will work with the National Cancer Institute to develop therapeutic proteins for the treatment of a certain type of cancer. Under the agreement, we have the right to acquire an exclusive license to intellectual
property developed in the CRADA for commercial use, subject to a non-exclusive royalty-free license retained by the U.S. government.





Vaccines





We are dedicated to becoming a leader in the development of novel vaccines for the prevention and
treatment of infectious diseases, cancer, autoimmune disease and allergy.





Market
Opportunity.    Worldwide sales of all vaccines in 1999 exceeded $6.5 billion and are expected to exceed approximately $10.9 billion by 2005. Recombinant DNA technology has enabled the development of prophylactic vaccine
products that are safer, cheaper and easier to manufacture. This may create new market potential for these types of products, such as the Hepatitis B vaccine market, which is estimated to have had 2001 sales of $1.6
billion.





The vaccine market is expected to increase
dramatically for several key reasons:





| | · |  | Vaccines are under development for the treatment of many existing diseases, such as cancer, autoimmune disease and allergy, and chronic infectious diseases. This will expand
the market size dramatically beyond the traditional use of vaccines as prophylactics for infectious diseases.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | · |  | Vaccines remain the best way to control epidemics and the spread of disease.
| | - |  | ----------------------------------------------------------------------------




| | · |  | Combination vaccines are being introduced into medical practice, making patients, particularly children, more likely to be vaccinated broadly against infectious diseases.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | · |  | Travel around the world is increasing at a dramatic rate. Traveling increases the probability that viruses, bacteria and other infectious agents will be disbursed worldwide.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | · |  | Adults are being vaccinated more frequently, expanding the patient population.
| | - |  | ------------------------------------------------------------------------------




We believe our proprietary technologies have the potential to transform the design and development of vaccines through the optimization of properties that allow for the generation of
broad and strong immune responses. This would enable us to help address both the treatment and prevention of a wide variety of diseases including cancer, allergy, autoimmune disease and infectious diseases such as AIDS and hepatitis.





Business Strategy.    Our strategy for vaccines is to partner and independently develop new and improved
preventative and therapeutic vaccines. We will outlicense and partner potential products that we choose not to develop independently and enter into additional collaborations to further our technologies and product development capabilities. By
collaborating with leading pharmaceutical companies we balance our return and our development risk. Additionally, the speed of our technologies allows many targets to be pursued simultaneously, thus decreasing portfolio risk.





Our vaccine business activities have been built primarily through grant funding of more than $25 million from the U.S. government. This
funding has enabled us to advance key programs and our technology platform as a whole.





Technology
Platform.    We believe our proprietary technologies have the potential to transform the design and development of vaccines through the optimization of properties that allow for the generation of broad and strong immune
responses. We have shown that we can generate new modified vaccines that have the potential to overcome the limitations of traditional vaccine development. This may enable us to help address both the treatment and prevention of a wide variety of
diseases including cancer, allergy, autoimmune disease and infectious diseases such as AIDS and hepatitis.





We believe our
technologies will help enable us to develop prophylactic and therapeutic vaccines with one or more of the following key characteristics:





| | · |  | The ability to generate the appropriate immune response.    Many prophylactic and therapeutic vaccines in development have not been successful due to
their inability to generate an immune response sufficient to treat or protect from disease. We have shown that our technologies can potentially be used to separately improve the various components of a vaccine, so that the overall immune response is
sufficiently improved. Vaccines with improved immunogenicity may be useful to treat cancer, allergy and chronic infectious diseases such AIDS, as well as protect against initial disease.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | · |  | The ability to protect against multiple forms of a disease with one vaccine.    Many infectious agents provide long-lasting protection
against subsequent infection with the same pathogen. However, many viruses (e.g., HIV, influenza) and certain bacteria change frequently so that they can evade the immune system. Our technologies can potentially be used to create novel vaccines that
can provide protection from most or all forms of disease in one product.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | · |  | Novel adjuvants to boost the relevant immune response.    Our technologies have been used to generate novel adjuvants, or components of vaccines that
boost the immunogenicity of the vaccine component. Adjuvants are expected to be critical components of successful vaccines, but have been disappointing because they are rarely effective without also causing unwanted side-effects. Our novel adjuvants
have the potential to be more efficient at boosting the immune response to the vaccine, and at the same time, cause fewer side effects. These novel adjuvants may be able to be used as components of vaccines against cancer, allergy and chronic
infectious diseases.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | · |  | Novel therapeutic vaccines to induce tolerance.    When the bodys immune systems attacks its own healthy tissue, autoimmune disease occurs.
Types of autoimmune disease include rheumatoid arthritis,
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



9




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multiple sclerosis, inflammatory bowel disease and psoriasis. Therapeutics that are able to intervene in this process by downregulating the immune systems attack of its own cells, and
re-educating these cells by inducing tolerance, could be effective as therapies for many kinds of autoimmune disease. Multiple naturally-occurring proteins, such as cytokines and antibodies, are under development as therapeutics for autoimmune
disease. However, many of these therapies are limited because they generally cause multiple different kinds of responses in the body. Our technologies can potentially be used to develop therapeutic vaccines with the ability to specifically
downregulate the immune response and induce tolerance.





Products/Pipeline.    We are developing
vaccines for the prevention and treatment of cancer, autoimmune diseases, allergy and infectious diseases. Products will be developed both internally by Maxygen, as well as through corporate collaborations for specific product opportunities.





Examples of Potential Products in Vaccine Pipeline





Product

Disease Indication

Partner/Maxygen Retained Rights

StatusMaxy-1200

Treatment of Colorectal Cancer

Maxygen

Pre-clinicalMaxy-1500

Prevention of Dengue Virus infections

Maxygen

Pre-clinicalMaxy-1100

Treatment of Hepatitis B

Maxygen

ResearchMaxy-201

HIV

International AIDS Vaccine Initiative

Research





| | · |  | Research means the discovery or creation of prototype products, including their characterization.
| | - |  | ---------------------------------------------------------------------------------------------------




| | · |  | Pre-clinical means product scale-up, formulation and further testing in animals, including toxicology to assess suitability for, and prepare for, clinical testing
in humans.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




Our two lead products are in pre-clinical development; the first is a therapeutic vaccine for the
treatment of colorectal cancer; the second is a vaccine to prevent dengue virus infection and the risk of dengue hemmhoragic fever. In addition, we have approximately ten prophylactic and therapeutic vaccine candidates in our research pipeline.





Vaccine Alliances





Aventis Pasteur.    In November 2001, we established a three-year collaboration with Aventis Pasteur to develop improved vaccines for a specific undisclosed target. Aventis Pasteur is the
new name of Pasteur Merieux Connaught, adopted at the creation of Aventis. Under the terms of the agreement, Maxygen will receive license fees, full research and development funding, minimum annual royalties, and potential milestone payments based
on success-based milestones, clinical trials, regulatory approvals and commercial sales and royalty payments on product sales. Aventis Pasteur will receive exclusive worldwide rights to commercialize the vaccines developed in the collaboration.





USAID.    In October 2001 we received a $3.7 million, three-year grant from the U.S. Agency for
International Development (USAID) to support the research and development of a novel, broadly protective malaria vaccine. Under the terms of the agreement, Maxygen will retain worldwide rights to commercialize successful vaccine candidates that
result from the program. According to the World Health Organization (WHO), malaria is a public health problem in more than 90 countries inhabited by over 2.4 billion people. Worldwide prevalence of the disease is estimated to be approximately 300 to
500 million new clinical cases each year, and




10




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mortality due to malaria is estimated to be over one million deaths per year. The WHO reports that the phenomenon of airport malaria, or the importing of malaria by international
travelers to non-endemic areas, is becoming increasingly common.





ALK-Abelló.    In February
2001, we established a three-year collaboration with ALK-Abelló A/S, a wholly-owned subsidiary of Chr. Hansen Holding A/S, to research and develop novel recombinant therapeutics for the treatment of specific allergies. We will collaborate
with ALK-Abelló to create therapies for treating specific allergies, including allergies to house dust mites and grasses, which are the cause of many common allergies. ALK-Abelló will receive exclusive worldwide rights to commercialize
all recombinant human therapeutics developed in the collaboration. Treatments for these allergies may provide ALK-Abelló with access to a market with a potential value of $1.6 billion. Under the terms of the collaboration, we will receive
license fees, technology access fees, research and development funding, and potential milestone payments based on clinical trials and commercial sales. We will also receive royalties on product sales.





International AIDS Vaccine Initiative.    In February 2001, we established a three-year collaboration to develop novel HIV
vaccines with the International AIDS Vaccine Initiative (IAVI) and DBLV, LLC, an entity established and funded by the Rockefeller Foundation. Under the agreement, DBLV will provide full research and development funding to us for at least three years
to expand our ongoing program in HIV vaccine development. We will retain all rights to commercialize the HIV vaccine candidates in all developed countries of the world, as well as in certain markets in the developing world. In recognition of the
great need for a vaccine against AIDS in the poorest countries of the world, we have granted IAVI a royalty-free license to develop and distribute HIV vaccines to those who cannot afford them in developing countries. According to the World Health
Organization and UNAIDS, 36.1 million people were living with HIV/AIDS at the end of 2000. Worldwide, AIDS has become the leading cause of death among infectious diseases. In 2000, AIDS killed 500,000 children and 2.5 million adults, and despite
existing prevention efforts an additional 600,000 children and 4.7 million adults became infected with HIV, the virus that causes AIDS.





Scripps Research Institute.    In September 2000, we established a research and screening collaboration with the Scripps Research Institute to identify potential vaccine candidates for the treatment and prevention
of HIV. We will use our proprietary technologies to create novel antigens capable of generating immune responses against the HIV virus. Scripps will analyze the novel antigens for their ability to immunize against the HIV virus.





Karolinska Institute.    In July 2000, we initiated a two-year program with the Karolinska Institute for the
development of novel allergy immunotherapeutics. Under the agreement, we will use our proprietary technologies to generate novel recombinant allergens for the treatment and prevention of certain common allergic conditions that the Karolinska
Institute will help screen using sera and lymphocytes from allergic patients. We will retain commercialization rights without any future financial obligation to the Karolinska Institute for any application of potential allergy products.





DARPA.    In 1998 and 1999 we received grants from the Defense Advanced Research Projects Agency
(DARPA) to use our MolecularBreeding directed molecular evolution technologies to (i) evolve a new generation of DNA vectors for rapid and efficient delivery of antigens for immunization, (ii) generate new vaccines with a broad spectrum of activity
against multiple strains of several different pathogens and (iii) deliver aerosol-based preventative and therapeutic agents.





NIST-ATP.    In 1997 we received a grant from the National Institute of Standards and Technology-Advanced Technology Program (NIST-ATP) to use our MolecularBreeding directed molecular evolution technologies to
develop new screening systems for use in accelerated discovery and development of new AIDS therapies and vaccines.




11




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Industrial Applications





Chemicals





Our chemicals business unit is dedicated to becoming the global leader in
providing proprietary biologically-based process solutions for the discovery and manufacture of bulk, specialty and fine chemicals, including pharmaceutical intermediates and products. It is our intention to operate our chemicals business through
our wholly-owned subsidiary Codexis, Inc.





Market Opportunity.    The chemicals industry is comprised
of three major segments: commodity, specialty and fine. Together, 2000 sales in these three segments exceeded $1.7 trillion. Within these segments, approximately $50 billion in sales is readily addressable by biological processing, for example,
either by fermentation or through the use of enzyme catalysts. Some examples of existing biologically-based chemical processes are listed below:





Product/Process

Company

Estimated Annual Sales ($US)Acrylamide

Nitto

$100+ millionPolylactic Acid

Cargill-Dow, LLC

$200 millionNicotinates (nitrile catalyst)

Lonza

$120 millionHigh fructose corn syrup

Archer Daniels Midland, A.E. Staley

$4.5 billionModified Penicillins (catalysts acylase)

DSM

$300+ millionAspartame (protease catalyst)

DSM/Tanabe, Tosoh

$500 million





An additional $200 billion in sales has been identified as potentially
addressable by biological approaches within the next 10-20 years. Included in the potential market is the manufacturing of major chemicals, plastics, vitamins, compounds used in the manufacture of pharmaceuticals, enzymes for use as catalysts,
pigments and additives in paint, and polymers and fibers in clothing.





Enzymes occurring in nature are generally unable to meet
the stringent activity requirements required for the commercial use of enzymes in industrial processes. Technologies such as our MolecularBreeding directed molecular evolution technologies are potentially able to overcome such shortcomings.





Business Strategy.    The chemical industry is undergoing a transformation in the way it produces
chemicals and materials. New genomic information from various organisms will help make renewable resources the preferred energy basis and carbon source for the manufacture of value-added chemicals and materials in the years to come.





Yet genomic information alone is not sufficient to complete the transformation. New tools, such as the ability to manipulate genes and
pathways in innovative ways, are critical for the development of enzymes that operate under conditions optimal for chemical processes, essentially serving to fit the enzyme to the process rather than the process to the enzyme. Our technologies
represent a powerful means for improving the properties of industrially relevant genes. For example, enhancements in the carbon efficiency of fermentation processes may be derived from the optimization of biochemical pathways in vivo.
Biocatalysis will complement and in some cases replace chemical catalysis, offering a more efficient and sustainable process.





The success of the transformed chemical industry will not only depend on new technologies to manufacture chemicals, but also on the discovery of new chemicals and materials with novel functionalities. MolecularBreeding directed molecular
evolution technologies will help develop both new processes and new chemicals with novel functionalities. Traditionally, this capability was recognized as adding value only in pharmaceutical discovery, however with technologies like
MolecularBreeding directed molecular evolution technologies, new molecules and structures that are cost-effective to synthesize may be developed that will broadly impact the chemical industry.




12




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The business strategy of our chemicals business unit is to partner for specific products and
processes with leaders in relevant segments of the chemical industry, ranging from commodity to pharmaceuticals, while retaining rights within those segments to develop other processes internally or to partner further down the process development
value chain. To date, we have entered into six collaborations with leading companies in their respective segments for the development of specific products or processes. These collaborations provide critical capabilities, revenues and a route to
market, helping to reduce the risk associated with developing a commercial product. We provide our collaborators with a range of process development capabilities, from fully integrated processes, single optimized process steps, to optimized
fermentation and biocatalyst evolution to enable competitive proprietary product development.





For products and processes where
specialized market expertise or significant capital is necessary, we will primarily work with partners to reach commercialization. Examples of such products include fuels, bulk chemicals and polymers, like polyester, specialty products like
performance thermoplastic resins and specialty process chemicals, like pulp and paper chemicals.





By retaining commercialization
and research rights in our collaborations, we expect to pursue independent development of high-value chemical products, as well as enter into additional strategic alliances with leading chemical companies. Furthermore, as we continue to expand our
libraries of tested biocatalysts, we should be able to address our customers process needs with increasing speed. This is critical in certain segments of the chemical industry, such as the pharmaceutical manufacturing segment, where there is a
very narrow window within which the process chemist must determine the economic and technical feasibility of a given process.





Technology Platform.    The chemicals business unit is focused on improving existing chemical processes and creating novel processes for the manufacturing of specialty and fine chemical products, including
pharmaceuticals. Our set of proprietary technologies can allow for the evolution of enzymes, multi-enzyme pathways and organisms, overcoming the existing limitations of enzyme catalysts and enabling the development of economically viable
biocatalytic and fermentative processes. We believe that our approach is faster, better and less expensive than traditional methods, enabling a new paradigm in process design in which a biological catalyst can be designed for a process, rather than
the process being designed around a catalyst.





In addition to our DNAShuffling recombination technologies, we have developed
expertise in developing high-throughput biological and chemical screening systems that closely mimic the commercial scale environment. Screening for trace amounts of a specific chemical, rheological properties of a polymer, a specific stereo- or
regioisomer are just some of the high-throughput screening capabilities we have developed to identify conversions and syntheses of interest. Coupled with the power of DNAShuffling recombination technologies, our screening systems help enable us to
rapidly develop integrated, commercially viable chemical processes at the relevant scale.





We have demonstrated that
MolecularBreeding directed molecular evolution technologies can allow for the creation of new modified enzymes for use as catalysts and modified metabolic pathways that overcome the limitations of naturally occurring enzymes. We are currently
generating libraries of proprietary enzymes for use as catalysts, which we believe will offer significant competitive advantages over existing chemical catalysts. These enzymes could provide increased yields and decreased manufacturing costs by a
reduction in requirements for raw materials, capital equipment and energy.





Products/Pipeline.    Our
chemicals business unit is targeting multiple major high-value, low-volume chemical processes in the specialty and fine chemical areas for internal development and later stage partnering. These products include specific pharmaceutical intermediates
and actives, antibiotics, vitamins and nutritional compounds and other fine chemicals. We have over 18 potential products and processes in our chemicals pipeline, six product candidates in development and three processes at commercial scale.




13




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Chemical Alliances





HerculesIn October 2000, we entered into a four-year collaboration with Hercules Incorporated focused on developing specific high value specialty
chemicals via custom-made biological catalysts for the pulp and paper industry. Total 1999 worldwide sales of pulp and paper chemicals were estimated to be over $13 billion. Under the terms of the collaboration, we will receive full research
funding, technology access fees, license fees and milestone payments which vary depending on the milestones achieved and commercial sales, as well as royalties on any product
sales.





Chevron.    In
October 2000, we entered into a three-year collaboration with Chevron Research and Technology Co. to develop novel bioprocesses for specific petrochemical products. The initial area of focus will be to develop a biocatalytic process for the
conversion of methane to methanol. Currently, the worldwide methanol market is estimated to be 11 billion pounds consumed annually at a price of $0.50 per pound. Chevron will have commercialization rights in exchange for license fees, technology
access fees, full research funding, success-based milestones, annual fees and product royalties.





Pfizer.    In September 2000, we extended a May 1998 agreement with Pfizer Inc. in the area of biochemical manufacturing of a specific pharmaceutical product. The product generates approximately $200 million in
sales per year for Pfizer. Under the 1998 agreement, we improved the selectivity of the biosynthetic pathway that is critical to the manufacture of Pfizers product, and delivered an improved pathway that is currently under commercial
development by Pfizer. In the expanded collaboration, commercial terms were agreed upon for the improved process, with success earning Maxygen research and commercial milestones as well as a percentage of all manufacturing cost savings once the
optimized commercial process is scaled up at Pfizer. Additionally, Pfizer has agreed to fund additional research and development at Maxygen to allow us to further improve the performance of the pathway. To date, Maxygen has received two milestone
payments for developing an improved second-generation manufacturing process for the Pfizer product.





Rio
Tinto.    In January 2000, we entered into a three-year collaboration with Technological Resources Pty Limited, a wholly-owned subsidiary of Rio Tinto Corporation plc, one of the worlds leading mining companies, to
develop enzymatic systems to increase the efficiency of carbon dioxide fixation in connection with the combustion of fossil fuels and for other purposes. The technology, if successful, has broad applicability to multiple billion-dollar industries.
Increased efficiency could play a significant role in the reduction of CO 2 emissions, which the U.S. Department of Energy
estimates to be approximately 1,400 million tons/yr with an approximate abatement cost of $200 to $350/ton. In connection with the collaboration, we will receive research and funding payments and technology advancement fees. In addition, Maxygen and
Rio Tinto each will share revenues with the other from certain products or processes that are commercialized by the other.





DSM.    In March 1999, we entered into a three-year collaboration with Gist-Brocades N.V., a subsidiary of DSM N.V., to utilize our technologies to develop novel enzymes for use in the manufacture of certain
classes of penicillin antibiotics. Antibiotics represent one of the largest product classes in the anti-infectives market, with certain penicillin intermediates, such as PenG and 6-APA, representing annual market opportunities of $200 million
to $300 million in total product sales. We will receive research funding over three years and will receive royalties from the commercialization of any enzymes developed through our technologies. We currently have one manufacturing process from the
collaboration in commercial development at DSM.





Novozymes (formerly a division of Novo Nordisk
A/S).    In September 1997, we entered into a five-year strategic collaboration with Novozymes, the worlds largest producer of industrial enzymes, for the development and bulk production of specific industrial enzymes
in fields such as laundry detergents, leather processing and pulp and paper manufacturing. Novozymes had a market share of 43% of the industrial enzymes market in 1999. The total current industrial enzymes market (a segment of the chemicals market)
is estimated at $1.8 billion, and is expected to grow to over $3 billion by 2008. In addition to providing Novozymes with an improved subtilisin molecule (one of the most studied and highly modified industrial enzyme products, with 1999 worldwide
sales in




14




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excess of $400 million) we provided an additional product candidate in 2000. In 2001 we announced the advancement of two further industrial enzyme product candidates into commercial development
bringing to a total of four the number of product candidates in commercial development under the agreement. In November 2001, the companies expanded the market areas addressed by the existing industrial enzymes collaboration. Under the terms of the
expanded relationship, Novozymes will be licensed to use MolecularBreeding directed molecular evolution technologies for additional industrial enzyme applications. Maxygen will receive royalty payments on the sales of any products developed under
the 1997 agreement and on the sale of any products in the expanded industrial enzyme market areas. In addition, Maxygen will have co-exclusive rights to use the MolecularBreeding directed molecular evolution technologies for certain new industrial
enzyme markets.





California Institute of Technology.    In 1998 we expanded a research cooperation
with Dr. Frances Arnolds laboratory at the Department of Chemical Engineering at the California Institute of Technology. This relationship was extended in 2001 for an additional four years. Dr. Arnolds research group focuses on
developing evolutionary protein design methods, engineering new enzymes and pathways, and using the results of laboratory evolution to elucidate mechanisms of enzyme function and protein adaptation. Dr. Arnold has collaborated with us since our
inception.





In addition to our corporate and academic collaborations we have received grants from NIST-ATP (1998) to develop
whole genome shuffling and from DARPA (1998) to develop enzymes with the capacity to inactivate microbial spores.





Agriculture





Our agriculture business unit is dedicated to becoming a global leader in providing proprietary
product solutions to important commercial problems in plant-based businesses through the application of advanced DNA breeding methods. It is our intention to operate our agricultural business through our wholly-owned subsidiary MaxyAg, Inc.





Market Opportunity.    The agricultural biotechnology seed market was estimated at approximately
$3 billion in sales in 2000. It is expected to grow to approximately $5-8 billion in sales by 2005 and to approximately $20-25 billion in sales by 2010. Biotechnology crops, first introduced to the market in 1996, have been adopted rapidly by
farmers and were planted on approximately 110 million acres in 2000. Adoption rates for transgenic crops are the highest for any new technology in agriculture. Biotechnology crops create value by reducing farmer costs, simplifying farming systems
and improving environmental sustainability through decreased use of conventional pesticides. Some examples of existing biotechnology-based products, the performance of transgenic crops relative to crop protection chemicals and an overview of the
market potential for transgenic crops are listed below:





Acreage of Transgenic Crops in 2000





Crop

Trait

Acres Planted in 2000 (Million)Soybean

Herbicide Tolerant

63.7Corn

Insect Tolerant

16.8Canola

Herbicide Tolerant

6.9Corn

Herbicide Tolerant

5.2Cotton

Herbicide Tolerant

5.2Cotton

Herbicide & Insect Tolerant

4.2Cotton

Insect Tolerant

3.7Corn

Herbicide & Insect Tolerant

3.5Total



109.2







15




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Global Crop Protection Market in 2000: by Product





Product Group

$US Million

% Change from 1999Herbicides

$
13,794

-3.8
%Insecticides

$
8,009

-3.0
%Fungicides

$
5,801

-4.4
%Transgenic Crops

$
3,044

+3.7
%





Global Transgenic Agriculture Market in 2000: by Crop





Crop

Global Acreage (Millions)

% Transgenic in 2002Soybean

178

36
%Cotton

84

16
%Canola

62

11
%Corn

346

7
%





Biotechnology-based developments in agriculture over the past decade have focused
on providing farmers with plants that resist insect pests and enable the use of convenient, more environmentally favorable herbicides with an associated improvement in sustainable farming practices. The next generation of biotechnology crops will
likely include plants capable of resisting more pests and diseases, further reducing agrochemical use, as well as crops with improved nutrient value for both human food and animal feed. Biotechnology research is also being directed toward developing
plants designed as factories for the production of molecules of high commercial value, including natural polymers for materials applications and fine chemicals for nutraceutical and pharmaceutical products. We believe our technology platform can be
used to create numerous commercial opportunities in crop protection and plant quality traits.





