Back to GetFilings.com

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2005

Commission file number 000-28401

MAXYGEN, INC.

(Exact name of registrant as specified in its charter)

515 Galveston Drive

Redwood City, California 94063

(Address of principal executive offices, including zip code)

(650) 298-5300

(Registrant’s telephone number, including area code)

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

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

As of May 1, 2005, there were 35,693,486 shares of the registrant’s common stock, $0.0001 par value per share, outstanding, which is the only class of common or voting stock of the registrant issued.

Table of Contents

MAXYGEN, INC.

FORM 10-Q

QUARTER ENDED MARCH 31, 2005

This report and the disclosures herein include, on a consolidated basis, the business and operations of Maxygen, Inc. and its wholly-owned subsidiaries, Maxygen ApS and Maxygen Holdings Ltd. For the three months ended March 31, 2004 and for the two months ended February 28, 2005, the operations of Codexis, Inc. are also included. On February 28, 2005 Maxygen’s voting interests in Codexis fell below 50% and from such date the financial position and results of operations of Codexis were no longer consolidated with the financial position and results of operations of Maxygen. The operations of Verdia, Inc. prior to its sale on July 1, 2004 are reflected as discontinued operations.

We make available on our website all reports filed with the Securities and Exchange Commission, including our reports on Form 10-K, 10-Q and 8-K, as soon as reasonably practicable after they have been filed. Our website is located at www.maxygen.com. Information contained on our website is not a part of this report.

Maxygen is a registered trademark of Maxygen, Inc. Codexis is a trademark of Codexis, Inc. The use of the word “partner” and “partnership” does not mean a legal partner or legal partnership.

2

Table of Contents

PART I – FINANCIAL INFORMATION

ITEM 1

FINANCIAL STATEMENTS

MAXYGEN, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)

See accompanying notes.

3

Table of Contents

MAXYGEN, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

(UNAUDITED)

See accompanying notes.

4

Table of Contents

MAXYGEN, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN THOUSANDS)

(UNAUDITED)

See accompanying notes.

5

Table of Contents

MAXYGEN, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. Basis of Presentation and Significant Accounting Policies

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information. The information as of March 31, 2005, and for the three months ended March 31, 2004 and March 31, 2005 includes all adjustments (consisting only of normal recurring adjustments) that the management of Maxygen, Inc. (“Maxygen” or the “Company”) believes necessary for fair presentation of the results for the periods presented. The condensed consolidated balance sheet as of December 31, 2004 has been derived from the audited financial statements at that date.

Results for any interim period are not necessarily indicative of results for any future interim period or for the entire year. The accompanying condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

On June 2, 2004, the Company agreed to sell Verdia, Inc. (its wholly-owned subsidiary) to Pioneer Hi-Bred International, Inc., a wholly-owned subsidiary of E.I. du Pont de Nemours and Company. This transaction closed on July 1, 2004 (see Note 6). The Company has reclassified the operating results of Verdia to discontinued operations in the condensed consolidated financial statements for the three months ended March 31, 2004 as a result of the Company’s sale of Verdia. The results of operations of Verdia prior to its sale on July 1, 2004 are reflected as discontinued operations in the Company’s condensed consolidated financial statements.

On February 28, 2005, as a result of the issuance of Codexis common stock in connection with the acquisition by Codexis of Julich Fine Chemicals GmbH and certain other events, the Company’s voting rights in Codexis have been reduced below 50%. As of February 28, 2005, Codexis was no longer a consolidated subsidiary of the Company and the Company’s ownership in Codexis is being accounted for under the equity method of accounting.

Principles of Consolidation

The consolidated financial statements include the amounts of the Company and its wholly-owned subsidiaries, Maxygen ApS (Denmark) and Maxygen Holdings Ltd. (Cayman Islands). For the three months ended March 31, 2004 and for the two months ended February 28, 2005, the results of operations of Codexis, Inc. are also included in the condensed consolidated financial statements. The condensed consolidated balance sheet at December 31, 2004 includes the financial position of Codexis as of that date. Subsequent to February 28, 2005, the Company’s investment in Codexis is reflected using the equity method of accounting.

In accordance with EITF Consensus 96-16, “Investor Accounting for an Investee When the Investor Has a Majority of the Voting Interest but the Minority Stockholder or Stockholders Have Certain Approval or Veto Rights” and paragraph 1 of ARB No. 51, “Consolidated Financial Statements”, the Company has included 100% of the net losses of Codexis in the determination of the Company’s consolidated net loss through February 28, 2005. As of February 28, 2005, the Company controlled less than 50% of the voting rights of the issued and outstanding shares of Codexis common and preferred stock. In accordance with APB 18, “The Equity Method of Accounting for Investments in Common Stock”, the Company is accounting for its investment in Codexis under the equity method of accounting after February 28, 2005.

As a result of the Company no longer consolidating the financial position of Codexis after February 28, 2005, the Company no longer reflects amounts as minority interest on the condensed consolidated balance sheet and has recorded a $2.4 million adjustment to additional paid-in capital to restore the negative additional paid-in capital that had resulted from Codexis’ preferred stock accretion prior to February 28, 2005.

Cumulative Effect Adjustment

Codexis was formed in January 2002 and financed by the Company and several other independent investors. In accordance with EITF 96-16 and ARB 51, through February 28, 2005, the Company consolidated 100% of the

6

Table of Contents

operating results of Codexis even though it only owned a majority of the voting interests in Codexis. From March 2002 through February 28, 2005, the Company had recorded losses of Codexis of $26.4 million, which was in excess of the Company’s investment basis of $9.8 million. On February 28, 2005, as a result of the acquisition of Julich Fine Chemicals GmbH by Codexis and certain other events, the Company’s voting rights in Codexis were reduced below 50%. As a result, as of such date the Company no longer consolidates the financial position and results of operations of Codexis with the Company’s financial results and instead accounts for Codexis under the equity method of accounting. To reflect what the Company’s basis in Codexis would have been under equity accounting, the Company recorded a one-time cumulative effect adjustment of $16.6 million for the three months ended March 31, 2005 to bring its investment basis in Codexis to zero. This cumulative effect adjustment does not have any tax consequences.

Reclassifications

Certain previously reported amounts have been reclassified to conform with the current period presentation. These reclassifications, when made, did not have any affect on income (loss) applicable to common stockholders, total assets or total liabilities and stockholders’ equity.

Revenue Recognition

The Company recognizes revenue from multiple element arrangements under collaborative research agreements, which include license payments, research and development services, milestones, and royalties. Revenue arrangements with multiple deliverables are accounted for under the provisions of Emerging Issues Task Force Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables”, and are divided into separate units of accounting if certain criteria are met, including whether the delivered item has stand-alone value to the customer and whether there is objective and reliable evidence of the fair value of the undelivered items in the arrangement. The consideration the Company receives is allocated among the separate units of accounting based on their respective fair values, and the applicable revenue recognition criteria are considered separately for each of the separate units.

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

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

The Company is eligible to receive royalties from licensees, which are typically based on third-party sales of licensed products. Royalties are recorded as earned in accordance with the contract terms when third-party results can be reliably measured and collectibility is reasonably assured.

The Company has been awarded grants from the Defense Advanced Research Projects Agency (“DARPA”), National Institute of Standards and Technology-Advanced Technology Program, the U.S. Agency for International Development and the U.S. Army Medical Research and Materiel Command for various research and development projects. The terms of these grant agreements are generally three years with various termination dates, the last of which is September 2005 for existing agreements. Revenue related to grant agreements is recognized as related research and development expenses are incurred.

7

Table of Contents

Income (Loss) per common share

Basic and diluted income (loss) per common share has been computed using the weighted-average number of shares of common stock outstanding during the period, less shares subject to repurchase. The following table presents the calculation of basic and diluted loss per common share (in thousands, except per share data):

In accordance with paragraph 15 of FAS 128, “Earnings Per Share,” the Company has excluded all outstanding stock options, outstanding warrants and shares subject to repurchase from the calculation of diluted income (loss) per common share because all such securities are antidilutive to loss from continuing operations for all applicable periods presented. The total number of shares excluded from the calculations of diluted income (loss) per share, prior to application of the treasury stock method for options, was 9,925,000 at March 31, 2004 and 9,576,000 at March 31, 2005.

