INTERMUNE INC - 10-Q Quarterly Report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2003

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number: 0-29801

InterMune, Inc.

(Exact name of registrant as specified in its charter)

Delaware		94-3296648
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

3280 Bayshore Blvd. Brisbane, California 94005
(Address of principal executive offices, including zip code)

(415) 466-2200
(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 ý No o

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

As of May 9, 2003, there were 31,761,594 outstanding shares of Common Stock, par value $.001 per share, of InterMune, Inc.

INTERMUNE, INC.

QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003

INDEX

Item			Page

Part I. Financial Information
1.	Financial Statements (unaudited):		3
	a.	Condensed Consolidated Balance Sheets at March 31, 2003 and December 31, 2002	3
	b.	Condensed Consolidated Statements of Operations for the three months ended March 31, 2003 and 2002	4
	c.	Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2003 and 2002	5
	d.	Notes to Condensed Consolidated Financial Statements	6
2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		12
	Risk Factors		17
3.	Quantitative and Qualitative Disclosures about Market Risk		32
4.	Controls and Procedures		33
Part II. Other Information			34
5.	Other Information		34
6.	Exhibits and Reports on Form 8-K		34
	Signatures and Certifications		36

PART I—FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

INTERMUNE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands, except share and per share data)

	March 31, 2003			December 31, 2002
ASSETS
Current assets:
Cash and cash equivalents	$	67,236		$	101,683
Available-for-sale securities	209,957			214,728
Accounts receivable, net	11,370			12,135
Inventories	9,466			6,604
Prepaid expenses	4,792			2,269
Total current assets	302,821			337,419
Property and equipment, net	10,922			10,833
Acquired product rights, net	29,396			30,336
Restricted cash	1,675			1,675
Notes receivable from employees	918			906
Other assets	3,445			3,712
Total assets	$	349,177		$	384,881

LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:
Accounts payable	$	15,693		$	16,843
Accrued compensation	4,500			5,353
Other current liabilities	14,799			29,590
Total current liabilities	34,992			51,786
Deferred rent	992			877
Convertible subordinated notes	149,500			149,500

Commitments:
Stockholders’ equity:
Convertible preferred stock, $0.001 par value; 5,000,000 shares authorized; no shares issued and outstanding at March 31, 2003 and December 31, 2002, respectively	—			—
Common stock, $0.001 par value, 45,000,000 shares authorized; 31,707,805 and 31,695,672 shares issued and outstanding at March 31, 2003 and December 31, 2002, respectively	32			32
Additional paid-in capital	481,425			481,881
Notes receivable from stockholder	(33		)	(38		)
Deferred stock compensation	(614		)	(947		)
Accumulated other comprehensive income	984			957
Accumulated deficit	(318,101		)	(299,167		)
Total stockholders’ equity	163,693			182,718
Total liabilities and stockholders’ equity	$	349,177		$	384,881

See accompanying Notes to Condensed Consolidated Financial Statements.

INTERMUNE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited, in thousands, except per share amounts)

	Three Months Ended March 31,
	2003			2002
Product sales
Actimmune	$	37,925		$	17,714
Others	2,481			1,038
Total product sales, net	40,406			18,752

Costs and expenses:
Cost of goods sold	9,787			5,403
Amortization of acquired product rights	940			815
Research and development	31,895			23,565
Selling, general and administrative	13,666			14,591
Acquired research and development and milestone payments	1,750			18,750
Total costs and expenses	58,038			63,124
Loss from operations	(17,632		)	(44,372		)
Other income (expense):
Interest income	1,140			1,688
Interest expense	(2,442		)	(2,444		)
Net loss	$	(18,934	)	$	(45,128	)
Basic and diluted net loss per common share	$	(0.60	)	$	(1.58	)
Weighted average shares used in computing basic and diluted net loss per common share	31,535			28,574

See accompanying Notes to Condensed Consolidated Financial Statements.

INTERMUNE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)

	Three Months Ended March 31,
	2003				2002

Cash flows used for operating activities:
Net loss	$	(18,934		)		$	(45,128		)
Adjustments to reconcile net loss to net cash used for operating activities:
Amortization of deferred compensation, net of reversals	(217		)		601
Non-cash stock compensation	17				243
Acquired research and development and milestone payments	1,750				18,750
Amortization and depreciation	1,819				1,434
Deferred rent	115				143
Changes in operating assets and liabilities:
Accounts receivable	765				(4,478			)
Inventories	(2,862		)		743
Other assets	(2,524		)		900
Accounts payable and accrued compensation	(2,003		)		3,765
Other accrued liabilities	2,209				3,982
Net cash used for operating activities		(19,865		)		(19,045			)
Cash flows from investing activities:
Purchase of property and equipment	(712		)		(2,848			)
Purchase of acquired product rights, including research and development and milestone payments	(18,750		)		(2,000			)
Purchases of available-for-sale securities	(121,417		)		(83,402			)
Sales of available-for-sale securities	93,234				26,500
Maturities of available-for-sale securities	32,981				21,092
Net cash used by investing activities	(14,664		)		(40,658			)
Cash flows from financing activities:
Proceeds from issuance of common stock, net	77				105,541
Repayment of notes receivable from stockholder	5				5
Net cash provided by financing activities	82				105,546
Net increase (decrease) in cash and cash equivalents	(34,447		)		45,843
Cash and cash equivalents at beginning of period	101,683				122,915
Cash and cash equivalents at end of period	$	67,236				$	168,758

Supplemental disclosure of cash flow information:
Accrued product rights payable to Marnac	$	—				$	18,750

See accompanying Notes to Condensed Consolidated Financial Statements.

INTERMUNE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of presentation

The accompanying unaudited condensed consolidated financial statements of InterMune, Inc. (“InterMune,” “we,” “our,” or “us”) have been prepared in accordance with generally accepted accounting principles for interim financial information and pursuant to the instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of InterMune’s management, the accompanying unaudited interim condensed consolidated financial statements contain all adjustments, consisting only of normal recurring adjustments, necessary to present fairly our financial position, results of operations and cash flows for the interim periods presented. The balance sheet at December 31, 2002 has been derived from audited financial statements at that date, but does not include all disclosures required by generally accepted accounting principles for complete financial statements.

Certain information and footnote disclosures usually included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. The accompanying interim condensed consolidated financial statements should be read in conjunction with our annual report filed with the SEC on Form 10-K for the year ended December 31, 2002. The results of operations for the interim periods presented are not necessarily indicative of results that may be expected for any other interim period or for the full fiscal year.

Principles of consolidation

The accompanying unaudited condensed consolidated financial statements include the accounts of InterMune and its wholly owned subsidiaries, InterMune Canada Inc., and InterMune Ltd. All intercompany accounts and transactions have been eliminated. To date, the operations of InterMune Canada Inc. and InterMune Ltd. have been immaterial.

Reclassifications

Certain prior year balance sheet amounts have been reclassified to conform with current year presentation.

Use of estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

We evaluate our estimates on an on-going basis, including those related to revenue recognition, bad debts, inventories, accrued clinical and preclinical expenses contingencies. We base our estimations on historical experience and on various other specific assumptions that are believed reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources.

Cash, cash equivalents and available-for-sale securities

Cash and cash equivalents consist of highly liquid investments with original maturities when purchased of less than three months. We classify all debt securities as available for sale. Cash equivalents and available-for-sale securities are carried at fair value, with unrealized gains and losses, and are reported as other comprehensive income, a separate component of stockholders’ equity. We have estimated the fair value amounts by using available market information. The cost of securities sold is based on the specific identification method.

Fair value of financial instruments

Financial instruments, including cash, accounts receivable, accounts payable and accrued liabilities, are carried at cost, which management believes approximates fair value because of the short-term maturity of these instruments. The fair value of convertible subordinated debt was $148.6 million at March 31, 2003, which we determined using available market information.

Concentration of risks

Cash equivalents and investments are financial instruments that potentially subject us to concentration of risk to the extent recorded on the balance sheet. We have established guidelines for investing excess cash relative to diversification and maturities that maintain safety and liquidity. We invest our excess cash in debt instruments of the U.S. Government and its agencies and high-quality corporate issuers, and, by policy, restrict our exposure to any single corporate issuer by imposing concentration limits. To minimize the exposure due to adverse shifts in interest rates, we maintain investments at an average maturity of generally less than two years.

Concentrations of credit risk, with respect to accounts receivable, exist to the extent of amounts presented in the financial statements. Three customers represented 58%, 12% and 12% of total accounts receivable at December 31, 2002, and two customers represented 58% and 14% of total accounts receivable at March 31, 2003. No other customer represented more than 10% of accounts receivable at December 31, 2002 or March 31, 2003.

Product sales to customers representing 10% or more of total sales during the three months ended March 31, are as follows:

Customer	2003		2002

Bergen Brunswig	—		12	%
Cardinal Healthcare	1	%	10	%
Caremark	10	%	8	%
Merck Medco	12	%	5	%
Priority Healthcare	60	%	44	%

Risks from third-party manufacturer concentration

We rely on a single-source manufacturer for each of our products. Actimmune® is produced solely by Boehringer Ingleheim Austria GmbH for all clinical and commercial supplies. Amphotec® is produced solely by Ben Venue Laboratories Inc., and Infergen® is produced solely by Amgen Inc. Any extended interruption in the supply of any products could result in the failure to meet clinical or commercial demand.

We purchase some commercial and clinical products from Boehringer Ingleheim in a foreign currency. This exposes us to foreign currency exchange rate risk, which we monitor as part of our overall risk management program. There are no other significant sources of foreign currency exchange risk. We do not currently hedge this risk.

Inventories

Inventories consist principally of raw materials and finished good products and are stated at the lower of cost or market. Cost is determined by the first-in, first-out (FIFO) method.

Property and equipment

Property and equipment are stated at cost and depreciated using the straight-line method over the estimated useful lives of the assets, which are generally three to five years. Leasehold improvements are amortized over the shorter of the lease term or the estimated useful life of the assets.

Acquired product rights

Initial payments for the acquisition of products that, at the time of acquisition, are already marketed or are approved by the FDA for marketing are typically capitalized and amortized ratably over the estimated life of the products, typically ten years. At the time of acquisition, the product life is estimated based upon the term of the agreement, the patent life of the product and management’s assessment of future sales and profitability of the product. This estimate is assessed regularly during the amortization period, and the asset value or useful life adjusted when appropriate. Initial payments for the acquisition of products that, at the time of acquisition, are under development or are not approved by the FDA for marketing, have not reached technical feasibility and have no foreseeable alternative future uses are expensed as research and development. Accumulated amortization of these intangible assets was $6.7 million at March 31, 2003.

