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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

For the fiscal year ended December 31, 2003

Commission File No. 0-14710

XOMA Ltd.

(Exact name of registrant as specified in its charter)

Securities registered pursuant to Section 12(b) of the Act: None

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

Common Shares, U.S. $.0005 par value

Preference Share Purchase Rights

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 Rule 12b-2 of the Act).  Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

The approximate aggregate market value of voting shares held by non-affiliates of the registrant is $386,336,777 as of June 30, 2003.

Number of Common Shares outstanding as of February 28, 2004: 84,232,049

DOCUMENTS INCORPORATED BY REFERENCE:

Portions of the Company’s Proxy Statement for the Company’s 2004 Annual General Meeting of Shareholders are incorporated by reference into Part III of this Report.

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XOMA Ltd.

2003 Form 10-K Annual Report

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PART I

Item 1.    Business

Overview

XOMA Ltd. (“XOMA” or the “Company”) is a biopharmaceutical company that develops and manufactures antibodies and other genetically-engineered protein products to treat immunological and inflammatory disorders, cancer, and infectious diseases. The Company’s strategy is to build a broad product pipeline through a combination of its own proprietary products and the use of its development infrastructure to attract collaborations with other companies.

Below is a summary of the Company’s current products and stages of clinical development:

In January of 2003, Genentech and XOMA announced the initiation of a Phase II study evaluating RAPTIVA^™ in patients with psoriatic arthritis that has since completed enrollment. Initial results from this study are expected in March of 2004. Genentech and XOMA continue to evaluate additional indications for RAPTIVA^™.

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XMP.629 is a topical anti-bacterial formulation of a BPI-derived peptide under development as a possible treatment for acne. Certain bacteria commonly found on human skin are associated with inflammatory lesions in acne patients. The emergence of strains resistant to current antibiotics used to treat acne has encouraged XOMA researchers to review the properties of the compound for this dermatological indication. In 2003, XOMA completed two Phase I clinical trials to evaluate skin irritation and pharmacokinetics of the compound. In January of 2004, the Company announced the initiation of Phase II clinical testing.

NEUPREX^® (rBPI₂₁) is an injectable formulation of rBPI₂₁, a modified recombinant fragment of BPI. BPI is a human host-defense protein made by PMN cells, a type of white blood cell that is involved in the body’s defenses against microbial infection.

In October of 2003, XOMA and Children’s Medical Center Dallas announced the initiation of an open-label, single center, dose escalation, investigator-sponsored, Phase I/II clinical trial of NEUPREX^® in pediatric patients with congenital heart abnormalities requiring open heart surgery (OHS) associated with CPB. The study plans to investigate dosing, efficacy endpoints and safety to assess the potential for conducting larger, additional studies.

In July of 2003, XOMA announced the termination of its license and supply agreements with Baxter Healthcare Corporation (“Baxter”) for this product. In return for a release from its obligations under the agreements, in January of 2004 Baxter made a one-time payment to XOMA of $10.0 million. Going forward, Baxter will have no involvement with the product.

XOMA has previously tested NEUPREX^® in clinical trials for several infectious and inflammatory conditions including meningococcemia and is evaluating future options for developing the product in multiple indications, including seeking a pharmaceutical partner.

BPI compounds for retinal disorders.    Results of in vitro and in vivo studies conducted by Joslin Diabetes Center at Harvard University (“Joslin”), presented in April of 2001 and published in February of 2002, show that compounds derived from BPI inhibit the function of multiple growth factors involved in blood vessel formation and angiogenesis in the retina while sparing key retinal cells (pericytes). These data suggest that these compounds may have potential for treating retinal disorders. XOMA is conducting further research together with Joslin.

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Below is a summary of certain proprietary technologies used by XOMA and available for licensing to other companies:

XOMA has granted more than 30 licenses to biotechnology and pharmaceutical companies to use its patented and proprietary technologies relating to bacterial expression of recombinant pharmaceutical products. Bacterial antibody expression is an enabling technology for the discovery and selection, as well as the development and manufacture, of recombinant protein pharmaceuticals, including diagnostic and therapeutic antibodies for commercial purposes. Bacterial antibody expression is also a key technology used in multiple systems for high-throughput screening of antibody domains. Expression of antibodies by phage display technology, for example, depends upon the expression and secretion of antibody domains from bacteria as properly folded, functional proteins.

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Current licensees include but are not limited to the following companies:

These licenses can sometimes be associated with broader collaboration agreements. For example, in December of 2003, XOMA and Diversa Corporation (“Diversa”) entered into a licensing and product development agreement. Under the terms of the agreement, Diversa will receive a license to use XOMA’s antibody expression technology for developing antibody products independently and with collaborators, and an option to a license for the production of antibodies under the XOMA patents. XOMA will receive a license fee and potential future milestone and royalty payments. Under the terms of the development portion of the agreement, XOMA and Diversa will combine their respective capabilities to discover and develop antibodies. Diversa will receive research funding and is entitled to receive milestones and royalties on any drugs developed under this portion of the agreement.

Human Engineering^™ is a proprietary technology that allows modification of any non-human monoclonal antibody to reduce or eliminate detectable immunogenicity in humans. The technology uses a unique algorithm developed at XOMA, based on analysis of the conserved structure-function relationships among antibodies. The method defines which residues in a non-human variable region are candidates to be modified. The result is a Human Engineered^™ antibody generated in a reduced amount of time, with preserved antigen binding, structure and function, and eliminated or greatly reduced immunogenicity.

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Financial and Legal Arrangements of Product Collaborations

Genentech

In April of 1996, XOMA and Genentech entered into an agreement whereby XOMA agreed to co-develop Genentech’s humanized monoclonal antibody product RAPTIVA^™. Under the terms of the agreement XOMA will receive 25% of U.S. operating profits or losses from RAPTIVA^™ in all indications. Up until the first FDA approval, Genentech financed XOMA’s share of development costs via convertible subordinated loans. Under the loan agreement, upon the FDA approval of the product, which occurred October 27, 2003, the Company elected to defer repayment of approximately $40.0 million as an offset against the Company’s future proceeds from its 25% share of U.S. operating profits on the product. On December 22, 2003, the Company issued 2,959 convertible preference shares to Genentech to repay the remaining outstanding balance of the development loan of $29.6 million. An additional debt facility was established to finance XOMA’s share of U.S. commercialization costs prior to FDA approval. Under the terms of the agreement, the outstanding balance under the commercial loan of $3.0 million related to 2002 commercialization costs was repaid in cash on January 23, 2004. The remaining balance of $10.3 million, which relates to 2003 commercialization costs, must be repaid by April 30, 2004. XOMA granted Genentech a security interest in the Company’s profit share on RAPTIVA^™ as collateral against any unpaid past due amounts of these loans.

The initial focus of the collaboration agreement was to develop RAPTIVA^™ to treat psoriasis and prevent or decrease the rejection of organ transplants. XOMA completed a Phase II efficacy study in Canada in psoriasis patients in late 1998, subsequently received a $2.0 million milestone payment from Genentech, and agreed with Genentech to continue collaborative development of the product in psoriasis and to expand the program to include all indications for the product. XOMA has an option to co-promote the product in the United States.

Genentech has granted Serono S. A. exclusive marketing rights to RAPTIVA^™ outside the U.S. and Japan. In February of 2003, Serono announced the filing of an application for European Union marketing approval of RAPTIVA^™ in moderate-to-severe plaque psoriasis. XOMA is entitled to a royalty from Genentech on sales of RAPTIVA^™ outside the United States.

Either party may terminate the agreement upon a breach of a material obligation by the other party. Upon termination, XOMA may be paid a royalty on all worldwide sales or have a percentage of its development costs reimbursed by Genentech. Whether the royalty will be paid, and at what rate, or the costs reimbursed will depend on which party terminates the agreement and at what point in the approval process such termination occurs.

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Millennium

In November of 2001, XOMA and Millennium announced an agreement in which they would collaborate to develop two of Millennium’s biotherapeutic agents, MLN2222 (also known as CAB2) and MLN2201, for certain vascular inflammation indications. In October of 2003, the Company announced the discontinuation of development of MLN2201. XOMA and Millennium are continuing with the development of MLN2222, a complement inhibitor for coronary artery bypass graft surgery, targeting vascular inflammation associated with such surgery. On December 18, 2003 the Company announced the initiation of a Phase I clinical trial for MLN2222. This trial is the first of two planned Phase I trials that will evaluate the safety, tolerability, pharmacokinetic and pharmacodynamic properties of MLN2222.

Under the terms of the amended agreement, XOMA will be responsible for development activities and related costs through the completion of Phase II trials for MLN2222. XOMA will make future payments to Millennium upon achievement of certain clinical milestones. After successful completion of Phase II, Millennium will have the right to commercialize the products and XOMA will have the option to choose between further participation in the development program and eventual profit sharing, or alternatively being entitled to future royalty and milestone payments.

In October of 2003, the Company announced the discontinuation of development of MLN2201, based on preliminary data from a Phase I study that did not meet predefined criteria necessary to support further product development efforts. Under the terms of the amended investment agreement and as a result of the termination of the MLN2201 development program, the remaining funding amounts were reduced by 40% from a total of $33.5 million to a total of $20.1 million as of October 2003. Under the terms of the development agreement, the Company has no future obligations to make milestone payments to Millennium for MLN2201.

In the first quarter of 2004, the Company announced the amendment of certain terms of the investment agreement with Millennium. The key elements of the revised investment agreement include an extension of the maturity date of the $5.0 million outstanding convertible debt to April 15, 2004 (or the third business day after the date the related registration statement is declared effective, if later), and a re-scheduling of the Company’s decision points regarding whether to sell the remaining $14.7 million worth of common shares from option dates through May of 2004, to four option dates through March of 2005, at each of which XOMA may issue up to $3,675,000 worth of common shares. In November of 2003, the Company exercised an option to sell 763,719 shares to Millennium for gross proceeds of $5.4 million or $7.07 per share. In June of 2003, the Company exercised an option to sell 608,766 shares to Millennium for gross proceeds of $4.0 million or $6.57 per share.

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Either party has the right to terminate upon the breach of a material obligation by the other party. Under certain circumstances, if XOMA fails to reach certain diligence milestones, Millennium has the right to terminate the agreement. In addition, any material breach by XOMA under the investment agreement, including with respect to Millennium’s registration rights, will give Millennium the right to terminate. The agreements remain in effect until terminated.