Comprehensive Income (Loss)

Comprehensive income (loss) is primarily comprised of net income (loss), net unrealized gains or losses on available-for-sale securities and foreign currency translation adjustments. Comprehensive income (loss) and its components for the three-month periods ended March 31, 2004 and March 31, 2005 were as follows (in thousands):

The components of accumulated other comprehensive loss were as follows (in thousands):

Recent Accounting Pronouncements

In November 2004 the FASB delayed the effective date for the measurement and recognition guidance contained in paragraphs 10-20 of EITF 03-01; this delay does not suspend the requirement to recognize other-than-temporary impairments as required by existing authoritative

8

Table of Contents

literature. The disclosure requirement of this guidance remains in effect. The Company does not expect the adoption of the recognition and measurement provisions of EITF 03-01 to significantly impact our results of operations or financial position but will reassess the impact once the rules are finalized.

On December 16, 2004, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 123 (revised 2004), Share-Based Payment, which is a revision of FASB Statement No. 123, “Accounting for Stock-Based Compensation.” Statement 123(R) supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and amends FASB Statement No. 95, “Statement of Cash Flows.” Statement 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative. Statement 123(R) must be adopted no later than the beginning of the first fiscal year beginning after June 15, 2005. The Company expects to adopt Statement 123(R) on January 1, 2006.

Statement 123(R) permits public companies to adopt its requirements using one of two methods:

The Company plans to adopt Statement 123 using the modified prospective method.

As permitted by Statement 123, the Company currently accounts for share-based payments to employees using Opinion 25’s intrinsic value method and, as such, generally recognizes no compensation cost for employee stock options. Accordingly, the adoption of Statement 123(R)’s fair value method will have a significant impact on the Company’s result of operations, although it will have no impact on the Company’s overall financial position. The impact of adoption of Statement 123(R) cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had the Company adopted Statement 123(R) in prior periods, the impact of that standard would have approximated the impact of Statement 123 as described in the disclosure of pro forma net income and earnings per share in Note 1 to the Company’s Consolidated Financial Statements. Statement 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. The Company cannot estimate what those amounts will be in the future because they depend upon, among other things, levels of share-based payments granted in the future, when employees exercise stock options and if and when the Company becomes profitable.

Stock-Based Compensation

The Company accounts for common stock options granted to employees using the intrinsic value method and, thus, recognizes no compensation expense for options granted with exercise prices equal to or greater than the fair value of the Company’s common stock on the date of the grant. Options granted to consultants are periodically re-valued as they vest in accordance with SFAS Statement 123 and EITF 96-18 using the Black-Scholes valuation model.

As permitted under SFAS No. 148, the Company has elected to continue to follow the intrinsic value method in accounting for its stock-based employee compensation arrangement as defined by Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees”, and related interpretations including Financial Accounting Standards Board Interpretation No. 44, “Accounting for Certain Transactions involving Stock Compensation”, an interpretation of APB No. 25. The following table illustrates the effect on net loss and income (loss) per common share if the Company had applied the fair value recognition provisions of SFAS No. 123, as

9

Table of Contents

amended by SFAS No. 148, using the Black-Scholes option-pricing model, to determine stock-based employee compensation (in thousands except per share data):

The Black-Scholes weighted average estimated fair values of stock options granted during the three months ended March 31, 2004 and 2005 were $5.13 and $6.99 per share, respectively.

2. Investments

Management determines the appropriate classification of debt securities at the time of purchase and reevaluates such designation as of each balance sheet date. The Company’s debt securities are classified as available-for-sale and are carried at estimated fair value in cash equivalents and investments. Unrealized gains and losses are reported as accumulated other comprehensive loss in stockholders’ equity. The amortized cost of debt securities in this category is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in interest income. Realized gains and losses on available-for-sale securities and declines in value deemed to be other than temporary, if any, are included in interest income and expense. The cost of securities sold is based on the specific identification method. Interest and dividends on securities classified as available-for-sale are included in interest income. The Company’s cash equivalents and investments as of March 31, 2005 were as follows (in thousands):

There were no realized gains or losses on the sale of available-for-sale securities for the three-month periods ended March 31, 2004 and March 31, 2005. The change in unrealized holdings gains (losses) on available-for-sale securities included in accumulated other comprehensive income (loss) were unrealized gains of $227,000 for the three months ended March 31, 2004 and unrealized losses of $108,000 for the three months ended March 31, 2005. The Company intends to hold the securities until maturity and therefore does not believe the unrealized losses of $690,000 are other than temporary.

10

Table of Contents

At March 31, 2005, the contractual maturities of investments were as follows (in thousands):

3. Derivatives and Financial Instruments

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

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

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

The purpose of the hedging activities is to minimize the effect of foreign currency exchange rate movements on the cash flows related to the Company’s funding of Maxygen ApS. To date, foreign currency contracts are denominated in Danish kroner. At March 31, 2005, the Company had foreign currency contracts outstanding in the form of forward exchange contracts totaling $9.7 million.

4. Litigation

In December 2001 a lawsuit was filed in the U.S. District Court for the Southern District of New York against Maxygen, Inc., its chief executive officer, Russell Howard and its then chief financial officer, Simba Gill, together with certain underwriters of Maxygen’s initial public offering and secondary public offering of common stock. The complaint, which alleges claims under Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934, is among the so-called “laddering” cases that have been commenced against over 300 companies that had public offerings of securities in 1999 and 2000. The complaint has been consolidated with other laddering claims in a proceeding styled In re Initial Public Offering Securities Litigation, No. 21 MC 92 (SAS), pending before the Honorable Shira A. Scheindlin. In February 2003, the court dismissed the Section 10(b) claim against Drs. Howard and Gill; the remainder of the case remains pending.

In June 2003 the Company agreed to the terms of a tentative settlement agreement along with other defendant issuers in In re Initial Public Offering Securities Litigation. The tentative settlement provides that the insurers of the 309 defendant issuers will pay to the plaintiffs $1 billion less any recovery of damages the plaintiffs receive from the defendant underwriters. If the plaintiffs receive over $5 billion in damages from the defendant underwriters, we will be entitled to reimbursement of various expenses incurred by us as a result of the litigation. As part of the tentative settlement, the Company will assign to the plaintiffs “excess compensation claims” and certain other of its claims against the defendant underwriters based on the alleged actions of the defendant underwriters. The settlement is subject to acceptance by a substantial majority of defendants and execution of a definitive settlement agreement. The settlement is also subject to approval of the Court, which cannot be assured. On February 15, 2005 the Court tentatively approved the proposed settlement, conditioned upon the parties altering the proposed settlement to comply with the Private Securities Litigation Reform Act’s settlement discharge provision. The settlement does not contemplate any settlement payments by Maxygen.

11

Table of Contents

If the settlement is not accepted by the requisite number of defendants or if it is not approved by the Court, the Company intends to defend the lawsuit vigorously. The Company believes the lawsuit against Maxygen and its officers is without merit. However, the litigation is in the preliminary stage, and the Company cannot predict its outcome. The litigation process is inherently uncertain. If the outcome of the litigation is adverse to the Company and if the Company is required to pay significant damages, the Company’s business would be significantly harmed.

The Company is not currently a party to any other material pending legal proceedings.

From time to time, the Company becomes involved in claims and legal proceedings that arise in the ordinary course of its business. The Company does not believe that the resolution of these claims will have a material adverse effect on its financial statements.