Impairment of long-lived assets

In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, if indicators of impairment exist, we assess the recoverability of the affected long-lived assets by determining whether the carrying value of such assets can be recovered through undiscounted future operating cash flows. If impairment is indicated, we will measure the amount of such impairment by comparing the carrying value of the asset to the present value of the expected future cash flows associated with the use of the asset. To date, no such indicators of impairment have been identified.

Revenue recognition and revenue reserves

Revenue is recognized upon shipment when title passes to a credit-worthy customer, and reserves are recorded for estimated returns, rebates, chargebacks and cash discounts. We are obligated to accept from customers the return of pharmaceuticals that have reached their expiration date. We are able to make reasonable and reliable estimates of product returns based on historical experience. We review all sales transactions for potential chargebacks each month and believe that our reserves are adequate. Shipping and handling costs are included in cost of goods sold.

Research and development expenses

Research and development (or R&D) expenses include salaries, contractor and consultant fees, external clinical trial expenses performed by contract research organizations, in-licensing fees and facility and administrative expense allocations. In addition, we fund R&D at research institutions under agreements which are generally cancelable at our option. Research costs typically consist of preclinical and toxicology work. Pharmaceutical development costs consist of product formulation, chemical analysis and the transfer and scale-up of manufacturing at our contract manufacturers. Clinical development costs include the costs of Phase I, II and III clinical trials. These costs along with the manufacturing scale-up costs are a significant component of research and development expenses.

Management accrues costs for clinical trial activities performed by contract research organizations based upon estimates of the percentage of work completed over the life of the individual study. These estimates may or may not match the actual services performed by the organizations as determined by patient enrollment levels and related activities. We monitor patient enrollment levels and related activities to the extent possible; however, if we underestimate activity levels associated with various studies at a given point in time, we could record significant research and development expenses in future periods. All such costs are charged to R&D expense as incurred.

Advertising costs

We expense advertising costs as incurred.

Income taxes

In accordance with SFAS No. 109, Accounting for Income Taxes, a deferred tax asset or liability is determined based on the difference between the financial statement and tax basis of assets and liabilities as measured by the enacted tax rates which will be in effect when these differences reverse. We provide a valuation allowance against net deferred tax assets unless, based upon the available evidence, it is more likely than not that the deferred tax assets will be realized.

Patent costs

Costs related to patents are expensed as incurred.

Comprehensive income (loss)

SFAS No. 130, Reporting Comprehensive Income, requires components of other comprehensive income, including unrealized gains or losses on our available-for-sale securities to be included in total comprehensive income (loss). Total comprehensive loss for each of the periods presented has been disclosed in the statements of stockholders’ equity.

Net loss per share

Basic net loss per share is computed by dividing the net loss for the period by the weighted average number of common shares outstanding during the period. Shares subject to repurchase by us are deducted from the outstanding shares in arriving at the weighted average shares outstanding. Diluted net loss per share is computed by dividing the net loss for the period by the weighted average number of common and common equivalent shares outstanding during the period. We excluded potentially dilutive securities, composed of incremental common shares issuable upon the exercise of stock options and common shares issuable on conversion of convertible notes, from diluted net loss per share because of their anti-dilutive effect.

2. NEW ACCOUNTING STANDARDS

In June 2002, the Financial Accounting Standards Board issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS No. 146 supersedes Emerging Issues Task Force Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs To Exit an Activity (Including Certain Costs Associated with a Restructuring)” and requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, as opposed to when management is committed to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. This Statement is effective for exit or disposal activities initiated after December 31, 2002. The adoption of SFAS No. 146 did not have a significant effect on our consolidated financial statements.

In November 2002, the FASB issued Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 requires that a liability be recorded in the guarantor’s balance sheet upon issuance of a guarantee. In addition, FIN 45 requires disclosures about the guarantees that an entity has issued, including a rollforward of the entity’s product warranty liabilities. FIN 45 is effective on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements of FIN 45 are effective for financial statements for interim and annual periods ending after December 31, 2002. The adoption of FIN 45 did not have a material impact on our consolidated financial statements.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure.” SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also requires that disclosures of the pro forma effect of using the fair value method of accounting for stock-based employee compensation be displayed more prominently and in a tabular format. Additionally, SFAS No. 148 requires disclosure of the pro forma effect in interim financial statements. The transition and annual disclosure requirements of SFAS No. 148 are effective for our 2002 fiscal year. See Note 7 below for disclosures required by SFAS 148.

In January 2003, the FASB issued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.” FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. We do not expect the adoption of FIN 46 to have a material effect on our results of operations and financial condition.

3. INVENTORIES

Inventories consist principally of raw material and finished good products and are stated at the lower of cost or market. Cost is determined by the first-in, first-out (FIFO) method (in thousands):

	March 31, 2003		December 31, 2002

Raw materials	$	182	$	182
Finished goods	9,284		6,422
Total inventories	$	9,466	$	6,604

4. OTHER ACCRUED LIABILITIES

Other accrued liabilities consist of the following (in thousands):

	March 31, 2003		December 31, 2002

Accrued clinical trial costs	$	7,123	$	4,342
Accrued interest	1,791		3,940
Payable to Amgen	—		2,000
Payable to Eli Lilly	—		15,000
Royalties payable	5,511		4,101
Other accrued liabilities	374		207
Total other accrued liabilities	$	14,799	$	29,590

5. COMPREHENSIVE INCOME (LOSS)

The only component of other comprehensive income is unrealized gains on available-for-sale securities. Comprehensive loss amounted to $18.9 million and $45.5 million for the three months ended March 31, 2003 and 2002, respectively.

6. DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION

We have determined that we have only one reportable segment because our management has organized our business around its functional lines.

Net product sales consisted of the following (in thousands):

	Three Months Ended March 31,
	2003		2002
Actimmune	$	37,925	$	17,714
Other	2,481		1,038
Total net product sales	$	40,406	$	18,752

The following table summarizes total net product sales from external customers by geographic regions. Revenues are attributed to countries based on the location of the customer (in thousands):

	Three Months Ended March 31,
	2003		2002
United States	$	39,731	$	17,987
Other countries	675		765
Total net product sales	$	40,406	$	18,752

7. STOCK-BASED COMPENSATION

We follow APB Opinion No. 25, “Accounting for Stock Issued to Employees,” in accounting for stock-based incentives. In October 1995 the FASB issued SFAS 123, “Accounting for Stock Based Compensation,” and in December 2002 the FASB issued SFAS 148, “Accounting for Stock-Based Compensation — Transition and Disclosure.” Although these pronouncements allow us to continue to follow the APB 25 guidelines for measuring and recording of employee stock-based compensation expense, we are required to disclose the effect on net loss and net loss per share as if we had applied fair value recognition provisions of SFAS 123 to stock-based employee compensation. The following tables provide such disclosure (in thousands except per share amounts):

	Three Months Ended March 31,
	2003			2002

Net loss, as reported	$	(18,934	)	$	(45,128	)
Add: Stock-based employee compensation expense, included in reported net loss, net of related tax effects	(217		)	601
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects	(6,174		)	(8,081		)

Pro forma net loss	$	(25,325	)	$	(52,608	)

Net loss per share:
Basic and diluted—as reported	$	(0.60	)	$	(1.58	)
Basic and diluted—pro forma	$	(0.80	)	$	(1.84	)

The pro forma impact of applying SFAS 123 in the first quarter of fiscal years 2003 and 2002 does not necessarily represent the pro forma impact in future quarters or years.

We estimate the fair value of each option grant on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:

	Three Months Ended March 31,
	2003		2002

Expected stock price volatility	83	%	88	%
Risk-free interest rate	1.75	%	3.88	%
Expected life (in years)	5.7		3.3
Expected dividend yield	—		—

We estimate the fair value of the employees’ stock purchase rights using the Black-Scholes option-pricing model with the following weighted average assumptions:

	Three Months Ended March 31,
	2003		2002

Expected stock price volatility	87	%	90	%
Risk-free interest rate	2.6	%	4.7	%
Expected life (in years)	2.0		2.0
Expected dividend yield	—		—

The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. This model also requires the input of highly subjective assumptions including the expected stock price volatility. Because our outstanding stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect this estimate, we believe the Black-Scholes model does not provide a reliable single measure of the fair value of our stock options.

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The discussion in this Quarterly Report on Form 10-Q contains forward-looking statements that involve risks and uncertainties. The statements contained in this report that are not historical statements are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements regarding our expectations, beliefs, intentions or strategies regarding the future, such as those, without limitation, in the discussions about:

• our strategy;

• governmental regulation and approval;

• sufficiency of our cash resources;

• revenues, including those from product sales and collaborations;

• product and product candidate development;

• our research and development expenses and other expenses; and

• our operational and legal risks.

All forward-looking statements included in this document are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. Our actual results could differ materially from those described in our forward-looking statements, and we caution readers not to place undue reliance on such statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this report under the heading “Risk Factors” below.

Overview

We are an independent biopharmaceutical company focused on developing and commercializing innovative products for the treatment of serious pulmonary, infectious and hepatic diseases. We have three marketed products, growing product revenues and advanced-stage clinical programs addressing a range of diseases with attractive markets. Our three marketed products are Actimmune®, Infergen® and Amphotec®. Actimmune is approved in the United States for two rare congenital disorders: chronic granulomatous disease and severe, malignant osteopetrosis. We market Infergen in the United States and Canada for the treatment of chronic hepatitis C infections. We have world-wide marketing rights to Amphotec for the treatment of invasive aspergillosis. We have a late-stage development pipeline that includes lead clinical programs focused on the development of interferon gamma-1b for the treatment of fibrotic diseases, cancer and infectious diseases; and oritavancin for the treatment of serious gram-positive infections. We also have clinical development programs for pirfenidone for the treatment of idiopathic pulmonary fibrosis and other fibrotic diseases and for a pegylated form of interferon alfacon-1 (PEG-Infergen) for the treatment of chronic hepatitis C infections. InterMune was incorporated in Delaware in March 2000.

