MorphoSys AG — Annual Report 2003

Annual Report 2003

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MorphoSys is committed to generating antibodies of the highest quality for its commercial partners as well as its own drug development programs. With its proprietary technologies, MorphoSys is developing the next generation of antibodies which can be used not only for research and diagnostics purposes, but also as highly effective and precise therapeutics. MorphoSys has developed the HuCAL[®] technology (the Human Combinatorial Antibody Library), at whose core sits an antibody library comprising more than twelve billion different, fully human antibodies. HuCAL[®] is a very powerful technology, allowing rapid and automated production of high-affinity antibodies. The most distinctive feature of the library is its unique capability to optimize fully human antibodies to pre-defined specifications, allowing MorphoSys researchers to “Engineer the Medicines of Tomorrow”.

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Key Figures

MorphoSys Group, U.S. GAAP, in million R, except share and personnel data

12/31/2003 12/31/2002 12/31/2001 R R R	12/31/2003 12/31/2002 12/31/2001 R R R	12/31/2003 12/31/2002 12/31/2001 R R R
Results
Revenues	15.3	16.8 16.1
R&D Expenses	9.0	19.6 9.9
S,G&A Expenses	7.6	18.7 10.1
Personnel Expenses (ExcludingStock-Based Compensation)	7.5	10.1 8.2
Depreciation	0.9	0.9 0.9
Amortization of Intangible Assets	1.6	1.2 0.8
Loss from Operations	(3.5)	(25.5) (7.3)
EBITDA (Earnings before Interest,Taxes, Depreciation and Amortization, excluding Stock-Based Compensation)	1.2	(18.7) (1.8)
Cash Provided by/(Used in)OperatingActivities	5.8	(15.2) (3.6)
Net Loss	(4.1)	(24.4) (6.5)
Balance Sheet
Total Assets	45.8	42.4 28.1
Cash, Cash Equivalents and Marketable Securities	23.2	19.1 12.1
Acquired Intangibles	17.0	10.3 6.9
Deferred Revenue	10.4	8.1 6.9
Stockholders’ Equity	30.2	20.6 17.7
MorphoSys Share
Shares Issued	4,901,332	3,949,706 3,591,331
Net Lossper Share(Basic and Diluted)	0.96	6.35 1.85
Dividend	-	- -
Share Price(in§)	11.14	15.95 61.45
Personnel Data
Total GroupEmployees	95	110 105

Corporate Profile

MorphoSys AG, located in Martinsried/Munich, is one of the world’s leading biotechnology companies focusing on antibodies. The Company’s technologies emphasize the use of fully human antibodies in both research and therapeutic applications. MorphoSys applies these innovative and proprietary technologies in order to discover disease related targets and new drugs for itself and its commercial partners. MorphoSys has led the emergence of the biotechnology sector in Germany and now plays a key role globally in the human antibody sector.

Founded in 1992, the Company’s product pipeline comprises more than 20 partnered and proprietary antibody therapeutic development programs. Since this time, the Company has entered into several partnerships with renowned companies from the pharmaceuticals and biotechnology sector, including: Bayer, Biogen Idec, Boehringer Ingelheim, Bristol-Myers Squibb, Centocor/ Johnson &Johnson, F.Hoffmann-La Roche, Pfizer and Schering.

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C O N T E N T S

Contents

• 2 Management Board

• 3 Letter to the Shareholders

• 8 Market & Strategy

• 14 Magazine: Clinical Development of Antibodies

• 20 Own Product Development & Partnerships

• 32 Interview with Prof. Dr. Boehncke

• 38 Research & Development

• 48 Corporate Governance

• 56 The MorphoSys Share

• 62 Management Report

86 Financial Statements

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• 86 Consolidated Statement of Operations 87 Consolidated Balance Sheets 88 Consolidated Statement of Changes in Stockholders’ Equity

• 90 Consolidated Statement of Cash Flows 92 Notes to the Consolidated Financial Statements

• 122 Summary of Significant Differences between German GAAP and U.S. GAAP

• 126 Independent Auditor’s Report

• 128 Balance Sheet According to German GAAP (HGB) 130 Profit & Loss Statement According to German GAAP (HGB)

• 131 Declaration of Corporate Governance Code

132	Supervisory Board Report
134	Supervisory Board
136	Glossary
138	Credo
140	Imprint

2 M A N A G E M E N T B O A R D

Management Board

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Dr. Simon E. Moroney Chief Executive Officer

Dave Lemus Executive Vice President and Chief Financial Officer

Dr. Thomas von Rüden Executive Vice President of Business Development and Chief Scientific Officer

• Dr. Moroney is one of MorphoSys’ co-foun - ders. He studied in New Zealand and grad uated with a Master of Science degree. He received a D. Phil. in chemistry from Oxford University while visiting as a Commonwealth scholar and subsequently worked for two years at ImmunoGen, Inc., Boston, on the development of antibodybased cancer drugs. From 1986 through 1989 he was employed by ETH in Zurich. Subsequently, Dr. Moroney was an assistant professor for chemistry at the University of British Columbia (Canada).

Dave Lemus has an M.B.A. from the MIT Sloan School of Management. He is also a C.P.A. (certified public accountant) in the U.S.A. Dave Lemus joined MorphoSys from F.Hoffmann-La Roche, where he served as Controller and Operations Manager of 90 pharmaceutical markets. Prior to this position he was Treasurer of Lindt & Sprüngli in Zurich, Switzerland, and worked in treasury management at Electrolux AB. Dave Lemus joined MorphoSys in February 1998.

After his studies at the Universities of Frankfurt, Mainz and Princeton, Dr. von Rüden completed his Ph.D. at the University of Mainz. Subsequently he worked at the European Laboratory of Molecular Biology, Heidelberg, and at the Institute of Molecular Pathology, Vienna. In September 1998 he joined MorphoSys from Boehringer Ingelheim, where he held the position of Director of the Molecular Biology Department. During his five years at Boehringer Ingelheim, he was recognized as a key figure in the company’s global drug discovery effort.

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L E T T E R T O T H E S H A R E H O L D E R S

Dear Shareholders,

The year 2003 was a transforming one for MorphoSys, in which cash flow from operations was positive for the first time in our history. This was achieved on the back of a challenging year in 2002, and was based on steps we took to ensure that the Company is on a solid foundation. This outstanding result represents a significant step in our Company’s development and was achieved without compromising our future HuCAL[®] -based product programs. We end the year with confidence that the first HuCAL[®] antibody will enter human clinical trials in 2004, which will be another milestone of great significance for the Company.

During the year, we observed a return of the pharmaceutical industry’s appetite for external collaborations. As I mentioned in my letter to you last year, big pharma’s response to the difficult economic climate was a reduction in their investment in external R&D. This trend is now reversing, which is good news for MorphoSys. The contract we signed at year-end with Pfizer was the best indication of this change. The deal is a multi-year strategic alliance with a significant level of committed cash, and marks a return of the successful deal types we have done in the past with companies such as Bayer, Centocor and Schering.

The recovery from the slump in pharma investment did not translate into increasing revenue in 2003, in line with guidance at the beginning of the year, which predicted that the improvement would be slow and that therefore no increase in turnover for the year should be expected. Allied to the slow recovery, we knew that it would take some time for the settlement of our patent dispute with Cambridge Antibody Technology (CAT) to translate into commercial success. We are confident that as existing programs progress, triggering more advanced milestone payments, and as pharma companies become more willing to invest in external collaborations, we can return to revenue growth.

The development of antibody products using our proprietary HuCAL[®] technology is at the heart of our strategy. Most of the running HuCAL[®] product programs are being driven by our partners. A central aspect of our business activities is to focus on blue-chip partners who have the resources and/or expertise to take HuCAL[®] -derived products through the development process. The two new additions to our roster of partners, Boehringer Ingelheim and Pfizer, illustrate this point.

Good progress was made in a number of the therapeutic antibody programs during 2003: developmental milestones were reached in programs with Centocor and Schering, Bayer committed to a new product program, and together with Roche we published promising data on

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L E T T E R T O T H E S H A R E H O L D E R S

our joint antibody program against Alzheimer’s disease. These and other therapeutic antibody programs are at the core of our success. The benefit for MorphoSys is in both the short and the longer term: we generate revenue today from technology license and research payments, and increasingly from milestone payments triggered by reaching key points in development programs. The milestone payments will become larger as products move into the clinical phases of development. Furthermore, we will generate revenues in the form of royalties on product sales.

We continue to augment these partner activities with programs that we have initiated ourselves. Again, we made significant progress during 2003, the highlights being the positive animal data we reported from studies conducted with our two most advanced programs, MOR101 for burns and MOR102 for psoriasis. Our strategy for these programs, and others that we have initiated, is to partner them for further development. We anticipate the first such outlicensing deal to be completed in 2004.

At year-end, a total of 8 HuCAL[®] antibody programs were in preclinical development, with 13 in research. Our business activities are focused on continually strengthening this pipeline: we expect it to grow significantly in 2004. How many of these programs will result in marketed drugs cannot yet be predicted. However, the unique power of HuCAL[®] in providing antibodies of fully human composition that are optimized in respect of key properties increases the likelihood that drugs derived from the technology will progress through the full development process. Therefore, we are confident that a significant proportion of these programs will result in successfully marketed products. Our entire pipeline of HuCAL[®] antibodies represents considerable future value.

In 2003, we launched Antibodies by Design, a new initiative to supply HuCAL[®] antibodies to the research community. This market is currently served by outdated monoclonal and polyclonal approaches, which suffer from the disadvantage of slowness when compared with HuCAL[®] . After six months, we are seeing a rapidly growing level of interest in Antibodies by Design, which achieved its first revenues in 2003.

Despite the progress, and despite the clear evidence that the Company is on a solid financial footing, the performance of our shares was disappointing. At year-end 2002, on the back of the news of our settlement with CAT, a surge in our stock meant that we entered 2003 with a share price representing a three-month high. Subsequently, we saw very little movement throughout the year, with the price locked in a narrow trading range. We continue to believe as before that there is substantial as yet unrecognized potential in our stock.

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L E T T E R T O T H E S H A R E H O L D E R S

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Dr. Simon E. Moroney,
Chief Executive Officer
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Corporate governance continues to be an important topic for all companies. During 2003, we adopted the recommendations of the German Corporate Governance Code. You can read the details of our adherence to these important principles on page 48. I would like to stress here that my executive management colleagues and I take this topic extremely seriously and ensure that we observe our undertakings to the letter. Some of the principles and concepts of the Code are embodied in a new undertaking that we have made as members of the Company, namely our credo. This important new document was drawn up during the year, in an effort which involved input from employees throughout the Company. The credo, which you can read on page 138, is our commitment to maintaining and enhancing our corporate culture, one of the Company’s strengths.

We enter 2004 in a positive frame of mind. By recording our first ever positive cash flow, we turned an important corner in 2003. We aim to build on this success in 2004. Perhaps most importantly, we expect to see the first HuCAL[®] antibody enter human clinical trials in 2004; the first of what we hope will be a steady flow over the next few years.

I want to take this opportunity to thank all of our senior management and employees for their contributions and their tireless efforts during the past year. I would also like to thank you, our shareholders, for your loyalty and confidence. With your continued support, we look forward to a successful year in 2004.

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Dr. Simon E. Moroney Chief Executive Officer

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8 M A R K E T & S T R A T E G Y

Commercializing Antibodies

In light of favorable demographic trends projected over the next few years, considerable growth rates can be expected in the future for innovative drugs. Of ever-increasing importance is the role played by therapeutic antibodies for the treatment of a variety of diseases such as cancer, inflammation or autoimmune diseases. Another important market for the use of MorphoSys’ HuCAL[®] antibodies are new antibody research applications.

Commercial Application of HuCAL[®]

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Commercializing the HuCAL[®] technology with collaboration partners

MorphoSys offers different types of business models through which partners can access the HuCAL[®] technology. Within the scope of the collaborations, the technologies are used for the development of human antibodies in the areas of research, diagnostics and therapeutics.

Developing and commercializing a proprietary product portfolio MorphoSys is currently developing therapeutic antibodies in the areas of cancer and inflammation. The aim is to obtain a partner prior to the start of clinical development.

Exploitation of HuCAL[®] in research – Antibodies by Design MorphoSys initiated a new business unit, Antibodies by Design. The aim of Antibodies by Design is to establish the HuCAL[®] technology as an industrial standard for making research antibodies.

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M A R K E T & S T R A T E G Y

Possible Uses of Antibodies

Antibodies are part of the body’s principal defense mechanism. They are themselves proteins and each individual has more than one billion different antibodies. An antibody is able to recognize and bind to a specific molecular structure on a potentially disease-related target. This binding process triggers a number of physiological reactions which can protect, or can be used to protect, humans against disease in a number of different ways. Antibodies can thus be applied as:

Antibodies are proteins naturally produced by humans and form a key element of the immune system.

• Therapeutic substances, since antibodies, when administered to the human body, can

• (1) bind to and block the disease-related target from negatively affecting healthy structures in the body,

• (2) transport a therapeutic “effector function”, where the effector can, for example, act upon cancer cells expressing the disease-related target by triggering their death;

• Diagnostic substances, whereby the antibody can identify certain structures on a diseaserelated target and can, for example, if combined with a radioactive marker, reveal the location and severity of the disease;

• Tools assisting the research and development of drugs by detecting and isolating proteins, determining where these proteins are distributed and made in the body, and mapping which molecules they interact with, in order to ultimately determine biological function.

Antibodies are therefore indispensable reagents for the advancement of the understanding of diseases, and the development of either conventional small-molecule (chemical) drugs or antibody therapeutics.

The Market for Antibodies

The market for therapeutic antibodies is estimated to grow at more than 30% over the next several years. In 2003 annual sales amounted to over 5 billion US $.

The success of biotechnology in medical research as well as in the development and manufacture of drugs is now well established. Moreover, the pressure to innovate is very high: of the 30,000 diseases known today, only 10,000 can be treated adequately.

Antibodies play an important role in the pharmaceutical industry. Today, roughly 20% of the biotechnological products on the market are antibodies. Therapeutic antibodies are the fastestgrowing class of drugs in the pharmaceutical market. With global sales growth rates of more than 30%, the importance of antibodies in modern medicine continues to increase. In 2003, the number of approved antibodies increased from 12 to 16, and more than 200 therapeutic antibodies are currently in clinical development.

10 M A R K E T & S T R A T E G Y

The continuing success of antibodies is due to several main factors. First, technological advances now allow fully human antibodies to be generated with relative ease. Being fully human, these antibodies have very few side effects and are ideally suited to use in certain diseases such as cancer. Second, the recently completed decoding of the human genome will allow for a better understanding of diseases, and thus additional points for therapeutic intervention using drugs such as antibodies. Last but not least, antibodies have well-understood properties and can be rapidly made against virtually any target.

Currently 16 antibodies are on the market and more than 200 therapeutic antibodies are in clinical development—a clear sign of the potential of therapeutic antibodies.

Product	Origin	Indication	Approved
OKT3	Murine	Transplant rejection	1986
ReoPro	Chimeric	Cardiovascular	1994
Rituxan	Chimeric	Cancer	1997
Zenapax	Humanized	Transplant rejection	1997
Simulect	Chimeric	Transplant rejection	1998
Remicade	Chimeric	Inflammation/	1998
		autoimmune diseases
Synagis	Humanized	Virus infection	1998
Herceptin	Humanized	Cancer	1998
Mylotarg	Humanized	Cancer	2000
Campath	Humanized	Cancer	2001
Zevalin	Murine—radiolabeled	Cancer	2002
Humira	Human (PCR library)	Inflammation/	2002
		Autoimmune diseases
Bexxar	Murine—radiolabeled	Cancer	2003
Xolair	Humanized	Cancer	2003
Raptiva	Humanized	Inflammation/	2003
		autoimmune diseases
Erbitux	Chimeric	Cancer	2003

M A R K E T & S T R A T E G Y 11

The MorphoSys Strategy

The Company’s strategy is to commercialize its proprietary HuCAL[®] technology for the development of antibodies as therapeutics, diagnostics and research reagents. Thereby MorphoSys can create significant value and support the future growth of the Company.

The MorphoSys business strategy is based on its proprietary antibody technology HuCAL[®] . This technology makes it possible to produce fully human antibodies which can be easily optimized. HuCAL[®] is distinguished from other antibody technologies by its unique ability to systematically improve the functional characteristics of the antibodies. Additionally, these antibodies can be easily optimized, labeled, or formulated in different formats.

The goal of systematically optimizing active substances for use as drugs has been pursued in drug development for decades. MorphoSys technologies now enable this systematic optimization process for antibodies. The use of HuCAL[®] , the leading technology in this field, allows MorphoSys and its partners to develop better, wholly novel antibodies for use as drugs.

MorphoSys intends to become profitable by providing high value-added services relating to therapeutic antibody generation as well as target discovery for pharmaceutical and biotechnology companies. MorphoSys has recently added proprietary antibody products to its offering. In this way, the Company will add significant value to its current capabilities, and at the same time deliver what the industry currently desperately seeks—more novel therapeutic products to combat disease.

Key elements of the Company’s business strategy include:

1. Commercializing MorphoSys’ HuCAL[®] technology with collaboration partners

To accelerate drug discovery and develop new, premium-priced drugs, pharmaceutical companies require new technologies for discovering active substances, as well as methods for identifying new disease-associated target molecules against which those drugs can be directed. MorphoSys exploits the full potential of antibodies as research tools and products in their own right by making them rapidly and reliably available through its HuCAL[®] GOLD library. MorphoSys believes that HuCAL[®] GOLD is superior to competing technologies and thus believes it can establish HuCAL[®] GOLD as an industry standard for antibody generation.

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MorphoSys offers its partners support in order to identify specific antibodies

In addition to licensing its HuCAL[®] technology, MorphoSys commercializes its proprietary technology and expertise by collaborating with pharmaceutical and biotechnology companies in the areas of therapeutic antibody generation and target validation. Through licensing and collaboration agreements with companies that are developing antibody-based therapeutics and are seeking to outsource a portion of their research functions, MorphoSys offers a combination of the use of its technologies and the support of its scientists in order to identify antibodies with certain characteristics and to optimize their specificity and affinity to the defined target on its customers’ behalf.

MorphoSys has expanded its HuCAL[®] technology with further technology platforms and services. MorphoSys works in close cooperation with several of its partners in the highthroughput generation of antibodies. MorphoSys generates antibodies for these partners and, on request, performs additional investigations and characterization of these antibodies. The results enable the collaboration partners to carry out further research more quickly to develop and market a therapeutic product.

MorphoSys intends to further expand both forms of collaboration with partners in order to generate revenues, e.g. through up-front payments, annual payments, research and development contributions as well as milestone and royalty payments.

2. Developing and commercializing a proprietary product portfolio

MorphoSys intends to build value by developing its own product portfolio. The Company is currently developing proprietary therapeutic antibodies in the areas of cancer and inflammation, and intends to continue to invest in new programs in these areas. In this regard, the Company aims to demonstrate efficacy in animal experiments for its antibody candidates before seeking a development partner. In contrast to the business described with collaboration partners, the Company carries all the costs of development prior to partnering. However, the level of payments in the form of up-front fees, milestones and royalties that can be reached on outlicensing typically exceed those possible in the partner-initiated business.

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3. Exploitation of HuCAL[®] in antibody research—Antibodies by Design

In 2003, MorphoSys initiated a new business unit, Antibodies by Design, in order to more fully exploit the commercialization of the HuCAL[®] technology in antibody research applications. The aim of Antibodies by Design is to establish the HuCAL[®] technology as an industrial standard for making research antibodies. More specifically, the unit’s current focus is on producing custom-generated research antibodies for potential partners, on a per antibody basis. In this capacity, Antibodies by Design can supply a client with high-affinity antibody reagents within eight to twelve weeks—significantly faster than other technologies currently can.

Antibodies by Design Management Team

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Dieter Lingelbach Joanne Crowe Dr. Achim Knappik
Senior Vice President Senior Director Senior Director
Marketing & Sales Research & Development
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Future Growth Opportunities

Through collaborations concluded with pharmaceutical and biotechnology companies such as Pfizer, Bayer, Centocor and Schering, MorphoSys generates short-term revenue from license fees for access to technology, research support, and payments for completed work. In the medium term, the Company benefits from performance payments for the achievement of so-called milestones. In the long term, there is additional growth potential: if a product derived from the HuCAL[®] technology is approved for the market, MorphoSys has a stake in the revenue in the form of royalties.

By developing its own therapeutic antibodies, MorphoSys has extended its business model, and thereby its future growth prospects. In MorphoSys’ proprietary programs, the aim is to obtain a partner prior to the start of clinical development who will assume responsibility for the further clinical development and commercialization of the products. Higher user fees and royalties are to be expected for outlicensing such product candidates than through fee-for-service deals, and as such offer the Company’s shareholders greater value and upside.

Antibodies in Clinical Development

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Left Page: Selection of antibodies in the laboratory Right Page: Steps in preclinical and clinical product development

Annual sales of antibody drugs presently amount to over US$ 5 billion. Currently, 16 therapeutic antibodies have already been approved and are used in various indications such as cancer, transplant rejection, rheumatoid arthritis, psoriasis, Crohn’s disease and antiviral prophylaxis. Of these 16, two have achieved blockbuster status, namely Remicade and Rituxan, both of which generated sales of more than US$1 billion in 2003. Looking ahead, more than 200 antibodies are presently in various phases of clinical development. Putting this number in perspective, 20% of all biopharmaceutical products in clinical development today are monoclonal antibodies—a clear indication of the increasing importance of antibodies as drugs.

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C L I N I C A L D E V E L O P M E N T O F A N T I B O D I E S

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Steps in Drug Development

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Research Development
I II III
Target Target Screening Lead substance Preclinical Clinical
identification validation identification/ development development
optimization
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Steps in Drug Development

The idea of specifically using antibodies as therapeutics against various diseases was conceived more than 25 years ago. Antibodies are natural weapons which can be used to remove foreign substances from the human body. It is this ability which researchers seek to exploit when developing antibody drugs.

In the above continuum drug development can be divided into the phases “research” and “development.” One of the first stages of the research phase is the identification of target molecules (target identification). The relevance of the target molecule as a point of therapeutic intervention with regard to particular diseases is subsequently tested (target validation). The next step is the

screening phase and identification of drug lead substances, whose properties are subsequently modified and optimized (so-called lead substance optimization).

After the lead substance has been identified and optimized, preclinicial and ultimately clinical development takes place. Many of the steps in preclinical and clinical development are subject to strict regulatory authority, and also include the establishment of procedures for drug manufacture.

Preclinical studies are performed in test tubes ( in vitro ) and using animal models ( in vivo ), in order to obtain preliminary information about effectiveness, dosing, and safety of a drug candidate. This phase of drug

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development also includes the specification of appropriate manufacturing procedures which guarantee sufficient amounts of the drug, while observing strictly controlled quality criteria. The results of preclinical studies are then submitted for review to regulatory authorities prior to clinical trials in humans.

Phase I clinical studies are performed on a small number of healthy subjects and provide the first information concerning appropriate dosage, safety and tolerability. Phase II clinical studies include controlled studies with a limited number of patients in order to assess the effectiveness of a product for specific indications, to determine the appropriate dosage and to identify the side effects and risks connected with a drug. Phase III clinical studies are controlled studies with a larger number of patients. Long-term administration of the drug is investigated in order to assess the fundamental benefit-risk ratio. In most cases, two or more phase III studies are required before the authorities’ approval can be obtained to market a drug.

Besides determination of efficacy, three different factors are of importance during clinical product development: cost, failure risk and duration. The cost for individual phases of clinical development depends on a number of factors, but it is determined mainly by the number of patients in the clinical studies, as well as the indication. Generally, the number of patients included in clinical trials is dependent on the indication and the clinical end point. The costs per patient can also vary enormously, depending on the type and duration of treatment. In antibody development, high production costs due to expensive manufacturing procedures add to the cost of clinical development.

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Why Antibodies?

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1. Higher success rates than NCEs 2. Speed to clinic
Probability that a molecule in phase I
will reach market
50%
40%
NCE
30%
20% Humanized
antibody
10%
0%
NCE Humanized Years 0 1 2 3 4 5 6 7 8
antibody
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Source: Adapted from Nature Biotechnology

The failure risk for product candidates in clinical development depends on the target molecule, the product class and the indication. The target molecule at which the drug is aimed plays a significant role. The risk of failure is lower when choosing a target of which the biology and disease relevance have been well researched compared to “new,” less well-characterized target molecules.

The duration of development also depends on the required length of therapy and the clinical end point. For this reason, clinical studies for cancer treatment last longer on average, since the effectiveness often only becomes clear in a higher survival rate several months or years after treatment. The duration of development is therefore determined primarily by the indication.

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The Winding Road of Drug Development A new drug Biologics license application (BLA) Phase III—clinical trials Long-term administration of the drug in order to assess the fundamental benefit-risk ratio

Phase II—clinical trials Assessment of the effectiveness of a product for specific indications, determination of the appropriate dosage, identification of the most frequently occurring short-term side effects and risks

Investigational new drug application (IND)

Phase I—clinical trials

First information concerning appropriate dosage, safety and tolerability

Preclinical development

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Preclinical studies are performed in vitro and in vivo (animal models), in order to obtain preliminary information about effectiveness, dosing, and safety of a drug candidate

Drug discovery

Identification of possible target molecules, whose relevance as a point of therapeutic intervention with regard to particular diseases is subsequently tested

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Advantages of Antibodies in

Clinical Development

Monoclonal antibodies are ideally suited as therapeutic substances as they can bind to very specifically defined target structures. Furthermore, the unique properties of antibodies cannot be mimicked by so-called small molecules (chemical substances which are used as drugs). Today, a clear trend towards antibodies can be seen, as evidenced by the large number of human and humanized antibodies being developed. One major factor underlying this trend is that there are fewer side effects with antibody-based therapies, and they are therefore more likely to be successful in clinical development. There are, however, additional benefits that accrue for drug developers through the use of antibody-based therapeutics:

Shorter Development Periods for Human Therapeutic Antibodies

An average of six years is estimated from target identification to preclinical development for small molecules.

This time period can be considerably faster for antibody development, and is expected to last two to three years. The time required for subsequent clinical development is then determined by the indication.

Higher Chances of Success for Human Therapeutic Antibodies

In addition to the shorter time period required for the development of human antibodies, higher success rates are also attributed to antibodies. Due to their mode of action and their very specific binding to a relevant target structure, antibodies are less toxic and have a better side-effect profile. These advantages are further highlighted by the fact that antibodies generated with the HuCAL[®] technology can be optimized. This ability, combined with a better understanding of disease pathways arising from the sequencing of the genome, should allow for the generation of antibodies with even higher success rates.

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O W N P R O D U C T D E V E L O P M E N T & P A R T N E R S H I P S

HuCAL[®] Technology in Use

MorphoSys’ HuCAL[®] technology has been used to generate fully human antibodies in partnership with several pharmaceutical and biotechnology companies. Additionally, the technology is employed in the development of MorphoSys’ own proprietary product portfolio. The central focus of both these efforts is the development of therapeutic antibodies. Increasingly, however, the technology is used for producing antibodies in non-therapeutic applications such as research. In this vein, MorphoSys recently created a new business unit, “Antibodies by Design”. The purpose of this business unit is the exploitation of the HuCAL[®] technology in “non-therapeutic” markets, particularly research reagents.

Fields of Use for the HuCAL[®] Technology

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Proprietary Antibody Therapeutic Antibody
Development Collaborations
Research Antibodies for
Non-Therapeutic Applications
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Own Product Development

In order to generate maximum added value from its proprietary HuCAL[®] technology in the long term, MorphoSys uses its technologies to develop its own products. MorphoSys is currently working on four internal antibody programs. The two most advanced programs, MOR101 and MOR102, are currently in the preclinical development stage. Two other programs are still in the research phase. The MOR201 program, inlicensed from ProChon, was discontinued in 2003.

MorphoSys intends to start new antibody programs each year. These product candidates are planned to be outlicensed prior to the start of clinical studies to partners in the pharmaceutical industry.

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Dr. Jutta Haunschild Director Preclinical Antibody Development

MOR101 and MOR102

MorphoSys’ first proprietary drug development programs, MOR101 and MOR102, are fully human antibodies directed against a certain adhesion molecule known as ICAM-1 (intercellular adhesion molecule-1). As ICAM-1 controls the interaction between certain kinds of cells during inflammatory reactions, binding of an antibody to ICAM-1 inhibits these interactions and thereby reduces inflammation.

