TULARIK INC - 10-Q Quarterly Report

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 whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes x No ¨

As of March 31, 2003, 55,308,406 shares of the Registrant’s common stock were outstanding.

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

The unaudited condensed consolidated financial statements of Tularik Inc. (“Tularik” or the “Company”) reflect, in the opinion of management, all adjustments, consisting only of normal and recurring adjustments, necessary to present fairly the Company’s consolidated financial position at March 31, 2003 and the Company’s consolidated results of operations for the three-month periods ended March 31, 2003 and 2002. Interim-period results are not necessarily indicative of results of operations or cash flows for a full-year period.

The year-end balance sheet data were derived from audited consolidated financial statements, but do not include all disclosures required by accounting principles generally accepted in the United States of America.

These unaudited condensed consolidated financial statements and the notes accompanying them should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2002. Stockholders are encouraged to review the Form 10-K for a broader discussion of the Company’s business and the opportunities and risks inherent therein. Copies of the Form 10-K are available from the Company upon request.

The unaudited condensed consolidated financial statements include the accounts of Tularik, its majority-owned subsidiary, Cumbre Inc., and Tularik’s wholly owned subsidiaries, Amplicon Corporation, Tularik Pharmaceutical Company, Tularik GmbH and Tularik Limited.

It is the Company’s policy to not allocate losses to any of its subsidiaries’ minority interests to the extent that such losses reduce the minority interests below the third-party minority stockholders’ liquidation preferences. As a result of this policy, 100% of Cumbre’s net loss has been included in the Company’s determination of net loss for the three-month periods ended March 31, 2003 and 2002.

In January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.” FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective immediately for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. The Company is currently evaluating the impact that the adoption of this standard will have on its financial statements.

The following table sets forth the computation of the Company’s basic and diluted net loss per share (in thousands, except per share amounts):

Outstanding options and warrants to purchase in the aggregate 6,417,808 shares of common stock at March 31, 2003 and 6,049,974 shares of common stock at March 31, 2002 were excluded from diluted earnings calculations for the three-month periods ended March 31, 2003 and 2002, respectively, because inclusion of options and warrants would have an anti-dilutive effect on losses in these periods. At March 31, 2003, 22,111 shares of common stock were subject to repurchase.

Comprehensive loss consists of net loss and other comprehensive loss. Other comprehensive loss includes certain changes in equity that are excluded from net loss. Specifically, unrealized holding gains and losses on Tularik’s investments and the effect of foreign currency exchange rate fluctuations are included in accumulated other comprehensive loss. Comprehensive loss and its components for the three-month periods ended March 31, 2003 and 2002 are as follows (in thousands):

As of March 31, 2003, the Company had purchased $4.3 million of corporate debt securities and bank certificates of deposits to collateralize one of the Company’s long-term debt facilities and the rent deposit on the Company’s new facilities in South San Francisco. Accordingly, the Company has classified these investments as restricted investments in the accompanying balance sheet.

The Company has elected to follow Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”), and related Interpretations in accounting for its stock options and stock purchase rights because, as discussed below, the alternative fair value accounting provided for under Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), requires use of option valuation models that were not developed for use in valuing employee stock options and rights.

Pro forma net loss and net loss per share information is required by SFAS 123, which also requires that the information be determined as if the Company had accounted for its employee stock options and rights granted subsequent to December 31, 1994 under the fair market value method of that statement. For employee stock options granted prior to the Company’s initial public offering in December 1999, the fair value for these options and the related purchase rights was estimated at the date of grant using the minimum value method.

For employee stock options granted subsequent to the Company’s initial public offering, the value was estimated at the date of grant using a Black-Scholes option-pricing model. The following weighted-average assumptions were used for 2003 and 2002, respectively: risk free interest rates of 2.91% and 3.8%; volatility factor of the expected market price of the Company’s common stock of 0.75 and 0.71; no dividend yield; and a weighted-average expected life of the options of 4.5 years. Pro forma information follows for the three-month periods ended March 31,:

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

This discussion and analysis should be read in conjunction with our unaudited condensed consolidated financial statements and accompanying notes included in this report and our 2002 consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2002. Operating results are not necessarily indicative of results that may occur in future periods.

This report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to the “safe harbor” created by those sections. These forward-looking statements include, but are not limited to, statements about:

These forward-looking statements are generally identified by words such as “expect,” “anticipate,” “intend,” “believe,” “hope,” “assume,” “estimate,” “plan,” “will” and other similar words and expressions. These forward-looking statements involve risks and

uncertainties that could cause our actual results to differ materially from those expressed or implied in the forward-looking statements as a result of certain factors, including those set forth in this Item 2 and those described in our Annual Report on Form 10-K for the year ended December 31, 2002, including under “Business—Risk Factors.” We undertake no obligation to publicly release any revisions to the forward-looking statements or to reflect events and circumstances after the date of this document.

Tularik seeks to discover and develop a broad range of novel and superior orally available medicines that act through the regulation of gene expression. Tularik’s scientific platform is focused on three therapeutic areas: cancer, immunology and metabolic disease. We currently have four drug candidates in clinical trials. T67 is in a pivotal clinical trial for the treatment of hepatocellular carcinoma (HCC). T607 is in phase 2 clinical trials for the treatment of HCC, ovarian cancer, gastric cancer and esophageal cancer. T487, for the treatment of inflammatory diseases, and T131, for the treatment of type 2 diabetes, are in phase 1 clinical trials to evaluate safety and pharmacokinetic profile. We have established strategic partnerships with Japan Tobacco Inc., Medarex, Inc. and Sankyo Company, Limited.

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to our research collaborations, investments, intangible assets, income taxes, financing operations and contingencies. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

Our consolidated financial statements include the results of Tularik in the United States and the results of the following subsidiaries:

Transactions and accounts between us and each of our subsidiaries have been eliminated. For non-United States operations, local currencies are the functional currencies. All assets and liabilities of foreign subsidiaries are translated into United States dollars at current exchange rates, equity is translated at historical rates and net losses are translated at the average exchange rates for the reporting periods. Aggregate gains and losses on currency exchange are included in other comprehensive income as a component of stockholders’ equity.

Collaborative research and development agreements provide for periodic payments in support of our research and development activities. Research revenue is recognized as research services are performed, or on a pro rata basis over the term estimated to complete a research program. The estimated term of a research program and the related revenues are subject to revision as the contract progresses towards completion. Payments we receive that are related to substantive at-risk milestones are recognized when our performance of the

milestone under the terms of the collaboration is achieved and there are no further performance obligations. Research support payments received in advance of work performed and technology access fees are recorded as deferred revenue. These upfront payments are recognized as revenue as the work is performed or over the stated or estimated terms of the collaborations. Changes in estimates on contract terms can cause an acceleration or delay in revenue recognition.

We maintain investment portfolio holdings of various issuers, types and maturities. We consider all highly liquid investments purchased with original maturities of three months or less to be cash equivalents. At March 31, 2003, these investment securities were classified as available-for-sale and consequently were recorded on the balance sheet at fair value with unrealized gains and losses reported as a separate component of accumulated other comprehensive income. Management assesses whether declines in the fair value of investment securities are other than temporary. If the decline in fair value is judged to be other than temporary, the cost basis of the individual security is written down to fair value and the amount of the write down is included in earnings. In determining whether a decline is other than temporary, management considers the following factors:

In July 2001, we acquired the computer-aided molecular design business of Protherics PLC. The total purchase price was allocated to software, laboratory equipment, furniture, computers, goodwill and liabilities. The value of the software was estimated based on Protherics’ costs to design, code and test the software. The software is being amortized over its useful life, which is estimated to be three years from the date of the acquisition. The value of the tangible assets acquired and liabilities assumed was estimated to be the carrying value at the date of the business combination. Goodwill of $3.1 million was determined to be the excess purchase price over the assets acquired and liabilities assumed. We review the goodwill for impairment at least annually. The effect of a change in our estimates and assumptions could be an impairment loss of up to $3.1 million.

For the quarter ended March 31, 2003, we incurred a net loss of $24.2 million, or $0.44 per share, compared to a net loss of $20.6 million, or $0.41 per share, for the same period in 2002.