5. Segment Information

On July 1, 2004, the Company sold Verdia, the sole component of its agriculture segment, to Pioneer Hi-Bred International, Inc., a wholly-owned subsidiary of E.I. du Pont de Nemours and Company. The operations of Verdia prior to its sale are reflected in the Company’s financial statements for the three months ended March 31, 2004 as discontinued operations. Thus the agriculture segment data provided in earlier reports is now reflected as discontinued operations (see Note 6). On February 28, 2005 the Company’s voting interests in Codexis fell below 50% and from such time Codexis ceased to be a consolidated subsidiary of the Company. Accordingly, the financial position of Codexis is included in the condensed consolidated balance sheet as of December 31, 2004 but excluded from the March 31, 2005 condensed consolidated balance sheet, and the results of operations of Codexis are included in the consolidated results presented below only until February 28, 2005. Thereafter the Company’s investment in Codexis is reflected under the equity method of accounting. The Company has determined its reportable operating segments based upon how the business is managed and operated. The accounting policies of the segments described above are the same as those described in Note 1. Corporate administrative costs are generally allocated based on headcount.

Segment Earnings

12

Table of Contents

Segment Revenue

Revenues for each operating segment are derived from the Company’s research collaboration agreements and government grants and are categorized based on the industry of the product or technology under development. On February 28, 2005 the Company’s voting interests in Codexis fell below 50% and from such time Codexis ceased to be a consolidated subsidiary of the Company. Thus the revenues of Codexis are included in the consolidated results presented below only until February 28, 2005 and thereafter the Company’s investment in Codexis is reflected under the equity method of accounting. The following table presents revenues for each reporting segment (in thousands):

Identifiable Assets

The following table presents indentifiable assets for each reporting segment (in thousands):

6. Discontinued Operations

On July 1, 2004 the Company completed the sale of Verdia, its agriculture subsidiary and sole component of its agriculture segment, to Pioneer Hi-Bred International, Inc., a wholly-owned subsidiary of E.I. du Pont de Nemours and Company, for $64 million in cash, less estimated income taxes and transaction costs of $1.4 million. The operating results of Verdia have been reclassified as discontinued operations for all periods presented. Results of discontinued operations provided below reflect the results of Verdia prior to its sale.

Summary operating results for the discontinued operations through March 31, 2004 are as follows (in thousands):

Three months ended March 31, 2004:

Verdia’s investment in its joint venture with Delta and Pine Land Company called DeltaMax Cotton LLC in which Verdia had an equity interest of 50% as of March 31, 2004 was accounted for under the equity method of accounting. As a result of the Company’s sale of Verdia on July 1, 2004, Verdia’s portion of the DeltaMax loss as of March 31, 2004 is included in the loss from discontinued operations on the Condensed Consolidated Statement of Operations for the three months ended March 31, 2004.

13

Table of Contents

7. Commitments

The Company has entered into various operating leases for its facilities and certain computer equipment and material contracts. The leases expire on various dates in 2005 through 2007. The facilities leases also include scheduled rent increases. The scheduled rent increases are recognized on a straight-line basis over the term of the leases. The material contracts expire on various dates in 2005 through 2006.

Minimum annual commitments under operating leases and material contracts are as follows (in thousands):

8. Acquisition of Julich Fine Chemicals GmbH by Codexis

On February 22, 2005, Codexis acquired all of the outstanding voting securities of Julich Fine Chemicals GmbH for approximately $3.0 million, consisting of $2.6 million of cash, shares of Codexis common stock valued at approximately $188,000 and transaction costs. Julich Fine Chemicals is a supplier of specialty enzymes and fine chemicals to pharmaceutical and chemical companies.

The Julich acquisition was accounted for using the purchase method of accounting. Accordingly, the condensed consolidated statement of operations for the quarter ended March 31, 2005 includes the results of operations of Julich since the effective date of its purchase through February 28, 2005. The purchase price allocation for Julich is preliminary, pending finalization of the intangible asset valuation. Upon completion of this matter, any necessary adjustments will be made to the purchase price allocation and will result in corresponding adjustments to goodwill.

9. Guarantees and Indemnifications

In November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others” (“FIN 45”). FIN 45 requires that upon issuance of a guarantee, the guarantor must recognize a liability for the fair value of the obligations it assumes under that guarantee.

As permitted under Delaware law and in accordance with the Company’s Bylaws, the Company indemnifies its officers and directors for certain events or occurrences, subject to certain limits, while the officer or director is or was serving at the Company’s request in such capacity. The indemnification agreements with the Company’s officers and directors terminate upon termination of their employment, but the termination does not affect claims for indemnification relating to events occurring prior to the effective date of termination. The maximum amount of potential future indemnification is unlimited; however, the Company’s director and officer insurance policy reduces the Company’s exposure and may enable the Company to recover a portion of any future amounts paid. The Company believes that the fair value of these indemnification agreements is minimal. Accordingly, the Company has not recorded any liabilities for these agreements as of March 31, 2005.

14

Table of Contents

Forward-Looking Statements

This report contains forward-looking statements within the meaning of federal securities laws that relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as “may,” “can,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “intend,” “potential” or “continue” or the negative of these terms or other comparable terminology. Risks and uncertainties and the occurrence of other events could cause actual results to differ materially from these predictions. Factors that could cause or contribute to such differences include those discussed below under “Risk Factors That May Affect Results of Operations and Financial Condition,” as well as those discussed in our Annual Report on Form 10-K for the year ended December 31, 2004.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of these statements. We are under no duty to update any of the forward-looking statements after the date of this report or to conform these statements to actual results.

ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Executive Summary

We are a leader in the application of directed molecular evolution, a process by which genes and related proteins are modified for specific commercial uses. Maxygen began operations in March 1997 with the mission to develop important commercial products through the use of biotechnology. Since then, we have established a focus in human therapeutics, particularly optimized protein pharmaceuticals.

Our business model focuses on developing next-generation protein pharmaceuticals that address significant markets, on our own or with partners. We currently have four next-generation protein therapeutic leads in pre-clinical development. The four lead product candidates seek to address significant opportunities and deficiencies in first-generation marketed protein products. The four product candidates are: an optimized alpha interferon for the treatment of hepatitis C virus infection, partnered with Roche; an optimized gamma interferon for the treatment of idiopathic pulmonary fibrosis and other indications, partnered with InterMune; and two leads to which we retain all rights: an optimized G-CSF for the treatment of neutropenia and an optimized Factor VII to treat uncontrolled bleeding. We currently expect that INDs will be filed on two of these programs in 2006.

The successful development of our product candidates is highly uncertain. Product development costs and timelines can vary significantly for each product candidate and are difficult to accurately predict. Various statutes and regulations also govern or influence the manufacturing, safety, labeling, storage, record keeping and marketing of each product. The lengthy process of seeking these approvals, and the subsequent compliance with applicable statutes and regulations, require the expenditure of substantial resources. Any failure by us to obtain, or any delay in obtaining, regulatory approvals could materially adversely affect our business.

In addition to our focus in human therapeutics, we established two industrial subsidiaries. Our chemicals subsidiary Codexis focuses on the development of biocatalysis and fermentation processes and products for the pharmaceutical industry. On February 28, 2005, as a result of the acquisition of Julich Fine Chemicals GmbH by Codexis and certain other events, our voting rights in Codexis were reduced below 50%. As a result, as of such date we no longer consolidated the financial position and results of operations of Codexis with our financial results and instead we account for Codexis under the equity method of accounting. To reflect what our basis in Codexis would have been under equity accounting, we recorded a one-time positive adjustment as a cumulative effect adjustment of $16.6 million for the three months ended March 31, 2005 to bring our investment basis in Codexis to zero. On July 1, 2004 we completed the sale of Verdia, our agriculture subsidiary, to Pioneer Hi-Bred International, Inc., a wholly-owned subsidiary of E.I. du Pont de Nemours and Company, for cash proceeds of $64 million. The discussion in this section reflects the results of Verdia as a discontinued operation for the three months ended March 31, 2004.