We have sustained losses on a quarterly and an annual basis since inception. As of March 31, 2003, we had an accumulated deficit of $318.1 million. Our loss from operations was $17.6 million for the three-month period ended March 31, 2003, and $44.4 million for the same period in 2002. These losses resulted from significant costs incurred in the development and commercialization of our products and product candidates and the acquisition of new technology.

Our expenses have consisted primarily of those incurred for research and development, sales and marketing and general and administrative costs associated with our operations. We expect that our research and development expenses will increase as we continue clinical development of our products and product candidates, and other expenses will increase as we expand our operations domestically and internationally. As a result, we expect to incur losses through at least the end of 2004.

We have a limited history of operations and expect that our quarterly and annual results of operations will fluctuate for the foreseeable future due to several factors, including market acceptance of current or new products, patent conflicts, the introduction of new products by our competitors, the timing and extent of our research and development efforts and the timing of significant orders. Our limited operating history makes accurate prediction of future operating results difficult or impossible.

Drug development in the United States is a process that includes several steps defined by the U.S. Food and Drug Administration (or FDA). The process begins with the filing of an Investigational New Drug Application (or IND) which, if successful, allows opportunity for clinical study of the potential new medicine. Clinical development typically involves three phases of trials: Phase I, II and III, and we have found that it accounts for an average of seven years of a drug’s total development time. The FDA may require, or companies may pursue, additional clinical trials after a product is approved. These so-called Phase IV trials may be made a condition to be satisfied after a drug receives approval. The results of Phase IV trials can confirm the effectiveness of a drug and can provide important safety information to augment the FDA’s voluntary adverse drug reaction reporting system. The most significant costs associated with clinical development are the Phase III trials, as they tend to be the longest and largest studies conducted during the drug development process. The successful development of our product candidates is highly uncertain. An estimation of product completion dates and completion costs can vary significantly for each product and are difficult to 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 responding to a New Drug Application (or NDA), a Biologic License Application (or BLA) or an NDA or BLA supplement, the FDA may grant marketing approval, request additional information or deny the application if it determines that the application does not provide an adequate basis for approval.

Status of Product Development Programs

We are pursuing the following product development programs:

Product Development Programs		Clinical Status at March 31, 2003

*INTERFERON GAMMA-1b*
Idiopathic pulmonary fibrosis		Phase III
Ovarian cancer		Phase III
Invasive aspergillosis		Phase II*
Liver fibrosis		Phase II
Non-Hodgkin’s Lymphoma		Phase IV

*NEXT-GENERATION INTERFERON GAMMA*		Preclinical studies

*ORITAVANCIN*
Complicated skin and skin-structure infections		Phase III
Bacteremia		Phase II*

*INFERGEN*
Chronic hepatitis C infections		Phase IV *

*PEG-INFERGEN*
Chronic hepatitis C infections		Phase I

*PIRFENIDONE*
Pulmonary fibrosis		Phase II*
Renal fibrosis		Phase II*
Hypertrophic cardiomyopathy		Phase II*
Hepatic cirrhosis		Phase II*
Radiation-induced fibrosis		Phase II*

* These clinical trials were initiated under investigational new drug applications held by a party other than InterMune.

Results of Operations

Revenue

Total product revenues were $40.4 million and $18.8 million for the three-month periods ended March 31, 2003 and 2002, respectively. Total revenues increased 115% over the comparable period in 2002, attributable to a volume increase in Actimmune sales over the comparable period. Actimmune revenues accounted for 94% of net product sales in each of the quarters ended March 31, 2003 and 2002, respectively. We project total net product sales for 2003 to be in the range of $170 million to $195 million, with Actimmune net product sales projected to be in the range of $160 million to $180 million for the year.

Cost of goods sold

Cost of goods sold were $9.8 million and $5.4 million for the three-month periods ended March 31, 2003 and 2002, respectively. Cost of goods sold included product manufacturing costs, royalties and distribution costs associated with our revenues. The gross margin percentage for our products was 76% and 71% for these periods in

2003 and 2002, respectively. The increase in gross margin for the first three months of 2003, when compared to the same period in 2002, was related to mix of products sold during the period and a lower effective royalty on Actimmune revenues.

Amortization of acquired product rights

We recorded amortization of acquired product rights of $0.9 million and $0.8 million for the three-month periods ended March 31, 2003 and 2002, respectively. The amount in the first quarter of 2003 was comprised of the amortization charges related to the acquisition of Amphotec, Infergen and interferon gamma patents. The 2002 amount was comprised of the amortization charge related to the acquisition of Amphotec and Infergen only.

Research and development expenses

Research and development expenses were $31.9 million and $23.6 million for the three-month periods ended March 31, 2003 and 2002, respectively, representing an increase of $8.3 million or 35%.

The increase in spending in the quarter in 2003, when compared to the same period in 2002, was due primarily to increased costs for clinical trial expenses for Actimmune and PEG-Interferon in new disease indications, clinical trial expenses and pre-FDA approval manufacturing qualification expenses for oritavancin. We expect that research and development expenses for the full year 2003 will be approximately $140 million to $150 million.

Selling, general and administrative expenses

Selling, general and administrative expenses were $13.7 million and $14.6 million for the three-month periods ended March 31, 2003 and 2002, respectively, representing a decrease of 6%.

The decrease in spending in the quarter in 2003, when compared to the same period in 2002, was attributable primarily to the consolidation and realignment of our sales and marketing team in 2003. We anticipate that selling, general and administrative expenses will continue to increase in absolute dollars as a result of the anticipated expansion of our administrative staff, increased marketing and selling expenses for our products in their approved diseases, and the expenses associated with expansion of our operations worldwide. We expect that selling, general and administrative expenses for the full year 2003 will be approximately $80 million to $85 million.

Acquired research and development and milestone payments

We recorded charges for acquired research and development and milestone payments of $1.8 million and $18.8 million for the three-month periods ended March 31, 2003 and 2002, respectively. The charge in 2003 related to certain milestone payments made in the period as a result of the commencement of the Phase I clinical trial for PEG-Infergen. We expensed this amount as acquired in-process research and development as PEG-Infergen is currently in clinical development, has not reached technical feasibility and has no foreseeable alternative future uses.

The charge in 2002 was related to our March 2002 license of the worldwide rights, excluding Japan, Korea and Taiwan, from Marnac, Inc., a privately held biopharmaceutical company, and its co-licensor KDL GmbH to develop and commercialize pirfenidone for all fibrotic diseases, including renal, liver and pulmonary fibrosis. Pirfenidone is not currently approved by the FDA. At the time of the product acquisition from Marnac and KDL, pirfenidone was in Phase II clinical development for certain fibrotic diseases of the lung, kidney and liver. Under the terms of the agreement, we received an exclusive license from Marnac and KDL in exchange for an up-front cash payment of $18.8 million and future milestone and royalty payments. We expensed the $18.8 million as acquired in-process research and development cost as pirfenidone is currently in clinical development, has not reached technical feasibility and has no foreseeable alternative future uses.

Interest income

Interest income decreased to $1.1 million for the three-month period ended March 31, 2003, compared to $1.7 million for the three-month period ended March 31, 2002. The interest income for the quarter in 2003, when compared to the same period in 2002, reflected declining investment yields on our cash and short-term investments

resulting from substantially lower market interest rates.

Interest expense

Interest expense of $2.4 million for the three-month period ended March 31, 2003, was consistent with the $2.4 million for the three-month period ended March 31, 2002. The sole component of interest expense for both of the periods in 2003 and 2002 was interest expense on the $149.5 million aggregate principal amount of 5.75% convertible subordinated notes issued in July 2001. These convertible subordinated notes mature in July 2006.

Liquidity and Capital Resources

At March 31, 2003, we had available cash, cash equivalents and available-for-sale securities of $277.2 million. Our cash reserves are held in a variety of interest-bearing instruments including high-grade corporate bonds, commercial paper and money market accounts. Cash in excess of immediate requirements is invested with regard to liquidity and return and, wherever possible, we seek to minimize the potential effects of concentration and degrees of risk.

For the three-month period ended March 31, 2003, cash expenditures for operating activities, additions to capital equipment and product acquisitions were $39.3 million. We anticipate that these expenditures will continue to increase in future periods.

Cash used in operations for the three-month periods ended March 31, 2003 and 2002, was $19.9 million and $19.0 million, respectively. The increase in cash used in operations was principally due to increases in net operating assets. Non-cash charges for the period in 2003 included amortization of acquired product rights, depreciation and a one time in-process research and development charge totaling $1.8 million. Significant changes in operating assets and liabilities in 2003 reflect a decrease in accounts receivable due to prompt cash receipts during the period, which was offset by a decrease in accounts payable and accrued compensation as a result of the timing of certain payments for operations in the period. Also impacting cash used in operations were an increase in other accrued liabilities principally due to higher clinical trial activities and higher royalties payable as a result of increased sales volume, and higher inventory levels to support increased sales volume.

Investing activities used $14.7 million in cash during the three-month period ended March 31, 2003, due in part to purchases of short-term investments totaling $121.4 million offset by $126.2 million of short-term investment maturities and sales, purchases of property and equipment of $0.7 million, and final payments to Amgen of $2.0 million for certain interferon gamma patents, and $15.0 million to Eli Lilly for the royalty rate reduction for future sales of oritavancin.

Cash provided by financing activities of $0.1 million for the three-month period ended March 31, 2003 was primarily the result of cash received for the exercise of stock options in the period.

We do not have any “special purpose” entities that are unconsolidated in our financial statements. We have no commercial commitments or loans with related parties, except for ongoing payments in connection with the oritavancin acquisition from Eli Lilly to Nicholas Simon, a former member of our Board of Directors who resigned in February 2003, and an executive employee loan to Dr. Marianne Armstrong, our Senior Vice President of Global Regulatory Operations and Corporate Compliance, that was in place prior to the enactment of the Sarbanes-Oxley Act of 2002.