Collaborative research and development revenue was $5.1 million for the quarter ended March 31, 2003, compared to $6.2 million for the quarter ended March 31, 2002. The expiration of our collaboration with the Roche Bioscience division of Syntex (U.S.A.) LLC in July 2002 caused a decrease in revenue of $2.1 million which was partially offset by $1.0 million in revenue related to our Sankyo collaboration.

Revenue from technology licenses was $1.6 million for the quarter ended March 31, 2003. We did not have any revenue from technology licenses in 2002. The revenue for the quarter ended March 31, 2003 related to receipt of preferred stock of a private company in exchange for a license to certain technology and the assignment of certain patents. The value attributed to the preferred stock was our estimate of fair value as of the date of receipt. Our estimate was based on information available to us including the most recent purchase price for the preferred stock by unrelated third parties, market conditions and the private company’s business progress.

Research and development expenses were $28.3 million for the quarter ended March 31, 2003, compared to $25.2 million for the quarter ended March 31, 2002. The increase in 2003 as compared to 2002 was primarily attributable to a $1.9 million increase in costs related to our clinical trial programs, a $0.8 million increase in costs related to increased headcount and a $0.5 million increase in research spending at our majority-owned subsidiary, Cumbre Inc.

General and administrative expenses were $3.0 million for the quarter ended March 31, 2003, compared to $2.7 million for the quarter ended March 31, 2002. The increase in 2003 as compared to 2002 was due to a $0.3 million increase in legal and accounting costs.

Interest income was $0.8 million for the quarter ended March 31, 2003, compared to $1.6 million for the quarter ended March 31, 2002. The decrease in 2003 as compared to 2002 was due to lower cash and investment balances as well as lower yields on our investment portfolio.

Since inception, our primary sources of funds have been the sale of equity securities, capital lease financings, non-equity payments from collaborators and interest income. Combined cash, cash equivalents and investments (both current and non-current) totaled $159.9 million at March 31, 2003 (including $17.7 million attributable to Tularik’s majority-owned subsidiary, Cumbre Inc.), a decrease of $29.9 million from December 31, 2002. The decrease was due to the use of $29.2 million to fund operations, the repayment of long-term debt of $2.4 million and the acquisition of property and equipment for $2.1 million. These reductions were partially offset by the receipt of $1.6 million of preferred stock of a private company in exchange for a license to certain technology and the assignment of certain patents, $1.3 million in proceeds from the issuance of long-term obligations and $1.0 million in proceeds from the issuance of common stock and from notes paid by stockholders. As of March 31, 2003, the average maturity of available-for-sale securities was approximately 113 days.

Our forecast of the period of time through which our financial resources will be adequate to support our operations is a forward-looking statement and involves risks and uncertainties, and actual results could vary as a result of a number of factors. We believe that our cash and investment securities and anticipated cash flow from existing collaborations will be sufficient to support our current operating plan through the second quarter of 2004. This estimate excludes the cash and investment securities of Cumbre Inc., our majority-owned subsidiary, as well as the funding of Cumbre’s operating plan. We have based this estimate on assumptions that may prove to be wrong. Our future capital requirements will depend on many factors, including:

Future capital requirements will also depend on the extent to which we acquire or invest in businesses, products and technologies. Until we can generate sufficient levels of cash from our operations, which we do not expect to achieve for at least several years, we expect to finance future cash needs through the sale of equity securities, strategic collaborations and debt financing as well as interest income earned on cash balances. In August 2001, we filed a registration statement on Form S-3 to offer and sell common stock and debt securities in one or more offerings up to a total amount of $250.0 million. Currently, $217.8 million remains available on the Form S-3, and we have no current commitments to offer and sell any securities that may be offered or sold pursuant to such registration statement. We cannot assure you that additional financing or collaboration and licensing arrangements will be available in the future when needed or that, if available,

financing or collaboration and licensing arrangements will be obtained on terms favorable to us or our stockholders. Insufficient funds may require us to delay, scale back or eliminate some or all of our research or development programs, to lose rights under existing licenses or to relinquish greater or all rights to drug candidates at an earlier stage of development or on less favorable terms than we would otherwise choose. Insufficient funds may also adversely affect our ability to operate as a going concern. If we raise additional funds by issuing equity securities, substantial dilution to existing stockholders may result.

Our cash and investments policy emphasizes liquidity and preservation of principal over other portfolio considerations. We select investments that maximize interest income to the extent possible given these two constraints. We satisfy our liquidity requirements by investing excess cash in securities with different maturities to match projected cash needs and limit concentration of credit risk by diversifying our investments among a variety of high credit-quality issuers.

Our stock option program is a broad-based, long-term retention program that is intended to attract and retain talented employees and to align stockholder and employee interests. Our program primarily consists of our 1997 Equity Incentive Plan and 1997 Non-Employee Directors’ Plan (collectively referred to as the 1997 Plans), under which stock options are granted to employees, directors and other service providers. Substantially all of our employees participate in our stock option program. In the past, we granted options under our 1991 Stock Plan. Although we no longer grant options under this plan, exercisable options granted under this plan are still outstanding.

On December 19, 2002, we announced that our Board of Directors approved a voluntary stock option exchange program for employees other than executive officers. Under the exchange program, employees were offered the opportunity to exchange approximately 2.4 million outstanding stock options with exercise prices equal to or greater than $14.00 per share for new stock options that will be granted at an exercise price determined on the date the new stock options will be granted. Participating employees will receive new stock options in exchange for outstanding stock options at an exchange ratio of 1 for 1. In accordance with the exchange program, on January 17, 2003, we cancelled approximately 2.1 million of our outstanding stock options. We expect to grant new options to purchase approximately 2.1 million shares of our common stock on July 18, 2003, which is the first business day that is six months and one day after the cancellation of the exchanged options. The exercise price per share of the expected new options will be equal to the fair market value of our common stock at the close of regular trading on July 17, 2003. The expected new stock options represent approximately 3.9% of the total shares of our common stock outstanding as of December 31, 2002, and could have a dilutive impact on our future earnings per share to the extent that the market price of our common stock exceeds the exercise price of the new stock options expected to be granted on July 18, 2003.

Investing in our common stock involves a high degree of risk. In addition to the information included in this report on Form 10-Q, you should carefully consider the risks

described below and in our Annual Report on Form 10-K for the year ended December 31, 2002 before purchasing our common stock. If any of the following risks actually occurs, our business could be materially harmed and our financial condition and results of operations could be materially and adversely affected. As a result, the trading price of our common stock could decline, and you might lose all or part of your investment. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties, not presently known to us, or that we currently see as immaterial, may also harm our business. If any of these additional risks and uncertainties occurs, the trading price of our common stock could decline, and you might lose all or part of your investment.

If we continue to incur operating losses for a period longer than anticipated, we may be unable to continue our operations.

We have generated operating losses since we began operations in November 1991. Net losses were $24.2 million in the first quarter of 2003, $20.6 million in the first quarter of 2002 and $9.2 million in the first quarter of 2001. Net losses were $93.8 million in 2002, $48.6 million in 2001 and $43.3 million in 2000. The extent of our future losses and the timing of potential profitability are highly uncertain, and we may never achieve profitable operations. We have been engaged in discovering and developing drugs since inception, which has required, and will continue to require, significant research and development expenditures. To date, we have no products that have generated any revenue. As of March 31, 2003, we had an accumulated deficit of approximately $297.3 million. Even if we succeed in developing a commercial product, we expect to incur losses for at least the next several years, and we expect that our losses will increase as we expand our research and development activities. These losses, among other things, have had and will have an adverse effect on our stockholders’ equity and working capital. If the time required to generate product revenues and achieve profitability is longer than anticipated, we may not be able to continue our operations. We do not anticipate that we will generate product revenues until at least 2006, and we do not anticipate that we will achieve profitability for at least several years after generating material product revenues. If we fail to obtain the necessary capital, we will not be able to fund our operations.

Because our product candidates are in an early stage of development, there is a high risk of failure.