To date, we have generated revenues from research collaborations with pharmaceutical, chemical and petroleum companies and from government grants. Moving forward, we anticipate establishing additional strategic alliances. However, as our internal resources and expertise have grown, we have strategically shifted our dependence on collaborative partner funding to advance our product candidates and business to an increased focus on internal product development in order to capture more of the potential value resulting from our efforts. We believe this is an

15

Table of Contents

important step in building long-term value in Maxygen. However, in the immediate term this will mean reduced revenues and increased operating losses. Consistent with our strategic shift, revenue from collaborative research agreements and government grants decreased from $28.7 million in 2002 to $22.9 million in 2003 to $16.3 million in 2004. Our revenues were $5.5 million in the three months ended March 31, 2005 compared to $4.9 million for the three months ended March 31, 2004. Due to our continuing shift to internal product development and the deconsolidation of Codexis, our revenue is expected to drop accordingly during the remainder of 2005.

For the purposes of this report, our continuing operations consist of the results of Maxygen, Inc. and our wholly-owned subsidiaries, Maxygen ApS (Denmark) and Maxygen Holdings Ltd. (Cayman Islands), as well as the results of our chemicals subsidiary, Codexis, Inc. through February 28, 2005.

We continue to maintain a strong cash position to fund our expanded internal product development, with cash, cash equivalents and marketable securities totaling $204.4 million as of March 31, 2005.

We have incurred significant operating losses since our inception. As of March 31, 2005, our accumulated deficit was $177.9 million. We have invested heavily in establishing our proprietary technologies. Our research and development expenses from continuing operations for the three months ended March 31, 2005 were $11.1 compared to $10.8 million for comparable period in 2004. We expect to incur additional operating losses over at least the next several years.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with general accepted accounting principles requires management to make judgments, estimates and assumptions in the preparation of our consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

Except as supplemented below, we believe there have been no significant changes in our critical accounting policies during the three months ended March 31, 2005, as compared to what was previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2004.

Consolidation

The consolidated financial statements presented in this report include the amounts of Maxygen and our wholly-owned subsidiaries, Maxygen ApS (Denmark) and Maxygen Holdings Ltd. (Cayman Islands). For the three months ended March 31, 2004 and for the two months ended February 28, 2005, 100% of the results of operations of Codexis are also included as well as the financial position of Codexis at December 31, 2004.

In accordance with EITF Consensus 96-16, “Investor Accounting for an Investee When the Investor Has a Majority of the Voting Interest but the Minority Stockholder or Stockholders Have Certain Approval or Veto Rights” and paragraph 1 of ARB No. 51, “Consolidated Financial Statements”, Maxygen has included 100% of the net losses of Codexis in the determination of its net loss through February 28, 2005. As of February 28, 2005, Maxygen controlled less than 50% of the voting rights of the issued and outstanding shares of Codexis common and preferred stock. In accordance with APB 18, “The Equity Method of Accounting for Investments in Common Stock”, Maxygen is accounting for its investment in Codexis under the equity method of accounting after February 28, 2005. The operations of Verdia, Inc. prior to its sale on July 1, 2004 are reflected as discontinued operations. All significant intercompany balances and transactions have been eliminated in consolidation.

Results of Operations

Revenues

Our total revenues increased from $4.9 million in the three months ended March 31, 2004 to $5.5 million in the three months ended March 31, 2005. The increase in collaborative research and development revenue of $541,000 for the three months ended March 31, 2005 as compared to the three months ended March 31, 2004 was primarily due to the achievement of a significant milestone from Roche in the first quarter of 2005, partially offset by the completion of the research and development funding terms of several collaborations during 2004 and the change to the equity method of accounting for our investment in Codexis as of February 28, 2005. The increase in grant revenue of $140,000 for the three months ended March 31, 2005 compared to the three months ended March 31, 2004 primarily reflects an increase in activity on our existing grant projects. For 2005, we expect our consolidated revenue to be approximately $7.5 million. This reduced level of revenues as compared to 2004 reflects the fact that Codexis revenues will not be included in Maxygen’s consolidated financial results after February 28, 2005 and that Maxygen’s focus has intensified on the development of its products as opposed to research collaborations.

16

Table of Contents

Revenues for each operating segment are derived from our research collaboration agreements and government research grants and are categorized based on the industry of the product or technology under development. Results of Codexis through February 28, 2005 are shown as Maxygen’s chemicals segment. The following table presents revenues for each operating segment (in thousands):

The increase in revenues for our human therapeutics segment primarily reflects the achievement of a significant milestone from Roche in the first quarter of 2005 partially offset by the completion of the research and development funding terms of our collaborations with Aventis Pasteur and ALK-Abelló A/S in 2004. Revenue for our human therapeutics segment for the next several quarters is expected to be lower than revenue for our human therapeutics segment in the period ended March 31, 2005, primarily due to the recognition of a significant milestone achievement in the period ended March 31, 2005 and as we continue to implement our strategy of concentrating on internally funded research and development and reduce our dependence on partner funded research and development. In addition, the funded research term of our collaboration with Roche is scheduled to end in the third quarter of 2005.

Research and Development Expenses

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

We do not track fully burdened research and development costs or capital expenditures by project. However, we do estimate, based on full-time equivalent personnel effort, the percentage of research and development efforts (as measured in hours incurred, which approximates costs) undertaken for projects funded by, on the one hand, our collaborators and government grants and, on the other hand, projects funded by Maxygen. We believe that presenting our research and development expenses in these categories will provide our investors with meaningful information on how our resources are being used.

The following table presents our approximate research and development expenses by funding category (in thousands):

As we do not track fully burdened research and development costs by project, the expense figures provided above are comprised of the number of hours expended in each category multiplied by the approximate cost per hour of research and development effort. In addition, project-specific external costs are added to these costs.

Due to the nature of our research and our dependence on our collaborative partners to commercialize certain results of the research, we cannot predict with any certainty whether any particular collaboration or research effort will ultimately result in a commercial product and therefore whether we will receive future milestone payments or royalty payments under our various collaborations.

Most of our product development programs are at an early stage and may not result in any marketed products.

17

Table of Contents

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

Our research and development expenses consist primarily of salaries and other personnel-related expenses, research consultants and external collaborative research expenses (including contract manufacturing), facility costs, supplies and depreciation of facilities and laboratory equipment. Research and development expenses increased from $10.8 million in the three months ended March 31, 2004 to $11.1 million in the three months ended March 31, 2005. The increase was primarily due to increased external collaborative research expenses associated with the development of our product candidates, including the manufacture of product candidates in preparation for clinical trials, offset in part during the three months ended March 31, 2005 by the change from consolidation to the equity method of accounting for our investment in Codexis as of February 28, 2005. Stock compensation expenses included in research and development expenses was $102,000 in the three months ended March 31, 2005 compared to $129,000 during the three months ended March 31, 2004. The decrease in stock compensation expenses was primarily related to the amortization of deferred compensation relating to the grant of stock options to employees before our initial public offering, which was fully amortized to expense by August 2004.

We expect that our research and development costs may decrease modestly in 2005 over 2004, due primarily to the change to the equity method of accounting for our investment in Codexis as of February 28, 2005, offset by an increase in research and development costs for the remainder of our consolidated operations as we increase our efforts on internally funded projects. We expect to continue to devote substantial resources to research and development and we expect research and development expenses to increase in the next several years if we are successful in advancing our product candidates into clinical trials. To the extent we out-license our product candidates prior to commencement of clinical trials or collaborate with others with respect to clinical trials, increases in research and development expenses may be reduced or avoided. We intend to manage the level of our expenditures for research and development, including clinical trials, to balance advancing our product candidates against maintaining adequate cash resources for our operations. Stock compensation expense related to research and development will increase considerably upon our implementation of Financial Accounting Standards Board Statement No. 123(R). While we cannot predict the actual impact of the implementation of FASB 123(R) at this time as we are still analyzing its potential impacts, we believe the fair value calculation set forth in Note 1 of the Consolidated Financial Statements will approximate the actual impact of FASB 123(R). We expect to adopt FASB 123(R) on January 1, 2006.