Alexion

In December of 2003, XOMA entered into a collaboration agreement with Alexion to jointly develop and commercialize a rationally designed TPO mimetic antibody to treat chemotherapy-induced thrombocytopenia. Thrombocytopenia is an abnormal blood condition in which the number of platelets is reduced, potentially leading to bleeding complications. Under the terms of the agreement, Alexion and XOMA will share development and commercialization expenses, including preclinical development, manufacturing, and marketing costs world-wide, as well as revenues, generally on a 70-30 basis, with Alexion retaining the larger portion. Alexion received a payment tied to initiation of the collaboration and may receive a payment tied to achievement of a regulatory milestone. XOMA will be entitled to royalty payments and milestones related to its bacterial expression technology. The collaboration will initially focus on preclinical, process development and scale-up work, with initial clinical testing anticipated in 2005.

Chiron

In March of 2004, the Company announced an exclusive multi-product collaboration agreement with Chiron Corporation (“Chiron”) for the development and commercialization of antibody products for the treatment of cancer. Under the terms of the agreement, the companies will share costs and profits on a 70-30 basis, with XOMA’s share being 30%. XOMA receives an initial payment of $10 million and a loan facility of up to $50 million to fund up to 75% of its share of development expenses. Chiron’s profit share is subject to a limited upward adjustment, which in turn may be reduced if XOMA achieves certain milestones or if Chiron elects to extend the program.

Onyx

In January of 2001, the Company entered into a strategic process development and manufacturing agreement with Onyx Pharmaceuticals, Inc. The initial term was five years, with options to extend for additional periods. Under the terms of the agreement, Onyx was obliged to pay to XOMA an initial payment as well as payments for development work and material produced, and payments upon achieving key milestones. In June of 2003, Onyx announced that it was discontinuing its therapeutic virus program to focus its resources on its BAY 43-9006 anticancer compound. On June 23, 2003, Onyx notified XOMA of its intention to terminate the Company’s related process development and manufacturing agreement effective 120 days from the date of notification. Onyx paid $0.5 million as a facility fee plus

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$1.0 million as a termination fee in the fourth quarter of 2003 and, in accordance with the Company’s revenue recognition policy, these amounts were recognized as revenue because the Company’s service commitments were completed. Additionally, the Company accelerated the amortization of $1.0 million remaining in deferred revenue over the 120-day notification period.

Baxter

In January of 2000, XOMA entered into license and supply agreements with the Hyland Immuno division of Baxter for NEUPREX^® for treatment of meningococcemia and substantially all future antibacterial and anti-endotoxin human clinical indications. In July of 2003, the Company and Baxter terminated the license and supply agreements for the NEUPREX^® product. Baxter agreed to make a one-time termination payment of $10.0 million to the Company. Until the payment was made, Baxter continued to reimburse the Company for a portion of certain development expenses incurred by XOMA. The Company recognized the $10.0 million termination fee as revenue in the third quarter of 2003 and wrote-off, as research and development expense, $1.3 million related to NEUPREX^® inventory on hand at the termination date. The $10.0 million termination payment was received in January of 2004.

Other Products

XOMA is seeking development and marketing partners for additional products in the Company’s pipeline. No assurance can be given regarding the timing or likelihood of future collaborative arrangements or of product licensure.

The Company is also pursuing additional opportunities to further broaden its product pipeline through product development collaborations with other pharmaceutical and biotechnology companies.

Competition

The biotechnology and pharmaceutical industries are subject to continuous and substantial technological change. Competition in the areas of recombinant DNA-based and antibody-based technologies is intense and expected to increase as new technologies emerge and established biotechnology firms and large chemical and pharmaceutical companies continue to advance in the field. A number of these large pharmaceutical and chemical companies have enhanced their capabilities by entering into arrangements with or acquiring biotechnology companies or entering into business combinations with other large pharmaceutical companies. Many of these companies have significantly greater financial resources, larger research and development and marketing staffs and larger production facilities than those of XOMA. Moreover, certain of these companies have extensive experience in undertaking preclinical testing and human clinical trials. These factors may

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enable other companies to develop products and processes competitive with or superior to those of the Company. In addition, a significant amount of research in biotechnology is being carried out in universities and other non-profit research organizations. These entities are becoming increasingly interested in the commercial value of their work and may become more aggressive in seeking patent protection and licensing arrangements. There can be no assurance that developments by others will not render the Company’s products or technologies obsolete or uncompetitive.

Without limiting the foregoing, we are aware that:

A number of companies are developing monoclonal antibodies targeting cancers, which may prove more effective than the ING-1 antibody.

It is possible that one or more other companies may be developing one or more products based on the same human protein as our NEUPREX^® product, and these product(s) may prove to be more effective than NEUPREX^® or receive regulatory approval prior to NEUPREX^® or any BPI-derived product developed by XOMA.

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Currently, there are at least two companies developing topical peptide treatments for acne which may compete with XMP.629. Micrologix Biotech, Inc. is developing MBI 594AN, a topical peptide that has completed a Phase IIB trial for the treatment of acne, and Helix Biomedix, Inc. is developing several peptide compounds.

Regulatory

XOMA’s products are subject to comprehensive preclinical and clinical testing requirements and to approval processes by the FDA and by similar authorities in other countries. The Company’s products are primarily regulated on a product-by-product basis under the U.S. Food, Drug and Cosmetic Act and Section 351(a) of the Public Health Service Act. Most of the Company’s human therapeutic products are or will be classified as biologic products. Approval of a biologic for commercialization requires licensure of the product and the manufacturing facilities. The review of therapeutic biologic products has been transferred within the FDA from the Center for Biologics Evaluation and Research to the Center for Drug Evaluation and Research, the body that reviews drug products. Because implementation of this plan may not be complete, the Company does not know when or how this change will affect it.

The FDA regulatory process is carried out in several phases. Prior to beginning human clinical testing of a proposed new biologic product, an IND is filed with the FDA. This document contains scientific information on the proposed product, including results of testing of the product in animal and laboratory models. Also included is information on manufacture of the product and studies on toxicity in animals, and a clinical protocol outlining the initial investigation in humans.

The initial stage of clinical testing, Phase I, ordinarily encompasses safety, pharmacokinetics and pharmacodynamic evaluations. Phase II testing encompasses investigation in specific disease states designed to provide preliminary efficacy data and additional information on safety. Phase III studies are designed to further establish clinical safety and efficacy and to provide information allowing proper labeling of the product following approval. Phase III studies are most commonly multi-center, randomized, placebo-controlled trials in which rigorous statistical methodology is applied to clinical results. Other designs may also be appropriate in specific circumstances.

Following completion of clinical trials, a Biologics License Application (“BLA”) is submitted to the FDA to request marketing approval. Internal FDA committees are formed which evaluate the application, including scientific background information, animal and laboratory efficacy studies, toxicology, manufacturing facility and clinical data. During the review process, a dialogue between the FDA and the applicant is established in which FDA questions are raised and additional information is submitted. During the final stages of the approval process, the FDA generally requests presentation of clinical or other data before an FDA advisory committee, at which point, some or all of such data may become available.

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Also, during the later stages of review, the FDA conducts an inspection of the manufacturing facility to establish the product is made in conformity with good manufacturing practice (“GMP”). If all outstanding issues are satisfactorily resolved and labeling established, the FDA issues a license for the product and for the manufacturing facility, thereby authorizing commercial distribution.

The FDA has substantial discretion in both the product approval process and the manufacturing approval process, and it is not possible to predict at what point, or whether, the FDA will be satisfied with the Company’s submissions or whether the FDA will raise questions which may delay or preclude product approval or manufacturing facility approval. As additional clinical data is accumulated, it will be submitted to the FDA and may have a material impact on the FDA product approval process. Given that regulatory review is an interactive and continuous process, the Company has adopted a policy of limiting announcements and comments upon the specific details of the ongoing regulatory review of its products, subject to its obligations under the securities laws, until definitive action is taken. There can be no assurance any of the products under development by the Company will be developed successfully, obtain the requisite regulatory approval or be successfully manufactured or marketed.

In Europe, most of the Company’s human therapeutic products are or will be classified as biologic and would be subject to a single European registration through a centralized procedure. The assessment of the Marketing Authorization Application is carried out by a rapporteur and co-rapporteur appointed by the Committee for Proprietary Medicinal Products (“CPMP”), which is the expert scientific committee of the European Medicines Evaluation Agency (“EMEA”).

The rapporteur and co-rapporteur are drawn from the CPMP membership representing member states of the European Union. They liaise with the applicant on behalf of the CPMP in an effort to provide answers to queries raised by the CPMP. Their assessment report(s) is circulated to and considered by the full CPMP membership, leading to the production ultimately of a CPMP opinion which is transmitted to the applicant and Commission. The final decision on an application is issued by the Commission. When a positive decision is reached, a Marketing Authorization, or “MA,” will be issued. Once approval is granted, the product can be marketed under the single European MA in all member states of the European Union. Consistent with the single MA, the labeling for Europe is identical throughout all member states except that all labeling must be translated into the local language of the country of intended importation and in relation to the content of the so called “blue box” on the outer packaging in which locally required information may be inserted. There can be no assurance any of the products under development by the Company will be developed successfully, obtain the requisite regulatory approval or be successfully manufactured or marketed.

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Patents and Trade Secrets

As a result of its ongoing activities, the Company holds and is in the process of applying for a number of patents in the United States and abroad to protect its products and important processes. The Company also has obtained or has the right to obtain exclusive licenses to certain patents and applications filed by others. However, the patent position of biotechnology companies generally is highly uncertain and no consistent policy regarding the breadth of allowed claims has emerged from the actions of the U.S. Patent and Trademark Office (the “Patent Office”) with respect to biotechnology patents. Accordingly, no assurance can be given the Company’s patents will afford protection against competitors with similar technologies, or others will not obtain patents claiming aspects similar to those covered by the Company’s patent applications.

During the period from September of 1994 to December of 2003, the Patent Office issued 71 patents to the Company related to its BPI-related products, including novel compositions, their manufacture, formulation, assay and use. The Company has more than 20 pending patent applications worldwide related to its BPI-related products. Numerous foreign patents have been granted which, along with additional pending foreign patent applications, correspond to the patents issued in the U.S.

The Company is the exclusive licensee of BPI-related patents and applications owned by New York University (“NYU”). These include seven issued U.S. patents directed to novel BPI-related protein and DNA compositions, as well as their production and uses. U.S. Patent Nos. 5,198,541 and 5,641,874, issued to NYU, relate to the recombinant production of BPI. The Company believes these patents have substantial value because they cover certain production methodologies that allow production of commercial-scale quantities of BPI for human use. In addition, the European Patent Office granted to NYU, EP 375724, with claims to N-terminal BPI fragments and their use, alone or in conjunction with antibiotics, for the treatment of conditions associated with bacterial infections.