We have no products that have received regulatory approval for commercial sale. All of our product candidates, except T67, are in early stages of development, and we face the risks of failure inherent in developing drugs based on new technologies. Except for T67, none of our product candidates has advanced beyond phase 2 clinical trials. In addition, none of our prospective products, including T67 and T607, are expected to receive regulatory approval and be commercially available until at least 2006.

In addition, to compete effectively, our products must be easy to use, cost-effective and economical to manufacture on a commercial scale. We may not achieve any of these objectives, and, as a result, we may be unable to successfully market and sell our current or future product candidates. In addition, any of our products may not attain market acceptance. Also, third parties may develop superior products or have proprietary rights that preclude us from marketing our products.

At any time, we may decide not to continue the development of a product candidate or not to commercialize a product candidate. For example, two of our drug candidates, T67 and T607, operate in a similar manner. Based on results at any stage of clinical trials, we may decide to discontinue development of one or both of these compounds. Additionally, even if clinical results are favorable for both compounds, we may decide to commercialize only one of these compounds.

Pre-clinical testing and clinical development are long, expensive and uncertain processes. It may take us several years to complete our testing, and failure can occur at any stage of testing. Interim results of trials do not necessarily predict final results, and acceptable results in early trials may not be repeated in later trials. Success in pre-clinical testing and early clinical trials does not ensure that later clinical trials will be successful. For example, a single partial response or even a small number of partial responses in cancer patients is not necessarily indicative of success in demonstrating efficacy in phase 2 and phase 3 clinical testing. A number of companies in the

pharmaceutical industry, including biotechnology companies, have suffered significant setbacks in advanced clinical trials, even after promising results in earlier trials.

Commercialization of our product candidates depends upon successful completion of clinical trials. We must provide the United States Food and Drug Administration and foreign regulatory authorities with pre-clinical and clinical data that demonstrates the safety and efficacy of our products before they can be approved for commercial sale.

Any clinical trial may fail to produce results satisfactory to the FDA. Pre-clinical and clinical data can be interpreted in different ways, which could delay, limit or prevent regulatory approval. Negative or inconclusive results or adverse medical events during a clinical trial could cause a clinical trial to be repeated or a program to be terminated. During 2002, we terminated phase 2 clinical trials of our anti-cytomegalovirus drug candidate, T611, and phase 2 clinical trials of our anti-cancer drug candidate, T64.

In addition, the FDA could determine that the design of a clinical trial is inadequate to produce reliable results and require us to revamp the design of the clinical trial or terminate the clinical trial altogether. If we need to revamp a clinical trial or perform more or larger clinical trials than planned, our financial results will be harmed.

In March 2003, we initiated a phase 2/3 clinical trial for T67 that will enroll approximately 750 first-line HCC patients. This trial is likely to take several years to complete and contemplates early termination if safety or efficacy data on the first 100 patients is unsatisfactory. The FDA has informed us that if trial results satisfy certain criteria, this one trial could support an application to market T67 for HCC, but additional trials may be necessary. Additionally, the FDA has informed us that it will require additional pre-clinical testing of T67 prior to regulatory approval, and we are in the process of performing this additional testing. Any setbacks in our T67 program could cause a substantial decline in our stock price.

We do not know whether our existing or any future clinical trials will demonstrate safety and efficacy sufficient to obtain the requisite regulatory approvals or will result in marketable products. Our failure to adequately demonstrate the safety and efficacy of our products under development will prevent receipt of FDA approval and, ultimately, commercialization of our product candidates.

For additional information concerning the testing of our prospective products, see “Business—Government Regulation” in our Annual Report on Form 10-K for the year ended December 31, 2002.

Significant delays in clinical testing could materially impact our product development costs. We do not know whether planned clinical trials will begin on time, will need to be revamped or will be completed on schedule, or at all. Clinical trials can be delayed for a variety of reasons, including delays in obtaining regulatory approval to commence a study, delays in reaching agreement on acceptable clinical study agreement terms with prospective clinical sites, delays in obtaining institutional review board approval to conduct a study at a prospective clinical site or delays in recruiting subjects to participate in a study.

In addition, we typically rely on third-party clinical investigators to conduct our clinical trials and other third-party organizations to oversee the operations of such trials and to perform data collection and analysis. As a result, we may face additional delaying factors outside our control if these parties do not perform their obligations in a timely fashion.

While we have not yet experienced delays that have materially impacted our clinical trials or product development costs, delays of this sort could occur for the reasons identified above or other reasons. If we have delays in testing or approvals, our product development costs will increase. For example, we may need to make additional payments to third-party investigators and organizations to retain their services or we may need to pay recruitment incentives. If the delays are significant, our financial results and the commercial prospects for our product candidates will be harmed, and our ability to become profitable will be delayed.

Since there is a narrow therapeutic window between efficacy and toxicity in certain anti-cancer drugs, clinical trials may be terminated at an early stage, and the development of the product candidate may be discontinued.

Two of our four current clinical candidates, T67 and T607, are cytotoxic agents directed to the treatment of cancer. Anti-cancer drugs of this type generally have a narrow therapeutic window between efficacy and toxicity. Because cancer patients are often critically ill and the anti-cancer drugs can be extremely toxic to humans, drug-related deaths and very serious side effects may occur in clinical trials. If unacceptable toxicity is observed in clinical trials, the trials may be terminated at an early stage despite favorable pre-clinical or early clinical results. In addition, if, in clinical trials, the product candidate proves to be too toxic to humans, the development of the product candidate may be completely discontinued.

Because we must obtain regulatory approval to market our products in the United States and foreign jurisdictions, we cannot predict whether or when we will be permitted to commercialize our products.

The pharmaceutical industry is subject to stringent regulation by a wide range of authorities. We cannot predict whether regulatory clearance will be obtained for any product we develop. A pharmaceutical product cannot be marketed in the United States until it has completed rigorous pre-clinical testing and clinical trials and an extensive regulatory clearance process implemented by the FDA. Satisfaction of regulatory requirements typically takes many years, is dependent upon the type, complexity and novelty of the product and requires the expenditure of substantial resources. Of particular significance are the requirements covering research and development, testing, manufacturing, quality control, labeling and promotion of drugs for human use.

Before commencing clinical trials in humans in the United States, we must submit and receive approval from the FDA of an investigational new drug application, or IND application. Clinical trials are subject to oversight by institutional review boards and the FDA and:

While we have stated that we intend to file one to two INDs per year over the next several years, this is only a statement of intent, and we may not be able to do so because we may not be able to identify potential product candidates. In addition, the FDA may not approve any IND in a timely manner, or at all.

Before receiving FDA clearance to market a product, we must demonstrate that the product is safe and effective on the patient population that will be treated. Delays or rejections of regulatory clearances may be encountered based upon additional government regulation from future legislation or administrative action or changes in FDA policy during the period of product development, clinical trials and FDA regulatory review. Failure to comply with applicable FDA or other applicable regulatory requirements may result in criminal prosecution, civil penalties, recall or seizure of products, total or partial suspension of production or injunction, as well as other regulatory action against our potential products or us. Additionally, we have limited experience in conducting and managing the clinical trials necessary to obtain regulatory approval.

Outside the United States, our ability to market a product is contingent upon receiving a marketing authorization from the appropriate regulatory authorities. This foreign regulatory approval process includes all of the risks associated with FDA clearance described above.

For additional information concerning regulatory approval of our prospective products, see “Business—Government Regulation” in our Annual Report on Form 10-K for the year ended December 31, 2002.

Failure to attract, retain and motivate skilled personnel and cultivate key academic collaborations will delay our product development programs and our research and development efforts.