General and Administrative Expenses

Our general and administrative expenses consist primarily of personnel costs for finance, human resources, business development, legal and general management, as well as insurance premiums and professional expenses, such as external expenditures for legal, accounting and commercial assessment of potential products. General and administrative expenses increased from $2.8 million in the three months ended March 31, 2004 to $3.8 million in the three months ended March 31, 2005. The increase was primarily due to professional fees related to an increase in market research and product profile development activity and regulatory compliance costs, offset in part by the change to the equity method of accounting for our investment in Codexis as of February 28, 2005. Stock compensation expenses included in general and administrative expenses was $6,000 in the three months ended March 31, 2005 compared to $22,000 during the three months ended March 31, 2004. The decrease in general and administrative stock compensation expenses was primarily related to the amortization of deferred compensation relating to the grant of stock options to employees before our initial public offering which was fully amortized to expense by August 2004.

We expect that our general and administrative expenses will increase in 2005, due primarily to increased professional fees, product assessment and personnel costs partially offset by the change to the equity method of accounting for our investment in Codexis as of February 28, 2005. Stock compensation expense related to general and administration will increase upon our implementation of Financial Accounting Standards Board Statement No.

18

Table of Contents

123(R). While we cannot predict the actual impact of the implementation of FASB 123(R) at this time as we are still analyzing its potential impacts, we believe the fair value calculation set forth in Note 1 of the Consolidated Financial Statements will approximate the actual impact of FASB 123(R). We expect to adopt FASB 123(R) on January 1, 2006.

Interest Income and Other (Expense), net

Interest income and other (expense), net represents income earned on our cash, cash equivalents and marketable securities, net of interest expense on our equipment leases and currency transaction gains or losses related to the funding of our Danish subsidiary Maxygen ApS. Interest income and other (expense), net increased from $574,000 in the three months ended March 31, 2004 to $672,000 in the three months ended March 31, 2005. Included in these amounts are foreign exchange losses of $167,000 in the three months ended March 31, 2004 and $596,000 in the three months ended March 31, 2005. The increase is due to increasing interest rates and higher average balances of cash, cash equivalents and marketable securities, partially offset by an increase in foreign exchange losses.

Cumulative Effect Adjustment

Codexis was formed in January 2002 and independently financed by Maxygen and several other investors in September and October of 2002. In August 2004 Codexis received additional equity funding from Pfizer. Until February 28, 2005, Maxygen recognized 100% of the operating results of Codexis even though we only owned a majority of the voting interests in Codexis. At such time we had recorded losses of Codexis in the amount of $26.4 million, which was in excess of our investment basis of $9.8 million. On February 28, 2005, as a result of the acquisition of Julich Fine Chemicals GmbH by Codexis and certain other events, our voting rights in Codexis were reduced below 50%. As a result, as of such date we no longer consolidate the financial position and results of operations of Codexis with Maxygen’s financial results and instead we account for Codexis under the equity method of accounting. To reflect what our basis in Codexis would have been under equity accounting, we recorded a non-recurring cumulative effect adjustment of $16.6 million for the three months ended March 31, 2005 to bring our investment basis in Codexis to zero. This cumulative effect adjustment does not have any tax consequences.

Subsidiary Preferred Stock Accretion

In 2002, Codexis sold $25 million of Codexis series B convertible preferred stock to investors, of which $5 million was purchased by Maxygen and $20 million was purchased by several unrelated investors. Series B convertible preferred stock includes a redemption provision, which provides that the holders of at least a majority of the outstanding shares of series B convertible preferred stock (excluding the series B convertible preferred stock held by Maxygen and its affiliates), voting together as a separate class, may require Codexis to redeem the series B convertible preferred stock. The redemption price for each share will be payable in cash in exchange for the shares of series B convertible preferred stock to be redeemed at a sum equal to the applicable original issue price per share plus five percent (5%) of the original issue price per year from the original issue date until the applicable redemption date, plus declared and unpaid dividends. Notice of redemption can be given at any time on or after the fifth anniversary of the original issue date. In connection with these redemption rights, we recorded accretion of the redemption premium for the series B convertible preferred stock, excluding the shares owned by Maxygen, in the amount of $250,000 in the three months ended March 31, 2004 and $167,000 million in the three months ended March 31, 2005. The accretion was recorded as subsidiary preferred stock accretion on the Consolidated Statement of Operations through February 28, 2005 and as a reduction of additional paid-in capital and an increase to minority interest on the Consolidated Balance Sheets. Any obligation to make redemption payments is solely an obligation of Codexis and any payments are to be made solely from assets of Codexis. Since we no longer consolidate the financial position of Codexis, we no longer reflect amounts as minority interest on our condensed consolidated balance sheet and we have recorded a $2.4 million adjustment to additional paid-in capital to eliminate the reduction of additional paid-in capital that had resulted from Codexis’ preferred stock accretion prior to February 28, 2005.

New Accounting Pronouncements

In November 2004 the FASB delayed the effective date for the measurement and recognition guidance contained in paragraphs 10-20 of EITF 03-01; this delay does not suspend the requirement to recognize other-than-temporary impairments as required by existing authoritative literature. The disclosure requirement of this guidance remains in effect. We do not expect the adoption of the recognition and measurement provisions of EITF 03-01 to significantly impact our results of operations or financial position but will reassess the impact once the rules are finalized.

19

Table of Contents

On December 16, 2004, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 123 (revised 2004), “Share-Based Payment,” which is a revision of FASB Statement No. 123, “Accounting for Stock-Based Compensation.” Statement 123(R) supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and amends FASB Statement No. 95, “Statement of Cash Flows.” Statement 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative. Statement 123(R) must be adopted no later than the beginning of the first fiscal year beginning after June 15, 2005. We expect to adopt Statement 123(R) on January 1, 2006.

Statement 123(R) permits public companies to adopt its requirements using one of two methods:

We plan to adopt Statement 123 using the modified prospective method.

As permitted by Statement 123, we currently account for share-based payments to employees using Opinion 25’s intrinsic value method and, as such, generally recognize no compensation cost for employee stock options. Accordingly, the adoption of Statement 123(R)’s fair value method will have a significant impact on our result of operations, although it will have no impact on our overall cash position. The impact of adoption of Statement 123(R) cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had we adopted Statement 123(R) in prior periods, the impact of that standard would have approximated the impact of Statement 123 as described in the disclosure of pro forma net income and earnings per share in Note 1 to our Notes to Consolidated Financial Statements. Statement 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. The Company cannot estimate what those amounts will be in the future because they depend upon, among other things, levels of share-based payments granted in the future, when employees exercise stock options and if and when we become profitable.

Liquidity and Capital Resources

Since inception, we have financed our continuing operations primarily through private placements and public offerings of equity securities, research and development funding from collaborators and government grants. In addition, on July 1, 2004 we received $64.0 million in cash as proceeds, before estimated income taxes and transaction costs of $1.4 million, from the sale of our agriculture segment, Verdia. As of March 31, 2005, we had $204.4 million in cash, cash equivalents and marketable securities.

Net cash used in operating activities was $6.8 million in the three months ended March 2004 and $14.1 million in the three months ended March 31, 2005. Uses of cash in operating activities were primarily to fund losses from continuing operations. The increase in cash used in operating activities for the three months ended March 31, 2005 primarily relates to the payment of accrued expenses relating to annual bonuses for 2004 and program termination costs during the three months ended March 31, 2005, which were not paid during the three months ended March 31, 2004.

Net cash provided by investing activities was $7.1 million in the three months ended March 31, 2004 and net cash used in investing activities $6.7 million in the three months ended March 31, 2005. The cash provided during 2004 was primarily related to maturities of available-for-sale securities in excess of purchases. The cash used during 2005 was primarily related to purchases of available-for-sale securities in excess of maturities and the $2.6 million used by Codexis to acquire Julich Fine Chemicals GmbH in February 2005. The majority of additions of property and equipment in 2004 and 2005 relate to Codexis’ investment in its bioprocessing facility. We expect to continue to make investments in the purchase of property and equipment to support our operations. We expect to use a portion of our cash to acquire or invest in businesses, products or technologies, or to obtain the right to use such technologies.