Between 1992 and 2003, eight patents related to BPI were issued to Incyte Genomics, Inc. (“Incyte”) by the Patent Office directed to endotoxin-associated uses of BPI, uses of BPI with polymannuronic acid, and LBP-BPI proteins. Effective as of July of 1998, XOMA is the exclusive licensee of BPI-related patents and applications owned by Incyte, including these eight U.S. patents, one granted European patent and pending applications worldwide.

From January of 1996 to December of 2003, XOMA was issued 10 patents directed to its LBP-related assays and products, including diagnostic and prognostic methods for measuring LBP levels in humans. XOMA has also acquired from Johnson & Johnson an exclusive sublicense to their LBP-related portfolio, including six U.S. patents issued to the discoverers of LBP, Drs. Richard Ulevitch and Peter Tobias, at the Scripps Research Institute in San Diego.

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During the period from July of 1991 to December of 2003, the Patent Office issued nine patents to the Company related to its bacterial expression technology, including claims to novel promoter sequences, secretion signal sequences, compositions and methods for expression and secretion of recombinant proteins from bacteria, including immunoglobulin gene products. U.S. Patent No. 5,028,530, issued to the Company, is directed to expression vehicles containing an araB promoter, host cells and processes for regulated expression of recombinant proteins. U.S. Patent Nos. 5,576,195 and 5,846,818 are related to DNA encoding a pectate lyase signal sequence, recombinant vectors, host cells and methods for production and externalization of recombinant proteins. U.S. Patent Nos. 5,595,898, 5,698,435 and 5,618,920 address secretable immunoglobulin chains, DNA encoding the chains and methods for their recombinant production. U.S. Patent Nos. 5,693,493, 5,698,417 and 6,204,023 relate to methods for recombinant production/secretion of functional immunoglobulin molecules. Numerous foreign patents have been granted which, along with additional pending foreign patent applications, correspond to the patents issued and allowed in the U.S.

If certain patents issued to others are upheld or if certain patent applications filed by others issue and are upheld, the Company may require certain licenses from others in order to develop and commercialize certain potential products incorporating the Company’s technology. There can be no assurance that such licenses, if required, will be available on acceptable terms.

Research and License Agreements

XOMA has contracted with a number of academic and institutional collaborators to conduct research and development activities. Under these agreements the Company generally funds either the research and development or evaluation of products, technologies or both, will own or obtain exclusive licenses to products or technologies developed, and may pay royalties on sales of products covered by certain licenses. The rates and durations of such royalty payments vary by product and institution, and range generally for periods from five years to indefinite duration. Aggregate expenses incurred by the Company under all of its research agreements were negligible for each of 2003, 2002 and 2001. The Company has entered into certain license agreements with respect to the following products:

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Each party has the right to terminate the agreement upon a material breach by the other party of its performance of its obligations under the agreement, subject to customary cure periods. Upon termination of the agreement prior to the expiration of the relevant patents, all rights in and to NYU’s intellectual property revert to NYU.

The agreement expires in July of 2008 unless, on or prior to such date, the license granted therein becomes fully paid up in accordance with its terms. Incyte has the right to terminate the agreement (subject to a customary cure period) upon a breach by XOMA of any of its material obligations under the agreement.

International Operations

The Company believes that, because the pharmaceutical industry is global in nature, international activities will be a significant part of the Company’s future business activities and that, when and if it is able to generate income, a substantial portion of that income will be derived from product sales and other activities outside the United States.

A number of risks are inherent in international operations. Foreign regulatory agencies often establish standards different from those in the United States, and an inability to obtain foreign regulatory approvals on a timely basis could have an adverse effect on the Company’s international business and its financial condition and results of operations. International operations may be limited or disrupted by the imposition of government controls, export license requirements, political or economic instability, trade restrictions, changes in tariffs, restrictions on repatriating profits, taxation, or difficulties in staffing and managing international operations. In addition, the Company’s business, financial condition and results of operations may be adversely affected by fluctuations in currency exchange rates. There can be no assurance that the Company will be able to successfully operate in any foreign market.

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The Company was incorporated in Delaware in 1981 and became a Bermuda company effective December 31, 1998 when it completed a shareholder-approved corporate reorganization, changing its legal domicile from Delaware to Bermuda and its name to XOMA Ltd. When referring to a time or period before December 31, 1998, or when the context so requires, the terms “Company” and “XOMA” refer to XOMA Corporation, a Delaware corporation and the predecessor of XOMA Ltd.

Employees

As of December 31, 2003, XOMA employed 226 non-unionized full-time employees at its California facilities, principally in Berkeley, California, and one employee in Ireland. The Company’s employees are engaged in clinical, process development and manufacturing, quality assurance and control, research and product development activities, and in executive, finance and administrative positions. The Company considers its employee relations to be excellent.

Available Information

The following information can be found on our website at http://www.xoma.com or can be obtained free of charge by contacting our Investor Relations Department at 800-246-9662 or by sending an e-mail message to investorrelations@xoma.com:

We intend to satisfy the applicable disclosure requirements regarding amendments to, or waivers from, provisions of our Code of Ethics by posting such information on our website.

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Item 2.    Properties

XOMA’s development and manufacturing facilities are located in Berkeley, California. The Company leases approximately 113,000 square feet of space including approximately 35,000 square feet of research and development laboratories, 48,000 square feet of production and production support facilities and 30,000 square feet of office space. Separately, a 17,000 square foot technology development and pilot facility is owned by XOMA.

In 2004, XOMA is producing the rBPI_21, MLN2222 and the TPO mimetic antibody products and has produced RAPTIVA^™ and ING-1 for clinical trial and other testing needs at its Berkeley manufacturing facilities, pursuant to a drug manufacturing license obtained from the State of California. The Company bases its manufacturing capability on recombinant DNA technology, which can produce therapeutic products from either mammalian or microbial cells. XOMA has established two 500-liter and three 2,750-liter fermentation trains with associated isolation and purification systems. XOMA does its own formulation and has the capacity to do its own small-scale filling, but normally contracts with third parties for final sterile filling and finishing.

The principal executive offices of XOMA are located at 2910 Seventh Street, Berkeley, California 94710 U.S.A. (telephone 510-204-7200).

Item 3.    Legal Proceedings

In July of 2003, a complaint was filed in the General Court of Justice, Superior Court Division, Orange County, North Carolina, in a lawsuit captioned Hamlet v. Genentech, Inc., et al., No. 03 CVS 1161, and was subsequently amended, by a participant in one of the Phase III clinical trials of RAPTIVA^™. The complaint asserts claims for alleged negligence, breach of fiduciary duty, fraud, misrepresentation and medical negligence against the plaintiff’s treating physician, the physician’s medical practice, Genentech, XOMA, the institutional review board responsible for the trial and the contract research organization retained to conduct the trial. The complaint seeks unspecified compensatory damages alleged to be in excess of $10,000.00. As set forth in the complaint, the plaintiff was initially in the placebo group of this trial; he did not receive RAPTIVA^™ during this time, and his claims are based on his failure to receive his indicated treatment, not his receipt of RAPTIVA^™. Although this case is at an early stage, XOMA believes the claims against it to be without merit and intends to vigorously defend against them. XOMA has filed a motion to dismiss all claims against it, and discovery has not yet commenced.

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Item 4.    Submission Of Matters To A Vote Of Security Holders

No matters were brought to a vote of XOMA’s shareholders in the quarter ended December 31, 2003.

Executive Officers of the Company

The executive officers of the Company and their respective ages (as of December 31, 2003) and positions with the Company are as follows:

The Board of Directors elects all officers annually. There is no family relationship between or among any of the officers or directors.

Business Experience

Mr. Castello became Chairman of the Board, President and Chief Executive Officer in March of 1993. From April of 1992 to March of 1993, Mr. Castello was President, Chief Executive Officer and a director. Mr. Castello was President and Chief Operating Officer of the Ares Serono Group from 1988 to 1991 and prior to that was President of the Serono Diagnostics Division from 1986 to 1988. Ares Serono is known in the United States for fertility drugs, and it is also the manufacturer of a bioengineered human growth hormone which is marketed primarily outside of the United States. Mr. Castello previously held senior management positions at Amersham International PLC and Abbott Laboratories. Mr. Castello is also a director of Cholestech Corporation, which is engaged in the business of developing products for the diagnostic measurement of cholesterol and other blood components.

Dr. Scannon is one of the founders of the Company and has served as a director since its formation. Dr. Scannon became Chief Scientific and Medical Officer in March of 1993. He served as President of the Company from its formation until April of 1992 and as Vice Chairman, Scientific and Medical Affairs from April of 1992 to March of 1993. From 1998 until 2001, Dr. Scannon served as a director of NanoLogics, Inc., a software company. From

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1979 until 1981, Dr. Scannon was a clinical research scientist at the Letterman Army Institute of Research in San Francisco. A Board-certified internist, Dr. Scannon holds a Ph.D. in organic chemistry from the University of California, Berkeley, and an M.D. from the Medical College of Georgia.

Clarence L. Dellio is Senior Vice President and Chief Operating Officer of the Company. Mr. Dellio joined the Company in 1984 as Vice President with responsibility for finance, manufacturing and administration. He became Senior Vice President, Operations in 1990 and Senior Vice President and Chief Operating Officer in October of 2002. Mr. Dellio was with Becton Dickinson & Company for 11 years prior to joining the Company, holding the positions of Vice President of Manufacturing, Director of Planning, and Division Controller of the BBL Microbiology Systems.

Peter B. Davis is Vice President, Finance and Chief Financial Officer of the Company. Before joining the Company in 1994, he was Vice President Financial Operations for the Ares-Serono Group. Previously, he was Chief Financial Officer of Akzo America Inc., where he was instrumental in structuring and negotiating acquisitions and joint ventures. He has also held executive financial positions with Stauffer Chemical Company and PepsiCo, Inc.

Christopher J. Margolin is Vice President, General Counsel and Secretary of the Company. Prior to joining the Company in 1991, Mr. Margolin was a corporate attorney holding several different executive legal positions for Raychem Corporation, an international high technology company, for 11 years. From 1975 to 1980, he was a division counsel for TRW Inc. and from 1972 to 1975, he was an associate at the law firm of McCutchen, Black, Verleger and Shea in Los Angeles.

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PART II

Item 5.    Market For Registrant’s Common Equity And Related Shareholder Matters

The Company’s common shares trade on the Nasdaq National Market under the symbol “XOMA”. The following table sets forth the quarterly range of high and low reported sale prices of the Company’s common shares on the Nasdaq National Market for the periods indicated.