We had approximately 423 employees as of March 31, 2003, including employees of our majority-owned subsidiary, Cumbre Inc. Our success depends on our continued ability to attract, retain and motivate highly qualified management, clinical and scientific personnel and on our ability to develop and maintain important relationships with leading academic institutions, clinicians and scientists. Following the departure of our then chief financial officer, Corinne H. Lyle, in February 2003 to pursue other opportunities, we have been engaged in a search to recruit a new chief financial officer. We may not be able to fill that position in the near future. Competition for personnel and academic collaborations is intense. In particular, our product development programs depend on our ability to attract and retain highly-skilled chemists and clinical development personnel. Currently, we do not have employment contracts with any of our management, scientific or development personnel. In addition, we do not carry any “key person” insurance. We are highly dependent on certain of our management, scientific and development personnel. In particular, the loss of the services of David V. Goeddel, our chief executive officer, could impede significantly the achievement of our research and development objectives, our relationships with existing and potential collaborators and the development of our product candidates. If we fail to negotiate additional acceptable collaborations with academic institutions and scientists, or if our existing academic collaborations are unsuccessful, our product development programs may be delayed. In addition, we will need to hire additional personnel and develop additional academic collaborations as we continue to expand our research and development activities. We do not know if we will be able to attract, retain or motivate personnel or maintain relationships.

The drug discovery methods we employ are relatively new and may not lead to the development of drugs.

The drug discovery methods we employ based upon the regulation of gene expression are relatively new. We do not know if these methods will lead to the discovery of commercially viable drugs. Our two cancer product candidates undergoing clinical testing do not act by the regulation of gene expression. There is limited scientific understanding generally relating to the regulation of gene expression and the role of genes in complex diseases, and relatively few products based on gene discoveries have been developed and commercialized by drug manufacturers. Even if we are successful in identifying the pathways that cells use to control the expression of genes associated with specific diseases, these discoveries may not lead to the development of drugs. Furthermore, our drug discovery efforts are focused on a number of target genes, the functions of which have not yet been fully identified. As a result, the safety and efficacy of drugs that alter the expression of these genes have not yet been established. Therefore, drugs we identify that alter the expression of our target genes may be proven unsafe and ineffectual and, as a result, our research and development activities may not result in any commercially viable products. We expect to in-license or acquire additional product candidates to augment the results of our internal research activities, and in-licensed candidates may not prove to be successful. We have not identified any additional potential product candidates to in-license or acquire, and we may not be successful in identifying potential product candidates in the future.

Currently, all of our corporate collaborations have terms of five years or less and include provisions that allow the other party to terminate on short notice. If we cannot maintain our key current corporate collaborations and enter into new corporate collaborations, our product development could be delayed.

We rely, to a significant extent, on our corporate collaborators to provide funding in support of our research and to jointly conduct some research and pre-clinical testing functions. We have active collaborations with Sankyo and the pharmaceutical division of Japan Tobacco on which we are dependent. The collaboration agreement with Sankyo provides that Sankyo may terminate the agreement on June 10, 2003 for any reason, or at the end of each ensuing year if intellectual property considerations prevent the collaboration from working with the targets being pursued in the collaboration. Either party may terminate the agreement at any time upon a material breach by the other party. The collaboration agreement with Japan Tobacco may be terminated by either party upon a material breach by the other party. The research collaboration may be terminated by Japan Tobacco at the end of the fourth year of the five-year research collaboration (June 1, 2004), on 75 days’ prior written notice. In both the Sankyo and Japan Tobacco collaborations each party may

elect to terminate its co-development obligations with respect to, and profit-sharing interest in, a given collaboration product with immediate effect upon written notice to the other party.

If any of our corporate collaborators were to breach or terminate their agreement with us or otherwise fail to conduct the collaborative activities successfully and in a timely manner, the pre-clinical or clinical development or commercialization of the affected product candidates or research programs could be delayed or terminated. We cannot control the amount and timing of resources our corporate collaborators devote to our programs or potential products. In addition, we expect to rely on our corporate collaborators for commercialization of some of our products.

The continuation of any of our partnered drug discovery and development programs may be dependent on the periodic renewal of our corporate collaborations. All of our corporate collaborations have terms of five or fewer years, which is less than the period required for the discovery, clinical development and commercialization of most drugs. Each of our corporate collaboration agreements provides that, upon expiration of a specified period after commencement of the agreement, the corporate collaborator has the right to terminate the agreement on short notice, and each corporate collaboration agreement provides that these terminations do not require cause. Our collaboration with Merck & Co., Inc. was terminated by Merck in March 1999, our collaboration with Sumitomo Pharmaceuticals Co., Ltd. expired in January 2000, our collaboration with Taisho Pharmaceutical Co., Ltd. was terminated by Taisho in March 2000, our collaboration with Knoll AG was terminated in October 2001, our collaboration with the pharmaceutical division of Japan Tobacco on obesity expired in September 2001, our collaboration with the pharmaceutical division of Japan Tobacco on lipid disorders was terminated in April 2002, the research portion of our collaboration with the Roche Bioscience division of Syntex (U.S.A.) LLC relating to inflammation expired in July 2002 and the research portion of our collaboration with Eli Lilly and Company relating to the treatment of blood clots expired in December 2001. Our existing corporate collaboration agreements also may terminate before the full term of the collaborations. Moreover, we may not be able to renew these collaborations on acceptable terms, if at all. If funding from one or more of our corporate collaborations was reduced or terminated, we would be required to devote additional internal resources to product development or scale back or terminate some development programs or seek alternative corporate collaborators.

There have been a significant number of business combinations among large pharmaceutical companies that have resulted in a reduced number of potential future corporate collaborators. If business combinations involving our corporate collaborators were to occur, the effect could be to diminish, terminate or cause delays in one or more of our corporate collaborations.

We may not be able to negotiate additional corporate collaborations on acceptable terms, if at all, and these collaborations may not be successful. Our quarterly operating results may fluctuate significantly depending on the initiation of new corporate collaboration agreements or the termination or expiration of existing corporate collaboration agreements.

We expect that our corporate collaborators will fund a smaller percentage of our expenses in the future and that we will be required to independently finance a greater percentage of our expenses than historically.

We expect our net spending on development to increase significantly and that our corporate collaborators will fund a smaller percentage of our expenses than historically. Until recently, our corporate collaboration strategy focused on partnering with pharmaceutical companies to fund our research in the regulation of gene expression. Over the past few years, as our partnered and unpartnered research has led to product candidates, our corporate collaboration strategy has evolved. In addition to seeking collaborations for our research-stage programs, we also seek to enter into collaborations for the development of compounds discovered through our research and development efforts. The timing of these collaborations may be linked to clinical results of our product candidates. Since we expect that our corporate collaborators will fund a smaller percentage of our expenses in the future, we will be required to independently finance a greater percentage of our expenses than historically.

We may not have the resources required to realize the value from our commercialization rights, and if we do not realize value from our commercialization rights, we may not achieve our commercial objectives.

If we do not effectively exploit the commercialization rights we have retained, we may not achieve profitability. In most of our corporate collaborations, we have retained various commercialization rights for the development and marketing of pharmaceutical products, including rights in specified geographical regions. For a description of programs for which we have retained commercialization rights, see “Business—Corporate Collaborations” in our Annual Report on Form 10-K for the year ended December 31, 2002. We may take advantage of these currently retained rights directly or may exploit retained rights through collaborations with others. The value of these rights, if any, will be largely derived from our ability, directly or with collaborators, to develop and commercialize drugs, the success of which is also uncertain.

The exploitation of retained commercialization rights requires sufficient capital; technological, product development, manufacturing and regulatory expertise and resources; and marketing and sales personnel. We may not be able to develop or obtain these resources in sufficient quantity, or of sufficient quality, to enable us to achieve our objectives. To the extent that we are required to rely on third parties for these resources, failure to establish and maintain our relationships will affect our ability to realize value from our retained commercialization rights. If we seek to commercialize products for which we have retained rights through joint ventures or collaborations, we may be required to relinquish material rights on terms that may not be favorable to us. We do not know whether we will be able to enter into any agreements on acceptable terms, if at all, or whether we will be able to realize any value from our retained commercialization rights.

If our competitors are better able to attract qualified personnel or collaborators, develop, license or acquire proprietary technology that is superior to our technology or develop and market products that are more effective than our product candidates, our commercial opportunity will be reduced or eliminated.