Business Strategy. We aim to
provide customers with transgenic traits that enhance the performance and value of seed products that address the crop protection, materials, food and feed markets.





Our long-term goal is to develop products on our own but intend to initially enter the market through research and development relationships and through product development alliances
with seed and plant propagation businesses. Our initial products will focus on non-food crops. We believe that this strategy decreases the financial risks associated with product development and marketing while building the necessary infrastructure
and capabilities to become an integrated company.





Technology Platform.    We believe our
technologies, including our proprietary MolecularBreeding directed molecular evolution technologies, can be used to create numerous commercial opportunities in crop protection and plant quality traits. Existing commercial product performance can be
enhanced and new product concepts may be enabled by our technologies. In addition, our technologies may be able to improve and help commercialize product concepts that have failed during development for reasons of inadequate efficacy.





While exploiting the advantages of MolecularBreeding directed molecular evolution technologies to improve and develop new traits, we are
committed to become experts with regard to the use of the following technologies:





| | · |  | high throughput plant-based screening of gene variants;
| | - |  | -------------------------------------------------------




| | · |  | high throughput bio-assays for insect, nematode, and fungal pathogens;
| | - |  | ----------------------------------------------------------------------




| | · |  | relevant crop transformation methods with commercial freedom to operate; and
| | - |  | ----------------------------------------------------------------------------




| | · |  | diversity-based gene discovery.
| | - |  | -------------------------------




We
are devoting a significant share of our internal resources to develop these technologies.




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Products/Pipeline.    Both in collaboration with our partners and
internally, we are working on a broad portfolio of 14 potential products in areas of yield improvement and quality traits, with five of these potential products already in development either internally or with our partners. We have retained
significant rights to develop and market certain applications of the products resulting from the collaborations. In addition to the existing collaborations, we are currently pursuing and expect to pursue independent development of high-value
agricultural products, and intend to enter into additional strategic alliances with leading agriculture companies.





Agriculture Alliances





Syngenta.    In June 1999, we entered into a five-year
strategic collaboration with Zeneca Limited, a wholly-owned subsidiary of AstraZeneca plc, now known as Syngenta, to utilize our MolecularBreeding directed molecular evolution technologies to improve the yield and quality of several of
Syngentas strategic crops. With global seed sales of $958 million in 2000, Syngenta currently holds 5% of the $9-11 billion global market in field crop seed and 12% of the $3-4 billion global market in vegetable and flower seed. We will
receive research and development funding as well as license fees, milestone payments based on field trials, regulatory approval and commercial sales and royalties on product sales. In 2001, two agriculture product candidates from the collaboration
were advanced into development at Syngenta.





DuPont.    In December 1998, we entered into a five-year
strategic collaboration with Pioneer Hi-Bred International, Inc., a wholly-owned subsidiary of E.I. duPont de Nemours and Company, to utilize our MolecularBreeding directed molecular evolution technologies to generate new gene variants for use in
the development of specific crop protection and quality grain traits in corn, soybeans and certain other crops. With global seed sales of $1.9 billion in 2000, Pioneer Hi-Bred currently holds 18% of the global market in field crop seed, including
44% of U.S. corn seed sales and 19% of U.S. soybean seed sales. We will receive research and development funding as well as license fees, success-based milestone payments and milestones based on regulatory approval and commercial sales and royalties
on product sales. We currently have one agricultural product candidate from the collaboration in development at DuPont.





Areas of Exploration





In addition to our current areas of focus in human therapeutics and industrial applications, we will continue to evaluate
opportunities in new business areas. We are assessing commercialization opportunities in the areas of gene therapy, natural product drugs and small molecule pharmaceuticals, nutraceuticals, animal health and nutrition including veterinary vaccines,
environmental applications, alternative fuels and certain other applications. In many instances, initial technology development and proof of principle models have already been established. Additional development may be funded through corporate
collaborators, government grants, other external funding or with our own funds for those products with significant potential.





Maxygens
Technologies





Evolution and DNA





Evolution is the process by which living organisms adapt to their environment. The first step of this process is sexual reproduction, which creates a variety of physical characteristics
that increase the diversity of a population. Second, nature exerts a selective force on the individuals, dictating which characteristics will be favored and be passed to the next generation. As a result of changing environmental and competitive
pressures, diversity may increase, leading to variation in the physical characteristics of individuals and species adapted for specific environments.





The physical characteristics of an organism are determined by genetic information inherited from the previous generation. This genetic information is coded for by DNA, a molecule found in the cells of living
organisms. DNA is comprised of four different chemical bases called nucleotides. Human cells have several billion nucleotides, the precise sequence of which determines the content of the genetic information. DNA is




17




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organized into discrete units called genes. Genes act alone or in combination to produce proteins, that not only form the fabric of cells but also direct them to perform biological functions,
which may in turn influence physical characteristics. Generally, the inherited biological properties or physical characteristics of an organism change only when the DNA in a gene is altered.





In summary, variations in genes provide the basis for inherited diversity in a population, thus maximizing the opportunity for developing characteristics optimally suited for a specific
environment.





Mutation and Recombination





There are two predominant methods by which nature is able to change the genetic information encoded by DNA to create diversity: mutation and recombination.





All organisms incur a certain number of mutations in their DNA as a result of normal cellular processes or interactions with external environmental
factors such as radiation from sunlight. Mutation typically involves changes in individual nucleotides and is essentially random. Almost all mutations are harmful to the function of genes, but a very small percentage are beneficial and may pass more
broadly into the population.





Sexually reproducing organisms use recombination, a process that involves the organized exchange
and reassortment of large sections of DNA from their parents. This process allows for new combinations of genes without disrupting the function of the newly created genes. This has a significant impact on physical characteristics and is the primary
cause of diversity in a sexually reproducing population.





Classical Breeding and Its Limitations





Without any knowledge of the genetic basis of evolution, humans have been breeding crops and animals for over 4,000 years in the search for better
physical characteristics. All of the domestic breeds of farm animals and horses, cereal crops, fruits, vegetables, crops for fiber, household pets, most ornamental flowers and many other species represent the results of many generations of selective
breeding by humans. In all these cases, humans have cross-bred crops or animals with the most desired physical characteristics to produce improvements in the next generation. For example, modern corn now has a dramatically higher yield than the wild
strain of corn, which produced very small amounts of grain. This improvement probably began with ancient Inca farmers continually selecting, breeding and propagating the most robust seed corn. This is known as classical breeding.





In the 19th century, advances in biology led to a better understanding of the basis of heredity. The discovery of the structure of DNA in
1953 subsequently led to the realization that genetic information was responsible for physical characteristics and that its manipulation could further improve the breeding process. In modern breeding, the DNA of offspring is often sequenced to
determine whether or not they are carrying undesirable genes. This reduces the probability of breeding poor quality stock and increases the pace of improvement.





Despite the improvements in classical breeding, this technique has a number of significant limitations. First, the process is extremely time consuming, since the offspring must mature to
determine if they carry the desired characteristic. For example, this cycle takes several years in cattle. Second, classical breeding can only be used to breed entire organisms and cannot readily use genetic information to modify or select for
specific genes and the traits they represent. This limitation is compounded when multiple genes encode the selected trait or when the simultaneous breeding of multiple traits is desired. Thus, the scope of potential improvements accessible by
classical breeding is limited.





MolecularBreeding Directed Molecular Evolution Technologies





Our technologies mimic the natural events of evolution. First, genes are subjected to DNAShuffling recombination technologies, generating a diverse
library of gene variants. Second, our proprietary MaxyScan




18




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screening systems select individual proteins from the gene variants in the library. The proteins that show improvements in the desired characteristics become the initial lead candidates. After
confirmation of activity, the initial lead candidates are then used as the genetic starting material for additional rounds of shuffling. Once the level of improvement needed for the particular commercial application is achieved, the group of lead
candidates is moved forward to the product or process development stage.





Other Technologies





In addition to our proprietary MolecularBreeding directed molecular evolution technologies, we have acquired and developed several complementary
technologies potentially useful for the development of protein-based products. Two such examples of our directed strategies to post-translationally modify protein drugs are our PEGylation and glycosylation technologies. These strategies represent a
comprehensive portfolio of know-how and technologies around proprietary algorithms and chemistries for the directed PEGylation or glycosylation of protein products. It is now generally accepted that effective, controlled PEGylation or glycosylation
of therapeutic proteins can enhance the proteins drug profile in terms of immunogenicity, stability, bioavailability and half-life.





LOGO




19




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Step One: DNAShuffling Recombination Technologies





Our DNAShuffling recombination technologies work as follows: a single gene or multiple genes are cleaved into fragments and recombined, creating a
population of new gene variants. The new genes created by DNAShuffling are then selected for one or more desired characteristics. This selection process yields a population of genes that becomes the starting point for the next cycle of
recombination. As with classical breeding, this process is repeated until genes expressing the desired properties are identified.





DNAShuffling recombination technologies can be used to evolve properties that are coded for by single genes, multiple genes or entire genomes. By repeating the process, DNAShuffling recombination technologies ultimately generate libraries
with a high percentage of genes that have the desired function. Due to the high quality of these libraries, a relatively small number of screening tests need to be performed to identify gene variants with the desired commercial qualities. This
process can significantly reduce the cost and time associated with identifying multiple potential products.





Step Two:
MaxyScan Screening





The ability to screen or select for a desired improvement in function is essential to the effective
development of an improved gene or protein. As a result, we have invested significant resources in developing automated, stringent, rapid screens and selection formats.





We have developed screening tests that can measure the production of proteins or small molecules in culture without significant purification steps or specific test reagents, thereby
eliminating time-consuming steps required for traditional screening tests. We are also focusing on the development of reliable, cell-based screening tests that are predictive of specific functions relevant to our human therapeutics programs.
Accordingly, we continue to develop new screening approaches and technologies. Our approach is to create multitiered screening systems where we use a less sensitive screening test as a first screen to quickly select proteins with the desired
characteristics, followed by a more sensitive screening test to confirm value in these variants and to select for final lead product candidates. Unlike approaches that create random diversity, MolecularBreeding produces potentially valuable
libraries of gene variants with a predominance of active genes with the desired function. As a result of capturing the natural process of sexual recombination with our proprietary DNAShuffling methods, we are also able to generate gene variants with
the desired characteristic at a frequency 5 to 10-fold higher than combinatorial chemistry, rational design or other directed evolution methods. This allows us to use complex biological screens and formats as a final screening test, as relatively
few proteins need to be screened to detect an improvement in the starting gene activity. Furthermore, this allows us to focus on developing screens that generate a broader range of information that is more responsive to commercial and clinical
concerns. This separates us from many of our potential competitors who invest significant time and money to screen billions of compounds per day. While we have the capability to screen billions of compounds per day, we generally need to screen far
fewer, on the order of 10,000 candidates per day or less.





Some of our screening capabilities include:





| | · |  | mass spectrometry;
| | - |  | ------------------




| | · |  | in vivo animal assays;
| | - |  | ----------------------




| | · |  | in vivo plant assays;
| | - |  | ---------------------




| | · |  | bioassays;
| | - |  | ----------




| | · |  | immunochemical assays;
| | - |  | ----------------------




| | · |  | chemical assays; and
| | - |  | --------------------




| | · |  | biochemical assays.
| | - |  | -------------------




We have access
to multiple sources of genetic starting material. In addition to the wealth of publicly available genetic sequence information, we are typically able to access our collaborators proprietary genes for




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use outside their specific fields of interest. Furthermore, we are able to inexpensively obtain our own genetic starting material or information, either through
our own in-house efforts or through collaborations with third parties. This information and such materials when coupled with our DNAShuffling recombination technologies, can provide a virtually infinite amount of new, proprietary gene variants with
potential commercial value.





LOGO





We use certain equipment and commercially available software in conjunction with our
DNAShuffling recombination technologies and MaxyScan screening systems. We have also developed software internally to help with and/or enable this process. We also use other internally developed software and other software purchased from third party
vendors to a limited extent in our research and development activities.





Demonstrated Successes of Our MolecularBreeding
Directed Molecular Evolution Technologies in Multiple Applications





We have consistently achieved improvement in gene
function using our MolecularBreeding directed molecular evolution technologies. Significant results have been demonstrated in many different systems that have relevance to multiple commercial applications. Our technologies have the ability to
generate improvements that would be difficult, costly, time intensive and, in many cases, impossible to achieve using other methods. We have shown that we can achieve improved gene function without a detailed understanding of the underlying complex
biological processes.





For example, we have demonstrated our ability to improve genes that increase the anti-viral activity of a
protein and develop new enzymes that have the potential to streamline chemical and pharmaceutical manufacturing processes. In addition, we have improved the performance of subtilisin, one of the most commercially valuable laundry detergent enzymes.
Subtilisin is one of the most highly studied enzymes and has been extensively modified to improve its commercial properties. This example demonstrates the ability of MolecularBreeding directed molecular evolution technologies to achieve further
improvements beyond the limits of modern biotechnology.




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A summary of representative experiments published by our scientists is set forth below.





Example

Property

Activity Increase

Publicationß-lactamase

Increased antibiotic resistance/enzyme activity

32,000-fold

Nature (1994)Antibody

Increased expression level

100-fold

Nature Medicine (1996)Antibody

Increased antibody/receptor binding

>440-fold

Nature Medicine (1996)Green fluorescent protein

Increased fluorescence

45-fold

Nature Biotechnology (1996)ß-galactosidase tofucosidase

Increase in activity

66-fold activity

Proceedings of the National Academy of Sciences (1997)Increase in specificity

1,000-fold specificityArsenate pathway(3 genes)

Increased bacterial resistance to arsenate

40-fold

Nature Biotechnology (1997)Cephalosporinase family

Increased antibiotic resistance

270-540-fold

Nature (1998)Subtilisin protease

Simultaneous improvement in 3 properties

2 to 4 fold in 3 properties

Nature Biotechnology (1999)Human ß-interferonfamily

Increased activity as measured by antiviral activity on mouse cells

285,000-fold

Nature Biotechnology (1999)HSV thymidine kinase family

Increased sensitivity to prodrug (AZT)

32-fold

Nature Biotechnology (1999)Atrazing Hydrolase

Novel enzyme activity

>1000

Chem Biol. (2001)Genome Shuffling

Improved streptomyces for production of polyketide antibiotic

Genome shuffling 1 year vs. classical strain improvement 20 years

Nature (2002)





Intellectual Property and Technology Licenses





Pursuant to the technology transfer agreement we entered into with Affymax Technologies N.V. and Glaxo Group Limited, each of which was then a wholly-owned subsidiary of what is now
GlaxoSmithKline plc, we were assigned all rights to the patents, applications and know-how related to MolecularBreeding directed molecular evolution technologies. Affymetrix, Inc. retains an exclusive, royalty-free license under most of the patents
and patent applications previously owned by Affymax for use in the diagnostics and research supply markets for specific applications. In addition, Affymax assigned jointly to us and to Affymetrix a family of patent applications relating to circular
PCR techniques.




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We have an extensive patent portfolio including 28 issued U.S. patents and 32 foreign patents
relating to our proprietary MolecularBreeding directed molecular evolution technologies. Counterpart applications of the U.S. patents are pending in other major industrialized countries. We have an additional 228 pending U.S. patent applications and
189 pending foreign and international counterpart applications relating to our MolecularBreeding directed molecular evolution technologies and specialized screening technologies, and the application of these technologies to diverse industries
including agriculture, protein pharmaceuticals, vaccines, gene therapy, chemicals and therapeutic drugs.





Our expanding patent
estate provides us with an increasingly broad and unique platform from which to create and improve therapeutic, industrial and other products. Patents owned by us or for which we have exclusive licenses cover a broad range of activities surrounding
recombination-based directed molecular evolution including:





| | · |  | methods for template-based gene recombination to produce chimeric genes;
| | - |  | ------------------------------------------------------------------------




| | · |  | methods for recombining nucleic acid segments produced by incomplete nucleic acid chain extension reactions to produce chimeric genes including the staggered extension process
(StEP);
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | · |  | methods utilizing reiterative screening or only a single cycle of screening;
| | - |  | ----------------------------------------------------------------------------




| | · |  | methods of combining any mutagenesis technique with DNA recombination methods to produce new chimeric genes;
| | - |  | ------------------------------------------------------------------------------------------------------------




| | · |  | methods using synthesized nucleic acid fragments;
| | - |  | -------------------------------------------------




| | · |  | in vivo and in vitro recombination methods of the above, in a variety of formats; and
| | - |  | -------------------------------------------------------------------------------------




| | · |  | methods of screening directed evolution libraries.
| | - |  | --------------------------------------------------




Such patents reinforce our preeminent position as the industry leader in recombination-based directed molecular evolution technologies for the preparation of chimeric genes for commercial applications.





In addition to the patents that we own directly, we have also exclusively licensed patent rights and technology for specific uses from
Novozymes, the California Institute of Technology (Caltech), the University of Washington and GGMJ Technologies, L.L.C. These licenses give us rights to an additional 13 issued U.S. patents, 29 U.S. pending patent applications, and 98 additional
international or foreign counterpart applications.





In addition, we received from Affymax a worldwide, non-exclusive license to
certain Affymax patent applications and patents related to technology for displaying multiple diverse proteins on the surface of bacterial viruses.





As part of our confidentiality and trade secret protection procedures, we enter into confidentiality agreements with our employees, consultants and potential collaborative partners. Despite these precautions, third
parties could obtain and use information regarding our technologies without authorization, or develop similar technology independently. It is difficult for us to police unauthorized use of our methods. Effective protection of intellectual property
rights is also unavailable or limited in some foreign countries. The protection of our proprietary rights may be inadequate and our competitors could independently develop similar technology or design around any patents or other intellectual
property rights we hold.





Competition





Any products that we develop through our technologies will compete in highly competitive markets. In the protein pharmaceuticals field we face competition from large pharmaceutical and biopharmaceutical companies such
as Eli Lilly and Company, Pharmacia, Inc., Genentech, Inc. and Amgen Inc. and from smaller biotechnology companies such as Human Genome Sciences, Inc. In the vaccines field we face competition from biotechnology companies such as Corixa Corporation
and Vical Corporation as well as large pharmaceutical




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companies including GlaxoSmithKline plc and Merck & Co., Inc. In chemicals, we face competition from large chemical companies such as E. I. du Pont de Nemours and Company and The Dow Chemical
Company and from smaller biotechnology companies such as Genencor International and Diversa Corporation. In the agriculture field we face competition from large agribusinesses, such as Monsanto Company and DowAgroScience and from smaller
biotechnology companies such as Paradigm Genetics.





Many of our potential competitors, either alone or together with their
collaborative partners, have substantially greater financial, technical and personnel resources than we do, and we cannot assure you that they will not succeed in developing technologies and products that would render our technologies and products
or those of our collaborators obsolete or noncompetitive. In addition, many of those competitors have significantly greater experience than we do in:





| | · |  | developing products;
| | - |  | --------------------




| | · |  | undertaking pre-clinical testing and clinical trials;
| | - |  | -----------------------------------------------------




| | · |  | obtaining FDA and other regulatory approvals of products; and
| | - |  | -------------------------------------------------------------




| | · |  | manufacturing and marketing products.
| | - |  | -------------------------------------




We are a leader in the field of directed molecular evolution. We are aware that companies such as Diversa Corporation and Applied Molecular Evolution have alternative methods for obtaining and generating genetic diversity. Academic
institutions such as Caltech and the University of Washington are working in this field, and we have licensed certain technology from Caltech and the University of Washington. This field is highly competitive and companies and academic and research
institutions are actively seeking to develop technologies that could be competitive with our technologies.





We are aware that
other companies and persons have described technologies that appear to have some similarities to our patented proprietary technologies. We monitor publications and patents that relate to directed molecular evolution to be aware of developments in
the field and evaluate appropriate courses of action in relation to these developments.





In early 2000, we initiated an
arbitration proceeding against Enchira Biotechnology Corporation (then known as Energy Biosystems Corporation) in connection with Enchiras claim that it had developed a new gene shuffling technology. We alleged that Enchira had
breached the confidentiality provisions and certain other terms of the Development and License Agreement entered into by Enchira and Maxygen in 1997, pursuant to which we disclosed confidential information regarding our MolecularBreeding directed
molecular evolution technologies to Enchira. An arbitration hearing was held in November 2000 and on March 8, 2001 we announced that the arbitrator had found that Enchira had breached three separate provisions of the Development and License
Agreement. The arbitrator found that the gene shuffling technology that Enchira calls Rachitt, and claims as its own, was derived from Maxygens technologies and has no notable or significant distinctions from those technologies and
that Maxygen is the exclusive owner of the gene shuffling technology contained in Rachitt. The arbitrator also found that Enchira had misused our confidential information. There were further arbitration proceedings and on November 5,
2001 we announced the remedy determined by the arbitrator. The arbitrator awarded us an injunction barring Enchira from using, practicing, licensing or selling Rachitt technology until 2017. The arbitrator further enjoined Enchira from using,
practicing, licensing or selling certain high throughput screening technology based on our technologies for three years. The arbitrator also ordered Enchira to reimburse Maxygen for attorneys fees and pay all costs of conducting the arbitration. The
California Superior Court confirmed the arbitrators decision in a final order and judgment issued on December 21, 2001.





Employees





As of January 31, 2002 we had 308 employees, 87 of whom hold Ph.D., Ph.D. equivalent or M.D. degrees and 262 of whom were
engaged in full-time research activities. We plan to expand our corporate development programs and hire additional staff as corporate collaborations and government grants are established. We




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continue to search for qualified individuals with interdisciplinary training and flexibility to address the various aspects and applications of our technologies. None of our employees is
represented by a labor union, and we consider our employee relations to be good.





Directors and Executive Officers





Our directors and executive officers, and their ages as of January 31, 2002, are as follows:





Name

Age

PositionRussell J. Howard, Ph.D.

51

Chief Executive Officer and DirectorSimba Gill, Ph.D.

37

PresidentMichael Rabson, Ph.D.

48

General Counsel and Senior Vice PresidentLawrence W. Briscoe

57

Chief Financial Officer and Senior Vice PresidentJohn Bedbrook, Ph.D.

52

President of AgricultureJan Møller Mikkelsen

42

President of Protein PharmaceuticalsAlan Shaw, Ph.D.

38

President of ChemicalsIsaac Stein(1)(2)

55

Chairman of the Board and DirectorRobert J. Glaser, M.D.(2)

83

DirectorM.R.C. Greenwood, Ph.D.

59

DirectorErnest Mario, Ph.D.(2)

62

DirectorGordon Ringold, Ph.D.(1)(2)

51

DirectorGeorge Poste, D.V.M., Ph.D.(1)

57

Director


---

|(1) |  | Member of the audit and finance committees
|--- |  | ------------------------------------------

|(2) |  | Member of the compensation committee
|--- |  | ------------------------------------




Russell J. Howard, Ph.D., has served as our chief executive officer and a director since June 1998 and is one of our co-founders. Dr. Howard was elected our president and chief operating officer in May 1997. Originally trained in
biochemistry and chemistry, Dr. Howard has spent over 20 years studying infectious diseases, primarily malaria, and currently serves on the National Institutes of Health and USAID advisory panels for malaria vaccine development. Before joining
Maxygen, Dr. Howard was from August 1994 to June 1996 the president and scientific director of Affymax Research Institute, an institute employing combinatorial chemistry and high throughput target screening to discover drug leads.