On February 28, 2004, there were approximately 3,025 shareholders of record of our common shares, one of which is Cede & Co., a nominee for Depository Trust Company (or DTC). All of the common shares held by brokerage firms, banks and other financial institutions as nominees for beneficial owners are deposited into participant accounts at DTC, and are therefore considered to be held of record by Cede & Co. as one shareholder.

The Company has not paid dividends on its common shares. The Company currently intends to retain any earnings for use in the development and expansion of its business. The Company, therefore, does not anticipate paying cash dividends on its common shares in the foreseeable future (see Note 7 to the Consolidated Financial Statements, “Share Capital”).

In the first quarter of 2004, the Company announced the amendment of certain terms of the November of 2001 investment agreement with Millennium. The key elements of the revised investment agreement include an extension of the maturity date of the $5.0 million outstanding convertible debt to April 15, 2004 (or the third business day after the date the related registration statement is declared effective, if later), and a re-scheduling of the Company’s decision points regarding whether to sell the remaining $14.7 million worth of common shares from option dates through May of 2004, to four option dates through March of 2005, at each of which XOMA may issue up to $3,675,000 worth of common shares. In November of 2003, the Company exercised an option to sell 763,719 shares to Millennium

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for gross proceeds of $5.4 million or $7.07 per share. In June of 2003, the Company exercised an option to sell 608,766 shares to Millennium for gross proceeds of $4.0 million or $6.57 per share. In December of 2002, XOMA issued approximately 1,443,000 shares to Millennium for gross proceeds of approximately $7.5 million or $5.20 per share. These sales of common shares to Millennium were exempt from registration under the Securities Act pursuant to Section 4(2) thereof.

XOMA continues to use the net proceeds from the sale of common shares to Millennium principally for the development of MLN2222 for certain vascular inflammation indications pursuant to our collaboration agreement with Millennium. Pending application of the net proceeds as described above, the Company has invested the remaining net proceeds of the sale in short-term, investment-grade, interest-bearing securities.

In September of 2003, the Company sold 9,000,000 common shares at a price of $8.00 per share in an underwritten public offering. The Company received approximately $67.2 million of net proceeds during the third quarter of 2003. In October of 2003, the underwriters for the public offering exercised their option to purchase 1,350,000 common shares at $8.00 per share to cover over-allotments. The Company received $10.2 million in additional net cash proceeds. The proceeds are to be used for general corporate purposes.

In December of 2003, the Company issued 2,959 of Series B preferred shares to Genentech in repayment of the $29.6 million outstanding balance under the convertible subordinated debt agreement.

The section labeled “Equity Compensation Plan Information” appearing in the Company’s proxy statement for the 2004 annual general meeting of shareholders is incorporated herein by reference.

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Item 6.    Selected Financial Data

The following table contains selected financial information including statement of operations and balance sheet data of XOMA for the years 1999 through 2003. The selected financial information has been derived from the audited consolidated financial statements of XOMA. The selected financial information should be read in conjunction with the consolidated financial statements and notes thereto included in Item 8 of this report and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Item 7 below. The data set forth below is not necessarily indicative of the results of future operations.

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Quarterly Results of Operations (Unaudited)

The following is a summary of the quarterly results of operations for the years ended December 31, 2003 and 2002.

Overview

XOMA is a biopharmaceutical company that develops and manufactures antibodies and other genetically-engineered protein products to treat immunological and inflammatory disorders, cancer, and infectious diseases.

In the near term, whether the Company can achieve profitability will be highly dependent on sales and expense levels from RAPTIVA^™, which the Company has been developing under a collaboration agreement with Genentech. Genentech is responsible for the manufacturing, marketing and sales effort in support of this product and XOMA will share in the ultimate profits and losses from those sales. RAPTIVA^™ was recently approved in the United States for treating patients suffering from moderate-to-severe plaque psoriasis, and is being tested as a treatment for additional indications. The Company is developing a number of products, both proprietary and under collaboration agreements with other companies, and may enter into additional development collaborations. XOMA’s objective in these development collaborations is to leverage its existing development infrastructure to broaden and strengthen its new product pipeline beyond what it can accomplish with proprietary products, thereby diversifying its development risk and gaining financial support from its collaboration partners.

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The Company’s focus is on maximizing its opportunity for profits from RAPTIVA^™, advancing the development of other proprietary and collaborative products in its pipeline, and conducting new product research and seeking additional collaborative agreements to further strengthen the product pipeline.

The Company incurred a net loss in each of the past three years and is expected to continue to operate at a loss until sufficient profits are generated from RAPTIVA^™ or until it achieves additional regulatory approvals and commencement of commercial sales of additional products. The timing of additional approvals is uncertain, and there can be no assurance that approvals will be granted or that revenues from product sales will be sufficient to attain profitability.

Critical Accounting Policies And The Use Of Estimates

The accompanying discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements and the related disclosures, 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, assumptions and judgments that affect the reported amounts in our consolidated financial statements and accompanying notes. On an on-going basis, we evaluate our estimates, including those related to terms of the research collaborations, investments, stock compension, impairment issues, the estimated useful life of assets 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 under different assumptions or conditions.

We believe the following policies to be the most critical to an understanding of our financial condition and results of operations because they require us to make estimates, assumptions and judgments about matters that are inherently uncertain.

Revenue Recognition

Revenue is recognized when the related costs are incurred and the four basic criteria of revenue recognition are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services rendered; (3) the fee is fixed and determinable; and (4) collectibility is reasonably assured. Determination of criteria (3) and (4) are based on management’s judgments regarding the nature of the fee charged for products or services delivered and the collectibility of those fees.

We recognize revenue from license and collaboration arrangements, contract services, and to a lesser extent, product sales. Our revenue arrangements with multiple elements are divided into separate units of accounting if certain criteria are met, including whether the

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delivered element has stand-alone value to the customer and whether there is objective and reliable evidence of the fair value of the undelivered items. The consideration we receive is allocated among the separate units based on their respective fair values, and the applicable revenue recognition criteria are applied to each of the separate units. Advance payments received in excess of amounts earned are classified as deferred revenue until earned.

License and Collaborative Fees

Revenue from non-refundable license or technology access payments under license and collaborative agreements where the Company has a continuing obligation to perform is recognized as revenue over the period of the continuing performance obligation.

Milestone payments under collaborative arrangements are recognized as revenue upon completion of the milestone events, which represent the culmination of the earnings process because the Company has no future performance obligations related to the payment. Milestone payments that require a continuing performance obligation on the part of the Company are recognized over the period of the continuing performance obligation. Amounts received in advance are recorded as deferred revenue until the related milestone is completed.

Contract Revenue

Contract revenue for research and development involves the Company providing research, development or manufacturing services to collaborative partners. The Company recognizes revenue under these arrangements as the related research and development costs are incurred and collectibility is reasonably assured.

Product Sales

The Company recognizes product revenue upon shipment when there is persuasive evidence that an arrangement exists, delivery has occurred, the price is fixed and determinable and collectibility is reasonably assured. Allowances are established for estimated uncollectible amounts, product returns, and discounts, if any.

Research and Development Expenses

Research and development expenses consist of direct and research-related allocated overhead costs such as facilities costs, salaries and related personnel costs and material and supply costs. In addition, research and development expenses include costs related to clinical trials to validate our testing processes and procedures and related overhead expenses. Expenses resulting from clinical trials are recorded when incurred based in part on estimates as to the status of the various trials. From time to time, research and development expenses may include upfront fees and milestones paid to collaborative partners for the purchase of rights to in-process research and development. Such amounts are expensed as incurred. The timing of upfront fees and milestone payments in the future may cause variability in our future research and development expenses.

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Results of Operations

Revenues

Total revenues in 2003 were $24.4 million, compared with $29.9 million in 2002 and $17.3 million in 2001.

License fee revenues in 2003 increased to $18.9 million from $16.9 million in 2002 and $4.8 million in 2001. These revenues include “up front” and milestone payments related to the outlicensing of XOMA’s products and technologies and other collaborative arrangements. The increase of $2.0 million in 2003 as compared to 2002 consisted primarily of the 2003 $10.0 million contract termination fee by Baxter related to the NEUPREX^® product partially offset by the 2002 recognition of non-recurring licensing agreement fees from MorphoSys AG (“MorphoSys”) and Cambridge Antibody Technology Limited that did not involve continuing commitments by XOMA and which were partially or completely recognized as revenue in 2002 in accordance with our revenue recognition policy. The recognition of these fees is also primarily responsible for the $12.0 million increase in 2002 as compared to 2001. During the fourth quarter of 2002, we were notified by MorphoSys of its intention to exercise its option to pay the second installment totaling $4.0 million owed to XOMA under a license agreement with 363,466 of its ordinary shares, which number of shares was determined with reference to the market price of MorphoSys shares at the time of such notice (October 23, 2002). Through December 31, 2003, the Company sold all of the MorphoSys stock for net proceeds of $4.3 million, including a gain on the sale of the MorphoSys investment of $0.3 million which was recognized as other income. Certain of our license agreements involve continuing performance obligations by XOMA for services, and in these cases the related licensing payments received are recorded as deferred revenue and then recognized as revenue over the period of continuing performance obligation. The following table illustrates the activity in deferred revenue for the years ended December 31, 2003, 2002 and 2001 (in millions):

The entire $0.1 million balance in deferred revenue at December 31, 2003 is expected to be recognized as revenue in 2004. Future amounts may also be impacted by additional consideration received, if any, under existing or any future licensing or other collaborative arrangements.

Revenues from contract services were $5.4 million in 2003, as compared to $13.1 million in 2002 and $10.1 million in 2001. These revenues related primarily to service arrangements with Baxter and Onyx. Product sales revenues, related primarily to supplying

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NEUPREX^® product to Baxter for use in clinical and other testing, were zero in 2003 and 2002 compared with $2.4 million in 2001. We do not expect any future contract service revenues under these agreements based on the termination of the NEUPREX^® service arrangements with Baxter and the discontinuation of the Onyx development and manufacturing agreements in 2003.

Revenues for the next several years will be largely determined by the timing and extent of our share of profits generated by Genentech’s sales of RAPTIVA^™ in the United States, potential royalties on RAPTIVA^™ sales outside of the United States and the establishment and nature of future outlicensing, collaboration and service arrangements.