An antibody which binds to ICAM-1 was in the past developed by Boehringer Ingelheim under the name BIRR-1 (Enlimomab). BIRR-1 was developed in clinical trial indications such as rheumatoid arthritis, acute stroke, burn injury and transplant rejection. In rheumatoid arthritis and burn injury studies, BIRR-1 exhibited positive efficacy trends, with only minor side effects. The development of BIRR-1 was discontinued for all indications following phase III results in stroke patient studies that revealed severe adverse effects. There is considerable evidence that these side effects were related to the murine IgG2a isotype of the antibody. In contrast to BIRR-1, MorphoSys has developed HuCAL[®] antibodies or antibody fragments, neither of which induces such side effects.

The development of MOR101 is directed at the treatment of severe skin burns. Skin burn wounds are classified according to their severity and the area of injured skin. Second-degree (deep dermal) burns are characterized by partially irreversible destruction of affected tissue, and are not simply an injury, but a form of disease. These burns trigger severe inflammatory reactions and edemas in affected areas, and can cause progression to third-degree burns resulting in irreversible skin damage requiring skin transplants.

Despite major progress in the care of severely burned patients, there is no specific treatment available for preventing the deterioration of second-degree burns. Such burns never fully recover, causing considerable functional strain and severe reduction in an affected patient’s quality of life. Moreover, through prevention of third-degree burns there is also a reduction in the need for skin transplants. In summary, improved wound healing and reduced numbers of skin transplants and follow-up surgeries could dramatically reduce hospitalization and related costs.

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MorphoSys also intends to develop MOR102, which is a fully human IgG4 antibody capable of binding to ICAM-1, for the treatment of chronic inflammatory diseases such as rheumatoid arthritis, psoriasis and others. Rheumatoid arthritis is a chronic multisystemic disease whose effects on patients are highly variable. The potential of inflammation causing cartilage destruction, bone erosion and subsequent changes in joint integrity is a hallmark of the disease. Another possible application for MOR102 is psoriasis. Psoriasis is an inflammatory, non-contagious skin disorder. Common clinical symptoms are inflammation and swelling of the skin. These lesions are covered with silvery white scales and cause itching, redness and pain. Current treatment options possess limited effectiveness or have considerable side effects.

First Promising Preclinical Results for MOR101 and MOR102

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In an animal model with human psoriatic skin proof of principle was demonstrated for MOR102. Systemic administration of MOR102 reduced epidermal thickness by 40% (lower picture)

Top: Psoriatic skin, untreated Bottom: Psoriatic Skin, treated with MOR102

In October 2003, Dr. Thomas von Rüden, Chief Scientific Officer, presented first promising animal data from preclinical studies of the anti-inflammatory antibody programs MOR101 and MOR102, at the Human Antibodies & Hybridomas Conference in Osaka, Japan.

In its antibody program MOR101, a chimeric Fab fragment derived from the murine BIRR-1 antibody was examined in an initial animal model conducted in collaboration with Prof. Dr. Dr. Pallua and Dr. Fuchs, Clinic for Plastic Surgery at the University of Aachen. The Fab fragment proved to be as potent as the immunoglobulin BIRR-1 antibody previously developed by Boehringer Ingelheim.

In an in vivo human psoriatic skin xenotransplant model conducted in collaboration with Prof. Dr. Boehncke, Department of Dermatology at the University of Frankfurt, proof of principle was demonstrated for MOR102, a HuCAL[®] IgG4 antibody. More specifically, the data showed that treatment with MOR102 reduced psoriatic epidermal thickness by 40% in mice carrying transplants of human psoriatic skin.

The fully human HuCAL[®] antibodies against ICAM-1 are expected to have excellent efficacy profiles in these inflammatory disorders while having none of the immunogenic side effects associated with the mouse antibody. Moreover, the antibodies are expected to suppress inflammation directly at the site of inflammation, as opposed to being systemically immunesuppressive. As such, systemic immune-suppressive side effects could be minimized.

As a result of these positive data, MorphoSys now plans to further preclinically develop its proprietary programs MOR101 and MOR102.

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Further Antibody Programs

MorphoSys currently has two additional antibody programs under way. Both programs are still in the research phase.

MOR202 is a human HuCAL[®] GOLD antibody against an undisclosed target molecule in the indication of oncology

Another antibody program is currently in progress. No further information on this has been presently disclosed.

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Lonza Biologics PLC

In January 2003, MorphoSys entered into a collaboration agreement with Lonza Biologics, a U.K. company specializing in the manufacturing of therapeutic ingredients and intermediates. The agreement provides for the production and supply of clinical-grade antibody drugs derived from MorphoSys HuCAL[®] technology over the next five years. With this agreement, MorphoSys gains access to Lonza’s process development and manufacturing capacity with respect to future antibody projects for both MorphoSys’ proprietary and partnered therapeutic antibody projects. As a result, the value added of MorphoSys’ preclinical products for outlicensing can be further enhanced.

Alliances and Partnered Product Development

MorphoSys presently has 13 active partnerships involving target validation and therapeutic antibody generation. These current collaborations are with (in alphabetical order):

		Development of thera-
Partner	Start	Expansion	peutic antibodies	Target research
Bayer AG	12/1999	06/2001	Several active programs
Biogen Idec, Inc.	12/2000	12/2001	Options for therapeutic
		antibody development
Boehringer Ingelheim	02/2003	One active program, one	—
GmbH		further option for therapeu-
		tic antibody development
Bristol-Myers Squibb	08/1998	07/2000	Options for therapeutic
		antibody development
Centocor, Inc.	12/2000	03/2002	Several active programs
GPC Biotech AG	04/1999	Two active programs	—
F.Hoffmann-La Roche AG	09/2000	One active program	—
ImmunoGen, Inc.	09/2000	06/2001	One active program
Oridis Biomed GmbH	09/2001	—
Pfizer, Inc.	12/2003	Options for therapeutic	—
		antibody development
ProChon Biotech Ltd.	05/2000	05/2002	One active program	—
ScheringAG	12/2001	Five active programs
XOMA Technology Ltd.	02/2002	Options for therapeutic
		antibody development

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Bayer AG

In December 1999, MorphoSys entered into a collaboration agreement with Bayer AG, encompassing a research collaboration and license agreement for the application of MorphoSys’ proprietary technologies in a number of Bayer’s research and development programs. The agreement specified four areas in which the two companies apply technologies:

• (1) to generate fully human therapeutic antibodies against targets provided by Bayer

• (2) to develop antibodies generated using the HuCAL[®] technology as in vitro diagnostics

• (3) to identify antibodies for use in monitoring the progress of clinical trials with selected drugs and

• (4) to identify and validate new targets emerging from Bayer’s genomics program, which will be used by Bayer in screens for new drug candidates.

The agreement, initially scheduled to last for two years, was extended for an additional four years in June 2001. MorphoSys’ HuCAL[®] technology has been installed at Bayer sites in Berkeley, California, as well as in Leverkusen, Germany.

The first milestone in the therapeutic part of the collaboration was achieved in February 2001. The milestone, the delivery of a tailored, high-affinity HuCAL[®] antibody for an undisclosed target, triggered a payment from Bayer. In addition, Bayer exercised exclusive options in February 2001 and in January 2003 for the development of specific HuCAL[®] antibodies. In addition to the efforts in the development of therapeutic antibodies, scientists from both companies have successfully applied the HuCAL[®] technology to a number of research programs for the validation of target molecules.

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Biogen Idec, Inc.

In December 2000, the Company and Biogen Idec, Inc. signed a collaboration agreement, within the framework of which MorphoSys will use its proprietary HuCAL[®] EST technology for the generation of human antibodies for ESTs, in order to support the identification and evaluation of drug candidates in Biogen Idec’s genome research. The antibodies are generated using MorphoSys’ proprietary HuCAL[®] technology. In December 2001, Biogen Idec extended the collaboration, increasing the number of ESTs included in the project. Additionally, Biogen Idec gained access to MorphoSys’ HuCAL[®] GOLD antibody library, which was installed at Biogen Idec in January 2002. Biogen Idec also has the option of developing certain HuCAL[®] and HuCAL[®] GOLD antibodies as therapeutics arising from the collaboration.

Boehringer Ingelheim GmbH

In February 2003, MorphoSys and Boehringer Ingelheim GmbH, entered into a therapeutic antibody collaboration and cross-license agreements. Under the terms of the agreements, MorphoSys received an exclusive, worldwide license to patents owned or controlled by Boehringer Ingelheim to develop, make and sell therapeutic and diagnostic antibodies targeting the ICAM-1 molecule. Boehringer Ingelheim will receive exclusive commercial licenses to therapeutic antibodies against two undisclosed targets, which MorphoSys will generate utilizing its HuCAL[®] GOLD antibody technology.

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In November 2003, Boehringer Ingelheim exercised its first option for the development of a therapeutic antibody. As a result, MorphoSys will develop a therapeutic antibody for Boehringer Ingelheim against an undisclosed target molecule for the treatment of inflammatory diseases such as asthma and rheumatoid arthritis. Boehringer Ingelheim will assume responsibility for the preclinical and clinical development and subsequent marketing of any resultant products, on which MorphoSys could earn milestones and royalties.

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Bristol-Myers Squibb

In August 1998, the Company and Bristol-Myers Squibb Company (formerly DuPont Pharmaceuticals Company) entered into a cooperation agreement under which Bristol-Myers Squibb acquired a non-exclusive license to MorphoSys’ HuCAL[®] antibody library technology. Under the agreement, Bristol-Myers Squibb applied HuCAL[®] technology in its pharmaceutical discovery programs for target characterization and validation. In July 2000, the parties extended this research license and agreed to collaborate in developing a system for fully automated high-throughput antibody generation, called AutoCAL™. The amended agreement provided for Bristol-Myers Squibb’s continued use of the HuCAL[®] libraries and for the installation of AutoCAL™ at Bristol-Myers Squibb’s facilities in Wilmington (Delaware, U.S.A.). Milestones were achieved in 2000 and 2001 with the successful generation of research antibodies against target molecules provided by Bristol-Myers Squibb using AutoCAL™.

Centocor, Inc.

In December 2000, MorphoSys AG and Centocor, Inc., a 100% subsidiary of Johnson & Johnson, signed a five-year collaboration agreement. Within the collaboration, MorphoSys shall use its proprietary HuCAL[®] technology to generate antibody drugs and to identify target molecules for Centocor. Centocor also has an option to develop up to 30 different therapeutic antibodies with MorphoSys. The agreement also allows Centocor access to the HuCAL[®] antibody library in combination with MorphoSys’ proprietary HuCAL[®] EST technology, in order to identify new disease-associated genes, which could become target molecules for future drug developments. MorphoSys also supplies the J&J subsidiaries, Janssen Research Foundation and R. W. Johnson Pharmaceutical Research Institute, with HuCAL[®] antibodies. In December 2001, HuCAL[®] GOLD was installed at Centocor.

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In March 2002, Centocor exercised its option to extend the existing agreement, thus increasing the amount of research and development work to be performed by MorphoSys and exercising an option to use AutoCAL™ in its research programs. In August 2002, MorphoSys reached the first milestone of the collaboration, when it generated and systematically optimized various antibodies against a Centocor target molecule. In November 2002, the successful installation of AutoCAL™ at Centocor was announced. In line with the extended collaboration, MorphoSys received a milestone payment upon the successful conclusion of AutoCAL™ test runs. In July 2003, MorphoSys reached the third milestone in its collaboration with Centocor, when several antibodies against a Centocor target molecule were generated and fulfilled all agreed success criteria.

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GPC Biotech AG

A collaboration agreement between MorphoSys and GPC Biotech AG was signed in April 1999. In the agreement, MorphoSys agreed to apply its HuCAL[®] technology to generate human antibodies against specific major histocompatibility complex (MHC) class II molecules (HLA-DR) provided by GPC Biotech. These molecules are crucial components of the immune system, which are able to distinguish between the body’s own tissue (self) and foreign organisms, and are possibly implicated in autoimmune diseases. The goal of the program is to develop a new generation of highly specific therapeutics to treat a variety of key autoimmune diseases, including rheumatoid arthritis and multiple sclerosis (MS), graft-versus-host disease (GVH), transplant rejection, as well as certain MHC class II-positive lymphoid malignancies.

In February 2000, MorphoSys achieved the first milestone in the collaboration, which triggered the associated milestone payment from GPC Biotech to MorphoSys. MorphoSys had delivered a series of human antibodies, which GPC Biotech confirmed efficiently destroyed specific cancer cells.

MorphoSys achieved the next milestone in September 2000 by delivering high-affinity antibodies for treatment of transplant rejection and GVH. Two additional preclinical milestones were achieved in July 2001, both confirming the ability of MorphoSys’ antibodies to perform successfully in animal models—a first in vivo proof of efficacy for MorphoSys’ HuCAL[®] technology. The first was the achievement of a preclinical milestone in GPC Biotech’s antibody program for the treatment of specific blood cancers, the MHC class II-positive B-cell lymphomas. The second related to the achievement of a preclinical milestone in GPC Biotech’s immunology antibody program for the treatment of transplant rejection and GVH.

During 2003, GPC Biotech announced that they expect the antibody to enter clinical trials in the second half of 2004.

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F. Hoffmann-La Roche AG

MorphoSys and F. Hoffmann-La Roche AG have been collaborating since September 2000 on the development of antibodies for treatment of Alzheimer’s disease. Within the framework of the collaboration, MorphoSys identified various antibodies from its HuCAL[®] library against the Alzheimer target molecule amyloid β-peptide (Aβ). Following two optimization phases, the fully human antibodies showed high-affinity binding to the target molecule.

MorphoSys presented successful animal data from its collaboration with Roche on Alzheimer’s disease at the 33rd Annual Meeting of the Society for Neuroscience in New Orleans (Louisiana, U.S.A.). The HuCAL[®] antibodies generated by MorphoSys within the framework of the collaboration bound very specifically to human amyloid plaques (protein deposits). In the Alzheimer’s animal model performed by Roche, the systemically administered antibodies displayed highly specific binding to the amyloid plaques in the brains of transgenic mice. Substantial accumulations of amyloid plaques in the brain are characteristic of Alzheimer’s patients. The use of antibodies against such amyloid plaques could therefore be a possible method of treatment of Alzheimer’s patients.

The antibodies bound with a very high specificity to amyloid plaques in human tissue sections from Alzheimer’s patients. Moreover, the antibodies were able to dissolve aggregates of Aβ-molecules in in vitro experiments. The optimized HuCAL[®] antibodies were further tested in an Alzheimer’s animal model. Following systemic administration of the antibodies, the antibodies overcame the blood-brain barrier and bound specifically to the β-amyloid plaques in the brain.

In December 2000 and March 2001, the first milestones in the collaboration were achieved. MorphoSys provided a series of HuCAL[®] antibodies that bound selectively to human cerebral tissue affected by Alzheimer’s disease. Both in in vitro studies and in the Alzheimer’s animal model, the HuCAL[®] antibodies generated by MorphoSys demonstrated a high binding affinity for the target molecule. In future, MorphoSys will receive milestone payments and royalties for any end products deriving from the collaboration.

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ImmunoGen, Inc.

In September 2000, the Company signed a collaboration agreement with ImmunoGen, Inc. The collaboration covers the development of therapeutic antibodies for use in cancer treatment. MorphoSys used its HuCAL[®] technology to generate human antibodies against an ImmunoGen cell-surface target molecule. In June 2001, the collaboration was extended by a license agreement giving ImmunoGen access for a period of four years to MorphoSys’ HuCAL[®] technology for the development of antibodies for research purposes.

In April 2002, MorphoSys achieved the first milestone in the collaboration with ImmunoGen, when it supplied antibodies against the ImmunoGen cell-surface target molecule from the field of cancer treatment that fulfilled all of the criteria agreed with ImmunoGen.

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Oridis Biomed Forschungs- und Entwicklungs GmbH

In September 2001, the Company signed a collaboration agreement with Oridis Biomed Forschungs- und Entwicklungs GmbH giving MorphoSys preferential access to one of Europe’s largest human tissue banks over a term of three years. The tissue collection is located in the Institute of Pathology of the University of Graz in Austria and comprises approximately 2.8 million paraffined human tissue samples and approximately 29,000 deepfrozen human tissue samples. The tissue bank contains a large number of both diseased and healthy tissues, and allows Oridis Biomed and its collaboration partners to identify potential therapeutic target molecules.

The aim of the collaboration is to characterize and validate new target molecules. MorphoSys uses its HuCAL[®] technology to generate antibodies against target molecule candidates with which Oridis Biomed has performed high-throughput protein expression analysis on a series of human tissue samples. For this purpose, Oridis Biomed acquired a license for MorphoSys’ HuCAL[®] technology and has access to certain MorphoSys antibodies. MorphoSys received the right to preliminary negotiations with regard to all antibody products resulting from the collaboration. In April 2002, HuCAL[®] GOLD was installed at Oridis Biomed.

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Pfizer, Inc.

In December 2003, MorphoSys and Pfizer, Inc. initiated a therapeutic antibody collaboration. Under the terms of this five-year agreement, MorphoSys will use its HuCAL[®] GOLD library to develop therapeutic antibodies against various target molecules from the Pfizer portfolio. In the collaboration, Pfizer is responsible for the preclinical development, clinical development, and subsequent commercialization of any resulting products. In return, MorphoSys will receive an upfront payment for access to its technology and, for each antibody developed in the collaboration, research support and milestone payments. In addition, MorphoSys stands to receive royalty payments, on any antibody products coming out of the collaboration. The potential value to MorphoSys in committed funding and potential developmental milestone payments on future products is in excess of US$ 50 million, not including royalties.

ProChon Biotech Ltd.

In May 2000, MorphoSys and ProChon Biotech Ltd. (“ProChon”), an Israeli biotechnology company, signed a collaboration agreement. The collaboration stipulates the use of MorphoSys’ technology for the development of therapeutic antibodies against a ProChon target molecule. In November 2000, MorphoSys achieved the first milestone by generating a series of human HuCAL[®] antibodies that were proven to block the function of the ProChon target molecule.

In July 2001, ProChon selected a novel antibody, a result of the collaboration, from the MorphoSys HuCAL[®] antibody library. The antibody potentially represents a new class of drugs as ProChon has proven that this antibody specifically blocks the function of mutated hyperactive forms of a human growth factor receptor.

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The collaboration agreement was initially extended in May 2002. With this extended agreement, the Company acquired exclusive rights to the development and commercialization of a group of HuCAL[®] antibodies resulting from the product development with ProChon, which are targeted against a human growth factor receptor, FGFR-3 (fibroblast growth factor receptor-3), in the field of oncology. This agreement was in connection with MorphoSys’ proprietary MOR201 product development program. Subsequently, the Company and ProChon agreed in July 2003 to transfer back all rights to the FGFR-3 antibodies, including the MOR201 program, to ProChon. Under this extended collaboration agreement, ProChon is currently developing up to four antibodies using the HuCAL[®] GOLD antibody library.

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Schering AG

In December 2001, MorphoSys AG and Schering AG signed a strategic collaboration for the development of antibody therapeutic agents and in vivo diagnostic agents. During the threeyear term of the agreement, Schering gained exclusive access to MorphoSys technology in the field of in vivo diagnostic agents. The collaboration involves a minimum of five therapeutic antibody projects and/or in vivo diagnostic agents. Moreover, the Company and Schering have agreed to jointly research potential therapeutic and diagnostic target molecules resulting from Schering’s genome program. Although the collaboration mainly applies to the indication of oncology, other indication areas such as the central nervous system, the immune system and the cardiovascular system may be included. In March 2002, the Company installed HuCAL[®] GOLD at Schering.

As part of this strategic agreement, in 2002 Schering received 357,880 shares which corresponded at the time to approximately 10% of MorphoSys AG’s common stock. MorphoSys received approximately w 24 million in proceeds as a result of the capital increase.

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XOMA Technology Ltd./XOMA Ireland Ltd.

In February 2002, MorphoSys and XOMA Technology Ltd./XOMA Ireland Ltd. (“XOMA”) concluded mutual license agreements for their antibody technologies. Under the terms of these agreements, MorphoSys received a license for itself and for its collaboration partners for the past and future use of XOMA antibody expression technology for the development of antibody products in connection with the phage display-based HuCAL[®] antibody library (the “XOMA license”). In return, XOMA received a five-year license from MorphoSys to use the MorphoSys HuCAL[®] GOLD antibody library, which XOMA will use for its own target molecule identification and for its research programs. Moreover, an option is included for the development of therapeutic antibodies.

MorphoSys acquired the XOMA license by issuing 363,466 shares arising from a capital increase in 2003.

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32 I N T E R V I E W W I T H P R O F . D R . B O E H N C K E

Interview with Prof. Dr. Wolf-Henning Boehncke

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MorphoSys is developing a promising antibody substance, MOR102, for the treatment of psoriasis. Presently, there are few methods for effective treatment of psoriasis and hence there is significant market potential for any approach that can better help those suffering from this disease. Prof. Dr. Wolf-Henning Boehncke investigated the antibody MOR102 in preclinical trials and shared his thoughts in this interview about psoriasis and MOR102.

Prof. Dr. Boehncke has been a lecturer at the Frankfurt/Main University Dermatology Clinic since 1996 and, as a senior physician, manages the department for “Allergology and Immunology.” Furthermore, he is the spokesperson for the “psoriasis team” within the German Dermatological Society. In 2003, Prof. Dr. Boehncke was awarded the science prize of the GlaxoSmithKline foundation, the Novartis Prize for therapy-related research, and the Galenus-von-Pergamon Prize for his excellent work in psoriasis research.

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MorphoSys Prof. Dr. Boehncke, why is there a significant need for better methods of treatment for psoriasis? Prof. Dr. Boehncke The number of people suffering from psoriasis is very large—at least 100 million cases worldwide are estimated. Importantly, an effective cure for this disease has not yet been found. Due to the severity of the illness, approximately 20% of all psoriasis patients require therapy beyond topical substances, i.e. systemic drug treatment or phototherapy. Unfortunately current therapy is lacking in several ways. More specifically, adverse side effects, drug-resistant variants and lack of long-term drug efficacy all contribute to problems associated with current treatments. Hence, I see the necessity to develop better therapeutic agents for the treatment of psoriasis. MorphoSys What is the advantage of using antibodies against psoriasis as opposed to smallmolecule drugs? Prof. Dr. Boehncke Therapeutic antibodies can inhibit the disease-related mediators or cell-to-cell interactions in a very targeted manner, thus considerably improving treatment of moderate to severe forms of psoriasis. MorphoSys How did the MOR102 project originate? Prof. Dr. Boehncke In clinical trials conducted a few years ago, Boehringer Ingelheim demonstrated that a mouse antibody, BIRR-1 (Enlimomab), could be successfully applied in the treatment of deep dermal burn and inflammatory diseases such as rheumatoid arthritis. BIRR-1 worked by targeting the cell adhesion molecule ICAM-1, which can be found on the inner surface of blood vessels. ICAM-1 is believed to play a major role in the development of psoriasis.

34 I N T E R V I E W W I T H P R O F . D R . B O E H N C K E

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Due to its animal-based origin, BIRR-1 brought with it certain problems in its use as a therapeutic agent. More specifically, human patients recognized this mouse-derived substance as “foreign” and mounted an immune response against it. These problems can be circumvented through the use of 100% human antibodies, such as those from MorphoSys’ HuCAL[®] GOLD library. MOR102 is therefore the human counterpart to BIRR-1, which should show similar efficacy in treating the disease, but without any of the negative side effects associated with the BIRR-1 mouse antibody.

MorphoSys Why is especially ICAM-1 such an interesting target to fight psoriasis?

Prof. Dr. Boehncke

It is known that psoriasis is an autoimmune response of the body, in which the immune system misinterprets the body’s own skin cells as “pathogenic” and attacks them. ICAM-1 is specifically over-expressed on the inner walls of the blood vessels beneath psoriasis-affected skin. It acts as a molecular partner, an “anchor” so to speak, to help the auto-reactive immune cells causing the disease to enter the skin tissue. An antibody capable of blocking this interaction— such as MOR102 —should reduce the severity of the disease significantly. This approach of targeting ICAM-1 taken by MorphoSys should not only show significant results in treating psoriasis, but also result in fewer side effects compared to other drug treatments.

MorphoSys What requirements must the MOR102 antibody fulfill to effectively treat psoriasis?

Prof. Dr. Boehncke

First, it must be capable of binding to the target molecule ICAM-1 as efficiently as BIRR-1 did. Only in this way it can limit the interaction of ICAM-1 with the relevant immune cells of the body and develop its therapeutic effect. Initial tests with MOR102 have demonstrated that the antibody has similar binding properties to BIRR-1, thus fulfilling a very important first step in treatment of the disease.

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MorphoSys What experience did you gain with MOR102 in the animal model?

Prof. Dr. Boehncke The preclinical investigation of MOR102 was performed using the so-called psoriasis SCID mouse model, which is considered a standard and predictive animal model in psoriasis drug development. SCID mice are laboratory test mice whose immune systems have been severely compromised, and on which psoriatic skin from human patients can be grafted. Thus, a piece of psoriatic tissue is available on these mice, which has all the major physiological properties of human psoriasis. In the animal model, treatment using MOR102 reduced the psoriasis by more than 40%—a very significant reduction.

MorphoSys Are these results indicative of future clinical trials in human beings?

Prof. Dr. Boehncke I have tested many active substances using this mouse model and have observed that results in this system are a good indicator of future results in human patients. I am therefore very optimistic that the MOR102 antibody will show promising effects once it goes into clinical trials.

MorphoSys Could you provide an overview of the further development of the project?

Prof. Dr. Boehncke An interesting next step would be comparison of the fully human antibody MOR102 with drugs that are already on the market to treat psoriasis. Should this show a good result, I imagine that the compound could progress into clinical development in human patients in 2005.

MorphoSys Prof. Dr. Boehncke, thank you very much for the interview.

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38 R E S E A R C H & D E V E L O P M E N T

HuCAL[®] —the Most Advanced Human Antibody Technology

Antibodies are produced by the human immune system as a reaction to foreign substances in the body, and are able to recognize and bind to almost any substance, from small molecules to whole microorganisms. It is this property which makes them ideal for use in medicine and research.

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Development of Antibody Technologies
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Murine Chimeric Humanized HuCAL [®] antibody
100% mouse protein 33% mouse protein approx. 10% mouse proteins 100% human proteins
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In recent decades, antibody-generation technologies have been subject to constant development. Originally, monoclonal antibodies were obtained by immunizing mice. However, antibodies derived from mice are of limited use as therapeutic agents since the human immune system recognizes such antibodies as foreign molecules and can trigger a defense reaction. In this case the human organism combats the antibody, which reduces the benefits of the therapeutic substance. It is possible to reduce such defense reactions by chimerizing or humanizing the mouse antibodies, thus decreasing their immunogenicity.

R E S E A R C H & D E V E L O P M E N T 39

MorphoSys has developed the most advanced technology for generating fully human antibodies. This technology allows the reproduction of the entire human antibody repertoire in a test tube. MorphoSys’ method makes it possible to isolate all sorts of antibody types within a very short period of time. The Human Combinatorial Antibody Library (HuCAL[®] ) comprises more than 12 billion human antibodies, the sequences of which are derived from an analysis of naturally occurring human gene sequences. Using the HuCAL[®] technology, fully human antibodies can be identified extremely quickly.

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Dr. Marlies Sproll Vice President Research & Development and International Project Management

MorphoSys Technologies

MorphoSys has developed a variety of technologies for use in the research, development and optimization of human antibodies. These technologies focus on the generation and screening of large high-quality collections, or libraries, of fully human antibodies, with the ability to engineer selected antibodies according to very specific requirements, as a means of developing new and useful drugs for the pharmaceutical industry. Although MorphoSys’ technologies are potentially of wide-ranging application, MorphoSys has primarily focused its efforts on developing antibodies for applications in the pharmaceutical industry to date, as it considers this to be the most profitable opportunity.

The MorphoSys HuCAL[®] antibody library is based on an established technology called phage display. This technology exploits the biological characteristic of bacteriophages. Phages are viruses that infect bacteria, and are completely harmless for humans. The bacteriophages contain the genetic information for antibody fragments and display antibody fragments on their surface. The antibodies displayed in this way maintain their natural binding characteristics and structure, and can bind to a corresponding antigen. During the selection process, only phages with fitting antibodies bind to the target molecules. Under this method, antibodies recognizing target molecules can be identified. As well as the antibody protein, the bacteriophages also contain the genetic information for the antibody and allow for the subsequent production of the selected antibodies.

