The accompanying discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements and the related disclosures, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts in our condensed consolidated financial statements and accompanying notes. On an on-going basis, we evaluate our estimates including, but not limited to, those related to terms of revenue recognition, long-lived assets, contingent warrant liabilities and stock-based compensation. We base our estimates on historical experience and on various other market-specific and other relevant assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ significantly from these estimates.

Overview

We are a leader in the discovery and development of innovative antibody-based therapeutics. Our lead drug candidate is gevokizumab (formerly XOMA 052), a humanized antibody that binds to the inflammatory cytokine interleukin-1 beta ("IL-1 beta"). In collaboration with our partner, Les Laboratoires Servier ("Servier"), gevokizumab is expected to enter global Phase 3 clinical development in 2012 for non-infectious uveitis ("NIU") and Behçet's uveitis. We anticipate Servier will enter gevokizumab into a Phase 2 study in a cardiovascular disease indication during 2012. Separately we have launched a Phase 2 proof-of-concept program for gevokizumab to evaluate additional indications for further development, including a clinical trial in moderate-to-severe inflammatory acne, which began enrolling patients in December 2011, and a clinical trial in erosive osteoarthritis of the hand, for which we plan to initiate enrollment in the second quarter of 2012.

We have entered into a license and collaboration agreement with Servier to jointly develop and commercialize gevokizumab in multiple indications. Gevokizumab is designed to inhibit the pro-inflammatory cytokine IL-1 beta, which is believed to be a primary trigger of pathologic inflammation in multiple diseases.

Our proprietary preclinical pipeline includes classes of antibodies that activate or sensitize the insulin receptor in vivo and represent potential new therapeutic approaches to the treatment of diabetes. We have developed these and other antibodies using some or all of our ADAPT™ antibody discovery and development platform, our ModulX™ technologies for generating allosterically modulating antibodies, and our OptimX™ technologies for optimizing biophysical properties of antibodies, including affinity, immunogenicity, stability and manufacturability.

In January 2012, we announced that we had acquired certain U.S. rights to a portfolio of antihypertensive products from Servier. The portfolio includes ACEON® (perindopril erbumine), a currently marketed angiotensin converting enzyme ("ACE") inhibitor, and three fixed-dose combination ("FDC") product candidates where perindopril is combined with another active ingredient(s), such as a calcium channel blocker. The proprietary form of perindopril in each of the combination product candidates provides patent protection until December 2023. We assumed commercialization activities for ACEON® in January 2012 following the transfer from Servier's previous licensee. In late February 2012, we initiated enrollment in a Phase 3 trial for perindopril arginine and amlodipine besylate, the first FDC product candidate. Partial funding for the Phase 3 trial will be provided by Servier; the balance of study expenses, consisting primarily of costs generated by our contract research organization, are expected to be paid by us over time from any profits generated by our ACEON® sales.

Our biodefense initiatives currently include a $65.0 million multiple-year contract funded by the National Institute of Allergy and Infectious Diseases ("NIAID"), a part of the National Institutes of Health ("NIH"), to support our ongoing development of anti-botulism antibody product candidates, of which the first, XOMA 3AB, is in a Phase 1 clinical trial. This contract is the third that NIAID has awarded us for the development of botulinum antitoxins. In October 2011, we announced that we had been awarded a fourth contract for up to $28.0 million over five years to develop broad-spectrum antitoxins for the treatment of human botulism poisoning, bringing the program's total potential awards to approximately $120 million. In January 2012, we announced that we will complete NIAID biodefense contracts currently in place but will not actively pursue future contracts. Should the government choose to acquire XOMA 3AB or other biodefense products in the future, we expect to be able to provide these antibodies through an outside manufacturer.

We also have developed antibody product candidates with premier pharmaceutical companies including Novartis AG ("Novartis") and Takeda Pharmaceutical Company Limited ("Takeda"). Two antibodies developed with Novartis, LFA102 and HCD122 (lucatumumab), are in Phase 1 and/or 2 clinical development by Novartis for the potential treatment of breast or prostate cancer and hematological malignancies, respectively.