We believe that we will continue to require substantial additional funding in order to complete the research and development activities currently contemplated and to commercialize our proposed products. We believe our existing cash, cash equivalents and available-for-sale securities, together with anticipated cash flows from our operations, will be sufficient to fund our operating expenses, debt obligations and capital requirements through at least the end of 2004. However, this forward-looking statement is based upon our current plans and assumptions, which may change, and our capital requirements may increase in future periods. Our future capital requirements will depend on many factors, including, but not limited to:

• the commercial performance of any of our products or product candidates in development that

receive commercial approval;

• our ability to partner our development and commercialization programs;

• the progress of our research and development efforts;

• the scope and results of preclinical studies and clinical trials;

• the costs, timing and outcome of regulatory reviews;

• determinations as to the commercial potential of our products in development;

• the pace of expansion of administrative expenses;

• the status of competitive products;

• the establishment of manufacturing capacity through third-party manufacturing agreements;

• the pace of expansion of our sales and marketing capabilities, in preparation for product launches;

• our possible geographic expansion;

• the establishment of collaborative relationships with other companies;

• the payments of the annual interest on our convertible subordinated debt; and

• whether in 2006 we must repay the principal in connection with our convertible subordinated debt.

As a result, we may require additional funds and may attempt to raise additional funds through equity or debt financings, collaborative arrangements with corporate partners or from other sources. We have no commitments for such fund raising activities. Additional funding may not be available to finance our operations when needed or, if available, the terms for obtaining such funds may not be favorable or may result in dilution to our stockholders.

RISK FACTORS

An investment in our common stock is risky. Stockholders and potential investors in shares of our stock should carefully consider the following risk factors, which update those risks contained in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2002 that was filed with the SEC on March 31, 2003, in addition to other information and risk factors in this report. We are identifying these risk factors as important factors that could cause our actual results to differ materially from those contained in any written or oral forward-looking statements made by or on behalf of InterMune. We are relying upon the safe harbor for all forward-looking statements in this report, and any such statements made by or on behalf of InterMune are qualified by reference to the following cautionary statements, as well as to those set forth elsewhere in this report.

We may not succeed in our development efforts or in growing product revenues.

We commenced operations in 1998 and have incurred significant losses to date. Our revenues have been limited primarily to sales of Actimmune. Although we are developing Actimmune for the treatment of idiopathic pulmonary fibrosis, ovarian cancer, invasive aspergillosis, liver fibrosis and non-Hodgkin’s lymphoma, Actimmune will not be marketed for any of these diseases before 2006, if at all. We market Infergen for the treatment of chronic hepatitis C infections, but we do not believe that Infergen will provide significant revenue to us before 2004, if ever. Although Amphotec has received regulatory approvals for commercial sales for invasive aspergillosis, we do not believe that it will provide significant revenue to us in the near future, if ever. We are developing oritavancin for the treatment of complicated skin and skin-structure infections and bacteremia, are planning a Phase III clinical trial of oritavancin for the treatment of nosocomial pneumonia, and are considering developing oritavancin for the treatment of other gram-positive bacterial infections, but oritavancin will not be marketed for any diseases before 2005, if at all. We are

developing PEG-Infergen, a pegylated form of Infergen, for the treatment of chronic hepatitis C infections, but PEG-Infergen will not be marketed for the treatment of chronic hepatitis C infections before 2007, if at all. We are developing pirfenidone for the treatment of idiopathic pulmonary fibrosis and other fibrotic diseases, but pirfenidone will not be marketed for any diseases before 2008, if at all.

Clinical development is a long, expensive and uncertain process, and delay or failure can occur at any stage of any of our clinical trials.

To gain approval to market a product for treatment of a specific disease, we must provide the FDA and foreign regulatory authorities with clinical data that demonstrate the safety and statistically significant efficacy of that product for the treatment of disease. Clinical development is a long, expensive and uncertain process, and delay or failure can occur at any stage of any of our clinical trials. A number of companies in the pharmaceutical industry, including biotechnology companies, have suffered significant setbacks in advanced clinical trials, even after promising results in earlier trials. Success in preclinical testing and early clinical trials does not ensure that later clinical trials will be successful.

For example, we recently reported data from our Phase III clinical trial of Actimmune for the treatment of idiopathic pulmonary fibrosis. The data show that Actimmune did not demonstrate statistically significant efficacy with respect to the primary or secondary endpoints of the Phase III clinical trial, although we believe that the data suggest possible survival benefits for certain patients with a mild-to-moderate form of the disease. We expect to analyze and disclose an additional four months of patient data and to disclose our additional analyses of the data from this Phase III clinical trial. If the additional data or our additional analyses show safety concerns, or do not confirm our survival observations of the initial data, we may decide to delay or stop further development of Actimmune for the treatment of idiopathic pulmonary fibrosis. The cessation of, or a significant delay in, Actimmune development activities for the treatment of idiopathic pulmonary fibrosis would have a material adverse effect on our business prospects and may cause our stock price to drop dramatically. Even if we do not delay or stop Actimmune development activities, any additional report of clinical trial results that are below the expectations of financial analysts or investors may result in a precipitous decline in our stock price.

We plan to meet with the FDA to discuss the results of this Phase III clinical trial, potential next steps to substantiate our survival observations and the possibility of conducting an additional trial of Actimmune for the treatment of patients with mild-to-moderate idiopathic pulmonary fibrosis. Generally, before granting a marketing approval of a drug for the treatment of a disease, the FDA requires that the drug demonstrate safety and statistically significant efficacy with respect to the primary and/or secondary endpoints of the clinical trial. We therefore believe that the FDA will require us to conduct an additional Phase III clinical trial of Actimmune for the treatment of idiopathic pulmonary fibrosis prior to approving Actimmune for the treatment of idiopathic pulmonary fibrosis.

If the FDA requires us to conduct another Phase III clinical trial of Actimmune for the treatment of idiopathic pulmonary fibrosis, we may not be able to reach agreement with the FDA as to the appropriate protocol for the additional Phase III clinical trial. In addition, even if we were to conduct another Phase III clinical trial, Actimmune may not demonstrate safety or statistically significant efficacy with respect to the primary or secondary endpoints of the protocol of that or any additional clinical trial. If such an additional Phase III clinical trial were to fail to demonstrate statistically significant efficacy, we may abandon the development of Actimmune for the treatment of idiopathic pulmonary fibrosis.

We have conducted other clinical trials that have not had positive results. We terminated our Phase III clinical trial of Actimmune for the treatment of multidrug-resistant tuberculosis after early microbiological results indicated that a standard nebulizer may not be an effective route of administration of Actimmune in patients with multidrug-resistant tuberculosis. We also terminated our Phase II clinical trial of Actimmune administered subcutaneously for the treatment of cystic fibrosis after interim results showed no treatment benefit. Our Phase II clinical trial of Actimmune administered by nebulizer for the treatment of cystic fibrosis was completed, but showed no treatment benefit. We terminated our Phase II clinical trial of Actimmune administered by nebulizer for the treatment of pulmonary mycobacterium avium complex after an interim analysis of the data showed no treatment benefit.

We do not know whether our planned clinical trials will begin on time, or at all, or will be completed on schedule, or at all. The commencement or completion of our clinical trials may be delayed or halted for numerous

reasons, including the following:

• a country’s regulatory authority does not approve a clinical trial protocol;

• patients do not enroll in clinical trials at the rate we expect;

• patients experience adverse side effects;

• patients die during a clinical trial for a variety of reasons, including the advanced status of their disease and medical problems that are not related to our products or product candidates;

• third-party clinical investigators may not perform our clinical trials on our anticipated schedule or consistent with the clinical trial protocol and good clinical practices, and other third-party organizations may not perform data collection and analysis in a timely or accurate manner;

• our contract laboratories fail to follow good clinical practices;

• the results of the clinical trial are inconclusive or negative; or

• sufficient quantities of the trial drug may not be available.

Our development costs will increase if we have material delays in our clinical trials or if we need to perform more or larger clinical trials than planned. For example, our development costs related to the use of Actimmune for the treatment of idiopathic pulmonary fibrosis will increase as a result of the statistically insignificant results in our recently completed Phase III clinical trial. If the delays are significant, our financial results and the commercial prospects for our products and product candidates will be harmed, and our prospects for profitability will be impaired.

Our failure to comply with FDA regulations prohibiting promotion of off-label uses and the promotion of products for which marketing clearance has not been obtained could result in regulatory enforcement action by the FDA, which would harm our business.

Physicians may prescribe legally available drugs for uses that are not described in the product’s labeling and that differ from those uses tested by us and approved by the FDA. Such off-label uses are common across medical specialties. For example, even though the FDA has not approved the use of Actimmune for the treatment of idiopathic pulmonary fibrosis, we are aware that physicians are prescribing Actimmune for the treatment of idiopathic pulmonary fibrosis. Likewise, we are aware that physicians are prescribing Infergen in combination with ribavirin for the treatment of chronic hepatitis C infections even though this combination has not been approved by the FDA for the treatment of chronic hepatitis C infections. The FDA does not regulate the behavior of physicians in their choice of treatments. The FDA does, however, restrict manufacturers’ communications on the subject of off-label use. Companies may not promote FDA approved drugs for off-label uses. Accordingly, we may not market Actimmune for the treatment of idiopathic pulmonary fibrosis, or Infergen in combination with ribavirin for the treatment of chronic hepatitis C infections. The FDA actively enforces regulations prohibiting promotion of off-label uses and the promotion of products for which marketing clearance has not been obtained. Failure to comply with these requirements can result in regulatory enforcement action by the FDA, which would have an adverse effect on our revenues, business and financial prospects, which would harm our business.

Budget constraints may force us to delay our efforts to develop certain products in favor of developing others, which may prevent us from meeting our stated timetables and commercializing such products as quickly as possible.

Because we are an emerging company with limited resources, and because research and development is an expensive process, we must regularly assess the most efficient allocation of our research and development budget. Accordingly, we may choose to delay our research and development efforts for a promising product candidate to allocate those resources to another valuable program, which could cause us to fall behind our initial timetables for development. As a result, we may not be able to fully realize the value of some of our product candidates in a timely manner, as they will be delayed in reaching the market.

The actual maximum market or peak revenue opportunity associated with our products or product candidates for the treatment of particular diseases may be much lower than our current or future estimates, causing a delay in our ability to become profitable.

In the course of conducting clinical trials, we may obtain results that require us to significantly revise our initial estimate for the maximum market or peak revenue opportunity for a product or product candidate for the treatment of particular diseases. In addition, even if our products or product candidates are approved for use in connection with one or more particular diseases, the actual maximum market or peak revenue opportunity for our products or product candidates for each disease may be much less than our estimates.