40 R E S E A R C H & D E V E L O P M E N T

MorphoSys’ principal proprietary technologies are summarized below:

HuCAL[®] and HuCAL[®] GOLD

The Human Combinatorial Antibody Libraries (“HuCAL[®] ”) including the latest and most powerful antibody library developed by MorphoSys, HuCAL[®] GOLD, are fully human antibody libraries based on human gene sequences. The HuCAL[®] GOLD library contains more than 12 billion different antibodies and contains a greater level of diversity than was present in earlier versions.

HuCAL[®] technology has four characteristics which MorphoSys believes distinguish it from competing technologies:

• Modularity: The human genes used as the basis for the HuCAL[®] technology are designed on the DNA level in a way that allows a rapid, directed “plug and play” approach to engineering the antibodies. For example, HuCAL[®] ’s modular construction allows a rapid and easy optimization of specific antibodies via variation of those regions of the antibody which contact the target molecule without compromising the human composition of the antibody.

• In vitro approach: Extensive experimentation has shown that HuCAL[®] provides a range of antibodies against a given target molecule even when it is difficult to obtain such antibodies with in vivo methods of antibody generation. This characteristic of HuCAL[®] results from the high diversity of the underlying library.

• Production aspects: Antibodies sourced from a HuCAL[®] library can be manufactured more easily and in higher yields compared to antibodies isolated from other antibody libraries due to particular features built into the genes encoding the antibodies.

• Immunogenicity: HuCAL[®] -derived antibodies are expected to show little or even no immunogenic response, since they contain, at most, only few mutations as compared to human germline-encoded antibodies. Antibody genes obtained by other methods which rely on antibody maturation frequently contain more such mutations, making them more distant from the human germline, which might contribute to unwanted immune reactions in patients.

TRIM

Trinucleotide-directed mutagenesis (TRIM) is a powerful technology for introducing variability into genes in a controlled fashion and thereby ensuring that the resulting gene libraries are of the highest possible quality. The use of this technology allows the introduction of any desired amino acid at will at each single position of the variable regions of the antibodies. All HuCAL[®] libraries have been generated using TRIM technology which has led to very highquality HuCAL[®] libraries by avoiding unproductive variations in the antibody genes.

R E S E A R C H & D E V E L O P M E N T 41

CysDisplay™

Cysteine-mediated phage display (CysDisplay™) is a novel, proprietary and efficient technology for selecting high-affinity antibodies from libraries, and is designed to provide a more efficient process of antibody identification. CysDisplay™ combines the advantages of the phage display technology such as phenotype-genotype linkage with the additional feature of a cleavable disulfide bond allowing efficient elution of interacting partners during the panning procedure. The technology is an advancement of the original phage display and is fully compatible with MorphoSys’ other technologies.

HuCAL[®] EST

HuCAL[®] EST is a proprietary technology that enables high-throughput generation of antibodies against protein fragments encoded by expressed sequence (EST). ESTs are fragments of DNA which contain parts of genes or complete genes. ESTs are sometimes used as tools for the analysis of unknown genes. Antibodies against such protein fragments are required to determine when, where and how much of the EST-encoded protein is expressed in various tissues, and to elucidate their function.

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The antibody selection process can be automated for highthroughput screening of the library

AutoCAL™

AutoCAL™ is a system of laboratory robots and software components developed by MorphoSys that enables the high-throughput screening of HuCAL[®] antibody libraries, resulting in the rapid selection of a highly diverse pool of specifically binding fragments of antibodies. AutoCAL™ is a modular and expandable system, allowing maximum flexibility.

In Situ Protein Expression Profiling

Staining of tissues with specific antibodies or immunohistochemistry (IHC) is a powerful method in target identification and validation. Antibodies selected from HuCAL[®] libraries have been shown to be ideal tools for high-throughput IHC. MorphoSys’ proprietary dimeric (two-armed) mini-antibodies are best suited for this application, because they can easily be produced in bacteria. In combination with the HuCAL[®] EST technology, novel targets, such as those derived from genomics approaches, can be validated by immunohistochemical studies within weeks. Through MorphoSys’ cooperation with Oridis Biomed GmbH, it has gained access to one of Europe’s largest tissue collections combined with Oridis Biomed GmbH’s broad expertise in the field of molecular pathology.

42 R E S E A R C H & D E V E L O P M E N T

MorphoSys’ Patent Portfolio

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Dr. Bernhard Virnekäs Senior Director Intellectual Property

Over the last few years, MorphoSys has built a strong intellectual property portfolio around its proprietary technology, HuCAL[®] (Human Combinatorial Antibody Library). To date, MorphoSys has 8 patents granted and more than 40 applications pending worldwide. The patents and pending applications cover a variety of different technologies, including antibody libraries, screening methods, certain antibody fragment formats and specific antibodies.

Settlement of the long-standing patent dispute with Cambridge Antibody Technology enabled MorphoSys to further strengthen its patent position. In another pending patent dispute brought against MorphoSys by Applied Molecular Evolution (AME), MorphoSys received a positive recommendation in January 2003 (Report and Recommendation). The Magistrate Judge recommended that the District Judge of the district court in Boston uphold MorphoSys’ petition for non-infringement of the patents and reject AME’s petition for patent infringement by MorphoSys. The Magistrate Judge’s recommendation has now been submitted to the District Judge for a final decision. If the District Judge accepts the Magistrate Judge’s recommendation, i.e. that MorphoSys has not infringed the patents in suit, all counts of AME’s charge will be decided in favor of MorphoSys.

MorphoSys’ Proprietary Intellectual Property

MorphoSys’ proprietary intellectual property consists of the following:

HuCAL[®]

HuCAL[®] patents have been granted in Australia, at the European Patent Office and in the United States, each patent having a life until 2016. The European patent was granted in June 2002 and has become effective across all E.U. countries, whereas the patent applications are still pending in Canada and Japan. Further divisional patent applications are pending in Australia, the United States and before the European Patent Office, with certain divisional applications already having been allowed for grant in the United States. Effective December 31, 2002, these patents as well as the pending patent applications have been assigned to MorphoSys IP GmbH.

HuCAL[®] EST

A patent application under the PCT was filed in 1999, designating Canada, Japan, the United States and the European Patent Office. The national/regional phases were entered into in 2001. In November 2003, the first HuCAL[®] EST patent was granted in the U.S.A.

CysDisplay™

A patent application under the PCT was filed in 1999, designating Australia, Canada, Israel, Japan, Norway, the United States and the European Patent Office. The national/regional phases were entered into in 2001.

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R E S E A R C H & D E V E L O P M E N T

HuCAL[®] GOLD

In July 2003, the Company filed a PCT application identifying Australia, Canada and the United States as countries in which it wished to subsequently secure patent protection through national granting procedures. The application covers a new vector concept, which is used in the HuCAL[®] GOLD library, and is based on a preliminary application filed in July 2002. Effective December 31, 2002, this patent application and every continuation of it was assigned to MorphoSys IP GmbH.

Third-Party Rights

Depending on the library format and screening system being used, the application of MorphoSys’ proprietary technologies requires access to various third-party licenses to guarantee the unrestricted utilization of its own technologies. Alternatively or in addition to entering into licensing agreements for proprietary third-party rights, MorphoSys may attempt to invalidate or restrict the rights so owned by third parties. As of the date of this report, MorphoSys had inlicensed the following proprietary third party-rights:

TRIM (trinucleotide-directed mutagenesis)

MorphoSys has obtained an exclusive license to the trinucleotide-directed mutagenesis (TRIM) technology patented by the Johns Hopkins University, U.S.A., and thus is able to use the technology in-house, or assign the rights to use this technology to licensees of its proprietary HuCAL[®] technology. The TRIM technology has been patented in the United States and at the European Patent Office. In December 2001, the European patent was opposed by two parties, Maxygen, Inc. and Novozymes A/S.

SCA Ventures, Inc., U.S.A.

MorphoSys has obtained a non-exclusive license to the scFv estate patented by SCA Ventures, Inc., a subsidiary of Enzon, Inc., and thus is able to use the technology in-house, or assign the rights to use this technology to licensees of its proprietary HuCAL[®] technology.

Genentech, Inc., U.S.A.

MorphoSys has a license to monovalent phage display from Genentech, Inc., with the rights to sublicense this technology to licensees of its HuCAL[®] technology.

Dyax Corporation, U.S.A.

MorphoSys possesses a worldwide, non-exclusive license to the patents of Dyax Corp. This license allows MorphoSys to practice conventional phage display in the areas covered by the Dyax claims. An important part of the agreement between Dyax and MorphoSys is that commercial partners of MorphoSys may obtain licenses to Dyax’s phage display patents for use in conjunction with a MorphoSys technology such as HuCAL[®] .

44 R E S E A R C H & D E V E L O P M E N T

Biosite Diagnostics, Inc., U.S.A.

MorphoSys has obtained a license to phage display of multimeric antibody fragments, such as Fabs, and is now able to sublicense the rights to use this technology to licensees of its proprietary HuCAL[®] technology.

XOMA Ireland Ltd., U.S.A.

MorphoSys entered into a license agreement in 2002 with XOMA, under which MorphoSys and its partners received certain rights to use the XOMA antibody expression technology for developing antibody products (including Fab and scFv formats) using MorphoSys’ phage display-based HuCAL[®] antibody library. MorphoSys also received a license for the production of antibodies (including Fab and scFv formats) under the XOMA patents.

Cambridge Antibody Technology Ltd., Great Britain

As part of the settlement agreement between MorphoSys and Cambridge Antibody Technology (CAT), signed in 2002, leaving MorphoSys free to develop and commercialize its HuCAL[®] GOLD activities without restriction. In addition, MorphoSys also received a license to the CAT patent estate in respect of previous HuCAL[®] libraries. Under the terms of the agreement, CAT received an equity stake of 588,160 ordinary shares in MorphoSys, as partial payment.

MOR101 and MOR102

Under the terms of the agreements with Boehringer Ingelheim, in February 2003, MorphoSys received an exclusive, worldwide license to patents owned or controlled by Boehringer Ingelheim to develop, make and sell therapeutic and diagnostic antibodies targeting the ICAM-1 molecule.

Number of granted and pending patents of MorphoSys, including third-party rights, by technology at December 31, 2003

Technology [third-party, from		Granted patents and pending
which patents were inlicensed]	Description	patent applications*
HuCAL® and HuCAL® GOLD	Fully modular and fully	Patents granted in Australia,
	synthetic human combinatorial	U.S.A. and Europe; further
	antibody library based on	patent applications pending
	consensus sequences
Trinucleotide-directed	New technique for generating	Patents granted inU.S.A.
mutagenesis (TRIM)	mixtures of oligonucleotides in	and Europe
[Johns Hopkins University]	a single automated synthesis
	usingtrinucleotide mixtures
scFv antibody fragments	Antibody fragment format	Patents granted_inter alia_
[Enzon]		inU.S.A. and Europe
Mini-antibodies	Multimeric antibody fragments	Patents granted_inter alia_ in
[Merck Patent GmbH]	linked via association domains	U.S.A. and Europe

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R E S E A R C H & D E V E L O P M E N T

Technology [third-party, from		Granted patents and pending
which patents were inlicensed]	Description	patent applications*
Mini-antibodies II	Targeted hetero-association	Patents granted in theU.S.A.;
	of recombinant proteins to	further patent applications
	multifunctional complexes	pending
Mini-antibodies III	Multimeric antibody fragments	Patent applications pending
scFv display	Display of scFv antibody	Patents granted in Europe
[Enzon]	fragments on an organism
Phage display	Display of proteins on phage	Patents granted in theU.S.A.
[Dyax]
Fab display	Display of Fab antibody	Patents granted_inter alia_ in
[Biosite]	fragments on phage	U.S.A., Japan and Europe
Monovalent phage display	Display of proteins on phage	Patents granted_inter alia_ in
[Genentech]	in monovalent form	U.S.A. and Europe
SIP screening technology	Selectively infective phage	Patent granted in theU.S.A.;
[MorphoSys/Garching	particles	further patent applications
Innovations]		pending
Library versus library	Interactive screening of	Patent applications pending
	two libraries
Fab display	Display of Fab antibody	Patent applications pending
	fragments on polyphage
	particles
Generation of antibodies	Generation of antibody	Patent granted in theU.S.A.;
againstESTs	fragments against	further patent applications
	EST-encoded polypeptides	pending
Alternative phage display	Display of proteins on phage	Patent applications pending
technology	usingdisulfide bridges
Secretion in_E. coli_	Functional expression of anti-	Patents granted_inter alia_ in
[XOMA]	body fragments in_E. coli_	U.S.A., Japan and Europe
	usingsecretion into periplasm
Anti-MHC II antibodies	Antibodies binding to human	Patent applications pending
[GPC/MorphoSys]	MHC class II molecules
Anti-TIMP-1 antibodies	Antibodies binding to human	Patent applications pending
[Bayer/MorphoSys]	TIMP-1
Anti-RTK antibodies	Antibodies that block	Patent applications pending
[ProChon/MorphoSys]	receptor tyrosine kinases
Anti-Aß antibodies	Antibodies binding to human	Patent applications pending
[Roche/MorphoSys]	Aß peptide
* Includes proprietary and inlicensed patents

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48

C O R P O R A T E G O V E R N A N C E

Corporate Governance

The term “corporate governance” can be understood as the legal and factual framework for responsible company management and supervision aimed at generating long-term added value. The essence of good corporate governance involves efficient cooperation between the Management and Supervisory Boards, respect for shareholders’ interests, as well as openness and transparency of corporate communication to the public.

MorphoSys welcomed the German Corporate Governance Code, first published in February 2002 by the independent Government Commission. Prior to the promulgation of this code, the Management and Supervisory Boards of MorphoSys had voluntarily approved the Company’s own corporate governance guidelines in September 2001. In doing so, MorphoSys became a pioneer in the German biotechnology sector in terms of corporate governance. In 2002, the Company’s guidelines were newly adapted to the recently issued German Corporate Governance Code. Looking ahead, MorphoSys will now adhere to the Code published by the Government Commission in lieu of a Company-specific code.

The declaration of conformity is available on the corporate website www.morphosys.com — Investors—Corporate Governance.

In December 2003, the Management and Supervisory Boards of MorphoSys submitted their declaration of conformity with the recommendations of the Government Commission German Corporate Governance Code in accordance with Article 161 of the German Stock Corporation Act. MorphoSys fully conforms with the supplemental code version of July 2003, save two exceptions. This declaration was published on December 22, 2003 on the Company’s website (see also declaration of conformity, page 131 of this report).

As an expression of its commitment to corporate governance, the Company introduced a code of ethics for its senior managers. The code is directed at all members of the Management Board and directors, as well as for all managers responsible for finance, controlling and accounting at the Company. Financial managers have an especially important and distinctive role to play within a company’s corporate governance, as it is they who must be authorized to prevent financial misconduct and to ensure that the accounts are fairly and accurately represented to the public.

C O R P O R A T E G O V E R N A N C E 49

Management Board and Supervisory Board

In the Management Board and Supervisory Board, MorphoSys has a divided management and supervisory structure in accordance with the German Stock Corporation Act.

Management Board

The Management Board of MorphoSys AG is comprised of three members and has a Chairman, who is the Chief Executive Officer. The Management Board is responsible for independently managing the enterprise and is obliged to act in the enterprise’s best interests. Moreover, the Management Board is responsible for developing the Company’s strategy, appointing persons to key posts within the Company, planning the Company budget, and supervising general Company management.

The Management Board and Supervisory Board cooperate closely to the benefit of the enterprise. An intensive, continual dialog between the two Boards is the basis for efficient corporate management. The Management Board informs the Supervisory Board regularly, without delay and comprehensively, of all issues important to the enterprise with regard to planning, business development, risk situation and risk management. The Company’s strategy is developed in close consultation with the Supervisory Board. For more operational Management Board decisions, such as the annual budget plan or larger-scale investment plans, Management Board regulations specify which actions require approval by the Supervisory Board. In these regulations, the Management Board’s information and reporting duties are also specified.

Supervisory Board

The Supervisory Board is comprised of six members, all of whom represent the Company’s shareholders. The Supervisory Board supervises and advises the Management Board in the management of the enterprise. The Supervisory Board regularly discusses business development and planning as well as strategy and its implementation with the Management Board.

Members of the MorphoSys Supervisory Board should be no older than 75. No former members of the MorphoSys AG Management Board are members of the Supervisory Board. All members of the Supervisory Board have many years of experience in the pharmaceutical and biotechnology industry and have been duly elected at the General Meeting by the shareholders. All members have term durations until the ordinary Shareholders’ meeting of 2004, except two members who have terms until the ordinary Shareholders’ meeting of 2006.

50 C O R P O R A T E G O V E R N A N C E

The Supervisory Board of MorphoSys AG has formed two committees, the Remuneration/ Nomination Committee and the Audit Committee. The Remuneration/Nomination Committee makes proposals on the appointment of Management Board members and other senior management, and also negotiates the conditions of employment and compensation for the Management Board. The Audit Committee’s duties include assisting the full Supervisory Board in the approval of the annual financial statements and the consolidated financial statements. The Committee also commissions the auditor to carry out the audit, specifies the main focus of the audit, determines the audit fee, and checks the independent status of the auditor. The Audit Committee’s other duties are codified in a Company Audit Committee Charter.

Compensation of the Management Board and Supervisory Board

Management Board Compensation

The compensation of a management board depends on the size and international activity of the enterprise and its economic and financial situation, as well as on the level of compensation in comparable companies, both in Germany and abroad. The appropriateness of the Management Board compensation at MorphoSys is subject to an annual review and is compared with the results of the Annual German Biotechnology Industry Remuneration Study (GRS Study).

The compensation of members of the Management Board has a performance-related element and is comprised of both fixed and variable components.

Company goals, such as the achievement of particular revenue levels or strategic targets, are specified by the Supervisory Board together with the Management Board at the beginning of the fiscal year, and are one basis for assessing achievement of the variable component of each member’s compensation. Additionally, each year personal targets each year are also agreed between the individual members of the Management Board and the Supervisory Board. At the end of each fiscal year, the Supervisory Board evaluates and assesses the goals and specifies the bonus, or variable compensation component, for the members of the Management Board.

Additionally, members of the Management Board take part in a stock option and/or convertible bond program. Such programs are approved by the Annual Shareholders’ Assembly, while the amount allocated to the Management Board is specified by the Supervisory Board. No restriction on the gain arising from stock options has been agreed for these programs.

For the 2003 fiscal year, the compensation of the Management Board amounted to a total of w 1,078,934. The compensation is disclosed for each individual member of the Management Board, subdivided into fixed, variable and other compensation.

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C O R P O R A T E G O V E R N A N C E

	Fixed	Variable	Other	Total compen-
inR	compensation	compensation	compensation	sation in 2003
Dr. Simon Moroney	212,100	94,500	60,261	366,861
Dave Lemus	166,650	57,750	140,145	364,545
Dr. Thomas von Rüden	192,136	80,530	74,862	347,528

Supervisory Board Compensation

In the 2003 fiscal year, the members of the Supervisory Board received at total of w 174,117, which was in accordance with the Annual Shareholders’ Assembly proposal in June 2003. This amount is composed of fixed compensation, attendance fees and travel expense reimbursement. According to the resolution of the General Meeting, the Chairman of the Supervisory Board receives a fixed compensation of w 22,000 and the other members of the Supervisory Board each receive w 12,000. In addition, the Chairman of the Supervisory Board receives a sum of w 3,000 for each meeting he chairs and the other members of the Supervisory Board receive w 1,500 for each meeting they attend. Additionally, the Chairman of each Supervisory Board Committee receives a sum of w 3,000; other committee members receive a sum of w 1,500.

inR 2003	inR 2003
Dr. Gerald Möller (Chairman)	47,427
Prof. Jürgen Drews (Deputy Chairman)	25,963
Dr. Daniel Camus	22,624
Prof. Andreas Plückthun	25,770
Dr. JörgReinhardt	23,888
Geoffrey N. Vernon	28,445

No consulting contracts with the Supervisory Board are currently in place.

In the context of their performance-related compensation, the members of the Supervisory Board also take part in the convertible bond program of MorphoSys AG. On the basis of the General Meeting resolution in June 2003, members of the Supervisory Board became entitled to subscribe for convertible bonds. The Chairman of the Supervisory Board was entitled to receive 2,500 non-interest-bearing convertible bonds, the Deputy Chairman 2,000 bonds and the other members 1,500 bonds.

During the reporting year, no members of the Management Board no the Supervisory Board were granted Company loans.

52 C O R P O R A T E G O V E R N A N C E

Stock Option and Convertible Bond Plans

The present stock option plan was adopted by the Shareholders’ assembly of MorphoSys AG on June 6, 2002. A general description of the various programs in place can be found in the Notes to the consolidated Financial Statements.

In the 2003 fiscal year, 36,000 stock options and 46,000 convertible bonds were issued to the Management Board. A total of 8,500 convertible bonds were issued to the Supervisory Board.

Stock options grants to the Management Board in fiscal year 2003:

				Potential	realizable value at
				expiry date at assumed annual
				rates of stock	price appreciation
Member of the	Number of	Exercise	Expiry		for option terms*
Management Board	options	price	date	5%	10%
Dr. Simon Moroney	22,000	§10.88	01/07/2008	§66,131	§146,132
Dave Lemus	-	-	-	-	-
Dr. Thomas von Rüden	14,000	§10.88	01/07/2008	§42,083	§92,993

*Based on the exercise price

Convertible bonds grants to the Management Board in fiscal year 2003:

				Potential realizable value at
				expiry date at assumed annual
				rates of stock price appreciation
Member of the	Number of	Exercise	Expiry	for convertible bond terms*
Management Board	options	price	date	5% 10%
Dr. Simon Moroney	12,000	§11.69	31/12/2005	§18,198 §37,744
Dave Lemus	24,000	§10.88-§11.69	31/12/2005	§34,925 §72,436
Dr. Thomas von Rüden	10,000	§11.69	31/12/2005	§15,165 §31,453
*Based on the exercise price

*Based on the exercise price

C O R P O R A T E G O V E R N A N C E 53

Risk Management

Responsible management of corporate risks is a key element of good corporate governance. MorphoSys has implemented a risk management system in order to identify risks at an early stage. The risk management system of MorphoSys is audited annually by the auditors. MorphoSys makes adaptations to the system each year as necessary in order to adjust the system to changing conditions. Further details can be found in the Risk Report on pages 79—81 of this report.

Fair and Open Disclosure

One of the most important aims of corporate communication at MorphoSys is to provide all shareholders and capital market participants with open and prompt information. MorphoSys reports to its shareholders on predefined dates four times in the course of the fiscal year. Quarterly reports are made available within 30 days, and annual financial statements within 60 days. The aim to provide the same information to all target groups at the same time is a high priority in this respect. MorphoSys uses its own Company website in order to provide current information promptly and directly to all shareholders and interested parties. In addition to the legally required ad hoc announcements, all major events within the Company are announced via press releases. All publications are also written and published in German and English. Moreover, the Company offers all interested parties the opportunity to be added to the Company’s mailing list.

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T H E M O R P H O S Y S S H A R E

The MorphoSys Share

The year 2003 witnessed the beginnings of a broader equity market recovery. Unfortunately, these gains did not translate into the performance of the MorphoSys share during the year. After a brief but very strong share price rally at the beginning of the year resulting from the settlement of the patent dispute with Cambridge Antibody Technology (CAT), the MorphoSys share price drifted sideways for the better part of the year, trading in a narrow range. However, with the restructuring plan announced in 2002, MorphoSys used the year to consolidate its activities in order to increase commercial deal flow and strengthen its financial position.

Development of the MprphoSys share price from January 1, 2003 until December 31, 2003, indexed

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T H E M O R P H O S Y S S H A R E 57

The MorphoSys Share

During fiscal year 2003, approximately 11.5 million MorphoSys shares changed hands, representing an increase of more than 5% of trading volume compared to the previous year. Translated into daily volume, an average of 45,000 shares were sold per trading day, compared with an average of 43,000 shares in 2002. The significant increase in trading volume represents not only capital increases executed throughout the year, but also increased visibility among investors. MorphoSys again remained one of the most heavily traded shares during the year, ranking 29th out of 178 technology companies in the Prime Standard segment.

In autumn 2002, the German Stock Exchange announced the introduction of a new indexing system for stocks listed on the Frankfurt Stock Exchange. The index for technology shares, the NEMAX50, was replaced with a new index, the TecDAX. The TecDAX represents the 30 largest technology companies in the Prime Standard index, as measured by market capitalization and trading volume. MorphoSys is presently not part of the TecDAX index, but is listed in the Prime Standard index and is represented in the industry sector index Prime Pharma & Healthcare.

During 2003, the MorphoSys share lost 30% of its value since December 31, 2002, whilst the Prime Pharma & Healthcare index gained by 20%. Using the MorphoSys share price based on December 20, 2002, the day prior to the announcement of the settlement of the patent dispute with CAT, the share price increase would have been 134% for the year.

Capital Increase and Shareholder Structure

During the year, two capital increases for licenses were executed—one issued to XOMA and the other to CAT.

In 2002, MorphoSys and XOMA concluded a mutual license agreement for their antibody technologies. Under the agreement, the Management Board and the Supervisory Board decided to issue XOMA 363,466 shares as partial payment for the license. In May 2003, the capital increase in favor of XOMA was raised and the corresponding shares issued to XOMA. MorphoSys was pleased to report in the third quarter that, as agreed, XOMA had sold all of its shares in MorphoSys and no longer held a stake in the Company.

58 T H E M O R P H O S Y S S H A R E

In December 2002, MorphoSys and Cambridge Antibody Technology (CAT) agreed a settlement in their longstanding patent dispute. Within the framework of the settlement, CAT received 588,160 MorphoSys shares. In August 2003, the capital increase was executed and the shares issued to CAT. A lockup for the shares was agreed between the two parties.

On December 31, 2003, the number of ordinary shares issued was 4,901,332. On this date, the largest shareholders were CAT, holding 12% (588,160 shares), and Schering with 7.3% (357,880 shares) of the total share capital. Approximately 80% of shares are considered free float, as defined by the German Stock Exchange. Of this amount, roughly 3.5% of these shares are held by the Management Board and the Supervisory Board.

	Number of
	Shares
Major EquityIssuances: 2003
Total Shares Issued December 31, 2002	3,949,706
Share Issuance for XOMA	363,466
Share Issuance for CAT	588,160
Total Shares Issued December 31, 2003	4,901,332

Conversion to IFRS

In 2002, the E.U. Commission decided to introduce the International Financial Reporting Standards (IFRS). The implication of this is that all European publicly traded companies must prepare their accounts from 2005 onwards in conformity to IFRS standards. MorphoSys’ consolidated financial statements are presently prepared in accordance with the generally accepted accounting principles (GAAP) in the U.S.A. It is anticipated that MorphoSys will convert its accounts to IFRS prior to this time.

T H E M O R P H O S Y S S H A R E 59

Corporate Communications

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Dr. Claudia Gutjahr-Löser Director Corporate Communications

The most important goal of corporate communication is to provide shareholders with prompt, accurate and comprehensive information. This is achieved through continuous dialog with private investors, institutional investors, analysts and journalists. In this capacity, MorphoSys makes use of all communication distribution channels, such as e-mail, internet and telephone conferences, in order to provide all market participants with the same information at the same time.

Due in large part to the protracted bear market and the resulting difficult financial situation for several banks, during the year there was a reduction in the number of analysts which regularly report on MorphoSys. This was, however, in line with the general trend in which most smaller capitalized companies find it increasingly difficult to attract analyst coverage. Currently, 14 analysts regularly report on the Company—six analysts fewer than at the end of 2002. However, during the year the ratings of 7 out of 14 analysts covering the Company had changed for the positive.

In the 2003 fiscal year, MorphoSys presented its strategy at a number of investor conferences and road shows. MorphoSys intends to increase such activities in 2004. In 2003, a letter to shareholders was also written and distributed, with the purpose of intensifying the dialog with private investors.

An important project aimed at improving communication was the relaunch of the Company’s website. As part of the commitment to fair disclosure, presentations and publications such as financial reports are available online and can be downloaded. Information on analyst meetings, telephone conferences, the year-end press conference, and the Annual Shareholders’ Assembly is promptly made available on the website. Further information can be found on the Company’s website: www.morphosys.com.