Research and Development Expenses

In 2003, research and development expense increased to $57.5 million, compared with $42.6 million in 2002 and $35.9 million in 2001. The $14.9 million increase in 2003 as compared to 2002 reflected increased spending on RAPTIVA^™, the Millennium collaboration products (MLN2201 and MLN2222), our proprietary XMP.629 peptide acne compound and new product research. This was partially offset by reduced spending on Onyx-015, NEUPREX^® and ING-1. The $6.7 million increase in 2002 compared to 2001 primarily reflected increased spending related to our co-development agreement with Genentech for RAPTIVA^™, our collaboration with Millennium for early stage research and development on MLN2222 and MLN2201 and XMP.629. The 2002 increase was partially offset by savings on NEUPREX^® and on certain earlier stage development programs that were discontinued in the later part of 2001. Our research and development activities can be divided into earlier stage programs, which include molecular biology, process development, pilot-scale production and preclinical testing, and later stage programs, which include clinical testing, regulatory affairs and manufacturing clinical supplies. Using the current costing methods, the costs associated with these programs approximate the following (in millions):

Our research and development activities can be divided into those related to our internal projects and those related to collaborative arrangements. The costs related to internal projects versus collaborative arrangements approximate the following (in millions):

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For 2003, 2002 and 2001, no single project accounted for more than 30% of our total research and development costs for that year.

The following table contains information regarding the products for which we are currently developing or which are available for licensing, including indications, FDA regulatory status and names of our collaborators, if any:

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We currently anticipate that research and development spending will increase in 2004, due primarily to increase spending on the XMP.629 acne program, the TPO mimetic program with Alexion which was initiated in December of 2003 and new product research including the cancer program with Chiron which was announced in March of 2004. These increases will be partially offset by reduced spending on the Millennium collaboration with MLN2201 being discontinued, on RAPTIVA^™ following its approval for moderate-to-severe plaque psoriasis in 2003 and on NEUPREX^®. Future research and development spending may also be impacted by potential new licensing or collaboration arrangements. Beyond this, the scope and magnitude of future research and development expenses are difficult to predict at this time. Generally speaking, biopharmaceutical development includes a series of steps, including in vitro and in vivo preclinical testing, and Phase I, II and III clinical studies in humans. Each of these steps is typically more expensive than the previous step, but actual timing and the cost to XOMA depend on the product being tested, the nature of the potential disease indication, and also on the terms of any collaborative arrangements with other companies. After successful conclusion of all of these steps, regulatory filings for approval to market the products must be completed, including approval of manufacturing processes and facilities for the product. Our research and development expenses currently include costs of personnel, supplies, facilities and equipment, consultants, patent expenses, and third party costs related to preclinical and clinical testing.

On October 27, 2003, the FDA approved RAPTIVA^™ for the treatment of adults with chronic moderate-to-severe plaque psoriasis who are candidates for systemic therapy or phototherapy. We have also initiated a separate Phase II study testing RAPTIVA^™ in patients suffering from psoriatic arthritis. If this latter clinical trial is successful, one or more additional trials may be required before regulatory approval.

Millennium’s biotherapeutic agent, MLN2222, is being developed pursuant to a collaboration agreement with Millennium that was announced in November of 2001 to reduce complications associated with patients undergoing surgical procedures involving cardiopulmonary bypass. In December of 2003, we initiated Phase I testing for the product that will evaluate its safety, tolerability, pharmacokinetic and pharmacodynamic properties.

XMP.629 is a BPI-derived topical peptide compound targeting acne. XOMA completed two Phase I trials of XMP.629, in 2003, evaluating the safety, skin irritation, and pharmacokinetics. In January of 2004, we announced the initiation of Phase II clinical testing in patients with mild-to-moderate acne.

NEUPREX^®, also known as rBPI₂₁, is a genetically-engineered fragment of a particular human protein. On July 3, 2003, the Company and Baxter terminated the license and supply agreements for the NEUPREX^® product. XOMA received a one-time termination payment of $10.0 million in January of 2004. Until such payment was made, Baxter continued to reimburse the Company for a portion of certain development expenses which were incurred.

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ING-1 is a Human Engineered^™ recombinant monoclonal antibody that binds with high affinity to an antigen expressed on epithelial cell cancers (breast, colorectal, prostate and others) and is designed to destroy cancer cells by recruiting the patient’s own immune system. In August of 2000, the Company filed an investigational new drug (“IND”) for testing ING-1 in a variety of adenocarcinomas. Phase I dosing and safety studies have been completed for intravenous and subcutaneous administration. XOMA plans to seek a partner for further development of this product.

In December of 2003, XOMA entered into a collaborative agreement with Alexion for the development and commercialization of a rationally designed TPO mimetic antibody to treat chemotherapy-induced thrombocytopenia. In 2004, the companies will focus on process development and preclinical activities.

XOMA was working under a process development and manufacturing agreement to support the development with Onyx Pharmaceuticals, Inc. of the ONYX-015 product. In June of 2003, Onyx announced it was discontinuing its therapeutic virus program to focus its resources on its BAY 43-9006 anticancer compound. In June of 2003 Onyx notified XOMA that they were terminating the product’s process development and manufacturing agreement.

Marketing, General and Administrative Expenses

In 2003, marketing, general and administrative expenses increased to $24.5 million compared with $19.4 million in 2002 and $8.7 million in 2001. The increase of $5.1 million in 2003 as compared to 2002 relates to increased spending for pre-launch activities for RAPTIVA^™. This was partially offset by reduced legal expenses related to our litigation with Biosite Incorporated and certain shareholder litigation, which totaled approximately $7.0 million in 2002. The most significant component of the $10.7 million increase in 2002 as compared to 2001 was legal expenses related to litigation. The litigation matters to which these expenses related were settled or otherwise resolved in 2002. Spending in 2002 also increased for XOMA’s share of marketing expenses related to pre-launch activities for RAPTIVA^™. Marketing, general and administrative expenses are expected to decrease in 2004, as RAPTIVA^™ selling and marketing expenses incurred by Genentech will no longer be included in the category, and instead will be included in the profit (loss) share line item.

Total Operating Costs and expenses

Total operating expenses in 2004 are expected to increase due to increased research and development expenses partially offset by decreased general and administrative expenses. Beginning in 2004, the Company plans to report its RAPTIVA^™ collaboration profit or loss as a single line item, which will include its share of Genentech’s United States operating

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profit or loss, royalty income on Genentech’s sales of RAPTIVA^™ outside the United States and any research and development cost sharing adjustment to reflect the terms of its agreement with Genentech. If the quarterly collaboration activity results in a profit, XOMA’s portion will be included in total revenues; if the quarterly collaboration activity results in a loss, XOMA’s portion will be included in operating expenses. We currently anticipate that because of product launch costs, RAPTIVA^™ will not be profitable in 2004. Research and development costs incurred directly by XOMA related to RAPTIVA^™ will continue to be included in research and development expense.

Investment and Other Income

Investment income decreased in 2003 to $0.5 million, a $0.4 million decrease over 2002 and decreased by $1.1 million in 2002 compared with 2001, reflecting lower average cash investment balances and lower interest rates.

Interest and Other Expense

Interest expense decreased by $0.2 million in 2003 as compared to 2002 and decreased by $0.5 million in 2002 compared with 2001. Interest expense for all three years primarily consisted of interest on the convertible notes due to Genentech and Millennium. This decrease in 2003 versus 2002 and 2002 versus 2001 was due to lower interest rates offset, in part, by higher loan balances.

Income Taxes

XOMA has recorded cumulative net deferred tax assets of $127.8 million and $125.0 million at December 31, 2003 and 2002, respectively, principally attributable to the timing of the deduction of certain expenses associated with certain research and development expenses, net operating loss, and other carryforwards. XOMA also recorded corresponding valuation allowances of $127.8 million and $125.0 million at December 31, 2003 and 2002, respectively, to offset these deferred tax assets, as management cannot predict with reasonable certainty that the deferred tax assets to which the valuation allowance relates will be realized.

As of December 31, 2003, XOMA had federal net operating loss carryforwards of approximately $231.6 million to offset future taxable income. We also had federal research and development tax credit carryforwards of approximately $17.7 million. If not utilized, these carryforwards will begin to expire in 2004. The availability of the Company’s net operating loss and tax credit carryforwards may be subject to substantial limitation if it is determined that the Company’s ownership has changed by more than 50 percent over a three year period.

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Liquidity and Capital Resources

Cash, cash equivalents and short-term investments increased by $47.0 million to $85.2 million at December 31, 2003. The 2002 balances of $38.2 million also included $1.5 million of restricted cash. Net cash provided by financing activities in 2003 was $97.3 million, $15.4 million in 2002, and $61.8 million in 2001. The increase in 2003 versus 2002 reflects the receipt of net proceeds of $87.8 million from issuances of common shares including underwritten public offerings and the underwriter’s exercise of an over-allotment option. The decrease in financing activities in 2002 versus 2001 is related to the issuance of common shares in 2001 for net proceeds of $48.1 million, of which $43.3 million was received in a public offering.

Net cash used in operating activities was $47.5 million in 2003, compared with $34.8 million in 2002 and $22.4 million in 2001. The increase in 2003 and 2002 primarily reflected higher net losses as a result of higher research and development expenses, as well as marketing expenses, related to the pre-launch activities for RAPTIVA^™. The increase in cash used in operating activities in 2002 compared with 2001 also reflected higher net operating losses due to litigation expenses.

Net cash used in investing activities for 2003, 2002 and 2001 was $1.2 million, $11.6 million, and $7.1 million, respectively. The decrease in 2003 is primarily the result of lower capital spending and the sale of MorphoSys shares valued at $4.0 million. In 2002 there was a significant increase in spending for renovations and expansion of manufacturing and warehouse facilities which were initiated in 2001 and completed in 2002 and is also the primary increase in 2002 compared to 2001. Additionally, investing activities for 2002 included $1.5 million used to satisfy a restricted cash requirement related to short-term loan agreement. Capital spending is expected to continue at more normal levels for 2004.

The Company’s cash, cash equivalents and short-term investments are expected to decrease through 2004 with the use of cash to fund ongoing operations.

Payments by period due under contractual obligations at December 31, 2003, mature as follows (in thousands):

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Other than the Genentech obligation and the capital lease obligations stated above, we have no other long-term obligations, nor any purchase obligations, as defined in Item 303(a)(5) of Regulation S-K.

The present outlook is for higher losses in 2004 compared to 2003, primarily due to decreased license and contract revenues, increased research and development expenses and costs related to the launch of RAPTIVA^™. In March of 2004, the Company announced an exclusive multi-product collaboration agreement with Chiron for the development and commercialization of antibody products for the treatment of cancer. Under the terms of the agreement, the companies will share costs and profits on a 70-30 basis, with XOMA’s share being 30%. XOMA receives an initial payment of $10 million and a loan facility of up to $50 million to fund up to 75% of its share of development expenses. Chiron’s profit share is subject to a limited upward adjustment, which in turn may be reduced if XOMA achieves certain milestones or if Chiron elects to extend the program. The Company’s strategy is to attempt to continue broadening its product pipeline through both internal development and additional collaborations such as its arrangements with Genentech, Millennium, Alexion and Chiron.