There are a number of reasons why there can be no assurance as to the portion of these maximum market or peak revenue opportunities we will realize, if at all, including if:

• only a subset of or no affected patients respond to therapy with any of our products or product candidates;

• the actual dose or efficacy of the product for a particular condition is different than currently anticipated;

• the treatment regimen is different in duration than currently anticipated;

• treatment is sporadic;

• we cannot sell a product at the price we expect;

• there are current and future competitive products that have greater acceptance in the markets than our products do; or

• we decide to launch a product, such as oritavancin, in fewer indications than we originally anticipated.

In the future, we may continue to make projections as to the potential market size or peak revenues for our products and product candidates and our anticipated date of profitability, but such projections remain subject to these factors and other risks described in this report.

If the FDA limits our communications with physicians related to the use of our products for any disease or withdraws its approval of any of our products for any disease for which they have been approved, our revenues would decline.

The FDA and foreign regulatory authorities may impose significant restrictions on the use or marketing of our products or impose ongoing requirements for post-marketing studies. Later discovery of previously unknown problems with any of our products or their manufacture may result in further restrictions, including withdrawal of the product from the market. Our existing approvals for disease, and any new approval for any other disease that we target, if granted, could be withdrawn for failure to comply with regulatory requirements or to meet our post-marketing commitments. If approval for a disease is withdrawn, we could no longer market the affected product for that disease. In addition, governmental authorities could seize our inventory of such product, or force us to recall any product already in the market, if we fail to comply with FDA or other governmental regulations.

If our clinical trials fail to demonstrate to the FDA and foreign regulatory authorities that any of our products or product candidates are safe and effective for the treatment of particular diseases, the FDA and foreign regulatory authorities will not permit us to market such products or product candidates for those diseases.

Our failure to adequately demonstrate the safety and effectiveness of any of our products or product candidates for the treatment of particular diseases will prevent our receipt of the FDA’s and other regulatory authorities’ approval and, ultimately, may prevent commercialization of our products and product candidates for those diseases.

The FDA and foreign regulatory authorities have substantial discretion in deciding whether, based on its benefits and risks in a particular disease, any of our products or product candidates should be granted approval for the treatment of that particular disease. Even if we believe that a clinical trial has demonstrated the safety and statistically significant efficacy of any of our products or product candidates for the treatment of a disease, the results may not be satisfactory to the FDA or other regulatory authorities. Preclinical and clinical data can be interpreted by the FDA and other regulators in different ways, which could delay, limit or prevent regulatory approval.

If regulatory delays are significant, our financial results and the commercial prospects for those of our products or product candidates involved will be harmed, and our prospects for profitability will be impaired.

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 the allocation of resources. Accordingly, we may elect to terminate our programs for and, in certain cases, our licenses to such product candidates or programs. For example, we have terminated our current research programs and licenses relating to pseudomonas aeruginosa, staphylococcus aureus and Moli1901 (duramycin) for cystic fibrosis.

We may not be able to obtain, maintain and protect certain proprietary rights necessary for the development and commercialization of our products or product candidates.

Our commercial success will depend in part on obtaining and maintaining patent protection on our products and product candidates and successfully defending these patents against third-party challenges. Our ability to commercialize our products will also depend in part on the patent positions of third parties, including those of our competitors. The patent positions of pharmaceutical and biotechnology companies can be highly uncertain and involve complex legal and factual questions. No consistent policy regarding the breadth of claims allowed in biotechnology patents has emerged to date. Accordingly, we cannot predict the scope and breadth of patent claims that may be afforded to other companies’ patents. In addition, we could incur substantial costs in litigation if we are required to defend against patent suits brought by third parties, or if we initiate these suits.

The degree of future protection for our proprietary rights is uncertain, and we cannot ensure that:

• we were the first to make the inventions covered by each of our pending patent applications;

• we were the first to file patent applications for these inventions;

• others will not independently develop similar or alternative technologies or duplicate any of our technologies;

• any of our pending patent applications will result in issued patents;

• any of our issued patents or those of our licensors will be valid and enforceable;

• any patents issued to us or our collaborators will provide a basis for commercially viable products or will provide us with any competitive advantages or will not be challenged by third parties;

• we will develop additional proprietary technologies that are patentable; or

• the patents of others will not have a material adverse effect on our business.

Others have filed and in the future may file patent applications covering uses and formulations of interferon gamma-1b, interferon alpha, pegylated versions of these products and other products in our development program. If a third party were issued a patent that blocked our ability to commercialize any of our products for any or all of the diseases that we are targeting, we would be prevented from commercializing that product for that disease or diseases unless we obtained a license from the patent holder. We may not be able to obtain such a license to a blocking patent on commercially reasonable terms, if at all.

Any legal action against our collaborators or us claiming damages and seeking to stop our commercial activities relating to the affected products and processes could, in addition to subjecting us to potential liability for damages, require our collaborators or us to obtain a license to continue to manufacture or market the affected products and processes. We cannot predict whether our collaborators or we would prevail in any of these actions or whether any license required under any of these patents would be made available on commercially reasonable terms, if at all. We believe that there is and will continue to be significant litigation in our industry regarding patent and other intellectual property rights.

We license certain patents relating to Actimmune, oritavancin, Infergen and pirfenidone from Genentech, Inc., Eli Lilly and Company, Amgen Inc., and Marnac, Inc. and KDL GmbH, respectively. If we breach any of our agreements with Genentech, Eli Lilly, Amgen or Marnac and KDL, any of these licensors could terminate the respective license, and we would have no further rights to utilize the licensed patents or trade secrets to develop and market the corresponding products.

We have licensed certain patents relating to Actimmune from Genentech. Certain of the U.S. patents covering DNA vectors and host cells relating to interferon gamma-1b expire in 2005 and 2006. In addition, a U.S. patent relating to the composition of interferon gamma-1b expires in 2014. Other material U.S. patents expire between 2009 and 2013. Six of Genentech’s U.S. patents and certain Amgen patent applications were involved in an interference as originally declared by the U.S. Patent and Trademark Office. In May 2002, we purchased the Amgen patent applications involved in the interference. In a decision granting a motion we filed in the interference, the U.S. Patent and Trademark Office redeclared the interference between our (formerly Amgen’s) patent applications and only one of the six Genentech patents that were involved in the original interference. As a result, the claims of the five Genentech patents no longer involved in the interference are not subject to revocation in that interference. Nevertheless, one or more claims of the sole Genentech patent and/or one or more claims of our (formerly Amgen’s) patent applications remaining in the interference may be revoked as a result of that interference. However, even if all of the claims in the interference were revoked, we would still retain patent protection for interferon gamma-1b through 2014.

We have licensed certain patents throughout the world relating to oritavancin from Eli Lilly. After patents related to the oritavancin compound expire in 2015, we will not be able to use such patents to block others from marketing oritavancin. In addition, we are aware of two U.S. patents, and corresponding European, Australian, Korean, Canadian and Japanese patents, that relate to a molecule that is produced during the manufacture of oritavancin. A derivative of this molecule is retained in the final oritavancin product. If any of these patents is interpreted to cover the oritavancin manufacturing process, any molecules formed during the manufacturing process or the final oritavancin product itself, we believe that such patent or patents could enable the patent holder to block our ability to commercialize oritavancin unless we obtained a license under such patent or patents. We cannot predict whether we would be able to obtain a license on commercially reasonable terms, if at all. If we were not able to obtain such a license under the patents on commercially reasonable terms, or at all, it would have a material adverse effect on our ability to commercialize the oritavancin product.

We have licensed U.S. and Canadian patent rights relating to Infergen, a type of interferon alpha, from Amgen. Two of Amgen’s U.S. patents relating to Infergen’s active ingredient, the interferon alfacon-1 molecule, expire in 2004. However, the U.S. Patent and Trademark Office recently issued a Certificate of Extension of Patent Term, officially extending the term of one of these patents by five years, to 2009. After expiration of the extended patent term in 2009, we would rely on a U.S. patent related to the use of interferon alfacon-1 at a dose within the range of 2 million to 30 million units of interferon alfacon-1 per administration for the treatment of chronic hepatitis C infections to block others from marketing interferon alfacon-1 for the treatment of chronic hepatitis C infections at these doses. When this patent expires in 2011, we will not be able to use this patent to block others from marketing Infergen or other forms of interferon alfacon-1 for the treatment of chronic hepatitis C infections in the United States.

Our competitors and their strategic partners have substantial and extensive patent rights in connection with the use of interferon alpha to treat a variety of diseases. Further, we believe that our competitors and their strategic partners may obtain additional patent rights in connection with filed patent applications for interferon alpha. We are uncertain of the extent to which the currently issued patents and any additional patents of our competitors that may issue will prevent us from marketing Infergen for the treatment of certain diseases. If because of these patents we are unable to market Infergen for a range of diseases, the commercial prospects for Infergen will be reduced and our prospects for

profitability may be impaired. In addition, our competitors and their strategic partners have substantial and extensive patent rights in connection with the use of pegylated interferon alpha to treat a variety of diseases. Although we have licensed from Amgen rights to PEG-Infergen, we may not have, and may not be able to license on commercially reasonable terms, if at all, sufficient rights to all the intellectual property necessary for us to commercialize PEG-Infergen.

We are aware of the settlement of a lawsuit involving Infergen filed in 1997 by Biogen, Inc. against Amgen in the U.S. District Court for the District of Massachusetts. The suit alleged that the manufacture of Infergen infringed three Biogen U.S. patents relating to vectors for expressing cloned genes, methods of making vectors and expressing cloned genes, and host cells. All claims in the lawsuit were dismissed with prejudice by order of the court in December 2001 under a settlement agreement entered into between Biogen and Amgen. Although Amgen has informed us that the settlement agreement applies to Infergen, we do not know the terms of the settlement agreement or how the terms of the settlement may affect our ability to commercialize Infergen in the United States. The settlement agreement may have a material adverse effect on our ability to commercialize Infergen in the United States.

We generally do not control the patent prosecution of technology that we license from others. Accordingly, we are unable to exercise the same degree of control over this intellectual property as we would exercise over technology that we own. For example, if Genentech fails to maintain the intellectual property licensed to us, we may lose our rights to develop and market Actimmune and may be forced to incur substantial additional costs to maintain or protect the intellectual property or to compel Genentech to do so.