Simba Gill, Ph.D., has served as our president since April 2000. Dr. Gill joined us in July 1998 as chief financial officer and senior
vice president of business development. Before joining Maxygen, Dr. Gill was, from November 1996 to July 1998, vice president of business development at Megabios Corp., a biotechnology research and development company. From November 1995 to November
1996, Dr. Gill was director of business development at Systemix, Inc., a biotechnology research and development company. Before joining Systemix, Dr. Gill held a variety of positions at Boehringer Mannheim, a pharmaceutical company, including global
product manager for erythropoietin, manager of corporate business development and director of new diagnostics program management. Dr. Gill received his Ph.D. in immunology at Kings College, London University in collaboration with the U.K.
biotechnology company Celltech, and his M.B.A. from INSEAD in Fontainbleau, France.





Michael Rabson, Ph.D., joined us in
September 1999 as general counsel and senior vice president. Before joining Maxygen, from February 1996 to September 1999, Dr. Rabson was a member of Wilson Sonsini Goodrich & Rosati, P.C. Dr. Rabson received his Ph.D. in infectious disease
epidemiology from Yale University and did a post-doctoral fellowship at the National Cancer Institute, National Institutes of Health. He was a patent examiner at the U.S. Patent and Trademark Office before he received his J.D. from Yale Law School.




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Lawrence W. Briscoe joined Maxygen in November 2000 as chief financial officer and
senior vice president. From July 1994 until November 2000, Mr. Briscoe was chief financial officer and vice president, finance and administration of Catalytica, Inc., a company engaged in the application of expertise in catalytic technologies to the
pharmaceutical and energy industries. Before joining Catalytica, he held various executive and financial positions, including president and chief operating officer and director at Brae Corporation, vice president of corporate development at
Transamerica Corp. and chief executive officer of United States Commercial Telephone Corp. Mr. Briscoe has a M.B.A. from Stanford University, an M.S. in business from the University of Southern California and a B.S. in electrical engineering from
the University of Missouri.





John Bedbrook,
Ph.D., joined Maxygen in November 1999 as president of agriculture. Before joining Maxygen, Dr. Bedbrook was chief executive officer of Plant Science Ventures and was chief technology officer at SAVIA from February 1998 to October 1999. Before
joining SAVIA, Dr. Bedbrook held several senior management positions including executive vice president of research and development and co-president at DNA Plant Technology Corp. from 1988 to 1997. Dr. Bedbrook received his Ph.D. in molecular
biology from the University of Auckland in New Zealand.





Jan Møller Mikkelsen, joined Maxygen in August 2000 as
co-president of our protein pharmaceuticals business. He became president of our protein pharmaceuticals business in September, 2001. Mr. Mikkelsen was a co-founder, and from April 1999 to August, 2000 was co-chief executive officer, of ProFound
Pharma A/S, a Danish biotechnology company. ProFound was acquired by Maxygen in August, 2000 and renamed Maxygen ApS. Prior to founding ProFound, Mr. Mikkelsen held various positions at Novo Nordisk A/S, an industrial enzyme company, including
director of protein discovery from 1991 to 1999.





Alan Shaw, Ph.D., joined Maxygen in September 2001 as president of
chemicals. From September, 2000 to August, 2001 Dr. Shaw was head of new business development and managing director, Lancaster Synthesis Group at Clariant Life Science Molecules, a unit within Clariants Life Science and Electronics division.
Prior to joining Clariant, Dr. Shaw was the chief operating officer of Archimica Fine Chemicals, the fine chemical division of BTP plc from 1999 to 2000. From 1994 to 1999, Dr. Shaw held the position of managing director of Chirotech Technology
Limited, the fine chemicals division of the ChiroScience Group plc. Dr. Shaw received his Ph.D. in Chemistry from the University of Durham.





Isaac Stein has served as our chairman of the board of directors since June 1998 and a director since May 1996. He is one of our co-founders. Since November 1982, Mr. Stein has been president of Waverley
Associates, Inc. a private investment firm. Mr. Stein is also a managing member of Technogen Enterprises, L.L.C. and of Technogen Managers, L.L.C., which is the general partner of Technogen Associates, L.P. He is also the chairman of the board of
trustees of Stanford University.





Robert J. Glaser, M.D., has served as a director since September 1997. Dr. Glaser was
director for medical science at the Lucille P. Markey Charitable Trust from 1984 to June 1997, and a trustee from 1988 to June 1997, when in accordance with the donors will, the Trust ceased operations. Dr. Glaser is a director of Hanger
Orthopedic Group, Inc. and was a director of the ALZA Corporation until it was acquired by Johnson & Johnson in 2001. He was Dean of the medical schools at the University of Colorado and Stanford University, and professor of social medicine at
Harvard University. Trained as an internist, Dr. Glaser has 124 publications on streptococcal infections, rheumatic fever, medical education and health care, as well as being a contributor to numerous scientific treatises. He was a founding member
of the Institute of Medicine, National Academy of Sciences, and a Fellow of the American Academy of Arts and Sciences, the American Philosophical Society and the Royal College of Physicians of London.





M.R.C. Greenwood, Ph.D., has served as a director since February 1999. Dr. Greenwood has been chancellor of the University of California
(UC) at Santa Cruz since July 1996. Before being named chancellor of UC Santa Cruz, Dr. Greenwood was dean of graduate studies and vice provost at UC Davis from July 1989 to July 1996. In addition, from November 1993 to May 1995, Dr.
Greenwood took a leave from UC Davis to serve




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as associate director for science in the White House Office of Science and Technology Policy. She is a member of the Institute of Medicine/National Academy of Sciences as well as a fellow and
past president of the American Association for the Advancement of Science. Dr. Greenwood received her Ph.D. in physiology, developmental biology and neurosciences from Rockefeller University.





Ernest Mario, Ph.D., has served as a director since July 2001. In January 2002, Dr. Mario founded Apothogen, Inc., a pharmaceutical company, where he serves as chairman and
chief executive officer. Dr. Mario was the chairman and chief executive officer of ALZA Corporation, a pharmaceutical company, until December, 2001. Prior to joining ALZA, Dr. Mario served as chief executive officer of Glaxo Holdings plc, a
pharmaceutical company, from May 1989 to March 1993, and as deputy chairman from January 1992 to March 1993. Prior to that time, Dr. Mario served as chairman and chief executive officer of Glaxo, Inc., a subsidiary of Glaxo Holdings, from 1988 to
1989 and as president and chief operating officer of Glaxo, Inc. from 1986 to 1988. Prior to joining Glaxo, Dr. Mario held various executive positions at Squibb Corporation and served as a director of that company. Dr. Mario is also a director of
Catalytica Energy Systems, Inc., Orchid Biosciences, Inc., Pharmaceutical Product Development, Inc., SonoSite, Inc., Boston Scientific Corporation and Millennium Pharmaceuticals.





Gordon Ringold, Ph.D., has served as a director since September 1997. Since 1997, Dr. Ringold has served as chairman and chief executive officer of SurroMed, a biotechnology
company focused on novel clinical databases. From March 1995 to February 2000, Dr. Ringold was chief executive officer and scientific director of Affymax Research Institute where he managed the development of novel technologies to accelerate the
pace of drug discovery. Before serving as chief executive officer, Dr. Ringold was the president and scientific director of Affymax Research Institute. Dr. Ringold received his Ph.D. in the laboratory of Dr. Harold Varmus, before joining the
Stanford University school of medicine, department of pharmacology, and serving as the vice president and director of the Institute for Cancer and Development Biology of Syntex Research. Dr. Ringold is a Managing Member of Technogen Enterprises,
L.L.C. and of Technogen Managers, L.L.C., which is the general partner of Technogen Associates, L.P.





George Poste,
D.V.M., Ph.D., has served as a director since October 1999. He is chief executive officer of Health Technology Networks, a consulting group specializing in genetics. Dr. Poste was chief science and technology officer at SmithKline Beecham, a
pharmaceutical company, from 1992 to 1999 and was a member of the board of directors of SmithKline Beecham. Dr. Poste is chairman of diaDexus and Structural GenomiX and serves on the board of directors of Illumina, Inc. and Orchid Biosciences, Inc.
He is a fellow of Pembroke College Cambridge and distinguished fellow at the Hoover Institution, Stanford University. He is a member of the Defense Science Board of the U.S. Department of Defense and in this capacity chairs the task force on
Bioterrorism.





Scientific Advisory Board





The following individuals are members of our Scientific Advisory Board:





Baruch S.
Blumberg, M.D., Ph.D., is a distinguished scientist at Fox Chase Cancer Center, Philadelphia, and university professor of medicine and anthropology at the University of Pennsylvania. Dr. Blumbergs research has covered many areas including
clinical research, epidemiology, virology, genetics and anthropology. Dr. Blumberg was awarded the Nobel Prize in 1976 for his work on infectious diseases and specifically for the discovery of the hepatitis B virus and has also been elected to the
National Inventors Hall of Fame for the invention of the hepatitis B vaccine. Dr. Blumbergs research and insight into infectious diseases are valuable to Maxygen programs related to vaccines and hepatitis B in particular.





Arthur Kornberg, M.D., is an active professor emeritus at the Stanford University School of Medicine, department of biochemistry. Dr.
Kornberg has received numerous accolades including several honorary degrees and awards, the National Medal of Science, and the Nobel Prize in Medicine in 1959. He is a member of several




27




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prestigious scientific societies and serves as a member of several scientific advisory boards. Dr. Kornbergs years of research in enzymes and metabolism is a valuable contribution to
directing the internal research programs of Maxygen.





Joshua Lederberg, Ph.D., a research geneticist, is professor
emeritus at the Rockefeller University, in New York. Formerly, Dr. Lederberg was a professor of genetics at the University of Wisconsin and at Stanford University School of Medicine. Dr. Lederberg is a pioneer in the field of bacterial genetics with
the discovery of genetic recombination in bacteria, work for which he received the Nobel Prize in physiology and medicine in 1958. Maxygen is funding work in Dr. Lederbergs laboratory pertaining to the ultimate limits of growth rates of
microbes. His work and guidance in genetic recombination is important to our MolecularBreeding directed molecular evolution technologies.





Alejandro C. Zaffaroni, Ph.D., is one of our co-founders. Dr. Zaffaroni is a biochemist by training and a highly successful biotechnology entrepreneur, who has co-founded and built several companies including
ALZA Corporation, DNAX Institute of Molecular and Cellular Biology, Affymax N.V. and Affymetrix, Inc. Dr. Zaffaroni has repeatedly recognized the commercial value of leading-edge technologies and has turned those visions into highly successful
companies. In 1995, Dr. Zaffaroni was awarded the National Medal of Technology by President Clinton in recognition of his contributions to the pharmaceutical and biotechnology industries.





Frances Arnold, Ph.D., is the Dick and Barbara Dickinson Professor of Chemical Engineering and Biochemistry at the California Institute of Technology. Dr. Arnold had authored or
co-authored more than 150 publications and has 27 patents issued or pending. Dr. Arnolds research focuses on engineering new enzymes and pathways by directing their evolution in the laboratory. A member of the National Academy of
Engineering and fellow of the American Institute for Medical and Biological Engineering, her numerous awards include the 2000 Professional Progress Award of the American Institute of Chemical Engineers, the Office of Naval Research Young
Investigator Award, a Presidential Young Investigator Award and a David and Lucille Packard Fellowship in Science and Engineering. Maxygen is funding work at Dr. Arnolds laboratory pertaining to directed molecular evolution. Dr. Arnold
provides on-going guidance in the field of directed molecular evolution and its applications in the chemical industry.





RISK FACTORS THAT MAY AFFECT
RESULTS OF OPERATIONS AND FINANCIAL CONDITION





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





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





We have incurred net losses since our inception, including a net loss of approximately $11.3 million in 1999, $59.6 million
in 2000 and $45.0 million in 2001. As of December 31, 2001, we had an accumulated deficit of approximately $128.7 million. We expect to have increasing net losses and negative cash flow for at least the next several years. The size of these net
losses will depend, in part, on the rate of growth, if any, in our contract revenues and on the level of our expenses. To date, we have derived all our revenues from collaborations and grants and expect to derive a majority of our revenue from such
sources for at least the next several years. Revenues from collaborations and grants are uncertain because our existing agreements have fixed terms and because our ability to secure future agreements will depend upon our ability to address the needs
of our potential future collaborators. We expect to spend significant amounts to fund research and development and enhance our core technologies. As a result of our acquisition of Maxygen ApS, we expect costs to increase further due to




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expanded operations and costs associated with operating in multiple international locations. As a result, we expect that our operating expenses will increase significantly in the near term and,
consequently, we will need to generate significant additional revenues to achieve profitability. Even if we do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis.





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





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





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





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





You must evaluate us in light of the uncertainties and complexities affecting an early stage biotechnology company. Our proprietary technologies are new and in the early stage of development. We may not develop
products that prove to be safe and efficacious, meet applicable regulatory standards, are capable of being manufactured at reasonable costs, or can be marketed successfully.





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





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





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




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





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





We May Encounter Difficulties in Managing Our Growth. These Difficulties Could Increase Our Losses.





We have experienced rapid and substantial growth that has placed and, if this growth continues as expected, will continue to place a strain on our human
and capital resources. If we are unable to manage this growth effectively, our losses could increase. The number of our employees increased from 143 at December 31, 1999 to 252 at December 31, 2000 to 305 at December 31, 2001. Our revenues increased
from $14.0 million in 1999 to $24.5 million in 2000 to $30.5 million in 2001. Our ability to manage our operations and growth effectively requires us to continue to expend funds to enhance our operational, financial and management controls,
reporting systems and procedures and to attract and retain sufficient numbers of talented employees. If we are unable to implement improvements to our management information and control systems in an efficient or timely manner, or if we encounter
deficiencies in existing systems and controls, then management may have access to inadequate information to manage our day-to-day operations. Failure to attract and retain sufficient numbers of talented employees will further strain our human
resources and could impede our growth and ability to satisfy our obligations under collaboration agreements. This would reduce our revenue, increase our losses and harm our reputation in the marketplace.





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





We are expanding internationally. In August 2000 we acquired Maxygen ApS, a Danish biotechnology company, and are now operating with international business locations. Expansion into an
international operational entity will require additional management attention and resources. We have limited experience in localizing our operations and in conforming our operations to local cultures, standards and policies. We may have to compete
with local companies who understand the local situation better than we do. We may not be successful in expanding into international locations or in generating revenues from foreign operations. Even if we are successful, the costs of operating
internationally are expected to exceed our international revenues for at least the next several years. As we continue to expand internationally, we are subject to risks of doing business internationally, including the following:





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




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




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




| | · |  | longer payment cycles, different accounting practices and problems in collecting accounts receivable;
| | - |  | -----------------------------------------------------------------------------------------------------




| | · |  | cultural non-acceptance of genetic manipulation and genetic engineering; and
| | - |  | ----------------------------------------------------------------------------




| | · |  | potentially adverse tax consequences.
| | - |  | -------------------------------------



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To the extent we expand our international operations and have additional portions of our
international revenues denominated in foreign currencies, we also could become subject to increased difficulties in collecting accounts receivable and risks relating to foreign currency exchange rate fluctuations.





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





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





| | · |  | diversion of management time (both ours and that of the acquired company) from focus on operating the businesses to issues of integration during the period of negotiation
through closing and further diversion of such time after closing;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | · |  | decline in employee morale and retention issues resulting from changes in compensation, reporting relationships, future prospects, or the direction of the business;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------




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




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




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





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





Since Our Technologies Can Be
Applied to Many Different Industries, If We Focus Our Efforts on Industries That Fail to Produce Viable Product Candidates, We May Fail to Capitalize on More Profitable Areas.





We have limited financial and managerial resources. Since our technologies may be applicable to numerous, diverse industries, we must prioritize our application of resources to discrete
efforts. This requires us to focus on product candidates in selected industries and forego efforts with regard to other products and industries. Our decisions may not produce viable commercial products and may divert our resources from more
profitable market opportunities.





Public Perception of Ethical and Social Issues May Limit the Use of Our Technologies, Which Could Reduce Our
Revenues.





Our success will depend in part upon our ability to develop products discovered through our technologies.
Governmental authorities could, for social or other purposes, limit the use of genetic processes or prohibit the practice of our directed molecular evolution technologies or other technologies. Ethical and other concerns about our directed molecular
evolution technologies or other technologies, particularly the use of genes from nature for commercial purposes, and products resulting therefrom, could adversely affect their market acceptance.





If the Public Rejects Genetically Engineered Products, We Will Have Less Demand for Our Products.





The commercial success of our potential products will depend in part on public acceptance of the use of genetically engineered products including drugs, plants and plant products. Claims that genetically engineered
products are unsafe for consumption or pose a danger to the environment may influence public attitudes. Our




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genetically engineered products may not gain public acceptance. Negative public reaction to genetically modified organisms and products could result in greater government regulation of genetic
research and resultant products, including stricter labeling laws or regulations, and could cause a decrease in the demand for our products.





The subject of genetically modified organisms has received negative publicity in Europe and the United States, which has aroused public debate. The adverse publicity could lead to greater regulation and trade
restrictions on genetic research and the resultant agricultural and other products could be subject to greater domestic or international regulation. Such regulation and restrictions could cause a decrease in the demand for our products.





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





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





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





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





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





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





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





The patent positions of biopharmaceutical and biotechnology companies, including our patent positions, are often uncertain and involve
complex legal and factual questions. We will be able to protect our proprietary rights from unauthorized use by third parties only to the extent that our proprietary technologies are covered by valid and enforceable patents or are effectively
maintained as trade secrets. We apply for patents covering our technologies and products as we deem appropriate. However, we may not obtain patents on all inventions for which we seek patents, and any patents we obtain may be challenged and may be
narrowed in scope or extinguished as a result of such challenges. Our existing patents and any future patents we obtain may not be sufficiently broad to prevent others from practicing our technologies or from developing competing products.




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Others may independently develop similar or alternative technologies or design around our patented technologies or products. In addition, others may challenge or invalidate our patents, or our
patents may fail to provide us with any competitive advantages.





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





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





Our commercial success depends in part on neither infringing patents nor proprietary rights of third parties, nor breaching any licenses that
we have entered into with regard to our technologies and products. Others have filed, and in the future are likely to file, patent applications covering genes or gene fragments that we may wish to utilize with our proprietary technologies, or
products that are similar to products developed with the use of our technologies or alternative methods of generating gene diversity. If these patent applications result in issued patents and we wish to use the claimed technology, we would need to
obtain a license from the third party.





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





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





In 2000, we initiated an arbitration proceeding against Enchira Biotechnology in connection with Enchiras claim that it had developed a new
gene shuffling technology. An arbitration hearing was held in November 2000 and on March 8, 2001 we announced that the arbitrator had found that Enchira had breached three separate provisions of a Development and License Agreement Enchira had
entered into with Maxygen. The arbitrator found that the gene shuffling technology that Enchira calls Rachitt, and claims as its own, was derived from Maxygens technologies and that Maxygen is the owner of the gene shuffling technology. The
arbitrator also found that Enchira had misused our confidential information. There were further arbitration proceedings and on November 5, 2001 we announced the arbitrator awarded us an injunction barring Enchira from using, practicing, licensing or
selling Rachitt technology until 2017 and had further enjoined Enchira from using, practicing, licensing or selling certain high throughput screening technology based on our technologies for three years. The arbitrator also ordered Enchira to
reimburse Maxygen for attorneys fees and pay all costs of conducting the arbitration. The California Superior Court confirmed the arbitrators decision in a final order and judgment issued on December 21, 2001.




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If We Lose Key Personnel or Are Unable to Attract and Retain Additional Personnel We May Be Unable to Pursue
Collaborations or Develop Our Own Products.





We are highly dependent on the principal members of our management and
scientific staff, the loss of whose services might adversely impact the achievement of our objectives. In addition, recruiting and retaining qualified scientific personnel to perform future research and development work will be critical to our
success. We do not currently have sufficient executive management personnel to execute fully our business plan. There is currently a shortage of skilled executives, which is likely to continue. As a result, competition for skilled personnel is
intense, and the turnover rate can be high. Although we believe we will be successful in attracting and retaining qualified personnel, competition for experienced scientists from numerous companies and academic and other research institutions may
limit our ability to do so on acceptable terms. Failure to attract and retain personnel could prevent us from pursuing collaborations or developing our products or core technologies.





Our planned activities will require additional expertise in specific industries and areas applicable to the products developed through our technologies. These activities will require the
addition of new personnel, including management, and the development of additional expertise by existing management personnel. The inability to acquire these services or to develop this expertise could impair the growth, if any, of our business.





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





Our future capital requirements will be substantial and will depend on many factors including payments received under collaborative
agreements and government grants, the progress and scope of our collaborative and independent research and development projects, the effect of any acquisitions, and the filing, prosecution and enforcement of patent claims.





Changes may also occur that would consume available capital resources significantly sooner than we expect. We may be unable to raise sufficient
additional capital. If we fail to raise sufficient funds, we will have to curtail or cease operations. We anticipate that existing cash and cash equivalents and income earned thereon, together with anticipated cash flows from operations, will enable
us to maintain our currently planned operations for at least the next 12 months. If our capital resources are insufficient to meet future capital requirements, we will have to raise additional funds to continue the development of our technologies
and complete the commercialization of products, if any, resulting from our technologies.





Some of Our Programs Depend on Government Grants, Which May
Be Withdrawn. The Government Has License Rights to Technology Developed With Its Funds.





We have received and expect to
continue to receive funds under various U.S. government research and technology development programs. The government may reduce funding in the future for a number of reasons. For example, some programs are subject to a yearly appropriations process
in Congress. Additionally, we may not receive funds under existing or future grants because of budgeting constraints of the agency administering the program. There can be no assurance that we will receive the entire funding under our existing or
future grants.





Our grants provide the U.S. government a non-exclusive, non-transferable, paid-up license to practice for or on
behalf of the inventions made with federal funds. If the government exercises these rights, the U.S. government could use these inventions and our potential market could be reduced.





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





The Food and Drug Administration must approve any vaccine or therapeutic product before it can be marketed in the U.S. Before we can file a
new drug application or biologic license application with the FDA, the product candidate must undergo extensive testing, including animal and human clinical trials, which can take




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many years and require substantial expenditures. Data obtained from such testing are susceptible to varying interpretations that could delay, limit or prevent regulatory approval. In addition,
changes in regulatory policy for product approval during the period of product development and regulatory agency review of each submitted new application or product license application may cause delays or rejections. The regulatory process is
expensive and time consuming. The regulatory agencies of foreign governments must also approve our therapeutic products before the products can be sold in those other countries.





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





Even after investing significant time and expenditures we may not obtain regulatory approval for our products. Even if we receive regulatory approval,
this approval may entail limitations on the indicated uses for which we can market a product. Further, once regulatory approval is obtained, a marketed product and its manufacturer are subject to continual review, and discovery of previously unknown
problems with a product or manufacturer may result in restrictions on the product, manufacturer or manufacturing facility, including withdrawal of the product from the market. In certain countries, regulatory agencies also set or approve prices.





Laws May Limit Our Provision of Genetically Engineered Agricultural Products in the Future. These Laws Could Reduce Our Ability to Sell These
Products.





We may develop genetically engineered agricultural products. The field-testing, production and marketing of
genetically engineered plants and plant products are subject to federal, state, local and foreign governmental regulation. Regulatory agencies administering existing or future regulations or legislation may not allow us to produce and market our
genetically engineered products in a timely manner or under technically or commercially feasible conditions. In addition, regulatory action or private litigation could result in expenses, delays or other impediments to our product development
programs or the commercialization of resulting products.





The FDA currently applies the same regulatory standards to foods
developed through genetic engineering as apply to foods developed through traditional plant breeding. However, genetically engineered food products will be subject to pre-market review if these products raise safety questions or are deemed to be
food additives. Our products may be subject to lengthy FDA reviews and unfavorable FDA determinations if they raise questions, are deemed to be food additives, or if the FDA changes its policy.





The FDA has also announced in a policy statement that it will not require that genetically engineered agricultural products be labeled as such, provided that these products are as
safe and have the same nutritional characteristics as conventionally developed products. The FDA may reconsider or change its labeling policies, or local or state authorities may enact labeling requirements. Any such labeling requirements could
reduce the demand for our products.