Based on current spending levels and anticipated revenues, the Company estimates it has sufficient cash resources, together with sources of funding available to it, to meet its anticipated net cash consumption levels through at least the end of 2005. Any significant revenue shortfalls, or increases in planned spending on development programs or losses on RAPTIVA^™ could shorten this period. Additional licensing arrangements or collaborations or otherwise entering into new equity or other financing arrangements could extend this period. Progress or setbacks by potentially competing products may also affect XOMA’s ability to raise new funding on acceptable terms. For a further discussion of the risks related to our business and their effects on our cash flow and ability to raise new funding on acceptable terms, see “Forward Looking Information And Cautionary Factors That May Affect Future Results” included in this Item 7 below.

Although operations are influenced by general economic conditions, the Company does not believe that inflation had a material impact on financial results for the periods presented. The Company believes that it is not dependent on materials or other resources that would be significantly impacted by inflation or changing economic conditions in the foreseeable future.

Recent Accounting Pronouncements

In November of 2002, the Financial Accounting Standards Board issued Emerging Issues Task Force (referred to as EITF) Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” EITF Issue No. 00-21 addresses certain aspects of the accounting by a company for arrangements under which it will perform multiple revenue-generating activities. EITF Issue No. 00-21 addresses when and how an arrangement involving multiple deliverables should be divided into separate units of accounting. EITF Issue No. 00-21

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provides guidance with respect to the effect of certain customer rights due to company nonperformance on the recognition of revenue allocated to delivered units of accounting. EITF Issue No. 00-21 also addresses the impact on the measurement and/or allocation of arrangement consideration of customer cancellation provisions and consideration that varies as a result of future actions of the customer or the company. Finally, EITF Issue No. 00-21 provides guidance with respect to the recognition of the cost of certain deliverables that are excluded from the revenue accounting for an arrangement. The provisions of EITF Issue No. 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The Company’s adoption of the recognition requirements in July of 2003 of EITF Issue No. 00-21 did not have a material impact on its consolidated financial position or results of operations.

In January of 2003, the FASB issued Interpretation No. 46 (or FIN 46), “Consolidation of Variable Interest Entities.” FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both. A variable interest entity is a corporation, partnership, trust, or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. A variable interest entity often holds financial assets, including loans or receivables, real estate or other property. A variable interest entity may be essentially passive or it may engage in research and development or other activities on behalf of another company. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities at the end of the first fiscal year or interim period ending after March 15, 2004. Certain of the disclosure requirements apply to all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. The Company’s adoption of the disclosure requirements in January of 2003 did not have an impact on the Company’s financial position and results of operations. The adoption of the initial recognition requirements of FIN 46 did not have a material impact on the Company’s financial position or result of operations and the adoption of the remaining provisions are also not expected to have a material effect.

In May of 2003, the FASB issued Statements of Financial Accounting Standards No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (FAS 150). FAS 150 establishes standards for the classification and measurement of financial instruments with characteristics of both liabilities and equity. FAS 150 is effective for financial instruments entered into or modified after May 31, 2003 except for certain mandatorily redeemable financial instruments for which the FASB announced on November 5, 2003 deferred effective dates for certain provisions of FAS150. The adoption of FAS 150 and the subsequent deferred effective dates did not and will not have a material effect on the Company’s financial position or results of operations.

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Forward-Looking Information And Cautionary Factors That May Affect Future Results

Certain statements contained herein related to the relative size of the Company’s loss for 2004, the relative levels of its expenses and revenues for the balance of 2004, the sufficiency of its cash resources, the marketing and sales effort in support of RAPTIVA^™, and the availability of clinical data, as well as other statements related to current plans for product development and existing and potential collaborative and licensing relationships, or that otherwise relate to future periods, are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements are based on assumptions that may not prove accurate. Actual results could differ materially from those anticipated due to certain risks inherent in the biotechnology industry and for companies engaged in the development of new products in a regulated market. Among other things, the actual loss for 2004 could be higher depending on revenues from licensees and collaborators, the size and timing of expenditures, and whether there are unanticipated expenses; expenses could be higher and/or revenues could be lower depending on research and development costs, availability of licensing opportunities and other factors; the sufficiency of cash resources could be shortened if expenditures are made earlier or in larger amounts than anticipated or are unanticipated or if funds are not available on acceptable terms; the marketing and sales effort for RAPTIVA^™ may not be successful due to the strength of competition or if physicians do not adopt the product as treatment for their patients; and the availability of clinical data may be delayed due to slower enrollment or other delays in the trial itself or due to problems with the collection, review or interpretation of the data. These and other risks, including those related to the results of pre-clinical testing; the timing or results of pending and future clinical trials (including the design and progress of clinical trials; safety and efficacy of the products being tested; action, inaction or delay by the FDA, European or other regulators or their advisory bodies; and analysis or interpretation by, or sub-mission to, these entities or others of scientific data); changes in the status of existing collaborative relationships; the ability of collaborators and other partners to meet their obligations; competition; market demand for products; scale-up and marketing capabilities; availability of additional licensing or collaboration opportunities; international operations; share price volatility; the Company’s financing needs and opportunities; uncertainties regarding the status of biotechnology patents; uncertainties as to the costs of protecting intellectual property; and risks associated with our status as a Bermuda company, are described in more detail in the remainder of this section.

The Marketing And Sales Effort In Support Of Our Only Product To Receive Regulatory Approval Has Only Recently Begun And May Not Be Successful.

RAPTIVA^™, our only product to receive regulatory approval, was approved by the FDA on October 27, 2003 for the treatment of chronic moderate-to-severe plaque psoriasis in adults who are candidates for systemic therapy or phototherapy. Genentech is responsible for the marketing and sales effort in support of this product and has only recently commenced the full

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intended scope of this effort. Unless and until RAPTIVA^™ is approved in this or other indications outside the United States, our interest in this product in this indication is limited to our 25% share of the operating profits or losses from sales of the product in the United States. We currently have no active role in this marketing and sales effort. Successful commercialization of this product is subject to a number of risks, including Genentech’s ability to implement its marketing and sales effort and achieve sales; the strength of competition from other products being marketed or developed to treat psoriasis; physicians’ and patients’ acceptance of RAPTIVA^™ as a treatment for psoriasis; Genentech’s ability to provide manufacturing capacity to meet demand for the product; and pricing and reimbursement issues. Many of these risks are discussed in more detail below.

Because All Of Our Products Are Still Being Developed, We Will Require Substantial Funds To Continue; We Cannot Be Certain That Funds Will Be Available And, If Not Available, We May Have To Take Actions Which Could Adversely Affect Your Investment.

If adequate funds are not available, we may have to dilute or otherwise adversely affect the rights of existing shareholders, curtail or cease operations, or file for bankruptcy protection in extreme circumstances. We have spent, and we expect to continue to spend, substantial funds in connection with:

Based on current spending levels, revenue estimates, net proceeds received from our recent underwritten public offering, repayment obligations of our debt owed to Genentech for our share of RAPTIVA^™ marketing costs, deferral of a portion of our development loan from Genentech, issuance of shares in repayment of the remainder of our development loan from Genentech and financing commitments from Millennium, we estimate we have sufficient cash resources, together with sources of funding available to us, to meet our anticipated net cash consumption levels through at least the end of 2005. However, to the extent we experience continuing losses on RAPTIVA^™ or changes in the timing or size of expenditures or unanticipated expenditures, or if our collaborators do not meet their obligations to us or anticipated revenues otherwise do not materialize, these funds may not be adequate for this period. In particular, our share of profits or losses from RAPTIVA^™ may materially impact our cash resources. As a result, we do not know whether:

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Cash balances and operating cash flow are influenced primarily by the timing and level of payments by our licensees and development partners, as well as by our operating costs.

Specifically, although the recent FDA approval of RAPTIVA^™ would generally be expected to improve operating cash flow to the extent of XOMA’s share of operating profits from sales of RAPTIVA^™ in the U.S., such approval also requires repayment in cash, shares or deferred repayment of up to $40.0 million of amounts owed to Genentech (approximately $53 million under both loan agreements as of December 31, 2003). In November of 2003, we announced our election to defer $40.0 million of such repayment and to repay the remainder of the development loan using shares. The commercialization loan is payable only in cash and approximately $3 million was paid in January of 2004 and approximately $10.3 million is due in April of 2004. In addition, the receipt of regulatory approval terminated Genentech’s obligation to continue to loan us our portion of development and commercialization expenses for RAPTIVA^™.

Most Of Our Therapeutic Products Have Not Received Regulatory Approval. If These Products Do Not Receive Regulatory Approval, Neither Our Third Party Collaborators Nor We Will Be Able To Manufacture And Market Them.

Our products cannot be manufactured and marketed in the United States and other countries without required regulatory approvals. Only one of our therapeutic products has received regulatory approval. The United States government and governments of other countries extensively regulate many aspects of our products, including:

In the United States, the FDA regulates pharmaceutical products under the Federal Food, Drug, and Cosmetic Act and other laws, including, in the case of biologics, the Public Health Service Act. At the present time, we believe that most of our products will be regulated by the FDA as biologics. The review of therapeutic biologic products has been transferred within the FDA from the Center for Biologics Evaluation and Research to the Center for Drug

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Evaluation and Research, the body that reviews drug products. Because implementation of this plan may not be complete, we do not know when or how this change will affect us. State regulations may also affect our proposed products.

The FDA has substantial discretion in both the product approval process and manufacturing facility approval process and, as a result of this discretion and uncertainties about outcomes of testing, we cannot predict at what point, or whether, the FDA will be satisfied with our or our collaborators’ submissions or whether the FDA will raise questions which may be material and delay or preclude product approval or manufacturing facility approval. As we accumulate additional clinical data, we will submit it to the FDA, which may have a material impact on the FDA product approval process.

Our potential products will require significant additional research and development, extensive preclinical studies and clinical trials and regulatory approval prior to any commercial sales. This process is lengthy and expensive, often taking a number of years. As clinical results are frequently susceptible to varying interpretations that may delay, limit or prevent regulatory approvals, the length of time necessary to complete clinical trials and to submit an application for marketing approval for a final decision by a regulatory authority varies significantly. As a result, it is uncertain whether:

For example,

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Given that regulatory review is an interactive and continuous process, we maintain a policy of limiting announcements and comments upon the specific details of the ongoing regulatory review of our products, subject to our obligations under the securities laws, until definitive action is taken.