The combination of our products with other drugs may have a greater therapeutic effect in treating certain diseases than our products alone. In some cases, third parties hold patents either on the potential companion drugs or on combination therapies that include our products. We may not be able to negotiate licenses or other rights to potential companion drugs on reasonable terms, or at all. If we are not able to negotiate these licenses or other rights, the market for our products may be diminished.

We rely on trade secrets to protect technology where we believe patent protection is not appropriate or obtainable. However, trade secrets are difficult to protect. We protect these rights mainly through confidentiality agreements with our corporate partners, employees, consultants and vendors. These agreements generally provide that all confidential information developed or made known to an individual during the course of their relationship with us will be kept confidential and will not be used or disclosed to third parties except in specified circumstances. In the case of employees and consultants, our agreements generally provide that all inventions made by the individual while engaged by us will be our exclusive property. We cannot be certain that these parties will comply with these confidentiality agreements, that we will have adequate remedies for any breach, or that our trade secrets will not otherwise become known or be independently discovered by our competitors. Under some of our research and development agreements, inventions discovered in certain cases become jointly owned by our corporate partner and us and in other cases become the exclusive property of one of us. It can be difficult to determine who owns a particular invention, and disputes could arise regarding those inventions.

Our research collaborators and scientific advisors have some rights to publish our data and proprietary information in which we have rights. Such publications may impair our ability to obtain patent protection or protect our proprietary information.

We rely on distributors and specialty pharmacies for approximately 93% of our product sales and currently one specialty pharmacy accounts for approximately 60% of our product sales. If those parties do not perform satisfactorily, our business will be harmed.

During the three-month period ending March 31, 2003, approximately 93% of sales of our products were sold through distributors and specialty pharmacies. As a result, our success depends on the continued customer support efforts of our network of distributors and specialty pharmacies. In addition, during this period one specialty pharmacy accounts for approximately 58% of our outstanding receivables and 60% of our total product sales. If this or any other specialty pharmacy or distributor that sells our products were to experience financial difficulties, or otherwise become unable or unwilling to sell our products, our business would be harmed. Additionally any reduction, delay or loss of orders from our significant distributors and specialty pharmacies could harm our revenues.

The use of distributors and specialty pharmacies involves certain risks, including risks that distributors and specialty pharmacies will:

• not effectively sell or support our products;

• reduce its efforts or discontinue to sell or support our products;

• not devote the resources necessary to sell our products in the volumes and within the time frames that we expect;

• be unable to satisfy financial obligations to us or others; or

• cease operations.

Even if regulatory authorities approve our products or product candidates for the treatment of the diseases we are targeting, our products may not be marketed or commercially successful.

Our products and product candidates are expensive, and we anticipate that the annual cost for treatment under each of the diseases for which we are seeking approval will be significant. These costs will vary for different diseases based on the dosage and method of administration. Accordingly, we may decide not to market any of our products or product candidates for an approved disease because we believe that it may not be commercially successful. Market acceptance of and demand for our products and product candidates will depend on many factors, including:

• cost of treatment;

• pricing and availability of alternative products;

• ability to obtain third-party coverage or reimbursement for our products or product candidates to treat a particular disease;

• perceived efficacy relative to other available therapies;

• relative convenience and ease of administration; and

• prevalence and severity of adverse side effects associated with treatment.

If third-party payors do not provide coverage or reimburse patients for our products, our revenues and prospects for profitability will suffer.

Our ability to commercialize our products or product candidates in particular diseases is highly dependent on the extent to which coverage and reimbursement for our products will be available from:

• governmental payors, such as Medicare and Medicaid;

• private health insurers, including managed care organizations; and

• other third-party payors.

Significant uncertainty exists as to the coverage and reimbursement status of pharmaceutical products. If governmental and other third-party payors do not provide adequate coverage and reimbursement levels for our products, market acceptance of our products will be reduced, and our sales will suffer. Many third-party payors provide coverage or reimbursement for only FDA approved indications.

The pricing and profitability of our products may be subject to control by the government and other third-party payors.

The continuing efforts of governmental and other third-party payors to contain or reduce the cost of healthcare through various means may adversely affect our ability to successfully commercialize products. For example, in most foreign markets, pricing and/or profitability of prescription pharmaceuticals are subject to governmental control. In the United States, we expect that there will continue to be federal and state proposals to implement similar governmental control. In addition, increasing emphasis on managed care in the United States will continue to put pressure on the pricing of pharmaceutical products. Cost-control initiatives could decrease the price that we would receive for Actimmune, Infergen, Amphotec or any other products we may develop in the future, such as oritavancin or pirfenidone, which would reduce our revenues and potential profitability.

Our failure or alleged failure to comply with anti-kickback and false claims laws could result in civil and/or criminal sanctions and harm our business.

We are subject to various federal and state laws pertaining to health care “fraud and abuse,” including anti-kickback laws and false claims laws. Anti-kickback laws make it illegal for a prescription drug manufacturer to solicit, offer, receive or pay any remuneration in exchange for, or to induce, the referral of business, including the purchase or prescription of a particular drug. The federal government has published regulations that identify “safe harbors” or exemptions for certain payment arrangements that do not violate the anti-kickback statutes. We seek to comply with the safe harbors. Due to the breadth of the statutory provisions and the absence of guidance in the form of regulations or court decisions addressing some of our practices, it is possible that our practices might be challenged under anti-kickback or similar laws. False claims laws prohibit anyone from knowingly and willingly presenting, or causing to be presented, for payment to third party payors (including Medicare and Medicaid) claims for reimbursed drugs or services that are false or fraudulent, claims for items or services not provided as claimed, or claims for medically unnecessary items or services. Our activities relating to the sale and marketing of our products may be subject to scrutiny under these laws. Violations of fraud and abuse laws may be punishable by criminal and/or civil sanctions, including fines and civil monetary penalties, as well as the possibility of exclusion from federal health care programs (including Medicare and Medicaid). If the government were to allege against or convict us of violating these laws, there could be a material adverse effect on us, including a decline in our stock price. Our activities could be subject to challenge for the reasons discussed above and due to the broad scope of these laws and the increasing attention being given to them by law enforcement authorities.

Discoveries or developments of new technologies by established drug companies or others may make our products obsolete.

Our commercial opportunities will be reduced or eliminated if our competitors develop and market products for any of the diseases that we target that:

• are more effective;

• have fewer or less severe adverse side effects;

• are better tolerated;

• have better patient compliance;

• receive better reimbursement terms;

• are more accepted by physicians;

• are more adaptable to various modes of dosing;

• have better distribution channels;

• are easier to administer; or

• are less expensive than our products or product candidates.

Even if we are successful in developing effective drugs, our products may not compete effectively with our competitors’ products. Researchers are continually learning more about diseases, which may lead to new technologies for treatment. Our competitors may succeed in developing and marketing products either that are more effective than those that we may develop, alone or with our collaborators, or that are marketed before any products we develop are marketed.

Our competitors include fully integrated pharmaceutical companies and biotechnology companies that currently have drug and target discovery efforts, as well as universities and public and private research institutions. Many of the organizations competing with us have substantially greater capital resources, larger research and development staffs and facilities, greater experience in drug development and in obtaining regulatory approvals and greater marketing capabilities than we do.

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

If third parties do not successfully carry out their contractual duties or meet expected deadlines, we will not be able to obtain regulatory approvals for our products and product candidates and will not be able to successfully commercialize our products and product candidates for targeted diseases. We do not have the ability to independently conduct clinical trials for our products and product candidates, and we rely on third parties such as contract research organizations, medical institutions and clinical investigators to perform this function. If these third parties do not perform satisfactorily, our clinical trials may be extended or delayed. We may not be able to locate any necessary acceptable replacements or enter into favorable agreements with them, if at all.

There are significant regulatory, supply, intellectual property and competitive barriers to entry that may prevent us from successfully marketing or developing Infergen or PEG-Infergen for the chronic hepatitis C infections market.

We have relaunched Infergen in the United States and Canada for the treatment of chronic hepatitis C infections. However, we believe that there are significant regulatory, supply, intellectual property and competitive barriers to Infergen’s penetration of the chronic hepatitis C infections market, including the following:

Regulatory. We believe that market acceptance of and demand for Infergen for the treatment of chronic hepatitis C infections may depend upon our ability to use Infergen in combination therapy with ribavirin or other anti-viral drugs. Before we may market Infergen in combination therapy with ribavirin or any other anti-viral drug, we will need to obtain FDA approval for such combination. To seek and obtain such approval, we will need to supplement Infergen’s current FDA approval with data that support combination use of Infergen and ribavirin or another anti-viral drug for increased effectiveness in treating chronic hepatitis C infections. We cannot be certain how long it would take us to submit such data and obtain such an approval from the FDA, if at all. Seeking FDA approval for Infergen combination therapy may, in certain circumstances, involve our complying with FDA patent certification and notice provisions relating to ribavirin that could result in deferral of up to 30 months or, in the case of judicial intervention, longer, of FDA approval pending the outcome of ongoing patent infringement litigation.

Supply. Even if we are able to obtain regulatory approval for Infergen in combination therapy with ribavirin or another anti-viral drug, there may not be a source of commercial supply for ribavirin or another anti-viral drug. We are not aware of any U.S. or Canadian manufacturer of ribavirin that has regulatory approval, other than the company that sells ribavirin capsules exclusively to Schering-Plough Corp. and provides bulk ribavirin to Roche Laboratories Inc., which are our primary competitors in the chronic hepatitis C infections market. There can be no assurance that an independent source of commercial supply will become available.

Intellectual Property. Our competitors and their strategic partners have substantial and extensive patent rights in connection with combination therapy of interferon alpha and ribavirin for the treatment of chronic hepatitis C infections. For example, we are aware of three U.S. patents that relate to the use of interferon alpha and ribavirin to treat chronic hepatitis C infections. These patents expire in 2015, 2016 and 2017. We believe that these patents may prevent us from marketing Infergen in combination therapy with ribavirin for certain patients. If, because of these patents we are unable to market Infergen with ribavirin or with another anti-viral drug, the commercial prospects for Infergen are likely to be reduced, and our prospects for profitability may be impaired. Further, we believe that our competitors and their

strategic partners may obtain additional patent rights in connection with filed patent applications for combination therapy of interferon alpha and other anti-viral drugs for the treatment of chronic hepatitis C infections. If those patent applications were to issue, we may be unable to market Infergen with ribavirin or with another anti-viral drug, reducing the commercial prospects for Infergen and our prospects for profitability.