20

Table of Contents

Net cash provided by financing activities was $1.6 million in the three months ended March 31, 2004 and the three months ended March 31, 2005. The cash provided during the three months ended March 31, 2004 was primarily from the proceeds of equipment loans entered into by Codexis and the proceeds of the sale of common stock in connection with our Employee Stock Purchase Plan and the exercise of stock options by employees. The cash provided during the three months ended March 31, 2005 was primarily from the proceeds of equipment loans entered into by Codexis net of repayments of such loans, Codexis’ assumption of loans upon the acquisition of Julich and the proceeds of the sale of common stock in connection with our Employee Stock Purchase Plan and the exercise of stock options by employees.

Cash provided by discontinued operations was $164,000 in the three months ended March 31, 2004. The cash provided by discontinued operations in 2004 relates to the amounts owed to Maxygen from Verdia for services provided to Verdia by Maxygen and reimbursement to Maxygen for payments made on behalf of Verdia.

The $2.4 million cash decrease due to the Codexis related net adjustment in the three months ended March 31, 2005 reflects the net impact on cash and cash equivalents due to Maxygen no longer consolidating Codexis after February 28, 2005.

In accordance with FAS No. 52, the functional currency for our Danish operations is its local currency. The effects of foreign exchange rate changes on the translation of the local currency financial statements into U.S. dollars are reported as a component of accumulated other comprehensives income (loss) on the Consolidated Balance Sheets. The effect of exchange rate changes on cash and cash equivalents was an increase of $46,000 in the three months ended March 31, 2004 and $497,000 in the three months ended March 31, 2005.

The following are contractual commitments as of March 31, 2005 associated with debt, lease obligations and material contracts (in thousands):

Assuming our research efforts for existing collaborations and grants continue for their full research terms, as of March 31, 2005 we had total committed funding of approximately $2.7 million remaining to be received over the next two years. Potential milestone payments from our existing collaborations could exceed $280 million based on the accomplishment of specific performance criteria. We may also earn royalties on product sales. In general, the obligation of our corporate collaborators to provide research funding cannot be terminated by either party before the end of the research term unless there has been a material breach of contract or either party has become bankrupt or insolvent. In the case of such an event, the agreement specifies the rights, if any, that each party will retain.

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

Discontinued Operations

The results of discontinued operations reflect the results of Verdia until it was sold on July 1, 2004. Our loss from discontinued operations was $ 1.5 million in the three months ended March 31, 2004.

Collaborative research and development revenue from discontinued operations was $1.4 million in the three months ended March 31, 2004. Collaborative research and development revenue from related party from discontinued operations was $1.2 million in the three months ended March 31, 2004. Grant revenue from discontinued operations was $147,000 in the three months ended March 31, 2004.

21

Table of Contents

Research and development expenses from discontinued operations were $3.2 million in the three months ended March 31, 2004. General and administrative expenses from discontinued operations were $374,000 in the three months ended March 31, 2004.

Interest income and other (expense), net from discontinued operations was $18,000 in the three months ended March 31, 2004. Equity in net loss of joint venture from discontinued operations was $701,000 in the three months ended March 31, 2004.

RISK FACTORS THAT MAY AFFECT RESULTS OF OPERATIONS AND FINANCIAL CONDITION

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

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

We have incurred losses since our inception, including a loss applicable to common stockholders of $33.9 million in 2002 and $33.7 million in 2003. During 2004 we recognized income applicable to common stockholders, primarily due to the sale of Verdia, of $8.3 million, but our loss from continuing operations was $49.1 million. For the three months ended March 31, 2005 we recognized income applicable to common stockholders of $7.7 million primarily due to a non-recurring adjustment of $16.6 million resulting from the cumulative effect adjustment, recorded as a result of the change to the equity method of accounting for our investment in Codexis. The loss from continuing operations for the three months ended March 31, 2005 was $8.7 million. As of March 31, 2005, we had an accumulated deficit of $177.9 million. We expect to incur net losses and negative cash flow from operating activities for at least the next several years. The size of these net losses will depend, in part, on the rate of growth, if any, in our revenues and on the level of our expenses. To date, we have derived substantially all our revenues from collaborations and grants and expect to derive a substantial majority of our revenue from such sources for at least the next several years. Revenues from collaborations and grants are uncertain because our existing agreements have fixed terms and because our ability to secure future agreements will depend upon our ability to address the needs of current and potential future collaborators. We expect to spend significant amounts to fund development of products and further research and development to enhance our core technologies. As a result, we expect that our operating expenses will exceed revenues in the near term and we do not expect to achieve profitability during the next several years. If the time required for us to achieve profitability is longer than we anticipate, we may not be able to continue our business.

We Need to Contain Costs in Order to Achieve Profitability.

We are continuing our efforts to contain costs. We believe strict cost containment in the near term is essential if our current funds are to be sufficient to allow us to achieve future profitability. We assess market conditions on an ongoing basis and plan to take appropriate actions as required. If we are not able to effectively contain our costs and achieve an expense structure commensurate with our business activities and revenues, we may have inadequate levels of cash for future operations or for future capital requirements, which could significantly harm our ability to operate the business.

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

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

22

Table of Contents

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

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

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

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

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

Legislative Actions, Pending and Potential New Accounting Pronouncements and Higher Compliance Costs are Likely to Adversely Impact Our Future Financial Position and Results of Operations.

Future changes in financial accounting standards, including the requirement that we expense all stock option grants and other stock-based compensation to employees beginning in January 2006, may cause adverse, unexpected earnings fluctuations and will adversely affect our financial position and results of operations. The magnitude of the impact of expensing stock-based compensation will depend in part upon the timing and amount of future equity compensation awards. New accounting pronouncements and varying interpretations of such pronouncements have occurred with frequency in the recent past and may occur in the future. In addition we may make changes in our accounting policies in the future. Compliance with changing regulation of corporate governance and public disclosure will also result in additional expenses. Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and Nasdaq National Market listing requirements, are creating uncertainty for companies such as ours and compliance costs are increasing as a result of this uncertainty and other factors. We are committed to maintaining high standards of corporate governance and public disclosure. As a result, we intend to invest all reasonably necessary resources to comply with evolving standards, and this investment will result in increased general and administrative expenses and may cause a diversion of management time and attention from revenue-generating activities to compliance activities.

If We Are Required to Account for Employee Stock Options Using the Fair Value Method, it Will Significantly Increase Our Net Loss.

There has been ongoing public debate concerning whether stock options granted to employees should be treated as a compensation expense and, if so, how to properly value such charges. On December 16, 2004, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 123 (revised 2004), “Share-Based Payment”. Statement 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based at their fair values. Statement 123(R) must be adopted no later than the beginning of the first fiscal year beginning after June 15, 2005. We expect to adopt Statement 123(R) on January 1, 2006. The adoption of Statement 123(R)’s fair value method will have a significant impact on our result of operations. Such charges will significantly increase our net loss and will delay our ability to achieve profitability.

23

Table of Contents

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

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

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

In some cases our collaborators already market a product that could be competitive with the product(s) that we are collaborating with them on for an improved version, and could conduct their operations in a manner that discriminates against the product that we developed.

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

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

Our ability to develop products depends in part on not infringing patents nor other proprietary rights of third parties, and not breaching any licenses that we have entered into with regard to our technologies and products. Others have filed, and in the future are likely to file, patent applications covering genes or gene fragments or corresponding proteins or peptides that we may wish to utilize with our proprietary technologies, or products that are similar to products developed with the use of our technologies or alternative methods of generating gene diversity. If these patent applications result in issued patents and we wish to use the patented technology, we would need to obtain a license from the third party, which may not be available on acceptable terms, if at all.

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

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

24

Table of Contents

Since Our Voting Control of Codexis Has Recently Fallen Below 50%, We No Longer Consolidate Codexis, Which Will Significantly Reduce Our Revenue.