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Management Report

Industry Overview

Macroeconomic Development

Europe’s economic growth remained modest in the first half of 2003. However, global economic expansionary forces, which had gained the upper hand in the early part of the year, accelerated in the second half of the year. The most powerful expansive impetus was provided by the U.S. economy, which in the third quarter posted the highest quarterly growth since 1984. The Japanese economy benefited from strong demand for imports from its neighbors in Asia and from the U.S.A. as well as from brisk domestic demand. Although the Eurozone could not keep up with the faster economic pace in the U.S.A. and the strong growth in Japan, there are many factors that indicate a gradual cyclical revival may have taken root in Europe.

The underlying economic conditions for a continuation of the recovery process developed favorably, in part because of low interest rate levels. Short-term interest rates in the Eurozone have dropped from 2.9% to 2.1% during 2003, while short-term U.S. interest rates remained at 1.0% at year-end—interest rate levels whose depths have not been seen since 1958. Mirroring this development in reverse, equity prices on the leading stock exchanges for the most part displayed an upward trend, which was mainly associated with solid quarterly results in the corporate sector. For example, during 2003, the Dow Jones Index increased by 25%, the Nikkei by 24% and the DAX by 37%.

The U.S. dollar exchange rate came under considerable pressure in the fourth quarter of 2003. At the end of December 2003, the euro/U.S. dollar exchange rate rose to US$ 1.26 per euro, thus reaching an all-time high since the introduction of the euro. Two reasons have been given for the euro’s record-breaking run; first and foremost, the continuing high budget deficit in the U.S.A. weighs in on the mind of investors, and second, the possibility looms that Asian central banks’ purchases of U.S. dollars may decline in the future.

Development within the Biotech Sector

The situation and sentiment within the biotech sector have changed rather substantially over the past two years. In 2003, the total number of companies in Germany in the biotech sector decreased for the first time since the mid-1990s. In 2002 and 2003, the number of newly founded companies did not offset the number of new insolvencies, liquidations and acquisitions/mergers. The most telling statistics of the industry—total headcount, the level of spending on research and development, and revenues—have all also declined.

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Number of companies/ Number of
new formations companies dissolved
400 40
365 360
350 332 35
300 279 31 30
250 25
200 20
150 15
100 11 10
6
50 57 59 5
44
25
0 0
1999 2000 2001 2002
Companies (total)
New formations
Companies dissolved
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Source: Ernst&Young, Biotechnology-Report 2003
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In contrast to the U.S.A., where seven biotech IPOs have taken place during the fourth quarter of 2003, no IPOs were successfully executed in Germany in 2003. Moreover, during the year, only a few companies in Europe, such as the Austrian company Intercell and U3 Pharma in Germany, reported the successful conclusion of equity financing. The inflow of capital in Europe to biotech companies amounted to US$ 2.5 billion compared to US$ 1.1 billion in the previous year. This compares to a total of US$ 15.1 billion invested in the U.S.A., a year-onyear increase of 65%. Positive news generated through strong revenue growth for the larger established biotech companies such as Amgen and Gilead and by a series of new approvals for companies such as FluMist (MedImmune) and Raptiva (Genentech/XOMA) also contributed substantially to the upturn in fortunes in the U.S. biotech sector. Also a catalyst was news from Genentech in the form of Avastin, at the ASCO (American Society for Clinical Oncology) meeting in May 2003. The contrast between Europe and the U.S.A. in the biotech sector development was also reflected in the development of equity prices: the NASDAQ Biotech index rose by 46% in 2003, while the German Prime Pharma & Healthcare index increased by only 20%.

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Nonetheless, pharmaceutical companies, irrespective of their geography, continue to remain under pressure to launch new products. Research spending of pharmaceutical companies has risen considerably since the 1980s. Nevertheless, productivity has decreased steadily in terms of the number of market approvals. Major pharmaceutical companies are investing increasingly in preclinical development products from the biotech sector, and no longer exclusively in product candidates in advanced stages of development. Wide-ranging research cooperation agreements signed in 2003, such as those between Aventis/ImmunoGen and Amgen/Biovitrum, are a clear sign of this development. Such alliances offer pharmaceutical companies the opportunity to outsource a part of their research and thus to spread the risks more efficiently. Many pharmaceutical companies now invest more than a fifth of their research budgets in such alliances.

In 2003, there was also uplifting news related to therapeutic antibodies. The number of approved therapeutic antibodies on the market increased from 12 to 16 by the end of the year. Two antibodies on the market, Rituxan and Remicade, are blockbuster drugs, meaning that they generated annual revenues of more than US$ 1 billion each. In total, global revenues of therapeutic antibodies grew to more than US$ 5 billion, a year-on-year growth of approximately 25%.

Although there were a few clinical development failures in 2003, such as Genmab’s antibody Humax-CD4 for the treatment of psoriasis, Genentech presented positive findings for Avastin from a phase III study with colorectal cancer patients at the annual meeting of the American Society for Clinical Oncology (ASCO). The German company Merck also presented promising data at this meeting relating to their therapeutic antibody cancer drug Erbitux. Despite stumbling blocks encountered in the U.S., Erbitux was approved during the year in Switzerland.

Financial Analysis

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Michael Grau
Senior Director
Finance & Accounting
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Operating Revenues

Compared to the same period of the previous year, revenues for the full year 2003 decreased by 9% to w 15.3 million (2002: w 16.8 million). Reasons behind the decline included later than anticipated timing for deal signing and milestone achievements, as well as foreign exchange effects. Using constant exchange rates (2002), MorphoSys 2003 revenues would have been w 0.6 million, or 4% higher.

A substantial majority of revenues recorded in 2003 relate to annual licensing fees received from existing partners. In this regard, milestone revenues amounted to w 0.5 million or 3% for the full year 2003 compared to 10% in the prior year. The Company also recorded grant revenues, arising from the German Federal Ministry of Education and Research (“Bundesministerium für Bildung und Forschung”), amounting to w 0.1 million during the reporting period, and remained essentially unchanged to the same period in the previous year.

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Of total revenues, approximately 82% related to therapeutic antibody collaborations, 17% to antibody research collaborations, and 0.2% to the “Antibodies by Design” initiative. For purposes of classification, the following partners were considered to be therapeutic antibody collaborations: Bayer, Centocor, GPC Biotech, ImmunoGen, ProChon, Roche, Schering and Pfizer. Target research collaborations consisted of: Biogen Idec, Bristol-Myers Squibb (formerly DuPont), ImmunoGen (expansion) and Oridis Biomed. Approximately 81% (2002: 77%) of total Company revenues arose from MorphoSys’ three largest alliances with Centocor, Bayer and Schering.

Geographically, 81% of MorphoSys’ commercial (non-grant) revenues in the amount of w 12.4 million were generated with biotechnology and pharmaceutical companies located in the United States and 19% in Europe, compared to 76% and 24% respectively for the prior year.

Operating Expenses

For the full year 2003, total operating expenses, including stock-based compensation expenses, substantially decreased by 56% to w 18.8 million (2002: w 42.3 million), a reduction of w 23.5 million, and was appreciably better than expected. A significant reduction in expense resulted from lower patent and licensing expenses arising from the settlement agreement with Cambridge Antibody Technology (“CAT”) and license agreement with XOMA. In addition, the Company’s restructuring plan implemented during the year 2003 also led to lower personnel-related costs and reduced product development-related costs.

Research and Development Expenses

Costs for research and development fell by w 10.6 million to w 9.0 million (2002: w 19.6 million). This decrease resulted chiefly from lower licensing costs as a result of the licensing and settlement agreements with CAT and XOMA in the prior year, as well as the Company’s decision to refocus efforts in proprietary product development. Under the Company’s restructuring plan, proprietary products will be outlicensed at the preclinical stage, thereby resulting in notably lower product development costs.

Revenues: Licenses vs. Milestones

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Grant revenues 1 %
Achievement of milestones 3 %
Licensing revenues 96 %
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Revenues by Region

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Europe 19 %
U.S.A. 81 %
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Sales, General and Administrative Expenses

Sales, general and administrative expenses amounted to w 7.6 million compared to w 18.7 million in the previous year. The decrease in general and administrative expenses was largely due to lower patent litigation costs with the amount of w 0.3 million (2002: w 7.0 million), arising as a result of the settlement with CAT in December 2002. Also substantially contributing to cost savings was the closing of MorphoSys U.S.A., Inc., with net savings to MorphoSys of approximately w 1.8 million for the year 2003.

Stock-Based Compensation

Stock-based compensation in the amount of w 2.2 million for the year 2003 was recorded as a non-cash charge (2002: w 3.9 million), resulting from application of SFAS No. 123 “Accounting for Stock-Based Compensation” under U.S. GAAP accounting. MorphoSys has been expensing stock options since fiscal year 1999. The decrease in stock-based compensation was mainly due to declining expenses from options and convertible bonds granted in prior periods. Stockbased compensation for new grants was also lower through the reduced stock price of MorphoSys shares underlying the programs at the time of grant, as well as forfeitures and reduced numbers of new grants.

Cost by Expenditure Type

Personnel costs (excluding expenses arising from stock-based compensation) amounted to w 7.5 million (2002: w 10.1 million) or 40% of total costs, and were the largest cost block within operating expenses in 2003. The reduced levels in 2003 compared to the prior year resulted from leaner staff structures arising from the Company’s restructuring plan implemented in 2003. External services, which include external lab funding and various outsourced administrative services, amounted to w 3.8 million (2002: w 8.1 million), or 20% of total costs, and were primarily reduced by lower levels of external lab funding and legal expenses. Intangible costs, which include patent litigation costs and amortization of licenses and patents, amounted to w 0.9 million (2002: w 15.1 million), or 5% of the total in 2003. Intangible costs were sharply lower in 2003 mainly due to savings arising from patent and licensing settlements entered into from the prior year. Infrastructure costs, which mainly include rent, utilities and equipment depreciation costs, amounted to w 2.3 million (2002: w 2.6 million), or 12% of total costs, and remained largely unchanged compared to the prior year.

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Cost by Expenditure Type

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Costs for personnel 40 %
Costs for external services 20 %
Costs for intangibles 5 %
Costs for infrastructure 12 %
Others 23 %
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Non-Operating Items

Non-operating income decreased by w 1.8 million to a non-operating loss of w 0.7 million (nonoperating income 2002: w 1.1 million), and was mainly due to interest expense. w 0.7 million resulted from the election to issue shares associated with the XOMA agreement and is a noncash charge relating to the accounting of such conversion under U.S. GAAP accounting. Additionally, w 0.2 million interest expense was recorded during the period and arose in connection with interest expense on liabilities associated with the CAT settlement. Additionally, the Company recorded an impairment charge related to unrealized losses on available-for-sale securities in the amount of w 0.8 million in the year of 2003. MorphoSys considers all reductions in market value of its marketable securities (available-for-sale securities) which are longer than six months in duration to be deemed other than temporary decline in value unless facts and circumstance indicate otherwise. Since the date of the write-off, the securities have regained their value by w 0.6 million, 75% of the original loss, at year-end 2003.

In December 2003, the Company recorded an unrealized gain of w 0.3 million as part of its hedging program to protect against foreign exchange exposure from the U.S. dollar reflected as non-operating income.

Net Loss

The Company posted a loss from operations in 2003 of w 3.5 million (2002: w 25.5 million), with sharply lower operating expenses responsible for the reduced loss levels. EBITDA (earnings before interest, taxes, depreciation and amortization and stock-based compensation) amounted to w 1.2 million; the first time MorphoSys has achieved a positive EBITDA result (2002: w (18.7) million). Mirroring this trend, the net loss of w 4.1 million in 2003 (2002: 24.4 million), was markedly lower due to lower operating expenses. The resulting loss per share for the full year 2003 amounted to w 0.96 (2002: w 6.35), a reduction of 85%.

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Liquidity/Cash Flows

On December 31, 2003, the Company had w 23.2 million in cash, cash equivalents and marketable securities, compared to a w 19.1 million balance at December 31, 2002—an increase of more than 20% over the prior year—and the first year in the Company’s history that such an increase in cash and short-term investments from operating activities took place. In 2003, cash provided by operating activities was also positive for the first year ever. For the full year 2003, cash provided by operations amounted to w 5.8 million in comparison to cash used in operating activities of w 15.2 million in the year 2002. During the year 2003, the Company’s current assets decreased by w 3.3 million to w 26.2 million compared to w 29.5 million at December 31, 2002, primarily as a result of lower receivables levels at year-end 2003.

Total Assets (in million E)*

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50
45
40
35 23.2
19.1
30
25
2.1
20 8.7
15
17.0
10 10.3
5
3.5 4.3
0
2003 2002
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Cash, cash equivalents, and marketable securities Accounts receivable Intangibles Other assets

• Differences due to rounding up/down, see balance sheet page 87.

Assets

Total assets increased by w 3.4 million to w 45.8 million in the year 2003, compared to w 42.4 million at December 31, 2002. The difference was attributable to the increase in intangible assets of w 8.3 million arising from the acquisition of the CAT license and was partly offset by a decrease in current assets of w 3.3 million.

Liabilities

During the year 2003, total current liabilities fell by w 8.0 million, principally due to the settlement in licenses payable of w 4.9 million (of which w 3.8 million was non-cash) as well as a drop of other accounts payable by w 2.0 million. The decrease in licenses payable resulted from the payment of certain obligations under the settlement agreement with CAT and the payment of the XOMA license agreement with equity.

Deferred revenue increased by w 2.3 million to w 10.4 million, largely as a result of the collaborations entered into in the fourth quarter of 2003. The long-term portion of w 6.1 million for the year ending December 31, 2003 (2002: w 3.7 million) was reclassified into non-current liabilities.

Equity

At year-end 2003, the total number of shares issued was 4,901,332 of which 4,841,570 were outstanding, compared to 3,949,706 and 3,889,944 in the prior year.

As part of the MorphoSys-XOMA licensing agreement signed in 2002, in October 2002 MorphoSys elected to issue 363,466 shares to XOMA as partial consideration for the XOMA license received. The capital increase was registered and the shares were issued to XOMA in the first half of the year 2003. In coordination with MorphoSys, XOMA successfully sold all their MorphoSys shares of stock by the third quarter of 2003.

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Liabilities (in million E)*

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50
45
7.7
40
35 7.9 15.7
30
25
6.1
20
15 30.2
20.6
10
5
0
2003 2002
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Current liabilities Non-current liabilities Stockholders’ equity

In December 2002, MorphoSys signed a settlement with CAT to resolve longstanding patent litigation issues. As part of the agreement, MorphoSys agreed to issue 588,160 shares to CAT as partial consideration for the CAT license. The license and subscription agreements were executed in July 2003 and the capital increase was registered in August 2003. The shares issued to CAT were subject to a lockup and CAT remained a shareholder at year-end.

Both aforementioned share issuances excluded stockholders’ preemptive rights as allowed under the Company’s Articles of Association and respective shareholder resolutions.

In May 2003, the annual stockholders’ assembly authorized the Company to increase its Conditional Capital II, IV and V up to 1,275,000, 450,269 and 111,447 shares respectively.

Capital Expenditure

During 2003, total investment in intangibles amounted to w 8.4 million (2002: w 3.7 million). A large majority of the increase related to the acquisition of the CAT license in 2003 acquired with MorphoSys equity. Amortization of capitalized intangibles for the year 2003 was w 1.6 million compared to w 1.2 million in the previous year.

Investment in property and equipment amounted to w 0.7 million in the year 2003 compared to w 0.9 million in the previous year. Depreciation for 2003 of w 0.9 million remained unchanged to the same period last year.

• Differences due to rounding up/down, see balance sheet page 87.

Subsidiaries/Segments/Organizational Structure

MorphoSys’ global headquarters is located in Martinsried/Munich, Germany. The Company’s R&D center and all administrative departments are currently located at its headquarters. The Company currently possesses two wholly owned subsidiaries:

MorphoSys U.S.A., Inc.

MorphoSys U.S.A., Inc. was formed in the year 2000 for the purpose of assisting MorphoSys AG in marketing and commercializing its technologies. The U.S. subsidiary, with its office in Charlotte, North Carolina, was responsible for all marketing and corporate development activities of MorphoSys. In November 2002, the Company announced restructuring measures with the aim of reducing expenditures related to the development of proprietary drug candidates and refocusing its commercial strategy. In line with these measures, the activities of MorphoSys U.S.A., Inc. were transferred to MorphoSys AG in Germany and the operations in Charlotte, NC, were substantially closed by year-end 2002. Termination of all leased office space was finalized in August 2003, and represented the last significant expenditure associated with the subsidiary.

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All costs, actual and estimated, which are associated with MorphoSys U.S.A., Inc. have been included in the financial statements and notes thereof.

MorphoSys IP GmbH

In November 2002, MorphoSys formed MorphoSys IP GmbH, whose purpose is to administer the internally generated intellectual property of MorphoSys AG. To this end, MorphoSys AG sold at fair market value the rights to certain internally generated intellectual property in 2002. MorphoSys IP GmbH is a wholly owned subsidiary of MorphoSys AG, and a profitpooling agreement exists between those two companies. In order to fulfill its operational needs, MorphoSys IP GmbH has contracted administrative services from MorphoSys AG and entered into a sublicensing agreement with MorphoSys AG, in order to enable MorphoSys AG to commercialize said patents/technologies.

Commercial Partnerships and Alliance Development

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Dr. Barbara Krebs Director Business Development

MorphoSys possesses one of the leading technologies in the field of human antibodies. The Company makes use of its technology not only in the development of its own products, but also in collaborations with internationally renowned pharmaceutical and biotech companies.

In 2003, the Company was able to report progress in its existing partnerships. In addition, existing collaborations were expanded and new collaborations signed. The following partnerships were either established or expanded in the 2003 fiscal year (in alphabetical order):

Boehringer Ingelheim GmbH

MorphoSys AG and Boehringer Ingelheim GmbH (“Boehringer Ingelheim”) signed a crosslicensing agreement in February 2003. Under the agreement, MorphoSys obtained the exclusive worldwide license for patents which are in possession or control of Boehringer Ingelheim, in order to develop, manufacture and sell therapeutic and diagnostic antibodies against ICAM-1 (intercellular adhesion molecule-1). For the sale of therapeutic or diagnostic antibodies against ICAM-1, MorphoSys will pay milestone payments and royalties to Boehringer Ingelheim. In return, Boehringer Ingelheim will receive exclusive licenses for therapeutic antibodies against two undisclosed target molecules that MorphoSys will develop with its HuCAL[®] GOLD antibody technology. Should antibodies be further developed by Boehringer Ingelheim, MorphoSys will receive milestone payments and royalties from Boehringer Ingelheim for the development and sale of these HuCAL[®] GOLD antibodies.

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Lonza Biologics

In January 2003, MorphoSys AG signed an agreement with Lonza Biologics (“Lonza”) for the production of clinical-grade HuCAL[®] antibodies. The term of the contract is five years and provisions in the contract guarantee MorphoSys access to Lonza’s antibody manufacturing capacities. The agreement comprises future development projects both for MorphoSys’ own antibody projects and for antibodies from collaborations. Under the scope of the collaboration, MorphoSys can offer its partners manufacturing capacities at Lonza and thereby substantially increase the value of its antibody projects.

Pfizer, Inc.

In December 2003, MorphoSys AG and Pfizer, Inc. (“Pfizer”) announced a collaboration for the development of therapeutic antibodies. Under the collaboration, MorphoSys will use its HuCAL[®] GOLD library to generate therapeutic antibodies against multiple targets from Pfizer. Pfizer is to carry out the preclinical and clinical development and the subsequent marketing of resultant products. MorphoSys received an upfront payment and, for each antibody developed in the collaboration, research support and milestone payments. MorphoSys also stands to receive royalty payments on any antibody products coming out of the collaboration. The potential value to MorphoSys in committed funding and potential developmental milestone payments on future products is estimated to be in excess of US$ 50 million, not including royalties.

Antibodies by Design

The Company launched a new business initiative, “Antibodies by Design,” in 2003. This new initiative was created to leverage MorphoSys’ core technological capabilities in the design and manufacture of antibodies for research purposes; it will commercialize the HuCAL[®] technology focusing on the custom generation of research antibodies for partners on an individual basis. The Company expects that it will partner Antibodies by Design’s “sequence-to-antibody” services with established catalog antibody providers and, subsequently, with protein array providers. Antibodies by Design’s “sequence-to-antibody” services are expected to allow for the development of custom antibodies from only the antigen sequence information with a lead time of approximately ten to twelve weeks, in comparison to the current market benchmark of six months.

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Manufacturing

As a result of its partnership with Lonza Biologics, MorphoSys has gained a competent partner in the production of antibody material. Lonza has many years of experience in the field of process optimization and production of biological agents. The production of clinical antibody material is a time-consuming and expensive procedure, which is strictly controlled by the relevant authorities.

For its own preclinical investigations, MorphoSys produces antibodies in milligrams. The new business initiative “Antibodies by Design” also produces antibodies for its customers in this quantity. The current MorphoSys capacity is fully capable of producing antibodies in these amounts, and these materials are used exclusively for research and are therefore not subject to any particular production guidelines. MorphoSys currently has no plans to build its own production facilities for the manufacture of clinical antibody material due to the investment and expense involved with such production sites.

Human Resources

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Silvia Dermietzel
Senior Director
Human Resources
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People at MorphoSys

At MorphoSys, there is a very high focus on Company personnel, as the Company’s future success is in large part due to the commitment and performance of the people working there. In order to achieve maximum corporate success, it is of central significance for the Company to hire the most highly qualified and motivated employees and to be able to retain them for the long term.

Various measures currently in place at the Company serve to create optimum working conditions for all employees. As an example, employees with personnel management responsibilities attend leadership and management skill seminars. In addition, technical or specialist training forms an important part of each employee’s experience at MorphoSys. As part of the Company’s international orientation, MorphoSys offers English courses to all its employees.

As in previous years, stock options and convertible bonds were offered to all employees as part of a long-term incentive scheme. The aim of this program is to give employees a long-term stake in the success of the Company. In addition, all employees take part in a Company-wide management-by-objectives program. The program’s targets include both Company and personal goals. The achievement of each employee’s goal is linked to the annual bonus program. Such measures guarantee a goal-orientated culture across the Company.

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In 2003, MorphoSys employees also produced a Company “Credo”. This credo is the model for interaction and communication within the Company as well as for cooperation with partners and customers. Intensive and open dialog across all levels of the hierarchy is promoted to ensure that all employees understand, promote and implement the Company’s essential values.

Significant Appointments

Supervisory Board of MorphoSys AG

At the ordinary stockholders’ assembly of May 16, 2003, the two members of the Supervisory Board Prof. Jürgen Drews and Prof. Andreas Plückthun were reelected. Prof. Jürgen Drews, Managing Director of the Bear Stearns Health Innoventure Fund, is Deputy Chairman of the Supervisory Board and has been on the MorphoSys AG Supervisory Board since 1997. Prof. Andreas Plückthun, Professor of Biochemistry at the University of Zurich, Switzerland, is a co-founder of MorphoSys AG.

Antibodies by Design

In order to establish the new business initiative, MorphoSys was able to recruit two new employees, experienced in the area of marketing and sales of research reagents during the year.

Dieter Lingelbach joined MorphoSys on April 1, 2003 from Roche Diagnostics, where he was responsible for global marketing and sales of biochemicals. He heads the new business initiative “Antibodies by Design” and serves as Senior Vice President. Mr. Lingelbach has almost 20 years of professional experience in management consulting at Booz, Allen & Hamilton and in diagnostics, health care and biotechnology at Roche Diagnostics (formerly Boehringer Mannheim), mostly in the areas of strategy development, marketing and sales.

Joanne Crowe joined MorphoSys in May 2003 from Qiagen, where she was International Marketing Director responsible for the management of global marketing activities and planning and administration of Qiagen’s marketing budget. At MorphoSys, she was appointed as Senior Director Marketing & Sales responsible for all marketing and sales activities of “Antibodies by Design.” Ms. Crowe has more than 12 years’ experience in marketing and marketing communications to the life science research industry.

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Employees

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120
100 24
80 24
60
86
40
71
20
0
2003 2002
S, G&A
R&D
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Dr. Günter Wellnhofer
Director
Technical Operations
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Number and Qualification of Employees

On December 31, 2003, the MorphoSys Group employed 95 employees (December 31, 2002: 110). The MorphoSys Group employed an average of 93 employees for the full year 2003 (2002: 116): For Q4 2003, the average was 95 employees (Q4 2002: 116).

Of the 95 employees, 71 worked in research and development and 24 in administration and sales. At the end of 2003, 35 of MorphoSys’ employees had a Ph.D. degree (December 31, 2002: 45).

On December 31, 2003, MorphoSys employed 2 trainees as “technical information processors in the area of information technology” (December 31, 2002: 2 trainees).

Environment and Health Protection

MorphoSys carries out its research in safety level “Bio I” and “Bio II” laboratories and under observance of all relevant legal guidelines. Internal standards are more stringent than those guidelines which are legally required. One designated full-time employee for work safety is part of the competent team of employees specifically responsible for work safety, biological safety and fire prevention. Employees are given regular training to inform them of the latest guidelines. To date, no official inspections have resulted in any requirement to change procedures. Due to regular maintenance by internal employees, all laboratory equipment adheres to the highest possible standard of safety.

A detailed waste management concept which has been extensively documented, ensures that disposal of laboratory waste is always in line with valid limits and guidelines.

Regular medical checks are carried out for all MorphoSys employees. An initial medical check is carried out for all new employees in the research department. Such checks are repeated yearly. Furthermore, employees are routinely vaccinated against hepatitis A and B.

Research and Development

MorphoSys uses its own HuCAL[®] technology for development of therapeutic antibodies and research reagents. This technology has been thoroughly tried and tested in numerous partnerships.

In the course of its therapeutic antibody collaborations, MorphoSys generates human antibodies for its partners which are then optimized according to their requirements. In the context of these partnerships, MorphoSys is responsible for the manufacture and optimization of the antibodies whereas the partner is responsible for preclinical and clinical development.

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More recently, MorphoSys has been developing its own proprietary therapeutic antibodies as candidates for outlicensing to potential partners, prior to their entry into clinical development.

Collaborations

In the course of the 2003 fiscal year, MorphoSys made significant progress in various existing collaborations.

Bayer AG

In January 2003, Bayer AG (“Bayer”) purchased an exclusive license to further develop a HuCAL[®] antibody. This antibody targets an undisclosed solid tumor target molecule. The antibody was selected from the HuCAL[®] library by Bayer Biotechnology, Berkeley, California, U.S.A and characterized in detail. Furthermore, the antibody demonstrated to be significantly effective in various cancer-animal models. Bayer is currently planning to further characterize the most promising candidate in further preclinical studies and then to proceed to clinical development in the indication of solid tumors.

In December 1999, MorphoSys and Bayer signed an extensive partnership agreement for the development of antibodies. In July 2001, the collaboration was extended for a further four years. The collaboration focuses on the manufacture of human antibodies for therapeutics, diagnostics, and genome research. Bayer is focusing on the development of therapeutic antibodies derived from HuCAL[®] and currently has several antibody programs in various indications. The acquisition of this exclusive license is Bayer’s second such license from MorphoSys. Moreover, Bayer retains further options for exclusive licenses for the development of therapeutic HuCAL[®] antibodies.

MorphoSys AG announced an agreement with Bayer HealthCare for the cross-licensing of certain technologies. Under the agreement, MorphoSys received the human cell line HKB 11 for production of HuCAL[®] antibodies. MorphoSys also received the right to use the cell line for its own research and an option for the commercial production of antibodies using the HKB 11 cell line. In exchange, Bayer will switch its in-house R&D programs to the MorphoSys HuCAL[®] GOLD antibody technology. Additionally, MorphoSys received an installation fee from Bayer HealthCare.

Boehringer Ingelheim GmbH

In the context of the partnership agreement signed in February 2003, Boehringer Ingelheim selected its first option for development of a therapeutic antibody in November 2003. MorphoSys will develop a therapeutic antibody against an undisclosed target molecule in the field of inflammatory diseases and select this antibody from the HuCAL[®] GOLD library. Boehringer Ingelheim will be responsible for the further preclinical and clinical development as well as for the subsequent marketing of any resulting products.

76 M A N A G E M E N T R E P O R T

Centocor, Inc.