Significant Developments in the First Quarter of 2012

Perindopril Franchise

? On January 17, 2012, we announced that we had acquired certain U.S. rights to a portfolio of antihypertensive products from Servier. The portfolio includes ACEON®, a currently marketed ACE inhibitor, and three FDC product candidates where a proprietary form of perindopril (perindopril arginine) is combined with another active ingredient(s), such as a calcium channel blocker. We assumed commercialization activities for ACEON® in January 2012 following the transfer from Servier's previous licensee.

? In February 2012, we initiated enrollment in a Phase 3 trial for perindopril arginine and amlodipine besylate, the first FDC product candidate. The trial is expected to enroll approximately 816 patients with hypertension to determine the safety and efficacy of the FDC versus either perindopril or amlodipine alone. Based on regulatory interaction to date, if the trial generates positive results, it is expected to be the only efficacy trial needed to complement existing clinical data and will support the submission of an application to the FDA seeking approval for this product candidate. Partial funding for the PATH trial was provided by Servier; the balance of study expenses, consisting primarily of costs generated by our contract research organization, are expected to be paid over time from the profits generated by our ACEON® sales.

Streamlining and Restructuring Charges

? On January 5, 2012, we implemented a streamlining of operations, which resulted in a restructuring designed to sharpen our focus on value-creating opportunities led by gevokizumab and our unique antibody discovery and development capabilities. The restructuring plan included a reduction of our personnel by 84 positions, or 34%, of which 52 were eliminated immediately and the remainder eliminated as of April 6, 2012. These staff reductions resulted primarily from our decisions to utilize a contract manufacturing organization for Phase 3 and commercial antibody production and to eliminate internal research functions that are non-differentiating or that can be obtained cost-effectively by contract service providers. As a result, we expect to reduce ongoing internal spending by approximately $14 million in 2012 compared to the 2011 level. In connection with the streamlining of operations, we incurred restructuring charges of $2.1 million related to severance, other termination benefits and outplacement services and $1.7 million related to the impairment and accelerated depreciation of various assets and leasehold improvements in the first quarter of 2012. In the remainder of 2012, we anticipate incurring an additional $0.1 million in severance charges and approximately $1.2 million in facility charges related to this streamlining of operations.

Management Change

? On January 4, 2012, the Company's Board of Directors appointed John Varian, a current Board member and the interim Chief Executive Officer, as Chief Executive Officer. W. Denman Van Ness continues to serve as Chairman of the Board.

Financings

? In the first quarter of 2012, we sold 2,285,375 shares of common stock through McNicoll, Lewis & Vlak LLC (now known as MLV & Co. LLC, "MLV"), under our At Market Issuance Sales Agreement dated February 4, 2011 (the "2011 ATM Agreement"), for aggregate gross proceeds of $3.3 million.

? In March 2012, we completed an underwritten public offering of 29,669,154 shares of our common stock, and accompanying warrants to purchase one half of a share of common stock for each share purchased, for gross proceeds of $39.2 million.

Results of Operations

Revenues

Total revenues for the three months ended March 31, 2012 and 2011, were as
follows (in thousands):


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                                      Three Months Ended March 31,
                                                                             Increase
                                       2012                 2011            (Decrease)
  License and collaborative fees   $       1,014       $         5,827     $     (4,813 )
  Contract and other                       8,851                 9,768             (917 )
  Total revenues                   $       9,865       $        15,595     $     (5,730 )

License and Collaborative Fees

License and collaborative fee revenue includes fees and milestone payments related to the out-licensing of our products and technologies. The decrease in license and collaborative fee revenue for the three months ended March 31, 2012, as compared to the same period of 2011, was primarily due to $5.5 million in revenue recognized in the first quarter of 2011 related to the collaboration and license agreement with Servier to jointly develop and commercialize gevokizumab in multiple indications. This decrease was partially offset by an increase in other licensing fees of $0.6 million. The generation of future revenue related to license fees and other collaborative arrangements is dependent on our ability to attract new licensees to our antibody technologies and new collaboration partners. We expect our revenues from license and collaborative fees in 2012 to remain comparable to 2011 levels.

Contract and Other Revenue

Contract and other revenues include agreements where we provide contracted
research and development services to our contract and collaboration partners,
including NIAID and Servier. The following table shows the activity in contract
and other revenue for the three months ended March 31, 2012 and 2011 (in
thousands):

                                   Three Months Ended March 31,
                                                                         Increase
                                     2012                2011           (Decrease)
      NIAID                      $       4,837       $       6,884     $     (2,047 )
      Servier                            3,649               2,082            1,567
      Other                                365                 802             (437 )
      Total contract and other   $       8,851       $       9,768     $       (917 )

The decrease in NIAID revenue is primarily due to decreased activity under NIAID Contract No. HHSN272200800028C ("NIAID 3"). This decrease in NIAID 3 contract revenue is partially offset by the recognition of $2.0 million in revenue related to an adjustment to previously-reported revenue from NIAID resulting from an audit by NIAID's contracting office. This revenue, which was previously deferred, was recognized upon the completion of negotiations with and approval by the NIH in March 2012. Also partially offsetting the decrease in contract and other revenue was an increase in gevokizumab clinical development and CMC activity under the collaboration with Servier and $0.5 million in activity under Contract No. HHSN272201100031C ("NIAID 4"), which was executed in October 2011.

Based on expected levels of revenue generating activities related to contract and other revenue, we expect a slight decrease in contract and other revenue in 2012 compared to 2011.

Research and Development Expenses

Biopharmaceutical development includes a series of steps, including in vitro and in vivo preclinical testing, and Phase 1, 2 and 3 clinical studies in humans. Each of these steps is typically more expensive than the previous step, but actual timing and the cost to us depends on the product being tested, the nature of the potential disease indication and the terms of any collaborative or development arrangements with other companies or entities. After successful conclusion of all of these steps, regulatory filings for approval to market the products must be completed, including approval of manufacturing processes and facilities for the product. Our research and development expenses currently include costs of personnel, supplies, facilities and equipment, consultants, third party costs and other expenses related to preclinical and clinical testing.

Research and development expenses were $15.7 million for the three months ended March 31, 2012, compared with $17.3 million for the same period of 2011. The decrease of $1.6 million for the three months ended March 31, 2012, as compared to the same period in 2011, was primarily due to a decrease in salaries and related personnel costs.

Salaries and related personnel costs are a significant component of research and development expenses. We recorded $7.0 million in research and development salaries and employee-related expenses for the three months ended March 31, 2012, as compared with $8.8 million for the same period of 2011. The decrease of $1.8 million was primarily due to a decrease of $1.0 million in salaries and benefits due to decreased headcount in manufacturing as result of the 2012 streamlining of operations, and a $0.7 million decrease in stock-based compensation.

Our research and development activities can be divided into earlier stage programs and later stage programs. Earlier stage programs include molecular biology, process development, pilot-scale production and preclinical testing. Also included in earlier stage programs are costs related to excess manufacturing capacity, which we expect will decrease in 2012 due to our streamlining objectives to utilize a contract manufacturing organization. Later stage programs include clinical testing, regulatory affairs and manufacturing clinical supplies. Certain research and development segment reclassifications have been made to previously reported amounts to conform to the current year's presentation. The costs associated with these programs approximate the following (in thousands):

                                         Three Months Ended March 31,
                                           2012                 2011
             Earlier stage programs   $        8,333       $       11,383
             Later stage programs              7,438                5,964
             Total                    $       15,771       $       17,347

Our research and development activities can also be divided into those related to our internal projects and those projects related to collaborative and contract arrangements. Certain research and development segment reclassifications have been made to previously reported amounts to conform to the current year's presentation. The costs related to internal projects versus collaborative and contract arrangements approximate the following (in thousands):

                                                 Three Months Ended March 31,
                                                   2012                 2011
    Internal projects                         $        6,682       $        7,408
    Collaborative and contract arrangements            9,089                9,939
    Total                                     $       15,771       $       17,347

For the three months ended March 31, 2012, the program upon which we incurred the largest amount of expense (gevokizumab) accounted for more than 40% but less than 50% of our total research and development expense, one development program (NIAID) accounted for more than 20% but less than 30%, and one development program (XMet) accounted for more than 10% but less than 20% of our total research and development expense. All remaining development programs accounted for less than 10% of our total research and development expense for the three months ended March 31, 2012. For the three months ended March 31, 2011, the program upon which we incurred the largest amount of expense (NIAID) accounted for more than 40% but less than 50%, and one development program (NIAID) accounted for more than 30% but less than 40% of our total research and development expenses. All remaining development programs accounted for less than 10% of our total research and development expense for the three months ended March 31, 2011.

We expect our research and development spending in 2012 will increase primarily due to the expected initiation of our Phase 3 clinical program for gevokizumab for the NIU indication, the initiation of our Phase 2 proof-of-concept program for gevokizumab to evaluate moderate-to-severe inflammatory acne and the expected initiation of our Phase 2 proof-of-concept program for erosive osteoarthritis of the hand, all under our license and collaboration agreement with Servier. In addition, we plan to announce the final proof-of-concept indication later in 2012. Also contributing to the expected increase is the initiation of a Phase 3 trial for perindopril arginine in combination with amlodipine besylate.

Future research and development spending may be impacted by potential new licensing or collaboration or development arrangements, as well as the termination of existing agreements. Beyond this, the scope and magnitude of future research and development expenses are difficult to predict at this time.

Selling, General and Administrative Expenses

Selling, general and administrative expenses include salaries and related personnel costs, facilities costs and professional fees. Selling, general and administrative expenses were $4.7 million for the three months ended March 31, 2012, compared with $5.4 million for the same period of 2011. The $0.7 million decrease for the first quarter of 2012, as compared to the same period of 2011, was primarily due to a decrease of $0.6 million in salary and related personnel costs, including a $0.4 million decrease in stock-based compensation.

Streamlining and Restructuring Charges

In January 2012, we implemented a streamlining of operations, which resulted in a restructuring designed to sharpen our focus on value-creating opportunities led by gevokizumab and its unique antibody discovery and development capabilities. The restructuring plan included a reduction of XOMA's personnel by 84 positions, or 34%, of which 52 were eliminated immediately and the remainder eliminated as of April 6, 2012. These staff reductions result primarily from our decision to utilize a contract manufacturing organization for Phase 3 and commercial antibody production and to eliminate internal research functions that are non-differentiating or that can be obtained cost-effectively by contract service providers.

During the three months ended March 31, 2012, in connection with this streamlining of operations, we recorded charges of $2.1 million related to severance, other termination benefits and outplacement services. We expect to incur an additional $0.1 million restructuring charge in the second quarter of 2012 related to severance, other termination benefits and outplacement services.

We plan to vacate two of our leased buildings in 2012 related to manufacturing operations and internal research functions. We did not incur any restructuring charges during the first quarter of 2012 in connection with the exit of these leased buildings as they were still in use; however, we expect to incur restructuring charges of approximately $1.2 million in the remainder of 2012, primarily related to the net present value of future minimum lease payments at the cease-use date, less potential estimated future sublease income.

As of March 31, 2012, we performed an impairment analysis of property and equipment and leasehold improvements related to our manufacturing operations. Since the estimated undiscounted future cash inflows from a certain group of these assets were less than the carrying value, we determined that these assets were impaired and recorded a related restructuring charge of approximately $0.8 million. Further, we changed the useful life of certain property and equipment and leasehold improvements impacted by our plans to vacate two leased buildings. As a result, we recorded accelerated depreciation of $0.9 million as a restructuring charge. We expect to incur additional restructuring charges of approximately $0.7 million in the remainder of 2012 related to the accelerated depreciation of leasehold improvements.

Other Income (Expense)

Interest Expense

Interest expense and amortization of debt issuance costs are shown below for the
three months ended March 31, 2012 and 2011 (in thousands):

                                  Three Months Ended March 31,
                                                                         Increase
                                    2012                  2011           (Decrease)
     Interest expense
     Servier loan             $            516         $       442     $          74
     GECC term loan                        417                   -               417
     Novartis note                          99                  84                15
     Other                                  10                   6                 4
     Total interest expense   $          1,042         $       532     $         510

The increase of $0.5 million in interest expense in 2012 as compared to 2011 was primarily due to interest expense related to the loan with GECC, which was funded in December 2011.

Other Expense

Other expense primarily consisted of unrealized and realized (losses) gains. The following table shows the activity in other expense for the three months ended March 31, 2012 and 2011 (in thousands):

                                                     Three Months Ended March 31,
                                                                              Increase
                                                2012            2011         (Decrease)
Other expense
Unrealized foreign exchange loss (1)          $    (402 )     $  (1,617 )   $      1,215
Realized foreign exchange gain (2)                   10             560             (550 )
Unrealized loss on foreign exchange options        (276 )             -             (276 )
Other                                                 4               -                4
Total other expense                           $    (664 )     $  (1,057 )   $        393

(1) Unrealized foreign exchange gain (loss) for the three months ended March 31, 2012 and 2011 primarily relates to gains (losses) on the re-measurement of the €15 million Servier loan.

(2) Realized foreign exchange gain for the three months ended March 31, 2011 primarily relates to the conversion into U.S. dollars of the €15 million cash proceeds received from Servier in January of 2011.

Revaluation of Contingent Warrant Liabilities

In March 2012, in connection with an underwritten offering, we issued five-year warrants to purchase 14,834,577 shares of XOMA's common stock at an exercise price of $1.76 per share. These warrants contain provisions that are contingent on the remote occurrence of a change in control, which would conditionally obligate us to repurchase the warrants for cash in an amount equal to their fair value using the Black-Scholes Option Pricing Model (the "Black-Scholes Model") on the date of such change in control. We believe the likelihood of a change in control prior to the expiration of the warrants is remote; however, due to these provisions, we are required to account for the warrants issued in March 2012 as a liability at fair value. In addition, the estimated liability related to the warrants is required to be revalued at each reporting period until the earlier of the exercise of the warrants, at which time the liability will be reclassified to stockholders' equity, or expiration of the warrants. At issuance, the fair value of the warrant liability was estimated to be $6.4 million using the Black-Scholes Model. We revalued the warrant liability at March 31, 2012 using the Black-Scholes Model and recorded an increase in the fair value of $14.7 million as a loss in the revaluation of contingent warrant liabilities line of our condensed consolidated statement of operations. As of March 31, 2012, 14,832,827 of these warrants were outstanding and had a fair value of $21.1 million. This increase in liability is primarily due to the excess of the market value of the Company's common stock at March 31, 2012 compared to the warrant exercise price.

In February 2010, in connection with an underwritten offering, we issued five-year warrants to purchase 1,260,000 shares of XOMA's common stock at an exercise price of $10.50 per share. These warrants contain provisions that are contingent on the remote occurrence of a change in control, which would conditionally obligate us to repurchase the warrants for cash in an amount equal to their fair value using the Black-Scholes Model the date of such change in control. We believe the likelihood of a change in control prior to the expiration of the warrants is remote; however, due to these provisions, we are required to account for the warrants issued in February 2010 as a liability at fair value. In addition, the estimated liability related to the warrants is required to be revalued at each reporting period until the earlier of the exercise of the warrants, at which time the liability will be reclassified to stockholders' equity, or expiration of the warrants. At December 31, 2011, the fair value of the warrant liability was estimated to be $0.3 million using the Black-Scholes Model. At March 31, 2012, we changed our expected volatility assumption in the Black-Scholes Model from an estimate of volatility based on historical stock price volatility observed on XOMA's underlying stock to a volatility estimate based on the volatility implied from warrants issued by XOMA in recent private placement transactions. We revalued the warrant liability at March 31, 2012 using the Black-Scholes Model and recorded a decrease in the fair value of $0.3 million as a gain in the revaluation of contingent warrant liabilities line of our condensed consolidated statement of operations. As of March 31, 2012, all of these warrants were outstanding.

. . .