The U.S. Department of Agriculture prohibits genetically engineered plants from being grown
and transported except pursuant to an exemption, or under strict controls. If our future products are not exempted by the USDA, it may be impossible to sell such products.




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Adverse Events in the Field of Gene Therapy May Negatively Impact Regulatory Approval or Public Perception of Any
Gene Therapy Products We or Our Collaborators May Develop.





Currently, we are not engaged in developing gene therapy
products; however, we may engage in these activities in the future either for our own account or with collaborators. If we develop, or our collaborators develop, gene therapy products, these products may encounter substantial delays in development
and approval due to the government regulation and approval process. Adverse events reported in gene therapy clinical trials may lead to more government scrutiny of proposed clinical trials of gene therapy products, stricter labeling requirements for
these products and delays in the approval of gene therapy products for commercial sale.





The commercial success of any potential
gene therapy products made by us or our collaborators will depend in part on public acceptance of the use of gene therapies for the prevention or treatment of human diseases. Public attitudes may be influenced by claims that gene therapies are
unsafe, and gene therapy products may not gain the acceptance of the public or the medical community. Negative public reaction to gene therapy could result in a decrease in demand for any gene therapy products we or our collaborators may develop.





Health Care Reform and Restrictions on Reimbursements May Limit Our Returns on Pharmaceutical Products.





Our future products are expected to include pharmaceutical products. Our ability and that of our collaborators to commercialize pharmaceutical products
developed with our technologies may depend in part on the extent to which reimbursement for the cost of these products will be available from government health administration authorities, private health insurers and other organizations. Third-party
payors are increasingly challenging the price of medical products and services. Significant uncertainty exists as to the reimbursement status of newly approved health care products, and there can be no assurance that adequate third party coverage
will be available for any product to enable us to maintain price levels sufficient to realize an appropriate return on our investment in research and product development.





Destructive Actions By Activists or Terrorists Could Damage Our Facilities, Interfere with Our Research Activities and Cause Ecological Harm. Any Such Adverse Events Could Damage Our Ability to Develop Products and
Generate Adequate Revenue to Continue Operations.





Activists and terrorists have recently shown a willingness to damage
physical facilities, equipment and biological materials to publicize and/or further their ideological causes. Recent events in New York City and Washington, D.C. show that the amount of damage people are willing and able to cause can be
considerable. Our operations and research activities could be adversely impacted depending upon the nature and extent of such acts. Such damage could include disability or death of our personnel, damage to our physical facilities, destruction of
animals and biological materials, disruption of our communications and/or data management software used for research and/or destruction of research records. Any such damage could delay our research projects and decrease our ability to conduct future
research and development. Damage caused by activist and/or terrorist incidents could also cause the release of hazardous materials, including chemicals, radioactive and biological materials, which could damage our reputation in the community. Clean
up of any such releases could also be time consuming and costly.





Any significant interruptions in our ability to conduct our
business operations or research and development activities could reduce our revenue and increase our expenses.





We Use Hazardous Chemicals and
Radioactive and Biological Materials in Our Business. Any Claims Relating to Improper Handling, Storage or Disposal of These Materials Could Be Time Consuming and Costly.





Our research and development processes involve the controlled use of hazardous materials, including chemicals, radioactive and biological materials. Some of these materials may be novel,
including viruses with




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novel properties and animal models for the study of viruses. Our operations also produce hazardous waste products. Some of our work also involves the development of novel viruses and viral animal
models. We cannot eliminate the risk of accidental contamination or discharge and any resultant injury from these materials. Federal, state and local laws and regulations govern the use, manufacture, storage, handling and disposal of these
materials. We believe that our current operations comply in all material respects with these laws and regulations. We could be subject to civil damages in the event of an improper or unauthorized release of, or exposure of individuals to, hazardous
materials. In addition, claimants may sue us for injury or contamination that results from our use or the use by third parties of these materials, and our liability may exceed our total assets. Compliance with environmental laws and regulations may
be expensive, and current or future environmental regulations may impair our research, development, or production efforts. We believe that our current operations comply in all material respects with applicable Environmental Protection Agency
regulations.





In addition, certain of our collaborators are working with these types of hazardous materials in connection with
our collaborations. To our knowledge, the work is performed in accordance with biosafety regulations. In the event of a lawsuit or investigation, we could be held responsible for any injury caused to persons or property by exposure to, or release
of, these viruses and hazardous materials. Further, under certain circumstances, we have agreed to indemnify our collaborators against damages and other liabilities arising out of development activities or products produced in connection with these
collaborations.





Our Collaborations With Outside Scientists May Be Subject to Change, Which Could Limit Our Access to Their Expertise.





We work with scientific advisors, consultants and collaborators at academic and other institutions. These scientists are
not our employees and may have other commitments that could limit their availability to us. Although our scientific advisors generally agree not to do competing work, if a conflict of interest between their work for us and their work for another
entity arises, we may lose their services. Although our scientific advisors and collaborators sign agreements not to disclose our confidential information, it is possible that certain of our valuable proprietary knowledge may become publicly known
through them.





We May Be Sued for Product Liability.





We may be held liable if any product we develop, or any product that is made with the use or incorporation of any of our technologies, causes injury or is found otherwise unsuitable during product testing,
manufacturing, marketing or sale. These risks are inherent in the development of chemical, agricultural and pharmaceutical products. Although we intend in the future to obtain product liability insurance, we do not have such insurance currently. Any
such insurance that we seek to obtain may be prohibitively expensive or may not fully cover our potential liabilities. Inability to obtain sufficient insurance coverage at an acceptable cost or otherwise to protect against potential product
liability claims could prevent or inhibit the commercialization of products developed by us or our collaborators. If we are sued for any injury caused by our products, our liability could exceed our total assets.





Our Stock Price Has Been, and May Continue to Be, Extremely Volatile.





The trading prices of life science company stocks in general, and ours in particular, have experienced extreme price fluctuations in the last two years. The valuations of many life science companies without consistent
product revenues and earnings, including ours, are high based on conventional valuation standards such as price to earnings and price to sales ratios. These trading prices and valuations may not be sustained. Any negative change in the publics
perception of the prospects of biotechnology or life science companies could depress our stock price regardless of our results of operations. Other broad market and industry factors may decrease the trading price of our common stock, regardless of
our performance. Market fluctuations, as well as general political and economic conditions such as recession or interest rate or currency rate fluctuations, also




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may decrease the trading price of our common stock. In addition, our stock price could be subject to wide fluctuations in response to factors including the following:





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




| | · |  | changes in financial estimates by securities analysts;
| | - |  | ------------------------------------------------------




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




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




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




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




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




| | · |  | period-to-period fluctuations in our operating results;
| | - |  | -------------------------------------------------------




| | · |  | future royalties from product sales, if any, by our strategic partners; and
| | - |  | ---------------------------------------------------------------------------




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




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





In December 2001 a lawsuit was filed in the U.S. District Court for the Southern District of New York against Maxygen, our chief executive officer, Russell Howard, and our then chief
financial officer (now president), Simba Gill, together with certain underwriters of our initial public offering and secondary public offering of common stock. The complaint, which alleges claims under Sections 11, 12(a)(2) and 15 of the Securities
Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934, is among the so-called laddering cases that have been commenced against a number of companies that had public offerings of securities prior to December 2000. The
complaint has been consolidated with other laddering claims in a proceeding styled In re Initial Public Offering Securities Litigation, No. 21 MC 92 (SAS), pending before the Honorable Shira A. Scheindlin. We believe the lawsuit against
Maxygen and its officers is without merit and intend to defend against it vigorously.





We Expect that Our Quarterly Results of Operations Will
Fluctuate, and This Fluctuation Could Cause Our Stock Price to Decline.





Our quarterly operating results have fluctuated in
the past and are likely to do so in the future. These fluctuations could cause our stock price to fluctuate significantly or decline. Some of the factors that could cause our operating results to fluctuate include:





| | · |  | expiration of research contracts with collaborators or government research grants, which may not be renewed or replaced;
| | - |  | ------------------------------------------------------------------------------------------------------------------------




| | · |  | the success rate of our discovery efforts leading to milestones and royalties;
| | - |  | ------------------------------------------------------------------------------




| | · |  | the timing and willingness of collaborators to commercialize our products, which would result in royalties; and
| | - |  | ---------------------------------------------------------------------------------------------------------------




| | · |  | general and industry specific economic conditions, which may affect our collaborators research and development expenditures.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------



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A large portion of our expenses are relatively fixed, including expenses for facilities,
equipment and personnel. Accordingly, if revenues decline or do not grow as anticipated due to expiration of research contracts or government research grants, failure to obtain new contracts or other factors, we may not be able to correspondingly
reduce our operating expenses. Failure to achieve anticipated levels of revenues could therefore significantly harm our operating results for a particular fiscal period.





Due to the possibility of fluctuations in our revenues and expenses, we believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future
performance. Our operating results in some quarters may not meet the expectations of stock market analysts and investors. In that case, our stock price would likely decline.





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





Our executive officers, directors and principal stockholders together control approximately 35% of our outstanding common stock, including GlaxoSmithKline plc, which owns approximately
19% of our outstanding common stock. As a result, these stockholders, if they act together, and GlaxoSmithKline plc by itself, are able to exert a significant degree of influence over our management and affairs and over matters requiring stockholder
approval, including the election of directors and approval of significant corporate transactions. In addition, this concentration of ownership may delay or prevent a change in control of Maxygen and might affect the market price of our common stock,
even when a change may be in the best interests of all stockholders. In addition, the interests of this concentration of ownership may not always coincide with our interests or the interests of other stockholders and accordingly, they could cause us
to enter into transactions or agreements that we would not otherwise consider.





Item 2    PROPERTIES





We lease an aggregate of 78,460 square feet of office and
laboratory facilities in Redwood City, California. Our leases expire on February 24, 2005 with respect to 59,390 square feet, on April 21, 2005 with respect to 7,912 square feet and on December 10, 2003 with respect to 11,158 square feet.





We lease an aggregate of 25,783 square feet of office and laboratory facilities in Horsholm, Denmark. Our lease expires on
October 31, 2010 but can be earlier terminated by us as of October 31, 2005.





We believe that our existing facilities are adequate to meet our needs for the immediate future and future growth can be accommodated by leasing additional or alternative space.





Item 3    LEGAL PROCEEDINGS





In December 2001 a lawsuit was filed in the U.S.
District Court for the Southern District of New York against Maxygen, our chief executive officer, Russell Howard, and our then chief financial officer (now president), Simba Gill, together with certain underwriters of our initial public offering
and secondary public offering of common stock. The complaint, which alleges claims under Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934, is among the so-called
laddering cases that have been commenced against a number of companies that had public offerings of securities prior to December 2000. The complaint has been consolidated with other laddering claims in a proceeding styled In re
Initial Public Offering Securities Litigation, No. 21 MC 92 (SAS), pending before the Honorable Shira A. Scheindlin. We believe the lawsuit against Maxygen and its officers is without merit and intend to defend against it vigorously.





We are not currently a party to any other material pending legal proceedings.





Item 4    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS





There were no
submissions of matters to a vote of security holders during the fourth quarter ended December 31, 2001.




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PART II





Item 5    MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS





Price Range of
Common Stock





Our common stock has been traded on the Nasdaq National Market since our initial public offering on December
16, 1999 under the symbol MAXY. Before such time, there was no public market for our common stock. During the last two fiscal years, through December 31, 2001, the high and low sale prices for our common stock, as reported on the Nasdaq National
Market, were as follows:





High

LowYear ended December 31, 2000First Quarter

$
186.00

$
52.00Second Quarter


80.00


34.00Third Quarter


80.06


40.06Fourth Quarter


53.00


22.00Year ended December 31, 2001First Quarter

$
25.38

$
9.75Second Quarter


22.00


10.50Third Quarter


19.60


11.65Fourth Quarter


22.53


11.41





On March 20, 2001 the last reported sale price of our common stock on the Nasdaq
National Market was $12.01 per share. On March 19, 2001, there were approximately 389 holders of record of our common stock.





Dividend Policy





We have never declared or paid any cash dividends on our capital stock. We currently intend to retain future earnings, if
any, for development of our business and, therefore, do not anticipate that we will declare or pay cash dividends on our capital stock in the foreseeable future.





Recent Sales of Unregistered Securities





We made the following unregistered sales of our securities during the
year ended December 31, 2001 that have not already been reported in an earlier quarterly report:





| | (i) |  | On September 1, 2001 we issued 8,399 shares of our common stock, and on December 1, 2001 we issued 6,979 shares of our common stock, in each case to a licensor in partial
payment for licenses of technology granted to us.
| | --- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | (ii) |  | Between September 30, 2001 and December 31, 2001 we issued a total of 2,776 shares of our common stock to four consultants in partial payment for consulting services rendered
to us.
| | ---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




There were no underwriters employed in connection with any of the transactions set forth above. The
issuances of securities described above were deemed to be exempt from registration under the Securities Act of 1933, as amended (the Securities Act) in reliance on Section 4(2) of the Securities Act and Regulation D promulgated
thereunder as transactions by an issuer not involving a public offering. The recipients of the securities in each such transaction represented their intention to acquire the securities for investment only and not with a view to or for sale in
connection with any distribution thereof and appropriate legends were affixed to the share certificates issued in such transactions. The recipients either received adequate information about us or had access, through employment or other
relationships, to such information. The recipients were knowledgeable, sophisticated and experienced in making investment decisions of this kind and received adequate information about us.




40




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Application of Initial Public Offering Proceeds





The effective date of our first registration statement, filed on Form S-1 under the Securities Act (No. 333-89413) relating to our initial public offering of common stock, was
December 15, 1999. Net proceeds to us were approximately $101.0 million. From the effective date through December 31, 2001, the proceeds were applied toward:





| | · |  | purchases and installation of equipment and build-out of facilities, $15.9 million;
| | - |  | -----------------------------------------------------------------------------------




| | · |  | repayment of indebtedness, $705,000;
| | - |  | ------------------------------------




| | · |  | working capital, $28.3 million; and
| | - |  | -----------------------------------




| | · |  | temporary investments in certificates of deposits, mutual funds and corporate debt securities, $56.0 million.
| | - |  | -------------------------------------------------------------------------------------------------------------




The use of the proceeds from the offering does not represent a material change in the use of the proceeds described in the registration statement.




41




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Item 6    SELECTED FINANCIAL DATA





The following selected financial information is
derived from our audited consolidated financial statements. When you read this selected financial data, it is important that you also read the historical financial statements and related notes included in this report, as well as the section of this
report entitled Managements Discussion and Analysis of Financial Condition and Results of Operations. Historical results are not necessarily indicative of future results. See Note 9 of Notes to Consolidated Financial Statements for
information concerning the deemed dividend upon issuance of convertible preferred stock in August 1999.





Year Ended December 31,1997


1998


1999


2000


2001(in thousands, except per share data)Consolidated Statement of Operations Data:Collaborative research and development revenue

$
341


$
1,077


$
8,895


$
13,299


$
25,100Grant revenue






1,646



5,122



11,166



5,428Total revenues


341



2,723



14,017



24,465



30,528Operating expenses:Research and development


2,757



7,207



16,094



38,534



54,044General and administrative


915



3,010



4,998



12,486



13,567Stock compensation expense


863



1,561



5,656



15,981



12,017Acquired in-process research and development(1)














28,959



Amortization of intangible assets














3,419



8,726Total operating expenses


4,535



11,778



26,748



99,379



88,354Loss from operations


(4,194
)


(9,055
)


(12,731
)


(74,914
)


(57,826
)Net interest income


161



229



1,413



15,329



12,862Net loss


(4,033
)


(8,826
)


(11,318
)


(59,585
)


(44,964
)Deemed dividend upon issuance of convertible preferred stock










(2,200
)






Net loss attributable to common stockholders

$
(4,033
)

$
(8,826
)

$
(13,518
)

$
(59,585
)

$
(44,964
)Basic and diluted net loss per share

$
(0.82
)

$
(1.31
)

$
(1.53
)

$
(1.96
)

$
(1.38
)Shares used in computing basic and diluted net loss per share


4,917



6,748



8,854



30,339



32,610





December 31,1997


1998


1999


2000


2001(in thousands)Consolidated Balance Sheet Data:Cash, cash equivalents and investments

$
2,693


$
15,306


$
136,343


$
258,015


$
234,877Working capital


2,152



12,264



132,510



216,388



195,923Total assets


3,154



17,600



145,578



301,699



277,418Non-current portion of equipment financing










1,644



1,295



673Accumulated deficit


(4,033
)


(12,859
)


(24,177
)


(83,762
)


(128,726
)Total stockholders equity


2,571



11,700



133,716



282,198



253,734


---

|(1) |  | Acquired in-process research and development related to the acquisition of Maxygen ApS and a privately held California corporation. See Notes 11 and 12 of the Notes to
Consolidated Financial Statements.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



42




---

Quarterly Financial Data


(unaudited)





Quarter EndedMarch 31,


June 30,


Sept. 30,


Dec. 31,(in thousands, except per share data)2001Collaborative research and development revenue

$
5,025


$
5,972


$
6,384


$
7,719Grant revenue


1,905



1,704



1,026



793Total revenues


6,930



7,676



7,410



8,512Operating expenses:Research and development


12,696



13,031



13,468



14,849General and administrative


3,548



3,952



3,168



2,899Stock compensation expense


3,543



3,512



2,674



2,288Amortization of intangible assets


2,181



2,182



2,182



2,181Total operating expenses


21,968



22,677



21,492



22,217Loss from operations


(15,038
)


(15,001
)


(14,082
)


(13,705
)Net interest income


3,974



3,455



3,196



2,237Net loss

$
(11,064
)

$
(11,546
)

$
(10,886
)

$
(11,468
)Basic and diluted net loss per share

$
(0.34
)

$
(0.35
)

$
(0.33
)

$
(0.35
)Shares used in computing basic and diluted net loss per share


32,184



32,534



32,707



32,958Quarter EndedMarch 31,


June 30,


Sept. 30,


Dec. 31,(in thousands, except per share data)2000Collaborative research and development revenue

$
3,046


$
3,195


$
3,178


$
3,880Grant revenue


2,368



2,960



2,784



3,054Total revenues


5,414



6,155



5,962



6,934Operating expenses:Research and development


6,246



7,828



11,582



12,878General and administrative


2,013



2,842



2,881



4,750Stock compensation expense


4,911



3,192



2,767



5,111Acquired in-process research and development(1)






912



28,047



Amortization of intangible assets










1,847



1,572Total operating expenses


13,170



14,774



47,124



24,311Loss from operations


(7,756
)


(8,619
)


(41,162
)


(17,377
)Net interest income


2,116



4,275



4,415



4,523Net loss

$
(5,640
)

$
(4,344
)

$
(36,747
)

$
(12,854
)Basic and diluted net loss per share

$
(0.20
)

$
(0.14
)

$
(1.18
)

$
(0.40
)Shares used in computing basic and diluted net loss per share


28,062



30,188



31,165



31,942


---

|(1) |  | Acquired in-process research and development related to the acquisition of Maxygen ApS and a privately held California corporation. See Notes 11 and 12 of the Notes to
Consolidated Financial Statements.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



43




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Item 7    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND


RESULTS OF
OPERATIONS





The following Managements Discussion and Analysis of Financial Condition and Results of Operations
contains forward-looking statements that are based upon current expectations. These forward-looking statements fall within the meaning of the federal securities laws that relate to future events or our future financial performance. In some cases,
you can identify forward-looking statements by terminology such as may, can, will, should, expect, plan, anticipate, believe, estimate,
predict, intend, potential or continue or the negative of these terms or other comparable terminology. Forward-looking statements involve risks and uncertainties. Our actual results and the timing of
events could differ materially from those anticipated in our forward-looking statements as a result of many factors, including those set forth under Risk Factors That May Affect Results of Operations and Financial Condition and elsewhere
in this report.





Overview





Maxygen was founded in May 1996 and began operations in March 1997. To date, we have generated revenues from research collaborations with agriculture, pharmaceutical, petroleum, and chemical companies and from government grants. We have
strategic collaborations with leading companies including: Aventis Pasteur in novel vaccines; Celltech in antibodies; InterMune in next generation interferon gamma therapies; Lundbeck in interferon beta therapies for central nervous system diseases
and multiple sclerosis; ALK-Abelló in allergy; the International AIDS Vaccine Initiative (IAVI) in HIV; Pfizer and DSM in pharmaceutical manufacturing; and Shearwater Corporation in protein pharmaceutical PEGylation technologies.
Additionally, we have a range of other strategic alliances in industrial applications, as well as funding from U.S. government organizations including from the Defense Advanced Research Projects Agency, the National Institute of Standards and
Technology-Advanced Technology Program and the U.S. Agency for International Development.





Revenue under strategic alliances and
government grants increased from $14.0 million in 1999 to $24.5 million in 2000 and was $30.5 million in 2001. Revenues may fluctuate from period to period and there can be no assurance that these collaborations will continue for their initial
term or beyond.





We have incurred significant losses since our inception. As of December 31, 2001, our accumulated deficit was
$128.7 million and total stockholders equity was $253.7 million. We have invested heavily in establishing our proprietary technologies. These investments have contributed to the increases in operating expenses from $26.7 million in 1999 to
$70.4 million in 2000 (excluding $29.0 million of acquired in-process research and development expense) and $88.4 million in 2001. Our total headcount increased from 143 employees at the end of 1999 to 252 employees at the end of 2000. As of
December 31, 2001 we had 305 employees, of whom 85% were engaged in research and development. We expect to incur additional operating losses over at least the next several years as we continue to expand our research and development efforts and
infrastructure.





On August 10, 2000, we completed our acquisition of Maxygen ApS, a Danish biotechnology company located in
Copenhagen, Denmark. Maxygen ApS is focused on the development of improved second-generation protein pharmaceutical products and has developed broad pre-clinical development capabilities and proprietary technologies and expertise that help to
address traditional shortcomings of protein pharmaceuticals such as half-life, stability and immunogenicity. The transaction was accounted for as a purchase. We issued 1,102,578 shares of our common stock and granted options to purchase an aggregate
of 41,812 shares of our common stock in connection with the acquisition of all the equity securities of Maxygen ApS. Of the 1,102,578 shares of common stock issued, 228,766 shares were issued with repurchase rights that lapse over a three year term.
The consideration, including liabilities assumed of $5.5 million and estimated acquisition costs of $1.0 million, aggregated $71.8 million, of which $3.0 million was allocated to tangible assets, $28.0 million to acquired in-process research and
development, $14.6 million to deferred compensation, $3.5 million to core technology, $705,000 to assembled workforce and $22.0 million to goodwill. The results of operations of Maxygen ApS are included in our operating results after August 10,
2000.




44




---




Critical Accounting Policies and Estimates





General





The consolidated financial statements are
prepared in accordance with accounting principles generally accepted in the United States that require us to make estimates and assumptions (see Note 1 of Notes to the Consolidated Financial Statements). We believe the following critical accounting
policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.





Goodwill and Intangible Impairment





In connection with the Maxygen ApS acquisition, we allocated $26.2 million
to goodwill and other intangible assets and amortize this goodwill and other intangible assets using the straight-line method over the assets estimated useful lives of three years, the term of expected benefit. We believed this term was
reasonable given that Maxygen ApS was a development stage entity and its technology was at an early stage of development and was yet unproven.





Goodwill and other intangible assets are generally evaluated on an individual acquisition or market basis whenever events or changes in circumstances indicate that such assets are impaired or the estimated useful
lives are no longer appropriate. If indicators of impairment exist, we will review our long-lived assets (including goodwill) for impairment based on estimated future discounted cash flows attributable to the assets and other factors to determine
the fair value of the respective assets. In the event such cash flows are not expected to be sufficient to recover the recorded value of the assets, the assets are written down to their estimated fair values. No impairment charges have been recorded
in 2000 or in 2001.





In June 2001, the Financing Accounting Standard Board issued Statement of Financial Accounting Standards
No. 141, Business Combinations and No. 142, Goodwill and Other Intangible Assets, effective for the fiscal years beginning after December 15, 2001. Under the new rules, goodwill will no longer be amortized but will be subject
to annual impairment tests in accordance with Statement No. 142. Other intangible assets will continue to be amortized over the useful lives.