Our commercial opportunity will be reduced or eliminated if our competitors develop and market products that are more effective, have fewer side effects or are less expensive than our product candidates. With respect to our drug discovery programs, other companies have product candidates in clinical trials to treat each of the diseases for which we are seeking to discover and develop product candidates. These competing potential drugs are further advanced in development than are any of our potential products and may result in effective, commercially successful products. Even if we, alone or with our collaborators, are successful in developing effective drugs, our products may not compete effectively with these products or other successful products. Our competitors may succeed in developing and marketing products either that are more effective than those that we may develop, alone or with our collaborators, or that are marketed before any products we develop are marketed.

Our competitors include fully integrated pharmaceutical companies and biotechnology companies with large drug and target discovery efforts and universities and public and private research institutions. We estimate that we have at least 20 competitors in the cancer area, including Bristol-Myers Squibb. Competition for T67 and T607 could include approved tubulin binding drugs, such as Taxol^®, Taxotere^®, navelbine, vincristine and vinblastine, and Thymitaq^®, a systemic chemotherapy that is in phase 3 testing for HCC. We estimate that we have at least 20 competitors in the immune disorders area, including Novartis. There are several drugs approved for the treatment of rheumatoid arthritis and/or psoriasis, such as Enbrel^® and Remicade^®, and many therapies in development, such as P38 map kinase inhibitors, that could compete with T487. We estimate that we have at least 15 competitors in the metabolic diseases area, including Glaxo SmithKline. There are a number of drugs in development that target PPARgamma (peroxisome proliferator-activated receptor gamma), as does our drug candidate T131, and there are two compounds targeting PPARgamma already on the market (Actos ^® and Avandia^®). In addition, companies pursuing different but related fields, such as gene therapy, represent substantial competition.

Many of the organizations competing with us have substantially greater capital resources, larger research and development staffs and facilities, greater experience in drug development and in obtaining regulatory approvals and greater marketing capabilities than we do. In addition, these organizations also compete with us to:

For additional information regarding the competition we face, see “Business—Competition” in our Annual Report on Form 10-K for the year ended December 31, 2002.

Because it is difficult and costly to protect our proprietary rights, we cannot ensure their protection.

Our commercial success will depend, in part, on obtaining patent protection on our products and successfully defending these patents against third-party challenges. The patent positions of pharmaceutical and biotechnology companies can be highly uncertain and involve complex legal and factual questions. No consistent policy regarding the breadth of claims allowed in biotechnology patents has emerged to date. Accordingly, we cannot predict with certainty the breadth of claims allowed in our patents and other companies’ patents.

The degree of future protection for our proprietary rights is uncertain because legal means afford only limited protection and may not adequately protect our rights or permit us to gain or keep our competitive advantage. For example:

As of March 31, 2003, we held more than 90 U.S. patents and had more than 100 patent applications pending before the United States Patent and Trademark Office. For some of our discoveries, corresponding non-U.S. patent protection has been received or is pending. Aspects of all of our product candidates that are in clinical trials are covered by issued patents and/or pending applications in the U.S. and in foreign countries that we consider to be important. Based on the subject matter claimed therein, our patents can be categorized as compound-related, including patents covering product candidates, research-related, including patents covering gene sequences and assay methodologies, or diagnostic-related, including patents covering methods of diagnosing disease states and methods of selecting appropriate treatment regimens for disease states. Of the more than 90 U.S. patents that we hold, approximately 20 patents are compound-related, having expiration dates between 2016 and 2020, more than 66 patents are research-related, having expiration dates between 2012 and 2020, and approximately four patents are diagnostic-related, having expiration dates in 2019. Subject to possible patent-term extension, the entitlement for which and the term of which we cannot predict, patent protection in the U.S. covering the compounds for our T67 and T607 product candidates will expire in 2016 and 2019, respectively. In addition, for T131 and T487, our other product candidates that are in clinical trials, patent applications are pending, but no patents have yet issued. Although third parties may challenge our rights to, or the scope or validity of, our patents, to date, we have not received any communications from third parties challenging our patents or patent applications covering our product candidates.

We are a party to various license agreements that give us rights to use specified technologies in our research and development processes. If we are not able to continue to license any such technology on commercially reasonable terms, our product development and research may be delayed. In addition, we generally do not control the patent prosecution of in-licensed technology and, accordingly, are unable to exercise the same degree of control over this intellectual property as we exercise over our internally developed technology.

We rely on trade secrets to protect technology where we believe patent protection is not appropriate or obtainable. However, trade secrets are difficult to protect. While we require employees, academic collaborators and consultants to enter into confidentiality agreements, we may not be able to adequately protect our trade secrets or other proprietary information.

Our research and development collaborators may have rights to publish data and information in which we have rights. In addition, we sometimes engage individuals, entities or consultants to conduct research that may be relevant to our business. The ability of these individuals, entities or consultants to publish or otherwise publicly disclose data and other information generated during the course of their research is subject to certain contractual limitations. The nature of the limitations depends on various factors, including the type of research being conducted, the ownership of the data and information and the nature of the individual, entity or consultant. In most cases, these individuals, entities or consultants are, at the least, precluded from publicly disclosing our confidential information and are only allowed to disclose other data or information generated during the course of the research after we have been afforded an opportunity to consider whether patent and/or other proprietary protection should be sought. If we do not apply for patent protection prior to such publication or if we cannot otherwise maintain the confidentiality of our technology and other confidential information, then our ability to receive patent protection or protect our proprietary information will be imperiled. See “Business—Patents and Other Proprietary Rights” in our Annual Report on Form 10-K for the year ended December 31, 2002.

Third-party claims of intellectual property infringement would require us to spend significant time and money and could prevent us from developing or commercializing our products.

Our commercial success depends in part on not infringing the patents and proprietary rights of other parties and not breaching any licenses that we have entered into with regard to our technologies and products. Because others may have filed, and in the future are likely to file, patent applications covering genes, gene products or therapeutic products that are similar or identical to ours, patent applications or issued patents of others may have priority over our patent applications or issued patents. We are aware of third-party patents in the biopharmaceutical area with broad claims that, if valid, could affect a wide variety of pharmaceuticals, including T67, T607 and other product candidates that we are pursuing. Patent holders sometimes send communications to a number of companies in related fields suggesting possible infringement, and we, like other biotechnology companies, have received this type of communication, including with respect to the third-party patents mentioned above. With respect to the claims raised by such third-party communications regarding our product candidates, we either: believe that our activities do not infringe the patents at issue; have discussed the matters with external patent counsel and, based in part on the advice of such counsel, believe that such third-party patents are invalid; or, because such third-party patents are the subject of current litigation proceedings with other parties, do not know if such third-party patents are valid. However, it is possible that a judge or jury will disagree with our conclusions regarding non-infringement or invalidity, and we could incur substantial costs in litigation if we are required to defend against patent suits brought by third parties or if we initiate these suits. Any legal action against our collaborators or us claiming damages and seeking to enjoin commercial activities relating to the affected products and processes could, in addition to subjecting us to potential liability for damages, require our collaborators or us to obtain a license to continue to manufacture or market the affected products and processes. It is not known whether any license required under any of these patents would be made available on commercially acceptable terms, if at all. Failure to obtain such licenses could materially and adversely affect our ability to develop, commercialize and sell our products. We believe that there may be significant litigation in the industry regarding patent and other intellectual property rights. If we become involved in litigation, it could consume a substantial portion of our management and financial resources and we may not prevail in any such litigation.

Even if regulatory authorities approve our products or product candidates for the treatment of the diseases we are targeting, the market may not accept our products or our products may not be commercially successful, and we may be unable to achieve profitability.

Even if our product development efforts are successful and the requisite regulatory approvals are obtained, we may not be able to commercialize our product candidates. Our profitability will depend on the market’s acceptance and commercial success of our product candidates.

We anticipate that the annual cost of our drug candidates for the treatment under each of the diseases for which we are seeking approval will be significant. These costs will vary for different diseases based on the dosage and method of administration. Accordingly, we may decide not to market any of our drug candidates for an approved disease

because we believe that it may not be commercially successful. In addition, our products may not gain market acceptance among physicians, patients, healthcare payors and the medical community. Market acceptance of and demand for our products and product candidates will depend on many factors, including the following:

If any of our products do not achieve market acceptance or are not commercially successful, we may not achieve profitability.