In addition, we are aware of a U.S. patent that relates to the use of pegylated interferon alpha to treat chronic hepatitis C infections. The term of this patent expires in 2016. We believe that this patent may prevent us from marketing PEG-Infergen (a pegylated form of Infergen) for the treatment of chronic hepatitis C infections. If because of this patent we are unable to market PEG-Infergen for the treatment of chronic hepatitis C infections, the commercial prospects for PEG-Infergen are likely to be reduced. Also, we believe that our competitors and their strategic partners have substantial and extensive patent rights relating to pegylation technology in general and the use of pegylated interferon alpha for the treatment of chronic hepatitis C infections in particular. Further, several third parties have substantial and extensive patent rights in connection with the use of pegylation to modify biologically active compounds generally. Although we have licensed from Amgen rights to PEG-Infergen, we may not have, and may not be able to license on commercially reasonable terms, if at all, sufficient rights to all the intellectual property necessary for us to commercialize PEG-Infergen for the treatment of chronic hepatitis C infections.

Competition. Pegylated interferon alpha products may have an advantage over non-pegylated products because they circulate longer in the body, permitting a less frequent dosing schedule and enhancing efficacy in some patients infected with the hepatitis C virus. Because our competitors Schering-Plough and Roche have commenced marketing their respective pegylated interferon alpha products, Infergen has a significant disadvantage in the market with respect to the frequency of administration. In addition, both of these companies have obtained and will likely continue to obtain significant patent protection relating to their respective products.

Further, specific targeted agents directed against the hepatitis C virus (HCV) may be effective in reducing the amount of virus in infected chronic hepatitis C patients. If the use of these specific targeted anti-HCV agents proves to be effective in the treatment of chronic hepatitis C, then the use of interferon-based therapies may diminish, which would harm our business.

Although we have relaunched Amphotec, this product may not be commercially successful.

In January 2002, we relaunched Amphotec. However, market acceptance of and demand for Amphotec will depend largely on the following factors:

• Acceptance by physicians of Amphotec as a safe and effective therapy for invasive aspergillosis: Competitors have spent considerable time positioning Amphotec in an unfavorable light within the medical community as inferior due to more infusion-related side effects, including high levels of chills and fever, relative to some other liposomal formulations of amphotericin.

• Pricing of alternative products: Competitive products may be discounted by competitors to limit Amphotec’s market penetration.

• Prevalence and severity of adverse side effects associated with Amphotec: The most frequent infusion-related events after initial dosages are chills and fever.

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

We do not have the resources, facilities or experience to manufacture any of our products or product candidates, such as PEG-Infergen or oritavancin, ourselves. Completion of our clinical trials and commercialization of our products requires access to, or development of, manufacturing facilities that meet FDA standards to manufacture a sufficient supply of our products. The FDA must approve facilities that manufacture our products for commercial purposes. We depend on third parties for the manufacture of our product candidates for preclinical and clinical purposes, and we rely on third parties with FDA approved manufacturing facilities for the manufacture of our products for commercial purposes.

Our manufacturing strategy for our products and product candidates also presents many risks, including the following:

• before we can obtain approval of any of our products or product candidates for the treatment of a particular disease, we must demonstrate to the FDA’s satisfaction that the drug used in the clinical trials is comparable to the commercial drug;

• delays in increasing manufacturing capacity to meet our needs for multiple clinical trials could delay clinical trials, regulatory submissions and commercialization of our product candidates;

• delays in transferring manufacturing technology between third parties could delay clinical trials, regulatory submissions and commercialization of our product candidates;

• manufacturers of our products are subject to ongoing periodic inspection by the FDA and other regulatory authorities for compliance with strictly enforced good manufacturing practices regulations and similar foreign standards, and we do not have control over our third-party manufacturers’ compliance with these regulations and standards;

• if we need to contract with other manufacturers, the FDA and foreign regulatory authorities must approve these manufacturers prior to our use or sale of their products. This would require new testing and compliance inspections. The new manufacturers would need to adopt existing manufacturing processes or develop comparable processes necessary for the production of our products;

• our manufacturers might not be able to fulfill our commercial needs, which would require us to seek new manufacturing arrangements and may result in substantial delays in meeting market demand;

• if market demand for our products is less than our purchase obligations to our manufacturers, we may incur substantial penalties; and

• we may not have intellectual property rights, or may have to share intellectual property rights, to any improvements in the manufacturing processes or new manufacturing processes for our products.

Any of these factors could delay clinical trials or commercialization of our products for particular diseases, interfere with current sales, entail higher costs and result in our being unable to effectively sell our products.

If we are unable to contract with third parties to manufacture Actimmune, Infergen or Amphotec in sufficient quantities, on a timely basis or at an acceptable cost, we may be unable to meet demand for Actimmune, Infergen or Amphotec and may lose potential revenues.

During 2002, we transitioned from Genentech to Boehringer Ingelheim Austria GmbH (BI Austria) for the manufacture of Actimmune. Under our supply agreement, BI Austria is required to supply commercially marketed Actimmune to us, subject to certain limits. If we do not receive sufficient quantities of commercial Actimmune from BI Austria, we may experience a shortage of commercial supply, which would have a material and adverse effect on our revenues, business and financial prospects. Even if we believe that BI Austria will be unable to meet our requirements for the manufacture of Actimmune, our agreement with BI Austria precludes us from seeking a secondary source until BI Austria has indicated to us its inability or unwillingness to meet our requirements.

Under our June 2001 agreement with Amgen by which we license Infergen, Amgen is obligated to manufacture and supply Infergen to us for our sales in the United States and Canada.

We presently have an agreement with Ben Venue Laboratories, Inc. for the manufacture of Amphotec for all purposes, which we are currently renegotiating. Our inability to receive terms in the new manufacturing agreement as favorable to us as those in our original agreement may have an adverse effect on our revenues, business and financial prospects.

If product liability lawsuits are brought against us, we may incur substantial liabilities.

The testing, marketing and sale of medical products entail an inherent risk of product liability. If product liability costs exceed our liability insurance coverage, we may incur substantial liabilities. Whether or not we were ultimately successful in product liability litigation, such litigation would consume substantial amounts of our financial and managerial resources, and might result in adverse publicity, all of which would impair our business. We may not be able to maintain our clinical trial insurance or product liability insurance at an acceptable cost, if at all, and this insurance may not provide adequate coverage against potential claims or losses.

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

We had 256 employees as of March 31, 2003 and our success depends on our continued ability to attract, retain and motivate highly qualified management and scientific personnel and on our ability to develop relationships with leading academic scientists. Competition for personnel and academic collaborations is intense. We are highly dependent on our current management and key scientific and technical personnel, including Scott Harkonen, our Chief Executive Officer, President and Chairman of our Board of Directors, as well as the other principal members of our management. Our success will depend in part on retaining the services of our existing management and key personnel and attracting and retaining new highly qualified personnel. In addition, we may need to hire additional personnel and develop additional academic collaborations as we continue to expand our research and development activities. We do not know if we will be able to attract, retain or motivate personnel or cultivate academic collaborations. Our inability to hire, retain or motivate qualified personnel or cultivate academic collaborations would harm our business and hinder the planned expansion of our business.

Our use of hazardous materials, chemicals, viruses and radioactive compounds exposes us to potential liabilities.

Our research and development activities involve the controlled use and disposal of hazardous materials, chemicals, infectious disease agents and various radioactive compounds. Although we believe that our safety procedures for handling and disposing of such materials comply with the standards prescribed by state and federal regulations, we cannot completely eliminate the risk of accidental contamination or injury from these materials. In the event of such an accident, we could be held liable for significant damages or fines.

Insurance coverage is increasingly difficult to obtain or maintain.

While we currently have insurance for our business, directors and officers, and property and products, first- and third-party insurance is increasingly more costly and narrower in scope, and we may be required to assume more risk in the future. If we are subject to third-party claims or suffer a loss or damage in excess of our insurance coverage, we may be required to share that risk in excess of our insurance limits. Furthermore, any first- or third-party claims made on our insurance policies may impact our future ability to obtain or maintain insurance coverage at reasonable costs, if at all.

If we fail to obtain the capital necessary to fund our operations, we will be unable to successfully execute our business plan.

We believe our existing cash, cash equivalents and available-for-sale securities, together with anticipated cash flows from our operations, will be sufficient to fund our operating expenses, debt obligations and capital requirements under our current business plan through at least the end of 2004. However, our current plans and assumptions may change, and our capital requirements may increase in future periods. We have no committed sources of capital and do not know whether additional financing will be available when needed, or, if available, that the terms will be favorable to our stockholders or us. If additional funds are not available, we may be forced to delay or terminate clinical trials, curtail operations or obtain funds through collaborative and licensing arrangements that may require us to relinquish commercial rights or potential markets, or grant licenses on terms that are not favorable to us. If adequate funds are not available, we will not be able to successfully execute our business plan.

If we continue to incur net losses for a period longer than we anticipate, we may be unable to continue our business.

We have lost money since inception, and our accumulated deficit was approximately $318.1 million at March 31, 2003. We expect to incur substantial additional net losses for at least the next two years. The extent of our future net losses and the timing of our profitability are highly uncertain, and we may never achieve profitable operations. We are planning to expand the number of diseases for which our products may be marketed, and this expansion will require significant expenditures. To date, we have generated revenues primarily through the sale of Actimmune. However, since we do not expect to seek FDA approval for the use of Actimmune for the treatment of idiopathic pulmonary fibrosis for at least three more years, Actimmune revenues may not continue to increase. After inclusion of the direct costs of commercializing Actimmune and royalties we must pay to Genentech on sales of Actimmune, we do not currently generate significant operating profits on those sales. If the time required for us to achieve profitability is longer than we anticipate, we may not be able to continue our business.

Other Risks

Our indebtedness and debt service obligations may adversely affect our cash flow.

Our annual debt service obligations on our 5.75% convertible subordinated notes due 2006 are approximately $8.6 million per year in interest payments. We intend to fulfill our debt service obligations, including repayment of the principal, both from cash generated by our operations and from our existing cash and investments. If we are unable to generate sufficient cash to meet these obligations and need to use existing cash or liquidate investments in order to fund our debt service obligations, including repayment of the principal, we may have to delay or curtail research and development programs.