In July 2003, MorphoSys achieved the third milestone in the collaboration with Centocor, Inc. (“Centocor”), a subsidiary of the U.S. company Johnson & Johnson. MorphoSys generated several antibodies against a Centocor target molecule in the inflammatory diseases indication. The antibodies, which were systematically optimized by MorphoSys, met all eight predefined success criteria, and thus triggered the milestone.

In December 2000, MorphoSys and Centocor undertook to collaborate on the development of human antibodies in various indications. In the context of the collaboration, Centocor was granted the option of developing therapeutic antibodies against up to 30 different target molecules. In March 2002, Centocor AutoCAL™ ordered the system developed by MorphoSys for the automated screening of the HuCAL[®] antibody library.

F. Hoffmann-La Roche

MorphoSys and F. Hoffmann-La Roche (“Roche”) presented successful and promising animal data from their collaboration on Alzheimer’s disease at the “33rd Annual Meeting of the Society for Neuroscience” in New Orleans, Louisiana, U.S.A. Within the collaboration, MorphoSys, using its HuCAL[®] library, generated antibodies against Roche’s Alzheimer target molecule amyloid β-peptide (Aβ). The antibodies bound very specifically to human amyloid plaques (protein deposits). In the Alzheimer animal model performed by Roche, the systemically administered antibodies demonstrated highly specific binding to the amyloid plaques in the brains of transgenic mice. Massive accumulations of amyloid plaques in the brain are symptomatic of Alzheimer patients. The use of antibodies against such amyloid plaques could therefore be a possible method of treatment for Alzheimer patients.

MorphoSys and Roche have been collaborating since September 2000 on developing antibodies for the treatment of Alzheimer’s disease. Using its proprietary HuCAL[®] library, MorphoSys generated various antibodies against the target molecule of Roche. Between December 2000 and March 2001, a total of four milestones were reached in the collaboration. MorphoSys provided a series of HuCAL[®] antibodies which bound selectively to human cerebral tissue affected by Alzheimer’s disease. Both in in vitro studies and in the Alzheimer animal model, the HuCAL[®] antibodies generated by MorphoSys showed a high affinity for the target molecule. Looking ahead, MorphoSys has the potential to receive milestone payments and royalties for end products derived from the collaboration.

Schering AG

In July 2003, MorphoSys and Schering AG (“Schering”) announced successful results from their collaboration. Working under the collaboration, MorphoSys selected and optimized antibodies against a Schering oncological target molecule. These antibodies had previously shown effectiveness in an in vitro test system. Moreover, the antibody showed specific accumulation in tumor tissue in tumor localization studies with mice.

M A N A G E M E N T R E P O R T 77

MorphoSys and Schering signed a strategic collaboration agreement in December 2001. As part of the collaboration, the companies are developing therapeutic antibodies and in vivo diagnostic agents, particularly in the oncology indication. The MorphoSys HuCAL[®] GOLD technology is used in Schering’s plants in Berlin and also at Berlex Biosciences in Richmond, California, U.S.A.

Proprietary Antibody Development

MorphoSys is developing human therapeutic antibodies in the indications of inflammatory diseases, cancer and infectious diseases. The Company intends to outlicense these candidates prior to the start of their clinical development. The pipeline with proprietary antibody products currently includes the following candidates:

MOR101 and MOR102 (ICAM-1)

MOR101 and MOR102 are human HuCAL[®] antibodies against the target molecule ICAM-1 (intercellular adhesion molecule-1), also known as CD54.

MOR101, a Fab fragment, is being developed for the indication of dermal burns. There is a significant medical need for this drug, as there are currently no drugs on the market which treat dermal burns.

MOR102, a HuCAL[®] IgG antibody, is currently being developed for the indication of psoriasis. Further development potential may arise from additional inflammation indications such as rheumatoid arthritis.

Due to their strong anti-inflammatory properties without related immune suppressive side effects, both anti-ICAM-1 antibodies have the potential to replace existing standard therapies.

In October 2003, MorphoSys published the first promising results from preclinical studies for MOR101 and MOR102.

In a preliminary animal model for MOR101, a chimeric Fab fragment derived from the murine BIRR-1 antibody was tested. The study demonstrated that this fragment displays the same effectiveness as the complete murine antibody BIRR-1. This study was performed in collaboration with Prof. Pallua and Dr. Fuchs, Plastic Surgery, University of Aachen.

In an animal model for psoriasis, it was shown that administration of MOR102 reduces epidermal swelling by 40%. The studies were performed in collaboration with Prof. Boehncke, Department of Dermatology, University of Frankfurt.

On the basis of these results, MorphoSys is planning to further develop the two antibody programs MOR101 and MOR102, and is currently looking for a partner to take over further preclinical and clinical development.

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Further Development Programs

MorphoSys currently has two further antibody programs. Both programs are still in the research phase:

MOR202 is a human HuCAL[®] antibody against an undisclosed target molecule in the indication of oncology.

Another program is currently in progress. No further information on this has been disclosed to date.

MorphoSys intends to outlicense its current therapeutic antibody programs to partners prior to clinical development.

Intellectual Property

For biotech companies such as MorphoSys, it is of critical importance to establish an extensive international patent portfolio to protect its proprietary technologies. The centerpiece of this portfolio is the proprietary technologies pertaining to the HuCAL[®] antibody library. Moreover, all additional patents which are necessary for the use of our proprietary technology have been inlicensed.

At present, MorphoSys has six granted patents and more than 40 patent applications are pending throughout the world.

IP Highlights of 2003 include:

A positive recommendation in the patent dispute with Applied Molecular Evolution (AME): The Magistrate Judge recommended that the District Judge of the district court in Boston, Massachusetts, U.S.A. allow MorphoSys’ petition for non-violation of AME’s patents and overrule AME’s petition for patent violation by MorphoSys. If the District Judge accepts the Magistrate Judge’s recommendation, all counts of AME’s charge will be decided in favor of MorphoSys.

The granting of the HuCAL[®] EST patent in the U.S.A.: the U.S. patent (U.S. 6,653,068) with the title of “Generation of Specific Binding Partners to (Poly)Peptides Encoded by Genomic DNA Fragments or ESTs” covers methods for expressing large quantities of EST-coded protein fragments as fusion proteins and the subsequent selection of HuCAL[®] antibodies against these proteins. The technology is currently employed in several of MorphoSys’ collaborations with partners.

Ideas Database

In 2003, MorphoSys set up software to assemble a database of ideas. A reason for using this software tool is to systematically record and evaluate employees’ ideas, notifications of inventions, and proposals for improvement. Through such a system, the creative potential of each employee can be noted, while at the same time a systematic workflow is ensured in order that interesting ideas are neither missed nor ignored.

M A N A G E M E N T R E P O R T 79

Risk Report

MorphoSys AG operates on a global basis. Its business activities comprise different risks, which are relevant to many business functions. The business, financial condition and results of operation of MorphoSys may be materially adversely affected by each of these risks. The Company has established a risk management system that is used regularly to identify, measure and control such risks as an integrated part of normal business activities.

Product Development

MorphoSys is committed to generating therapeutic antibodies for its commercial partners and, more recently, its own account. Thus, the Company’s product pipeline comprises both partnered and proprietary therapeutic antibody development programs. These programs are subject to a number of risks of failure inherent in the development of medical therapies. Product candidates require preclinical studies and clinical trials in humans as well as regulatory approval prior to commercialization. To date, none of the Company’s licensees or partners has commercialized a product based on MorphoSys’ HuCAL[®] technology, and HuCAL[®] -derived therapeutics are not expected to be commercially available for a number of years. In addition, none of the HuCAL[®] -derived product candidates has reached clinical development and thus has not yet proven that it may be able to successfully complete all stages of clinical testing and regulatory approval procedures. Preclinical studies may not predict and do not ensure safety or efficacy in humans, and are not necessarily indicative of the results that may be achieved in pivotal clinical trials with humans.

Competition and Technological Change

MorphoSys’ business environment is characterized by rapid change and intense competition. Its competitors include major pharmaceutical, chemical and biotech companies possessing greater financial, technical and marketing resources than those available to MorphoSys. In addition, certain biotech companies have formed collaborations with large established companies to support research, development and commercialization of products that may be competitive with those of MorphoSys. Moreover, certain research and academic institutions are also active in areas similar to MorphoSys. Some of MorphoSys’ competitors currently focus their business efforts on gaining a share of the market and offer their technology at little or no cost to collaboration partners. The first pharmaceutical product to reach the market is often at a significant advantage to later entrants, particularly since subsequent potential entrants must prove an advantage of their product over products already in the market.

80 M A N A G E M E N T R E P O R T

There is a risk that MorphoSys’ competitors could succeed in developing technologies and products that are safer, less costly and more effective than its technologies or products. In addition, there is a risk that these technologies could produce products that reach the market earlier and could be more successful than those developed by MorphoSys.

Dependence on Health Care and Pharmaceutical Spending

MorphoSys is directly and indirectly dependent on various sources of income, including, in particular, fees, milestone payments and royalties from licensees and partners, the financial condition of public treasuries and the financial markets, the government and governmental health authorities, research institutions, private health insurers and other organizations.

Part of MorphoSys’ revenue is derived from entering into collaborations with partners, including pharmaceutical companies. Many collaborative and/or outlicensing agreements provide for milestone payments and fees to be paid subject to the satisfaction of specific criteria. MorphoSys has no control over whether its partners or licensees will be able to meet such milestones, nor will MorphoSys be able to control whether products derived from its technology are being developed at all by its partners. Moreover, certain pharmaceutical companies may be more likely to seek to inlicense products which have already reached a relatively advanced stage of development, such as Phase II compounds, as opposed to less-advanced product candidates still in preclinical stages. Consequently, the products in MorphoSys’ pipeline may not reach a sufficiently advanced stage of development to be of interest to these pharmaceutical companies for some time. Therefore the Company can offer no assurance that there will be a guaranteed revenue stream from current or future collaborations.

IP Risks

MorphoSys is or has been involved in legal proceedings in Germany and certain foreign jurisdictions, including the United States, including claims brought by and against it for license or patent infringement, which arise in the ordinary course of business. While the Company cannot predict the ultimate outcome of the still pending proceedings, management does not currently believe them to have a material adverse affect on the business, financial condition and results of operations of MorphoSys. However, the field of recombinant antibody libraries and phage display, in which the Company is active, is relatively new, and the intellectual property position of the various parties involved is becoming increasingly complex and litigious. Therefore, MorphoSys can offer no assurance that further patent suits will not be brought by companies possessing existing patents or patents which have not yet been granted or which the Company is currently not aware of. Any such proceedings, if brought and subsequently decided against MorphoSys, could have a material adverse effect on the business, financial condition and results of operations of MorphoSys.

M A N A G E M E N T R E P O R T 81

Additional Funding Requirements

MorphoSys’ future capital requirements will continue to be substantial and will be dependent on many factors, including its ability to find licensees and to enter into satisfactory collaboration agreements as well as the success of such collaborations in generating revenues (e.g., licensing fees, milestone payments and royalties). The costs of preclinical testing of MorphoSys’ products and technologies as well as the costs associated with filing, defending and enforcing patent rights may exceed the returns from these products. MorphoSys may also need to raise additional funds in future years. The Company can offer no assurance that adequate funds will be available to MorphoSys when needed on satisfactory terms or at all. If adequate funds are not available or are not available on acceptable terms, MorphoSys may have to further reduce its expenditures for research and development, production or marketing. Any such development could have a material adverse effect on MorphoSys’ business, financial condition and results of operations. If additional funds are raised by issuing shares, stockholders are likely to experience a dilution of their interests.

Currency Risk

The group accounts are administered in euros. While the expenses of MorphoSys are predominantly paid in euros, a significant part of the sales depend on the current exchange rate of US dollars and euros. Though the Company examines the necessity of hedging transaction to minimize those currency risks once a year and closes them if necessary to prevent the annual results from negative effects. Therefore, the gains and losses resulting from hedging transactions are offset from the revenue transactions, which are hedged. In addition, it is not contain, that hedging transactions will be sufficient to adjust extreme fluctuations in exchange rates.

82 M A N A G E M E N T R E P O R T

Outlook for 2004

Outlook for the Biotech Sector

Looking ahead into 2004, approximately 30 drugs will be launched onto the market, including products such as Avastin (Genentech), Erbitux (Imclone Systems) and Cinacalcet (Amgen). In addition to the product launches, 45 FDA approvals are expected—a number which could reinvigorate the outlook for the entire industry. Other positive news from the sector, including regulatory approvals and clinical milestones, could also provide an impetus to attract further money flow into the sector.

Strategy

MorphoSys will continue to execute its strategy of partnered and proprietary therapeutic antibody development in 2004. This strategy has served the Company well in 2003, providing a positive cash flow for the year while an ever-stronger pipeline of therapeutic antibodies is being created. Management will continue to focus on securing new partnerships within which the Company’s proprietary HuCAL[®] technology can be applied to generating future product candidates as a means of increasing the Company’s long-term value. An important aspect of these activities in 2004 will be securing a development partner for the Company’s most advanced proprietary drug candidates MOR101 and MOR102. Additional proprietary product candidates, currently in the research phase, represent the next opportunities for outlicensing. The “Antibodies by Design” initiative, started in 2003, will continue to be pursued. The management of MorphoSys believes the Company is well positioned to execute its strategy and looks forward to a successful 2004.

Revenues

As communicated in the previous year, 2003 was a year of consolidation after the restructuring at year-end 2002. Based on its market research, MorphoSys foresees an increase in demand for its technologies and products in 2004 as the pharma industry ramps its investment in external research and development. Company revenues are expected to increase in 2004 and achieve a double-digit percentage increase over the previous year. As such, these revenue projections are consistent with expectations for a growth company. Revenue sources, as in previous years, will consist of committed annual licensing fees arising from the Company’s multiyear partnerships and success milestones achieved within these partnerships. Within the scope of these partnerships, it is anticipated that at least one HuCAL[®] -derived antibody will be taken by one of MorphoSys’ partners into clinical development. Also expected is the acquisition of new business partners, in the context of therapeutic antibody collaborations.

New sources of revenue are expected in 2004 which include the outlicensing of MorphoSys preclinical programs, in particular, MOR101 and MOR102. Also newly contributing to revenue will be the “Antibodies by Design” initiative, formed in the year 2003, which focuses on the non-therapeutic antibody business and, in particular, on the generation of custom antibodies for research purposes.

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M A N A G E M E N T R E P O R T

Expenses

Expenses are expected to rise slightly over 2003 levels. Above all, intangibles expense is likely to rise over 2003 levels due to higher amortization charges on licenses acquired in 2003. The higher charges are related to changes in accounting estimates in 2003 on the size of the license payments, as well as, due to the fact that full-year amortization charges will be charged against income, as opposed to partial-year charges in 2003 on CAT and XOMA licenses acquired. The difference in magnitude of these charges relates to the timing of the license acquisitions during the year 2003. Revenue generation and milestone achievement in certain collaborations will also trigger higher payments to third-party licensors. Finally, expenses related to continuation of the AME litigation case are also expected to edge intangibles costs higher in 2004.

Capital Investment

Capital expenditures on property and equipment are expected to remain essentially constant, as compared to the previous year. The acquisition of substantial intangibles licenses, as was the case in the prior year, is currently not anticipated.

Human Resources

Headcount is currently anticipated to increase only modestly. All increases are contingent on new business/collaborations to support the same.

R&D Activities

In line with the previous year, MorphoSys’ R&D team will focus on generating results and milestones within existing collaborations, and continue developing the existing portfolio of research/preclinical candidates for outlicensing. It is also planned that two new proprietary research/preclinical programs are to be started during the year, for eventual outlicensing.

Marketing/Commercial

The Company will continue to intensify its efforts to attract new therapeutic antibody partners. In addition, the outlicensing of MorphoSys’ proprietary antibody candidates shall also be a priority going forward. Furthermore, the Company will continue to expand its marketing efforts relating to the “Antibodies by Design” initiative, in order to further develop the market for custom-generated non-therapeutic antibodies.

Dividends

Although MorphoSys expects to continue the trend of reducing its losses, the Company believes that the payment of dividends should be deferred until such time as its financial and liquidity position supports the same. As such, any profits generated by the business shall be reinvested into the operation of its business in order to create further growth opportunities for the future.

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86 F I N A N C I A L S T A T E M E N T S

Consolidated Statement of Operations

idated Statement of Operations	idated Statement of Operations	idated Statement of Operations
12/31/2003 12/31/2002 R R
Revenues	15,308,464	16,757,097
OperatingExpenses
Research and Development	8,998,012	19,591,834
Sales, General and Administrative	7,601,078	18,742,819
Stock-based Compensation	2,175,430	3,940,412
Total OperatingExpenses	18,774,520	42,275,065
Loss from Operations	(3,466,056)	(25,517,968)
Interest Income	212,461	445,859
Interest Expense	874,415	687
Impairment of Marketable Securities	753,768	–
Other Income, Net	733,767	713,586
Loss before Taxes	(4,148,011)	(24,359,210)
Foreign Income Tax Expense	21	18,084
Net Loss	(4,148,032)	(24,377,294)
Basic and Diluted Net Lossper Share	(0.96)	(6.35)
Shares Used in ComputingBasic and Diluted Net Lossper Share	4,332,438	3,838,670

See accompanying notes

87

F I N A N C I A L S T A T E M E N T S

Consolidated Balance Sheets

Assets
Current Assets
Cash and Cash Equivalents	6,652,456	842,082
Marketable Securities	16,508,575	18,274,338
Accounts Receivable	2,111,710	8,732,790
Prepaid Expenses and Other Current Assets	948,575	1,684,729
Total Current Assets	26,221,316	29,533,939
Propertyand Equipment, Net	1,907,895	2,097,796
Patents, Net	6,103,675	6,898,990
License Fees, Net	10,898,904	3,352,604
Other Assets	627,130	509,984
Total Assets	45,758,920	42,393,313
Liabilities and Stockholders’ Equity
Current Liabilities
Accounts Payable	258,732	2,273,539
Current Portion of License Payable	677,060	5,569,291
Current Portion of Deferred Revenue	4,272,249	4,378,995
Accrued Employee Benefits	949,122	1,468,907
Other Accrued Expenses and Liabilities	1,524,439	2,029,608
Total Current Liabilities	7,681,602	15,720,340
Non-Current Liabilities
License Payable, Net of Current Portion	1,651,360	2,275,347
Deferred Revenue, Net of Current Portion	6,086,205	3,707,360
Convertible Bonds Due to Related Parties	157,200	74,800
Total Non-Current Liabilities	7,894,765	6,057,507
Stockholders’ Equity
Common Stock,§3.00 Par Value; 8,626,344 and 7,345,582 Ordinary Shares Authorized; 4,901,332 and 3,949,706 Ordinary Shares Issued; 4,841,570 and 3,889,944 Ordinary Shares Outstanding; for 2003 and 2002, respectively	14,703,996	11,849,118
Treasury Stock (59,762 and 59,762 Shares for 2003 and 2002, respectively), at Cost	(21,934)	(21,934)
Additional Paid-In Capital	68,623,807	59,193,912
Accumulated Other Comprehensive Income/(Loss)	912,755	(517,591)
Accumulated Deficit	(54,036,071)	(49,888,039)
Total Stockholders’ Equity	30,182,553	20,615,466
Total Liabilities and Stockholders’ Equity	45,758,920	42,393,313

See accompanying notes

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F I N A N C I A L S T A T E M E N T S

Consolidated Statement of Changes in Stockholders’ Equity

	Common Stock
	Shares	R
Balance at January1,2002	3,591,331	10,773,275
Exercise of Stock Options	495	1,485
Compensation Related to the Grant of Stock Options	–	–
Capital Increase for Euro Conversion	–	718
Capital Increase against Cash,
Net of Issuance Cost of§25,249	357,880	1,073,640
Other Comprehensive Loss:
Change in Unrealized Losses on
Available-for-Sale Securities	–	–
Foreign CurrencyGain from Consolidation	–	–
Net Loss	–	–
Comprehensive Loss	–	–
Balance at December 31,2002	3,949,706	11,849,118
Compensation Related to the Grant of Stock Options	–	–
Capital Increase against Contribution in Kind (XOMA),
Net of Issuance Cost of§23,314	363,466	1,090,398
Capital Increase against Contribution in Kind (CAT),
Net of Issuance Cost of§150,000	588,160	1,764,480
Other Comprehensive Loss:
Change in Unrealized Gain on
Available-for-Sale Securities	–	–
Foreign CurrencyGain from Consolidation	–	–
Net Loss	–	–
Comprehensive Loss	–	–
Balance at December 31,2003	4,901,332	14,703,996
See accompanying notes

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F I N A N C I A L S T A T E M E N T S

	Accumulated Other Total TreasuryStock Additonal Comprehensive Accumulated Stockholders’ Paid-In Capital Income/(Loss) Deficit Equity Shares R R R R R 59,762 (21,934) 32,452,966 37,047 (25,510,745) 17,730,609 – – 7,177 – – 8,662 – – 3,940,412 – – 3,940,412 – – (718) – – 0 – – 22,794,075 – – 23,867,715 – – – (557,178) – (557,178) – – – 2,540 – 2,540 – – – – (24,377,294) (24,377,294) – – – – – (24,931,932) 59,762 (21,934) 59,193,912 (517,591) (49,888,039) 20,615,466 – – 2,175,430 – – 2,175,430 – – 3,110,896 – – 4,201,294 – – 4,143,569 – – 5,908,049 – – – 1,418,156 – 1,418,156 – – – 12,190 – 12,190 – – – – (4,148,032) (4,148,032) – – – – – (2,717,686) 59,762 (21,934) 68,623,807 912,755 (54,036,071) 30,182,553	Accumulated Other Total TreasuryStock Additonal Comprehensive Accumulated Stockholders’ Paid-In Capital Income/(Loss) Deficit Equity Shares R R R R R 59,762 (21,934) 32,452,966 37,047 (25,510,745) 17,730,609 – – 7,177 – – 8,662 – – 3,940,412 – – 3,940,412 – – (718) – – 0 – – 22,794,075 – – 23,867,715 – – – (557,178) – (557,178) – – – 2,540 – 2,540 – – – – (24,377,294) (24,377,294) – – – – – (24,931,932) 59,762 (21,934) 59,193,912 (517,591) (49,888,039) 20,615,466 – – 2,175,430 – – 2,175,430 – – 3,110,896 – – 4,201,294 – – 4,143,569 – – 5,908,049 – – – 1,418,156 – 1,418,156 – – – 12,190 – 12,190 – – – – (4,148,032) (4,148,032) – – – – – (2,717,686) 59,762 (21,934) 68,623,807 912,755 (54,036,071) 30,182,553
	59,762 (21,934) 32,452,966 37,047 (25,510,745)	17,730,609
	– – 7,177 – –	8,662
	– – 3,940,412 – –	3,940,412
	– – (718) – –	0
	– – 22,794,075 – –	23,867,715
	– – – (557,178) –	(557,178)
	– – – 2,540 –	2,540
	– – – – (24,377,294)	(24,377,294)
	– – – – –	(24,931,932)
	59,762 (21,934) 59,193,912 (517,591) (49,888,039)	20,615,466
	– – 2,175,430 – –	2,175,430
	– – 3,110,896 – –	4,201,294
	– – 4,143,569 – –	5,908,049
	– – – 1,418,156 –	1,418,156
	– – – 12,190 –	12,190
	– – – – (4,148,032)	(4,148,032)
	– – – – –	(2,717,686)
	59,762 (21,934) 68,623,807 912,755 (54,036,071)	30,182,553

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F I N A N C I A L S T A T E M E N T S

Consolidated Statement of Cash Flows

idated Statement of Cash Flows	idated Statement of Cash Flows	idated Statement of Cash Flows
12/31/2003 12/31/2002 R R
OperatingActivities
Net Loss	(4,148,032)	(24,377,294)
Adjustments to Reconcile Net Loss to Net Cash Used for OperatingActivities:
Depreciation	851,743	890,034
Amortization of Intangible Assets	1,637,863	1,236,457
Net Gain on Sales of Marketable Securities	(326,270)	(276,872)
Unrealized Net Gain on Derivative Financial Instruments	(315,929)	–
Impairment of Marketable Securities	753,768	–
Gain on Sale of Propertyand Equipment	(2,652)	(3,940)
Net Gain from AccountingEstimate Change	(2,272,053)	–
Net Expense from Share Issuance(XOMA)	417,608	–
Recognition of Deferred Revenue	(7,930,121)	(6,416,412)
Stock-Based Compensation	2,175,430	3,940,412
Changes in OperatingAssets and Liabilities:
Accounts Receivable	6,621,080	(4,168,422)
Prepaid Expenses and Other Assets	1,098,937	(654,141)
Accounts Payable	(2,014,807)	2,020,599
Licenses Payable	89,612	3,847,910
Deferred Revenue	10,202,220	7,570,741
Accrued Employee Benefits	(519,785)	286,364
Other Accrued Expenses and Liabilities	(505,169)	858,768
Net Cash Provided by/(Used in)OperatingActivities	5,813,443	(15,245,796)

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InvestingActivities:
Purchases of Marketable Securities	(12,075,587)	(39,552,408)
Proceeds from Sales of Marketable Securities	14,832,008	29,054,127
Purchases of Propertyand Equipment	(682,077)	(921,770)
Proceeds from Disposals of Propertyand Equipment	22,887	25,508
Additions to Patents	(58,746)	(496,630)
Net Cash Provided by/(Used in)InvestingActivities	2,038,485	(11,891,173)
FinancingActivities:
Proceeds from the Issuance of Common Stock, Net	–	23,876,377
Proceeds from the Issuance of Convertible Bonds to Related Parties	82,400	74,800
Purchases of Derivative Financial Instruments	(164,000)	–
Payment of Financed License Payable	(1,798,830)	–
Cost of Share Issuance	(173,314)	–
Net Cash Provided by/(Used in)FinancingActivities	(2,053,744)	23,951,177
Effect of Exchange Rate Differences on Cash	12,190	2,540
Increase/(Decrease)in Cash and Cash Equivalents	5,810,374	(3,183,252)
Cash and Cash Equivalents at the Beginningof the Period	842,082	4,025,334
Cash and Cash Equivalents at the End of the Period	6,652,456	842,082
Supplemental Disclosures of Cash Flow Information:
Cash Received Duringthe Year for Foreign Income Taxes	–	38,472
Unrealized Gain/(Loss)on Marketable Securities	1,418,156	(557,178)
Interest Paid	201,170	–
Non-Cash Settlement of License Payable(XOMA)	4,224,608	–
License to be Settled in Equity	–	3,160,386
Non-Cash Settlement of License Payable(CAT)	8,330,102	–
Capital Increase for Euro Conversion	–	718

See accompanying notes

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Notes to the Consolidated Financial Statements

1 Organization and Summary of Significant Accounting Policies

Business and MorphoSys AG (“the Company”) is a biotechnology company using combinatorial biology in Organization drug discovery with the principal objective of developing and commercially exploiting new enabling technologies across a broad scientific spectrum. The Company was founded in July 1992 as a German limited liability company. In June 1998, MorphoSys AG was transformed into a German stock corporation. In March 1999, the Company went public on Germany’s Neuer Markt , the stock exchange designated for high-growth enterprises. On January 15, 2003, MorphoSys AG was admitted to the Prime Standard segment of the Frankfurt Stock Exchange.

Substantially all operations are located in Germany. The Company has two wholly owned subsidiaries:

• MorphoSys U.S.A., Inc., which was incorporated in the United States on February 16, 2000. The subsidiarys purpose was to assist the Company in the sale and licensing of MorphoSys AG products. MorphoSys U.S.A., Inc. substantially ceased its operations in November 2002. MorphoSys IP GmbH, which was incorporated in Munich, Germany, on November 6, 2002. The subsidiary’s purpose is to purchase, maintain and administer certain intangible assets of the MorphoSys Group. The Company’s operations are physically located at the premises of MorphoSys AG, and the operations of MorphoSys IP GmbH commenced on December 31, 2002.

The accompanying consolidated financial statements reflect the application of certain significant accounting policies as described in this note and elsewhere in the accompanying consolidated financial statements and notes.

Basis of Financial The accompanying financial statements have been prepared in accordance with accounting Statement Presentation principles generally accepted in the United States of America (U.S. GAAP). In accordance with German law, the Company is required to publish its financial statements in accordance with the German Commercial Code, which represents generally accepted accounting principles in Germany (“German GAAP”). German GAAP varies in certain significant respects from U.S. GAAP. Accordingly, the Company has recorded certain adjustments, principally relating to revenue recognition and the recording of certain costs, in order to present the accompanying financial statements in accordance with U.S. GAAP.

Use of Estimates

The preparation of the consolidated financial statements in conformity with accounting standards generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

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Cash and	The Company considers all highly liquid investments with an original maturity of three
Cash Equivalents	months or less to be cash equivalents. The Company invests its cash in deposits with two
	major German financial institutions.
Consolidation	The accompanying financial statements consolidate the financial position, results of operations,
	and cash flows of MorphoSys AG and its subsidiaries. All intercompany transactions and
	balances have been eliminated.
Marketable Securities	The Company accounts for its marketable securities using Statement of Financial Accounting
	Standards (“SFAS”) No. 115, “Accounting for Certain Investments in Debt and Equity Securi-
	ties.” Management determines the proper classifications of securities at the time of purchase
	and reevaluates such designations as of each balance sheet date. At December 31, 2003 and
	at December 31, 2002, such securities that we are classified as available-for-sale we are car-
	ried at market value, with unrealized gains and losses reported in accumulated other compre-
	hensive income, which is a separate component of stockholders’ equity. Realized gains and
	losses on sales of investments, as determined on a specific identification basis, are included in
	the statements of operations when the investment is sold or matures. On a regular basis, the
	Company tests for impairment. If a decline in the fair value of available-for-sale securities is
	judged to be other than temporary, the cost basis for the security is written down to fair value
	as new cost basis. The written-down amount is included in earnings as an impairment charge.
	The Company considers a decline in the market value of a marketable security which is
	longer than six months in duration to be deemed other than temporary unless specific facts
	and circumstances indicate otherwise.
Derivative Financial	The Company accounts for its derivative instruments usingSFAS No. 133 “Accounting for
Instruments	Derivative Instruments and Hedging Activities” and its corresponding amendments under
	SFAS No. 138.SFAS No. 133 requires the Company to measure every derivative instrument
	at fair value and record them as either an asset or liability. Changes in fair value are record-
	ed in other income (see note 5).
Property and Equipment	Property and equipment is stated at cost, less accumulated depreciation and amortization.
	Major replacements and improvements are capitalized while general repairs and maintenance
	are charged to expense as incurred. Assets are depreciated over three to ten years using the
	straight-line method. Leasehold improvements are amortized over the estimated useful lives
	of the assets or the related lease term, whichever is shorter.

94 N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S

Revenue Recognition The Company’s revenues include technology access fees; fees earned from research and development collaboration agreements predominately with companies based in the United States.

Revenue related to non-refundable technology access fees, subscription fees and license fees is deferred and recognized on a straight-line basis over the relevant periods of the agreement, generally the research term or the estimated useful life of the collaboration for those contracts without a stipulated term unless a more accurate means of recognizing revenue is available. Research and development collaboration service fees are recognized in the period that the services are provided. Milestone revenues are recognized upon achievement of certain criteria.

Investment grants from governmental agencies for the support of specific research and development projects are recorded as revenue to the extent the related expenses have been incurred: under the terms of the investment grants, the governmental agencies generally have the right to audit the use of the payments received by the Company.

For revenue arrangements with multiple deliverables the Company tests for separate units of accounting based on the criteria stated in EITF 00-21. If certain criteria are met, the consideration will be allocated among the separate units based on their respective fair values, and the applicable revenue recognition criteria will be considered separately for each of the separate units.

Deferred revenue represents revenues received but not yet earned per the terms of the contracts. At December 31, 2002, deferred revenue included w 2.8 million, for which cash was not received until January 2003. At December 31, 2003, cash was received for all deferred revenue recorded.

Segment Reporting	The Company operates primarily in one business segment related to the development of anti-
	body therapeutics within the biotech industries. Accordingly, the Company does not disclose
	significant additional segment information under the definition of segment reporting, defined
	by the standards ofSFAS No. 131, “Disclosure About Segments of an Enterprise and Related
	Information.”
Research and Development	Research and development costs are expensed as incurred.

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Stock-Based The Company applies the provisions of SFAS No. 123 “Accounting for Stock-Based CompenCompensation sation,” which requires the Company to record the estimated fair value of stock options and other awards at the grant date as compensation expense over the period in which the employees render the services associated with the award.

Foreign Currency The financial statements of foreign subsidiaries have been translated into euros in accordance

Translation with SFAS No. 52, “Foreign Currency Translation.” All balance sheet accounts have been translated using the exchange rates in effect at the balance sheet date. The statement of operations amounts has been translated using the average exchange rate for the year. The gains and losses resulting from the changes in exchange rates from year to year have been reported in accumulated other comprehensive income.

• Net Loss per Share Basic and diluted loss per share is calculated in accordance with SFAS No. 128, “Earnings per Share.” Basic loss per share is based upon the number of weighted-average shares of common stock outstanding for the respective years.

The Company’s outstanding stock options and convertible bonds were excluded from the above calculations of dilutive net loss per share, as the effect of their inclusion would have been anti-dilutive.

• Impairment of LongThe Company evaluates the carrying value of long-lived assets and identifiable intangible

• Lived and Identifiable assets for potential impairment whenever events or changes in circumstances indicate that Intangible Assets the carrying amount of such assets may not be recoverable. Recoverability is determined by comparing projected undiscounted cash flows associated with such assets to the related carrying value. An impairment loss is recognized when the estimated undiscounted future cash flows are less then the carrying amount of the asset. An impairment loss would be measured as the amount by which the carrying value of the assets exceeds the fair value of the asset.

• Patent Costs The Company capitalizes costs related to obtaining patents and protecting granted patents from infringement. Capitalized costs principally relate to the costs of legal counsel. Patent costs are amortized on a straight-line basis over the lesser of their estimated economic life or remaining patent term (10 years). Amortization commences at the time the patent is issued. The Company’s patents covering its proprietary HuCAL[®] technology were granted in Australia in October 2000, in the United States of America in October 2001 and in Europe in June 2002. Further patent applications are pending in Canada and Japan.

96 N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S

Accounting for Acquired	The Company acquired license rights by making upfront licensing payments, annual mainte-
License Rights	nance fees and sublicensing payments to third parties. The Company amortizes up-front
	licensing payments on a straight-line basis over the estimated useful life of the acquired
	license (10 years). Annual maintenance fees are amortized over the term of each annual agree-
	ment. Sublicensing payments are amortized on a straight-line basis over the life of the con-
	tract or the estimated useful life of the collaboration for those contracts without a stipulated
	term.
Concentration of	Financial instruments that potentially subject the Company to concentrations of credit risk
Credit Risk	consist primarily of cash, cash equivalents, marketable securities and accounts receivable.
	The Company’s cash and cash equivalents are principally denominated in euros and U.S. dol-
	lars. Marketable securities are placed in high-quality securities. Cash, cash equivalents and
	marketable securities are maintained principally with two high-quality financial institutions
	in Germany. The Company continually monitors its positions with, and the credit quality of,
	the financial institutions, which are counter parties to its financial instruments, and does not
	anticipate non-performance. The Company’s revenues and accounts receivable are subject to
	credit risk as a result of customer concentrations. One customer individually accounted for
	approximately 88% of the Company’s 2003 accounts receivable balance. In addition, three cus-
	tomers individually accounted for 40%, 27% and 15% of the Company’s total revenues in the
	year 2003. On December 31, 2002, two customers accounted for 50% and 46% for the prior
	year’s accounts receivable balance and three customers individually accounted for 39%, 25%
	and 13% of the Company’s revenues in 2002.
Accounts Receivable	For accounts receivable, the allowance for doubtful accounts is based on the management’s
	assessment of the collectibility of specific customer accounts and the aging of the accounts
	receivable. If there is a deterioration of a major customer’s credit worthiness or actual de-
	faults are higher than the historical experience, management’s estimates of the recoverability
	of amounts due the Company could be adversely affected. Based on management assessment,
	no allowance was necessary on December 31, 2003 and 2002. The company does not require
	collateral from customers for accounts receivable. On December 31, 2003 and 2002, accounts
	receivable included unbilled amounts of approximatelyw119,360 andw265,000 respectively.
Income Taxes	The Company accounts for income taxes underSFAS No. 109, “Accounting for Income Taxes”
	using the liability method. Income taxes and credits are provided at statutory rates for taxable
	items included in the statements of operations, regardless of the period in which such items
	are reported for income tax purposes. Deferred income taxes are recognized for temporary
	differences between the financial statement and income tax bases of assets and liabilities for
	whichincome tax benefits will be realized in future years. Deferred tax assets are reduced by
	a valuation allowance if, based upon the weight of available evidence, it is more likely than
	not that some portion or all of the related tax asset will not be realized.

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Fair Value of Financial The carrying value of financial instruments such as cash and cash equivalents, accounts reInstruments ceivable and accounts payable approximate their fair value based upon the short-term maturities of these instruments. The fair value of marketable securities is based upon quoted market prices (see note 3). The fair value of license payables are determined by the effective interest method. Convertible bonds are recorded at their accreted values, which approximate the cash outlay that is due upon the note settlements.

Reclassifications Certain amounts in the prior year’s consolidated financial statements have been reclassified to conform to the current year’s presentation.

Effects of New In November 2002, the Emerging Issues Task Force (EITF) of the FASB issued EITF 00-21,

Accounting Standards “Revenue Arrangements with Multiple Deliverables,” which addresses certain aspects of the

and Regulations accounting for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. Under EITF 00-21, revenue arrangements with multiple deliverables should be divided into separate units of accounting if certain criteria are met, including whether there is objective and reliable evidence of the fair value of the undelivered items. In addition, the consideration should be allocated among the separate units based on their respective fair values, and the applicable revenue recognition criteria should be considered separately for each of the separate units. EITF 00-21 is effective for the Company’s revenue arrangements entered into beginning July 1, 2003. Our adoption of EITF 00-21 did not have a material impact on our results of operations or financial position.

In July 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”), an interpretation of Accounting Research Bulletin No. 51, “Consolidated Financial Statements.” FIN 46 prescribes how to identify variable interest entities and how an enterprise assesses its interests in a variable interest entity to decide whether to consolidate that entity. In October 2003, the implementation date of FIN 46 was deferred until the end of the first interim or annual period ending after December 15, 2003. On December 24, 2003, the FASB issued a revision to Interpretation 46 (“46R”) to clarify some of the provisions of FASB Interpretation No. 46, “Consolidation of Variable Interest Entities,” and to exempt some entities from its requirements.

Under the new guidance, special effective date provisions apply to enterprises that have fully or partially applied Interpretation 46 prior to issuance of this revised interpretation. Our adoption of FIN 46 did not have a significant effect on our results of operations or financial position.

98 N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities,” which amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and hedging activities under FAS No. 133. The amendments set forth in SFAS No. 149 improve financial reporting by requiring that contracts with comparable characteristics be accounted for similarly. The provisions of SFAS No. 149 are effective for contracts entered into or modified after June 30, 2003. Our adoption of SFAS No. 149 did not have a significant effect on our results of operations or financial position.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. The provisions of SFAS No. 150, which also include a number of new disclosure requirements, are effective for instruments entered into or modified after May 15, 2003 and pre-existing instruments as of the beginning of the first interim period that commences after June 15, 2003. The adoption of SFAS No. 150 did not have a significant effect on our results of operations or financial position.

On December 17, 2003, the Securities and Exchange Commission (“SEC”) published Staff Accounting Bulletin (SAB) No. 104, “Revenue Recognition.” SAB No. 104 updates portions of the SEC staff’s interpretive guidance provided in SAB No. 101 and included in Topic 13 of the Codification of Staff Accounting Bulletins. SAB No. 104 deletes interpretive material no longer necessary, and conforms the interpretive material retained, because the pronouncements issued by the FASB’s EITF on various revenue recognition topics, including EITF 00-21. SAB No. 104 also incorporates the codification of certain sections SAB No. 101’s frequently asked questions and answers. The adoption of SAB No. 104 did not have a significant effect on our results of operations or financial position.

2 Restructuring

In November 2002, MorphoSys announced restructuring measures. These measures included the discontinuation of clinical drug development and the refocusing of the Company’s commercial strategy. These measures were implemented in 2003 with the aim of strengthening the Company’s financial position by significantly reducing its cost base.

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In November 2002, the Company took actions to reduce its headcount by 24% from 120 to 91 employees, thereof 26 in Germany and 3 in the U.S.A. The total amount of expenses relating to the restructuring plan amounted to w 731,837. Of this total amount, w 387,415 were part of the sales, general and administrative costs (of which w 268,610 are related to MorphoSys U.S.A., Inc.), and w 344,421 were allocated to Research & Development expenses. The w 268,610 include leasehold improvements, cancellation fees, and severance payments. At December 31, 2002, w 47,449 of the total termination benefits had been paid and w 684,388 were included in accrued expenses, of which w 415,778 were included in accrued employee benefits. Payments made in 2003 related to restructuring activities from 2002, approximated the estimated accrual at December 31, 2002. In August 2003, the last remaining liability related to the early termination of leased office space in the U.S. was settled. No significant further expenditures are currently anticipated. Therefore, the restructuring accrual at December 31, 2003 was zero.

3 Marketable Securities

Marketable securities consist of the following as of December 31, 2003 and 2002 (in thousands w):

in 000’sR Maturity Cost	Gross Unrealized Holding Gains Losses Market Value 456 – 3,724 161 – 2,723 245 – 10,426 862 – 16,873 364 16,509 – (526) 3,268 – (269) 2,520 239 – 12,850 239 (795) 18,638 364 18,274
12/31/2003
HVB Euro Bond 06/07/2011 3,268
HVB Debentures 12/06/2009 2,562
DB Money Market Funds daily 10,181
16,011
Restricted Cash
12/31/2002
HVB Euro Bond 06/07/2011 3,794
HVB Debentures 12/06/2009 2,789
DB Money Market Funds daily 12,611
19,194
Restricted Cash

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The net unrealized holding gains of w 861,929 for the year ending December 31, 2003 and net unrealized holding losses of w 556,228 for the year ending December 31, 2002 were recorded as a separate component of stockholders’ equity. The unrealized losses in 2002 were due to a decline in the market value of marketable securities placed with HypoVereinsbank, as a result of a downgrading of the bank.

The Company invested an aggregate amount of w 3.8 million in a silent partnership of HypoVereinsbank Luxembourg and w 2.8 million in securities of the HypoVereinbank AG. Under SFAS No. 115 “Accounting for Certain Investments in Debt and Equity Securities,” both investments are designated as available-for-sale and are reported at fair value on the Company’s balance sheet. Under the Company’s accounting policy, marketable securities are presumed to be impaired if their fair value is less than their cost basis for more than six months, unless specific facts and circumstances indicate otherwise. If the Company deems these investments further impaired at the end of any other period, an additional impairment may occur. During 2002/2003, MorphoSys’ HypoVereinsbank investments had traded below their original cost basis for more than six months, and therefore the Company deemed that an impairment of these investments had occurred. Accordingly, impairment charges from January 2003 to June 2003 of w 753,768 were recognized in June 2003. Since June 30, 2003, the two impaired investments have recovered, and at December 31, 2003, the two investments had regained w 617,000 in market value.

For further details of restricted cash items, see note 4.

4 Restricted Assets

The Company has classified as restricted cash certain cash and cash equivalents and marketable securities in other assets that are not available for use in its operations. At December 31, 2003 and 2002, the Company had commitments of w 364,000 for guarantees issued and w 157,200 and w 74,800 respectively for convertible bonds issued to employees.

5 Derivative Financial Instruments

In May 2003, MorphoSys entered into foreign currency options contracts to hedge foreign exchange exposure related to U.S. dollar accounts receivable. At December 31, 2003, options contracts in the notional amount of w 4,690,583 or US$ 5,250,000 were outstanding and will mature between January 2004 and February 2004. The fair market value at December 31, 2003 was w 479,929 and recorded in other current assets on the balance sheet. The Company did not have any derivative financial instruments at December 31, 2002.

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At December 31, 2003, the remaining contract premium for derivatives amounted to w 164,000.

For the period ending December 31, 2003, unrealized gains amounted to w 315,929, of which w 193,500 were realized in January 2004 and included in total foreign exchange gains of w 389,196 (2002: w 483,042).

6 Accumulated Other Comprehensive Income/(Loss)

Accumulated other comprehensive income/(loss) consists of unrealized gains or losses on marketable securities and translation adjustments from consolidation. For the period ending December 31, 2003 and 2002, the components of accumulated other comprehensive income/ (loss) were as follows (in thousands w):

	12/31/2003	12/31/2002
	in 000’sR	in 000’sR
Net Unrealized Gain/(Loss)on Available-for-Sale Securities	862	(556)
Foreign CurrencyTranslation Adjustment	51	38
Accumulated Other Comprehensive Income/(Loss)	913	(518)

The impairment charge on the HypoVereinsbank investments of w 753,768 was recognized as an unrealized loss in the statement of operations and removed from accumulated other comprehensive income (loss).

7 Intangible Assets

The following sets forth the intangible asset classes as of December 31, 2003 and 2002 (in thousands w):

Amortized Intangibles
Patents	8,569	8,531
License Rights	12,140	3,810
Accumulated Amortization Patents	(2,571)	(1,717)
Accumulated Amortization Licenses	(1,241)	(457)
Unamortized Intangible Assets
Patents	106	85
Net Intangible Assets	17,003	10,252

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The changes in the carrying amount of unamortized patents for the period ending December 31, 2003 is as follows (in thousands w):

12/31/2003 in 000’sR Unamortized Intangibles Balance on December 31, 2002 85 Additions for the Full Year 2003 21 Balance on December 31,2003 106	12/31/2003 in 000’sR Unamortized Intangibles Balance on December 31, 2002 85 Additions for the Full Year 2003 21 Balance on December 31,2003 106
Balance on December 31, 2002	85
Additions for the Full Year 2003	21
Balance on December 31,2003	106

Amortization is expected to commence on unamortized patents once the related patents are issued. Amortization expense on intangible assets totaled w 1,637,863 for the twelve-month period ending December 31, 2003 (December 31, 2002: w 1,236,457). Patents are amortized over 10 years starting from the date of the first patent grant. Licenses are amortized over 10 years from the date of the acquisition.

Future amortization for the years 2004 to 2008 and thereafter are as follows (in thousands w):

12/31 in 000’sR 2004 2,071 2005 2,071 2006 2,071 2007 2,071 2008 2,071 Thereafter 6,542 16,897	12/31 in 000’sR 2004 2,071 2005 2,071 2006 2,071 2007 2,071 2008 2,071 Thereafter 6,542 16,897
2004	2,071
2005	2,071
2006	2,071
2007	2,071
2008	2,071
Thereafter	6,542
	16,897

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8 Property and Equipment

Property and equipment consist of the following at December 31, 2003 and 2002 (in thousands w):

12/31/2003 12/31/2002 in 000’sR in 000’sR Office and LaboratoryEquipment 3,605 3,145 Furniture and Fixtures 1,267 1,260 Purchased Software 1,186 1,044 Total 6,058 5,449 Less Accumulated Depreciation (4,150) (3,351) Net Propertyand Equipment 1,908 2,098	12/31/2003 12/31/2002 in 000’sR in 000’sR Office and LaboratoryEquipment 3,605 3,145 Furniture and Fixtures 1,267 1,260 Purchased Software 1,186 1,044 Total 6,058 5,449 Less Accumulated Depreciation (4,150) (3,351) Net Propertyand Equipment 1,908 2,098	12/31/2003 12/31/2002 in 000’sR in 000’sR Office and LaboratoryEquipment 3,605 3,145 Furniture and Fixtures 1,267 1,260 Purchased Software 1,186 1,044 Total 6,058 5,449 Less Accumulated Depreciation (4,150) (3,351) Net Propertyand Equipment 1,908 2,098
Office and LaboratoryEquipment	3,605	3,145
Furniture and Fixtures	1,267	1,260
Purchased Software	1,186	1,044
Total	6,058	5,449
Less Accumulated Depreciation	(4,150)	(3,351)
Net Propertyand Equipment	1,908	2,098

9 Commitments

The Company leases facilities and equipment under long-term operating leases. Total rent expense amounted to w 899,676 and w 983,908 for the years ending December 31, 2003 and 2002 respectively. In January 2004, MorphoSys amended the existing lease agreement of its facilities. The new lease agreement expires in September 2009. Future minimum payments under non-cancelable operating leases with initial terms of one year or more are as follows (in thousands w):

12/31 in 000’sR 2004 1,191 2005 968 2006 933 2007 897 2008 893 Thereafter 893 5,775	12/31 in 000’sR 2004 1,191 2005 968 2006 933 2007 897 2008 893 Thereafter 893 5,775
2004	1,191
2005	968
2006	933
2007	897
2008	893
Thereafter	893
	5,775

The Company’s total expenses under operating leases in the years ending December 31, 2003 and 2002 totaled approximately w 1,058,111 and w 1,280,221 respectively.

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10 Contingent Liabilities

In June 2001, a lawsuit was filed against the Company by Applied Molecular Evolution, Inc., (“AME”) San Diego, U.S.A., at the United States District Court of Massachusetts in Boston, U.S.A., alleging that the Company infringes the Kauffman-Ballivet patent family. These patents cover the stochastic production of proteins and were granted in the late 1990s. A trial date has not yet been set, although in January 2003, MorphoSys confirmed that it had received a positive “Report and Recommendation” from the Magistrate Judge to the District Judge for the District Court in Boston, Massachusetts, U.S.A., in the legal action filed by Applied Molecular Evolution. The Magistrate Judge recommended that MorphoSys’ motion for summary judgment of non-infringement be allowed and that AME’s motion for partial summary judgment of infringement be denied. As a result, no provisions for contingent liabilities have been made in the Company’s financial statements.

In December 2002, the Company and Cambridge Antibody Technology (“CAT”) entered into a settlement agreement pursuant to which they agreed to settle all patent disputes between the two companies. Pursuant to the settlement agreement, the Company agreed to make annual payments of w 1.0 million over the next five years as well as issue 588,160 new shares of common stock and make certain ongoing royalty and milestone payments, and in return will receive a license under certain CAT patents with respect to the previous and future development of HuCAL[®] libraries. The Company has the option to buy out its cash obligations to CAT for a predefined fixed amount at any time during the duration of the agreement. The Company recorded an accrual for the settlement with CAT in the year 2002. In addition, the Company recorded a net present value discount of approximately w 1.2 million on the annual payments to record the liability at its estimated fair value of w 3.8 million. The discount of 13% on the cash payments is being amortized to interest expense over the period of the payments. For the full year 2003, w 0.2 million was charged to interest expense. The settlement agreement was finalized in July 2003 and the Company engaged an external valuation expert to complete a valuation, whose basis provided the necessary information to finalize the accounting.

Based on the valuation analysis, the Company determined the fair value of the different components of the agreement and allocated the total consideration paid for each component based on the fair values of the consideration received. The completion of the analysis resulted in an accounting estimate change which reduced Research and Development expense by w 2.3 million. Accordingly, a total of w 1.9 million was expensed for the release. The remaining w 8.3 million of consideration represents the value of the license received and has been capitalized as an intangible asset and will be amortized over its expected useful life of 10 years.

Management is not aware of any other matters that could give rise to any material liability to the Company that would have a material adverse effect on the Company’s financial condition or results of operations.

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The change in accounting estimate had the following effect on net loss and net loss per share for the years ending December 31, 2003 and 2002 (in thousands w, except for per share data):

12/31/2003 12/31/2002 in 000’sR in 000’sR Net Loss (4,148) (24,377) Effect from Change in AccountingEstimate (2,272) 2,272 Pro-Forma Loss (6,420) (22,105) Basic and Diluted Net Lossper Share (0.96) (6.35) Effect from Change in AccountingEstimate (0.52) 0.59 Pro-Forma Net Lossper Share (1.48) (5.76)	12/31/2003 12/31/2002 in 000’sR in 000’sR Net Loss (4,148) (24,377) Effect from Change in AccountingEstimate (2,272) 2,272 Pro-Forma Loss (6,420) (22,105) Basic and Diluted Net Lossper Share (0.96) (6.35) Effect from Change in AccountingEstimate (0.52) 0.59 Pro-Forma Net Lossper Share (1.48) (5.76)	12/31/2003 12/31/2002 in 000’sR in 000’sR Net Loss (4,148) (24,377) Effect from Change in AccountingEstimate (2,272) 2,272 Pro-Forma Loss (6,420) (22,105) Basic and Diluted Net Lossper Share (0.96) (6.35) Effect from Change in AccountingEstimate (0.52) 0.59 Pro-Forma Net Lossper Share (1.48) (5.76)
Net Loss	(4,148)	(24,377)
Effect from Change in AccountingEstimate	(2,272)	2,272
Pro-Forma Loss	(6,420)	(22,105)
Basic and Diluted Net Lossper Share	(0.96)	(6.35)
Effect from Change in AccountingEstimate	(0.52)	0.59
Pro-Forma Net Lossper Share	(1.48)	(5.76)

11 Stockholders’ Equity

Common Stock

On December 31, 2003, the common stock of the Company was w 14,703,996. This represented an increase of w 2,854,878 compared to December 31, 2002 balance of w 11,849,118. The increase arose as a result of the issuance of 363,466 shares to XOMA for a capital increase against contribution in kind, which was registered on May 6, 2003 in the commercial register, and the issuance of 588,160 shares to CAT for a capital increase against contribution in kind, which was registered on August 26, 2003 in the commercial register.

On March 28, 2002, the Company’s common stock increased by w 1,073,640 from w 10,773,275 to w 11,846,915 with new shares arising from Authorized Capital II, in conjunction with the Schering collaboration signed in December 2001. In addition, the Company’s common stock increased by w 718 from w 11,846,915 to w 11,847,633 to avoid fractional common stock as calculated by its imputed nominal value per share. During the year 2002, 495 shares were raised from conditional capital through exercise of the same number of employee stock options, thereby increasing the amount of subscribed capital by w 1,485, to a total of w 11,849,118, or 3,949,706 shares.

Authorized Capital

On May 6, 2003, 363,466 shares of Authorized Capital I were issued to XOMA for a capital increase against contribution in kind.

On May 16, 2003, shareholders’ assembly authorized the Company to create a maximum of 431,317 new shares of Authorized Capital II and a maximum of 1,725,269 new shares of Authorized Capital I.

106 N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S

In August 2003, 588,160 shares of Authorized Capital I were issued to CAT for a capital increase against contribution in kind. Unused Authorized Capital I equaled 1,137,109 and 1,431,529 shares at December 31, 2003 and 2002 respectively. Unused Authorized Capital II equaled to 431,317 and 394,921 shares at December 31, 2003 and 2002 respectively.

Conditional Capital No stock options or convertible bonds were exercised in the year 2003. During the year 2002, 495 shares were raised from conditional capital through exercise of the same number of employee stock options, thereby increasing the amount of subscribed capital by w 1,485.

On May 16, 2003, the shareholders’ assembly authorized the Company to create additional shares for Conditional Capital III, IV and V in the maximum amount of 1,275,000, 450,269 and 111,447 shares respectively.

In 2002, previously authorized Conditional Capital I and II, consisting of w 97,875 and w 900,750 respectively, and arising from prior year resolutions, were retained. Conditional Capital III, to allow issuance of convertible bonds and consisting of w 2,625,000 (875,000 shares) was also retained. Conditional Capital IV, an authorization to issue convertible bonds to management and employees as part of an equity incentive scheme, was retained and consisted of w 900,000 (300,000 shares). The shareholder assembly authorized the creation of Conditional Capital V consisting of w 223,668 (74,556 shares), which authorizes the Company to issue additional share options to employees.

• Dividends Dividends may only be declared and paid from the accumulated retained earnings (after deduction of certain reserves) shown in the Company’s annual German statutory accounts. Such amounts differ from the total of additional paid-in capital and accumulated deficit as shown in the accompanying consolidated financial statements as a result of the adjustments made to present the consolidated financial statements in accordance with U.S. GAAP. As of December 31, 2003 and 2002, the Company’s German statutory accounts reflected no accumulated earnings available for distribution and accordingly, the Company’s ability to pay dividends would depend upon the future earnings of the Company.

Additional Paid-In Capital On December 31, 2003, additional paid-in capital amounted to w 68,623,807 (December 31, 2002 w 59,193,912). The increase of w 9.4 million is due to stock-based compensation provisions in the amount of w 2,175,430, w 3,110,896 as a result of the XOMA share issuance, and w 4,143,569 as a result of the CAT share issuance.

In 2002, the additional paid-in capital was increased by w 3,940,412 resulting from stockbased compensation provisions, premiums associated with the capital increase against cash from the agreement with Schering, and the exercise of employee stock options.

Treasury Stock Treasury Shares totaling w 21,934 (59,762 shares) at December 31, 2003, remained unchanged compared to December 31, 2002.

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12 Stock Options

1998 Employee Stock Option Program

Effective June 15, 1998, the Company introduced an incentive stock option plan (“1998 Plan”) which provides for the grant of options to purchase shares of the Company’s common stock to key employees and members of the Company’s Management Board. The 1998 Plan authorized the grant of options to personnel for 96,075 shares of the Company’s common stock in the form of 45,450 registered warrants, each equal to one share of common stock and 50,625 shares deliverable upon exercise of non-warrant option rights. The Company reserved 55,350 common shares plus 68,650 shares of treasury stock for stock options. All option rights granted under this 1998 Plan have a 10-year term.

Each warrant entitles the holder to receive one share. Upon exercise of a warrant, the exercise price, which equals the fair value of the shares on the date of grant, is due and payable. The holder of warrants can exercise up to the full amount of warrants 6 months after the date of grant. The holder of warrants also has the right to sell them. The warrants or shares obtained upon exercise vest annually on a graded basis over three years.

The non-warrant option rights are granted by way of an option agreement by the Company to the employee. For all grants commencing after June 1998, a two year holding period is required after the date of grant, after which the holder of non-warrant option rights can exercise up to the amount of vested option rights.

1999 Employee Stock Effective July 21, 1999, the Company amended the incentive stock option plan (“1999 Plan”)

Option Program authorizing the additional grant of options to employees for up to 300,250 shares, arising from conditional capital, and deliverable upon exercise of non-warrant option rights. On October 31, 1999, a grant of 98,100 shares was made to Company employees, management and the Supervisory Board. The option rights are non-transferable, and have a maximum life of 5 years. Additionally, a two-year holding period is required after the date of grant, after which the holder of the option rights can exercise up to the amount of vested option rights, under the condition that the value of the underlying stock has appreciated 10% per annum, cumulatively, in the year of exercise.

In the year 2002, additional grants to employees were made under the 1999 Plan, with terms identical to the 1999 stock options grants. 5,500 options were granted on January 15, 2002, to employees of MorphoSys AG.

In the year 2003, additional grants to executive board members were made under the 1999 Plan, with terms identical to the 1999 stock options grants. 36,000 options were granted on July 7, 2003, to executive board members of MorphoSys AG.

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2002 Employee Stock Option Program

Effective June 6, 2002, the Company amended the incentive stock option plan (“2002 Plan”) authorizing the additional grant of options to employees for up to 74,556 shares, arising from conditional capital, and deliverable upon exercise of non-warrant option rights. On July 9, 2002, a grant of 7,500 shares was made to Company employees. The terms are very similar to those of “1999 Employee Stock Option Program.” On May 16, 2003, the stockholders’ assembly authorized the Company to grant additional 36,891 shares under the “2002 Employee Stock Option Program” with identical terms.

In the year 2003, grants to employees were made under the 2002 Plan, with terms identical to the 1999 and 2002 stock options grants. 2,500 options and 15,000 options were granted on January 15, 2003 and July 1, 2003 respectively to employees of MorphoSys AG.

On January 15, 2004, 35,000 options were granted to employees with terms identical to the 1999, 2002 and 2003 stock options grants.

A summary of the activity under the Company’s employee incentive stock option plans for the years ending December 31, 2003 and 2002 is represented as follows:

		Weighted-
		Average Price
	Shares	R
Outstandingat January1,2002	285,465	30.12
Granted	13,000	41.07
Exercised	(495)	17.50
Forfeited	(32,500)	31.71
Outstandingat December 31,2002	265,470	30.48
Outstandingat January1,2003	265,470	30.48
Granted	53,500	10.89
Exercised	–	0.00
Forfeited	(47,225)	31.65
Outstandingat December 31,2003	271,745	26.40

Stock options exercisable at December 31, 2003 and 2002 amounted to 179,295 and 133,720 shares respectively. The weighted-average exercise prices of stock options exercisable were w 27.91 and w 25.40 at December 31, 2003 and 2002 respectively. Furthermore, the weightedaverage fair value of options granted during 2003 and 2002 is estimated to be w 7.57 and w 17.98 respectively.

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The following table presents weighted-average price and information about contractual life for significant option groups outstanding at December 31, 2003:

		Remaining
Range of	Number	Contractual Life	Weighted-Average	Number of	Weighted-Average
Exercise Prices	Outstanding	(in Years)	Exercise Price	Exercisables	Exercise Price
§10.88—§20.00	101,470	4.55	§14.02	47,970	§17.50
§20.01—§58.00	161,150	1.68	§25.46	126,075	§23.98
§58.01—§217.00	9,125	1.86	§180.78	5,250	§217.60
	271,745			179,295

The Company accounts for stock-based compensation in accordance with the provisions of SFAS No. 123. Compensation expense recorded in 2003 and 2002 in connection with stock options was w 1,864,722 and w 2,458,368 respectively. The fair value of the options issued in - 2003 was calculated using the Black-Scholes option pricing model and the following assump tions: risk-free interest rates ranging from 2.96% to 3.61%, dividend yield of 0%, 115% expected volatility and an expected option life of 3.0 years. For option grants in 2002, the following assumptions were used: risk-free interest rates ranging from 4.50% to 5.14%, dividend yield of 0%, 60% expected volatility and identical option life as of 2003.

Option valuation models require the input of highly subjective assumptions. Because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.

Stock Option Repricing On September 1, 2001, the Company reissued 94,100 options to employees, which were cancelled on July 5, 2001. The reissued options have similar characteristics and vesting provisions as the original options granted. In accordance with SFAS No. 123, the reissued options were revalued at the date of reissuance using the Black-Scholes optionpricing model. A fair market value of approximately w 5,950,000 was assigned to the reissued options, which will be recognized over the vesting period of the reissued options. During the year ending December 31, 2003 and 2002, the Company recognized approximately w 1,650,000 and w 2,226,000 respectively of stock-based compensation expense relating to these reissued stock options.

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13 Convertible Bonds

At the Company’s shareholder assembly in July 2002, the Company was authorized until June 30, 2006 to issue up to 300,000 non-interest-bearing convertible bonds with a par/nominal value of w 1.00 each to employees and members of the Board of Management of the Company and its affiliates. The preemptive rights of the stockholders were excluded. On May 16, 2003, the stockholders’ assembly authorized the Company to grant additional 150,269 shares.

On January 15, 2002, pursuant to a Management Board decision, the Company issued 91,500 convertible bonds to the Management Board and employees of the Company.

The convertible bonds cannot be transferred or encumbered, other than through inheritance/ death, or in the event of disability to work, the Board of Management can allow the transfer with good cause.

The conversion rights may only be exercised if a declaration of termination of the employment agreement with the owner of the convertible bonds has not been declared at the time of exercise and a mutual termination agreement has not been entered into. In the event of non-exercise of the conversion rights, beneficiaries are refunded amounts paid to acquire the convertible bonds (i.e. w 1.00 per bond/share).

The beneficiaries may exercise the conversion rights only after the expiration of a waiting period of one year of grant date. Each convertible bond with a nominal value of w 1.00 allows the exchange into one share of ordinary no-par value common stock of the Company against payment of the exchange price. The convertible bonds cannot be exercised beyond December 31, 2004.

The exchange price for the convertible bonds issued on January 15, 2002 was w 57.56, representing the average closing price of a share of the Company in the final XETRA auction at the Frankfurt Stock Exchange during the last five trading days preceding the resolution of the Board of Management on the issuance of the convertible bonds.

The exercise of the conversion rights is only possible if the stock exchange price on at least one day during the lifetime of the convertible bonds has amounted to w 63.31, or 110% of the average stock exchange price in the final XETRA auction at the Frankfurt Stock Exchange during the five trading days prior to the resolution of the Board of Management on the issuance of the convertible bonds.

N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S 111

Shares, which are issued by virtue of the conversion rights, may participate in the profits of the Company at the first time in the business year for which no stockholders’ resolution on the distribution of profits has been passed at the time of the issuance.

In the year 2003, additional grants to employees were made under the 2002 Plan, with terms identical to the 2002 stock convertible bonds grants. 70,700, 8,500 and 14,000 convertible bonds were granted on April 1, 2003, May 17, 2003 and July 1, 2003 respectively to board members, executive board members and employees of MorphoSys AG. The exercise prices for the convertible bonds were w 11.69, w 10.00 and w 10.88 respectively.

The nominal value of w 5,400, relating to convertible bonds forfeited on December 31, 2003, was paid back to the respective people in January 2004.

				Weighted-
			Convertible	Average Price
			Bonds	R
Outstanding	at	January1,2002	–	0.00
Granted			91,500	57.56
Forfeited			(16,700)	57.56
Outstanding	at	December 31,2002	74,800	57.56
Outstanding	at	January1,2003	74,800	57.56
Granted			93,200	11.41
Forfeited			(16,200)	43.97
Outstanding	at	December 31,2003	151,800	30.68

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None of the convertible bonds granted in 2002 and exercisable in 2003 were exercised as of December 31, 2003.

			Remaining
	Range of	Number	Contractual Life	Weighted-Average	Number of	Weighted-Average
	Exercise Prices	Outstanding	(in Years)	Exercise Price	Exercisables	Exercise Price
§	10.00—§20.00	88,400	2.00	§11.40	0	§11.40
	§57.56	63,400	1.00	§57.56	63,400	§57.56
		151,800			63,400

The Company accounts for stock-based compensation in accordance with the provisions of SFAS No. 123. Compensation expense recorded in 2003 and 2002 in connection with convertible bonds was w 310,708 and w 1,482,044 respectively. The fair value of the convertible bonds issued was calculated using the Black-Scholes pricing model using the following assumptions: risk-free interest rates ranging from 2.96% to 3.31%; dividend yield of 0%; 115% expected volatility; and an expected life of 2.0 years. For convertible bond issuance in 2002, the following assumptions were used: risk-free interest of 4.50%, dividend yield of 0%, 60% expected volatility and an option life of 2 years.

Option valuation models require the input of highly subjective assumptions. Because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.

14 Taxes

As a result of the net losses incurred by the Company each year since inception, no provision for income taxes has been recorded. At December 31, 2003, the Company has net operating loss carry-forwards of approximately w 31 million to offset future taxable income. Under current German tax laws, these loss carry-forwards have an indefinite life and may be used to offset the Company’s future taxable income. Net operating loss carry-forwards are subject to review and possible adjustment by the German taxing authorities. Furthermore, under current German tax laws, certain substantial changes in the Company’s ownership may limit the amount of net operating loss carry-forwards, which could be utilized annually to offset future taxable income. Subsequent significant ownership changes could further effect the limitation in future years.

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Significant components of the Company’s deferred tax liabilities and assets are as follows (in thousands w):

Deferred Tax Liabilities:
Intangibles	3,302	2,553
Other	373	(7)
Total Deferred Tax Liabilities	3,675	2,546
Deferred Tax Assets:
Net OperatingLoss Carry-Forwards	11,628	9,303
Deferred Revenue	230	360
Total Deferred Tax Assets	11,858	9,663
Valuation Allowance for Deferred Tax Assets	(8,183)	(7,117)
Net Deferred Tax Assets	3,675	2,546
Net Deferred Tax Liabilities/(Assets)	–	–

The Company has incurred losses since inception and has provided a full valuation allowance on its deferred tax assets at December 31, 2003 and 2002, since realization of these future benefits is uncertain. Income tax expense for the year ending December 31, 2003 amounted to w 21 compared to w 18,000 in 2002, which related to current foreign taxes.

Under German corporate tax law, taxes on income are composed of corporate taxes, trade taxes and an additional surtax. The Company’s combined German statutory tax rate is 37%. A reconciliation between the income tax expense computed at the corporate statutory tax rate of 37% and the Company’s effective tax rate for the years ending December 31, 2003 and 2002 is as follows (in thousands w):

Tax Provision at German StatutoryRates	(1,535)	(9,013)
Change in Valuation Allowance	1,066	(1,951)
Change in StatutoryRates	–	233
Sale of Intangible Assets to Subsidiary	–	9,250
Stock-Based Compensation	805	1,458
Other	(336)	41
	1340	18

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15 Directors’ Dealings and Executive Compensation

The table below shows the shares, stock options and convertible bonds, and changes of ownership of the same, which were held by the Management and the Supervisory Board during the year 2003:

Shares

Management
Dr. Simon Moroney (held through a controlled entity) 113,461 – –	113,461
Dave Lemus – – –	–
Dr. Thomas von Rüden – – –	–
Total 113,461 – –	113,461
SupervisoryBoard
Dr. Gerald Möller – – –	–
Dr. Daniel Camus – – –	–
Prof. Dr. Jürgen Drews – – –	–
Prof. Dr. Andreas Plückthun 59,300 – –	59,300
Dr. JörgReinhardt – – –	–
Dr. GeoffreyN. Vernon – – –	–
Total 59,300 – –	59,300

Management
Dr. Simon Moroney 25,000 22,000 –	47,000
Dave Lemus 21,000 – –	21,000
Dr. Thomas von Rüden 50,700 14,000 –	64,700
Total 96,700 36,000 –	132,700
SupervisoryBoard
Dr. Gerald Möller 6,100 – –	6,100
Dr. Daniel Camus – – –	–
Prof. Dr. Jürgen Drews 5,930 – –	5,930
Prof. Dr. Andres Plückthun 3,500 – –	3,500
Dr. JörgReinhardt 3,500 – –	3,500
Dr. GeoffreyN. Vernon 3,500 – –	3,500
Total 22,530 – –	22,530

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Convertible Bonds

Management
Dr. Simon Moroney 12,000 12,000 –	24,000
Dave Lemus 10,000 24,000 –	34,000
Dr. Thomas von Rüden 10,000 10,000 –	20,000
Total 32,000 46,000 –	78,000
SupervisoryBoard
Dr. Gerald Möller – 2,500 –	2,500
Dr. Daniel Camus – 1,500 –	1,500
Prof. Dr. Jürgen Drews – – –	–
Prof. Dr. Andres Plückthun – 1,500 –	1,500
Dr. JörgReinhardt – 1,500 –	1,500
Dr. GeoffreyN. Vernon – 1,500 –	1,500
Total – 8,500 –	8,500

Compensation for the Management Board consisted of fixed and variable components. Fixed compensation for the Management Board in 2003 amounted to w 570,886, compared to w 533,541 in the year 2002. Variable compensation for the Management Board in 2003 amounted to w 232,780, compared to w 181,636 in 2002. Other compensatory benefits amounted to w 275,268 in 2003 and w 178,999 in 2002.

Total compensation for the Supervisory Board in 2003 amounted to w 193,839 (2002: w 163,466).

16 Corporate Governance

The Company issued its statement according to Section 161 of the German Stock Corporation Act (Aktiengesetz). This declaration was published and made accessible to stockholders accordingly on December 22, 2003.

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17 Research and Development Agreements

The Company has a significant number of research and development agreements related to its discovery and development strategy. The following is a brief description of certain of these agreements, which have had, or may have, a significant financial impact (in chronological order).

GPC Biotech AG, Munich, Germany

In April 1999, the Company signed a collaboration and license agreement with GPC Biotech AG (“GPC AG”), Munich. The objective of the collaboration program is to utilize the Company’s technologies to generate human antibodies against GPC targets and to deliver such antibody products to GPC for confirmation of achievement of predefined success criteria. The Company received from GPC upfront research and development funding/exclusivity payments as well as the potential for milestone and royalty payments.

Bayer Corporation, Berkeley, U.S.A.

In December 1999, the Company announced a collaboration with Bayer AG encompassing a research collaboration and license agreement for the application of the Company’s proprietary technologies in a number of Bayer’s research and development programs. The agreement specified four areas in which the two companies apply the Company’s technologies. The Company’s HuCAL[®] (Human Combinatorial Antibody Library) technology is being used to generate fully human therapeutic antibodies against up to ten targets provided by Bayer. In addition, Bayer has an option to develop antibodies generated using the HuCAL[®] technology as in vitro diagnostics. Furthermore, HuCAL[®] is being used to identify antibodies for use in monitoring the progress of clinical trials with selected drugs. The fourth and last area of application is the use of MorphoSys’ technologies to identify and validate new targets emerging from Bayer’s genomics program, which will be used by Bayer in screens for new drug candidates.

Under the terms of the agreement, Bayer made an up-front payment to the Company upon signing the agreement, and pays in addition annual license fees and support for research and development funding at the Company. Furthermore, Bayer pays exclusivity fees for using the HuCAL[®] technology on up to ten potential targets, as well as milestone fees on antibodies delivered by the Company that meet preagreed success criteria. Any antibody-based products developed in the collaboration trigger development-related milestone and royalty payments by Bayer to the Company. In the course of the agreement, Bayer has thus far taken two exclusive licenses on antibodies from MorphoSys, and cross-licensed their HKB-11 cell line against installation of HuCAL[®] GOLD at selected Bayer sites.

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• ProChon Biotech Limited, In May 2000, the Company signed a cooperation and license agreement with ProChon, Rehovot, Israel Israel. The firms will collaborate in the development of human therapeutic antibodies against a ProChon target. The fees payable to the Company include payments representing a license payment, as well as program-related milestones upon achievement of certain success-related criteria. ProChon will also pay royalties to the Company on marketed products derived from the collaboration. In May 2002, the two companies expanded their existing agreement, whereby MorphoSys acquired the rights to a portfolio of anti-cancer antibodies in development at ProChon. The agreement gave MorphoSys the exclusive right to develop and commercialize the antibodies for therapeutic applications in the field of oncology, and in particular against the target FGFR-3.

In July 2003, the agreement was amended. It is intended that MorphoSys continues with ProChon to develop up to 4 antibodies with MorphoSys’ HuCAL[®] GOLD library, but MorphoSys will return all rights concerning FGFR-3 antibodies to ProChon.

• F. Hoffmann-La Roche, In September 2000, the Company entered into a collaboration and license agreement for the Switzerland development of human therapeutic antibodies against a Roche target. Under the terms of the agreement, the Company receives a license payment, development-related milestone payments, and royalties on marketed products. The Company will apply its (HuCAL[®] ) Fab technology to the generation and optimization of antibodies for the Roche target. Roche will be responsible for the clinical development, regulatory approval and worldwide marketing of any resulting products.

• ImmunoGen, U.S.A. In September 2000, the Company signed a collaboration and license agreement with ImmunoGen, U.S.A. The parties will collaborate in the discovery and development of human monoclonal antibodies against certain specified targets. ImmunoGen will be responsible for developing one or more antibodies generated by the Company into a marketable product. Under the agreement, the Company will receive a license payment, as well as developmentrelated milestone payments and royalties on marketed products.

The existing agreement between the two companies was expanded in June 2001, whereby the expanded agreement provided for a research license from the Company to ImmunoGen for the Company’s HuCAL[®] antibody library technology for the generation of research antibodies for use in ImmunoGen’s functional genomics programs, in order to help validate new targets. The expanded agreement has a duration of four years.

118 N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S

• Biogen, U.S.A. In December 2000, the Company signed a collaboration agreement with Biogen. Under the agreement, the two companies will collaborate in applying the Company’s proprietary EST technology for generating antibodies against expressed sequence tags to validate drug targets in Biogen’s genomics programs. The agreement includes an option for Biogen to develop selected antibodies identified during the collaboration as therapeutics. Biogen will pay MorphoSys a technology access fee, as well as research and development funding. In the event that any antibody-based therapeutics will be developed, Biogen will make milestone and royalty payments to the Company. In December 2001, Biogen expanded the agreement to include an additional amount of ESTs beyond those defined in the original agreement. In addition, the duration of the original license granted to Biogen was extended.

• Centocor, U.S.A. In December 2000, the Company signed a subscription and license agreement with Centocor, Inc. (“Centocor”). The intention of the collaboration is to facilitate the research, discovery and development of novel antibody therapeutics. Centocor will have access to the HuCAL[®] technology at various sites; in addition, the Company will generate antibodies against Centocor targets. Under the agreement, the Company will receive committed technology license fees, exclusivity fees, research and development funding, and milestone payments. Should Centocor market any drugs as a result of the collaboration, the Company will receive royalty payments. The contract has a duration of 5 years unless otherwise extended. Centocor will be responsible for development and marketing of any potential drugs.

• Oridis Biomed, Austria In September 2001, Oridis Biomed (“Oridis”) and the Company entered into a wide-ranging agreement under which the Company gained preferred access to Oridis’ tissue collection, residing at the Institute of Pathology, University of Graz, Austria.

The goal of the collaboration is the characterization and validation of new therapeutic targets. The Company will apply its HuCAL[®] technology to make antibodies to candidate targets, which Oridis Biomed will use to carry out high-throughput protein expression analysis on a range of human tissues. In return, Oridis received a license to the Company’s HuCAL[®] technology, and will have access to certain antibodies from the Company. The Company received a first right of negotiation to all antibody products resulting from the collaboration. The Company receives and pays license fees from Oridis.

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Schering AG, Germany In December 2001, the Company and Schering AG (“Schering”) formed a strategic alliance for the development of antibody therapeutics and in vivo diagnostics. As part of the agreement, Schering and the Company will combine their resources over the three-year collaboration term to exclusively pursue a minimum of five therapeutic and several in vivo diagnostic projects. Furthermore, the two partners will jointly undertake research to identify additional potential therapeutic and diagnostic targets emerging from Schering’s genomics program.

Over the lifetime of the agreement, the Company will receive license fees, milestone payments and royalties on any end products emerging from the collaboration. Additionally, Schering purchased 357,880 shares at an average price of w 66.79 per share in February 2002 as part of their strategic commitment to the partnership.

Pfizer, Inc., U.S.A. In December 2003, the Company announced a collaboration and license agreement with Pfizer, Inc. The intention of the collaboration is to facilitate the research, discovery and development of novel antibody therapeutics. The Company will apply its HuCAL[®] GOLD technology to the generation and optimization of antibodies for multiple Pfizer targets. Under the agreement, the Company received a committed upfront fee, research support, and depending on collaboration progress, milestone payments and royalties. Pfizer is responsible for the clinical development, regulatory approval and worldwide marketing of any resulting products.

18 Acquired License Agreements

The Company is party to license agreements covering certain patented technology.

Dyax Corporation, U.S.A. In October 1996, the Company signed a license agreement with Dyax Corporation, under which the Company received a royalty-bearing, non-exclusive, worldwide license to patents owned by Dyax covering certain technologies relating to the use and practice of phage display. The Company may use the licensed technologies for research and discovery of novel therapeutic agents and targets, and may sublicense the technology to its commercial partners. The Company paid an upfront technology access fee, in addition to annual maintenance and transfer fees.

120 N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S

• SCA Ventures, Inc., U.S.A. In December 1999, the Company concluded a non-exclusive product-derived license agreement with SCA Ventures, Inc., U.S.A., in which the Company obtained a non-exclusive license from SCA Ventures in order to design, discover, develop, make, use, sell, offer for sale and import HuCAL[®] -derived products under SCA Ventures’ patent rights in single-chain antibodies. The Company may use the SCA Ventures’ licensed technologies for the research and discovery of novel therapeutic agents and targets, and may sublicense the technology to its commercial partners. The Company may terminate this agreement for any reason upon 6 months prior written notice to SCA Ventures. The Company pays an upfront license fee, annual maintenance and transfer fees.

• Biosite Diagnostics, In January 2000, the Company signed a collaboration agreement with Biosite Diagnostics, Inc., Inc., U.S.A. under which the Company receives a royalty-bearing, non-exclusive, worldwide license to patents owned by Biosite and XOMA Corporation covering certain technologies relating to the display and screening of multi-chain antibodies. The Company may use the licensed technologies for research and discovery of novel therapeutic agents and targets, and may sublicense the technology to its commercial partners. Unless earlier terminated, the term of this agreement shall either be the expiration of the parties’ respective obligations to pay royalties, or the expiration of the last patent right licensed by one party to the other. The Company pays an upfront technology access fee, in addition to annual maintenance and transfer fees.

• Genentech, Inc., U.S.A. In May 2000, the Company concluded a license agreement with Genentech, Inc., granting the Company rights under Genentech patents relating to monovalent phage display screening technology. The Company may use the licensed technologies for research and discovery of novel therapeutic agents and targets, and may sublicense the technology to its commercial partners. The Company pays an upfront technology access fee, in addition to annual maintenance and transfer fees.

• XOMA Ireland Limited In February 2002, the Company concluded a cross-licensing agreement for antibody-related technologies with XOMA Ireland Ltd. Under the agreement, the Company received a license to use the XOMA antibody expression technology for developing antibody products (including Fab and scFv formats) using MorphoSys’ phage display-based HuCAL[®] antibody library. MorphoSys also received a license for the production of antibodies (including Fab and scFv formats) under XOMA patents. Under the agreement, XOMA obtained a license to use the MorphoSys HuCAL[®] antibody library for its target discovery and research programs. The agreements also provide for the release of the Company from any past activities using the Company’s technology to the extent they also use XOMA’s antibody expression technology.

121

N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S

Pursuant to the agreement, MorphoSys paid w 1.1 million to XOMA with a second payment of w 4.6 million due in September 2002. At the Company’s option, the second installment could be paid in cash or with new shares of the Company’s common stock equivalent to w 5.5 million. The Company recorded w 2.5 million as a charge to research and Development expenses in the year 2002. The remaining w 3.2 million represents the value of the license received, and has been capitalized as an intangible asset and will be amortized over its expected useful life of 10 years.

In October 2002, the Company exercised the option to pay the second installment with 363,466 new shares of its common stock, which was determined with reference to the market price of the Company’s common stock at the time of the notice. The Company recorded a charge to interest expense related to this exercise of the option at the time the shares were issued in May 2003 which equaled w 0.7 million.

Cambridge Antibody Technologies PLC, Cambridge, U.K.

In December 2002 and effective July 2003, the Company entered into a licensing and settlement agreement with CAT. The settlement agreement covers MorphoSys’ past, present and future use, the commercialization of all versions of its HuCAL[®] libraries, and all patents in the ongoing disputes between the two companies. This includes the litigation in the United States regarding CAT’s Griffiths, McCafferty, Winter II and Winter/Lerner/Huse patents as well as oppositions launched by MorphoSys at the European Patent Office against CAT’s Winter II and McCafferty patents.

The companies agreed to terms under which MorphoSys will be free to develop and commercialize its HuCAL[®] technologies. CAT undertook not to sue MorphoSys in relation to present HuCAL[®] GOLD libraries and all future derivatives thereof. In addition, MorphoSys received a license to the CAT patent estate in respect of previous HuCAL[®] libraries. CAT will receive an annual payment of w 1 million over the next five years. It will also receive other financial consideration from MorphoSys’ activities related to its HuCAL[®] GOLD libraries for a defined period of time. CAT will receive milestone and royalty payments under the license for products developed using previous HuCAL[®] libraries. In addition, CAT received an equity stake of 588,160 ordinary shares in MorphoSys under the license agreement. MorphoSys retains the option to buy out its obligations to CAT for a predefined fixed amount at any time during the duration of the agreement.

122 N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S

Summary of Significant Differences between German GAAP and U.S. GAAP

The financial statements of the Company are prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”), which differ in certain respects from German generally accepted accounting principles (“German GAAP”) as prescribed by the German Commercial Code. The following is a summary of the significant differences between applied U.S. GAAP and German GAAP that may affect the Company’s net income and equity for the periods presented.

Deferred tax assets—Under U.S. GAAP, deferred tax assets arising from a tax loss carryforwards and temporary differences are generally recorded and must be analyzed in light of whether realization of the assets is “more likely than not.” This means a level of likelihood that is greater than 50%. As a result of this analysis, a deferred tax asset may be subject to a valuation allowance. Under German GAAP, deferred tax assets generally may not be recognized with respect to a tax loss carry-forwards because expected future tax savings are not recognizable before the realization of such profits.

Intangible assets—Under U.S. GAAP, certain expenses (i.e. costs associated with obtaining one’s own patent) are capitalized as intangible assets and amortized on a straight-line basis over their estimated useful lives. Under German GAAP, such costs are expensed as incurred. The capitalization of certain acquired license rights is accounted for according to an expert valuation under U.S. GAAP. Under German GAAP, the splits are based on the net present value or acquisition cost.

Amortization life of acquired license rights—Under U.S. GAAP, these rights are amortized over their estimated useful economic life of 10 years. Under German GAAP, the amortization period of 8 years follows the rates used for tax purposes

Revenue recognition—Under U.S. GAAP, more stringent revenue recognition criteria exist which can result in differences in the periods in which revenue is recognized under German GAAP. In the fourth quarter of 2000, the Company implemented the U.S. Securities and Exchange Commission SAB 101, which requires non-refundable technology access payment revenue to be amortized over future periods of benefit. Although not required to do so, the Company will also use the same practice of revenue recognition in its German GAAP (HGB) accounts starting for the year 2001 and onwards.

123

N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S

Stock-based compensation—The Company accounts for stock option and convertible bond grants in accordance with SFAS No. 123 and recognizes compensation expense. Under German GAAP, compensation expense is not being recognized.

Private placement and initial public offering costs—Under U.S. GAAP, certain costs in connection with a private placement or an initial public offering of equity are recorded as a reduction of additional paid-in capital. Under German GAAP, such costs are expensed as incurred.

Unrealized holding gains and losses on available-for-sale securities—Under U.S. GAAP, unrealized holding gains and losses on available-for-sale securities are recorded as a component of equity. Unrealized losses are only recorded in the statement of operations, when the unrealized loss is deemed to be other than temporary. If the reasons for an impairment in prior years are no longer applicable, under German GAAP, the investment is written up to its net realizable value, and at most to its acquisition cost. Under German GAAP, unrealized losses are recorded in the statement of operations.

Unrealized holding gains and losses on derivative financial instruments—Under U.S. GAAP, unrealized gains and losses on derivatives are recorded as other income/expense. Under German GAAP, increased market value is not recorded.

Non-current liabilities— U.S. GAAP requires to record long-term liabilities with its present value of the future payments, using an interest rate commensurate with the risk involved. Under HGB, the long-term liabilities are recorded with their repayment amounts.

124 N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S

Roll-Forward of Fixed Assets

I. Intangible Assets
Patents	8,616,089 58,746 0	8,674,835
License Rights	3,810,297 8,330,102 0	12,140,399
	12,426,386 8,388,848 0	20,815,234
II. Property and Equipment
Purchased Software	1,043,890 141,793 0	1,185,683
Office and LaboratoryEquipment	3,120,604 532,652 41,954	3,611,302
Furniture and Fixtures	1,259,429 7,632 0	1,267,061
	5,423,923 682,077 41,954	6,064,046

N O T E S T O T H E C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S 125

	Accumulated Depreciation 01/01/2003 Depreciation Disposals 12/31/2003 R R R R	Accumulated Depreciation 01/01/2003 Depreciation Disposals 12/31/2003 R R R R	Accumulated Depreciation 01/01/2003 Depreciation Disposals 12/31/2003 R R R R	Net Book Values 12/31/2003 12/31/2002 R R 6,103,675 6,898,990 10,898,904 3,352,604 17,002,579 10,251,594 405,492 571,064 827,721 729,953 674,682 796,779 1,907,895 2,097,796 Profit/Loss Equity in Foreign in Foreign Currency Currency 269,101 24,221 23,891 0	Net Book Values 12/31/2003 12/31/2002 R R 6,103,675 6,898,990 10,898,904 3,352,604 17,002,579 10,251,594 405,492 571,064 827,721 729,953 674,682 796,779 1,907,895 2,097,796 Profit/Loss Equity in Foreign in Foreign Currency Currency 269,101 24,221 23,891 0	Net Book Values 12/31/2003 12/31/2002 R R 6,103,675 6,898,990 10,898,904 3,352,604 17,002,579 10,251,594 405,492 571,064 827,721 729,953 674,682 796,779 1,907,895 2,097,796 Profit/Loss Equity in Foreign in Foreign Currency Currency 269,101 24,221 23,891 0
	1,717,099 854,061 0	2,571,160			6,103,675	6,898,990
	457,693 783,802 0	1,241,495			10,898,904	3,352,604
	2,174,792 1,637,863 0	3,812,655			17,002,579	10,251,594
	472,826 307,365 0	780,191			405,492	571,064
	2,390,651 414,649 21,719	2,783,581			827,721	729,953
	462,650 129,729 0	592,379			674,682	796,779
	3,326,127 851,743 21,719	4,156,151			1,907,895	2,097,796
	Chart of Consolidated Entity as of December 31, 2003 Exchange Rate at December 31, 2003; One Unit of Foreign Share of Currency Currency inR Capital in %
	MorphoSysU.S.A., Inc. Charlotte, North Carolina,U.S.A. US $ 1.25800 100.00 MorphoSys IP GmbH § - 100.00

126 A U D I T O P I N I O N

Independent Auditor’s Report

We issue the following opinion on the consolidated financial statements and the Group management report:

“We have audited the consolidated financial statements, comprising of the balance sheet, statement of operations, statement of changes in stockholders’ equity and statement of cash flows, as well as the notes to the consolidated financial statements, prepared by MorphoSys AG, Martinsried, Germany, for the business year from January 1 to December 31, 2003. The preparation and the content of the consolidated financial statements are the responsibility of the Company’s executive board. Our responsibility is to express an opinion whether the consolidated financial statements are in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) based on our audit.

We conducted our audit of the consolidated financial statements in accordance with German auditing regulations and generally accepted standards for the audit of financial statements promulgated by the Institut der Wirtschaftsprüfer (IDW). Those standards require that we plan and perform the audit such that it can be assessed with reasonable assurance whether the consolidated financial statements are free of material misstatements.

Knowledge of the business activities and the economic and legal environment of the Company and evaluations of possible misstatements are taken into account in the determination of audit procedures. The evidence supporting the amounts and disclosures in the consolidated financial statements are examined on a test basis within the framework of the audit. The audit includes assessing the accounting principles used and significant estimates made by management and Company’s executive board, as well as evaluating the overall presentation of the consolidated financial statements.

A U D I T O P I N I O N 127

We believe that our audit provides reasonable basis for our opinion.

In our opinion, the consolidated financial statements give a true and fair view of the net assets, financial position, results of operations and cash flows of the Group for the business year in accordance with U.S. GAAP.

Our audit, which also extends to the Group’s management report presentation of additional disclosures required by Article 36 of the 7th EU Directive prepared by the executive board, for the business year from January 1 to December 31, 2003, has not led to any reservations. In our opinion, on the whole the Group’s management report together with the other disclosures in the consolidated financial statements provides a suitable understanding of the Group’s position and suitably presents the risks of future development.

In addition, we confirm that the consolidated financial statements and the Group’s management report for the business year from January 1 to December 31, 2003 satisfy the conditions required for the Company’s exemption from its obligation to prepare consolidated financial statements and the Group’s management report in accordance with German law.”

Munich, February 9, 2004

Ernst & Young Deutsche Allgemeine Treuhand AG Wirtschaftsprüfungsgesellschaft

von Petrikowsky Dr. Napolitano Wirtschaftsprüfer Wirtschaftsprüfer

128

F I N A N C I A L S T A T E M E N T S I N A C C O R D A N C E W I T H G E R M A N G A A P

Balance Sheet in Accordance with German GAAP (HGB)

MorphoSys AG Financial Statements as of December 31, 2003 and December 31, 2002

31.12.2003 12/31/2003 12/31/2002 Assets R R	31.12.2003 12/31/2003 12/31/2002 Assets R R	31.12.2003 12/31/2003 12/31/2002 Assets R R
A. Fixed Assets
I. Intangible Assets
1. Franchises, Trademarks, Patents Licences, and Similar Rights and Licences to Such Rights	7,877,584	1,025,961
II. Tangible Assets
1. Land, Leasehold Rights and Buildings, IncludingLeasehold Improvements	518,777	599,859
2. Other Equipment, Furniture and Fixtures	983,625	926,873
	1,502,402	1,526,732
III. Financial Assets
1. Shares in SubsidiaryCompanies	184,916	186,916
2. Loans to Affiliated Companies	25,000,000	25,000,000
	25,184,916	25,186,916
B. Current Assets
I. Inventories
1. Work in Progress	119,360	264,592
2. Raw Materials, Supplies and Production Materials	40,755	40,755
	160,115	305,347
II. Receivables and Other Assets
1. Trade Accounts Receivable All Due within One Year	1,992,350	5,642,224
2. Receivables Due from Enterprises in which the Company has a ParticipatingInterest, All Due within One Year	0	3,626
3. Other Assets, Due after One Year §7,555(Prior Year:§7,555)	1,188,655	1,106,792
	3,181,005	6,752,642
III. Short-Term Securities Investments
1. TreasuryStock	21,934	21,934
2. Other Short-term Investments	16,627,644	18,398,797
	16,649,578	18,420,731
IV. Cash on Hand and Cash in Banks	6,782,279	740,627
C. Prepaid Expenses and Deferred Charges	397,981	679,763
	61,735,860	54,638,719

129

F I N A N C I A L S T A T E M E N T S I N A C C O R D A N C E W I T H G E R M A N G A A P

A. Equity
I. Capital Subscribed	14,703,996	11,849,118
II. Capital Surplus	59,291,294	53,710,300
III. Earnings Reserves
1. Reserve for TreasuryStock	21,934	21,934
IV. Accumulated Deficit	(32,167,506)	(26,975,675)
	41,849,718	38,605,677
B. Accruals
1. Other Accruals	1,980,495	3,330,800
	1,980,495	3,330,800
C. Liabilities
1. Bonds, thereof Convertible§63,400(Prior Year:§0)	151,800	74,800
2. Trade Accounts Payable	454,854	2,512,684
3. Liabilities to Companies in which Investments are Held Thereof Due after One Year§2,000,000 (Prior Year:§3,000,000)	3,000,000	5,000,000
4. Liabilities Due to Enterprises in which the Company Has a ParticipatingInterest	4,265,675	516,200
5. Other Liabilities Due within One Year §313,747 (Prior Year:§283,002) Thereof for Taxes§177,721 (Prior Year:§151,489) Thereof for Social Security §117,933(Prior Year:§131,512)	313,747	283,002
	8,186,076	8,386,686
D. Deferred Income	9,719,571	4,315,556
	61,735,860	54,638,719

130

F I N A N C I A L S T A T E M E N T S I N A C C O R D A N C E W I T H G E R M A N G A A P

Profit and Loss Statement in Accordance with German GAAP (HGB)

MorphoSys AG Financial Statements for the Period from January 1 to December 31, 2003 and 2002

31.12.2003 2003 2002 R R	31.12.2003 2003 2002 R R	31.12.2003 2003 2002 R R
1. Sales	14,975,087 16,423,769
2. Cost of Sales	13,766,099	19,547,999
3. Gross Profit/(Loss)on Sales	1,208,988	(3,124,230)
4. SellingExpenses	608,039	2,567,295
5. General Administration Expenses	6,354,591	16,045,805
6. Other OperatingExpenses	247,421	313,549
7. Other OperatingIncome	(100,551)	(190,482)
8. Expenses from Transfer of Losses	1,260,330	0
9. Expenses/(Income)from Other Short-term Securities	(994,231)	518,897
10. Other Interest and Similar Income (thereof§755,938 from Affiliated Companies)	(974,366)	(440,592)
11. Result from OrdinaryActivities	(5,192,245)	(21,938,702)
12. ExtraordinaryIncome	0	25,000,000
13. Other Taxes	414	(225)
14. Net Gain/(Loss)	(5,191,831)	3,061,073
15. Loss Carried Forward	(26,975,675)	(30,036,748)
16. Accumulated Deficit	(32,167,506)	(26,975,675)

D E C L A R A T I O N O F C O N F O R M I T Y 131

Corporate Governance

Declaration of Compliance with Regard to the German Corporate Governance Code

At the meeting on December 16, 2003, the Board of Management and the Supervisory Board approved the following Declaration of Compliance pursuant to sec. 161 of the German Act on Stock Corporations (AktG):

MorphoSys AG complies with all recommendations of the German Corporate Governance Code—in the version of May 21, 2003—with the following exceptions:

The stock option program for the Board of Management does not provide a cap for unforeseen developments within the meaning of Code sec. 4.2.3, sent. 6.

The present D&O insurance policy at MorphoSys AG does not include a deductible for Management and Supervisory Board members (Code sec. 3.8, para. 2).

Subsequent to the Declaration of Compliance of December 2002, MorphoSys AG complied with the recommendations of the November 26, 2002 version of the German Corporate Governance Code, with the following exception:

Our D&O insurance policy included no deductible for Managing Directors and Supervisory Board members (Code sec. 3.8, para. 2).

Martinsried/Planegg, December 16, 2003 MorphoSys AG

For the Management Board:

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Dr. Simon Moroney

Dr. Thomas von Rüden

Dave Lemus

For the Supervisory Board:

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Dr. Gerald Möller Chairman

132 S U P E R V I S O R Y B O A R D R E P O R T

Supervisory Board Report

In fiscal year 2003, the MorphoSys AG Supervisory Board carried out all its tasks and monitoring functions assigned to it by law and statute. In this capacity, the Supervisory Board advised and supervised the Management Board throughout the year. As part of its duties, the Management Board regularly informed the members of the Supervisory Board in both written and oral reports about the financial status and corporate developments of the Company, important Company transactions, and the strategic planning of the Company.

Supervisory Board Meetings and Committees

A total of seven Supervisory Board meetings were held during the year. In addition to these meetings, the Supervisory Board was promptly informed by the Management Board of all significant corporate events. Moreover the Chairman of the Supervisory and Management Boards maintained regular contact during the year, either by telephone or in personal discussions.

All events presented to the Supervisory Board were discussed in depth with the Management Board. In 2003, the main focus was on:

Strategic planning, including the multiyear business plan

• The Company’s own product development projects The annual budget for 2004 Mergers and acquisitions

During the fiscal year 2003, two different committees were in existence: the Audit Committee and the Remuneration/Nomination Committee. The composition of the committees can be found on page 134. The Audit Committee met a total of four times during the year, and the Remuneration/Nomination Committee met once in 2003.

At the ordinary General Meeting on May 16, 2003, Prof. Jürgen Drews and Prof. Andreas Plückthun were reelected as members of the Supervisory Board. Both have many years of experience in the pharmaceutical and biotechnology industry as well as in the field of antibody technology. We are very pleased to have the continued support of both members and the benefit of their experience.

Corporate Governance and Declaration of Conformity

In the 2003 fiscal year, the Supervisory Board concerned itself with the implementation of the German Corporate Governance Code. Both the Management Board and the Supervisory Board consider themselves bound by the principles of good corporate governance. In accordance with item 3.10 of the German Corporate Governance Code, the Management Board also reports on Corporate Governance for the Supervisory Board on pages 48—53 of this Annual Report.

S U P E R V I S O R Y B O A R D R E P O R T 133

In December 2003, the Management Board and the Supervisory Board issued an updated declaration of conformity in accordance with Article 161 of the German Stock Corporation Act (AktG), which was promptly made available to shareholders on the Company’s website. Save two exceptions, MorphoSys AG complies with all recommendations of the Government Commission German of the Corporate Governance Code valid at year-end.

Audit of the Annual Financial Statements

The auditor chosen at the 2003 ordinary General Meeting and appointed by the Audit Committee, Ernst & Young Deutsche Allgemeine Treuhand AG, Munich, audited the MorphoSys Group’s annual financial statements and notes thereto, the Company’s management report, the annual financial statements and notes to the annual financial statements of MorphoSys AG according to HGB (German accounting standards), and the Company’s systems for internal control. The consolidated financial statements were audited according to German and U.S. standards. The auditors confirmed that the annual financial statements are an accurate and fair reflection of the financial situation, the results of business activity and the Group’s cash flow for the fiscal year in accordance with U.S. GAAP. The auditors awarded an unqualified audit opinion. The consolidated financial statements according to U.S. GAAP were supplemented by a Group management report and further notes in accordance with Article 292a of the German Commercial Code (HGB). The submitted U.S. GAAP consolidated financial statements exempted the Company from the obligation to produce consolidated statements according to German law. This exemption was confirmed by the auditors.

The Management Board submitted the financial statements described above promptly and prior to the relevant Supervisory Board meeting. The annual financial statements were discussed in depth at the Supervisory Board meeting on February 20, 2004. The Company’s auditors attended the Supervisory Board meeting, reported on the audit and fielded all questions from the Supervisory Board. Following the Supervisory Board’s review of the annual financial statements and the recommendation of the Audit Committee, the Supervisory Board accepted the auditor’s report and conclusions in accordance with Article 172 of the German Stock Corporation Act (AktG). After its final review, the Supervisory Board approved the financial statements without objection or amendments.

On behalf of my colleagues on the Supervisory Board, I would like to thank you, the Management Board and all employees, for your tireless commitment to the Company during the 2003 fiscal year.

Martinsried/Planegg, February 2004

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Dr. Gerald Möller Chairman of the Supervisory Board

134 S U P E R V I S O R Y B O A R D

MorphoSys Supervisory Board

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Dr. Gerald Möller, Chairman Heidelberg, Germany Managing Director, HBM BioCapital Management GmbH, Heidelberg, Germany

Prof. Dr. Jürgen Drews, Deputy Chairman Feldafing, Germany and Naples, U.S.A. Managing Director, Bear Stearns Health Innoventure Fund LLC

Chairman of the Remuneration/ Nomination Committee

Member of the Remuneration/ Nomination Committee

Member of the Supervisory Board of: BioAgency AG, Germany (Chairman) febit AG, Germany (Chairman) MTM Laboratories AG, Germany (Director) 4sigma, Bermuda (Chairman) Ferraris Group plc, U.K. (Director) FIND Foundation for Innovative New Diagnostics, Switzerland (Director) Pelikan Technologies, Inc., U.S.A. (Chairman)

Member of the Supervisory Board of: Axxima Pharmaceuticals AG, Germany (Chairman) GPC Biotech AG, Germany (Chairman) TeGenero AG, Germany (Chairman) Genaissance Pharmaceuticals, Inc., U.S.A. (Chairman) Protein Design Labs, Inc., U.S.A. (Director) Human Genome Sciences, Inc.*, U.S.A. (Director)

• Membership in comparable domestic and foreign supervisory boards of commercial enterprises

135

S U P E R V I S O R Y B O A R D

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Dr. Daniel Camus Paris, France C.F.O. and Member of the Executive Committee, Electricité de France

Prof. Dr. Andreas Plückthun Zurich, Switzerland Professor of Biochemistry, University of Zurich

Dr. Jörg Reinhardt Ehrenkirchen, Germany Director Pharmaceutical Development and Member of the Executive Committee, Novartis AG

Dr. Geoffrey N. Vernon Tavistock, U.K. Executive Chairman, Ziggus Holding Ltd.

Member of the Audit Committee

Member of the Remuneration/ Nomination Committee

Chairman of the Audit Committee

Member of the Supervisory Board of: EnBW, Germany Dalkia Holding*, France

Member of the Supervisory Board of: Advanced Medical Solutions Ltd., U.K. (Chairman) Ark Therapeutics Ltd., U.K. (Director) Arrow Therapeutics Ltd.*, U.K. (Director)

Bionex Ltd., U.K. (Director) Bioniche Pharma Group Ltd., Ireland (Chairman)

BMR Ltd., Ireland (Chairman) Drug Abuse Sciences Ltd., U.S.A. (Director)

KetoCytonics Inc.*, U.S.A. (Chairman)

Medisys plc, U.K. (Director) Peptor Ltd., Israel (Chairman) Talia Technologies Ltd.*, Israel (Director)

XTL Biopharmaceuticals Ltd.*, Israel (Chairman)

136 G L O S S A R Y

Glossary

A

Affinity

Binding strength between binding partners, e.g. antibody/antigen

F

Fab fragment

Antibody fragment, comprises antigen-binding domain

FDA

Antibody

Proteins of the immune system that recognize antigens thereby triggering an immune response

Food and Drug Administration

FGFR-3

Fibroblast Growth Factor Receptor-3

Antibody library

A collection of genes that encode corresponding human antibodies

Folding

Three-dimensional arrangement of protein chains; an event leading to that structural arrangement during expression

Antigen

Foreign substance stimulating antibody production; binding partner of antibody

Fv

Antibody fragment; comprises both variable domains responsible for antigen binding

Antigen binding site

Part of variable domains of antibodies responsible for antigen binding

G

Gene

Part of DNA encoding a defined structure (e.g. a protein) or a function

C

CDR

Complementarity Determining Regions – part of the antibody that makes contact with target molecule and determines its specificity

Genome

Total DNA of an organism (genes, genetic signaling structures as well as additional DNA sections)

Genomics

E

E. coli

Escherichia coli; bacteria, often used as host cells

Analysis of composition and interaction of genetic information

EMEA

European Medicines Evaluation Agency

EST

Expressed sequence tag

H

HuCAL[®]

Human Combinatorial Antibody Library. Proprietary antibody library enabling rapid generation of specific human antibodies for all applications

Expression

Conversion of genetic information in a corresponding protein

I

ICAM-1

Intercellular Adhesion Molecule-1

IHC

Immunohistochemistry – staining of tissues with specific antibodies

Immunization Generation of antibodies by administering antigen

Immunoglobulin See antibody

In vitro

In a test tube

In vivo In a living organism

G L O S S A R Y 137

• L

Library

Here—collection of a multitude of different molecules (gene library, peptide library, protein, especially antibody library) for screening and/or selection

Ligand

R R & D

Research and Development

Recombinant

Formed by (re)combination of parts of one or different starting DNA molecules

Binding partner

RTK

Receptor Tyrosine Kinase

M Mini-antibody

Multimeric antibody fragments formed by association of smaller antigen-binding fragments

S Screening

Searching in libraries for molecules with desired properties

Modularity

P

Structure formed by modular, interchangeable building blocks

Monoclonal antibody

Homogeneous antibody originating from a single clone, produced by hybridoma cell

Peptide

Short chain of amino acids

S,G&A

Sales, General and Administrative

Single-chain Fv

Antibody fragment; comprises both variable domains responsible for antigen binding fused as a single protein chain

Specificity

Property of e.g. antibodies to discriminate between different, but similar, antigens

Phage

Abbreviation for bacteriophage, a virus that infects bacteria

Phage display technology

Screening technology; presentation of peptides/proteins of surface of phages

T

Target

Target molecule for therapeutic intervention, e.g. on surface of diseased cell

TRIM

Trinucleotide Mutagenesis

Phage genome

Collection of genes that form the genetic code of the phage

Trinucleotide

So-called codon consisting of three nucleotides; corresponds on DNA level to amino acid

Phage library

Collection of phages presenting library of peptides/proteins on the surface

U

U.S. GAAP

Generally accepted accounting principles in the U.S.

Protein

Polymer consisting of amino acids, e.g., antibodies, enzymes

Proteomics

Analysis of functions and interactions of proteins of an organism

138 C R E D O

Credo

Our Company’s philosophy is people-focused. Our strategy is long-term oriented and market-focused. All our employees support these principles.

Our goal is to apply our expertise and technologies to build one of the world’s leading biotechnology companies. The work of every single employee is important and contributes to increasing our Company’s value. Together, we strive for economic success for both our Company and our business partners. We use our resources in a purposeful manner to be competitive and profitable, as well as to maintain the best standards of quality and technology. Clear and simple processes enable us to work fast and efficiently and be flexible in any situation.

We deal with all our business partners in a competent, respectful and honest way. We strive to surpass our customers’ expectations. With our high-quality products we make a decisive contribution to our customers’ success. By attending to the needs of our customers, personally and individually, we build long-term trusting relationships, thereby also ensuring our own success.

By encouraging a friendly and open Company climate, we create a motivating and pleasant working environment. Within our teams, as well as throughout the Company, we support and help each other in achieving our goals. Honesty, trust and respect are the basis of our corporate culture. We judge our actions self-critically. We commit to both giving and accepting constructive criticism and suggestions, as well as to expressing genuine praise. Information is exchanged as completely and directly as possible. Questions are addressed objectively and without bias; decisions are communicated openly, at an early stage and with appropriate

C R E D O 139

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explanation. We contribute to the Company’s progress with commitment and a readiness to learn. We assume responsibility for our actions. Further development and training are actively promoted and supported. The personal situations and social interests of each member of staff are taken into consideration. Our managerial staff provides support and backing, affords the greatest possible freedom for the execution of tasks, and acts in an exemplary manner.

We commit to acting responsibly and to adopting all necessary measures in order to protect the safety of our employees and the environment. With an open communications policy, we create confidence and trust in our interaction with the public.

Our commercial activities are directed towards developing competitive products and increasing our Company’s value for the benefit of our shareholders, while paying appropriate, performance-related salaries and securing jobs. We have the courage to make decisions and to address and actively deal with our differences. Assumption of individual responsibility and acting on one’s own initiative are important qualities that are encouraged of all our employees. We deal with mistakes constructively, in order to learn from them and thus permanently improve the quality of our work.

This credo defines the spirit of MorphoSys; it provides us with objectives and orientation, is a binding provision for all our actions, and can be called upon by every single member of staff at any time.

140 I M P R I N T

Imprint

MorphoSys AG

Lena-Christ-Str. 48 82152 Martinsried/Planegg Germany Telephone: +49-89-89927-0 Fax: +49-89-89927-222 www.morphosys.com

Corporate Communications: Dave Lemus Chief Financial Officer Telephone: +49-89-89927-439 Fax: +49-89-89927-5439 E-mail: [email protected]

Dr. Claudia Gutjahr-Löser Director Corporate Communications Telephone: +49-89-89927-122 Fax: +49-89-89927-5122 E-mail: [email protected]

Mario Brkulj PR Specialist Telephone: +49-89-89927-454 Fax: +49-89-89927-5454 E-mail: [email protected]

Concept and Design 3st kommunikation GmbH, Mainz

Photos

Inge Miczka (3st kommunikation) Sigrid Reinichs, Munich Stefan Wildhirt, Offenbach

Printer

Societäts Druckerei GmbH, Frankfurt am Main

Highlights 2003

MorphoSys and Boehringer Ingelheim Sign Cross-Licensing Agreement

Under the agreement, MorphoSys obtained the exclusive worldwide license to Boehringer Ingelheim patents for the development and sale of therapeutic and diagnostic antibodies against ICAM-1. In return, Boehringer Ingelheim will receive exclusive licenses for therapeutic antibodies against two undisclosed target molecules.

February

January

Bayer Purchases an Exclusive License for a HuCAL[®] Antibody

This antibody targets an undisclosed solid tumor target molecule. The acquisition of an exclusive license is Bayer’s second licence from MorphoSys.

MorphoSys and Lonza Biologics Sign Manufacturing Agreement

MorphoSys und Schering Announce Successful Results from their Collaboration

Working under the collaboration, MorphoSys selected and optimized antibodies against a Schering oncological target molecule. These antibodies had previously showed effectiveness in an in vitro test system and showed specific accumulation in tumor tissue in tumor localization studies with mice.

July

MorphoSys Achieves Third Milestone in Centocor-Collaboration

MorphoSys generated several antibodies against a Centocor target molecule in the inflammatory diseases indication. The antibodies, which were systematically optimized by MorphoSys, met all eight predefined success criteria, and thus triggered the milestone.

The term of the contract is five years and provisions in the contract guarantee MorphoSys access to Lonza’s antibody manufacturing capacities. The agreement comprises future development projects both for MorphoSys’ own antibody projects and for antibodies from collaborations.

First Promising Results from Pre-clinical Studies for MOR101 and MOR102 MorphoSys presented first promising results from animal models for MOR101 und MOR102 during a conference in Japan.

October November

Therapeutic Antibody Collaboration with Pfizer The potential value to MorphoSys in committed funding and potential developmental milestone payments is estimated to be in excess of US$ 50 million, not including royalties.

December

The Granting of the HuCAL[®] EST Patent in the U.S.A.

MorphoSys issued U.S. Patent for HuCAL[®] EST technology. The technology is currently employed in several of MorphoSys’ collaborations with partners.

Progress in Alzheimer-Cooperation with Roche

MorphoSys and Roche presented successful and promising animal data from their collaboration on Alzheimer’s disease at the “33rd Annual Meeting of the Society for Neuroscience” in New Orleans, U.S.A.

Financial Calendar

February 26, 2004

April 29, 2004 May 11, 2004

July 29, 2004 October 28, 2004

Year End 2003 Results Analyst Meeting and Press Conference Frankfurt /Germany Three Months’ Report Publication Annual Shareholders’ Assembly Munich/Germany Six Months’ Report Publication Nine Months’ Report Publication

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