If we do not progress in our programs as anticipated, our stock price could decrease.

For planning purposes, we estimate the timing of a variety of clinical, regulatory and other milestones, such as when a certain product candidate will enter clinical development, when a clinical trial will be completed or when an application for regulatory approval will be filed. Our estimates are based on present facts and a variety of assumptions. Many of the underlying assumptions are outside of our control. If such milestones are not achieved when we expect them to be, investors could be disappointed, and our stock price may decrease.

We rely on third parties to conduct clinical trials for our drug candidates and those third parties may not perform satisfactorily.

We do not have the ability to independently conduct clinical trials for drug candidates, and we rely on third parties such as contract research organizations, medical institutions and clinical investigators to perform this function. We expect that our phase 2/3 trial for the treatment of HCC with T67 will involve as many as 75 treatment sites and other logistical complexities. We plan to rely on a contract research organization to manage this trial. If third parties in this trial or others do not perform satisfactorily or meet expected deadlines, our clinical trials may be extended or delayed. We may not be able to locate any necessary replacements or enter into favorable agreements with them, if at all. In some cases, we may not be able to obtain regulatory approvals for our drug candidates and therefore may not be able to successfully commercialize our drug candidates for targeted diseases.

If we are unable to contract with third parties to manufacture our products in sufficient quantities and at an acceptable cost, we may be unable to meet demand for our products and lose potential revenues.

Completion of our clinical trials and commercialization of our product candidates require access to, or development of, facilities to manufacture a sufficient supply of our product candidates. We will depend on our collaborators or third parties for the manufacture of compounds for pre-clinical, clinical and commercial purposes in their FDA-approved manufacturing facilities. Our products may be in competition with other products for access to these facilities. Consequently, our products may be subject to manufacturing delays if collaborators or outside contractors give other products greater priority than our products. For this and other reasons, our collaborators or third parties may not be able to manufacture these products in a cost-effective or timely manner. If not performed in a timely manner, the clinical trial development of our product candidates or their submission for regulatory approval could be delayed, and our ability to deliver products on a timely basis could be impaired or precluded. We may not be able to enter into any necessary third-party manufacturing arrangements on acceptable terms, if at all. Our current dependence upon others for the manufacture of our products may adversely affect our future profit margin and our ability to commercialize products on a timely and competitive basis. We do not intend to develop or acquire facilities for the manufacture of product candidates for clinical trials or commercial purposes in the foreseeable future.

If we are unable to create sales, marketing and distribution capabilities or enter into agreements with third parties to perform these functions, we will not be able to commercialize products.

We currently have no sales, marketing or distribution capability. In order to commercialize any products, we must internally develop sales, marketing and distribution capabilities or make arrangements with a third party to perform these services. We intend to market some products directly and rely on relationships with one or more pharmaceutical companies with established distribution systems and direct sales forces to market other products. To market any of our products directly, we must develop a marketing and sales force with technical expertise and with supporting distribution capabilities. We may not be able to establish in-house sales and distribution capabilities or relationships with third parties. To the extent that we enter into co-promotion or other licensing arrangements, our product revenues are likely to be lower than if we directly marketed and sold our products, and any revenues we receive will depend upon the efforts of third parties, which efforts may not be successful and are outside of our control.

Our ability to generate revenues will be diminished if we fail to obtain acceptable prices or an adequate level of reimbursement for our products from third-party payors.

The continuing efforts of government and third-party payors to contain or reduce the costs of health care through various means will limit our commercial opportunity. For example, in some foreign markets, pricing and profitability of prescription pharmaceuticals are subject to government control. In the United States, we expect that there will continue to be a number of federal and state proposals to implement similar government control. In addition, increasing emphasis on managed care in the United States will continue to put pressure on the pricing of pharmaceutical products. Cost control initiatives could decrease the price that any of our collaborators or we would receive for any products in the future. Further, cost control initiatives could adversely affect our collaborators’ ability to commercialize our products and our ability to realize revenues from this commercialization.

Our ability to commercialize pharmaceutical products, alone or with collaborators, may depend in part on the extent to which reimbursement for the products will be available from:

Significant uncertainty exists as to the reimbursement status of newly approved health care products. Third-party payors, including Medicare, are challenging the prices charged for medical products and services. Government and other third-party payors increasingly are attempting to contain health care costs by limiting both coverage and the level of reimbursement for new drugs and by refusing, in some cases, to provide coverage for uses of approved products for disease indications for which the FDA has not granted labeling approval. Third-party insurance coverage may not be available to patients for any products we discover and develop, alone or with collaborators. If government and other third-party payors do not provide adequate coverage and reimbursement levels for our products, the market acceptance of these products may be reduced.

Some of our advisors and directors, including our chief executive officer, have affiliations that may present conflicts of interest that may be adverse to your best interests.

Genentech, Inc. is a potential competitor of ours and may be one of our investors. David V. Goeddel, our chief executive officer and a member of our Board of Directors, is a consultant to Genentech. A. Grant Heidrich, III, chairman of our Board of Directors, also serves on the board of directors of Millennium Pharmaceuticals, Inc. Millennium has publicly disclosed that it is pursuing programs that are competitive with, and may have scientific overlap with, our programs. Edward W. Holmes, M.D., a member of our Board of Directors, also serves on the scientific advisory board of Glaxo SmithKline, which may be pursuing programs that compete with our programs. Additionally, members of our Board of Directors and management serve on the boards of directors of privately held companies that may have programs that are competitive with, and may have scientific overlap with, our programs. As a result of these potential conflicts of interests, these advisors or directors may act in a manner that advances their best interests and not necessarily the best interests of us or our stockholders.

Because our collaboration agreements may allow our collaborators to develop competitive products, conflicts may arise with our collaborators that may result in the withdrawal of support for our product candidates.

If conflicts arise between us and our corporate or academic collaborators or scientific advisors, the other party may act in its self-interest and not in the interest of our stockholders. Some of our corporate or academic collaborators are conducting multiple product development efforts within each disease area that is the subject of the collaboration with us. For example, we understand that Japan Tobacco and Medarex are independently developing drug candidates within the metabolic disease and cancer areas, respectively, which may be competitive with drug candidates from our collaborations with these companies. Generally, in each of our collaborations, we have agreed not to conduct independently, or with any third party, any research that is competitive with the research conducted under our collaborations. Our collaborations may have the effect of limiting the areas of research that we may pursue, either alone or with others. Our collaborators, however, may develop, either alone or with others, products in related fields that are competitive with the products or potential products that are the subject of these collaborations. Competing products, either developed by the collaborators or to which the collaborators have rights, may result in their withdrawal of support for our product candidates.

If we fail to obtain the capital necessary to fund our operations, we will be unable to successfully develop products.

Additional financing will be required in the future to fund operations. We do not know whether additional financing will be available when needed, or that, if available, we will obtain financing on terms favorable to our stockholders or us. Together with our majority-owned subsidiary, Cumbre Inc., we have spent $506.4 million since our inception. We expect our operating and capital spending to increase in the future as we expand operations to support the development of new and existing drug candidates. The extent of any actual increases in operating or capital spending will depend on the clinical success of our drug candidates.

We believe that our existing cash and investment securities and anticipated cash flow from existing collaborations will be sufficient to support our current operating plan through the second quarter of 2004. We have based this estimate on assumptions that may prove to be wrong. Our future capital requirements depend on many factors that affect our research, development, collaboration and sales and marketing activities. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”

Raising additional capital by issuing securities or through collaboration and licensing arrangements would cause dilution to existing stockholders or require us to relinquish rights to our technologies or product candidates.

We may raise additional financing through public or private equity offerings, debt financings or additional corporate collaboration and licensing arrangements. To the extent we raise additional capital by issuing equity securities, our stockholders may experience dilution. To the extent that we raise additional funds through collaboration and licensing arrangements, it may be necessary to relinquish some rights to our technologies or product candidates, or grant licenses on terms that are not favorable to us. If adequate funds are not available, we will not be able to continue developing our products and we may not become profitable.

If product liability lawsuits are successfully brought against us, we may incur substantial liabilities and may be required to limit commercialization of our products.

