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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark one)

For the quarterly period ended June 30, 2004

OR

For the transition period from              to              .

Commission File No. 0-19312

MEDAREX, INC.

(Exact Name of Registrant as Specified in Its Charter.)

Registrant’s Telephone Number, Including Area Code: (609) 430-2880

Indicate by check x whether 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 x whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  x    No  ¨

The number of shares of common stock, $.01 par value, outstanding as of July 30, 2004 was 79,271,264 shares.

MEDAREX, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

See notes to these unaudited consolidated financial statements.

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MEDAREX, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except per share data)

See notes to these unaudited consolidated financial statements.

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MEDAREX, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

See notes to these unaudited consolidated financial statements.

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MEDAREX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Dollars in thousands, unless otherwise indicated, except per share data)

1. Basis of Presentation and Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared from the books and records of Medarex, Inc. and Subsidiaries (the “Company”) in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by United States generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Interim results are not necessarily indicative of the results that may be expected for the year. The balance sheet at December 31, 2003 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2003.

Net Loss per Share

Basic and diluted net loss per share are calculated in accordance with the Financial Accounting Standards Board (“FASB”) SFAS No. 128, Earnings per Share. Basic net loss per share is based upon the number of weighted average shares of common stock outstanding. Diluted net loss per share is based upon the weighted average number of shares of common stock and dilutive potential shares of common stock outstanding. Potential shares of common stock result from the assumed exercise of outstanding stock options, which are included under the treasury stock method. For the three and six month periods ended June 30, 2003 and 2004, all potentially dilutive securities have been excluded from the computation of diluted net loss per share, as their effect is antidilutive.

Marketable Securities and Long-Term Non-Marketable Investments

Marketable securities consist of fixed income investments with a maturity of greater than three months and other highly liquid investments that can be readily purchased or sold using established markets. Marketable securities include those securities of debt and publicly traded equity securities accounted for under the cost method. Under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, these investments are classified as available-for-sale and are reported at fair value on the Company’s consolidated balance sheets. Unrealized holding gains and losses are reported within accumulated other comprehensive income as a separate component of shareholders’ equity. Under the Company’s accounting policy, a decline in the fair value of marketable securities is deemed to be “other than temporary” and such marketable securities are generally considered to be impaired if their fair value is less than the Company’s cost basis for more than six months, or some other period in light of the particular facts and circumstances surrounding the investment. If a decline in the fair value of a marketable security below the Company’s cost basis is determined to be other than temporary, such marketable security is written down to its estimated fair value as a new cost basis and the amount of the write-down is included in earnings as an impairment charge.

In addition, the Company has investments in several of its partners whose securities are not publicly traded. Because these securities are not publicly traded, the Company values these investments by using

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MEDAREX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Dollars in thousands, unless otherwise indicated, except per share data)

information acquired from industry trends, the management of these companies, financial statements, and other external sources. Specifically, the Company’s determination of any potential impairment of the value of privately held securities includes an analysis of the following for each company on a periodic basis: review of interim and year-end financial statements, cash position and overall rate of cash used to support operations, the progress and development of technology and product platform, the per share value of subsequent financing and potential strategic alternatives. Based on the information acquired through these sources, the Company records an impairment charge when it believes an investment has experienced a decline in value that is considered to be other than temporary.

The Company recorded impairment charges of $0, $0, $0 and $0.2 million related to investments in partners whose securities are publicly traded for the three and six month periods ended June 30, 2003 and 2004, respectively. In addition, the Company recorded impairment charges of $0, $0, $0 and $0.1 million in partners whose securities are privately held for the three and six month periods ended June 30, 2003 and 2004, respectively. Such impairment charges are included with “Interest and other income” in the Company’s consolidated statement of operations for the three and six month periods ended June 30, 2004.

Stock Based Compensation

The Company accounts for its stock option plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock option-based employee compensation cost is reflected in net loss, as all options granted under the Company’s stock option plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net loss per share if the Company had applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.

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MEDAREX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Dollars in thousands, unless otherwise indicated, except per share data)

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions:

Recently Issued Accounting Pronouncements

In January 2003, the FASB issued Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an interpretation of ARB 51.” The primary objectives of this interpretation are to provide guidance on the identification of entities for which control is achieved through means other than through voting rights (“variable interest entities”) and how to determine when and which business enterprise (the “primary beneficiary”) should consolidate the variable interest entity. This new model for consolidation applies to an entity in which either (i) the equity investors (if any) do not have a controlling financial interest; or (ii) the equity investment at risk is insufficient to finance that entity’s activities without receiving additional subordinated financial support from other parties. In addition, FIN 46 requires that the primary beneficiary, as well as all other enterprises with a significant variable interest in a variable interest entity, make additional disclosures. Certain disclosure requirements of FIN 46 were effective for financial statements issued after January 31, 2003.

In December 2003, the FASB issued FIN No. 46 (revised December 2003), “Consolidation of Variable Interest Entities” (“FIN 46-R”) to address certain FIN 46 implementation issues. The effective dates and impact of FIN 46 and FIN 46-R are as follows:

(i) Special purpose entities (“SPEs”) created prior to February 1, 2003. The adoption of the provisions applicable to SPEs created prior to February 1, 2003 had no impact on our financial statements.

(ii) Non-SPEs created prior to February 1, 2003. The adoption of the provisions applicable to Non-SPEs created prior to February 1, 2003 had no impact on our financial statements.

(iii) All entities, regardless of whether a SPE, that were created subsequent to January 31, 2003. The provisions of FIN 46 were applicable for variable interests in entities obtained after January 31, 2003. The adoption of the provisions applicable to SPEs and all other variable interests obtained after January 31, 2003 had no impact on our financial statements.

2. Investments in Genmab

As a result of a series of transactions, including an initial public offering by Genmab A/S, a Danish biotechnology company (“Genmab”), of its ordinary shares in October 2000, the Company owned approximately 31.3% interest in Genmab as of December 31, 2002.

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MEDAREX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Dollars in thousands, unless otherwise indicated, except per share data)

In July 2003, the Company received 246,914 shares of Genmab stock valued at $2.0 million representing payment for the fourth of five annual payments under an August 2000 binding memorandum of understanding between the Company and Genmab. The Company’s ownership percentage in Genmab was approximately 31.8% as of June 30, 2004. The Company’s ownership percentage in Genmab was subsequently reduced in July 2004 as a result of a private placement of stock by Genmab (see Note 11).

During the three and six month periods ended June 30, 2003, the value of the Company’s investment in Genmab was adjusted to reflect the Company’s share of Genmab’s net loss ($3.2 million) and ($6.9 million), respectively, and unrealized gains of $0.2 million and $2.4 million, respectively, related to foreign exchange translation. During the three and six month periods ended June 30, 2004, the value of the Company’s investment in Genmab was further adjusted to reflect the Company’s share of Genmab’s net loss ($5.6 million) and ($10.4 million), respectively, and an unrealized loss of $36 thousand and an unrealized gain of $0.5 million, respectively, related to foreign exchange translation. Such foreign exchange translation adjustments are included within accumulated other comprehensive income in the Company’s consolidated balance sheets. The Company’s share of Genmab’s net loss for the three and six month periods ended June 30, 2003 reflects a reconciliation of revenue recognition between the accounting principles generally accepted in the United States used by the Company and international financial reporting standards used by Genmab in its published financial results. The net loss reported by the Company for these periods is greater than would have been reported if the Company had used the same reporting standards as Genmab.

Summary financial information for Genmab is as follows:

3. Debt Exchange and Cancellation

In January 2004, the Company and certain holders of its 4.50% Convertible Subordinated Notes due 2006 (the “4.50% Notes”) completed an exchange and cancellation of $33.0 million principal amount of the 4.50% Notes, for the issuance of $21.986 million in aggregate principal of a new series of the Company’s 4.25% Convertible Senior Notes due August 15, 2010, in a limited number of transactions. As a result of this exchange and cancellation, the Company’s total convertible debt was reduced by $11.014 million. In addition, the Company recorded a gain on the early extinguishment of debt of approximately $0.3 million for the six month period ended June 30, 2004 in connection with the exchange and cancellation. Such gain is included within net loss on the extinguishment of debt in the Company’s consolidated statement of operations.

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MEDAREX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Dollars in thousands, unless otherwise indicated, except per share data)

4. Proposed Public Offering of Celldex Therapeutics, Inc. Common Stock

The Company’s wholly-owned subsidiary Celldex Therapeutics, Inc. (“Celldex”) has filed a registration statement with the Securities and Exchange Commission related to a proposed public offering of a portion of its common stock. As part of this transaction, the Company has assigned or licensed to Celldex certain intellectual property related to the Company’s vaccine technology, including the rights to MDX-1307, one of the Company’s product candidates for the treatment of cancer, as well as the IND associated with this product which became effective in February 2004. If the public offering is completed, the Company anticipates that it would continue to hold approximately 75% of the outstanding shares of common stock of Celldex.

5. Convertible Senior Notes

On May 3, 2004, the Company completed a private placement pursuant to Rule 144A of the Securities Act of 1933, as amended, of $150.0 million of 2.25% Convertible Senior Notes due May 15, 2011 (the “2.25% Notes”) to qualified institutional investors. The 2.25% Notes are initially convertible into shares of the Company’s common stock at the rate of 72.9129 per each $1,000 principal amount of the 2.25% Notes, which is equivalent to an initial conversion price of approximately $13.72 per share, subject to anti-dilution adjustments.

The Company will pay interest on the 2.25% Notes on May 15 and November 15 of each year beginning on November 15, 2004. The Company received net proceeds from the private placement of approximately $145.2 million (after deducting the initial purchasers’ discounts and offering expenses).

Noteholders have the option, subject to certain conditions, to require the Company to repurchase the notes in the event of a change in control at a price equal to 100% of the principal amount of the notes plus accrued and unpaid interest to the date of repurchase.

6. Debt Repurchase and Cancellation

Concurrent with the private placement described in Note 5, the Company repurchased approximately $65.6 million in aggregate principal amount of its 4.50% Notes for cancellation. The Company recorded a loss on the early extinguishment of debt of approximately $1.2 million and an additional charge associated with the write-off of the related deferred debt issuance costs of approximately $1.0 million during the three and six month periods ended June 30, 2004.

On May 27, 2004 the Company announced its intention to redeem all of its remaining outstanding 4.50% Notes. The redemption date is July 1, 2004 and the redemption price is 101.8% of the approximately $76.4 million remaining outstanding 4.50% Notes plus accrued and unpaid interest through June 30, 2004 (see Note 11 – Subsequent Events).

7. Acquisition of Ability Biomedical Corporation

On June 24, 2004, the Company entered into an agreement to acquire all of the outstanding capital stock of Ability Biomedical Corporation, a privately held Canadian biotechnology company, including Ability Biomedical’s intellectual property related to IP-10, a protein believed to be associated with a variety of immune disorders, including multiple sclerosis, rheumatoid arthritis, inflammatory bowel disease, chronic obstructive pulmonary disease and type I diabetes.

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MEDAREX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Dollars in thousands, unless otherwise indicated, except per share data)

Under the terms of the agreement, the Company will purchase all of the outstanding capital stock of Ability Biomedical for approximately $4.7 million in a combination of cash and/or Medarex stock. Upon achievement of certain development milestones with respect to the Company’s anti-IP-10 antibody program, but no later than September 4, 2007, the Company may be required to pay an additional amount of approximately $3.56 million in cash and/or common stock subject to fluctuations in currency exchange rates. In lieu of such additional payment, the Company also has the option to revert to the original joint collaboration agreement with Ability Biomedical whereby each party would be responsible for 50% of the costs. The acquisition closed in August 2004 (see Note 11 – Subsequent Events).

8. Contingencies

The Company has a contingent commitment to pay $1.0 million to Essex Chemical Corporation (“Essex”) without interest in installments equal to 20% of net after tax earnings of the Company in future years. The Company’s contingent commitment, as amended, to pay up to $1.0 million out of future earnings may be satisfied, at the Company’s option, through the payment of cash or shares of the Company’s common stock having a fair market value equal to the amount owed, provided that such shares are registered with the Securities and Exchange Commission. The Company accrued $0.7 million related to this liability during 2000, and such amount remains accrued at June 30, 2004.

In the ordinary course of business, the Company is at times subject to various legal proceedings. The Company does not believe that any of its current legal proceedings, individually or in the aggregate, will have a material adverse effect on its operations or financial condition.

9. Comprehensive Loss

Comprehensive loss is comprised of net loss and other comprehensive income (loss). Other comprehensive income (loss) includes changes in the fair value of the Company’s marketable securities and the foreign exchange translation of the Company’s equity position in Genmab. The following table sets forth the components of comprehensive loss:

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MEDAREX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Dollars in thousands, unless otherwise indicated, except per share data)

10. Segment Information

The Company is an integrated monoclonal antibody-based company with antibody discovery, development and manufacturing capabilities. The operations of the Company and its wholly owned subsidiaries constitute one business segment.

Revenue from customers representing 10% or more of total revenues is as follows:

No other single customer accounted for more than 10% of the Company’s total revenues for the three and six month periods ended June 30, 2003 and 2004, respectively.

11. Subsequent Events

On July 1, 2004 the Company completed the redemption and cancellation of its remaining outstanding 4.50% Notes. The Company redeemed its remaining approximately $76.4 million aggregate principal amount of 4.50% Notes for approximately $77.7 million plus accrued interest of approximately $1.7 million. The funds used for the redemption of the remaining 4.50% Notes and accrued interest are classified within segregated cash in the total current assets section of the Company’s June 30, 2004 consolidated balance sheet. The Company recorded a loss on the early extinguishment of debt of approximately $2.4 million in connection with this redemption and cancellation.

On July 6, 2004 Genmab completed an international private placement of 5.6 million shares of its stock. As a result of this private placement, the Company’s ownership percentage of Genmab was reduced to approximately 25.0%. In connection with the private placement and in accordance with a Share Lending Agreement, the Company lent up to 750,000 shares of its stock in Genmab to be used for over allotment purposes. Such shares were returned to the Company in July 2004.

On July 13, 2004, the Company entered into an amendment to Collaboration and License Agreement with Gilead Sciences, Inc. (the successor in interest to NeXstar Pharmaceuticals, Inc.), referred to herein as the Gilead Amendment. Under the terms of the Gilead Amendment, the Company agreed to pay Gilead a total of $8.5 million in eight equal installments of $1,062,500, payable at the Company’s election, in cash, registered shares of its common stock or a combination thereof, in exchange for (i) a reduction of certain future royalty payment obligations, payable by the Company to Gilead, and (ii) an expansion of the scope of certain licenses from Gilead to the Company relating to certain intellectual property rights regarding anti-CTLA-4 products. The first of these payments was paid on August 2, 2004 through the issuance of 185,622 shares of the Company’s common stock to Gilead. The seven remaining payments will be made on a quarterly basis, commencing on October 1, 2004 and ending on April 3, 2006. If the Company decides to make a quarterly installment payment in shares of its common stock, the number of shares of common stock subject to issuance for any installment will be determined by dividing (x) $1,062,500 (less any cash paid in connection with the installment) by (y) the average of the closing sales prices of the Company’s common stock for each of the trading days during the five-trading-day period ending on (and including) the trading day that is two trading days immediately prior to the applicable date of issuance as publicly reported by NASDAQ. In the event that, during the 60-day period following the applicable date of issuance of such common stock, Gilead sells all of the shares of the Company’s common stock delivered as part of an installment payment under the Gilead License and the proceeds of such sale are less than $1,062,500 (less any cash paid in connection with such installment), the Company must pay the difference to Gilead in cash. If such sale proceeds exceed $1,062,500 (less any cash paid in connection with such installment), Gilead must pay the Company 50% of any such excess in cash. In the event that, during any such 60-day period, Gilead does not sell all of the shares of the Company’s common stock comprising the installment, there will be no such adjustment.

On July 30, 2004, the Company entered into an Assignment and Termination Agreement with Pharma Pacific Pty Ltd. and certain other parties thereto, referred to herein as the Pharma Pacific Agreement. Under the terms of the Pharma Pacific Agreement, the Company agreed to pay Pharma Pacific $1.5 million in exchange for (i) the assignment of certain intellectual property rights to the Company, and (ii) the termination of certain licenses. This payment was made through the issuance of 240,925 shares of the Company’s common stock to Pharma Pacific on August 4, 2004. In the event that, during the 60-day period following the date of issuance of such common stock, Pharma Pacific sells all of the shares of the Company’s common stock delivered as payment under the Pharma Pacific Agreement and the proceeds of such sale are less than $1.5 million, the Company must pay the difference to Pharma Pacific in cash. If such sale proceeds exceed $1.5 million, Pharma Pacific must pay the Company 50% of any such excess in cash. In the event that, during any such 60-day period, Pharma Pacific does not sell all of the shares of the Company’s common stock comprising the installment, there will be no such adjustment.

On August 5, 2004, the Company completed the acquisition of Ability Biomedical (See Note 7 – Acquisition of Ability Biomedical Corporation). Under the terms of the share purchase agreement, the Company made cash payments totaling approximately $593 thousand and issued a total of 731,823 shares of its common stock valued at approximately $4.3 million in exchange for all of Ability Biomedical’s issued and outstanding stock. In the event that, during the 60-day period following an issuance of shares of the Company’s common stock to the Ability Biomedical shareholders in connection with the acquisition, a shareholder sells all of the shares so issued and the proceeds of such sale are less than the amount due to the shareholder under the share purchase agreement, the Company must pay the difference to such shareholder in cash. If such sale proceeds exceed the amount due to the shareholder under the share purchase agreement, the shareholder must pay the Company 50% of any such excess in cash. In the event that, during any such 60-day period, the Ability Biomedical shareholder does not sell all of the shares so issued, there will be no such adjustment.

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

This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which represent our projections, estimates, expectations or beliefs concerning among other things, financial items that relate to management’s future plans or objectives or to our future economic and financial performance. Forward-looking statements involve known and unknown risks and uncertainties and are indicated by words such as “anticipates”, “expects”, “intends”, “believes”, “plans”, “could”, “potential” and similar words and phrases. These risks and uncertainties include, but are not limited to, our early stage of product development, history of operating losses and accumulated deficit, additional financing requirements and access to capital funding, dependence on strategic alliances, government regulation of the biopharmaceutical industry and other risks that may be detailed from time to time in our periodic reports and registration statements filed with the Securities and Exchange Commission. All forward-looking statements included in this Quarterly Report are based on information available to us as of the date hereof, and we do not assume any obligation to update any such forward-looking statements. Our actual results may differ materially from the results discussed in the forward-looking statements. Among the factors that could cause actual results to differ materially are the factors detailed in “Item 5” below. References to our products, business, financial results or financial condition should be considered to refer to us and our subsidiaries unless the context otherwise requires.

Overview

We are a biopharmaceutical company focused on the discovery and development of fully human antibody-based therapeutic products. We believe that our UltiMAb Human Antibody Development System^® enables us to rapidly create and develop fully human antibodies for a wide range of diseases, including cancer, inflammation and autoimmune diseases.

We believe that antibodies are proven candidates for therapeutic products. To date, the United States Food and Drug Administration, or FDA, has approved 17 antibody-based therapeutic products for sale in the United States. In 2003, 15 of these products generated aggregate worldwide sales in excess of $5.0 billion. We intend to participate in this market and, to this end, are developing an expanding pipeline of therapeutic antibody products generated through the use of our proprietary UltiMAb^™ human antibody development technology.

Currently, 17 antibody products derived from our UltiMAb human antibody development technology are in human clinical trials, or have had regulatory applications submitted for such trials. These antibodies are designed to treat a wide range of diseases, such as cancer (including various lymphomas), rheumatoid arthritis and other inflammatory and autoimmune diseases. Five of these antibody products are fully owned by Medarex and its affiliates: MDX-010 (Phase II clinical trials), MDX-060 (Phase II clinical trial), MDX-070 (Phase II clinical trial), MDX-214 (Phase I/II clinical trial) and MDX-1307 (Phase I clinical trial). These fully owned antibody products are being developed for the treatment of various diseases, including cancer, lymphoma and/or HIV. In the second quarter of 2004, we submitted a Special Protocol Assessment to the FDA for a pivotal program for MDX-010 in combination with gp100 vaccine and filed the manufacturing data necessary to initiate this pivotal program. Subject to final discussions with the FDA and the completion of study commencement procedures such as Institutional Review Board reviews, we expect to begin enrolling patients in this pivotal program during the third quarter of 2004. One antibody for autoimmune disease, MDX-018 (Phase I/II clinical trial), is being jointly developed with our licensing partner, Genmab A/S, and four are being developed separately by Genmab: HuMax^™-CD4 (Phase II clinical trials) for cutaneous T-cell lymphoma, HuMax-IL15/AMG714 (Phase II clinical trial) for rheumatoid arthritis, HuMax-EGFr (Phase I/II clinical trial) for head and neck cancer and HuMax-CD20 (Phase I/II clinical trial) for lymphomas. Additionally, our licensing partners, including Novartis Pharma AG and Centocor, Inc. (a subsidiary of Johnson & Johnson), among others, are developing a total of seven antibody products, for inflammatory and/or autoimmune diseases

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and cancer that are currently in early clinical trials. We and our partners also have a number of product candidates in preclinical development. The preceding information regarding the clinical status of antibody products is based on our and our partners’ public disclosure and other publicly available information.

Our revenue is principally derived through the licensing of our fully human antibody technology to pharmaceutical and biotechnology companies. The terms of these license agreements typically include potential license fees and a series of potential milestone payments commencing upon the initiation of clinical trials and continuing through commercialization. These payments may total $7 million to $10 million per product if the antibody receives approval from the FDA and equivalent foreign agencies. We are also entitled to receive royalties on product sales. Additional revenue may be earned from the sales to, and in some cases, the manufacturing of antibodies for our partners, as well as from government grants.

Our most significant costs on an annual basis are research and development expenses and general and administrative expenses. Research and development expenses represent those costs which support the advancement of our product pipeline and primarily consist of personnel costs, facilities (including depreciation), research and laboratory supplies, funding of outside research, license and technology access fees, expenses related to antibody manufacturing and clinical trial expenses. We believe that continued investment in research and development is critical to attaining our strategic objectives. General and administrative expenses consist primarily of personnel expenses for executive, finance, legal and administrative personnel, professional fees and other general corporate expenses. We may be required to add personnel in the future and incur additional costs as we expand our business activities.

We have a history of operating losses and may not achieve profitability. As of June 30, 2004, we had an accumulated deficit of approximately $487.4 million. Over the next several years, we expect to incur substantial expenses as we continue to identify, develop and manufacture our potential products, invest in research and move forward with our product development. Our commitment of resources to research and the continued development of our product candidates will require substantial additional funds. Our operating expenses may also increase as we invest in research or acquire additional technologies, as additional potential products are selected as clinical candidates for further development and as some of our earlier stage product candidates move into later stage clinical development. In addition, we may incur significant milestone payment obligations as our products progress towards commercialization. In the absence of substantial revenues from new corporate collaborations or other sources, we will incur substantial operating losses and may be required to delay, reduce or eliminate certain of our research and development programs.

Critical Accounting Policies

The methods, estimates and judgments we use in applying our most critical accounting policies have a significant impact on the results we report in our consolidated financial statements. We evaluate our estimates and judgments on an on-going basis. We base our estimates on historical experience and on assumptions that we believe to be reasonable under the circumstances. Our experience and assumptions form the basis for our judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may vary from what we anticipate and different assumptions or estimates about the future could materially change our reported results. We believe the following accounting policies are the most critical to us, in that they are important to the portrayal of our financial statements and they require our most difficult, subjective or complex judgments in the preparation of our consolidated financial statements:

Revenue Recognition

We receive payments from our customers and partners for the sale of antibodies, for licenses to our proprietary technology, for product development services and from the achievement of product development

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milestones. These payments are generally non-refundable and are reported as deferred revenue until they are recognizable as revenue. We follow the following principles in recognizing revenue:

Investments

Our investment policy calls for investments in fixed income high grade securities such as U.S. corporate debt securities, U.S. treasury obligations and money market funds for which we believe there is not a significant risk of loss. Our primary objectives for our investment portfolio are liquidity and safety of principal. Investments are made to achieve the highest rate of return consistent with these two objectives. However, in the course of our business, we have made and may continue to make investments in companies (both public and private) as part of our strategic collaborations. Investments in companies whose securities are publicly traded (other than Genmab) are classified as marketable securities on our consolidated balance sheets. The fair market value of investments in our partners whose securities are publicly traded was approximately 1.5% and 1.0% of total marketable securities as of December 31, 2003 and June 30, 2004, respectively.

Under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, our marketable securities are classified as available-for-sale securities and are carried at fair value. Marketable securities will include those securities of debt and publicly traded equity securities accounted for under the cost method. These securities trade on listed exchanges; therefore, fair value is readily available. These securities are also subject to an impairment charge when we believe an investment has experienced a decline in value that is other than temporary. Under our accounting policy, a decline in the value of our investments is deemed to be other than temporary and such investments are generally considered to be impaired if their value is less than our cost basis for more than six (6) months, or some other applicable period in light of the facts and circumstances surrounding the investments.

In addition, in connection with our collaborative partnering business, we sometimes make strategic investments in the securities of companies that are privately held. Investments in our partners whose equity is not publicly traded are classified in separate line items in our consolidated balance sheet entitled “Investments in IDM” and “Investments in, and advances to, other partners” and were approximately $59.3 million as of June 30, 2004. These securities are carried at original investment cost. Because these securities are not listed on a financial exchange, the value of these investments is inherently more difficult to estimate than investments in

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public companies. We value these investments by using information acquired from industry trends, the management of these companies, financial statements, and other external sources. Specifically, our determination of any potential impairment of the value of privately held securities includes an analysis of the following for each company on a periodic basis: review of interim and year-end financial statements, cash position and overall rate of cash used to support operations, the progress and development of technology and product platform, the per share value of subsequent financing and potential strategic alternatives. Based on the information acquired through these sources, we record an investment impairment charge when we believe an investment has experienced a decline in value that is other than temporary.

Future adverse changes in market conditions or adverse changes in financial condition and/or operating results of the companies in which we invest that may not be reflected in an investment’s current carrying value may also require an impairment charge in the future.

Valuation of Long-Lived and Intangible Assets

We assess the impairment of identifiable intangible assets and long-lived assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important that could trigger an impairment review include the following:

When we determine that the carrying value of intangible assets or long-lived assets are not recoverable based upon the existence of one or more of the above indicators of impairment, we may be required to record impairment charges for these assets that have not been previously recorded.

Acquired In-Process Technology

Acquired In-Process Technology expense is determined based on an analysis using risk-adjusted cash flows expected to be generated by products that may result from in-process technologies which have been acquired. This analysis includes forecasting future cash flows that are expected to result from the progress made on each in-process project prior to the acquisition date. Cash flows are estimated by first forecasting, on a product-by-product basis, net revenues expected from the sales of the first generation of each in-process project and risk adjusting these revenues to reflect the probability of advancing to the next stage of the FDA approval process. The forecast data in the analysis is based on internal product forecast information maintained by us in the ordinary course of business. The inputs used in analyzing Acquired In-Process Technology is based on assumptions, which we believe to be reasonable but which are inherently uncertain and unpredictable. These assumptions may be incomplete or inaccurate, and unanticipated events and circumstances may occur. Appropriate operating expenses are deducted from forecasted net revenues on a product-by-product basis to establish a forecast of net returns on the completed portion of the in-process technology. Finally, net returns are discounted to a present value using discount rates that incorporate the weighted average cost of capital relative to the biotech industry and our company as well as product specific risks associated with the acquired in-process research and development products. The product specific risk factors include the product’s phase of development, type of antibody under development, likelihood of regulatory approval, manufacturing process capability, scientific rationale, preclinical safety and efficacy data, target product profile, and development plan. In addition to the product specific risk factors, a discount rate is used for the valuation, which represents a

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considerable risk premium to our weighted average cost of capital. The valuations used to estimate Acquired In-Process Technology require us to use significant estimates and assumptions that if changed, may result in a different valuation for Acquired In-Process Technology.

Results of Operations

Three months ended June 30, 2003 and 2004

Contract and License Revenues

Contract and license revenues totaled $1.5 million and $1.2 million for the three month periods ended June 30, 2003 and 2004, respectively. Contract and license revenues for the three month period ended June 30, 2004 decreased by $0.3 million or 18% as compared to the three month period ended June 30, 2003. This decrease relates primarily to decreased revenue of $0.4 million from Eli Lilly and Company and $0.3 million from Incyte Genomics, Inc., partially offset by increased revenues of $0.5 million from Bristol-Myers Squibb Co. Because contract and license revenues depend to a large extent on the product development efforts of our partners and licensees, our period-to-period contract and license revenues can fluctuate significantly and are inherently difficult to predict.

Sales, Contract and License Revenues from Genmab

Sales, contract and license revenues from Genmab were $0.8 million and $0.7 million for the three month periods ended June 30, 2003 and 2004, respectively. Sales, contract and license revenues from Genmab for the three month period ended June 30, 2004 decreased by $0.1 million or 9% as compared to the three month period ended June 30, 2003. This decrease is primarily the result of a decrease in antibody exclusive licenses granted to Genmab in the second quarter of 2004 as compared to the second quarter of 2003.

Research and Development Expenses

Research and development expenses for our products in development were $23.8 million and $30.1 million for the three month periods ended June 30, 2003 and June 30, 2004, respectively. Research and development expenses for the three month period ended June 30, 2004 increased by $6.3 million, or 27% as compared to the three month period ended June 30, 2003. Historically, due to the relatively small number of our products in clinical trials, we have not accounted for our research and development expenses on a project-by-project basis and, therefore, we do not provide a breakdown of such historical information in that format. We have, historically, tracked our costs in the categories discussed below, namely, “research” and “product development” and by the types of costs as outlined below. Our research costs consist of costs associated with the breeding, care and continued development of our HuMAb-Mouse and KM-Mouse, as well as costs associated with research and testing of our product candidates prior to reaching the preclinical stage. Such research costs primarily include personnel costs, facilities (including depreciation), research supplies, funding of outside research and license and technology access fees. Our product development costs consist of costs of preclinical development (including manufacturing) and conducting and administering clinical trials. Such product development costs also include personnel costs, facilities (including depreciation), supply expense related to antibody manufacturing and clinical trial expenses.

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The following table sets forth a breakdown of our research and development expenses by those associated with research and those associated with product development for the periods indicated.

Research Costs

Research costs for the three month period ended June 30, 2004 decreased by $0.8 million, or 8% as compared to the three month period ended June 30, 2003. The decrease in research costs primarily relates to the following:

Product Development Costs

Product development costs for the three month period ended June 30, 2004 increased by $7.2 million, or 51% as compared to the three month period ended June 30, 2003. The increase in product development costs primarily relates to the following:

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We expect product development costs to increase in the future as more of our products enter clinical trials. In addition, we may be obligated to make milestone payments on certain of our products as they progress through the clinical trial process.

Completion of clinical trials may take several years or more. The length of time varies according to the type, complexity and intended use of the product candidate. We estimate that clinical trials of the type we generally conduct are typically completed over the following periods:

The duration and cost of clinical trials may vary significantly over the life of a particular project as a result of, among other things, the following factors:

We continue to explore new collaborative arrangements that may affect future spending for research and development. As part of our partnering strategy, a significant portion of the research and development expenses incurred in connection with products using our technology is expected to be borne by our partners. We believe this allows us to participate in the research and development of substantially more potential product candidates than we could develop on our own if we bore the entire cost of development. Products using our technology are currently in various stages of development from preclinical to Phase II. The successful development of these product candidates is dependent on many factors, including among other things, the efforts of our partners, unforeseen delays in, or expenditures relating to, preclinical development, clinical testing, manufacturing or regulatory approval, failure to receive market acceptance, the emergence of competitive products and the inability to produce or market our products due to third-party proprietary rights.

General and Administrative Expenses

General and administrative expenses include compensation, professional services, consulting, travel and facilities (including depreciation) and other expenses related to legal, business development, finance, information systems and investor relations. General and administrative expenses totaled $5.2 million and $5.5 million for the three month periods ended June 30, 2003 and 2004, respectively. General and administrative expenses increased by $0.3 million for the three month period ended June 30, 2004, or 6%, as compared to the three month period ended June 30, 2003. This increase is primarily attributable to higher insurance costs of $0.2 million and increased legal costs of $0.1 million. General and administrative expenses are expected to increase in the future as our products are developed and we expand our business activities.

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Equity in Net Loss of Affiliate

Equity in net loss of affiliate represents our share of Genmab’s net loss for the three month periods ended June 30, 2003 and 2004. Genmab is an affiliated company and is accounted for using the equity method of accounting. The recognition of our share of Genmab’s net losses reduces the carrying value, or basis, of our investment in Genmab. We expect that during the second half of 2004 the remaining basis of our investment in Genmab will be reduced to zero and, accordingly, recognition of our share of Genmab’s net losses will be suspended.

Equity in net loss of affiliate was $3.2 million and $5.6 million for the three month periods ended June 30, 2003 and 2004, respectively. Equity in net loss of affiliate for the three month period ended June 30, 2004 increased by $2.4 million, or 76%, as compared to the three month period ended June 30, 2003. This increase reflects an increase in Genmab’s net loss as a result of its expanded research and development efforts.

Interest and Other Income

Interest and other income consists primarily of interest earned from our cash, cash equivalents and marketable securities. Interest and other income was $3.1 million and $1.9 million for the three month periods ended June 30, 2003 and 2004, respectively. Interest and other income for the three month period ended June 30, 2004 decreased by $1.2 million, or 39% as compared to the three month period ended June 30, 2003. The decrease reflects lower returns on our investment portfolio. We anticipate lower interest and other income in the future as we continue to fund our operations and capital expenditures from our cash reserves.

Interest Expense

Interest expense was primarily related to interest and amortization of issuance costs on (i) our 4.25% Convertible Senior Notes issued in July 2003 or the 4.25% Notes; (ii) our 4.50% Convertible Subordinated Notes issued in June 2001 or the 4.50% Notes; and (iii) our 2.25% Convertible Senior Notes issued in May, 2004 or the 2.25% Notes. Interest expense was $2.3 million and $4.0 million for the three month periods ended June 30, 2003 and 2004, respectively. Interest expense for the three month period ended June 30, 2004 increased by $1.7 million, or 71%, as compared to the three month period ended June 30, 2003, reflecting the addition of interest expense on the 4.25% Notes and the 2.25% Notes. The 4.25% Notes are due in August 2010 and interest is payable semi-annually on February 15 and August 15 of each year. The 2.25% Notes are due in May 2011 and interest is payable semi-annually on May 15 and November 15 of each year. We expect interest expense to decrease in the future as a result of the redemption and repurchase of the 4.50% Notes (see further explanation under the section entitled Other Liquidity Matters).

Net Loss on Extinguishment of Debt

In connection with a private placement of $150.0 million of 2.25% Notes (see further discussion under the section entitled Liquidity and Capital Resources), we repurchased $65.6 million in aggregate principal amount of our 4.50% Notes for cancellation. As a result of this repurchase and cancellation we recorded a loss on the early extinguishment of debt of approximately $2.2 million for the three month period ended June 30, 2004.

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Six months ended June 30, 2003 and 2004

Contract and License Revenues

Contract and license revenues totaled $3.7 million and $2.3 million for the six month periods ended June 30, 2003 and 2004, respectively. Contract and license revenues for the six month period ended June 30, 2004 decreased by $1.4 million or 37% as compared to the six month period ended June 30, 2003. This decrease relates primarily to decreased revenue of $0.7 million from Eli Lilly, $0.5 million from Amgen, Inc. and $0.4 million from Genesto A/S. Because contract and license revenues depend to a large extent on the product development efforts of our partners and licensees, our period-to-period contract and license revenues can fluctuate significantly and are inherently difficult to predict.

Sales, Contract and License Revenues from Genmab

Sales, contract and license revenues from Genmab were $2.5 million and $1.5 million for the six month periods ended June 30, 2003 and 2004, respectively. Sales, contract and license revenues from Genmab for the six month period ended June 30, 2004 decreased by $1.0 million, or 40%, as compared to the six month period ended June 30, 2003. This decrease is primarily the result of a decrease in antibody exclusive licenses granted to Genmab in the first half of 2004 as compared to the first half of 2003.

Research and Development Expenses

Research and development expenses for our products in development were $47.3 million and $53.1 million for the six month periods ended June, 2003 and 2004, respectively. Research and development expenses for the six month period ended June 30, 2004 increased by $5.8 million, or 12%, as compared to the six month period ended June 30, 2003. Historically, due to the relatively small number of our products in clinical trials, we have not accounted for our research and development expenses on a project-by-project basis and, therefore, we do not provide a breakdown of such historical information in that format. We have, historically, tracked our costs in the categories discussed below: research and product development and by the types of costs as outlined below. We separate research and development expenditures on the basis of amounts associated with research and amounts associated with product development. Our research costs consist of costs associated with the breeding, care and continued development of our HuMAb-Mouse and KM-Mouse, as well as costs associated with research and testing of our product candidates prior to reaching the preclinical stage. Such research costs primarily include personnel costs, facilities (including depreciation), research supplies, funding of outside research and license and technology access fees. Our product development costs consist of costs of preclinical development (including manufacturing) and conducting and administering clinical trials. Such product development costs also include personnel costs, facilities (including depreciation), supply expense related to antibody manufacturing and clinical trial expenses.

The following table sets forth a breakdown of our research and development expenses by those associated with research and those associated with product development for the periods indicated.

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Research Costs

Research costs for the six month period ended June 30, 2004 decreased by $0.8 million, or 4% as compared to the six month period ended June 30, 2003. The decrease in research costs primarily relates to the following:

Product Development Costs

Product development costs for the six month period ended June 30, 2004 increased by $6.6 million, or 23% as compared to the six month period ended June 30, 2003. The increase in product development costs primarily relates to the following:

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We expect product development costs to increase in the future as more of our products enter clinical trials. In addition, we may be obligated to make milestone payments on certain of our products as they progress through the clinical trial process.

General and Administrative Expenses

General and administrative expenses include compensation, professional services, consulting, travel and facilities (including depreciation) and other expenses related to legal, business development, finance, information systems and investor relations. General and administrative expenses totaled $10.9 million and $11.3 million for the six month periods ended June 30, 2003 and 2004, respectively. General and administrative expenses increased by $0.4 million for the six month period ended June 30, 2004, or 4% as compared to the six month period ended June 30, 2003. This increase is primarily attributable to higher insurance costs of $0.4 million and increased facility costs of $0.1 million. General and administrative expenses are expected to increase in the future as our products are developed and we expand our business activities.

Equity in Net Loss of Affiliate

Equity in net loss of affiliate represents our share of Genmab’s net loss for the six month periods ended June 30, 2003 and 2004. Genmab is an affiliated company and is accounted for using the equity method of accounting. The recognition of our share of Genmab’s net losses reduces the carrying value, or basis, of our investment in Genmab. We expect that during the second half of 2004 the remaining basis of our investment in Genmab will be reduced to zero and, accordingly, recognition of our share of Genmab’s net losses will be suspended.

Equity in net loss of affiliate was $6.9 million and $10.4 million for the six month periods ended June 30, 2003 and 2004, respectively. Equity in net loss of affiliate for the six month period ended June 30, 2004 increased by $3.5 million or 49% as compared to the six month period ended June 30, 2003. This increase reflects an increase in Genmab’s net loss as a result of its expanded research and development efforts.

Interest and Other Income

Interest and other income consists primarily of interest earned from our cash, cash equivalents and marketable securities. Interest and other income was $5.7 million and $5.9 million for the six month periods ended June 30, 2003 and 2004, respectively. Interest and other income for the six month period ended June 30, 2004 increased by $0.2 million, or 3% as compared to the six month period ended June 30, 2003. Included in interest and other income for the six month period ended June 30, 2004 is a gain on the sale of common stock of Protein Design Labs, Inc. of approximately $1.7 million offset by an impairment loss on investments in certain of our partners of $0.3 million. Excluding the impact of this gain and this impairment loss, interest and other income would have decreased by $1.2 million, or 21%, as compared to the six month period ended June 30, 2003. The decrease reflects lower returns on our investment portfolio. We anticipate lower interest and other income in the future as we continue to fund our operations and capital expenditures from our cash reserves.

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Additional Payments Related to Asset Acquisitions

Additional payments related to asset acquisitions of $0.1 million for the six month period ended June 30, 2003 represents additional purchase payments to Northwest Biotherapeutics, Inc. Pursuant to the terms of the agreement, under certain circumstances we were required to pay an amount equal to the difference between the proceeds received by Northwest Biotherapeutics from the sale of any shares of our common stock delivered as payment of any installment of the purchase price of the assets and the total amount of the purchase price installment due under the agreement. No similar payments were made in the six month period ended June 30, 2004.

Interest Expense

Interest expense was primarily related to interest and amortization of issuance costs on the 4.25% Notes, the 4.50% Notes and the 2.25% Notes. Interest expense was $4.6 million and $7.6 million for the six month periods ended June 30, 2003 and 2004, respectively. Interest expense for the six month period ended June 30, 2004 increased by $3.0 million, or 64% as compared to the six month period ended June 30, 2003 reflecting the addition of interest expense on our 4.25% Notes which were issued in July 2003 and our 2.25% Notes issued in May 2004. The 4.25% Notes are due in August 2010 and interest is payable semi-annually on February 15 and August 15 of each year. The 2.25% Notes are due in May 2011 and interest is payable semi-annually on May 15 and November 15 of each year. We expect interest expense to decrease in the future as a result of the redemption and repurchase of the 4.50% Notes (see further explanation under the section entitled Other Liquidity Matters.

Net Loss on Extinguishment of Debt

In connection with a private placement of $150.0 million of 2.25% Notes (see further discussion under the section entitled Liquidity and Capital Resources), we repurchased $65.6 million in aggregate principal amount of our 4.50% Notes for cancellation. As a result of this repurchase and cancellation we recorded a loss on the early extinguishment of debt of approximately $2.2 million for the three month period ended June 30, 2004.

In January 2004, we and certain holders of our 4.50% Notes completed in a limited number of transactions, an exchange and cancellation of $33.0 million in aggregate principal amount of the 4.50% Notes, for the issuance of $21.986 million in aggregate principal of a new series of 4.25% Convertible Senior Notes due August 15, 2010. As a result of this exchange and cancellation, our total convertible debt was reduced by $11.014 million and we recorded a gain of approximately $0.3 million for the six month period ended June 30, 2004. We calculated the gain in accordance with EITF 96-19, Debtor’s Accounting for a Modification or Exchange of Debt Instruments. EITF 96-19 requires that the gain on the early extinguishment of debt be computed using the fair value of the newly issued convertible debt which, at the time of the debt exchange, was trading at a premium to the principal amount of the notes. We classified the premium associated with the newly issued 4.25% notes of approximately $10.2 million as capital in excess of par value in accordance with APB 14, Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants.

Cumulative Effect of a Change in Accounting Principle

Cumulative effect of a change in accounting principle for the six month period ended June 30, 2003 was $0.8 million. Effective January 1, 2003, we changed our method of accounting for asset retirement obligations in accordance with SFAS No. 143, Accounting for Asset Retirement Obligations. Previously, we were not required to recognize amounts related to asset retirement obligations. Under SFAS No. 143, we now recognize

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asset retirement obligations in the period in which they are incurred if a reasonable estimate of a fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. The adoption of SFAS No. 143 resulted in an increase in net property, buildings and equipment of approximately $1.4 million, recognition of an asset retirement obligation liability of approximately $2.2 million and a cumulative effect of a change in accounting principle of approximately $0.8 million.

Liquidity and Capital Resources

We require cash to fund our operations, to make capital expenditures and strategic investments, and to pay debt service on our convertible notes. Since inception, we have financed our operations through the sale of our securities in public and private placements, sales of our products for research purposes, development and manufacturing services, technology transfer and license fees and milestone payments. We expect to continue to fund our cash requirements from these sources in the future.

At June 30, 2004, we had approximately $398.5 million in cash, cash equivalents, marketable securities and segregated cash. We primarily invest our cash equivalents and marketable securities in highly liquid, interest-bearing, investment grade and government securities in order to preserve principal.

Cash Used in Operating Activities

Cash used in operating activities was $43.5 million and $50.4 million for the six month periods ended June 30, 2003 and 2004, respectively. This reflects an increase of $6.9 million for the six month period ended June 30, 2004 as compared to the six month period ended June 30, 2003. The increase is primarily due to higher research and development expenses as well as a decrease in cash received from partners. The increase in research and development expenses resulted primarily from higher personnel costs, expenses related to our facilities, third-party research and contract manufacturing costs, and the costs of clinical trials. All of these costs were higher as result of our increased clinical trial and product development activities. The decrease in cash received from our partners is a direct result of decreased contract and license revenue and decreased sales, contract and license revenues from Genmab. As previously indicated, revenues can fluctuate significantly since they depend, in large part, on the product development efforts of our partners and licensees.

We have incurred and will continue to incur significant costs in the area of research and development, including preclinical and clinical trials, as our products are developed. We plan to spend significant amounts to progress our current products through the clinical trial and commercialization process as well as to develop additional product candidates on our own or with partners. As our products progress through the clinical trial process, we may be obligated to make significant milestone payments on certain of our products. We also expect to incur future facility costs as a result of our continued capital expansion, renovations and replacements, but at a reduced rate. To a lesser extent, we expect our general and administrative costs to increase as we expand our administrative and business development activities. Furthermore, we expect our investment income to decrease as we fund our future operations and capital expenditures from our cash reserves. We anticipate that our operating expenditures may be partially offset by revenues from partners for license fees, milestone payments, development and manufacturing services.

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Cash Provided by (Used in) Investing Activities

Net cash provided by investing activities was $78.9 million for the six month period ended June 30, 2003 compared to net cash used in investing activities of $51.2 million for the six month period ended June 30, 2004. The overall increase in cash used in investing activities was primarily the result of the following factors:

Cash Provided by Financing Activities

Net cash provided by financing activities was $0.3 million and $78.4 million for the six month periods ended June 30, 2003 and 2004, respectively. Cash provided by financing activities for the six month period ended June 30, 2003 resulted from the proceeds received from purchases under our Employee Stock Purchase Plan (ESPP) offset, in part, by principal payments on equipment leases. Cash provided by financing activities for the six month period ended June 30, 2004 resulted primarily from the net proceeds of approximately $145.2 million received from the private placement of $150.0 million of 2.25% notes offset, in part, by cash used of approximately $66.8 million to repurchase a portion of our 4.50% notes for cancellation. The private placement of our 2.25% Convertible Senior Notes and the repurchase and cancellation of a portion of our 4.50% Convertible Subordinated Notes are discussed in further detail the section entitled Other Liquidity Matters.

Other Liquidity Matters

In connection with our merger with Essex Medical Products in 1987, we are committed to pay to Essex Chemical Corporation, or Essex 20% of our net after-tax income until a total of $1.0 million has been paid, contingent upon the occurrence of certain events. As the result of our net income in 2000 we accrued $0.7 million payable to Essex, which remains accrued at June 30, 2004. At our option, this obligation may be satisfied by the payment of shares of our common stock having a fair market value equal to the amount owed, provided such shares are registered for sale with the Securities and Exchange Commission.

Our wholly-owned subsidiary Celldex Therapeutics, Inc. has filed a registration statement with the Securities and Exchange Commission related to a proposed public offering of a portion of its common stock. As part of this transaction, we have assigned or licensed to Celldex certain intellectual property related to our vaccine technology, including the rights to MDX-1307, one of our product candidates for the treatment of cancer, as well as the IND associated with this product which became effective in February 2004. If the public offering is completed, we anticipate that we will continue to hold approximately 75% of the outstanding shares of common stock of Celldex. We cannot assure you that this transaction will be consummated.

On May 3, 2004, we completed a private placement pursuant to Rule 144A of the Securities Act of 1933, as amended, of $150.0 million of 2.25% Convertible Senior Notes due May 15, 2011 to qualified institutional investors. The 2.25% notes are initially convertible into shares of our common stock at the rate of 72.9129 per each $1,000 principal amount of the 2.25% notes, which is equivalent to an initial conversion price of approximately $13.72 per share, subject to anti-dilution adjustments.

We will pay interest on the 2.25% notes on May 15 and November 15 of each year beginning on November 15, 2004. We received net proceeds from the private placement of approximately $145.2 million (after deducting the initial purchasers’ discounts and estimated offering expenses).

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Noteholders have the option, subject to certain conditions, to require us to repurchase the 2.25% notes in the event of a change in control at a price equal to 100% of the principal amount of the notes plus accrued and unpaid interest to the date of repurchase.

Concurrent with this private placement, we repurchased $65.6 million in aggregate principal amount of our 4.50% notes for cancellation. On July 1, 2004, we completed the redemption of all of our remaining outstanding 4.50% Notes. The redemption price was 101.8% of the approximately $76.4 million aggregate principal amount of the notes redeemed or approximately $77.7 million, plus accrued and unpaid interest of approximately $1.7 million through June 30, 2004.

On July 13, 2004, we entered into an amendment to Collaboration and License Agreement with Gilead Sciences, Inc. (the successor in interest to NeXstar Pharmaceuticals, Inc.), referred to herein as the Gilead Amendment. Under the terms of the Gilead Amendment, we agreed to pay Gilead a total of $8.5 million in eight equal installments of $1,062,500, payable at the our election, in cash, registered shares of our common stock or a combination thereof, in exchange for (i) a reduction of certain future royalty payment obligations, payable by us to Gilead, and (ii) an expansion of the scope of certain licenses from Gilead to us relating to certain intellectual property rights regarding anti-CTLA-4 products. The first of these payments was paid on August 2, 2004 through the issuance of 185,622 shares of our common stock to Gilead. The seven remaining payments will be made on a quarterly basis, commencing on October 1, 2004 and ending on April 3, 2006. If we decide to make a quarterly installment payment in shares of our common stock, the number of shares of our common stock subject to issuance for any installment will be determined by dividing (x) $1,062,500 (less any cash paid in connection with the installment) by (y) the average of the closing sales prices of our common stock for each of the trading days during the five-trading-day period ending on (and including) the trading day that is two trading days immediately prior to the applicable date of issuance as publicly reported by NASDAQ. In the event that, during the 60-day period following the applicable date of issuance of such common stock, Gilead sells all of the shares of our common stock delivered as part of an installment payment under the Gilead License and the proceeds of such sale are less than $1,062,500 (less any cash paid in connection with such installment), we must pay the difference to Gilead in cash. If such sale proceeds exceed $1,062,500 (less any cash paid in connection with such installment), Gilead must pay us 50% of any such excess in cash. In the event that, during any such 60-day period, Gilead does not sell all of the shares of our common stock comprising the installment, there will be no such adjustment.

On July 30, 2004, we entered into an Assignment and Termination Agreement with Pharma Pacific Pty Ltd. and certain other parties thereto, referred to herein as the Pharma Pacific Agreement. Under the terms of the Pharma Pacific Agreement, we agreed to pay Pharma Pacific $1.5 million in exchange for (i) the assignment of certain intellectual property rights to us, and (ii) the termination of certain licenses. This payment was made through the issuance of 240,925 shares of our common stock to Pharma Pacific on August 4, 2004. In the event that, during the 60-day period following the date of issuance of such common stock, Pharma Pacific sells all of the shares of our common stock delivered as payment under the Pharma Pacific Agreement and the proceeds of such sale are less than $1.5 million, we must pay the difference to Pharma Pacific in cash. If such sale proceeds exceed $1.5 million, Pharma Pacific must pay us 50% of any such excess in cash. In the event that, during any such 60-day period, Pharma Pacific does not sell all of the shares of our common stock comprising the installment, there will be no such adjustment.

On August 5, 2004, we completed the acquisition of Ability Biomedical Corporation, a privately held Canadian biotechnology company including Ability Biomedical’s intellectual property related to IP-10. IP-10, also known as CXCL 10, is a protein believed to be associated with a variety of immune disorders, including multiple sclerosis, rheumatoid arthritis, inflammatory bowel disease, chronic obstructive pulmonary disease and type I diabetes. We are currently investigating MDX-1100, a fully human antibody that targets IP-10, in preclinical studies, and we expect to file an Investigational New Drug, or IND, application with the FDA for MDX-1100 in the first half of 2005.

Under the terms of the share purchase agreement, we made cash payments totaling approximately $593 thousand and issued a total of 731,823 shares of our common stock valued at approximately $4.3 million in exchange for all of Ability Biomedical’s issued and outstanding stock. In the event that, during the 60-day period following an issuance of shares of our common stock to the Ability Biomedical shareholders in connection with the acquisition, a shareholder sells all of the shares so issued and the proceeds of such sale are less than the amount due to the shareholder under the share purchase agreement, we must pay the difference to such shareholder in cash. If such sale proceeds exceed the amount due to the shareholder under the share purchase agreement, the shareholder must pay us 50% of any such excess in cash. In the event that, during any such 60-day period, the Ability Biomedical shareholder does not sell all of the shares so issued, there will be no such adjustment. Upon the achievement of certain development milestones with respect to our anti-IP-10 antibody program, but no later than September 4, 2007, we may be required to pay Ability Biomedical shareholders an additional amount of approximately $3.68 million in cash and/or common stock, subject to fluctuations in currency exchange rates. In lieu of such additional payment, we also have the option to revert to the original January 2003 joint collaboration agreement with Ability whereby each party would be responsible for 50% of the costs.

Financial Uncertainties Related to Potential Future Milestone Payments

Effective September 4, 2002, we entered into a Collaboration and License Agreement with Kirin Brewery Co., Ltd., which provides for us to exchange with Kirin certain cross-licenses for each other’s technology for the development and commercialization of human antibody products. Pursuant to a letter of intent that was superceded by the Collaboration and License Agreement, we and Kirin developed the KM-Mouse^®, a unique crossbred mouse which combines the traits of our HuMAb-Mouse^® with Kirin’s TC Mouse^™. Under the Collaboration and License Agreement, we are exchanging cross-licenses with Kirin with respect to the KM-Mouse and other antibody-generating mice. In addition, certain of the cross-licenses granted under the Collaboration and License Agreement are subject to license, milestone and royalty payments by one party to the other.

Through June 30, 2004, we have not made any milestone payments to Kirin. Based on a total of three products we are developing which use or, we believe may use, Kirin technology that (i) are currently in clinical trials, or (ii) we anticipate may enter clinical trials through the end of 2005, we may be required to make milestone payments to Kirin aggregating up to approximately $12.75 million with respect to such products, or a maximum of approximately $4.25 million per product. Our future milestone payment obligations to Kirin may or may not be triggered, and may vary in size, depending on a number of variables, almost all of which are currently unknown, including the following:

We have also entered into a number of other agreements that contain licenses of third-party technology which may be used together with our own platform technologies for the generation, development and/or manufacture of our antibody products. In addition, we have entered into other third-party agreements that contain licenses associated with antibody products that target specific antigens. Many of these agreements contain milestone payments that are due with respect to products using/targeting the licensed technology/antigen only if and when certain specified pre-commercialization events occur. Not all of our

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products currently under development trigger such milestone payments. Through June 30, 2004, we have made no milestone payments under these agreements. In addition, under the agreements we currently have in place (other than with Kirin), based on a total of five products we are developing for which milestones are potentially due and that (i) are now in clinical trials, or (ii) which we anticipate may enter clinical trials before the end of 2005, we may be obligated to make future milestone payments aggregating up to approximately $30.625 million with respect to such products. In general, potential milestone payments for our antibody products may or may not be triggered under these licenses, and may vary in size, depending on a number of variables, almost all of which are currently uncertain. Typically, the events that trigger these payments per product include:

In addition, the licenses above may trigger royalty payments in connection with the commercialization of certain of our products. To date, we have not made any royalty payments on sales of our products and believe we are at least a few years away from selling any products that would require us to make any such royalty payments. Whether we will be obligated to make milestone or royalty payments in the future is subject to the success of our product development efforts and, accordingly, is inherently uncertain.

Future Liquidity Resources

Our current sources of liquidity are cash, cash equivalents and marketable securities, interest and dividends earned on such cash, cash equivalents and marketable securities, contract and licensing revenue and sales of our products for research. We believe that such sources of liquidity will be sufficient to meet our operating, debt service, and capital requirements for at least the next 24 months; however, this 24-month period assumes the use of a significant portion of the approximately $147.0 million and/or the $150.0 million required to meet our repayment obligations with respect to our convertible notes due on August 15, 2010 and May 15 2011, respectively. To the extent our convertible notes are converted into shares of our common stock on or before their maturity dates, we will have use of that portion of the notes so converted to fund our on-going operations. In any event, we will require additional financing within this time frame and may raise funds through public or private financings, line of credit arrangements, collaborative relationships and/or other methods. The use of cash on hand or other financial alternatives will depend on several factors including, but not limited to, the future success of our products in clinical development, the prevailing interest rate environment, and access to the capital markets. We can not assure you that we will be able to raise such additional funds. We may be unable to raise sufficient funds to complete development of any of our product candidates, to continue operations or to repay our debt obligations upon maturity. As a result, we may face delay, reduction or elimination of research and development programs or preclinical or clinical trials, in which case our business, financial condition or results of operations may be materially harmed.

Recently Issued Accounting Pronouncements

In January 2003, the FASB issued Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an interpretation of ARB 51.” The primary objectives of this interpretation are to provide guidance on the identification of entities for which control is achieved through means other than through voting rights (“variable interest entities”) and how to determine when and which business enterprise (the “primary beneficiary”) should consolidate the variable interest entity. This new model for consolidation applies to an

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entity in which either (i) the equity investors (if any) do not have a controlling financial interest; or (ii) the equity investment at risk is insufficient to finance that entity’s activities without receiving additional subordinated financial support from other parties. In addition, FIN 46 requires that the primary beneficiary, as well as all other enterprises with a significant variable interest in a variable interest entity, make additional disclosures. Certain disclosure requirements of FIN 46 were effective for financial statements issued after January 31, 2003.

In December 2003, the FASB issued FIN No. 46 (revised December 2003), “Consolidation of Variable Interest Entities” (“FIN 46-R”) to address certain FIN 46 implementation issues. The effective dates and impact of FIN 46 and FIN 46-R are as follows:

(i) Special purpose entities (“SPEs”) created prior to February 1, 2003. The adoption of the provisions applicable to SPEs created prior to February 1, 2003 had no impact on our financial statements.

(ii) Non-SPEs created prior to February 1, 2003. The adoption of the provisions applicable to Non-SPEs create prior to February 1, 2003 had no impact on our financial statements.

(iii) All entities, regardless of whether a SPE, that were created subsequent to January 31, 2003. The provisions of FIN 46 were applicable for variable interests in entities obtained after January 31, 2003. The adoption of the provisions applicable to SPEs and all other variable interests obtained after January 31, 2003 had no impact on our financial statements.

Item 3. Quantitative and Qualitative Disclosures about Market Risks.

We do not use derivative financial instruments in our operations or investment portfolio. We regularly invest excess operating cash in deposits with major financial institutions, money market funds, notes issued by the U.S. Government, as well as fixed income investments and U.S. bond funds both of which can be readily purchased or sold using established markets. We believe that the market risk arising from our holdings of these financial instruments is minimal. We do not believe we have material exposure to market risks associated with changes in interest rates, as we have no variable interest rate debt outstanding. While we do not believe we have any material exposure to market risks associated with interest rates, we may experience reinvestment risk as fixed income securities mature and are reinvested in securities bearing lower interest rates.

We may be exposed to exchange conversion differences in translating the foreign results of our investment in Genmab to U.S. dollars. Depending upon the relative strengthening or weakening of the U.S. dollar, the conversion difference could be significant.

Item 4. Controls and Procedures

Evaluation of disclosure controls and procedures: We maintain “disclosure controls and procedures”, as such term is defined under Exchange Act Rule 13a-15(e), that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. In designing and evaluating the disclosure controls and procedures, our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives and in reaching a reasonable level of assurance our management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. We have carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief

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Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon their evaluation and subject to the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective in ensuring that material information relating to our business is made known to the Chief Executive Officer and Chief Financial Officer by others within our Company during the period in which this report was being prepared.

Changes in internal controls: There were no significant changes in our internal controls or other factors that could significantly affect those controls subsequent to the date of our management’s evaluation.

Limitations on the Effectiveness of Controls: Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

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Part II — Other Information

Item 1. Legal Proceedings

In the ordinary course of our business, we are at times subject to various legal proceedings. We do not believe that any of our current legal proceedings, individually or in the aggregate, will have a material adverse effect on our operations or financial condition.

Item 4. Submission of Matters to a Vote of Security Holders

At the Annual Meeting of Shareholders held on May 19, 2004, our shareholders elected two Class III Directors each to serve for a term to expire in 2007. Our shareholders also voted to confirm the appointment of Ernst & Young LLP as independent auditors for the 2004 fiscal year. Out of the 79,093,026 eligible votes, 64,232,318 were cast at the meeting either by proxies solicited in accordance with Section 14 of the Securities Exchange Act of 1934, as amended, and the regulations set forth thereunder, or by securities holders voting in person. There were no broker non-votes. In the case of directors, abstentions are treated as votes withheld and are included in the table. The tabulation of votes for each nominee is set forth under Item No. 1 below, and the appointment of Ernst & Young LLP as independent auditors for the 2004 fiscal year is set forth in Item No. 2 below:

Item No. 1

Nominees for Directors

The following persons are incumbent directors whose terms of office continue after the Annual Meeting:

Item No. 2

Ratification of the selection of Ernst & Young LLP as Independent Registered Public Accounting Firm for the 2004 fiscal year:

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Item 5. Other Information

Additional factors that might affect future results include the following:

Our product candidates are in early stages of development, and they have not been and may not ever be approved for sale and/or commercialized.

Our human antibody technology is a new approach to the generation of antibody-based therapeutic products. Active product candidates employing our human antibody technology are in the early and middle stages of clinical development. Based on public disclosures, regulatory applications, including Investigational New Drug Applications, or INDs, have been submitted to the FDA or comparable foreign authorities, for 17 product candidates derived from our UltiMAb platform. To date, neither we nor our partners have any product candidates employing our human antibody technology that have been approved for sale by the FDA or comparable foreign authorities and/or commercialized. In addition, we are not aware of any commercialized fully human monoclonal antibody therapeutic products that have been generated from any technologies similar to ours. Product candidates employing our human antibody technology may not advance beyond the early or middle stages of product development or demonstrate clinical safety and effectiveness.

Our human antibody technology may not generate antibodies against all the antigens to which it is exposed in an efficient and timely manner, if at all. If our human antibody technology fails to generate antibody product candidates, or if we or our partners do not succeed in the development of products employing our antibody technology, those product candidates may not be approved or commercialized and our business, financial condition and results of operations may be materially harmed.

Successful development of our products is uncertain. To date, no revenues have been generated from the commercial sale of our products and our products may not generate revenues in the future.

Our development of current and future product candidates is subject to the risks of failure inherent in the development of new pharmaceutical products and products based on new technologies. These risks include:

In certain instances, we have experienced delays in our product development and clinical testing as a result of slower than anticipated patient recruitment. In a number of instances, we have terminated the development of certain products in the early stages of human clinical testing due to a lack of effectiveness. In addition, we determined not to continue the development of one late-stage product candidate due to both a lack of effectiveness and unforeseen safety issues that arose in clinical testing. None of these products employed our core fully human antibody technology.

Because of these risks, our research and development efforts or those of our partners may not result in any commercially viable products. If a significant portion of these development efforts are not successfully completed, required regulatory approvals are not obtained or any approved products are not commercially successful, our business, financial condition and results of operations may be materially harmed.

Because we and our partners have not begun commercial sales of our products, our revenue and profit potential are unproven and our limited operating history makes it difficult for an investor to evaluate our

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business and prospects. Our technology may not result in any meaningful benefits to our current or potential partners. No revenues have been generated from the commercial sale of our products, and our products may not generate revenues in the future. Further, due to our limited operating history, we have difficulty accurately forecasting our revenue. Our business and prospects should be considered in light of the heightened risks and unexpected expenses and problems we may face as a company in an early stage of development in a new and rapidly evolving industry.

We have incurred large operating losses and we anticipate that these losses will continue.

We have incurred large operating losses and we anticipate that these losses will continue for the foreseeable future. In particular, as of June 30, 2004, we had an accumulated deficit of approximately $487.4 million. Our net losses were $129.3 million and $74.5 million for the year ended December 31, 2003 and the six month period ended June 30, 2004, respectively. Our losses have resulted principally from:

We intend to continue to make significant investments in:

In addition, we may be obligated to make milestone payments on certain of our products as they progress through the clinical trial process.

We do not know when or if we or our partners will complete any pending or future product development efforts, receive regulatory approval or successfully commercialize any approved products.

We may continue to incur substantial operating losses even if our revenues increase. As a result, we cannot predict the extent of future losses or the time required for us to achieve profitability, if at all.

Our operating results may vary significantly from period-to-period, which may result in a decrease in the price of our securities.

Our future revenues and operating results are expected to vary significantly from period-to-period due to a number of factors. Many of these factors are outside of our control. These factors include:

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Period-to-period comparisons of our results of operations may not be relied upon as an indication of future performance.

It is possible that in some future periods, our operating results may be below expectations of analysts and investors. If this happens, the price of our securities may decrease.

We may need substantial additional funding. We may not be able to obtain sufficient funds to grow our business or continue our operations.

We will continue to expend substantial resources for research and development, including costs associated with developing our antibody technology and conducting preclinical testing and clinical trials. Our future capital requirements will depend on a number of factors, including, by way of example:

We believe our current sources of liquidity will be sufficient to meet our near term operating, debt service and capital requirements for at least the next 24 months. However, this 24-month period assumes the use of a significant portion of the proceeds we received from the sale of our convertible notes. To the extent our convertible notes are converted into shares of our common stock on or before their maturity dates, we will have use of that portion of the principal amount of the notes so converted to fund our on-going operations. In any event, we will require additional financing within this time frame and may raise funds through public or private financings, line of credit arrangements, collaborative relationships and/or other methods. The use of cash on hand or other financial alternatives will depend on several factors including, but not limited to, the future success of our products in clinical development, the prevailing interest rate environment, and access to the capital markets. We may be unable to raise sufficient funds to complete development of any of our product candidates, to continue operations or to repay our debt obligations at maturity. As a result, we may face delay, reduction or elimination of research and development programs or preclinical or clinical trials, in which case our business, financial condition or results of operations may be materially harmed.

We have a significant amount of debt and may have insufficient cash to satisfy our debt service obligations. In addition, the amount of our debt could impede our operations and flexibility.

We have a significant amount of existing debt and debt service obligations, which, unless converted to shares of our common stock or redeemed, will mature in 2010 (approximately $147.0 million) and 2011 ($150.0 million), respectively. Our ability to make payments on our debt will depend on our future operating performance and ability to generate cash and may also depend on our ability to obtain additional debt or equity financing. Generally, during the last five years, our operating cash flows were negative and insufficient to cover our fixed charges. Our ability to generate sufficient operating cash flow to service our indebtedness, including the notes, and fund our operating requirements will depend on our ability, alone or with others, to successfully develop, manufacture, and obtain required regulatory approvals and market our product candidates, as well as other factors, including general economic, financial, competitive, legislative and regulatory conditions, some of which are beyond our control. If we are unable to generate sufficient operating cash flow to service our

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indebtedness and fund our operating requirements, we may need to obtain additional debt or equity financing to do so, which may not be available to us on satisfactory terms or at all. In addition, if new indebtedness is incurred, the risks relating to our ability to service our indebtedness that we face could intensify.

Even if we are able to meet our debt service obligations, the amount of debt we have could adversely affect us in a number of ways, including by:

Clinical trials required for our product candidates are expensive and time-consuming, and their outcome is uncertain.

In order to obtain FDA approval to market a new drug product, we or our partners must demonstrate proof of safety and efficacy in humans. To meet these requirements, we or our partners will have to conduct extensive preclinical testing and “adequate and well-controlled” clinical trials. Conducting clinical trials is a lengthy, time-consuming and expensive process. The length of time may vary substantially according to the type, complexity, novelty and intended use of the product candidate, and often can be several years or more per trial. Delays associated with products for which we are directly conducting preclinical or clinical trials may cause us to incur additional operating expenses. Moreover, we will continue to be affected by delays associated with the preclinical testing and clinical trials of certain product candidates conducted by our partners over which we have no control. The commencement and rate of completion of clinical trials may be delayed by many factors, including, for example:

Even if we obtain positive results from preclinical or clinical trials, we may not achieve the same success in future trials. Clinical trials may not demonstrate statistically sufficient safety and effectiveness to obtain the requisite regulatory approvals for product candidates employing our human antibody technology. In a number of instances, we have terminated the development of certain products in the early stages of human clinical testing due to a lack of effectiveness. None of these products employed our core fully human antibody technology. In addition, we have determined not to continue the development of one late-stage product candidate due to both a lack of effectiveness and unforeseen safety issues that arose in clinical testing. This product did not employ our core fully human antibody technology.

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Generally, our clinical trials, including our melanoma trials, are conducted in patients with serious life-threatening diseases for whom conventional treatments have been unsuccessful or for whom no conventional treatment exists, and in some cases, our product is used in combination with approved therapies that themselves have significant adverse event profiles. During the course of treatment, these patients could suffer adverse medical events or die for reasons that may or may not be related to our products. The most common adverse events associated with our melanoma trials have consisted of flu-like symptoms such as fever, chills and nausea. These events were expected and generally responded to standard medical therapy. In addition, some patients have experienced anticipated drug-related autoimmune adverse events, such as dermatitis and colitis, ranging from mild in most cases to severe in a very small number of instances. Almost all of these adverse events responded to medical therapy. In a very small number of instances, fatalities have occurred during the course of these trials — such fatalities may or may not be attributable to our product. We believe that these adverse events will not materially affect our ability to continue with clinical trials of this product as planned. We cannot assure you that additional safety issues will not arise with respect to our products in the future.

To date, we have experienced slower than expected rates of patient recruitment in certain of our clinical trials. As a result, in certain instances, we have experienced delays in our product development and clinical testing. In addition, data obtained from clinical trials of our products to date have been insufficient to demonstrate safety and efficacy under applicable FDA guidelines. As a result, these data will not support an application for regulatory approval without further clinical trials. Clinical trials that we conduct or that third-parties conduct on our behalf may not demonstrate sufficient safety and efficacy to obtain the requisite regulatory approvals for any of our product candidates. We expect to commence new clinical trials from time to time in the course of our business as our product development work continues. The failure of clinical trials to demonstrate safety and effectiveness for our desired indications could harm the development of that product candidate as well as other product candidates. Any change in, or termination of, our clinical trials could materially harm our business, financial condition and results of operations.

Success in early clinical trials may not be indicative of results obtained in later trials.

Results of our early clinical trials and those of our partners using our human antibody technology are based on a limited number of patients and may, upon review, be revised or negated by authorities or by later stage clinical results. Historically, the results from preclinical testing and early clinical trials have often not been predictive of results obtained in later clinical trials. A number of new drugs and biologics have shown promising results in initial clinical trials, but subsequently failed to establish sufficient safety and effectiveness data to obtain necessary regulatory approvals. Data obtained from preclinical and clinical activities are subject to varying interpretations, which may delay, limit or prevent regulatory approval.

In addition, regulatory delays or rejections may be encountered as a result of many factors, including changes in regulatory policy during the period of product development. For example, the FDA has moved several product categories previously regulated by the agency’s Center for Biologics Evaluation and Research, or CBER, to the agency’s Center for Drug Evaluation and Research, or CDER. These product categories include antibodies as well as cytokines, growth factors, enzymes, interferons and certain proteins. FDA has also recently announced a planned reorganization within CDER to create a new consolidated office for the review of oncology therapies. Oncology therapies are currently reviewed by different offices within CDER. The effect that these reorganizations at the FDA will have on clinical trials and product approval outcomes or timing is uncertain, but could cause delays or other currently unforeseeable effects.

Product candidates employing our antibody technology may fail to gain market acceptance.

Even if clinical trials demonstrate the safety, effectiveness, potency and purity of products developed by us or our partners using our technology and all regulatory approvals have been obtained, product candidates employing our antibody technology may not gain market acceptance among physicians, patients, third-party

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payors and the medical community. For example, the current delivery systems for antibody-based therapeutic products are intravenous and subcutaneous injection, which are generally less well received by patients than tablet or capsule delivery. The degree of market acceptance of any product candidates employing our technology will depend on a number of factors, including, for example:

In addition, many of our activities involve genetic engineering in animals and animal testing, controversial subjects which have received adverse publicity from animal rights activists and various other interest groups. Such adverse publicity could decrease market acceptance of products employing our technology.

If products employing our technology do not achieve significant market acceptance, our business, financial condition and results of operations may be materially harmed.

The successful commercialization of our antibody products will depend on obtaining coverage and reimbursement for use of these products from third-party payors.

Sales of pharmaceutical products largely depend on the reimbursement of patients’ medical expenses by government health care programs and private health insurers. Without the financial support of the governments or third-party payors, the market for products employing our human antibody technology will be limited. These third-party payors are increasingly challenging the price and examining the cost effectiveness of medical products and services. In addition, significant uncertainty exists as to the reimbursement status of newly approved healthcare products. We may need to conduct post-marketing studies in order to demonstrate the cost-effectiveness of our products. Such studies may require us to dedicate a significant amount of resources. Our project candidates may not be considered cost-effective. Third-party payors may not reimburse sales of products employing our human antibody technology, or enable us or our partners to sell them at profitable prices.

Third-party payors control health care costs by limiting both coverage and the level of reimbursement for new health care products. In the future, the United States government may institute price controls and further limits on Medicare and Medicaid spending. Internationally, medical reimbursement systems vary with differing degrees of regulation. Pricing controls and reimbursement limitations could affect the payments we receive from sales of products generated using our human antibody technology. These variations could harm our ability and the ability of our partners to sell products generated using our human antibody technology in commercially acceptable quantities at profitable prices.

We may experience pressure to lower the prices of any prescription pharmaceutical products we are able to obtain approval for because of new and/or proposed federal legislation.

New federal legislation, enacted in December 2003, has added an outpatient prescription drug benefit to Medicare, effective January 2006. In the interim, Congress has established a discount drug card program for Medicare beneficiaries. Both benefits will be provided primarily through private entities, which will attempt to negotiate price concessions from pharmaceutical manufacturers. These negotiations may increase pressures to lower prices. While the new law specifically prohibits the United States government from interfering in price negotiations between manufacturers and Medicare drug plan sponsors, some members of Congress are pursuing legislation that would permit the United States government to use its enormous purchasing power to demand

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discounts from pharmaceutical companies, thereby creating de facto price controls on prescription drugs. In addition, the new law contains triggers for Congressional consideration of cost containment measures for Medicare in the event Medicare cost increases exceed a certain level. These cost containment measures could include some sorts of limitations on prescription drug prices. Our results of operations could be materially harmed by the Medicare prescription drug coverage legislation, by the potential effect of such legislation on amounts that private insurers will pay for our products and by other healthcare reforms that may be enacted or adopted in the future.

We may face increased competition from products imported from Canada or other countries.