Because All Of Our Products Are Still Being Developed, We Have Sustained Losses In The Past And We Expect To Sustain Losses In The Future.

We have experienced significant losses and, as of December 31, 2003, we had an accumulated deficit of $599.5 million.

For the year ended December 31, 2003, we had a net loss of approximately $58.7 million, or $0.78 per share (basic and diluted). For the year ended December 31, 2002, we had a net loss of approximately $33.2 million, or $0.47 per share (basic and diluted). We expect to incur additional losses in the future, primarily due to increased sales and marketing expenses related to RAPTIVA^™, the Alexion collaboration, the Millennium collaboration, our XMP.629 compound and new product research including our oncology product collaboration with Chiron Corporation.

Our ability to achieve profitability is dependent in large part on obtaining regulatory approval for our products and entering into agreements for product development and commercialization, both of which are uncertain. Our ability to fund our ongoing operations is dependent on the foregoing factors and on our ability to secure additional funds. Because all

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of our products are still being developed, we do not know whether we will ever achieve profitability or whether cash flow from future operations will be sufficient to meet our needs.

If Third Party Collaborators Do Not Successfully Develop And Market Our Products, We May Not Be Able To Do So On Our Own.

Our financial resources and our marketing experience and expertise are limited. Consequently, we depend to a large extent upon securing the financial resources and marketing capabilities of third parties with whom we collaborate.

Because our collaborators are independent third parties, they may be subject to different risks than we are and have significant discretion in determining the efforts and resources they will apply. We do not know whether Genentech, Millennium, Alexion or Chiron will successfully develop and market any of the products that are or may become the subject of one of our collaborations.

Even when we have a collaborative relationship, other circumstances may prevent it from resulting in successful development of marketable products.

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Although we continue to evaluate additional strategic alliances and potential partnerships, we do not know whether or when any such alliances or partnerships will be entered into.

Because We Have No History Of Profitability And Because The Biotechnology Sector Has Been Characterized By Highly Volatile Stock Prices, Announcements We Make And General Market Conditions For Biotechnology Stocks Could Result In A Sudden Change In The Value Of Our Common Shares.

As a biopharmaceutical company, we have experienced significant volatility in our common shares. Fluctuations in our operating results and general market conditions for biotechnology stocks could have a significant impact on the volatility of our common share price. From December 31, 2001 through March 5, 2004, our share price has ranged from a high of $12.19 to a low of $2.84. On March 5, 2004, the last reported sale price of the common shares as reported on the Nasdaq National Market was $6.23 per share. Factors contributing to such volatility include, but are not limited to:

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We Or Our Third Party Collaborators May Not Be Able To Increase Existing Or Acquire New Manufacturing Capacity Sufficient To Meet Market Demand.

Genentech is responsible for manufacturing or arranging for the manufacturing of commercial quantities of RAPTIVA^™. Should Genentech have difficulty in providing manufacturing capacity to produce RAPTIVA^™ in sufficient quantities, we do not know whether we will be able to meet market demand. If any of our other products are approved, because we have never commercially introduced any pharmaceutical products, we do not know whether the capacity of our existing manufacturing facilities can be increased to produce sufficient quantities of our products to meet market demand. Also, if we or our third party collaborators need additional manufacturing facilities to meet market demand, we cannot predict that we will successfully obtain those facilities because we do not know whether they will be available on acceptable terms. In addition, any manufacturing facilities acquired or used to meet market demand must meet the FDA’s quality assurance guidelines.

Because We Only Recently Received Approval For Our Only Approved Product And We Do Not And Cannot Currently Market Any Of Our Other Products For Commercial Sale, We Do Not Know Whether There Will Be A Viable Market For Our Products.

Even though we and Genentech recently received FDA approval to market RAPTIVA^™ and even if we receive regulatory approval for our other products, our products may not be accepted in the marketplace. For example, physicians and/or patients may not accept a product for a particular indication because it has been biologically derived (and not discovered and developed by more traditional means) or if no biologically derived products are currently in widespread use in that indication, as is currently the case with psoriasis. Similarly, physicians may not accept RAPTIVA^™ if they believe other products to be more effective or are more comfortable prescribing other products that have been on the market longer than RAPTIVA^™. Consequently, we do not know if physicians or patients will adopt or use our products for their approved indications.

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Other Companies May Render Some Or All Of Our Products Noncompetitive Or Obsolete.

Developments by others may render our products or technologies obsolete or uncompetitive. Technologies developed and utilized by the biotechnology and pharmaceutical industries are continuously and substantially changing. Competition in the areas of genetically engineered DNA-based and antibody-based technologies is intense and expected to increase in the future as a number of established biotechnology firms and large chemical and pharmaceutical companies advance in these fields. Many of these competitors may be able to develop products and processes competitive with or superior to our own for many reasons, including that they may have:

These factors may enable others to develop products and processes competitive with or superior to our own or those of our collaborators. In addition, a significant amount of research in biotechnology is being carried out in universities and other non-profit research organizations. These entities are becoming increasingly interested in the commercial value of their work and may become more aggressive in seeking patent protection and licensing arrangements.

Furthermore, positive or negative developments in connection with a potentially competing product may have an adverse impact on our ability to raise additional funding on acceptable terms. For example, if another product is perceived to have a competitive advantage, or another product’s failure is perceived to increase the likelihood that our product will fail, then investors may choose not to invest in us on terms we would accept or at all.

Without limiting the foregoing, we are aware that:

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A number of companies are developing monoclonal antibodies targeting cancers, which may prove more effective than the ING-1 antibody.

It is possible that one or more other companies may be developing one or more products based on the same human protein as our NEUPREX^® product, and these product(s) may prove to be more effective than NEUPREX^® or receive regulatory approval prior to NEUPREX^® or any BPI-derived product developed by XOMA.

Currently, there are at least two companies developing topical peptide treatments for acne which may compete with XMP.629. Micrologix Biotech, Inc. is developing MBI 594AN, a topical peptide that has completed a Phase IIB trial for the treatment of acne, and Helix Biomedix, Inc. is developing several peptide compounds.

Even If We Or Our Third Party Collaborators Bring Products To Market, We May Be Unable To Effectively Price Our Products Or Obtain Adequate Reimbursement For Sales Of Our Products, Which Would Prevent Our Products From Becoming Profitable.

If we or our third party collaborators succeed in bringing our product candidates to the market, they may not be considered cost-effective, and reimbursement to the patient may not be available or may not be sufficient to allow us to sell our products on a competitive basis. In both the United States and elsewhere, sales of medical products and treatments are dependent, in part, on the availability of reimbursement to the patient from third-party payors, such as government and private insurance plans. Third-party payors are increasingly challenging the prices charged for pharmaceutical products and services. Our business is affected by the

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efforts of government and third-party payors to contain or reduce the cost of health care through various means. In the United States, there have been and will continue to be a number of federal and state proposals to implement government controls on pricing. In addition, the emphasis on managed care in the United States has increased and will continue to increase the pressure on the pricing of pharmaceutical products. We cannot predict whether any legislative or regulatory proposals will be adopted or the effect these proposals or managed care efforts may have on our business.

If Our And Our Partners’ Patent Protection For Our Principal Products And Processes Is Not Enforceable, We May Not Realize Our Profit Potential.

Because of the length of time and the expense associated with bringing new products to the marketplace, we and our partners hold and are in the process of applying for a number of patents in the United States and abroad to protect our products and important processes and also have obtained or have the right to obtain exclusive licenses to certain patents and applications filed by others. However, the patent position of biotechnology companies generally is highly uncertain and involves complex legal and factual questions, and no consistent policy regarding the breadth of allowed claims has emerged from the actions of the U.S. Patent and Trademark Office with respect to biotechnology patents. Legal considerations surrounding the validity of biotechnology patents continue to be in transition, and historical legal standards surrounding questions of validity may not continue to be applied, and current defenses as to issued biotechnology patents may not in fact be considered substantial in the future. These factors have contributed to uncertainty as to:

The Patent Office has issued approximately 71 patents to us related to our products based on human bactericidal permeability-increasing protein, which we call BPI, including novel compositions, their manufacture, formulation, assay and use. In addition, we are the exclusive licensee of BPI-related patents and applications owned by New York University and Incyte Pharmaceuticals Inc. The Patent Office has also issued nine patents to us related to our bacterial expression technology.

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If certain patents issued to others are upheld or if certain patent applications filed by others issue and are upheld, we may require licenses from others in order to develop and commercialize certain potential products incorporating our technology or we may become involved in litigation to determine the proprietary rights of others. These licenses, if required, may not be available on acceptable terms, and any such litigation may be costly and may have other adverse effects on our business, such as inhibiting our ability to compete in the marketplace and absorbing significant management time.

Due to the uncertainties regarding biotechnology patents, we also have relied and will continue to rely upon trade secrets, know-how and continuing technological advancement to develop and maintain our competitive position. All of our employees have signed confidentiality agreements under which they have agreed not to use or disclose any of our proprietary information. Research and development contracts and relationships between us and our scientific consultants and potential customers provide access to aspects of our know-how that are protected generally under confidentiality agreements. These confidentiality agreements may not be honored or may not be enforced by a court. To the extent proprietary information is divulged to competitors or to the public generally, such disclosure may adversely affect our ability to develop or commercialize our products by giving others a competitive advantage or by undermining our patent position.

Protecting Our Intellectual Property Can Be Costly And Expose Us To Risks Of Counterclaims Against Us.

We may be required to engage in litigation or other proceedings to protect our intellectual property. The cost to us of this litigation, even if resolved in our favor, could be substantial. Such litigation could also divert management’s attention and resources. In addition, if this litigation is resolved against us, our patents may be declared invalid, and we could be held liable for significant damages. In addition, if the litigation included a claim of infringement by us of another party’s patent that was resolved against us, we or our collaborators may be enjoined from developing, manufacturing, selling or importing products, processes or services without a license from the other party.

The Financial Terms Of Some Of Our Existing Or Future Collaborative Arrangements Could Result In Dilution Of Our Share Value.

In November of 2003, we announced that we exercised our option to defer payment of $40.0 million of our convertible loan from Genentech related to the development of RAPTIVA^™ and pay the remaining balance of approximately $29.6 million under the development loan with preference shares before year-end 2003. These preference shares were issued in December of 2003 and are convertible into an aggregate of 3,818,395 common

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shares at a conversion price of approximately $7.75 per share, the price determined under the loan agreements at the time we notified Genentech of our election.

Our financing arrangement with Millennium includes a $5.0 million convertible note we issued to Millennium in November of 2001, which comes due in April of 2004 and which we intend to convert into common shares at that time. In addition, we have the option to issue up to $14.7 million worth of common shares, excluding the convertible debt, to Millennium through March of 2005. As of February 28, 2004, the total amount issuable in 2004 was approximately $11.0 million. The number of shares to be issued will be based on a conversion price to be calculated at the time of conversion. This arrangement, as well as future arrangements we may enter into with similar effect, could result in dilution in the value of our shares.

Because Many Of The Companies We Do Business With Are Also In The Biotechnology Sector, The Volatility Of That Sector Can Affect Us Indirectly As Well As Directly.

The same factors that affect us directly because we are a biotechnology company can also adversely impact us indirectly by affecting the ability of our collaborators, partners and others we do business with to meet their obligations to us or our ability to realize the value of the consideration provided to us by these other companies.

For example, in connection with our licensing transactions relating to our bacterial expression technology, we have in the past and may in the future agree to accept equity securities of the licensee in payment of license fees. The future value of these or any other shares we receive is subject both to market risks affecting our ability to realize the value of these shares and more generally to the business and other risks to which the issuer of these shares may be subject.

As We Do More Business Internationally, We Will Be Subject To Additional Political, Economic And Regulatory Uncertainties.

We may not be able to successfully operate in any foreign market. We believe that, because the pharmaceutical industry is global in nature, international activities will be a significant part of our future business activities and that, when and if we are able to generate income, a substantial portion of that income will be derived from product sales and other activities outside the United States. Foreign regulatory agencies often establish standards different from those in the United States, and an inability to obtain foreign regulatory approvals on a timely basis could put us at a competitive disadvantage or make it uneconomical to proceed with a product’s development. International operations may be limited or disrupted by:

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Because We Are A Relatively Small Biopharmaceutical Company With Limited Resources, We May Not Be Able To Attract And Retain Qualified Personnel, And The Loss Of Key Personnel Could Delay Or Prevent Achieving Our Objectives.

Our success in developing marketable products and achieving a competitive position will depend, in part, on our ability to attract and retain qualified scientific and management personnel, particularly in areas requiring specific technical, scientific or medical expertise. There is intense competition for such personnel. Our research, product development and business efforts would be adversely affected by the loss of one or more of key members of our scientific or management staff, particularly our executive officers: John L. Castello, our Chairman of the Board, President and Chief Executive Officer; Patrick J. Scannon, M.D., Ph.D., our Senior Vice President and Chief Scientific and Medical Officer; Clarence L. Dellio, our Senior Vice President and Chief Operating Officer; Peter B. Davis, our Vice President, Finance and Chief Financial Officer; and Christopher J. Margolin, our Vice President, General Counsel and Secretary. We have employment agreements with Mr. Castello, Dr. Scannon and Mr. Davis. We currently have no key person insurance on any of our employees.

We Are Exposed To An Increased Risk Of Product Liability Claims.

The sale, testing and marketing of medical products entails an inherent risk of allegations of product liability. We believe that we currently have adequate levels of insurance for our clinical trials, however, in the event of one or more large, unforeseen awards, such levels may not provide adequate coverage. We will seek to obtain additional insurance, if needed, as commercialization of RAPTIVA^™ continues; however, because we have not yet determined whether additional insurance is needed, we do not know whether adequate insurance coverage will be available or be available at acceptable costs. A significant product liability claim for which we were not covered by insurance would have to be paid from cash or other assets. To the extent we have sufficient insurance coverage, such a claim would result in higher subsequent insurance rates.

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We May Be Subject To Increased Risks Because We Are A Bermuda Company.

Alleged abuses by certain companies that have changed their legal domicile from jurisdictions within the United States to Bermuda have created an environment where, notwithstanding that we changed our legal domicile in a transaction that was approved by our shareholders and fully taxable to our company under U.S. law, we may be exposed to various prejudicial actions, including:

We do not know whether any of these things will happen, but if implemented one or more of them may have an adverse impact on our future operations or our share price.

If You Were To Obtain A Judgment Against Us, It May Be Difficult To Enforce Against Us Because We Are A Foreign Entity.

We are a Bermuda company. All or a substantial portion of our assets may be located outside the United States. As a result, it may be difficult for shareholders and others to enforce in United States courts judgments obtained against us. We have irrevocably agreed that we may be served with process with respect to actions based on offers and sales of securities made hereby in the United States by serving Christopher J. Margolin, c/o XOMA Ltd., 2910 Seventh Street, Berkeley, California 94710, our United States agent appointed for that purpose. We have been advised by our Bermuda counsel, Conyers Dill & Pearman, that there is doubt as to whether Bermuda courts would enforce judgments of United States courts obtained in actions against XOMA or our directors and officers that are predicated upon the civil liability provisions of the U.S. securities laws or entertain original actions brought in Bermuda against XOMA or such persons predicated upon the U.S. securities laws. There is no treaty in effect between the United States and Bermuda providing for such enforcement, and there are grounds upon which Bermuda courts may not enforce judgments of United States courts. Certain remedies available under the United States federal securities laws may not be allowed in Bermuda courts as contrary to that nation’s policy.

Our Shareholder Rights Agreement Or Bye-laws May Prevent Transactions That Could Be Beneficial To Our Shareholders And May Insulate Our Management From Removal.

In February of 2003, we adopted a new shareholder rights agreement (to replace the shareholder rights agreement that had expired), which could make it considerably more difficult or costly for a person or group to acquire control of XOMA in a transaction that our board of directors opposes.

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Our bye-laws:

These provisions of our shareholders rights agreement and our bye-laws, alone or in combination with each other, may discourage transactions involving actual or potential changes of control, including transactions that otherwise could involve payment of a premium over prevailing market prices to holders of common shares, could limit the ability of shareholders to approve transactions that they may deem to be in their best interests, and could make it considerably more difficult for a potential acquirer to replace management.

Item 7A.    Quantitative And Qualitative Disclosures About Market Risk

Interest Rate Risk.    The Company’s exposure to market rate risk for changes in interest rates relates primarily to its investment portfolio. XOMA does not invest in derivative financial instruments. By policy, the Company makes its investments in high quality debt securities, limits the amount of credit exposure to any one issuer, limits duration by restricting the term of the instrument, and holds investments to maturity except under rare circumstances.

XOMA also has a long-term interest bearing obligation to Genentech. Interest on this obligation of LIBOR plus 1% was reset at the end of June and December each year and, therefore, variable.

The table below presents the amounts and related weighted interest rates of the Company’s cash equivalents at December 31, 2003:

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Item 8.    Financial Statements And Supplementary Data

The following consolidated financial statements of the registrant, related notes, and report of independent auditors are set forth beginning on page F-1 of this report.

Not Applicable.

Item 9A.    Controls And Procedures

Under the supervision and with the participation of our management, including our Chairman of the Board, President and Chief Executive Officer and our Vice President, Finance and Chief Financial Officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-14(c) promulgated under the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this report. Based on this evaluation, our Chairman of the Board, President and Chief Executive Officer and our Vice President, Finance and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to the Company and its consolidated subsidiaries required to be included in our periodic SEC filings.

In April of 2003, the Company implemented a new financial reporting system which represents a significant change in our internal controls. During our evaluation of internal controls conducted for the second quarter of 2003, special procedures were performed regarding the system conversion and implementation. We concluded that the system conversion and implementation was properly controlled to ensure accurate financial reporting. Apart from continuing implementation of this new system, there were no changes in the Company’s internal control over financial reporting during the fourth fiscal quarter of 2003 that have materially affected, or are reasonable likely to materially affect, the Company’s internal control over financial accounting.

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PART III

Item 10.    Directors And Executive Officers Of The Registrant

The section labeled “Item 1—Election of Directors” appearing in the Company’s proxy statement for the 2004 annual general meeting of shareholders is incorporated herein by reference. Certain information concerning the Company’s executive officers is set forth in Part I of this Form 10-K.

Item 11.    Executive Compensation

The section labeled “Compensation of Executive Officers” appearing in the Company’s proxy statement for the 2004 annual general meeting of shareholders is incorporated herein by reference.

Item 12.    Security Ownership Of Certain Beneficial Owners And Management and Related Shareholder Matters

The section labeled “Share Ownership” appearing in the Company’s proxy statement for the 2004 annual general meeting of shareholders is incorporated herein by reference.

Item 13.    Certain Relationships And Related Transactions

The section labeled “Certain Transactions” appearing in the Company’s proxy statement for the 2004 annual general meeting of shareholders is incorporated herein by reference.

Item 14.    Principal Accountant Fees And Services

The section labeled “Item 2—Appointment of Independent Auditors” appearing in the Company’s proxy statement for the 2004 annual general meeting of shareholders is incorporated herein by reference.

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PART IV

Item 15.    Exhibits, Financial Statement Schedules And Reports On Form 8-K

(a)  The following documents are included as part of this Annual Report on Form 10-K:

(1)  Financial Statements:

All financial statements of the registrant referred to in Item 8 of this Report on Form 10-K.

(2)  Financial Statement Schedules:

All financial statements schedules have been omitted because the required information is included in the consolidated financial statements or the notes thereto or is not applicable or required.

(3)  Exhibits:

See “Index to Exhibits.”

(b)  Reports on Form 8-K:

(1)  On October 10, 2003, we filed a Current Report on Form 8-K reporting under Item 5—Other Events the issuance of a press release announcing that XOMA Ltd. discontinued development of MLN2201, one of two products of an ongoing development collaboration with Millennium Pharmaceuticals, Inc.

(2)  On December 18, 2003, we filed a Current Report on Form 8-K reporting under Item 5—Other Events the issuance of a press release announcing that XOMA Ltd. and Alexion Pharmaceuticals, Inc. agreed to collaborate for the development and commercialization of an antibody to treat chemotherapy-induced thrombocytopenia.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on this 15th day of March 2004.

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

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Index To Financial Statements

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REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

To the Board of Directors and Shareholders of XOMA Ltd.

We have audited the accompanying consolidated balance sheets of XOMA Ltd. as of December 31, 2003 and 2002 and the related consolidated statements of operations, shareholders’ equity (net capital deficiency) and cash flows for each of the three years in the period ended December 31, 2003. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

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

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of XOMA Ltd. as of December 31, 2003 and 2002, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States.

/s/    ERNST & YOUNG LLP

Palo Alto, California

February 6, 2004, except for Note 12,

    as to which the date is February 27, 2004

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XOMA Ltd.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share amounts)