The testing and marketing of medical products entail an inherent risk of product liability. Although we are not aware of any historical or anticipated product liability claims, if we cannot successfully defend ourselves against product liability claims, we may incur substantial liabilities or be required to limit commercialization of our products. We currently carry product liability insurance that covers our clinical trials up to a $10 million annual aggregate limit. Our inability to obtain sufficient product liability insurance at an acceptable cost to protect against potential product liability claims could prevent or inhibit the commercialization of pharmaceutical products we develop, alone or with corporate collaborators. We or our corporate collaborators may not be able to obtain insurance at a reasonable cost, if at all. While under various circumstances we are entitled to be indemnified against losses by our corporate collaborators, indemnification may not be available or adequate should any claims arise.

If our officers, directors and largest stockholders choose to act together, they may be able to control our management and operations, acting in their best interests and not necessarily those of other stockholders. Moreover, sales by these stockholders could depress our stock price.

As of March 31, 2003, our directors, executive officers and holders of 5% or more of our outstanding common stock and their affiliates beneficially owned approximately 38.4% of our common stock. Accordingly, they collectively have the ability to determine the election of all of our directors and to determine the outcome of most corporate actions requiring stockholder approval. They may exercise this ability in a manner that advances their best interests and not necessarily those of other stockholders.

As of December 31, 2002, ZKB Pharma Vision AG, a Swiss investment company, owned 11,358,238 shares of our common stock, which represents approximately 20.5% of our outstanding common stock. In January 2003, at the request of ZKB Pharma Vision AG, we filed a registration statement on Form S-3 to register for resale the 11,358,238 shares of common stock held by ZKB Pharma Vision AG. Any decision by any large stockholder, including ZKB Pharma Vision AG, to sell substantial amounts of our stock could depress our stock price. The registration statement was declared effective on April 1, 2003.

Our stock price may be volatile, and your investment in our stock could decline in value.

The market prices for securities of biotechnology companies, including our stock price, have been highly volatile and may continue to be highly volatile in the future. During the first quarter of 2003, our common stock traded between $3.61 and $7.58. During 2002, our common stock traded between $5.83 and $25.36. The following factors, in addition to other risk factors described in this filing, may have a significant impact on the market price of our common stock:

If we use biological and hazardous materials in a manner that causes injury or violates laws, we may be liable for damages.

Our research and development activities involve the controlled use of potentially harmful biological materials as well as hazardous materials, chemicals and various radioactive compounds. We cannot completely eliminate the risk of accidental contamination or injury from the use, storage, handling or disposal of these materials. In the event of contamination or injury, we could be held liable for damages that result, and any liability could exceed our resources. We are subject to federal, state and local laws and regulations governing the use, storage, handling and disposal of these materials and specified waste products. The cost of compliance with these laws and regulations could be significant.

Anti-takeover provisions in our charter documents and under Delaware law may make an acquisition of us more difficult and may prevent attempts by our stockholders to replace or remove our current management.

Provisions of our amended and restated certificate of incorporation and bylaws, as well as provisions of Delaware law, could make it more difficult for a third party to acquire us, even if doing so would benefit our stockholders. In addition, these provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our Board of Directors. Because our Board of Directors is responsible for appointing the members of our management team, these provisions could in turn affect any attempt by our stockholders to replace current members of our management team. These provisions:

We adopted a stockholder rights plan that may discourage, delay or prevent a merger or acquisition that is beneficial to our stockholders.

In December 2002, our Board of Directors adopted a stockholder rights plan that may have the effect of discouraging, delaying or preventing a merger or acquisition that is beneficial to our stockholders by diluting the ability of a potential acquiror to acquire us. Pursuant to the terms of the plan, when a person or group, except under certain circumstances, acquires 20% or more of our outstanding common stock or ten business days after commencement or announcement of a tender or exchange offer for 20% or more of our outstanding common stock, the rights (except those rights held by the person or group who has acquired or announced an offer to acquire 20% or more of our outstanding common stock) would generally become exercisable for shares of our common stock at a discount. Because the potential acquiror’s rights would not become exercisable for our shares of common stock at a discount, the potential acquiror would suffer substantial dilution and may lose its ability to acquire us. In addition, the existence of the plan itself may deter a potential acquiror from acquiring us. As a result, either by operation of the plan or by its potential deterrent effect, mergers and acquisitions of us that our stockholders may consider in their best interests may not occur.

The financial results of Cumbre Inc., our majority-owned subsidiary, are consolidated with our own. In the first quarters of 2003 and 2002, Cumbre generated net losses of approximately $1.8 million and $1.2 million, which represented approximately 7% and 6% of our consolidated net losses, respectively. In 2002 and 2001, Cumbre generated net losses of approximately $6.5 million and $1.7 million, which represented approximately 7% and 3% of our consolidated net losses, respectively. While two of our executive officers are on the board of directors of Cumbre and another member of Cumbre’s board of directors is on our Board of Directors, the operating goals of Cumbre are different from our goals. Cumbre is focused on building an infrastructure to support drug discovery, while we are using our existing drug discovery infrastructure to advance drug candidates through the development process. Cumbre’s capital expenditures and operating expenses are expected to grow at a faster rate than ours, which may have a significant impact on our future consolidated operating results. Cumbre’s expected faster growth relates to the costs required to build the infrastructure to support Cumbre’s drug discovery efforts. As of March 31, 2003, we owned approximately 52% of the outstanding shares of Cumbre’s capital stock and approximately 48% of Cumbre’s capital stock on a fully-diluted, as converted basis (which assumes the exercise of warrants to purchase 76,000 shares of Cumbre’s capital stock, the exercise of options to purchase 1,717,967 shares of Cumbre’s common stock and the conversion of all of Cumbre’s preferred stock outstanding at March 31, 2003). Cumbre may issue additional options subsequent to March 31, 2003. These options may dilute our ownership interest in Cumbre.

Our exposure to market risk is principally limited to our cash equivalents and investments that have maturities of less than two years. We maintain an investment portfolio of investment grade liquid debt securities that limits the amount of credit exposure to any one issue, issuer or type of instrument. The securities in our investment portfolio are not leveraged, are classified as available-for-sale and are therefore subject

to interest rate risk. We currently do not hedge interest rate exposure. If market interest rates were to increase by 100 basis points, or 1%, from March 31, 2003 levels, the fair value of our portfolio would decline by approximately $0.2 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.

Because we translate foreign currencies into United States dollars for reporting purposes, exchange rates can have an impact on our financial condition, although this impact is generally immaterial. We believe that our exposure to currency exchange risk is low because our German and British subsidiaries satisfy their financial obligations almost exclusively in their local currencies. As of March 31, 2003, we did not engage in foreign currency hedging activities.

We are exposed to investment risks related to the changes in the fair value of our investments. We have investments in several private companies. These investments are included in “Other investments” in the accompanying consolidated financial statements.

We have invested $2.0 million in several private companies through the purchase of preferred stock. We also received $1.6 million in preferred stock of a private company in exchange for a license to certain technology and the assignment of certain patents. These investments are being carried at cost in the case of the purchased securities and at fair value on the date of receipt for the preferred stock received for the technology license and patent assignment. We do not believe our preferred stock investments were impaired as of March 31, 2003.

Should the companies in which we have invested experience a deterioration of operating results or financial position, impairment charges may be necessary.

Based on their evaluation as of a date within 90 days of the filing date of this report, our principal executive officer and principal financial officer have concluded that Tularik’s disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) are sufficiently effective to ensure that the information required to be disclosed by Tularik in the reports that we file under the Exchange Act is gathered, analyzed and disclosed with adequate timeliness, accuracy and completeness.

There have been no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation referred to above, nor were there any significant deficiencies or material weaknesses in Tularik’s internal controls. Accordingly, no corrective actions were required or undertaken.

A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, if any, within a company have been detected.

On January 27, 2003, we announced that we had begun phase 1 clinical testing to evaluate the safety and pharmacokinetic profile of T131, our drug candidate to treat type 2 diabetes. The randomized, double-blinded, dose-escalation trial is being conducted in healthy adult volunteers in the United Kingdom. T131 acts through PPARgamma, a target involved in the body’s ability to respond to insulin.