We may add additional lease lines to finance capital expenditures and may obtain additional long-term debt and lines of credit. If we issue other debt securities in the future, our debt service obligations will increase further.

Our indebtedness could have significant additional negative consequences, including:

• requiring the dedication of a substantial portion of our expected cash flow from operations to service our indebtedness, thereby reducing the amount of our expected cash flow available for other purposes, including capital expenditures;

• increasing our vulnerability to general adverse economic and industry conditions;

• limiting our ability to obtain additional financing;

• limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we compete; and

• placing us at a possible competitive disadvantage to less leveraged competitors and competitors that have better access to capital resources.

If a change in control occurs, we may be required to redeem our 5.75% convertible subordinated notes due 2006.

If there is a change in control of our company, the holders of our 5.75% convertible subordinated notes due 2006 may require us to redeem some or all of the notes. Although the indenture governing the notes allows us in certain circumstances to pay the redemption price in shares of our common stock, if a change in control were to occur, we may not have sufficient funds to pay the redemption price for all the notes tendered. We have not established a sinking fund for payment of the notes, nor do we anticipate doing so.

If our officers, directors and certain stockholders choose to act together, they may be able to significantly influence our management and operations, acting in their best interests and not necessarily those of other stockholders.

At March 31, 2003, our directors, executive officers and greater than 5% stockholders and their affiliates beneficially owned approximately 56% of our issued and outstanding common stock. Accordingly, they collectively may have the ability to significantly influence the election of all of our directors and to significantly influence the outcome of corporate actions requiring stockholder approval. They may exercise this ability in a manner that advances their best interests and not necessarily those of other stockholders.

We have implemented anti-takeover provisions which could discourage, prevent or delay a takeover, even if the acquisition would be beneficial to our stockholders.

The existence of our stockholder rights plan and provisions of our amended and restated certificate of incorporation and bylaws, as well as provisions of Delaware law, could make it more difficult for a third party to acquire us, even if doing so would benefit our stockholders. These provisions:

• establish a classified board of directors so that not all members of our board may be elected at one time;

• authorize the issuance of up to 5,000,000 shares of “blank check” preferred stock that could be issued by our board of directors to increase the number of outstanding shares and hinder a takeover attempt;

• limit who may call a special meeting of stockholders;

• prohibit stockholder action by written consent, thereby requiring all stockholder actions to be taken at a meeting of our stockholders; and

• establish advance notice requirements for nominations for election to our board of directors or for proposing matters that can be acted upon at stockholder meetings.

In addition, Section 203 of the Delaware General Corporation Law, which prohibits business combinations between us and one or more significant stockholders unless specified conditions are met, may discourage, delay or prevent a third party from acquiring us.

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

The trading price of our common stock has been and is likely to continue to be extremely volatile. Our stock price could be subject to wide fluctuations in response to a variety of factors, including the following:

• adverse results or delays in clinical trials;

• failure to meet our publicly announced revenue projections;

• actual or anticipated variations in quarterly operating results;

• announcements of technological innovations;

• our failure to commercialize additional FDA-approved products;

• our decision not to initiate a planned clinical trial;

• new products or services offered by us or our competitors;

• changes in financial estimates by securities analysts;

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

• issuances of debt or equity securities; or

• other events or factors, many of which are beyond our control.

In addition, the stock market in general, and the Nasdaq National Market and biotechnology companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of these companies. Broad market and industry factors may negatively affect the market price of our common stock, regardless of actual operating performance. In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been instituted against companies. This type of litigation, if instituted, could result in substantial costs and a diversion of management’s attention and resources, which would harm our business.

Substantial sales of shares may 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 or conversion of our 5.75% convertible subordinated notes due 2006, the market price of our common stock may decline. These sales also might 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. We are unable to predict the effect that sales may have on the then-prevailing market price of our common stock.

We have filed a registration statement covering shares of common stock issuable upon exercise of options and other grants pursuant to our stock plans. In addition, some of the holders of common stock that are parties to our amended and restated investor rights agreement are entitled to registration rights.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We maintain an investment portfolio of depository accounts, master notes and liquidity optimized investment contracts. The securities in our investment portfolio are not leveraged, are classified as available-for-sale and are, due to their short-term nature, subject to minimal interest rate risk. We currently do not hedge interest rate exposure. Because of the short-term maturities of our investments, we do not believe that a change in market rates would have a significant negative impact on the value of our investment portfolio.

The primary objective of our investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. To achieve this objective, we invest our excess cash in debt instruments of the U.S. Government and its agencies and high-quality corporate issuers, and, by policy, restrict our exposure to any single corporate issuer by imposing concentration limits. To minimize the exposure due to adverse shifts in interest rates, we maintain investments at an average maturity of generally less than two years.

The table below presents the principal amounts and weighted-average interest rates by year of maturity for our investment portfolio:

	2003			2004			2005			2006			2007	2008	Total		Fair value at March 31, 2003
	(in millions)

Assets:
Cash equivalent and available-for-sale securities	$	138,659		$	78,890		$	19,500		$	3,000		—	—	$	240,049	$	245,723
Average interest rate	1.5		%	2.1		%	1.6		%	1.6		%	—	—	—		—
Liabilities:
5.75% Convertible subordinated notes due 2006	—			—			—			$	149.5		—	—	$	149.5	$	146.1
Average interest rate	—			—			—			5.75		%	—	—	—		—

We have some obligations in foreign currencies, principally the purchase of Actimmune inventory, which is denominated in Euros. We do not currently use derivative financial instruments to mitigate this exposure.

ITEM 4. CONTROLS AND PROCEDURES

(a) Our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures (as defined in Securities Exchange Act Rule 13a-14(c)) are sufficiently effective to ensure that the information required to be disclosed by us in the reports that we file under the Exchange Act is gathered, analyzed and disclosed with adequate timeliness, accuracy and completeness, based on an evaluation of such controls and procedures conducted within 90 days prior to the date hereof.

(b) Our chief executive officer and chief financial officer have concluded that there have been no significant changes in our internal controls or in other factors that could significantly affect these internal controls subsequent to the date of the evaluation referred to above, nor were there any significant deficiencies or material weaknesses in our internal controls. Accordingly, no corrective actions were required or undertaken with respect to significant deficiencies or material weaknesses in our internal controls.

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

PART II—OTHER INFORMATION

ITEM 5. OTHER INFORMATION

(a) As required by Section 202 of the Sarbanes-Oxley Act of 2002, our Audit Committee has approved all of the non-audit services performed by Ernst & Young LLP, our independent auditors, during the period covered by this Quarterly Report. These services related to tax compliance assistance, tax consultations, statutory audits, employee benefit plan compliance, stock option plan compliance, and other technical, financial reporting and compliance services.

(b) Nicholas J. Simon resigned as a member of our board of directors in February 2003.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.

(a) Exhibits:

EXHIBIT NUMBER		DESCRIPTION OF DOCUMENT
3.1		Certificate of Incorporation of Registrant.(1)
3.2		Certificate of Ownership and Merger, dated April 26, 2001.(2)
3.3		Bylaws of Registrant.(1)
4.1		Specimen Common Stock Certificate.(1)
4.2		Amended and Restated Investor Rights Agreement, dated January 7, 2000, between Registrant and certain holders of the common stock.(1)
4.3		Indenture, dated as of July 5, 2001, between Registrant and The Bank of New York.(3)
4.4		Stockholder Rights Agreement, dated July 17, 2001, between Registrant and Mellon Investor Services LLC. (4)
4.5		Registrant’s Certificate of Designation of Series A Junior Participating Preferred Stock (4)
10.57*		Amendment No. 4, dated January 28, 2003, to Development and Marketing Agreement, dated March 23, 2001, between Registrant and Boehringer Ingelheim International GmbH.
99.1		Certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

* Confidential treatment has been requested with respect to certain portions of this exhibit. Omitted portions have been filed separately with the Securities and Exchange Commission.

(1) Filed as an exhibit to the Registrant’s Registration Statement on Form S-1 filed with the Securities and Exchange Commission on February 2, 2000 (No. 333-96029), as amended by Amendment No. 1 filed with the Commission on February 18, 2000, as amended by Amendment No. 2 filed with the Commission on March 6, 2000, as amended by Amendment No. 3 filed with the Commission on March 22, 2000, as amended by Amendment No. 4 filed with the Commission on March 23, 2000 and as amended by Amendment No. 5 filed with the Commission on March 23, 2000.

2) Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2001.

(3) Filed as an exhibit to the Registrant’s Current Report on Form 8-K on July 10, 2001.

(4) Filed as an exhibit to the Registrant’s Current Report on Form 8-K on July 18, 2001.

(b) Reports on Form 8-K:

On January 7, 2003, we filed a report on Form 8-K describing the press release announcing that we expect 2002 revenue will be at the upper end of our previously estimated range of $105-$110 million, announcing

preliminary survival data from the follow-up period of our Phase III clinical trial of Actimmune for the treatment of idiopathic pulmonary fibrosis, and announcing that we would update investors of the same at the 21^st Annual JP Morgan H&Q Healthcare Conference. On January 30, 2003, we filed a report on Form 8-K describing the press release announcing a senior management change.

SIGNATURES

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

Date:	May 13, 2003		InterMune, Inc.


		By:	/s/ SHARON SURREY-BARBARI
			Sharon Surrey-Barbari
			Chief Financial Officer and Senior Vice President of Finance and Administration (Principal Financial and Accounting Officer and Duly Authorized Officer)

CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO
SECTION 302(a) OF THE SARBANES-OXLEY ACT OF 2002

I, W. Scott Harkonen, certify that:

1. I have reviewed this quarterly report on Form 10-Q of InterMune, Inc.;

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

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

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

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

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

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

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

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

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

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

Date: May 13, 2003

Signed:	/s/ SCOTT HARKONEN
	SCOTT HARKONEN Chief Executive Officer and President (Duly Authorized Officer)

CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO
SECTION 302(a) OF THE SARBANES-OXLEY ACT OF 2002

I, Sharon Surrey-Barbari, certify that:

1. I have reviewed this quarterly report on Form 10-Q of InterMune, Inc.;

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

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

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

Date: May 13, 2003

Signed:	/s/ SHARON SURREY-BARBARI
	SHARON SURREY-BARBARI Chief Financial Officer and Senior Vice President of Finance and Administration (Principal Financial and Accounting Officer and Duly Authorized Officer)