As a result of the issuance of Codexis common stock in connection with the acquisition by Codexis of Julich Fine Chemicals GmbH and certain other events, our voting rights in Codexis have been reduced below 50%. As a result, as of the date upon which such rights fell below 50%, we will no longer consolidate the financial results of Codexis with the financial results of Maxygen. This will result in a significant reduction in the revenue (and expenses) of Maxygen in its consolidated financial statements, which currently include Codexis’ financial results through February 28, 2005. Such a reduction in revenue could lead to a reduction in the share price of our stock.

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

Our future capital requirements will depend on many factors including payments received under collaborative agreements, joint ventures and government grants, the progress and scope of our collaborative and independent research and development projects, the extent to which we advance products into clinical trials with our own resources, the effect of any acquisitions, and the filing, prosecution and enforcement of patent claims.

Changes may also occur that would consume available capital resources significantly sooner than we expect. We may be unable to raise sufficient additional capital. In difficult economic periods the ability of biotechnology companies to raise capital is severely limited, particularly companies such as Maxygen without human therapeutic products in late clinical development. If we fail to raise sufficient funds, we may have to curtail or cease operations. We anticipate that existing cash and cash equivalents and income earned thereon, together with anticipated revenues from collaborations, joint ventures and grants, will enable us to maintain our currently planned operations for at least the next twelve months. If our capital resources are insufficient to meet future capital requirements, we will have to raise additional funds to continue the development of our technologies and complete the commercialization of products, if any, resulting from our technologies. If adequate funds are not available, we will not be able to successfully execute our business plan.

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

Since August 2000, when we acquired Maxygen ApS, a Danish biotechnology company, we have been operating with international business locations. Operation as an international entity requires additional management attention and resources. We have limited experience in operating internationally and in conforming our operations to local cultures, standards and policies. We also must compete with local companies who understand the local situation better than we do. Due to these operational impediments we may have trouble generating revenues from foreign operations. Even if we are successful, the costs of operating internationally are expected to continue to exceed our international revenues for at least the next several years. As we continue to operate internationally, we are subject to risks of doing business internationally, including the following:

The Manufacturing of our Products Candidates Present Technological, Logistical and Regulatory Risks, Each of Which May Adversely Affect our Potential Revenues.

The manufacturing and manufacturing development of pharmaceuticals, and, in particular, biologicals, are technologically and logistically complex and heavily regulated by the FDA and other governmental authorities. The manufacturing and manufacturing development of our products and product candidates present many risks, including, but not limited to, the following:

25

Table of Contents

Any of these factors could delay clinical trials, regulatory submissions and/or commercialization of our products, entail higher costs and result in our being unable to effectively sell our products.

Our Manufacturing Strategy, Which Relies on Third-Party Manufacturers, Exposes us to Additional Risks as a Result of Which We May Lose Potential Revenues.

We do not currently have the resources, facilities or experience to manufacture any product candidates or potential products ourselves. Completion of our clinical trials and commercialization of our products will require access to, or development of, manufacturing facilities that meet FDA standards to manufacture a sufficient supply of our potential products. We currently depend on third parties for the scale up and manufacture of our product candidates for preclinical and clinical purposes. If our third party manufacturers are unable to manufacture preclinical or clinical supplies in a timely manner or are unable or unwilling to satisfy our needs or FDA requirements, it could delay clinical trials, regulatory submissions or commercialization of our potential products, entail higher costs and result in our being unable to sell our products. In addition, technical problems or other manufacturing delays could delay the advancement of potential products into preclinical or clinical trials or result in the termination of development of particular product candidates, adversely affecting our product development timetable, which in turn could adversely affect our stock price.

Substantial Sales of Shares May Adversely Impact the Market Price of our Common Stock.

If our stockholders sell substantial amounts of our common stock, including shares issued upon the exercise of outstanding options, the market price of our common stock may decline. Our common stock trading volume is low and thus the market price of our common stock is particularly sensitive to trading volume. Our low trading volume may also make it more difficult for us to sell equity or equity related securities in the future at a time and price that we deem appropriate. Significant sales of our common stock may adversely impact the then-prevailing market price of our common stock.

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

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

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

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

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

26

Table of Contents

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

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

We will be able to protect our proprietary rights from unauthorized use by third parties only to the extent that our proprietary technologies are covered by valid and enforceable patents or are effectively maintained as trade secrets. The patent positions of biopharmaceutical and biotechnology companies, including our patent positions, are often uncertain and involve complex legal and factual questions. We apply for patents covering our technologies and potential products as we deem appropriate. However, we may not obtain patents on all inventions for which we seek patents, and any patents we obtain may be challenged and may be narrowed in scope or extinguished as a result of such challenges. Our existing patents and any future patents we obtain may not be sufficiently broad to prevent others from practicing our technologies or from developing competing products. Enforcement of our patents against infringers could require us to expend significant amounts with no assurance that we would be successful in any litigation. Others may independently develop similar or alternative technologies or design around our patented technologies or products. In addition, others may challenge or invalidate our patents, or our patents may fail to provide us with any competitive advantages.

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

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

The Food and Drug Administration must approve any vaccine or therapeutic product before it can be marketed in the U.S. Before we can file a new drug application or biologic license application with the FDA, the product candidate must undergo extensive testing, including animal and human clinical trials, which can take many years and require substantial expenditures. Data obtained from such testing are susceptible to varying interpretations that could delay, limit or prevent regulatory approval. In addition, changes in regulatory policy for product approval during the period of product development and regulatory agency review of each submitted new application or product license application may cause delays or rejections. The regulatory process is expensive and time consuming. The regulatory agencies of foreign governments must also approve our therapeutic products before the products can be sold in those other countries.

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

Even if we receive regulatory approval, this approval may entail limitations on the indicated uses for which we can market a product. Further, once regulatory approval is obtained, a marketed product and its manufacturer are subject to continual review, and discovery of previously unknown problems with a product or manufacturer may result in restrictions on the product, manufacturer or manufacturing facility, including withdrawal of the product from the market. In certain countries, regulatory agencies also set or approve prices.

If Approval of Our Potential Products Is Delayed or Potential Products Do Not Perform as Expected, Our Stock Price and Ability to Raise Capital Will be Reduced.

The development and regulatory process for human therapeutic products is long and uncertain. Most product candidates fail before entering clinical trials and most clinical trials do not result in a marketed product. In addition,

27

Table of Contents

due to the nature of human therapeutic research and development, the expected timing of product development and initiation of clinical trials and the results of such development and clinical trials are uncertain and subject to change at any point. This uncertainty may result in research delays; product candidate failures and clinical trial delays and failures. Such delays and failures could drastically reduce the price of our stock and our ability to raise capital. Without sufficient capital, we would need to reduce operations and could be forced to cease operations.

Preclinical Development is a Long, Expensive and Uncertain Process, and We May Terminate One or More of our Current Preclinical Development Programs.

We may determine that certain preclinical product candidates or programs do not have sufficient potential to warrant further funding. Accordingly, we may elect to terminate our programs for such product candidates or programs at any time. If we terminate a preclinical program in which we have invested significant resources, our financial condition and results of operations may be adversely affected, as we will have expended resources on a program that will not provide a return on our investment and we will have missed the opportunity to have allocated those resources to potentially more productive uses. Termination of such programs could cause the price of our stock to drop drastically.

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

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

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

Our Stock Price Has Been, and May Continue to Be, Extremely Volatile, and an Investment in Our Stock Could Decline in Value.