On March 25, 2003, we announced the enrollment of the first patient in the registration trial for T67, our lead anti-cancer drug candidate for patients suffering from HCC. This pivotal phase 2/3 study is expected to include approximately 750 first line HCC patients and will be performed at up to 75 sites in the United States and abroad. The primary goal of the study will be to determine whether there is a survival benefit to the patients treated with T67 compared to doxorubicin.

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

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

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

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

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

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

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

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

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

6. The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

/s/ David V. Goeddel

David V. Goeddel

Chief Executive Officer

I, William J. Rieflin, Acting Chief Financial Officer of Tularik Inc., certify that:

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

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

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



		/s/ William J. Rieflin
		William J. Rieflin Executive Vice President, Administration and Acting Chief Financial Officer

PART I.	FINANCIAL INFORMATION

	Item 1. Unaudited Consolidated Financial Statements	2

	Item 2. Management’s Discussion and Analysis of Financial Condition and Results Of Operations	7

	Item 3. Quantitative and Qualitative Disclosures About Market Risk	25

	Item 4. Controls and Procedures	26

PART II.	OTHER INFORMATION

	Item 5. Other Information	27

	Item 6. Exhibits and Reports on Form 8-K	27

	Signatures	27

	Certifications	28

ASSETS	March 31, 2003			December 31, 2002 (1)
Current assets:
Cash and cash equivalents	$	85,669		$	95,670
Short-term investments		70,631			81,030
Prepaid expenses and other current assets		5,399			4,600

Total current assets		161,699			181,300
Property and equipment, net		30,393			31,188
Other investments		3,633			13,087
Restricted investments		4,272			4,272
Other assets		3,703			3,360
Goodwill		3,100			3,100

Total assets	$	206,800		$	236,307

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	4,442		$	4,840
Accrued compensation and related liabilities		2,425			3,111
Accrued liabilities		6,344			5,789
Current portion of capital lease obligations		7,558			7,927
Deferred revenue		8,629			12,119

Total current liabilities		29,398			33,786
Long-term portion of capital lease obligations		13,610			14,179
Long-term portion of deferred revenue		8,729			10,300
Other non-current liabilities		3,444			3,060

Total liabilities		55,181			61,325

Minority interest in Cumbre Inc.		26,250			26,250
Stockholders’ equity:
Common stock		55			55
Additional paid-in capital		421,692			420,338
Notes receivable from stockholders		(27	)		(28	)
Deferred compensation, net		(13	)		(41	)
Accumulated other comprehensive income		922			1,457
Accumulated deficit		(297,260	)		(273,049	)

Total stockholders’ equity		125,369			148,732

Total liabilities and stockholders’ equity	$	206,800		$	236,307

	Three months ended March 31,
	2003			2002
Revenue:
Collaborative research and development	$	5,061		$	6,176
Technology license fee		1,600			—

		6,661			6,176

Operating expenses:
Research and development		28,329			25,244
General and administrative		2,976			2,714

		31,305			27,958

Loss from operations		(24,644	)		(21,782	)
Interest and other income		839			1,619
Interest expense		(406	)		(392	)

Net loss	$	(24,211	)	$	(20,555	)

Basic and diluted net loss per share	$	(0.44	)	$	(0.41	)

Weighted-average shares used in computing basic and diluted net loss per share		55,103,415			50,008,537

	For the three months ended March 31,
	2003			2002
Cash flows from operating activities:
Net loss	$	(24,211	)	$	(20,555	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		2,919			2,743
Amortization of deferred stock compensation		28			107
Amortization of loan discount		10			—
Non-cash stock compensation		359			311
Non-cash license fee revenue		(1,600	)		—
Changes in assets and liabilities:
Other assets		(975	)		(19	)
Accounts payable and other liabilities		(708	)		(1,748	)
Deferred revenue		(5,061	)		(2,354	)

Net cash used in operating activities		(29,239	)		(21,515	)

Cash flows from investing activities:
Maturities of available-for-sale securities		136,811			82,255
Purchases of available-for-sale securities		(115,404	)		(77,625	)
Purchase of restricted cash		—			(2,271	)
Acquisition of property and equipment		(2,133	)		(2,850	)

Net cash provided by (used in) investing activities		19,274			(491	)

Cash flows from financing activities:
Payments of long-term obligations		(2,376	)		(1,644	)
Proceeds from issuance of long-term obligations		1,349			—
Proceeds from notes receivable from stockholders		16			89
Proceeds from issuances of common stock, net		976			3,953

Net cash (used in) provided by financing activities		(35	)		2,398

Effect of exchange rates on cash		(1	)		—

Net change in cash and cash equivalents		(10,001	)		(19,608	)
Cash and cash equivalents at the beginning of the period		95,670			109,392

Cash and cash equivalents at the end of the period	$	85,669		$	89,784

Supplemental disclosure of non-cash financing activities:
Issuance of warrant in connection with lease amendment	$	255		$	—

	Three months ended March 31,
\	2003			2002
Numerator:
Net loss	$	(24,211	)	$	(20,555	)

Denominator:
Weighted-average shares of common stock outstanding		55,133			50,138
Less: weighted-average shares subject to repurchase		(30	)		(129	)

Weighted-average shares used in computing basic and diluted net loss per share		55,103			50,009

Basic and diluted net loss per share	$	(0.44	)	$	(0.41	)

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	2003			2002
	(in thousands)
Net loss, as reported	$	(24,211	)	$	(20,555	)
Add: Deferred compensation amortization		28			107
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards		(10,047	)		(4,007	)

Pro forma net loss	$	(34,230	)	$	(24,455	)

Loss per share (basic and diluted):
As reported	$	(0.44	)	$	(0.41	)

Pro forma	$	(0.62	)	$	(0.49	)

Subsidiary Name	Location	Ownership
Amplicon Corporation	United States	Wholly owned
Tularik Pharmaceutical Company	United States	Wholly owned
Cumbre Inc.	United States	Majority-owned
Tularik GmbH	Germany	Wholly owned
Tularik Limited	United Kingdom	Wholly owned

			Options Outstanding
(Shares in thousands)	Shares Available for Grant		Number of Shares		Weighted-Average Exercise Price
December 31, 2001	509		5,929		$	16.14
Grants	(2,372	)	2,372			9.85
Exercises	—		(656	)		13.25
Forfeitures (1)	436		(436	)		21.67
Additional shares reserved	2,146		—

December 31, 2002	719		7,209			15.00
Grants	(1,307	)	1,307			4.96
Exercises	—		(109	)		5.13
Forfeitures (1)(2)	2,345		(2,345	)		22.94
Additional shares reserved	2,472		—

March 31, 2003	4,229		6,062		$	9.98

	As of March 31, 2003
	Exercisable			Unexercisable			Total
	Shares	Wtd.-Avg. Exercise Price		Shares	Wtd.-Avg. Exercise Price		Shares	Wtd.-Avg. Exercise Price
	(Shares in thousands)
In-the-Money	1,367	$	2.77	1,269	$	4.78	2,636	$	3.73
Out-of-the-Money (1)	1,009		19.94	2,417		12.63	3,426		14.78

Total Options Outstanding	2,376			3,686			6,062

	YTD 2003		2002		2001
Net grants during the year as % of outstanding shares	2.36	%	4.32	%	3.99	%
Grants to Named Executive Officers* during the period as % of outstanding shares	1.85	%	1.02	%	0.70	%
Grants to Named Executive Officers during the period as % of total options granted	78.39	%	23.61	%	17.58	%

EXHIBIT NUMBER

3.1		Amended and Restated Certificate of Incorporation. (1)

3.2		Amended and Restated Bylaws. (2)

4.1		Specimen Common Stock Certificate. (3)

99.1		Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (4)

	TULARIK INC.

April 29, 2003	by:	/s/ David V. Goeddel
		David V. Goeddel Chief Executive Officer


April 29, 2003	by:	/s/ William J. Rieflin
		William J. Rieflin Executive Vice President, Administration and Acting Chief Financial Officer