We will apply the new rules on accounting for goodwill and other intangible assets beginning in the first quarter of 2002. Application of the nonamortization provisions of Statement No. 142 is expected to result in a
decrease in net loss of $7.6 million in 2002 and $4.6 million in 2003. During 2002, we will perform the first of the required impairment tests of goodwill and indefinite-lived intangible assets as of January 1, 2002 and have not yet determined what
the effect of these tests will be on the earnings and our financial position.





Source of Revenue and Revenue Recognition
Policy





We recognize revenues from research collaboration agreements as earned upon achievement of the performance
requirements of the agreements. Our existing corporate collaboration agreements generally provide for research funding for a specified number of full time equivalent researchers working in defined research programs. Revenue related to these payments
is earned as the related research work is performed. In addition, these collaborators may make technology advancement payments that are intended to fund development of our core technology, as opposed to a defined research program. These payments are
recognized ratably over the applicable funding period. Payments received that are related to future performance are deferred and recognized as revenue as the performance requirements are achieved. As of December 31, 2001, we have deferred revenues
of approximately $12.5 million.





Revenue related to performance milestones is recognized based upon the achievement of the
milestones, as defined in the respective agreements. Payments received related to substantive, at-risk incentive milestones, if any, are recognized as revenue upon achievement of the incentive milestone event because we have no future performance
obligations related to the payment and we judge the event to be the culmination of a separate earnings process. Incentive milestone payments are triggered either by the results of our research efforts




45




---

or by events external to Maxygen, such as regulatory approval to market a product. Royalties are recorded as earned in accordance with the contract terms when third party results are reliably
measured and collectibility is reasonably assured.





Revenue related to grant agreements with various government agencies is
recognized as related research and development expenses are incurred. We recognize revenue related to these grant agreements as the related research and development expenses are incurred, and when these research and development expenses are within
the prior approved funding amounts or collectibility is reasonably assured because we have received information regarding additional funding authorizations. Certain grant agreements provide an option for the government to audit the amount of
research and development expenses, both direct and indirect, that have been submitted to the government agency for reimbursement. We believe the overhead rates we used to calculate our indirect research and development expenses are within the
contractual guidelines of allowable costs and are reasonable estimates of our indirect expenses incurred through the term of the agreement.





Our sources of potential revenue for the next several years are likely to be license, research, technology advancement and milestone payments under existing and possible future collaborative arrangements, government
research grants, and royalties from our collaborators based upon revenues received from any products commercialized under those agreements. See Note 3 of Notes to Consolidated Financial Statements.





Deferred Compensation





Deferred compensation for
options granted to employees has been determined as the difference between the deemed fair market value for financial reporting purposes of our common stock on the date the applicable options were granted and the exercise price. Deferred
compensation for options granted to consultants has been determined in accordance with Statement of Financial Accounting Standards No. 123 and EITF 96-18 as the fair value of the equity instruments issued. Compensation for related options granted to
consultants is periodically remeasured as the underlying options vest.





In connection with the grant of stock options to
employees before our initial public offering, we recorded deferred stock compensation of approximately $2.4 million in 1998 and $19.5 million in 1999. These amounts were initially recorded as a component of stockholders equity and are being
amortized as charges to operations over the vesting period of the options using a graded vesting method. We recognized stock compensation expense related to the deferred compensation amortization on these option grants of approximately $2.5 million
in 1999, $3.7 million in 2000 and $2.5 million in 2001, which were included in research and development expense, and approximately $2.4 million in 1999, $4.1 million in 2000 and $2.3 million in 2001, which were included in general and administrative
expense.





In connection with the grant of stock options to consultants, we recorded stock compensation expense of $714,000 in
1999, $2.6 million in 2000 and $256,000 in 2001, which were included in research and development expense, and $68,000 in 1999, $407,000 in 2000 and $50,000 in 2001, which were included in general and administrative expense. Due to the acceleration
of executive stock option awards, an additional $1.6 million stock compensation expense included in research and development expense was recorded in 2000.





In connection with the Maxygen ApS acquisition in August 2000, stock options were granted in exchange for outstanding warrants to purchase Maxygen ApS securities. In connection with this exchange we recorded aggregate
deferred compensation totaling $1.5 million. This amount is being amortized over the remaining vesting period of the options, of which $298,000 was expensed in 2000 and $714,000 in 2001. For the shares exchanged that had a right of repurchase,
deferred compensation of $13.1 million was recorded. This amount is being amortized to expense over a three-year graded vesting period. A total of $3.3 million was recognized as expense in 2000 and $6.2 million in 2001.




46




---




Results of Operations





Revenues





Our total revenues increased from $14.0 million in 1999, to $24.5 million in
2000 and to $30.5 million in 2001. The increase in collaborative research and development revenue was due to additional strategic alliances and the expansion of existing alliances. The increase in grant revenue from 1999 to 2000 is due to additional
grants from the government. The decline in grant revenue from 2000 to 2001 reflects the expiration of five government grants that began in late 1997, early 1998 and early 1999. We expect our total revenues to increase in 2002 as new projects are
initiated under existing collaboration agreements and as new collaboration arrangements are consummated.





Revenues for each
operating segment are derived from our research collaboration agreements and government research grants and are categorized based on the industry of the product or technology under development.





Year Ended December 31,1999

2000

2001Human Therapeutics

$
3,811

$
9,295

$
12,403Chemicals


2,613


4,782


7,315Agriculture


7,593


10,388


10,810Total Revenue

$
14,017

$
24,465

$
30,528





The increase in revenue for each segment was due to additional strategic
alliances and the expansion of existing alliances as well as additional government research grants.





Research and Development
Expenses





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





The table below lists our major collaborative partners, defined as those contributing greater than 10% of total
collaborative research revenue in 2001, for whom we conducted research and development, together with the date upon which the funded research term of the contract is scheduled to end. Contracts may only be extended by mutual agreement between
Maxygen and the collaborative partner.





Collaborator

Funded Research EndsPartner A

December 23, 2003Partner B

June 18, 2004Partner C

September 18, 2003





We do not track fully burdened research and development costs or capital
expenditures by project. However, we estimate based on full-time equivalent (FTE) effort, that approximately 63% in 1999, 55% in 2000 and 50% in 2001 of research and development efforts (as measured in hours incurred) were undertaken for
collaborative projects funded by our collaborators and government grants, and approximately 37% in 1999, 45% in 2000 and 50% in 2001 of research effort was on our own internally funded research projects. Due to the nature of our research and our
dependence on our collaborative partners to commercialize the results of the research, we cannot predict with any certainty whether any particular collaboration or research effort will ultimately result in a commercial product and therefore whether
we will receive future milestone payments or royalty payments under our various collaborations.




47




---




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





Our research and development expenses consist primarily of
salaries and other personnel-related expenses, facility costs, supplies and depreciation of facilities and laboratory equipment. Research and development expenses increased from $19.3 million in 1999, to $50.0 million in 2000 and to $63.7 million in
2001. Included in research and development expenses is stock compensation expense of $3.2 million in 1999, $11.5 million in 2000 and $9.6 million in 2001. The increase is primarily due to our accelerated efforts in all aspects of research and
development, including increased expenditures resulting from our acquisition of Maxygen ApS in August 2000, as well as investments in our technology platform and in the development of product candidates.





Research and development expenses represented 137% of total revenues in 1999, 204% of total revenues in 2000 and 209% in 2001. The increases between
periods was primarily due to increased staff necessary to manage and support our growth plus increased research and development costs resulting from our acquisition of Maxygen ApS and new collaboration agreements. This is offset in part by the
growth in our total revenues.





We expect research and development costs to increase during 2002 as new projects are initiated
under existing collaboration agreements and as new collaboration arrangements are consummated. We expect to continue to devote substantial resources to research and development, and we expect that research and development expenses will continue to
increase in absolute dollars for at least the next several years. The acquisition of Maxygen ApS and subsequent on-going operations has significantly increased our research and development expenses in absolute dollars.





General and Administrative Expenses





Our general and administrative expenses consist primarily of personnel costs for finance, human resources, business development, legal and general management, as well as professional expenses, such as legal and
accounting. General and administrative expenses have increased from $7.5 million in 1999 to $17.0 million in 2000 and decreased to $16.0 million in 2001. Included in general and administrative expenses is stock compensation expense of $2.5 million
in 1999, $4.5 million in 2000 and $2.4 million in 2001. The increases in total general and administrative expenses from 1999 to 2000 was primarily due to increased staffing necessary to manage and support our growth and increased costs associated
with being a public company. The decrease in total general and administrative expenses from 2000 to 2001 was primarily due to lower stock compensation expense.





General and administrative expenses represented 53% of total revenues in 1999, 71% of total revenues for 2000 and 52% of total revenues for 2001. The increase from 1999 to 2000 was primarily due to increased staffing
necessary to manage and support our growth and increased costs associated with being a public company. The decrease from 2000 to 2001 was due primarily to the growth in our total revenue between
periods.




48




---

We expect that our general and administrative expenses will increase in absolute dollar amounts for at least the next several years as
we increase staff and add infrastructure and as a result of increased professional fees and insurance premiums. We expect that general and administrative expenses as a percentage of total revenue will continue to decrease as our revenues increase
and research and development activities expand more quickly than our general and administrative expenses.





In-Process
Research and Development





On May 8, 2000, we acquired certain in-process technology through the acquisition of a privately
held California corporation. In connection with the acquisition we issued 39,600 shares of our common stock. Pursuant to the terms of the acquisition agreement, 18,500 shares of our common stock are being held in escrow until such time contingencies
regarding the patents related to the acquired technology are resolved. Accordingly, we recorded a charge for acquired in-process research and development of $912,000 representing the fair value of the 21,100 shares delivered to the sellers at
closing, plus certain transaction expenses. Shares in escrow will be valued and accounted for when, and if, the contingencies are resolved and the shares are delivered to the sellers. As opportunities present themselves, we intend to continue to
acquire new technologies and companies. Such acquisitions could lead to additional direct and indirect expenses that could negatively affect our results of operations.





On August 10, 2000, we acquired Maxygen ApS for total consideration of approximately $71.8 million, including $5.5 million for the assumption of liabilities and $1.0 million for
estimated acquisition costs. Prior to the acquisition, Maxygen ApS was a Danish privately-held, development-stage company that had minimal revenues since its inception in April 1999. Maxygen ApS is focused on the development of improved
second-generation protein pharmaceutical products and has developed broad pre-clinical development capabilities and proprietary technologies and expertise that help to address traditional shortcomings of protein pharmaceuticals such as half-life,
stability and immunogenicity. Approximately $28.0 million of the total purchase price represented the value of in-process research and development projects that are at a pre-clinical stage of development, had not yet reached technological
feasibility, and had no alternative future use. This amount was charged to our operations in the third quarter ended September 30, 2000. The acquisition was accounted for under the purchase method of accounting. Accordingly, the results of
operations of Maxygen ApS are included in the consolidated financial statements from August 10, 2000. See Note 12 of Notes to Consolidated Financial Statements.





The $28.0 million in-process research and development charge represents the value determined by an independent appraiser, using a discounted cash flow methodology, to be attributable to
the six pre-clinical stage in-process research and development projects of Maxygen ApS based on a valuation analysis of such research and development. In-process technology was expensed upon acquisition as technological feasibility had not been
established and no alternative future uses existed. To value the in-process technology we considered, among other factors, the stage of development of each project, the time and resources needed to complete each project, expected income and
associated risks. Associated risks included the inherent difficulties and uncertainties in completing the project, in obtaining regulatory approval to market, and the risks related to the viability of and potential changes to future target markets.
The charge relates to specific on-going research and development. Management of Maxygen believes that the allocation of the purchase price to in-process research and development was appropriate given the future potential of this research and
development to contribute to the operations of Maxygen. Assuming this research continues through all stages of clinical development, we project substantial future research and development expenditures related to this technology.





We continue to fund and develop the in-process research and development projects acquired through Maxygen ApS. There can be no assurances
that the in-process projects acquired will achieve technological feasibility or that we will be able to successfully market products based on such technology. Should these in-process projects fail, the value of our investment in these incomplete
technologies would be insignificant or zero. A failure to successfully develop and market these products could have a material adverse affect on our business and financial condition and could also result in an impairment charge to goodwill.




49




---




As opportunities present themselves, we intend to acquire new technologies and companies; such
acquisitions could lead to additional direct and indirect expenses that could negatively affect our results of operations.





Goodwill and Other Intangible Assets





In connection with the Maxygen ApS acquisition, we allocated $26.2 million
to goodwill and other intangible assets and will amortize this goodwill and other intangible assets over three years. Amortization expense of $3.4 million in 2000 and $8.7 million in 2001 was recorded on goodwill and other intangible assets.





Net Interest Income





Net interest income represents income earned on our cash, cash equivalents and marketable securities net of interest expense. Net interest income increased from $1.4 million in 1999 to $15.3 million in 2000 and
decreased to $12.9 million in 2001. The increase from 1999 to 2000 was due to higher average balances of cash, cash equivalents and marketable securities as a result of our public offerings in December 1999 and March 2000. The decrease from 2000 to
2001 was due to lower average balances of cash, cash equivalents and marketable securities and decreased interest rates.





Provision for Income Taxes





We incurred net operating losses in 1999, 2000 and 2001, and consequently did not
pay any U.S. federal or state income taxes. As of December 31, 2001, we had net operating loss carryforwards for federal income tax purposes of approximately $38 million, which expire in the years 2012 through 2021 and federal research and
development tax credits of approximately $1.4 million, which expire in the years 2012 through 2021.





Utilization of our net
operating losses and credits may be subject to substantial annual limitation due to the ownership change limitations provided by the Internal Revenue Code of 1986, as amended, and similar state provisions. Such an annual limitation could result in
the expiration of the net operating losses and credits before utilization. See Note 10 of Notes to Consolidated Financial Statements.





New Accounting
Pronouncements





In October 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards
No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (Statement 144), which addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supersedes Statement 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, and the accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of Operations for a disposal of a segment of a
business. Statement 144 is effective for fiscal years beginning after December 15, 2001. We will adopt Statement 144 as of January 1, 2002 and do not expect that the adoption of the Statement will have a significant impact on our financial
position and results of operations.





Liquidity and Capital Resources





Since inception, we have financed our operations primarily through private placements and public offerings of equity securities, receiving aggregate consideration from such sales
totaling $302.5 million and research and development funding from collaborators and government grants totaling approximately $139.2 million. As of December 31, 2001, we had $234.9 million in cash, cash equivalents and investments.





Our operating activities used cash of $3.0 million in 1999, $12.8 million in 2000 and $15.1 million in 2001. Uses of cash in operating
activities were primarily to fund net operating losses.




50




---




Net cash used in investing activities was $4.5 million in 1999, $151.1 million in 2000 and
$49.1 million in 2001. The cash used during 2000 and 2001 primarily represented purchases of available-for-sale securities. This was partially offset by the maturities and sale of available-for-sale securities.





Additions of property and equipment were $4.5 million in 1999, $5.4 million in 2000 and $10.6 million in 2001. The increase is primarily due to the
expansion of our offices and laboratories in Redwood City, CA as well as new equipment purchased at Maxygen ApS. We expect to continue to make significant investments in the purchase of property and equipment to support our expanding operations. We
may use a portion of our cash to acquire or invest in complementary businesses, products or technologies, or to obtain the right to use such complementary technologies.





Financing activities provided cash of $128.6 million in 1999, $139.0 million in 2000 and $1.3 million in 2001. The 1999 amount primarily consists of the net proceeds we received from the
sale of common stock in our initial public offering in December 1999. The 2000 amount primarily consists of the net proceeds received from the sale of common stock in a public offering in March 2000. The cash provided in 2001 was primarily from the
proceeds of the sale of common stock in connection with our Employee Stock Purchase Plan and the exercise of stock options by employees. This was partially offset by payments on equipment financing obligations of $533,000.





The following are contractual commitments at December 31, 2001 associated with debt and lease obligations (in thousands):





Payments Due by PeriodContractual Commitment

Total

1 year

2-3 years

4-5 yearsOperating Leases

$
15,440

$
4,711

$
9,455

$
1,274Long-Term Debt


1,295


622


673


Total Contractual Commitments

$
16,735

$
5,333

$
10,128

$
1,274





Assuming our research efforts for existing collaborations are expended for the
full research term, as of December 31, 2001 we have total committed funding of approximately $139 million, of which approximately $106 million is from our collaborators and $33 million is from government funding. Of these committed funds, we have
approximately $59 million remaining to be received over the next three years. In addition, potential milestone payments from our existing collaborations could exceed $300 million based on the accomplishment of specific performance criteria, and we
may earn royalties on product sales. In general, the obligation of our corporate collaborators to provide research funding cannot be terminated by either party before the end of the research term unless there has been a material breach of contract
or either party has become bankrupt or insolvent. In the case of such an event, the agreement specifies the rights, if any, that each party will retain.





We believe that our current cash, cash equivalents, short-term investments and long-term investments together with funding received from collaborators and government grants will be sufficient to satisfy our
anticipated cash needs for working capital and capital expenditures for at least the next 12 months. However, it is possible that we will seek additional financing within this timeframe. We may raise additional funds through public or private
financing, collaborative relationships or other arrangements. Additional funding, if sought, may not be available on terms favorable to us. Further, any additional equity financing may be dilutive to stockholders, and debt financing, if available,
may involve restrictive covenants. Our failure to raise capital when needed may harm our business and operating results.




51




---




Item 7A    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK


We are exposed to financial market risks, including
changes in interest rates and foreign currency exchange. To mitigate some of these risks, we utilize currency forward contracts. We do not use derivative financial instruments for speculative or trading purposes.





Interest Rate Risk





The primary objective of our
investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. To achieve this objective, we maintain our portfolio of cash equivalents, short-term and long-term investments in a
variety of securities, including corporate obligations and money market funds. All securities are held in U.S. currency. As of December 31, 2001, approximately 88% of our total portfolio will mature in one year or less, with the remainder maturing
in less than two years.





The following table represents the fair value balance of our cash, cash equivalents, short-term and
long-term investments that are subject to interest rate risk by year of expected maturity and average interest rates as of December 31, 2001 (dollars in thousands):





Expected Maturity2001


2002Cash and cash equivalents

$
48,388



Average interest rates


2.36
%


Short-term investments

$
157,557



Average interest rates


4.35
%


Long-term investments





$
28,932Average interest rates






4.62
%





We did not hold derivative instruments intended to mitigate interest rate risk as
of December 31, 2001, and we have never held such instruments in the past. If market interest rates were to increase by 100 basis points, or 1%, from December 31, 2001 levels, the fair value of our portfolio would decline by approximately $2.6
million. The modeling technique used measures the change in fair values arising from an immediate hypothetical shift in market interest rates and assumes ending fair values include principal plus accrued interest. In addition, we had outstanding
debt related to equipment financing of $1.3 million as of December 31, 2001, with a range of interest rates of between 11.73% and 12.78%.





Foreign
Currency Exchange Risk





A majority of our revenue, expense and capital purchasing activities are transacted in U.S. dollars.
However, in 2000 we acquired a wholly-owned subsidiary in Denmark, Maxygen ApS. The functional currency of Maxygen ApS is the Danish kroner. To protect against reductions in value and the volatility of future cash flows caused by changes in foreign
exchange rates, we have established a cash flow hedging program. Currency forward contracts are utilized in these hedging programs. Our hedging programs reduce, but do not always eliminate, the impact of foreign currency exchange rate movements.
Gains and losses on these foreign currency investments would generally be offset by corresponding losses and gains on the related hedging instruments, resulting in negligible net exposure to Maxygen. At December 31, 2001 we had no foreign currency
cash flow forward contracts outstanding.




52




---

Item 8     FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA





REPORT OF ERNST & YOUNG LLP,
INDEPENDENT AUDITORS





The Board of Directors and Stockholders  Maxygen, Inc.





We have audited the accompanying consolidated balance sheets of Maxygen, Inc. as of December 31, 2000 and 2001, and the related consolidated statements of operations, stockholders
equity, and cash flows for each of the three years in the period ended December 31, 2001. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements
based on our audits.





We conducted our audits in accordance with auditing standards generally accepted in the United States.
Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.





In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Maxygen, Inc. at December 31, 2000 and 2001, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2001
in conformity with accounting principles generally accepted in the United States.





| | /s/ | ERNST &YOUNG LLP
| | --- | ----------------




Palo Alto, California  February 1, 2002




53




---

MAXYGEN, INC.





CONSOLIDATED BALANCE SHEETS


(in thousands, except share and per share data)





December 31,2000


2001ASSETSCurrent assets:Cash and cash equivalents

$
111,374


$
48,388Short-term investments


110,805



157,557Grant and other receivables


8,425



7,300Prepaid expenses and other current assets


1,180



2,279Total current assets


231,784



215,524Property and equipment, net


9,916



17,340Goodwill and other intangible assets, net of accumulated amortization of $3,419 and $12,145 at December 31, 2000 and 2001,
respectively


22,760



14,034Long-term investments


35,836



28,932Deposits and other assets


1,403



1,588Total assets

$
301,699


$
277,418LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable

$
2,143


$
3,398Accrued compensation


1,859



2,355Accrued legal expenses


935



815Deferred rent


342



937Other accrued liabilities


3,356



2,381Deferred revenue


6,228



9,093Current portion of equipment financing obligations


533



622Total current liabilities


15,396



19,601Deferred revenue


2,810



3,410Non-current portion of equipment financing obligations


1,295



673Commitments and contingenciesStockholders equity:Preferred stock, $0.0001 par value, 5,000,000 shares authorized, no shares issued and outstanding at December 31, 2000 and
2001






Common stock, $0.0001 par value, 100,000,000 shares authorized, 33,576,736 and 34,026,414 shares issued and outstanding at December
31, 2000 and 2001, respectively


3



3Additional paid-in capital


386,026



389,607Notes receivable from stockholders


(776
)


(339
)Deferred stock compensation


(19,880
)


(8,509
)Accumulated other comprehensive income


587



1,698Accumulated deficit


(83,762
)


(128,726
)Total stockholders equity


282,198



253,734Total liabilities and stockholders equity

$
301,699


$
277,418





See accompanying notes.




54




---




MAXYGEN, INC.





CONSOLIDATED STATEMENTS OF OPERATIONS


(in thousands, except share and per share data)





Year ended December 31,1999


2000


2001Collaborative research and development revenue

$
8,895


$
13,299


$
25,100Grant revenue


5,122



11,166



5,428Total revenues


14,017



24,465



30,528Operating expenses:Research and development


16,094



38,534



54,044General and administrative


4,998



12,486



13,567Stock compensation expense(1)


5,656



15,981



12,017Acquired in-process research and development






28,959



Amortization of goodwill and other intangible assets






3,419



8,726Total operating expenses


26,748



99,379



88,354Loss from operations


(12,731
)


(74,914
)


(57,826
)Interest income and other (expense), net


1,413



15,329



12,862Net loss


(11,318
)


(59,585
)


(44,964
)Deemed dividend upon issuance of convertible preferred stock (Note 9)


(2,200
)






Net loss attributable to common stockholders

$
(13,518
)

$
(59,585
)

$
(44,964
)Basic and diluted net loss per share

$
(1.53
)

$
(1.96
)

$
(1.38
)Shares used in computing basic and diluted net loss per share


8,854



30,339



32,610(1)  Stock compensation expense related to the following:Research and development

$
3,156


$
11,468


$
9,626General and administrative


2,500



4,513



2,391$
5,656


$
15,981


$
12,017








See accompanying notes.




55




---




MAXYGEN, INC.





CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY


(In thousands, except share and per share data)





Convertible Preferred Stock


Common Stock

Additional Paid-In Capital


Notes Receivable from Stockholders


Deferred Stock Compensation


Accumulated Other Comprehensive


Accumulated


Total StockholdersShares


Amount


Shares


Amount




Income


Deficit


EquityBalance at January 1, 1999

7,461,667


$
1


9,230,500


$
1

$
27,706


$
(548
)

$
(2,601
)

$



$
(12,859
)

$
11,700Issuance of common stock to employees upon exercise of options for cash and promissory notes








2,640,650






1,645



(863
)














782Options granted to consultants for services rendered















875



















875Issuance of common stock for services rendered and certain technology rights








191,600






845



















845Issuance of Series D convertible preferred stock to investors at $5.50 per share for cash, less issuance costs of $37

3,636,364













19,963



















19,963Issuance of Series E convertible preferred stock to a collaborator at $6.25 per share

800,000













5,000



















5,000Issuance of common stock for initial public offering at $16.00 per share less issuance costs of $9,403








6,900,000



1


100,996



















100,997Conversion of convertible preferred stock to common stock

(11,898,031
)


(1
)

11,898,031



1






















Deferred stock compensation















19,487







(19,487
)










Amortization of deferred stock compensation























4,872











4,872Net loss and comprehensive loss































(11,318
)


(11,318
)Balance at December 31, 1999








30,860,781



3


176,517



(1,411
)


(17,216
)






(24,177
)


133,716Issuance of common stock to employees and upon exercise of options for cash and promissory notes








194,712






1,063



















1,063Options granted to consultants for services rendered















2,944



















2,944Issuance of common stock for services rendered and certain technology rights








17,146






1,001



















1,001Issuance of common stock for follow-on offering at $97.00 per share less issuance costs of $8,167








1,500,000






137,332



















137,332Issuance of common stock and options for acquisitions








1,122,378






66,166







(14,606
)










51,560Repurchase of common stock and cancellation of options








(118,281
)





(572
)


51



513











(8
)Payments of stockholder notes



















584















584Acceleration of employee stock options















1,575



















1,575Amortization of deferred compensation























11,429











11,429Components of comprehensive loss:Net loss































(59,585
)


(59,585
)Currency translation adjustment



























66







66Change in unrealized gain on available-for-sale securities



























521







521Comprehensive loss



































(58,998
)Balance at December 31, 2000








33,576,736



3


386,026



(776
)


(19,880
)


587



(83,762
)


282,198Issuance of common stock upon exercise of options for cash and for services rendered








340,624






1,238



















1,238Issuance of common stock under employee stock purchase plan








106,471






1,075



















1,075Issuance of common stock under 401(k) employer matching contribution








34,525






642



















642Stock compensation expense for consultant options, fully vested stock options and warrants for services rendered















384







(135
)










250Repurchase of common stock and cancellation of options








(31,942
)





(19
)


















(19
)Payments of stockholder notes



















437















437Amortization of deferred compensation, net of $261,000 reversed for terminated employees















261







11,506











11,767Components of comprehensive loss:Net loss































(44,964
)


(44,964
)Currency translation adjustment



























(159
)






(159
)Change in unrealized gain on available-for-sale securities



























1,270







1,270Comprehensive loss



































(43,853
)Balance at December 31, 2001




$



34,026,414


$
3

$
389,607


$
(339
)

$
(8,509
)

$
1,698


$
(128,726
)

$
253,734





See accompanying notes.




56




---

MAXYGEN, INC.


CONSOLIDATED STATEMENTS OF CASH FLOWS


(in thousands)





Year ended December 31,1999


2000


2001Operating activitiesNet loss

$
(11,318
)

$
(59,585
)

$
(44,964
)Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization


729



1,611



3,139Amortization of intangible assets






3,418



8,726Non-cash stock compensation


4,862



13,004



12,417Common stock issued and stock options granted to consultants for services rendered and for certain technology rights


1,730



3,945



976Acquired in-process research and development






28,959



Changes in operating assets and liabilities:Grant and other receivables


(2,438
)


(5,137
)


1,125Prepaid expenses and other current assets


(529
)


(380
)


(1,099
)Deposits and other assets


(211
)


(770
)


(185
)Accounts payable


(96
)


(3,714
)


1,255Accrued compensation


241



1,465



496Accrued legal expenses


147



556



(120
)Deferred rent


137



205



595Other accrued liabilities


1,232



2,070



(975
)Deferred revenue


2,572



1,576



3,465Other


(105
)


(19
)


Net cash used in operating activities


(3,047
)


(12,796
)


(15,149
)Investing activitiesCash acquired in acquisition






349



Purchases of available-for-sale securities






(179,120
)


(197,607
)Maturities of available-for-sale securities






33,000



131,239Sale of available-for-sale securities










27,789Acquisition of property and equipment


(4,492
)


(5,366
)


(10,563
)Net cash used in investing activities


(4,492
)


(151,137
)


(49,142
)Financing activitiesProceeds from issuance of convertible preferred stock, net of issuance costs


24,963







Borrowings under equipment financing obligations


1,834



166



Repayments under equipment financing obligations






(172
)


(533
)Payments received on promissory notes






584



437Proceeds from issuance of common stock, net of issuance costs


101,779



138,386



1,401Net cash provided by financing activities


128,576



138,964



1,305Net increase (decrease) in cash and cash equivalents


121,037



(24,969
)


(62,986
)Cash and cash equivalents at beginning of period


15,306



136,343



111,374Cash and cash equivalents at end of period

$
136,343


$
111,374


$
48,388Schedule of noncash transactionsTangible and intangible assets acquired in acquisition for shares of common stock, net of cash acquired and liabilities
assumed

$



$
53,210


$
Shares issued for technology

$



$
958


$
Issuance of common stock in exchange for note receivable

$
863


$



$






See accompanying notes.




57




---



MAXYGEN, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS




1.    Summary of Significant Accounting Policies





Organization and Principles of Consolidation





Maxygen,
Inc. (the Company) was incorporated in Delaware on May 7, 1996. The Company develops and applies proprietary directed molecular evolution technologies, also known as MolecularBreeding, to evolve new or improved properties
into single genes, multigene pathways, vectors, and genomes. Since the technology can be applied to a wide range of genetic targets, the Company will explore commercial opportunities for the directed evolution of human pharmaceuticals, as well as
industrial products. The MolecularBreeding directed molecular evolution technologies were conceived at Affymax Research Institute (Affymax), a subsidiary of Glaxo Group Ltd. In March 1997, ownership to the MolecularBreeding directed
molecular evolution technologies patent applications and patents were transferred by Affymax to the Company in exchange for the issuance of 5,460,000 shares of common stock.





The Company will require additional financial resources to complete the development and commercialization of its products. Management plans to continue to finance the Company primarily
through issuances of equity securities, collaborative research and development arrangements, government grants, and debt financing. If the financing arrangements contemplated by management are not consummated, the Company may have to seek other
sources of capital or reevaluate its operating plans.





The consolidated financial statements include the amounts of the Company
and its wholly-owned subsidiaries, Maxygen ApS (Denmark), which was acquired by the Company in August 2000, and Maxygen Holdings Ltd. (Cayman Islands). All significant intercompany balances and transactions have been eliminated in consolidation.





Foreign Currency Translation





The functional currency of Maxygen ApS is the Danish kroner. Assets and liabilities of Maxygen ApS are translated at current exchange rates, and the related revenues and expenses are translated at average exchange
rates in effect during the period. Gains and losses from currency translation are included in other comprehensive income (loss). Currency transaction gains or losses are included in interest income and other, net, and are not significant to the
Companys operating results.





Use of Estimates





The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported
in the financial statements and accompanying notes. Actual results could differ from those estimates.





Cash, Cash Equivalents
and Investments





The Company considers all highly liquid investments with maturity dates of three months or less, as of the
date of purchase, to be cash equivalents. Cash equivalents include marketable debt securities, municipal, government and corporate debt obligations. Short and long-term investments include municipal, government and corporate debt obligations.





Management determines the appropriate classification of debt securities at the time of purchase and reevaluates such
designation as of each balance sheet date. The Companys debt securities are classified as available-for-sale and are carried at estimated fair value in cash equivalents and investments. Unrealized gains




58




---



MAXYGEN, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)




and losses are reported as a component of accumulated other comprehensive income (loss) in stockholders equity. The amortized cost of debt securities in this category is adjusted for
amortization of premiums and accretion of discounts to maturity. Such amortization is included in interest income. Realized gains and losses and declines in value deemed to be other-than-temporary, if any, are included in interest income and
expense. The cost of securities sold is based on the specific identification method. Interest and dividends on securities are included in interest income.





Derivative Financial Instruments





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





On December 22, 2000, the Company entered into
derivative contracts for the first time and has recorded those contracts under Financial Accounting Standard No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133), as amended, which requires that
all derivative instruments be reported on the balance sheet at fair value and establishes criteria for designation and evaluating effectiveness of hedging relationships. Since these were the Companys first derivative contracts, no cumulative
effect adjustment was required upon adoption of SFAS 133.





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





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





The purpose of the hedging activities is to minimize the effect of foreign exchange rate movements on the cash
flows related to the Companys funding of Maxygen ApS. All foreign currency contracts are denominated in Danish kroner. During 2001, forecasted cash flow exceeded the actual cash required by Maxygen ApS, resulting in a net loss of $261,000,
which was recorded in interest income and other, net.





As a matter of policy, the Company only enters into contracts with
counterparties that have at least an A (or equivalent) credit rating. The counterparties to these contracts are major financial institutions. Exposure to credit loss in the event of nonperformance by any of the counterparties is limited
to only the recognized, but not realized, gains attributable to the contracts. Management believes risk of loss is remote and in any event would not be material. Costs associated with entering into such contracts have not been material to the
Companys financial results. The Company does not utilize derivative financial instruments for trading or speculative purposes. At December 31, 2001, the Company had no foreign currency contracts outstanding in the form of forward exchange
contracts or any other derivative instruments.




59




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MAXYGEN, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)




Concentration of Credit Risk





Financial instruments that potentially subject the Company to a concentration of credit risk consist of investments and accounts receivable. The Company is exposed to credit risks in the
event of default by the financial issuers or collaborators to the extent of the amount recorded on the balance sheet. A significant portion of the Companys accounts receivable balance at December 31, 2000 and 2001 consist of balances due from
government agencies. Each grant agreement is subject to funding approvals by the U.S. government. Certain grant agreements provide an option for the government to audit the amount of research and development expenses, both direct and indirect, that
have been submitted to the government agency for reimbursement.





Property and Equipment





Property and equipment, including the cost of purchased software, are stated at cost, less accumulated depreciation. Depreciation is provided using the
straight-line method over the estimated useful life of the assets (generally three to five years). Leasehold improvements are amortized over the shorter of the lease term or the estimated useful life of the assets.





Goodwill and Other Intangible Assets





Goodwill and other intangible assets are amortized using the straight-line method over the assets estimated useful lives of three years. See Note 12 for detail of intangible assets acquired.





Long-Lived Assets





Management generally evaluates long-lived assets, including goodwill and other intangible assets on an individual acquisition or market basis whenever events or changes in circumstances indicate that such assets are impaired or the
estimated useful lives are no longer appropriate. If indicators of impairment exist, the Company will review its long-lived assets (including goodwill) for impairment based on estimated future discounted cash flows attributable to the assets. In the
event such cash flows are not expected to be sufficient to recover the recorded value of the assets, the assets are written down to their estimated fair values. No impairment charges have been recorded to date.





Revenue Recognition





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





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




60




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MAXYGEN, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)




performance obligations related to the payment. Incentive milestone payments are triggered either by the results of the Companys research efforts or by events external to the Company, such
as regulatory approval to market a product. Royalties, if any, are recognized when earned.





The Company was awarded grants from
the Defense Advanced Research Projects Agency, National Institute of Standards and Technology-Advanced Technology Program and the U.S. Agency for International Development totaling approximately $32.9 million since inception for various research and
development projects. The terms of these grant agreements are three years with various termination dates, the last of which is September 2004 for existing agreements. Revenue related to grant agreements is recognized as related research and
development expenses are incurred.





Research and Development Expenses





Research and development expenses consist of costs incurred for Company-sponsored as well as collaborative research and development activities. These
costs include direct and research-related overhead expenses, which include salaries and other personnel-related expenses, facility costs, supplies and depreciation of facilities and laboratory equipment, as well as the cost of funding research at
universities and other research institutions, and are expensed as incurred. Costs to acquire technologies that are utilized in research and development and that have no alternative future use are expensed when incurred. See Note 4 for detail
regarding the Companys sponsored license and research agreements.





The Company does not track or allocate actual costs by
collaboration or project, as the requirement from its collaborative partners is to staff the various projects on a full-time-equivalent (FTE) employee basis. Accordingly, the Company tracks the assignment of these FTEs to each
project over time. Based on the analysis of these FTEs, approximately 50% in 2001, 55% in 2000 and 63% in 1999 of the Companys research effort (as measured in hours incurred) was on research conducted on behalf of collaborative partners
and government grants. Approximately 50% in 2001, 45% in 2000 and 37% in 1999 of the Companys research effort was on Company-funded research.





Stock-Based Compensation





The Company accounts for common stock options granted to
employees using the intrinsic value method and, thus, recognizes no compensation expense for options granted with exercise prices equal to or greater than the fair value of the Companys common stock on the date of the grant. In 1999, 2000 and
2001, the Company recognized stock compensation expense related to certain stock option grants. See Note 9. Pro forma information required by Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation
(SFAS 123) is also included in Note 9.





Stock compensation expense for options granted to non-employees has been
determined in accordance with SFAS 123 and EITF 96-18 as the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measured. The fair value of options granted to non-employees is
periodically remeasured as the underlying options vest.





Net Loss Per Share





Basic and diluted net loss per common share has been computed using the weighted-average number of shares of common stock outstanding during the period,
less shares subject to repurchase. Unaudited pro forma basic and diluted net loss per common share has been computed for the year ended December 31, 1999 as described above, and also gives effect to the conversion of the convertible preferred stock
that automatically converted to common




61




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MAXYGEN, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)




stock immediately before the completion of the Companys initial public offering (using the if-converted method) from the original date of issuance.





The following table presents the calculation of basic and diluted net loss per share (in thousands, except share and per share data):





Year ended December 31,1999


2000


2001Net loss attributable to common stockholders

$
(13,518
)

$
(59,585
)

$
(44,964
)Basic and diluted:Weighted-average shares of common stock outstanding


10,879



32,466



33,843Less: weighted-average shares subject to repurchase


(2,025
)


(2,127
)


(1,233
)Weighted-average shares used in computing basic and diluted net loss per share


8,854



30,339



32,610Basic and diluted net loss per share

$
(1.53
)

$
(1.96
)

$
(1.38
)Pro forma: (unaudited)Shares used above


8,854Pro forma adjustment to reflect weighted effect of conversion of convertible preferred stock (unaudited)


9,395Shares used in computing pro forma basic and diluted net loss per share (unaudited)


18,249Pro forma basic and diluted net loss per share (unaudited)

$
(0.74
)





The Company has excluded convertible preferred stock, outstanding warrants,
outstanding stock options and shares subject to repurchase from the calculation of diluted loss per common share because all such securities are antidilutive for all periods presented. The total number of shares excluded from the calculations of
diluted net loss per share, before application of the treasury stock method for options, was approximately 2,601,000 at December 31, 1999, 6,652,000 at December 31, 2000 and 8,317,000 at December 31, 2001. Such securities, had they been dilutive,
would have been included in the computations of diluted net loss per share. See Note 9 for further information on these securities.





Comprehensive Income (Loss)





Comprehensive income (loss) is primarily comprised of net unrealized gains or
losses on available-for-sale securities and foreign currency translation adjustments. The components of accumulated other comprehensive income are as follows (in thousands):





December 31,2000

2001Unrealized gain (loss) on available-for-sale securities

$
521

$
1,791Foreign currency translation adjustments


66


(93
)Accumulated other comprehensive income

$
587

$
1,698





There were no components of other comprehensive income in 1999.




62




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MAXYGEN, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







Recent Accounting Pronouncements





In June 2001, the Financing Accounting Standard Board issued Statement of Financial Accounting Standards No. 141, Business Combinations and
No. 142, Goodwill and Other Intangible Assets, effective for the fiscal years beginning after December 15, 2001. Under the new rules, goodwill will no longer be amortized but will be subject to annual impairment tests in accordance with
Statement No. 142. Other intangible assets will continue to be amortized over the useful lives.





The Company will apply the new
rules on accounting for goodwill and other intangible assets beginning in the first quarter of 2002. Application of the nonamortization provisions of the Statement is expected to result in a decrease in net loss of $7.6 million in 2002 and $4.6
million in 2003. During 2002, the Company will perform the first of the required impairment tests of goodwill and indefinite-lived intangible assets as of January 1, 2002 and has not yet determined what the effect of these tests will be on the
earnings and financial position of the Company.





In October 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (Statement 144), which addresses financial accounting and reporting for the impairment or disposal of long-lived assets
and supersedes Statement 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, and the accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of Operations
for a disposal of a segment of a business. Statement 144 is effective for fiscal years beginning after December 15, 2001. The Company will adopt Statement 144 as of January 1, 2002 and it does not expect that the adoption of the Statement will
have a significant impact on the Companys financial position and results of operations.





2.    Cash Equivalents and
Investments





The Companys cash equivalents and investments as of December 31, 2001 are as follows (in thousands):





Amortized Cost


Gross Unrealized Gains

Gross Unrealized Losses


Estimated Fair ValueMoney market funds

$
48,388


$


$



$
48,388Corporate debt obligations


150,623



1,733


(27
)


152,329U.S. government agency securities


10,200



28






10,228Commercial paper


23,875



57






23,932Total


233,086



1,818


(27
)


234,877Less amounts classified as cash equivalents


(48,388
)









(48,388
)Total investments

$
184,698


$
1,818

$
(27
)

$
186,489





The Companys cash equivalents and investments as of December 31, 2000 were
as follows (in thousands):





Amortized Cost


Gross Unrealized Gains

Gross Unrealized Losses


Estimated Fair ValueMoney market funds

$
42,992


$


$



$
42,992Corporate debt obligations


92,502



518


(62
)


92,958Commercial paper


122,000



65






122,065Total


257,494



583


(62
)


258,015Less amounts classified as cash equivalents


(111,374
)









(111,374
)Total investments

$
146,120


$
583

$
(62
)

$
146,641




63




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MAXYGEN, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







Realized gains or losses on the sale of available-for-sale securities for 1999,
2000 and 2001 were insignificant.





At December 31, 2000 and 2001 the contractual maturities of investments were as follows (in
thousands):





At December 31,

At December 31,2000

2001

2000

2001Amortized Cost

Estimated Fair ValueDue within one year

$
110,475

$
156,302

$
110,805

$
157,557Due after one year through two years


35,645


28,396


35,836


28,932$
146,120

$
184,698

$
146,641

$
186,489





3.    Collaborative Agreements





At December 31, 2001, the Company had thirteen active multi-year research and development collaborations with collaborative partners. These agreements
typically include up-front licensing fees, technology advancement fees and research funding, as well as the potential to earn milestone payments and royalties on future product sales or cost savings. The agreements generally require the Company to
devote a specified number of full-time equivalent employees to the research efforts over defined terms ranging from three to five years. Total revenue recognized under the collaboration agreements was $8.9 million in 1999, $13.3 million in 2000 and
$25.1 million in 2001.





Assuming the Companys research efforts for existing collaborations are expended for the full
research term, the Company has total committed funding of approximately $106.3 million from their collaborators. The Company can receive potential milestone payments from existing collaborations, which could exceed $307.8 million, based on the
accomplishment of specific performance criteria, in addition to earned royalties on product sales or cost savings. There can be no assurances that the Companys research efforts will result in the receipt of future milestone payments.





In general, the Companys research obligations and the obligations of the Companys corporate partners to provide
research funding cannot be terminated before the end of the research term unless there has been a material breach of the contract or either party has become bankrupt or insolvent. In the case of such an event, the agreement specifies the rights, if
any, that each party will retain.





The following table represents the percentage of the Companys total revenue that has
been recognized pursuant to the Companys largest non-grant collaborators:





December 31,1999


2000


2001Partner A

42.8
%

24.5
%

19.9
%Partner B

11.4
%

17.9
%

15.3
%Partner C




3.1
%

10.8
%





No other collaborator has comprised more than 10% of revenue in any period
presented. In addition to providing the research funding summarized above, certain of the Companys collaborators have also purchased equity investments in the Company. These agreements are summarized below.





Aventis Pasteur





In
November 2001, the Company established a three-year collaboration with Aventis Pasteur to develop improved vaccines for a specific undisclosed target. Aventis Pasteur is the new name of Pasteur Merieux




64




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MAXYGEN, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)




Connaught, since the creation of Aventis. Under the terms of the agreement, the Company will receive license fees, full research and development funding, minimum annual royalties, and potential
milestone and royalty payments on product sales, if any. Aventis Pasteur will receive exclusive worldwide rights to commercialize the vaccines developed in the collaboration.





InterMune, Inc.





In September 2001, Maxygen Holdings Ltd.,
a wholly-owned subsidiary of the Company, entered into a three-year license and collaboration agreement with InterMune, Inc. (InterMune) to develop and commercialize novel, next-generation interferon gamma products. Under the terms of
the agreement, InterMune will take product candidates developed by the Company into clinical development. InterMune will fund optimization and development of the next-generation interferon gamma products, and will retain exclusive worldwide
commercialization rights for all human therapeutic indications. Under the terms of the collaboration agreement, the Company will receive up-front license fees, research and development funding, and potential development and commercialization
milestone payments. In addition, the Company will also be entitled to receive royalties on product sales, if any.





ALK-Abelló A/S





In February 2001, the Company established a three-year collaboration with
ALK-Abelló A/S, a wholly-owned subsidiary of Chr. Hansen Holding A/S, Denmark, to research and develop novel recombinant therapeutics for the treatment of specific allergies. The Company will collaborate with ALK-Abelló to create
therapies for treating specific allergies, including allergies to house dust mites and grasses, which are the cause of many common allergies. Under the terms of the collaboration, the Company will receive license fees, technology access fees,
research and development funding, and potential milestone payments. The Company will also be entitled to receive royalties on product sales, if any. ALK-Abelló will receive exclusive worldwide rights to commercialize all recombinant human
therapeutics developed in the collaboration.





International AIDS Vaccine Initiative





In February 2001, the Company established a three-year collaboration with the International AIDS Vaccine Initiative and DBLV, LLC, an entity established
and funded by the Rockefeller Foundation to develop novel HIV vaccines. Under the agreement, DBLV will provide full research and development funding to the Company for at least three years to expand the Companys ongoing program in HIV vaccine
development. The Company will retain all rights to commercialize the HIV vaccine candidates in all developed countries of the world, as well as in certain markets in the developing world.





Hercules Incorporated





In November 2000, the Company
entered into a four-year collaboration with Hercules Incorporated (Hercules) focused on developing high value specialty chemicals via custom-made biological catalysts. Under the terms of the collaboration, the Company will receive full
research funding, technology access fees, license fees and milestone payments, as well as royalties on any product sales. Hercules will retain exclusive worldwide commercialization rights for specific applications of products generated in the
collaboration. The Company will retain rights to all applications of products not exclusively licensed to Hercules. The collaboration is focused on a number of high revenue-generating products in Hercules core business.




65




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MAXYGEN, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)




Chevron Research and Technology Co.





In October 2000, the Company entered into a three-year collaboration with Chevron Research and Technology Co. (Chevron) to develop novel bioprocesses for specific
petrochemical products. Under the terms of the agreement, the Company will receive full research funding, license fees, technology access fees, milestones, and product royalties. Chevron will receive worldwide commercialization rights.





H. Lundbeck A/S





In September 2000, Maxygen ApS, a wholly-owned subsidiary of the Company, entered into a three-year collaborative research and development agreement with H. Lundbeck A/S (Lundbeck), to develop an improved interferon beta
pharmaceutical product that could be used for central nervous system diseases, including multiple sclerosis. Under the terms of the agreement, the Company will receive research and development funding as well as license fees, milestone payments and
royalties on product sales. Lundbeck has licensed rights to this product for central nervous system diseases. The Company has retained rights for neurological indications in key Asian markets and global rights for all indications outside of central
nervous system diseases, including inflammatory disease and cancer.





Pfizer





In September 2000, the Company extended a May 1998 agreement with Pfizer Inc. (Pfizer) in the area of biochemical manufacturing of a
specific pharmaceutical product. Under the 1998 agreement, the Company improved the selectivity of the biosynthetic pathway that is critical to the manufacture of Pfizers product, and delivered an improved pathway that is currently under
commercial development by Pfizer. In the expanded collaboration, commercial terms were agreed upon for the improved process, with success earning the Company research and commercial milestones as well as a percentage of all manufacturing cost
savings once the optimized commercial process is scaled up at Pfizer. Additionally, Pfizer has agreed to fund additional research and development to allow the Company to further enhance the performance of the pathway.





Technological Resources PTY Limited





In January 2000, the Company entered into a three-year collaborative research and development agreement with Technological Resources PTY Limited, a wholly-owned subsidiary of Rio Tinto Limited (TRPL), to
develop novel enzymatic systems to increase the efficiency of carbon dioxide fixation in connection with the combustion of fossil fuels and for other purposes more generally for use in chemical bioprocessing and other applications. Pursuant to the
agreement, the Company will receive research and funding payments and technology advancement fees. In addition, the parties will share revenues on certain commercialized products and processes.





Gist-brocades N.V.





In March 1999, the Company
entered into a three-year collaborative research and license agreement with Gist-brocades N.V., a subsidiary of DSM N.V. (DSM) to utilize the Companys proprietary MolecularBreeding directed molecular evolution technologies to
develop certain novel enzymes involved in the manufacture of certain classes of antibiotics. Under the terms of the agreement, the Company will receive research funding and royalties from the commercialization of any enzymes developed through the
Companys technology. DSM will receive worldwide commercialization rights.




66




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MAXYGEN, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)




Syngenta





In June 1999, the Company entered into a five-year collaborative research agreement with Zeneca Limited, a wholly-owned subsidiary of AstraZeneca plc, now known as Syngenta (Syngenta) to improve the yield
and quality of several of Syngentas strategic crops. The Company will receive research and development funding as well as license fees, milestone payments and royalties on product sales. Syngenta will receive worldwide commercialization
rights.





On an annual basis beginning in the second year of the agreement, Syngenta must either pay an annual technology
advancement fee or purchase shares of the Companys stock at a 50% premium to the then current fair value. If Syngenta elects to buy stock, the resulting premium will be accounted for as technology advancement funding. The technology
advancement funding is intended to fund the Companys continuing development of its core MolecularBreeding directed molecular evolution technologies.





In August 1999, in conjunction with the agreement, Syngenta purchased 800,000 shares of Series E convertible preferred stock at $6.25 per share (subsequently converted to common stock upon the Companys initial
public offering). The Company recorded a deemed dividend of $2.2 million at the date of issuance. The deemed dividend is further described in Note 9.





E.I. duPont de Nemours and Company





In December 1998, the Company entered into a
five-year collaborative research and license agreement with Pioneer Hi-Bred International, Inc., a subsidiary of E.I. duPont de Nemours and Company (DuPont) to utilize MolecularBreeding directed molecular evolution technologies to
generate novel gene products for use in the development of specific crop protection and quantity grain traits in corn, soybeans, and certain other crops. The Company will receive research and development funding as well as license fees, milestone
payments and royalties on product sales. DuPont will receive worldwide commercialization rights.





In December 1998, in
conjunction with the agreement, DuPont purchased 1,000,000 shares of Series C convertible preferred stock at $5.00 per share, which was the fair value of the preferred stock on the date of issuance (subsequently converted to common stock upon the
Companys initial public offering). Furthermore, in December 1999, DuPont purchased 312,500 shares of the Companys common stock at the initial public offering price of $16.00.





Novozymes





In September 1997, the Company entered into a
five-year license and collaboration agreement with Novo Nordisk A/S (now known as Novozymes) to use MolecularBreeding directed molecular evolution technologies to develop products in specific industrial enzyme fields. In November 2001,
the companies expanded the market areas addressed by the existing industrial enzymes collaboration. Under the terms of the expanded relationship, Novozymes will be licensed to use MolecularBreeding directed molecular evolution technologies for
additional industrial enzyme applications. Maxygen will receive royalty payments on the sales of any products developed under the 1997 agreement and on the sale of any products in the expanded industrial enzyme market areas. In addition, Maxygen
will have co-exclusive rights to use the MolecularBreeding directed molecular evolution technologies for certain new industrial enzyme markets.





Other Collaborations





The Company has recognized revenue in fiscal 1999, 2000 and 2001
under other corporate collaborations for which it has completed all of its research obligations.




67




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MAXYGEN, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)




4.    Sponsored License and Research Agreements





The Company has entered into several research agreements to fund research at universities and other organizations. These agreements are generally cancelable by either party upon written
notice and may be extended by mutual consent of both parties. Research and development expenses are recognized as the related services are performed, generally ratably over the period of the service. Expenses under these agreements were
approximately $1.1 million in 1999, $4.9 million in 2000 and $3.3 million in 2001.





In 2000, the Company paid $320,000 and
issued 16,000 shares of common stock with a fair value of $958,000 in exchange for a technology license. This amount is included in research and development expense for 2000 as it relates to technology that is in research and development and has no
alternative future uses. In 1999 the Company issued 175,000 shares of common stock with a fair value of $783,000 to research institutions in exchange for technology licenses. This amount is included in research and development expense for 1999 as
the related technology is in research and development and has no alternative future uses.





5.    Property and Equipment





Property and equipment consisted of the following (in thousands):





December 31,2000


2001Leasehold improvements

$
2,249


$
5,226Machinery and laboratory equipment


8,536



14,690Computer equipment and software


1,019



1,727Furniture and fixtures


670



1,39412,474



23,037Less accumulated depreciation and amortization


(2,558
)


(5,697
)Property and equipment, net

$
9,916


$
17,340





6.    Equipment Financing





In June 1999, the Company entered into an equipment financing agreement for up to $2.0 million with a financing company. In July 1999 through May 2000, the Company financed $2.0
million in equipment purchases structured as loans. The equipment loans are to be repaid over 48 months at interest rates of 11.73% to 12.78% and are secured by the related equipment. During the first 6 months of the loan terms, the payments consist
of interest only. Accumulated amortization of assets acquired pursuant to these obligations was approximately $623,000 at December 31, 2000 and $915,000 at December 31, 2001.





At December 31, 2001, the Companys future minimum principal payments under the equipment financing arrangements are as follows (in thousands):





Year endingDecember 31,2002

$
6222003


6182004


55$
1,295




68




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MAXYGEN, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)




7.    Commitments





The Company has entered into various operating leases for its facilities and certain computer equipment. These leases expire on various dates in 2003, 2004 and 2005. The facilities leases also include scheduled rent
increases. The scheduled rent increases are recognized on a straight-line basis over the term of the lease.





Minimum annual
rental commitments under operating leases are as follows (in thousands):





Year endingDecember 31,2002

$
4,7112003


5,0442004


4,4112005


1,274$
15,440





Total rent expense was $1.3 million in 1999, $2.3 million in 2000 and $4.4
million in 2001.





8.    Related Party Transactions





The Company issued full recourse loans to certain employees, of which $1.6 million was outstanding at December 31, 1999, $926,000 was outstanding at December 31, 2000 and $690,000 was
outstanding at December 31, 2001. These loans bear interest at rates ranging from 4.63% to 6.42% with terms ranging from three to five years. The loans were for the purchase of the Companys common stock and are classified in stockholders
equity. One full recourse loan for $150,000 was made for the purchase of a home and is classified as other assets. This loan bears an interest rate of 5.59% with a term of three years.





9.    Stockholders Equity





Convertible Preferred Stock





In connection with the terms of the collaboration agreement with Syngenta, the Company issued Series E convertible
preferred stock in August 1999 at $6.25 per share. At the date of issuance, the Company believed the per share price of $6.25 represented the fair value of the preferred stock and was in excess of the deemed fair value of its common stock. After the
commencement of the Companys initial public offering process, the Company re-evaluated the deemed fair market value of its common stock as of August 1999 and determined it to be $9.00 per share. Accordingly, the incremental fair value is
deemed to be the equivalent of a preferred stock dividend. The Company recorded the deemed dividend at the date of issuance by offsetting charges and credits to additional paid in capital of $2,200,000, without any effect on total stockholders
equity. The amount increased the loss allocable to common stockholders in the calculation of basic net loss per share for 1999.





In December 1999, the Company completed its initial public offering of common stock under the Securities Act of 1933, in which $101.0 million in net proceeds was realized (including net proceeds from a simultaneous private placement and the
exercise of the underwriters over-allotment option). Upon the completion of the initial public offering, all of the Series A, B, C, D, and E preferred stock outstanding converted into 11,898,031 shares of common stock.




69




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MAXYGEN, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)




Preferred Stock





The Company is authorized, subject to limitations prescribed by Delaware law, to provide for the issuance of preferred stock in one or more series, to establish from time to time the number of shares included within
each series, to fix the rights, preferences and privileges of the shares of each wholly unissued series and any qualifications, limitations or restrictions thereon, and to increase or decrease the number of shares of any such series (but not below
the number of shares of such series then outstanding) without any further vote or action by the stockholders.





401(k) Savings
Plan





The Company has a savings plan that qualifies as a deferred salary arrangement under Section 401(k) of the Internal
Revenue Code (the 401(k) Plan). Under the 401(k) Plan, participating employees may defer a percentage (not to exceed 20%) of their eligible pretax earnings up to the Internal Revenue Services annual contribution limit. All
employees on the United States payroll of the Company age 18 years or older are eligible to participate in the 401(k) Plan. The Company has not been required to contribute to the 401(k) Plan but in 2001 elected to match contributions of its
participating employees in an amount up to a maximum of the lesser of (i) 50% of the employees 401(k) contribution or (ii) 6% of the employees yearly base salary. The matching contribution is made in the form of newly issued shares
of Maxygen common stock as of each June 30th and December 31st. All matching contributions vest immediately. Maxygen may discontinue such matching contributions at any time. The Companys matching contribution to the 401(k) Plan was $642,000 in
2001.





1997 Stock Option Plan





In 1997, the Company adopted the 1997 Stock Option Plan (the 1997 Plan) under which the board of directors may issue incentive stock options to employees, including officers and members of the board of
directors who are also employees, and nonqualified stock options to employees, officers, directors, consultants, and advisors of the Company. Under the 1997 Plan, incentive options to purchase the Companys common stock may be granted to
employees at prices not lower than fair value on the date of grant, as determined by the board of directors. Nonstatutory options (options that do not qualify as incentive options) may be granted to key employees, including directors and
consultants, at prices not lower than 85% of fair value on the date of grant (110% in certain cases), as determined by the board of directors. The maximum term of the options granted under the 1997 Plan is ten years. Certain options can be
immediately exercisable, at the discretion of the board of directors. Shares issued pursuant to the exercise of an unvested option are subject to the Companys right of repurchase, which generally lapses over four years (lapsing at a rate of
25% at the end of each year). If not immediately exercisable, options generally vest over four years (vesting at a rate of 25% at the end of each year). The 1997 Plan provides for annual increases in the number of shares available for issuance on
the first day of each year, beginning January 1, 2001, equal to the lesser of 1,500,000 shares, 4% of the outstanding shares on the date of the annual increase, or an amount determined by the board of directors. At December 31, 2001,
974,591 shares remain available under the 1997 Plan.





1999 Nonemployee Directors Stock Option Plan





In September 1999, the Company adopted the 1999 Nonemployee Directors Stock Option Plan (the Directors Plan) and reserved a total
of 300,000 shares of common stock for issuance thereunder. Each nonemployee director who becomes a director of the Company will be automatically granted a nonstatutory stock option to purchase 20,000 shares of common stock on the date upon which
such person first becomes a director. At each board meeting immediately following each annual stockholders meeting, each non-employee director will automatically be granted a nonstatutory option to purchase 5,000 shares of common stock. The
exercise




70




---



MAXYGEN, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)




price of options under the Directors Plan will be equal to the fair market value of the common stock on the date of grant. Options have a term of ten years. Generally, each initial grant under
the Directors Plan will vest as to 25% of the shares subject to the option one year after the date of grant and at a rate of 25% of the shares at the end of each of the succeeding three years. Each subsequent grant will generally vest in full one
year after the date of grant. The Directors Plan will terminate in September 2009, unless terminated earlier in accordance with the provisions of the Directors Plan. At December 31, 2001, 230,000 shares remain available under the Directors Plan.





2000 International Stock Option Plan





In April 2000, the Company adopted the 2000 International Stock Option Plan (the International Plan) under which the board of directors may issue nonqualified stock options
to employees, directors and consultants of non-U.S. subsidiaries of the Company. Under the International Plan, nonstatutory options may be granted at prices not lower than 85% of fair value at the date of grant (except in the case of replacement
options in the context of acquisitions), as determined by the board of directors. The maximum term of the options granted under the International Plan is ten years. Options vest and become exercisable pursuant to a vesting schedule, generally over
four years at a rate of 25% at the end of each year. The International Plan provides for the issuance of options covering up to 1,000,000 shares of common stock of the Company. The International Plan also provides for annual increases in the number
of shares available for issuance on the first day of each year, beginning January 1, 2002, equal to 0.6% of the outstanding shares on the date of the annual increase, or a lower amount determined by the board of directors. At December 31, 2001,
18,260 shares remain available under the International Plan.





2000 Non-Officer Employee Stock Option Plan





In December 2000, the Company adopted the 2000 Non-Officer Stock Option Plan (the Non-Officer Plan) under which the board of
directors may issue nonqualified stock options to employees (other than executive officers and stockholders owning 10% or more of the Companys common stock) and consultants of the Company or any of its affiliates. Under the Non-Officer Plan,
nonstatutory options may be granted at prices not lower than 85% of fair value at the date of grant (except in the case of replacement options in the context of acquisitions), as determined by the board of directors. The maximum term of the options
granted under the Non-Officer Plan is ten years. Options vest and become exercisable pursuant to a vesting schedule, generally over four years at a rate of 25% at the end of each year. The Non-Officer Plan provides for the issuance of options
covering up to 1,500,000 shares of common stock of the Company. The Non-Officer Plan also provides for annual increases in the number of shares available for issuance on the first day of each year, beginning January 1, 2001, equal to the greater of
(i) 250,000 shares or (ii) 0.7% of the outstanding shares on the date of the annual increase, or a lower amount determined by the board of directors. At December 31, 2001, 210,527 shares remain available under the Non-Officer Plan.




71




---



MAXYGEN, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







Activity under the 1997 Plan, the Directors Plan, the International Plan and the
Non-Officer Plan (collectively, the Plans) was as follows:





Options OutstandingShares Available


Number of Shares


Weighted-Average Exercise Price Per ShareBalance at January 1, 1999

2,609,830


1,794,670


$
0.27Shares authorized

1,800,000






Options granted

(2,986,830
)

2,986,830


$
3.25Options exercised




(2,640,650
)

$
0.62Options canceled

64,488


(64,488
)

$
0.35Balance at December 31, 1999

1,487,488


2,076,362


$
4.11Shares authorized

4,000,000






Options granted

(3,264,710
)

3,264,710


$
51.27Options exercised




(127,172
)

$
0.73Options canceled

153,907


(153,907
)

$
23.01Balance at December 31, 2000

2,376,685


5,059,993


$
34.05Shares authorized

1,593,069






Options granted

(3,038,799
)

3,038,799


$
14.70Options exercised




(294,897
)

$
1.72Options canceled

493,111


(493,111
)

$
34.12Options expired

9,312


(9,312
)

$
40.09Balance at December 31, 2001

1,433,378


7,301,472


$
27.29





The options outstanding and exercisable under the Plans at December 31, 2001 are
as follows:





Options Outstanding



Options ExercisableExercise Price Range

Number

Weighted Average Remaining Contractual Life (in Years)

Weighted Average Exercise Price

Number

Weighted Average Exercise Price$  0.20$  0.30

326,513

6.4

$
0.27

202,513

$
0.26$  0.50$  0.75

353,383

7.4

$
0.71

51,908

$
0.70$  7.50$11.00

745,500

7.9

$
7.95

329,675

$
7.91$11.38$16.10

2,491,268

9.4

$
13.77

671,193

$
13.20$17.20$24.25

651,132

8.8

$
20.40

32,625

$
20.09$26.00$35.13

650,940

8.9

$
31.03

188,359

$
31.59$41.25$59.81

1,917,736

8.5

$
54.93

392,450

$
54.30$62.00$81.00

74,000

8.3

$
68.31

18,500

$
68.31$162.50

91,000

8.2

$
162.50

22,750

$
162.507,301,472

8.6

$
27.29

1,909,973

$
23.26





The weighted-average grant date fair value of options granted was $10.02 in 1999,
$35.02 in 2000 and $9.25 in 2001.




72




---



MAXYGEN, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







1999 Employee Stock Purchase Plan





In September 1999, the Company adopted the 1999 Employee Stock Purchase Plan (the Purchase Plan). A total of 400,000 shares of the
Companys common stock were initially reserved for issuance under the Purchase Plan. The Purchase Plan permits eligible employees to purchase common stock at a discount, but only through payroll deductions, during defined offering periods. The
price at which stock is purchased under the Purchase Plan is equal to 85% of the fair market value of the common stock on the first day of the offering period or on the purchase date, whichever is lower. The initial offering period commenced on
December 16, 1999. In addition, the Purchase Plan provides for annual increases in the number of shares available for issuance under the purchase plan on the first day of each year, beginning January 1, 2001, equal to the lesser of 200,000 shares,
0.75% of the outstanding shares on the date of the annual increase, or a lower amount determined by the board of directors. The Purchase Plan will terminate in September 2019, unless terminated earlier in accordance with the provisions of the
Purchase Plan. The first purchase under the Purchase Plan occurred on September 29, 2000 when 67,540 shares of common stock were purchased. In 2001, 106,471 shares of common stock were purchased pursuant to the Purchase Plan. The weighted
average fair value of purchase rights granted during the year was $7.53 in 2000 and $4.45 in 2001.





Fair value disclosures





Pro forma net loss information is required to be disclosed by SFAS 123 and has been determined as if the Company has
accounted for its employee stock options and common stock purchase rights under the fair market value method of that statement.





For 1999, the fair value of the options were estimated at the date of grant using the minimum value method. For 2000 and 2001, the Company calculated the fair value using the Black-Scholes option pricing model. The following assumptions
were used:





1999

2000

2001Expected dividend yield

0%

0%

0%Risk-free interest rate rangeOptions

5.1% to 6.2%

5.4% to 6.5%

3.6% to 5.0%Risk-free interest rate rangeESPP



5.8% to 6.2%

3.5% to 6.3%Expected lifeOptions

5 years

4 years

4 yearsExpected lifeESPP



0.8 years

0.4 yearsExpected volatility



0.9

0.8





For purposes of pro forma disclosures, the estimated fair value of the options is
amortized to expense over the options vesting periods. The effect of SFAS 123 will not be fully reflected until fiscal 2002. The Companys pro forma net loss information is as follows (in thousands, except per share amounts):





Year ended December 31,1999


2000


2001Net loss attributable to common stockholdersas reported

$
(13,518
)

$
(59,585
)

$
(44,964
)Net loss attributable to common stockholderspro forma

$
(13,669
)

$
(94,058
)

$
(91,068
)Basic and diluted net loss per shareas reported

$
(1.53
)

$
(1.96
)

$
(1.38
)Basic and diluted net loss per sharepro forma

$
(1.54
)

$
(3.10
)

$
(2.79
)




73




---



MAXYGEN, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







During the year ended December 31, 1999, the Company issued 15,000 shares of common
stock for services rendered at a deemed fair market value of $4.00 per share and granted options to purchase 87,000 shares of common stock to consultants for services rendered. Stock compensation expense of $928,000 was recognized in 1999 related to
these transactions. During the year ended December 31, 2000, the Company issued 1,146 shares of common stock to consultants for services rendered. Stock compensation expense of $43,000 was recognized in 2000 related to these transactions. Options
granted to consultants are periodically re-valued as they vest in accordance with SFAS 123 and EITF 96-18 using a Black-Scholes model and the following weighted-average assumptions for 2000: estimated volatility of 0.9, risk-free interest rates of
4.4% to 6.2%, no dividend yield, and an expected life of the option equal to the full term, generally ten years from the date of grant. The assumptions for 2001 were estimated volatility of 0.7, risk-free interest rates of 4.4% to 5.6%, no dividend
yield, and an expected life of the option equal to the full term, generally ten years from the date of grant. The Company recorded total compensation expense of $3.0 million in 2000 and $250,000 in 2001 related to the Black-Scholes revaluation of
options grants to consultants in prior years. In addition, in 2000 the Company recorded $1.6 million stock compensation related to the acceleration of an executive stock option award.





During the years ended December 31, 1997, 1998 and 1999, in connection with the grant of certain stock options to employees, the Company recorded deferred stock compensation of $2.6
million, $2.4 million and $19.5 million, respectively, representing the difference between the exercise price and the deemed fair value of the Companys common stock for financial reporting purposes on the date such stock options were granted.
Deferred compensation is included as a reduction of stockholders equity and is being amortized to expense on a graded vesting method. During the years ended December 31, 1999, 2000 and 2001, the Company recorded amortization of deferred stock
compensation expense of approximately $4.9 million, $7.8 million and $4.6 million, respectively.





In addition, the Company
recorded $14.6 million of deferred compensation upon the assumption of the outstanding Maxygen ApS options and the issuance of restricted stock to founders in connection with the August 2000 acquisition of Maxygen ApS. See Note 12. The deferred
compensation is being amortized over the remaining vesting term of the options. The deferred compensation pertaining to the restricted stock is being amortized using the graded vesting method. A total of $3.6 million and $6.9 million deferred
compensation expense was recognized in the year ended December 31, 2000 and 2001, respectively, in connection with the Maxygen ApS options.





Common Stock





At December 31, 1999, 2000 and 2001, there were 2,692,718, 1,627,866 and
995,113 shares of restricted common stock subject to the Companys lapsing right of repurchase at a weighted-average price of $0.61, $7.97 and $3.78, respectively.





At December 31, 2001, the Company has reserved shares of common stock for future issuance as follows:





2000 Non-Officer Employee Stock Option Plan

1,750,0002000 International Stock Option Plan

1,000,0001999 Employee Stock Purchase Plan

525,9891999 Nonemployee Directors Stock Option Plan

300,0001997 Stock Option Plan

5,684,850Warrants

20,0009,280,839




74




---



MAXYGEN, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







10.    Income Taxes





There has been no provision for U.S. federal, U.S. state, or foreign income taxes for any period as the Company has incurred operating losses in all periods and for all jurisdictions.
Foreign pre-tax (loss) income was $(6.1) million in 2001 and $(2.8) million in 2000.





Deferred income taxes reflect the net tax
effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Companys deferred tax assets are as follows
(in thousands):





December 31,2000


2001Net operating loss carryforwards

$
4,500


$
13,500Research credits


1,510



2,300Other


5,070



6,070Total deferred tax assets


11,080



21,870Valuation allowance


(11,080
)


(21,870
)Net deferred tax assets

$



$






Realization of deferred tax assets is dependent upon future earnings, if any, the
timing and amount of which are uncertain. Accordingly, the net deferred tax assets have been fully offset by a valuation allowance. The valuation allowance increased by $10.8 million and $5.0 million during 2001 and 2000, respectively. Approximately
$4.0 million of the valuation allowance relates to the tax benefits of stock option deductions that will be credited to additional paid-in-capital when realized.





As of December 31, 2001, the Company had net operating loss carryforwards for federal income tax purposes of approximately $38 million which expire in the years 2012 through 2021 and
federal research and development tax credits of approximately $1.4 million which expire in the years 2012 through 2021. As of December 31, 2001, the Company had net operating loss carryforwards for state income tax purposes of approximately $8
million which expire in the years 2005 through 2011 and state research and development tax credits of approximately $1.2 million which have no expiration date.





Utilization of the Companys net operating loss may be subject to substantial annual limitation due to the ownership change limitations provided by the Internal Revenue Code and similar state provisions. Such an
annual limitation could result in the expiration of the net operating loss before utilization.





A reconciliation of income taxes
at the statutory federal income tax rate to net income taxes included in the accompanying statements of operations is as follows:





December 31,2000


2001U.S. federal taxes benefitAt statutory rate

$
(20,259
)

$
(15,288
)Non-deductible acquired in-process R&D


9,846



Non-deductible goodwill


1,162



2,967Non-deductible deferred compensation


5,403



3,938Effect of differences in foreign tax rates






2,059Unutilized net operating losses


3,848



6,324Total

$



$





75




---



MAXYGEN, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







11.    Acquisition of Technology





On May 8, 2000, the Company acquired certain in-process technology through the acquisition of a privately held California corporation. In connection
with the acquisition, the Company issued 39,600 shares of Company common stock. Pursuant to the terms of the acquisition, 18,500 shares of Company common stock are being held in escrow until such time as contingencies regarding the patents related
to the acquired technology are resolved. Accordingly, the Company has recorded a charge for acquired in-process research and development of $912,000 representing the fair value of the 21,100 shares delivered to the sellers at closing, plus certain
transaction expenses. Shares in escrow will be valued and accounted for when, and if, the contingencies are resolved and the shares are delivered to the sellers. Had the acquisition occurred on January 1, 1999, pro forma revenue would be unchanged
from amounts reported in the consolidated financial statements and the increase to pro forma net loss would be immaterial.





12.    Acquisition of ProFound Pharma A/S





On August 10, 2000, the Company completed its
acquisition of Maxygen ApS (then known as ProFound Pharma A/S), a Danish biotechnology company located in Copenhagen, Denmark. Before the acquisition, Maxygen ApS was a privately-held, development-stage company that had minimal revenues since its
inception in April 1999. Maxygen ApS is focused on the development of improved second-generation protein pharmaceutical products and has developed broad pre-clinical development capabilities and proprietary technologies and expertise that help to
address traditional shortcomings of protein pharmaceuticals such as half-life, stability and immunogenicity. The Company acquired all of the equity securities of Maxygen ApS in exchange for 1,102,578 shares of its common stock and options to
purchase an aggregate of 41,812 shares of its common stock. Of the 1,102,578 common stock issued, 228,766 shares were issued with repurchase rights that lapse over a three-year vesting term. The transaction was accounted for as a purchase and the
results of Maxygen ApS are included in consolidated results of operation from the date of acquisition.





The total purchase price
of Maxygen ApS is as follows (in thousands):





Fair value of common stock issued

$
63,378Assumption of Maxygen ApS options at fair value


1,960Assumed liabilities


5,487Acquisition expenses


1,000Total consideration


71,825Less: Deferred stock compensation related to unvested options


(1,456
)Deferred stock compensation related to issuance of restricted common stock


(13,149
)Allocable purchase price

$
57,220





The purchase price allocation is as follows (in thousands):





Amount

Useful LivesTangible net assets

$
2,995

Intangible assets acquired:In-process research and development


28,047

Assembled workforce


705

3Core technology


3,435

3Goodwill


22,038

3$
57,220




76




---



MAXYGEN, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







A valuation of the purchased assets was undertaken to assist the Company in
determining the fair value of each identifiable intangible asset and in allocating the purchase price among the acquired assets, including the portion of the purchase price attributed to in-process research and development projects. Standard
valuation procedures and techniques were utilized in determining the fair value of the technology in the development stage, the Company considered, among other factors, the stage of development of each project, the time and resources needed to
complete each project, expected income and associated risks. Associated risks included the inherent difficulties and uncertainties in completing the project and obtaining regulatory approval to market, and the risks related to the viability of and
potential changes to future target markets. The analysis resulted in $28.0 million of the purchase price being charged to acquired in-process research and development. There can be no assurance that the in-process projects acquired, as noted above,
will achieve technological feasibility or that the Company will be able to successfully market products based on such technology. Should these in-process projects fail, the value of the Companys investment in these incomplete technologies
would be insignificant or zero. A failure to successfully develop and market these products could have a material adverse affect on the Companys business, financial condition or results of operations.





The deferred compensation amount represents the intrinsic value of the unvested stock options assumed in the transaction plus the fair value of the
restricted common stock issued. The amortization period of the options is the remaining future vesting period of the unvested options. The deferred compensation related to the restricted common stock is amortized using a graded vesting method.





The following unaudited pro forma summary consolidated operations information of the Company is presented excluding the charge
for in-process research and development, as if the acquisition of Maxygen ApS had occurred at the beginning of 1999 and does not purport to be indicative of what would have occurred had the acquisition been made as of the beginning of 1999 or of the
results that may occur in the future.





Year ended December 31,1999


2000(in thousands, except per share amounts)Total revenues

$
14,017


$
24,535Total operating expenses


(41,167
)


(93,834
)Net loss


(27,857
)


(53,933
)Basic and diluted net loss per share

$
(1.44
)

$
(1.74
)





13.    Litigation





In December 2001 a lawsuit was filed in the U.S. District Court for the Southern District of New York against Maxygen, Inc., certain officers of the Company, and certain underwriters of
the Companys initial public offering and secondary public offering of common stock. The complaint, which alleges claims under Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934,
is among the so-called laddering cases that have been commenced against a number of companies that had public offerings of securities prior to December 2000. The complaint has been consolidated with other laddering claims in a proceeding
styled In re Initial Public Offering Securities Litigation, No. 21 MC 92 (SAS), pending before the Honorable Shira A. Scheindlin.





The complaint seeks damages in an unspecified amount. The Company believes that the claims alleged against the Company and its officers are without merit and intends to defend the action vigorously. The Company does not expect the outcome
of this matter to have a material effect on its financial position or results from operations.




77




---



MAXYGEN, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)




14.     Segment Information





The Company has four reportable segments: human therapeutics, agriculture, chemicals and all other. The Company has determined its reportable operating segments based upon how the business is managed and operated. The
accounting policies of the segments described above are the same as those described in Note 1. The Company does not identify or allocate assets by operating segment, nor does management evaluate segments on these criteria.





Segment Earnings





The Company evaluates the
performance of its operating segments without considering the effects of net interest expense and income, amortization of intangibles and stock compensation expense, all which are managed by corporate headquarters. Corporate administrative costs
including depreciation and amortization expense are allocated based on headcount.





Year Ended December 31,1999


2000


2001Human therapeutics

$
(3,328
)

$
(10,934
)

$
(21,583
)Chemicals


(6,824
)


(15,232
)


(8,745
)Agriculture


3,077



(389
)


(3,808
)All other










(2,947
)Total segment loss


(7,075
)


(26,555
)


(37,083
)Interest income, net


1,413



15,329



12,862Stock compensation


(5,656
)


(15,981
)


(12,017
)Amortization of intangibles






(3,419
)


(8,726
)Acquired in-process R&D






(28,959
)


Total net loss

$
(11,318
)

$
(59,585
)

$
(44,964
)





Segment Revenue





Revenues for each operating segment are derived from the Companys research collaboration agreements and government grants and are categorized based on the industry of the product
or technology under development.





Year Ended December 31,1999

2000

2001Human therapeutics

$
3,811

$
9,295

$
12,403Chemicals


2,613


4,782


7,315Agriculture


7,593


10,388


10,810All other








Total revenue

$
14,017

$
24,465

$
30,528




78




---



MAXYGEN, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







Geographic Information





The Companys primary country of operation is the United States, its country of domicile. Revenues are attributed to countries based on the location of collaborators. Long-lived
assets include property and equipment and intangible assets.





Year Ended December 31,1999

2000

2001RevenuesUnited States

$
11,373

$
17,288

$
17,949Denmark


455


1,246


6,236United Kingdom


1,593


4,388


4,666Other foreign countries


596


1,543


1,677Total revenue

$
14,017

$
24,465

$
30,528





December 31,2000

2001Long-Lived AssetsUnited StatesNature Biotechnology (1996)

$
36,424

$
45,270DenmarkNature Biotechnology (1996)


2,690


4,110Total long-lived assets

$
39,114

$
49,380





Major Customers





Major customers that represent more than 10% of total Company revenue are presented in the following table:





1999


2000


2001Human TherapeuticsCustomer A

14.2
%

10.3
%

Customer B

8.5
%

11.8
%

5.4
%Customer C




3.1
%

10.8
%AgricultureCustomer D

42.8
%

24.5
%

19.9
%Customer E

11.4
%

17.9
%

15.3
%




79




---




Item 9    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND


FINANCIAL DISCLOSURE





None.





PART III





Item 10    DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT





The information
required by this item, other than concerning our executive officers, is incorporated by reference from the sections captioned Proposal No. 1. Election of Directors, Board of Directors Meetings and Committees and Directors
Compensation and Section 16(a) Beneficial Ownership Reporting Compliance contained in our proxy statement for the 2002 annual meeting of stockholders to be filed on or before April 30, 2002. Information required by Item 10
concerning our executive officers is set forth in Part I of this report.





Item 11    EXECUTIVE COMPENSATION





The information required by this item is
incorporated by reference from the section captioned Executive Compensation contained in our proxy statement for the 2002 annual meeting of stockholders to be filed on or before April 30, 2002.





Item 12    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT





The
information required by this item is incorporated by reference from the section captioned Security Ownership of Certain Beneficial Owners and Management contained in our proxy statement for the 2002 annual meeting of stockholders to be
filed on or before April 30, 2002.





Item 13    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS





The information
required by this item is incorporated by reference from the section captioned Related Party Transactions contained in our proxy statement for the 2002 annual meeting of stockholders to be filed on or before April 30, 2002.




80




---




PART IV





Item 14    EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K





Upon
written request, Maxygen will provide, without charge, a copy of this annual report on Form 10-K, including the consolidated financial statements, financial statement schedules and any exhibits for our most recent fiscal year. All requests should be
sent to:





Maxygen, Inc.


Investor Relations


515 Galveston Drive


Redwood City, CA 94063


(650) 298-5300





In addition, the Securities and Exchange Commission maintains a website that provides access to all filings made electronically by us at www.sec.gov. Our website is located at
www.maxygen.com. Information contained on our website is not a part of this annual report.





The following documents are being
filed as part of this report:





a)Financial Statements.





PageReport of Ernst & Young LLP, Independent Auditors

53Consolidated Balance Sheets

54Consolidated Statements of Operations

55Consolidated Statement of Stockholders Equity

56Consolidated Statements of Cash Flows

57Notes to Consolidated Financial Statements

58





Financial statement schedules have been omitted because they are either presented
elsewhere, are inapplicable or are immaterial as defined in the instructions.





b)  We did not file any reports on Form
8-K during 2001.





c)Exhibits.





Exhibit Number

Description of Exhibit2.1

Exchange Agreement, dated as of April 12, 2000 (the Exchange Agreement), by and among Maxygen, Inc., Maxygen Holdings
Ltd., ProFound Pharma A/S (ProFound) and the shareholders of ProFound (1)2.2

Amendment No. 1 to the Exchange Agreement, dated as of July 31, 2000, by and among Maxygen, Inc., Maxygen Holdings Ltd., ProFound
and the shareholders of ProFound (1)3.1

Amended and Restated Certificate of Incorporation (2)3.2

Amended and Restated Bylaws (2)4.1

Specimen Common Stock Certificate (Exhibit 4.1 to Amendment No. 1) (3)4.2

Amended and Restated Registration Rights Agreement among Maxygen and certain Maxygen stockholders dated as of November 13, 2000
(4)*10.1

Form of Executive Officer and Director Indemnification Agreement (Exhibit 10.7) (3)*10.2

Form of Executive Officer Change of Control Plan (Exhibit 10.1) (5)*10.3

1997 Stock Option Plan, as amended, with applicable option agreement (Exhibit 10.1) (4)




81




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Exhibit Number

Description of Exhibit*10.4

1999 Nonemployee Directors Stock Option Plan, as amended, with applicable option agreement (Exhibit 10.3) (5)*10.5

1999 Employee Stock Purchase Plan, as amended (Exhibit 10.11) (4)*10.6

2000 International Stock Option Plan, as amended, with applicable option agreement*10.7

2000 Non-Officer Stock Option Plan, as amended, with applicable option agreement (6)*10.8

Form of Promissory Note issued in connection with exercise of stock options (Exhibit 10.10) (3)10.9

Lease between Metropolitan Life Insurance Company and Maxygen dated as of October 21, 1998 (Exhibit 10.4) (3)10.10

First Amendment to Lease dated as of February 26, 1999 by and between Metropolitan Life Insurance Company and Maxygen (Exhibit
10.5) (3)10.11

Second Amendment to Lease dated as of October 24, 2000 by and between Metropolitan Life Insurance Company and Maxygen (Exhibit
10.6) (4)10.12

Lease between Metropolitan Life Insurance Company and Maxygen dated April 21, 2000 (Exhibit 10.2) (2)10.13

Lease Agreement between ProFound Pharma A/S and The Science Park in Horsholm dated May 5, 2000 (7)10.14

Sublease between Cygnus, Inc. and Maxygen dated March 30, 2001 (Exhibit 10.2) (5)10.15+

Technology Transfer Agreement among Maxygen, Affymax Technologies N.V. and Glaxo Group Limited dated March 14, 1997, as amended,
effective March 1, 1998 (Exhibit 10.3 to Amendment No. 2) (3)10.16+

License and Collaboration Agreement between Maxygen and Novo Nordisk A/S effective as of September 17, 1997, as amended June 29,
1998, July 29, 1998, and April 19, 1999 (Exhibit 10.11 to Amendment No. 2) (3)10.17+

Collaborative Research and License Agreement entered into as of December 23, 1998 by and between Pioneer Hi-Bred International,
Inc. and Maxygen (Exhibit 10.12 to Post-Effective Amendment No. 1) (3)10.18+

Agreement between Maxygen and Gist-Brocades B.V. entered into March 15, 1999 (Exhibit 10.13 to Amendment No. 2) (3)10.19+

Collaboration Agreement effective as of June 18, 1999 by and between Zeneca Limited and Maxygen (Exhibit 10.14 to Amendment No.
2) (3)10.20+

Collaborative Research and Development Agreement made as of January 19, 2000 between Technological Resources Pty Limited and
Maxygen (Exhibit 10.15 to Amendment No. 1) (8)10.21+

Cooperative Research and Development Agreement between the National Cancer Institute, National Institutes of Health dated
February 24, 2000 (Exhibit 10.20) (8)21.1

List of Subsidiaries23.1

Consent of Ernst & Young LLP, Independent Auditors24.1

Power of Attorney (included on signature page)


---

|* |  | Management contract or compensatory plan or arrangement.
|- |  | --------------------------------------------------------




|+ |  | Confidential treatment has been granted with respect to portions of the exhibit. A complete copy of the agreement, including the redacted terms, has been separately filed with
the Securities and Exchange Commission.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



82




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|(1) |  | Incorporated by reference to the corresponding exhibit to Maxygens Current Report on Form 8-K (File No. 000-28401) filed with the Securities and Exchange Commission
on August 15, 2000.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




|(2) |  | Incorporated by reference to the corresponding or indicated exhibit to Maxygens Quarterly Report on Form 10-Q (File No. 000-28401) for the quarter ended June 30,
2000, filed with the Securities and Exchange Commission on August 14, 2000.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




|(3) |  | Incorporated by reference to the corresponding or indicated exhibit to Maxygens Registration Statement on Form S-1, as amended (No. 333-89413) initially filed with the
Securities and Exchange Commission on October 20, 1999.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




|(4) |  | Incorporated by reference to the indicated exhibit to Maxygens Annual Report on Form 10-K (File No. 000-28401) for the year ended December 31, 2000, filed with the
Securities and Exchange Commission on March 21, 2001.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




|(5) |  | Incorporated by reference to the indicated exhibit to Maxygens Quarterly Report on Form 10-Q (File No. 000-28401) for the quarter ended June 30, 2001, filed with the
Securities and Exchange Commission on August 14, 2001.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




|(6) |  | Incorporated by reference to exhibit 99.3 to Maxygens Registration Statement on Form S-8 (No. 333-57486) filed with the Securities and Exchange Commission on March
23, 2001.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




|(7) |  | Incorporated by reference to exhibit 10.1 to Maxygens Quarterly Report on Form 10-Q (File No. 000-28401) for the quarter ended September 30, 2000, filed with the
Securities and Exchange Commission on November 14, 2000.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




|(8) |  | Incorporated by reference to the indicated exhibit to Maxygens Registration Statement on Form S-1, as amended (No. 333-31580) initially filed with the Securities and
Exchange Commission on March 3, 2000.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



83




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SIGNATURES





Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.








|March 25, 2002 | 
|-------------- | 

MAXYGEN, INC.By:

/s/    RUSSELL J. HOWARDRussell J. Howard Chief Executive Officer





POWER OF ATTORNEY





KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Michael Rabson and Lawrence W. Briscoe or either of them, his or her true and
lawful attorneys-in-fact and agents, with full power of substitution and re-substitution, for him or her and in his or her name, place and stead, in any and all capacities to sign any and all amendments to this Report on Form 10-K, and to file the
same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every
act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or either of them,
or their, his or her substitutes or substitute, may lawfully do or cause to be done by virtue hereof.





Pursuant to the
requirements of the Securities Exchange Act of 1934, as amended, this Report on Form 10-K has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.





Signature

Title

Date/s/    RUSSELL J. HOWARD Russell J. Howard

Chief Executive Officer and Director (Principal Executive Officer)

March 25, 2002/s/    LAWRENCE W. BRISCOE Lawrence W. Briscoe

Chief Financial Officer (Principal Financial and Accounting Officer)

March 25, 2002/s/    ISAAC STEIN Isaac Stein

Chairman of the Board

March 25, 2002/s/    ROBERT J. GLASER Robert J. Glaser

Director

March 25, 2002/s/    M.R.C. GREENWOOD M.R.C. Greenwood

Director

March 25, 2002/s/    ERNEST MARIO Ernest Mario

Director

March 25, 2002/s/    GORDON RINGOLD Gordon Ringold

Director

March 25, 2002/s/    GEORGE POSTE George Poste

Director

March 25, 2002




84




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EXHIBIT INDEX





Exhibit Number

Description of Exhibit2.1

Exchange Agreement, dated as of April 12, 2000 (the Exchange Agreement), by and among Maxygen, Inc., Maxygen Holdings
Ltd., ProFound Pharma A/S (ProFound) and the shareholders of ProFound (1)2.2

Amendment No. 1 to the Exchange Agreement, dated as of July 31, 2000, by and among Maxygen, Inc., Maxygen Holdings Ltd., ProFound
and the shareholders of ProFound (1)3.1

Amended and Restated Certificate of Incorporation (2)3.2

Amended and Restated Bylaws (2)4.1

Specimen Common Stock Certificate (Exhibit 4.1 to Amendment No. 1) (3)4.2

Amended and Restated Registration Rights Agreement among Maxygen and certain Maxygen stockholders dated as of November 13, 2000
(4)*10.1

Form of Executive Officer and Director Indemnification Agreement (Exhibit 10.7) (3)*10.2

Form of Executive Officer Change of Control Plan (Exhibit 10.1) (5)*10.3

1997 Stock Option Plan, as amended, with applicable option agreement (Exhibit 10.1) (4)*10.4

1999 Nonemployee Directors Stock Option Plan, as amended, with applicable option agreement (Exhibit 10.3) (5)*10.5

1999 Employee Stock Purchase Plan, as amended (Exhibit 10.11) (4)*10.6

2000 International Stock Option Plan, as amended, with applicable option agreement*10.7

2000 Non-Officer Stock Option Plan, as amended, with applicable option agreement (6)*10.8

Form of Promissory Note issued in connection with exercise of stock options (Exhibit 10.10) (3)10.9

Lease between Metropolitan Life Insurance Company and Maxygen dated as of October 21, 1998 (Exhibit 10.4) (3)10.10

First Amendment to Lease dated as of February 26, 1999 by and between Metropolitan Life Insurance Company and Maxygen (Exhibit
10.5) (3)10.11

Second Amendment to Lease dated as of October 24, 2000 by and between Metropolitan Life Insurance Company and Maxygen (Exhibit
10.6) (4)10.12

Lease between Metropolitan Life Insurance Company and Maxygen dated April 21, 2000 (Exhibit 10.2) (2)10.13

Lease Agreement between ProFound Pharma A/S and The Science Park in Horsholm dated May 5, 2000 (7)10.14

Sublease between Cygnus, Inc. and Maxygen dated March 30, 2001 (Exhibit 10.2) (5)10.15+

Technology Transfer Agreement among Maxygen, Affymax Technologies N.V. and Glaxo Group Limited dated March 14, 1997, as amended,
effective March 1, 1998 (Exhibit 10.3 to Amendment No. 2) (3)10.16+

License and Collaboration Agreement between Maxygen and Novo Nordisk A/S effective as of September 17, 1997, as amended June 29,
1998, July 29, 1998, and April 19, 1999 (Exhibit 10.11 to Amendment No. 2) (3)10.17+

Collaborative Research and License Agreement entered into as of December 23, 1998 by and between Pioneer Hi-Bred International,
Inc. and Maxygen (Exhibit 10.12 to Post-Effective Amendment No. 1) (3)10.18+

Agreement between Maxygen and Gist-Brocades B.V. entered into March 15, 1999 (Exhibit 10.13 to Amendment No. 2) (3)




---

Exhibit Number

Description of Exhibit10.19+

Collaboration Agreement effective as of June 18, 1999 by and between Zeneca Limited and Maxygen (Exhibit 10.14 to Amendment No.
2) (3)10.20+

Collaborative Research and Development Agreement made as of January 19, 2000 between Technological Resources Pty Limited and
Maxygen (Exhibit 10.15 to Amendment No. 1) (8)10.21+

Cooperative Research and Development Agreement between the National Cancer Institute, National Institutes of Health dated
February 24, 2000 (Exhibit 10.20) (8)21.1

List of Subsidiaries23.1

Consent of Ernst & Young LLP, Independent Auditors24.1

Power of Attorney (included on signature page)


---

|* |  | Management contract or compensatory plan or arrangement.
|- |  | --------------------------------------------------------




|+ |  | Confidential treatment has been granted with respect to portions of the exhibit. A complete copy of the agreement, including the redacted terms, has been separately filed with
the Securities and Exchange Commission.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




|(1) |  | Incorporated by reference to the corresponding exhibit to Maxygens Current Report on Form 8-K (File No. 000-28401) filed with the Securities and Exchange Commission
on August 15, 2000.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




|(2) |  | Incorporated by reference to the corresponding or indicated exhibit to Maxygens Quarterly Report on Form 10-Q (File No. 000-28401) for the quarter ended June 30, 2000,
filed with the Securities and Exchange Commission on August 14, 2000.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




|(3) |  | Incorporated by reference to the corresponding or indicated exhibit to Maxygens Registration Statement on Form S-1, as amended (No. 333-89413) initially filed with the
Securities and Exchange Commission on October 20, 1999.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




|(4) |  | Incorporated by reference to the indicated exhibit to Maxygens Annual Report on Form 10-K (File No. 000-28401) for the year ended December 31, 2000, filed with the
Securities and Exchange Commission on March 21, 2001.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




|(5) |  | Incorporated by reference to the indicated exhibit to Maxygens Quarterly Report on Form 10-Q (File No. 000-28401) for the quarter ended June 30, 2001, filed with the
Securities and Exchange Commission on August 14, 2001.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




|(6) |  | Incorporated by reference to exhibit 99.3 to Maxygens Registration Statement on Form S-8 (No. 333-57486) filed with the Securities and Exchange Commission on March
23, 2001.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




|(7) |  | Incorporated by reference to exhibit 10.1 to Maxygens Quarterly Report on Form 10-Q (File No. 000-28401) for the quarter ended September 30, 2000, filed with the
Securities and Exchange Commission on November 14, 2000.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




|(8) |  | Incorporated by reference to the indicated exhibit to Maxygens Registration Statement on Form S-1, as amended (No. 333-31580) initially filed with the Securities and
Exchange Commission on March 3, 2000.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------