The trading prices of life science company stocks in general, and ours in particular, have experienced significant price fluctuations in the last several years. During the twelve-month period ended March 31, 2005, the price of our common stock on the Nasdaq National Market ranged from $8.15 to $12.79. The valuations of many life science companies without consistent product revenues and earnings, including ours, are high based on valuation standards such as price to sales ratios and progress in product development and/or clinical trials. Trading prices based on these valuations may not be sustained. Any negative change in the public’s perception of the prospects of biotechnology or life science companies could depress our stock price regardless of our results of operations. Other broad market and industry factors may decrease the trading price of our common stock, regardless of our performance. Market fluctuations, as well as general political and economic conditions such as recession or interest rate or currency rate fluctuations, also may decrease the trading price of our common stock. In addition, our stock price could be subject to wide fluctuations in response to factors including the following:

28

Table of Contents

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

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

Our executive officers, directors and principal stockholders together control approximately 29% of our outstanding common stock, including GlaxoSmithKline plc, which owns approximately 18% of our outstanding common stock. As a result, these stockholders, if they act together, and GlaxoSmithKline plc by itself, could exert a significant degree of influence over our management and affairs and over matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. In addition, this concentration of ownership may delay or prevent a change in control of Maxygen and might affect the market price of our common stock, even when a change may be in the best interests of all stockholders. In addition, the interests of this concentration of ownership may not always coincide with our interests or the interests of other stockholders and accordingly, they could cause us to enter into transactions or agreements that we would not otherwise consider. This concentration of ownership could also depress our stock price.

ITEM 3

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk management

Our cash flow and earnings are subject to fluctuations due to changes in foreign currency exchange rates, interest rates, the fair value of equity securities held and our stock price. We attempt to limit our exposure to some or all of these market risks through the use of various financial instruments. There were no significant changes in our market risk exposures during the three months ended March 31, 2005. These activities are discussed in further detail in Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk” of our Annual Report on Form 10-K for the year ended December 31, 2004.

ITEM 4

CONTROLS AND PROCEDURES

Company management is required to perform two evaluations each quarter in connection with its disclosure controls and procedures (“Disclosure Controls”) and its internal control over financial reporting (“Internal Control”). This Controls and Procedures section describes those evaluations, their limitations and the conclusions of Company management based on such evaluations.

Controls Evaluations. Company management, with the participation of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), has (i) evaluated the effectiveness of our Disclosure Controls as of March 31, 2005, and (ii) evaluated whether any change in Internal Control that occurred in the most recently completed fiscal quarter has materially affected, or is reasonably likely to materially affect, our Internal Control.

CEO and CFO Certifications. Appearing as Exhibits 31.1 and 31.2 of this report are the certifications of our CEO and CFO that are required in accordance with Rule 13a-14 of the Exchange Act. This Controls and Procedures section includes the information concerning the controls evaluation referred to in the certifications and it should be read in conjunction with the certifications for a more complete understanding of the topics presented.

Definition of Disclosure Controls. Disclosure Controls are controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act, such as this report, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure Controls are also designed to ensure that such information is accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.

Definition of Internal Control. Internal Control consists of the control processes designed with the objective of providing reasonable assurance regarding the reliability of financial reporting and the preparation of financial

29

Table of Contents

statements for external purposes in accordance with generally accepted accounting principles (“GAAP”) and includes those policies and procedures that (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets, (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures are being made only in accordance with authorizations of management and directors and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements.

Limitations on the Effectiveness of Controls. Our management, including our CEO and CFO, does not expect that our Disclosure Controls and Internal Control 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 will be 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 Maxygen 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 controls. 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, controls may become inadequate because of changes in conditions, or deterioration in the degree of compliance with the policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

Scope of the Controls Evaluation. The CEO/CFO evaluation of our Disclosure Controls included a review of the controls’ objectives and design, the controls’ implementation by Maxygen and the effect of the controls on the information generated for use in this report. In the course of the controls evaluation, we sought to identify errors, controls problems or acts of fraud. Elements of our controls are also evaluated on an ongoing basis by personnel in our Finance department. The overall goals of these various evaluation activities are to monitor our Disclosure Controls and to make modifications as necessary. Our intent in this regard is that the Disclosure Controls will be maintained as dynamic systems that change (including with improvements and corrections) as conditions warrant.

Among other matters, we sought in our evaluation to determine whether there were any significant deficiencies or material weaknesses in our Internal Control, or whether we had identified any acts of fraud involving personnel who have a significant role in our Internal Control. This information was important both for the controls evaluation generally and because item 5 in the certifications of our CEO and CFO require that the CEO and CFO disclose that information to our Audit Committee and to our independent registered public accounting firm.

Quarterly Reports

Quarterly Evaluation of Disclosure Controls. Based upon the controls evaluation, our CEO and CFO have concluded that our Disclosure Controls were effective as of March 31, 2005 to ensure that material information relating to Maxygen and its consolidated subsidiaries is made known to management, including the CEO and CFO, particularly during the period when our periodic reports are being prepared.

Quarterly Evaluation of Changes in Internal Control. During the most recently completed fiscal quarter there have been no significant changes in our Internal Control that has materially affected, or is reasonably likely to materially affect, our Internal Control.

30

Table of Contents

PART II – OTHER INFORMATION

ITEM 1

Legal Proceedings

In December 2001 a lawsuit was filed in the U.S. District Court for the Southern District of New York against Maxygen, Inc., its chief executive officer, Russell Howard and its then chief financial officer, Simba Gill, together with certain underwriters of Maxygen’s initial public offering and secondary public offering of common stock. The complaint, which alleges claims under Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934, is among the so-called “laddering” cases that have been commenced against over 300 companies that had public offerings of securities in 1999 and 2000. The complaint has been consolidated with other laddering claims in a proceeding styled In re Initial Public Offering Securities Litigation, No. 21 MC 92 (SAS), pending before the Honorable Shira A. Scheindlin. In February 2003, the court dismissed the Section 10(b) claim against Drs. Howard and Gill; the remainder of the case remains pending.

In June 2003 the Company agreed to the terms of a tentative settlement agreement along with other defendant issuers in In re Initial Public Offering Securities Litigation. The tentative settlement provides that the insurers of the 309 defendant issuers will pay to the plaintiffs $1 billion less any recovery of damages the plaintiffs receive from the defendant underwriters. If the plaintiffs receive over $5 billion in damages from the defendant underwriters, we will be entitled to reimbursement of various expenses incurred by us as a result of the litigation. As part of the tentative settlement, the Company will assign to the plaintiffs “excess compensation claims” and certain other of its claims against the defendant underwriters based on the alleged actions of the defendant underwriters. The settlement is subject to acceptance by a substantial majority of defendants and execution of a definitive settlement agreement. The settlement is also subject to approval of the Court, which cannot be assured. On February 15, 2005 the Court tentatively approved the proposed settlement, conditioned upon the parties altering the proposed settlement to comply with the Private Securities Litigation Reform Act’s settlement discharge provision. The settlement does not contemplate any settlement payments by Maxygen.

If the settlement is not accepted by the requisite number of defendants or if it is not approved by the Court, the Company intends to defend the lawsuit vigorously. The Company believes the lawsuit against Maxygen and its officers is without merit. However, the litigation is in the preliminary stage, and the Company cannot predict its outcome. The litigation process is inherently uncertain. If the outcome of the litigation is adverse to the Company and if the Company is required to pay significant damages, the Company’s business would be significantly harmed.

The Company is not currently a party to any other material pending legal proceedings.

From time to time, the Company becomes involved in claims and legal proceedings that arise in the ordinary course of its business. The Company does not believe that the resolution of these claims will have a material adverse effect on its financial statements.

ITEM 2

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Not applicable.

ITEM 3

DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

31

Table of Contents

ITEM 5

OTHER INFORMATION

Pre-Approval of Non-Audit Services

In connection with its selection of Ernst & Young LLP to serve as our independent registered public accounting firm for the fiscal year ending December 31, 2005, the Audit Committee of the Board of Directors approved the following non-audit services to be performed by Ernst & Young LLP: (i) consultations regarding ongoing compliance with Section 404 of the Sarbanes-Oxley Act of 2002, (ii) review of the Company’s Form S-8 and Proxy Statement filings and (iii) consultations regarding certain Danish option grant issues.

The Audit Committee has determined that the rendering of the audit-related and tax services described above by Ernst & Young LLP is compatible with maintaining the auditor’s independence.

ITEM 6

EXHIBITS

The following exhibits are filed as part of this report: