10-Q 1 avigen_10q.htm QUARTERLY AND TRANSITION REPORT

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

________________

FORM 10-Q
________________

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

For the quarterly period ended June 30, 2006

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

	For the transition period from ___________ to ___________

Commission file number 0-28272

AVIGEN, INC.
(Exact name of registrant as specified in its charter)

Delaware	13-3647113
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)

1301 Harbor Bay Parkway

Alameda, California 94502

(Address of principal executive offices and zip code)

(510) 748-7150

(Registrant’s telephone number,

including area code)

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer. or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act).

Large accelerated filer o

Accelerated filer x

Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

The number of outstanding shares of the registrant’s Common Stock as of August 1, 2006, was 25,001,187 shares.

AVIGEN, INC.
FORM 10-Q
Quarter Ended June 30, 2006

INDEX

PART I. FINANCIAL INFORMATION

		PAGE

Item 1.	Financial Statements (unaudited)	3
	Condensed Balance Sheets at June 30, 2006 and December 31, 2005	3
	Condensed Statements of Operations -	4
	For the three and six months ended June 30, 2006 and 2005 and the period
	from October 22, 1992 (inception) through June 30, 2006
	Condensed Statements of Cash Flows -	5
	For the six months ended June 30, 2006 and 2005 and the period from
	October 22, 1992 (inception) through June 30, 2006
	Notes to Condensed Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of
	Operations	15
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	33
Item 4.	Controls and Procedures	33

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	34
Item 1A.	Risk Factors	34
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	34
Item 3.	Defaults Upon Senior Securities	34
Item 4.	Submission of Matters to a Vote of Security Holders	35
Item 5.	Other Information	35
Item 6.	Exhibits	36

SIGNATURES		37

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements

AVIGEN, INC.
(a development stage company)

CONDENSED BALANCE SHEETS
(in thousands, except share and per share information)

		June 30,		December 31,
		2006		2005
		(Unaudited)		Note 1

ASSETS
Current Assets:
Cash and cash equivalents	$	7,583	$	11,510
Available-for-sale securities		61,861		48,450
Restricted investments - current		8,000		-
Accrued interest		564		470
Prepaid expenses and other current assets		542		737
Total current assets		78,550		61,167
Restricted investments		2,428		10,428
Property and equipment, net		3,208		3,929
Deposits and other assets		576		740
Total assets	$	84,762	$	76,264

LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable and other accrued liabilities	$	1,783	$	984
Accrued compensation and related expenses		582		534
Loan payable - current		8,000		-
Total current liabilities		10,365		1,518
Long-term loan payable		-		8,000
Deferred rent and other liabilities		1,189		1,282

Stockholders' equity:
Preferred Stock, $0.001 par value, 5,000,000 shares
authorized, none issued and outstanding		-		-
Common Stock, $0.001 par value, 50,000,000 shares authorized,
24,974,386 and 20,907,273 shares issued and outstanding at
June 30, 2006 and December 31, 2005, respectively		25		21
Additional paid-in capital		257,864		237,258
Accumulated other comprehensive loss		(551)		(540)
Deficit accumulated during development stage		(184,130)		(171,275)
Total stockholders' equity		73,208		65,464
Total liabilities and stockholders' equity	$	84,762	$	76,264

See accompanying notes.

AVIGEN, INC.
(a development stage company)

CONDENSED STATEMENTS OF OPERATIONS
(in thousands, except for share and per share information)
(unaudited)

									Period
									from
									October
									22, 1992
	Three Months Ended				Six Months Ended				(inception)
	June 30,				June 30,				through
	2006		2005		2006		2005		June 30, 2006
Revenue	$	-	$	11	$	103	$	20	$	15,574

Operating expenses:
Research and development		3,551		3,665		6,552		7,306		147,832
General and administrative		1,971		2,013		4,786		3,892		65,240
Impairment loss related to long-lived assets		-		4,490		-		4,490		6,130
In-license fees		-		-		3,000		-		8,034
Total operating expenses		5,522		10,168		14,338		15,688		227,236
Loss from operations		(5,522)		(10,157)		(14,235)		(15,668)		(211,662)
Interest expense		(112)		(74)		(214)		(137)		(2,917)
Interest income		724		408		1,291		793		30,283
Sublease income		141		-		282		-		282
Other (expense) income, net		(64)		(25)		21		(26)		(116)

Net loss	$	(4,833)	$	(9,848)	$	(12,855)	$	(15,038)	$	(184,130)

Basic and diluted net loss per common share	$	(0.21)	$	(0.48)	$	(0.59)	$	(0.74)

Shares used in basic and diluted net loss per common share calculation	23,014,205		20,381,506		21,959,027		20,381,378

See accompanying notes.

AVIGEN, INC.
(a development stage company)

CONDENSED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

					Period from
					October 22,
					1992
	Six Months Ended				(inception)
	June 30,				through
	2006		2005		June 30, 2006
Operating Activities
Net cash used in operating activities	$	(10,395)	$	(8,544)	$	(149,099)

Investing Activities
Purchases of property and equipment		(56)		(26)		(28,511)
Proceeds from disposal of property and equipment		142		-		373
Increase (decrease) in restricted investments		-		1,000		(10,428)
Purchases of available-for-sale securities		(76,479)		(19,885)		(848,039)
Maturities of available-for-sale securities		63,057		25,759		785,628
Net cash (used in) provided by investing activities		(13,336)		6,848		(100,977)
Financing Activities
Proceeds from long-term obligations		-		-		10,133
Proceeds from warrants and options exercised		451		1		14,800
Proceeds from issuance of common stock, net of issuance costs and repurchases		19,353		-		224,972
Other financing activities		-		-		7,754
Net cash provided by financing activities		19,804		1		257,659
Net (decrease) increase in cash and cash equivalents		(3,927)		(1,695)		7,583
Cash and cash equivalents, beginning of period		11,510		3,217		-
Cash and cash equivalents, end of period	$	7,583	$	1,522	$	7,583

See accompanying notes.

AVIGEN, INC.
(a development stage company)

NOTES TO CONDENSED FINANCIAL STATEMENTS

1. Unaudited Interim Financial Statements

Our accompanying unaudited condensed financial statements of Avigen, Inc. have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments, consisting only of normal recurring adjustments and accruals, considered necessary for a fair presentation of the results for the interim periods presented have been included. Operating results reported for the three and six months ended June 30, 2006 are not necessarily indicative of the results that may be expected for any other interim period or for the entire year ending December 31, 2006. These unaudited interim financial statements should be read in conjunction with our audited financial statements and the notes thereto included in our Annual Report on Form 10-K for the period ended December 31, 2005, filed with the Securities and Exchange Commission on March 16, 2006.

The balance sheet at December 31, 2005 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements.

Use of Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires our management to make judgments, assumptions and estimates that affect the amounts reported in our financial statements and the accompanying notes. Actual results could differ materially from those estimates.

2. Share-Based Compensation

We adopted the provisions of FASB Statement No. 123(R), (“FAS 123(R)”), “Share-Based Payment,” effective January 1, 2006, using the modified prospective transition method, and thereby recognize the compensation cost for all share-based awards to employees in the financial statements based on their grant-date fair value. Share-based compensation expense is recognized over the period during which the employee is required to perform service in exchange for the award, which generally represents the scheduled vesting period. We have no awards with market or performance conditions. Estimated compensation expense for awards outstanding at January 1, 2006, but not yet vested as of the date we adopted FAS 123(R), will be recognized over the remaining service period using the compensation cost calculated based on the same estimate of grant-date fair value previously reported for pro forma disclosure purposes under FAS 123.

As of January 1, 2006, Avigen had three share-based compensation plans available for employee, nonemployee director, and consultant grants. The 1996 Equity Incentive Plan (“1996 Plan”) and the 1996 Non-Employee Directors’ Stock Option Plan (“Directors’ Plan”) were both approved by our stockholders and had a ten-year duration which terminated on March 29, 2006. As of June 30, 2006, we had an aggregate of 2,280,843 shares of our common stock reserved for issuance under these plans subject to outstanding awards and there was no longer any shares reserved under these plans for future grants. In general, the outstanding options under these plans were granted at fair market value on the date of grant with a term of 10 years. Grants under the 1996 Plan generally become exercisable on a quarterly basis over a vesting period of either three or four years. Grants under the Directors’ Plan become exercisable in three annual installments.

The third plan was the 2000 Equity Incentive Plan (“2000 Plan”), which was adopted by Avigen’s Board of Directors in June 2000 and amended and restated as the 2006 Incentive Stock Option Plan (“2006 Plan”) in February 2006. The 2006 Plan was approved by stockholders on May 31, 2006, and currently represents the only outstanding stock option plan with shares available for future grant. The adoption of the 2006 Plan did not increase the number of shares available for grant under the 2000 Plan, but enables Avigen to grant incentive stock options to its employees, which enhance the after tax value of these options to the recipients, use a greater array of stock awards than was previously available under the 2000 Plan, and removed the forty percent limitation on the number of shares that could be granted to directors and officers under the 2000 Plan. As of June 30, 2006, we had (1) an aggregate of 1,951,877 shares of our common stock reserved for issuance under the 2006 Plan that are subject to options outstanding prior to May 31, 2006, and are therefore subject to the terms of the 2000 Plan; and (2) an aggregate of 16,000 shares of our common stock reserved for issuance under the 2006 Plan subject to outstanding options granted since May 31, 2006, and are therefore subject to the terms of the 2006 Plan, and 2,941,730 shares available for future grants of share-based awards under the 2006 Plan.

In general, options have been granted under these plans at fair market value on the date of grant with a term of 10 years and become exercisable on a quarterly basis over a four-year vesting period.

The amount of compensation expense recognized under FAS 123(R) during the three and six months ended June 30, 2006 under all plans was comprised of the following (in thousands, except per share data):

	Three Months		Six Months
	Ended		Ended
	June 30, 2006		June 30, 2006
Research and development	$	(131)	$	(256)
General and administrative		(210)		(516)
Share-based compensation expense before taxes		(341)		(772)
Related income tax benefits		-		-
Share-based compensation expense	$	(341)	$	(772)
Net share-based compensation expenses per basic and diluted common share	$	(0.02)	$	(0.04)

Since we have cumulative operating losses as of June 30, 2006 for which a valuation allowance has been established, we recorded no income tax benefits for share-based compensation arrangements. Additionally, no incremental tax benefits were recognized from stock options exercised during the three- and six-month periods ended June 30, 2006, which would have resulted in a reclassification to reduce net cash provided by operating activities with an offsetting increase in net cash provided by financing activities. Prior to our adoption of FAS 123(R) as of January 1, 2006, share-based compensation expense was not recognized in our Statements of Operations. As of June 30, 2006, there was approximately $3.4 million of total unrecognized compensation expense related to non-vested, share-based compensation arrangements granted under the 1996 Plan, Directors’ Plan, and 2006 Plan.

The fair value of each option award is estimated on the date of grant using a Black-Scholes-Merton option pricing model (“Black-Scholes model”) that uses the assumptions noted in the following table. Expected volatilities are based on the historical volatility of our common stock. The expected term of options granted is based on analyses of historical employee termination rates and option exercises. The risk-free interest rates are based on the U.S. Treasury yield for a period consistent with the expected term of the option in effect at the time of the grant. Share-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards that is ultimately expected to vest during the period. The estimated forfeiture rates are based on analyses of historical data, taking into account patterns of involuntary termination and other factors. The following assumptions were used to determine share-based compensation expense for the three- and six-month periods ended June 30, 2006:

	Three months	Six months
	ended	ended
	June 30, 2006	June 30, 2006
Expected volatility	0.5725 - 0.6217	0.5725 - 0.6334
Risk free interest rate	4.99%	4.77%
Expected life of options in years	3.5 - 4.5	3.5 - 4.5
Expected dividend yield	0%	0%

A summary of the option activity under all of our plans during the six-month period ended June 30, 2006 is presented below:

				Weighted
		Weighted		average
		average		remaining	Aggregate
	Number of	exercise price		contractual	Intrinsic
	Shares	per share		term (in years)	Value
Outstanding at December 31, 2005	3,487,254	$	10.87
Granted	1,261,500	$	5.10
Exercised	(127,353)	$	3.54
Forfeited or expired	(372,681)	$	5.11
Outstanding at June 30, 2006	4,248,720	$	9.88	6.59	$	2,722,000
Exercisable at June 30, 2006	2,454,636		$ 13.87	4.78	$	1,222,000

The weighted average grant-date fair value of options granted during the six-month periods ended June 30, 2006 and 2005 were $2.48 per share and $1.71 per share. The total intrinsic value of options exercised during the six months ended June 30, 2006 and 2005, were approximately $276,134 and $161, respectively.

A summary of the status of our nonvested stock options as of June 30, 2006 and the changes during the six-month period then ended are presented below:

		Weighted
		average
		grant-date
	Number of	fair value
	Shares	per share
Nonvested at December 31, 2005	1,160,302	$ 3.77
Granted	1,261,500	$ 5.10
Vested or Cancelled	(627,718)	$ 4.53
Nonvested at June 30, 2006	1,794,084	$ 4.44

Pro Forma Information under FAS 123

Prior to the adoption of FAS 123(R), we accounted for stock option grants in accordance with Accounting Principals Board (“APB”) Opinion 25, “ Accounting for Stock Issued to Employees ” (APB 25) and related interpretations. Under APB 25, when the exercise price of employee stock options equals the market price of the underlying stock on the date of the grant, no compensation expense is recognized.

The following table illustrates the pro forma effect on our net loss and loss per common share if we had applied the fair value recognition provisions of FAS 123 to our stock-based employee compensation for the periods ended June 30, 2005 (in thousands, except for per share data):

	Three Months		Six Months
	Ended		Ended
	June 30, 2005		June 30, 2005
Net loss - as reported	$	(9,848)	$	(15,038)
Add: Stock-based employee compensation included in reported net loss		-		-
Less: Total stock-based employee compensation expense determined under
the fair-value-based method for all awards		(756)		(1,545)
Net loss - pro forma	$	(10,604)	$	(16,583)
Net loss per common share basic and diluted – as reported	$	(0.48)	$	(0.74)
Net loss per common share basic and diluted - pro forma	$	(0.52)	$	(0.81)

For purposes of disclosure pursuant to FAS 123, the estimated fair value of our employee stock options is amortized to expense on a straight-line basis over the vesting period of the options, generally over four years. The assumptions used to determine the pro forma expenses under the Black-Scholes option valuation model for the three and six months ended June 30, 2005 were based upon the following:

	Three months	Six months
	ended	ended
	June 30, 2005	June 30, 2005
Expected volatility	0.6771	0.6900
Risk free interest rate	3.87%	3.88%
Expected life of options in years	4.5	4.5
Expected dividend yield	0%	0%

For equity awards to non-employees, including lenders, lessors, and consultants, we also apply the Black-Scholes method to determine the fair value of such investments in accordance with FAS 123(R) and Emerging Issues Task Force Issue No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods, or Services.” The options and warrants granted to non-employees are re-measured as they vest and the resulting value is recognized as an expense against our net loss over the period during which the services are received or the term of the related financing.

3. Cash and cash Equivalents, Available-For-Sale Securities, and Restricted Investments

Cash and Cash Equivalents

We consider all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. These amounts are recorded at cost, which approximates fair market value.

Available- for-Sale Securities

We invest our excess cash balances in marketable securities, primarily corporate debt securities, federal agency obligations, asset-backed securities, U.S. treasuries, and municipal bonds, with the primary investment objectives of preservation of principal, a high degree of liquidity, and maximum total return. We have classified our investments in marketable securities as available-for-sale. Available-for-sale securities are reported at market value and unrealized holding gains and losses, net of the related tax effect, if any, are excluded from earnings and are reported in other comprehensive income and as a separate component of stockholders’ equity until realized. A decline in the market value of a security below its cost that is deemed to be other than temporary is charged to earnings, and would result in the establishment of a new cost basis for the security.

Our available-for-sale securities consist principally of obligations with a minimum short-term rating of A1/P1 and a minimum long-term rating of A- and with effective maturities of less than three years. The cost of securities sold is based on the specific identification method. Interest on securities classified as available for sale is included in interest income.

Restricted Investments

At June 30, 2006, $8.0 million and $2.4 million were classified as restricted investments in current and long term assets, respectively. At December 31, 2005, $10.4 million was classified as long term restricted investments. The sum of our long term and current restricted investments at the end of each period represents the combined aggregate portion of our portfolio of available-for-sale securities that were pledged in connection with certain liabilities at the end of each period. The change in classification of $8.0 million of long term restricted investments to current assets at June 30, 2006 represents the scheduled repayment of the outstanding borrowings of our loan payable in June 2007, which is less than one year from the date of these financial statements.

The following is a summary of cash, restricted investments, and available-for-sale securities as of June 30, 2006 (in thousands):

			Gross		Gross
			Unrealized		Unrealized		Fair
	Cost		Gains		Losses		Value
Cash	$	7,583	$	-	$	-	$	7,583
Corporate debt securities		26,300		-		(227)		26,073
Federal agency obligations		19,119		-		(206)		18,913
Asset-backed and other securities		26,521		-		(104)		26,417
Auction rate certificates		-		-		-		-
Treasury obligations		900		-		(14)		886
Total	$	80,423	$	-	$	(551)	$	79,872
Amounts reported as:
Cash and cash equivalents	$	7,583	$	-	$	-	$	7,583
Restricted Investments		10,428		-		-		10,428
Available for sale securities		62,412		-		(551)		61,861
Total	$	80,423	$	-	$	(551)	$	79,872

The weighted average maturity of our investment portfolio at June 30, 2006 was 318 days, with $54.9 million carrying an effective maturity of less than twelve months, and $25.0 million carrying an effective maturity between one and three years.

The following is a summary of cash, restricted investments, and available-for-sale securities as of December 31, 2005 (in thousands):

			Gross		Gross
			Unrealized		Unrealized		Fair
	Cost		Gains		Losses		Value
Cash	$	11,510	$	-	$	-	$	11,510
Corporate debt securities		21,415		-		(197)		21,218
Federal agency obligations		26,013		-		(306)		25,707
Asset-backed and other securities		9,882		5		(24)		9,863
Treasury obligations		2,108		-		(18)		2,090
Total	$	70,928	$	5	$	(545)	$	70,388
Amounts reported as:
Cash and cash equivalents	$	11,510	$	-	$	-	$	11,510
Restricted Investments		10,428		-		-		10,428
Available for sale securities		48,990		5		(545)		48,450
Total	$	70,928	$	5	$	(545)	$	70,388

The weighted average maturity of our investment portfolio at December 31, 2005 was 291 days, with $37.7 million carrying an effective maturity of less than twelve months, and $32.7 million carrying an effective maturity between one and three years.

Net realized losses were approximately $2,000 and $11,000 for the six months ended June 30, 2006 and 2005, respectively.

At June 30, 2006 and December 31, 2005, we had the following available-for-sale securities that were in an unrealized loss position but were not deemed to be other-than-temporarily impaired (in thousands):

June 30, 2006	Less Than 12 Months				12 Months or Greater
	Gross				Gross
	Unrealized		Fair		Unrealized		Fair
	Losses		Value		Losses		Value
Corporate debt securities	$	(121)	$	12,616	$	(107)	$	13,457
Federal agency obligations		(179)		13,833		(26)		5,081
Asset-backed and other securities		(64)		26,753		(40)		6,436
Treasury obligations		(14)		886		-		-
Total	$	(378)	$	54,088	$	(173)	$	24,974


December 31, 2005	Less Than 12 Months				12 Months or Greater
	Gross		Estimated		Gross		Estimated
	Unrealized		Fair		Unrealized		Fair
	Losses		Value		Losses		Value
Corporate debt securities	$	(108)	$	11,246	$	(88)	$	8,883
Federal agency obligations		(101)		12,789		(205)		12,918
Asset-backed and other securities		(4)		996		(20)		5,385
Treasury obligations		(8)		1,201		(11)		889
Total	$	(221)	$	26,232	$	(324)	$	28,075

The gross unrealized losses reported above for periods ended June 30, 2006 and December 31, 2005 were caused by rises in market interest rates during those periods. No significant facts or circumstances have occurred to indicate that these unrealized losses are related to any deterioration in the creditworthiness of the issuers of the marketable securities we own. Based on our review of these securities, including our assessment of the duration and severity of the related unrealized losses, we have not recorded any other-than-temporary impairments on these investments.

4. Impairment Loss related to Long-Lived Assets

At June 30, 2005, in connection with the preparation of our financial statements, we evaluated the ongoing value of the leasehold improvements and equipment associated with approximately 40,000 square feet of manufacturing, laboratory, and office space we have under lease through July 2008. We determined to initiate this evaluation as a result of actions we had taken to discontinue funding of our AAV-based programs in order to focus our development efforts and financial resources on our small molecule product candidates.

Based on these evaluations, we determined that our future operations would not require the full capacity of these leased facilities and that long-lived assets with a net carrying value of $4.5 million were no longer recoverable and were in fact impaired. At June 30, 2005, we recorded an impairment loss related to long-lived assets in the facility and wrote down the related carrying value of the leasehold improvements, laboratory and office equipment and furniture to approximate their estimated fair value.

Fair value was based on the expected incremental sublease cash flows we estimated we could receive in excess of our prorated existing operating lease obligations based on current market lease rental rates at the time for similar mixed use properties. Based on market conditions at June 30, 2005, including vacancy rates and the expected time needed to sublease the facilities, we did not expect to receive significant incremental rents related to the long-lived assets. The impairment charges primarily represent accelerated depreciation expense, which is a non-cash expense that was scheduled to be recognized over the next five years.

5. License Agreement – Sanochemia Pharmazeutika AG

In January 2006, we entered into a license agreement with SDI Diagnostics International LTD, a division of Sanochemia Pharmazeutika AG (Sanochemia). Under the terms of the agreement, Avigen received an exclusive license to develop and commercialize the compound tolperisone in North America. This compound is the active pharmaceutical ingredient in our product candidate, AV650, for the treatment of spasticity and neuromuscular spasm. Under the terms of the agreement, Avigen paid Sanochemia $3.0 million in initial license costs and is required to make additional future payments in the event of achievement of successful clinical and regulatory product development milestones and to make royalty payments on sales. Avigen and Sanochemia have also entered into a long-term supply agreement under which Sanochemia will manufacture, and Avigen will purchase for additional cost, the AV650 product for Avigen’s clinical and commercial supply. The $3.0 million initial payment was nonrefundable, does not include any significant future performance requirements by Sanochemia, and the licensed compound does not have an alternative future use to Avigen beyond the AV650 product. As such, we recognized the entire initial payment as expense during the period ended March 31, 2006 and expect that any future payments we make under the terms of the agreement will also be recorded as expense.

6. Severance Expense

In January 2006, our Chief Financial Officer resigned from Avigen. In connection with his resignation, Avigen agreed to pay severance benefits including base salary for a period of one year and continued health benefits for up to twelve months. In addition, Avigen agreed to modify outstanding stock options held by the executive to allow for six months of additional vesting and an extended period to exercise all vested stock options for up to two years. As a result of this separation and the related modification of outstanding stock options held by the executive, we recognized a severance expense of approximately $288,000 and a non-cash, share-based compensation charge of approximately $108,000 for the period ending March 31, 2006.

7. Comprehensive Loss

Components of other comprehensive loss, including unrealized gains and losses on available-for-sale investments, were included as part of total comprehensive loss.

	Three Months Ended		Six Months Ended
(Amounts in thousands)	June 30,		June 30,
	2006	2005	2006	2005
Net loss	$ (4,833)	$ (9,848)	$(12,855)	$(15,038)
Net unrealized (loss) gain on available-for-sale securities	(17)	200	(11)	(12)
Comprehensive loss	$ (4,850)	$ (9,648)	$(12,866)	$(15,050)

8. Basic and Diluted Net Loss Per Common Share

Basic net loss per common share is computed by dividing net loss by the weighted-average number of common shares outstanding during the period. The computation of basic net loss per share for all periods presented is derived from the information on the face of the statement of operations, and there are no reconciling items in either the numerator or denominator.

Diluted net loss per common share is computed as though all potential common shares that are dilutive were outstanding during the year, using the treasury stock method for the purposes of calculating the weighted-average number of dilutive common shares outstanding during the period. Potential dilutive common shares consist of shares issuable upon exercise of stock options and warrants. Securities that potentially could have diluted basic earnings per common share, but were excluded from the diluted net loss per common share computation because their inclusion would have been anti-dilutive, were as follows:

	Three Months Ended		Six Months Ended
	June 30,		June 30,
	2006	2005	2006	2005
Potential dilutive stock options outstanding	367,926	474,330	249,497	462,989
Outstanding securities excluded from the potential
dilutive common shares calculation (1)	2,669,864	3,826,199	2,607,571	3,851,767

(1)

For purposes of computing the potential dilutive common shares, we have excluded outstanding stock options and warrants to purchase common stock whose exercise prices exceed the average of the closing sale prices of our common stock as reported on the Nasdaq Global Market for the period.

9. Stockholder’s Equity

On May 12, 2006, we completed a private placement to selected institutional investors. In connection with the transaction, we sold 3,939,760 shares of our common stock at $5.37 per share for total cash proceeds of $19.4 million, net of issuance costs.

During the six-month period ended June 30, 2006, we received $451,000 in cash proceeds related to the exercise of stock options for 127,353 shares of common stock.

As of June 30, 2006, we had one warrant outstanding for 15,000 shares of our common stock with an exercise price equal to $6.50. The warrant was issued in March 2004 as partial consideration for the acquisition of certain intellectual property rights used in our research and development activities and has a ten-year term.

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

The following discussion may be understood more fully by reference to the financial statements, notes to the financial statements, and management’s discussion and analysis of financial conditions and results of operations contained in our Annual Report on Form 10-K for the year ended December 31, 2005, filed with the Securities and Exchange Commission on March 16, 2006.

This Quarterly Report on Form 10-Q contains forward-looking statements, which include, but are not limited to, statements of our expectations regarding our future financial results, and statements about future events and results regarding our drug development programs, clinical trials, sources of revenue, receipt of regulatory approvals, our expectations related to savings in personnel costs and facilities overhead attributable to our workforce reduction and subleasing of portions of our operating facilities, our expectations regarding future levels of research and development expenses and general and administrative expenses, our expectations related to our need to obtain additional funding to support the anticipated future needs of our research and development activities, and our estimates of the fair value of our securities portfolio at assumed market interest rates. In some cases, you can identify forward-looking statements by such terms as “may,” “might,” “can,” “will,” “should,” “could,” “would,” “expect,” “plan,” “seek,” “anticipate,” “believe,” “estimate,” “project,” “intend,” “predict,” “potential,” “if” and similar expressions which imply that the statements relate to future events and are based on assumptions and subject to risks and uncertainties. Given these uncertainties, you should not place undue reliance on these forward-looking statements. We discuss the risks we believe are most important in greater detail under the heading “Risk Relating to our Business” below and elsewhere in this report. Also, these forward-looking statements represent our estimates and assumptions only as of the date of this Form 10-Q. Avigen undertakes no obligation to update any of the forward- looking statements contained in this report to reflect any future events or developments.

Overview

Avigen is a biopharmaceutical company focused on developing and commercializing small molecule therapeutics and biologics to treat serious neurological and neuromuscular disorders. Our current lead product candidates primarily address spasticity and neuromuscular spasm and neuropathic pain. Avigen’s goal is to retain rights to commercialize our products in North America and therefore we expect, when appropriate, to build a sales and marketing infrastructure. We will seek to out-license rights to develop and market our products outside the United States. We will also continue to look for opportunities to expand our pipeline of compounds through a combination of internal research, acquisitions, and in-licensing as appropriate.

In building our pipeline, we focus on selecting compounds we believe have the potential to strongly differentiate themselves from existing therapies and address needs currently unmet by, or with an improved risk-benefit profile when compared to, alternative available treatments. In particular, we believe our drug candidates have unique mechanisms of action in the indications being pursued and have the potential to minimize side-effects, such as sedation, that can interfere markedly with resumption of normal activity. Moreover, our two leading programs, AV650 and AV411, are commercially approved pharmaceuticals outside the United States. We believe this significant human experience in markets outside the U.S. will help accelerate our clinical development and approval for these products in North America.

In January 2006, we acquired exclusive license rights to develop and commercialize proprietary formulations of the compound tolperisone (AV650) for the North American market. These rights include relevant patent filings, as well as clinical data held by SDI Diagnostics International LTD, a division of Sanochemia Pharmazeutika AG (Sanochemia) relating to AV650. Sanochemia has also agreed to supply AV650 to us exclusively for the North American market. Under the terms of the agreement, we made an upfront payment of $3.0 million and will make additional payments to Sanochemia based on the parties’ achievement of clinical and regulatory product development milestones and sales of AV650.

In May 2006, we completed a private placement of common stock with institutional investors of approximately $21.2 million. Under the terms of the transaction Avigen sold approximately 3.9 million shares of common stock at a purchase price of $5.37 per share. The transaction did not include any warrants or other enhancements.

In June 2006, we announced that we had received approval to initiate a Phase IIa exploratory therapeutic clinical trial with AV411 (ibudilast) at the Royal Adelaide Hospital in Adelaide, Australia to assess safety, tolerability and preliminary indication of efficacy in neuropathic pain patients. The Phase IIa trial is a placebo-controlled, double-blinded study primarily in patients suffering from diabetic neuropathy. We intend to use our experience in this dose-escalating trial to improve the design of a larger U.S. clinical trial.

In June 2006, we also announced that we had received approval from the U.S. Food and Drug Administration to commence an initial clinical trial of AV650. AV650 is a New Chemical Entity (NCE) in the U.S. The initial clinical trial will be a Phase I study to assess the safety and pharmacokinetic profile, as well as AV650's lack of sedation in normal volunteers.

Prior to 2003, Avigen focused exclusively on building a product development portfolio of DNA-based drug delivery technologies based primarily on adeno-associated virus (AAV) vectors we developed. Our efforts included significant investment in early stage research in the field of gene therapy, which led to our filing of three separate INDs and our initiation of three corresponding phase I or phase I/II clinical trials. In 2003, we began to pursue the development of non-gene therapy products to diversify our portfolio, which is now our focus. In December 2005, we entered into an agreement with Genzyme Corporation, whereby we assigned to Genzyme our rights to certain AAV-related intellectual property, our gene therapy clinical trial programs for Parkinson’s disease and hemophilia, AAV-related contracts, and the use of previously manufactured clinical-grade vector materials. Under the terms of the agreement, we received a $12.0 million initial payment and could receive significant additional development milestones, sublicensing fees and royalty payments based on the successful development of products by Genzyme utilizing technologies previously developed by us. In addition, if Genzyme fails to diligently pursue the commercialization or marketing of products using the assigned technology, as specified in the agreement, certain of the rights we assigned could revert back to Avigen at a future date.

We are a development stage company and have primarily supported the financial needs of our research and development activities since our inception through public offerings and private placements of our equity securities. We have not received any revenue from the sale of our products in development, and we do not anticipate generating revenue from the sale of products in the foreseeable future. As a result, we expect that we will need to obtain additional funding to support the anticipated future needs of our research and development activities, including the costs to complete clinical trials. We expect our source of revenue, if any, for the next several years to consist of payments under the Genzyme agreement, collaborative arrangements with third parties, government grants, and non-gene therapy-related license fees. We have incurred losses since our inception and expect to incur substantial losses over the next several years due to lack of any substantial revenue and the continuation of our ongoing and planned research and development efforts, including preclinical studies and clinical trials. There can be no assurance that we will successfully develop, commercialize, manufacture, or market our product candidates or ever achieve or sustain product revenue for profitability. At June 30, 2006 we had an accumulated deficit of $184.1 million and cash, cash equivalents, available-for-sale securities, and restricted investments of approximately $79.9 million. We believe that our capital resources at June 30, 2006, will be adequate to fund our operating needs for approximately the next two to three years.

Critical Accounting Policies and Significant Judgments and Estimates

Our financial statements have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported revenues and expenses during the reporting periods. On an ongoing basis, we evaluate our estimates and judgments related to revenue recognition, valuation of investments in financial instruments, impairment of property and equipment, and recognition of research and development expenses. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We believe the following accounting policies are critical to the process of making significant judgments and estimates in the preparation of our financial statements. These policies are consistent with those presented in our Annual Report on Form 10-K for the period ended December 31, 2005.

Revenue recognition

We recognize revenue when the four basic criteria for revenue recognition as described in SEC Staff Accounting Bulletin No. 104, “Revenue Recognition,” are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the fee is fixed or determinable; and (4) collectibility is reasonably assured.

We recognize non-refundable license or assignment fees, including development milestone payments associated with license or assignment agreements, for which we have no further significant performance obligations and no continuing involvement requirements related to product development, on the earlier of the dates on when the payments are received or when collection is assured. For example, in connection with the $12.0 million payment received under the terms of the Genzyme agreement, we concluded that as of December 31, 2005, we did not have any significant performance obligations under the agreement that would defer the completion of the earnings process, and so recognized the entire $12.0 million payment received as revenue at that time.

We recognize revenue associated with up-front license, technology access and research and development funding payments under collaborative agreements ratably over the relevant periods specified in the agreements, generally the development phase. This development phase can be defined as a specified period of time, however, in certain cases, the collaborative agreement specifies a development phase that culminates with milestone objectives but does not have a fixed date and requires us to estimate the time period over which to recognize this revenue. Our estimated time periods are based on management's estimate of the time required to achieve a particular development milestone considering the projected level of effort and current stage of development. If our estimate of the development-phase time period changes, the amount of revenue we recognize related to up-front payments for a given period will accelerate or decrease accordingly.

Valuation of investments in financial instruments

We carry investments in financial instruments at fair value with unrealized gains and losses included in accumulated other comprehensive income or loss in stockholders’ equity. Our investment portfolio does not include equity securities or derivative financial instruments that could subject us to material market risk; however, we do invest in corporate obligations that subject us to varying levels of credit risk. Management assesses whether declines in the fair value of investment securities are other-than-temporary. If a decline in fair value of a financial instrument is judged to be other-than-temporary, the cost basis of the individual security is written down to fair value and the amount of the write down is included in earnings. In determining whether a decline is other-than-temporary, management considers:

the length of time the market value of the security has been less than cost;
the financial condition and near-term prospects of the issuer; and
our intent and ability to retain an investment in the issuer for a period of time sufficient to allow for any anticipated recovery in market value, which could be until maturity.

The determination of whether a decline in fair value is other-than-temporary requires significant judgment, and could have a material impact on our balance sheet and results of operations. We have not had any write-downs for other-than-temporary declines in the fair value of our financial instruments since our inception.

In addition, when management commits to holding individual securities until maturity in order to avoid the recognition of an other-than-temporary impairment, those securities would no longer be classified as available-for-sale. In addition, such securities would be further evaluated to determine whether the security, based on the remaining duration until its scheduled maturity, should be identified as a current or long-term asset. As of June 30, 2006, management had not designated any individual securities as held-to-maturity for the purposes of avoiding an other-than-temporary impairment.

Impairment of property and equipment

We have invested significant amounts on construction for improvements to leased facilities we use for our research and development activities, with the largest portion of our spending made to modify manufacturing facilities that are intended to comply with requirements of government mandated manufacturing rules for pharmaceutical production. Management assesses whether the carrying value of long-lived assets is impaired whenever events or changes in circumstances indicate that the asset may not be fully recoverable. An impairment loss is recognized when the total of the estimated future cash flows expected to result from the use of the asset and its eventual disposition are less than its carrying value or appraised value, as appropriate. If the value of our long-lived assets is judged to be impaired, the cost basis of the property and equipment is written down to fair value and the amount of the write down is included in our net loss. In determining whether the value of our property and equipment is impaired, management considers:

failure of manufacturing facilities and equipment to comply with government mandated policies and procedures;
failure of the product candidates for which the manufacturing facilities have been constructed to receive regulatory approval; and
the extent that facilities could be idled or abandoned due to a decrease in the scope of our research and development activities for an other-than-temporary period, resulting in excess capacity.

The determination of whether the value of our property and equipment is impaired requires significant judgment, and could have a material impact on our balance sheet and results of operations. In 2005, we determined that the scope of our research and development activities had changed such that we would not effectively utilize certain portions of our leased facilities that had been designed to support our gene therapy programs. After considering alternative uses for these spaces, we decided it was not cost effective to re-engineer the rooms representing approximately 40,000 square feet of manufacturing, laboratory, and office space under lease through May 2008 and approximately 11,000 square feet of similar space we have under lease through November 2010. We determined we would maximize our potential cost savings by subleasing the properties. Based on current market conditions for rental property at the time of the reduction in the scope of our research and development activities, and our subsequent completion of sublease agreements for approximately 26,000 square feet, we did not expect to fully recover the value invested in leasehold improvements and equipment, and reduced our net carrying value for these assets to their then current fair value, resulting in an impairment loss for the year ended December 31, 2005 of approximately $6.1 million. This amount does not impact our cash flows and primarily represents an acceleration of depreciation charges that would have been recognized over the remaining three and five year lease periods.

Research and development expenses

Research and development expenses consist of expenses incurred in performing research and development activities including related salaries and benefits, facilities and other overhead costs, clinical trial and related drug product costs, contract services and other outside service expenses. Research and development expenses are charged to operating expense in the period incurred and consist of costs incurred for our independent, as well as our collaborative, research and development activities.

Pursuant to management’s assessment of the services that have been performed on clinical trials and other contracts, we recognize expenses as the services are provided. Several of our contracts extend across multiple reporting periods. Management assessments include, but are not limited to an evaluation by the project manager of the work that has been completed during the period, measurement of progress prepared internally, estimates of incurred costs by the third-party service providers, and management’s judgment. The determination of the percentage of work completed that determines the amount of research and development expense that should be recognized in a given period requires significant judgment, and could have a material impact on our balance sheet and results of operations. These estimated expenses may or may not match the actual fees billed by the service providers as determined by actual work completed. We monitor service provider activities to the extent possible; however, if we underestimate activity levels associated with various studies at a given point in time, we could record significant research and development expenses in future reporting periods.

Share-based compensation expense

Effective January 1, 2006, we adopted FAS 123(R) using the modified prospective transition method and therefore have not restated prior periods’ results. Under the fair value recognition provisions of FAS 123(R), we recognize share-based compensation expense net of estimated forfeitures, and therefore only recognize compensation expense for the portion of share-based payment awards that are expected to vest over the service period. Prior to our adoption of FAS 123(R), we accounted for share-based payments in accordance with APB 25, and accordingly, generally recognized compensation expense related to share-based payments with intrinsic value and accounted for forfeitures as they occurred.

We calculate the fair value of share-based compensation expense using a Black-Scholes options pricing model which requires the input of highly subjective assumptions, including the expected term of the share-based awards, stock price volatility, and pre-vesting option forfeitures. We estimate the expected life of options granted based on historic behavior of our option holders and we estimate the volatility of our common stock at the date of grant based on the historical volatility of our common stock. The assumptions used in calculating the fair value of our share-based awards represent our best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, our share-based compensation expense could be materially different in future periods. In addition, FAS 123(R) requires we estimate forfeitures at the time of grant and only recognize expense for the portion of awards that are expected to vest. Our estimate of the forfeiture rate is based on historical experience of our share-based awards that are granted, exercised and cancelled. If our actual forfeiture rate is materially different from our estimate, the share-based compensation expense in future periods could be significantly different from what we have recorded in the current period.

If factors change and we employ different assumptions in the application of FAS 123(R) in future periods, the compensation expense that we record under SFAS 123(R) may differ significantly from what we have recorded in the current period. Therefore, we believe it is important for investors to be aware of the high degree of subjectivity involved when using option pricing models to estimate share-based compensation under FAS 123(R). Option-pricing models were developed for use in estimating the value of traded options, which are listed on organized exchange markets, that have no vesting or hedging restrictions, are fully transferable and do not cause dilution. Because our share-based payments have characteristics significantly different from those of freely traded, listed options, and because changes in the subjective input assumptions can materially affect our estimates of fair values, in our opinion, existing valuation models, including the Black-Scholes, may not provide reliable measures of the fair values of our share-based compensation. Consequently, there is a risk that our estimates of the fair values of our share-based compensation awards on the grant dates may bear little resemblance to the actual values realized upon the exercise, expiration, early termination or forfeiture of those share-based payments in the future. Employee stock options, may expire worthless or otherwise result in zero intrinsic value as compared to the fair values originally estimated on the grant date and reported in our financial statements. Alternatively, value may be realized from these instruments that are significantly in excess of the fair values originally estimated on the grant date and reported in our financial statements. Estimates of share-based compensation expenses are significant to our financial statements, but do not impact our statements of cash flows.

The guidance in FAS 123(R) is relatively new, and best practices are not well established. The application of these principles may be subject to further interpretation and refinement over time. There are significant differences among option valuation models, and this may result in a lack of comparability of our recognition of share-based compensation expenses versus other companies that use different models, methods and assumptions.

Results of Operations

Revenue

	Three Months Ended		Six Months Ended
(In thousands, except percentages)	June 30,		June 30,
	2006	2005	2006	2005
Revenue	$ -	$ 11	$ 103	$ 20
Percentage (decrease) increase over prior period	(100%)		415%

No revenues were reported for the three-month period ended June 30, 2006 compared to $11,000 for the three-month period ended June 30, 2005. 2005 revenues represented license fees associated with intellectual property we have subsequently assigned to Genzyme Corporation.

Revenues for the six-month periods ended June 30, 2006 and 2005 were $103,000 and $20,000, respectively. 2006 revenues represented income from our participation with the University of Colorado on a grant that was funded by the National Institutes of Health.

Research and Development Expenses

As a result of organizational changes made in 2005, our current operations allow us to better use external resources to optimize the pace and cost of development of our product candidates. These changes included a reduction of our headcount and the sublease of a portion of our operating facilities in the second half of 2005. As a result, our current business model reduces our exposure to fixed costs for manufacturing staff and facilities and gives us more control over the strategic timing and application of our resources.

Our research and development expenses can be divided into two primary functions, costs to support research and preclinical development and costs to support preparation for and implementation of human clinical trials. Research and preclinical development costs include activities associated with general research and exploration, animal studies, production of drug substances for use by external collaborators in general research and exploration, development of processes to translate research achievements into commercial scale capabilities, and in-house and independent third-party validation testing of potential acquisition or in-license drug candidates. Clinical development costs include activities associated with preparing for regulatory approvals, maintaining regulated and controlled processes, manufacturing drug substances for use in human clinical trials, and supporting subject enrollment and subject administration within clinical trials.

The costs associated with the two primary functions of our research and development activities approximate the following (in thousands, except percentages):

		Three Months Ended			Percentage		Six Months Ended			Percentage
					increase					increase
					(decrease)					(decrease)
	June 30,				over	June 30,				over
	2006		2005		prior year	2006		2005		prior year
Research and preclinical development	$	2,673	$	2,446	9%	$	4,982	$	4,787	4%
Clinical development		878		1,219	(28%)		1,570		2,519	(38%)
Total research and development expenses	$	3,551	$	3,665	(3%)	$	6,552	$	7,306	(10%)

Because a significant percentage of our research and development resources are dedicated to activities that focus on broad methods and mechanisms that may be used in multiple product applications, including production and administration techniques, the majority of our costs are not directly attributed to individual development programs. Decisions regarding our project management and resource allocation are primarily based on interpretations of scientific data, rather than cost allocations. Our estimates of costs between research and preclinical development and clinical development are primarily based on staffing roles within our research and development departments. As such, costs allocated to specific projects may not necessarily reflect the actual costs of those efforts and, therefore, we do not generally evaluate actual costs-incurred information on a project-by-project basis. In addition, we are unable to estimate the future costs to completion for any specific projects.

Research and preclinical development

	Three Months Ended		Percentage	Six Months Ended		Percentage
			increase			increase
			(decrease)			(decrease)
(In thousands, except percentages)	June 30,		over	June 30,		over
	2006	2005	prior year	2006	2005	prior year
Personnel-related	$ 469	$ 907	(48%)	$ 949	$ 1,864	(49%)
Share-based compensation	78	-	na	142	-	na
External research and development	1,046	242	333%	1,690	376	349%
Depreciation	271	473	(43%)	546	947	(42%)
Other expenses including facilities overhead	809	824	(2%)	1,655	1,600	3%
Total research and preclinical development expenses	$ 2,673	$ 2,446	9%	$ 4,982	$ 4,787	4%

The increase in our research and preclinical development expenses for the three- and six-month periods ended June 30, 2006, compared to the same periods in 2005, of $227,000 and $195,000, respectively, were primarily due to changes in costs for the following:

higher expenditures for external research and development services from third-party service providers of $804,000 and $1.3 million, respectively, primarily related to an increase in external preclinical animal studies and scientific consulting work to support the progress of our lead drug candidates, AV411 and AV650, and
the recognition of approximately $78,000 and $142,000, respectively, in non-cash expense for stock-based compensation in compliance with FAS 123(R) adopted January 1, 2006,

partially offset by,

lower personnel-related expenses of $438,000 and $915,000, respectively, reflecting a significantly lower average staff level as a result of a staff reduction in August 2005, partially offset by higher average salaries in 2006, and
lower depreciation charges of $202,000 and $401,000, respectively, primarily as a result of the impairment charges for leasehold improvements and equipment that were recognized in 2005.

Clinical development

	Three Months Ended				Percentage	Six Months Ended				Percentage
					increase					increase
					(decrease)					(decrease)
(In thousands, except percentages)	June 30,				over	June 30,				over
	2006		2005		prior year	2006		2005		prior year
Personnel-related	$	319	$	375	(15%)	$	700	$	824	(15%)
Share-based compensation		54		-	na		114		-	na
External clinical development		194		111	74%		297		219	36%
Depreciation		-		336	(100%)		-		672	(100%)
Other expenses including facilities overhead		311		397	(22%)		459		804	(43%)
Total clinical development expenses	$	878	$	1,219	(28%)	$	1,570	$	2,519	(38%)

The decrease in our total clinical development expenses for the three- and six-month periods ended June 30, 2006, compared to the same periods in 2005, of $341,000 and $949,000, respectively, were primarily due to changes in costs for the following:

lower personnel-related expenses of $56,000 and $124,000, respectively, reflecting a lower average staff level as a result of a staff reduction in August 2005, partially offset by higher average salaries in 2006,
no depreciation charges in 2006, compared to depreciation charges of $336,000 and $672,000, respectively, in the 2005 periods, primarily as a result of the impairment charges for leasehold improvements and equipment that were associated with our manufacturing facilities, that were recognized in 2005 and subsequently subleased, and
lower other expenses of $86,000 and $345,000, respectively, including facilities overhead, primarily reflecting a decrease in the amount of square footage of the facilities used to support our clinical development and manufacturing activities which have primarily been subleased,

partially offset by,

higher expenditures for external clinical development services from third-party suppliers of $83,000 and $78,000, respectively, associated with the preparation for our scheduled small molecule clinical trials in 2006 compared to the level of services incurred in connection with our gene therapy trials in 2005, and
the recognition of approximately $54,000 and $114,000, respectively, in non-cash expense for stock option compensation in compliance with FAS 123(R) adopted January 1, 2006.

Total research and development expenses for the three and six months ended June 30, 2006 were within management’s expectations. If we are successful in our efforts to develop our product candidates, including the costs of supporting multiple clinical trials in the second half of 2006, our total research and development spending in 2006 will likely rise.

General and Administrative Expenses

	Three Months Ended				Percentage	Six Months Ended				Percentage
					increase					increase
					(decrease)					(decrease)
(In thousands, except percentages)	June 30,				over	June 30,				over
	2006		2005		prior year	2006		2005		prior year
Personnel-related	$	732	$	876	(16%)	$	1,675	$	1,698	(1%)
Share-based compensation		210		-	na		516		-	na
Severance		-		-	-		288		-	100%
Legal and professional fees		228		387	(41%)		586		743	(21%)
Facilities, depreciation and other allocated expenses		801		750	7%		1,721		1,451	18%
Total general and administrative expenses	$	1,971	$	2,013	(2%)	$	4,786	$	3,892	23%

The decrease in our total general and administrative expenses for the three months period ended June 30, 2006, compared to the same period in 2005, of $42,000, was primarily due to changes in costs for the following:

lower personnel-related expenses of $144,000, reflecting a lower average staff level, partially offset by higher average salaries in 2006, and
lower legal and professional fees of $159,000, primarily associated with patent filings and business contracts,

partially offset by,

the recognition of approximately $210,000 in non-cash expense for stock option compensation in compliance with FAS 123(R) adopted January 1, 2006.

The $894,000 increase in our total general and administrative expenses for the six months ended June 30, 2006, compared to the same period in 2005 was primarily due to changes in costs for the following:

the recognition of approximately $408,000 in non-cash expense for stock option compensation in compliance with FAS 123(R) adopted January 1, 2006, and $108,000 in non-cash expense in connection with the severance-related modification of previously issued stock options,
the recognition of approximately $288,000, in severance expenses in connection with the resignation of our former CFO, and
higher facilities, depreciation and other allocated expenses of $270,000, primarily representing recruiting and other administrative costs,

partially offset by,

lower legal and professional fees of $157,000, primarily associated with patent filings and business contracts.

We expect our current level of general and administrative expenses to continue over the next few quarters. However, if we are successful in our efforts to develop our product candidates, we expect general and administrative spending levels may increase to connection with the changing needs of the company.

Impairment Loss Related to Long-Lived Assets

	Three Months Ended		Six Months Ended
(In thousands except percentages)	June 30,		June 30,
	2006	2005	2006	2005
Impairment loss related to long-lived assets	$ -	$ 4,490	$ -	$ 4,490

In connection with the organizational and structual changes initiated last year, as of June 30, 2005, we determined that our future operations would not require the full capacity of our leased facilities, and we began to pursue potential cost savings through a sublease. However, based on the current market conditions at the time, we did not expect sublease rates to allow us to recover fully the costs of our investment in leasehold improvements to the building. As a result, we recorded an impairment charge of $4.5 million during the quarter ended June 30, 2005 to reduce the carrying value of certain leasehold improvements and equipment to zero. This amount did not impact our cash flows and represented an acceleration of depreciation charges that would have been recognized over the remainder of the assets’ lives. We did not recognize any impairments to our long-lived assets in 2006.

In-license Fees

	Three Months Ended		Six Months Ended
(In thousands except percentages)	June 30,		June 30,
	2006	2005	2006	2005
In-license fees	$ -	$ -	$ 3,000	$ -

In January 2006, we entered into a license agreement and paid Sanochemia an initial fee of $3.0 million as consideration for an exclusive license to develop and commercialize proprietary formulations of the neuroactive compound in AV650 in North America. We did not enter into any in-license agreements in 2005.

Interest Income

	Three Months Ended		Six Months Ended
(In thousands except percentages)	June 30,		June 30,
	2006	2005	2006	2005
Interest income	$ 724	$ 408	$ 1,291	$ 793
Percentage change over prior period	77%		63%

Almost all of our interest income is generated from our investments in high-grade marketable securities of government and corporate debt. The increase in interest income for the three- and six-month periods ended June 30, 2006, as compared to the same periods in 2005 was due to increase in the average outstanding balance of our total portfolio, reflecting the $12 million received from Genzyme Corporation in December 2005 and the $21.2 million proceeds from the private placement completed in May 2006, as well as the rising average yield earned on our portfolio.

Sublease Income

	Three Months Ended		Six Months Ended
(In thousands except percentages)	June 30,		June 30,
	2006	2005	2006	2005
Sublease income	$ 141	$ -	$ 282	$ -

As of December 2005, approximately 26,250 square feet of our aggregate facilities in two buildings was subleased to two separate corporate tenants not affiliated with Avigen. Remaining contractual, sublease income of $1.7 million will be recognized ratably over the remaining terms of the leases, which expire in May 2008 and November 2010.

Liquidity and Capital Resources

Since our inception in 1992, cash expenditures have significantly exceeded our revenue. We have funded our operations primarily through public offerings and private placements of our equity securities. Between May 1996, the date of our initial public offering, and December 2005, we raised $189 million from private placements and public offerings of our common stock and warrants to purchase our common stock.

In May 2006, we completed a private placement of common stock with institutional investors, raising approximately $19.4 million in net proceeds. The transaction represented the sale of approximately 3.9 million shares of common stock at a purchase price of $5.37 per share. There were no warrants or other enhancements included in the transaction.

In addition to funding our operations through sales of our common stock, in March 2003, we received $2.5 million in research support from Bayer Corporation in connection with our collaboration on a gene therapy product for hemophilia, and in December 2005, we received a $12.0 million payment from Genzyme Corporation in connection with the agreement transferring to Genzyme rights to most of our AAV-based intellectual property, our gene therapy clinical trial programs for Parkinson’s disease and hemophilia, and clinical grade vector materials. We have attempted to contain costs and reduce cash flow by renting facilities, subleasing facilities no longer critical to our future operations, contracting with third parties to conduct research and development and using consultants, where appropriate. We expect to incur additional future expenses, resulting in significant additional cash expenditures, as we continue our research and development activities, including our efforts to develop, manufacture, and commercialize our current drug candidates, expand our product portfolio with additional development candidates through internal research, acquisition or in-licensing, and undertake additional preclinical studies and clinical trials of our product candidates. We also expect to incur substantial additional expenses relating to the filing, prosecution, maintenance, defense and enforcement of patent and other intellectual property claims.

At June 30, 2006, we had cash, cash equivalents, available-for-sale securities, and restricted investments, of approximately $79.9 million, compared to approximately $70.4 million at December 31, 2005. At June 30, 2006 and December 31, 2005, $10.4 million of restricted assets were pledged to secure certain current and long-term liabilities. At June 30, 2006 and December 31, 2005, the portion of our investment portfolio pledged as collateral, which we refer to as restricted investments, includes $10.0 million for our line of credit and approximately $428,000 for letters of credit which serve as security deposits on a building leases. The classification of $8.0 million of these restricted investments as current at June 30, 2006, represents the scheduled repayment of outstanding borrowings of our loan payable in June 2007, or less than one year from the date of these financial statements. As these liabilities are due to be fully paid in less than twelve months, the remaining restricted investments are classified as short-tem. Our restricted investments would not be considered a current source of additional liquidity.

As of June 30, 2006, our commitments under leases and other obligations, net of scheduled cost recoveries under sublease agreements, were not materially different from that reported as of December 31, 2005. As of December 31, 2005, we had net commitments under leases and other obligations totaling approximately $16.7 million, payable in varying amounts over more than five years, as more fully described in Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2005 filed with the SEC on March 16, 2006.

Operating Activities. Net cash used in operating activities was $10.4 million during the six months ended June 30, 2006, which includes the payment of $3.0 million to Sanochemia in connection with our in-license agreement for AV650. The remainder of the cash used in operating activities was primarily used to support our internal research and development activities, as well as preclinical studies and clinical trials performed by third parties. The level of cash used in operating activities during this quarter was in line with management’s expectations.

Investing and Financing Activities. Net cash used in investing and provided by financing activities during the six months ended June 30, 2006 was $13.3 million and $19.8 million, respectively. The cash used in investing activities consisted primarily of purchases of available-for-sale securities, net of sales and maturities, offset to a small degree by $142,000 proceeds from our sale of laboratory and office equipment and furniture in connection with our consolidation of facilities previously used for our gene therapy activities. The cash provided by financing activities consisted of proceeds from the private placement of out common stock to institutional investors in May 2006, as well as proceeds from the exercise of stock options during the period.

We believe we will continue to require substantial additional funding in order to complete the research and development activities currently contemplated and to commercialize our proposed products. We believe that with the reductions in our staff over the past two years and the consolidation of our operations and sublease of portions of our facilities, and the proceeds of the private placement in May 2006, our financial resources at June 30, 2006 will be adequate to fund our projected operating needs for approximately two to three years. However, this forward-looking statement is based upon our current plans and assumptions regarding our future operating and capital requirements, which may change. Our future operating and capital requirements will depend on many factors, including:

how successful, if at all, we are at acquiring or in-licensing compounds, and the nature of the consideration we pay for acquired or in-licensing compounds;
continued scientific progress in research and development programs;
the scope and results of preclinical studies and clinical trials;
the time and costs involved in obtaining regulatory approvals;
the costs involved in filing, prosecuting and enforcing patents claims and other intellectual property rights;
the costs involved in obtaining licenses to patented technologies from third-parties that may be needed to commercialize our product candidates;
competing technological developments;
the cost of manufacturing our product candidates for clinical trials and sales;
the costs of sales, marketing and commercialization activities;
how successful, if at all, we are at acquiring or in-licensing additional compounds, and the nature of the consideration we pay for acquired or in-licensed compounds; and
other factors which may not be within our control.

We will need to obtain additional funding prior to the time, if any, that we are able to market any product candidates. We cannot assure our investors that we will be able to enter into financing arrangements on acceptable terms or at all. Without additional funding, we may be required to delay, reduce the scope of, or eliminate one or more of our research or development programs.

Risks Related to Our Business

We expect to continue to operate at a loss and we may never achieve profitability

Since our inception in 1992, we have not been profitable, and we cannot be certain that we will ever achieve or sustain profitability. To date, we have been engaged in research and development activities and have not generated any revenues from product sales. As of June 30, 2006, we had an accumulated deficit of $184.1 million. Developing new compounds will require significant additional research and development activities, including preclinical testing and clinical trials, and regulatory approval. We expect these activities, together with our general and administrative expenses, to result in operating losses for the foreseeable future. Our ability to achieve profitability will depend, in part, on our ability to successfully identify, acquire and complete development of proposed products, and to obtain required regulatory approvals and manufacture and market our approved products directly or through business partners.

If we are able to enhance our existing pipeline of product candidates through the in-license or other acquisition of additional development candidates, we may expose ourselves to new risks that were not identified prior to negotiating the in-license or other acquisition agreement that may prevent us from successfully developing or commercializing our product candidates

Even if we are able to in-license or acquire potential products, we may fail to identify risks during our due diligence efforts, or new risks may arise later in the development process of our product candidates, that we may be unable to adequately address. If we are unable to address such previously unidentified risks in a timely manner, we will have paid too much for the acquisition or in-license of the potential product, and our business and results of operations will be harmed.

Our historic research and development activities have primarily focused on our gene delivery products, which raises uncertainty about our ability to develop and commercialize more conventional small molecule product candidates effectively

We have limited experience in developing or commercializing conventional small molecule product candidates. If we are unable to effectively develop any of the products in our development portfolio or any new products we in-license or acquire, it would significantly reduce our ability to create commercial opportunities for such products.

Many potential competitors who have greater resources and experience than we do may develop products and technologies that make ours non-competitive or obsolete

There are many entities, both public and private, including well-known, large pharmaceutical companies, chemical companies, biotechnology companies and research institutions engaged in developing pharmaceuticals for neurological and other applications similar to those that may be targeted by us. Competitors may succeed in developing products that are more effective and less costly than any that we develop and also may prove to be more successful in the manufacturing and marketing of products, which would render the products that we develop non-competitive or obsolete. Furthermore, many of our competitors are more experienced than we are in drug development and commercialization, obtaining regulatory approvals, and product manufacturing and marketing. Accordingly, our competitors may succeed in obtaining regulatory approval for products more rapidly and more effectively than we do. Any product that we successfully develop and for which we gain regulatory approval must then compete for market acceptance and market share. Accordingly important competitive factors, in addition to completion of clinical testing and the receipt of regulatory approval, will include product efficacy, safety, timing and scope of regulatory approvals, availability of supply, marketing and sales capacity, reimbursement coverage, pricing and patent protection.

We are aware that other companies are conducting preclinical studies and clinical trials for products that could compete with products we intend to acquire or develop. See "Item 1. Business -- Competition" of our Annual Report on From 10-K for the year-ended December 31, 2005, for a more detailed discussion of the competition we face.

The regulatory process is expensive, time consuming and uncertain and may prevent us from obtaining required approvals for the commercialization of our product candidates

Prior to marketing in the United States, any product developed by us must undergo rigorous preclinical testing and clinical trials as well as an extensive regulatory approval process implemented by the FDA. This process is lengthy, complex and expensive, and approval is never certain. Positive results from preclinical studies and early clinical trials do not ensure that positive results will be demonstrated in clinical trials designed to permit application for regulatory approval.

Potential problems we may encounter in the implementation stages of our studies include the chance that we may not be able to conduct clinical trials at preferred sites, obtain sufficient test subjects, or begin or successfully complete clinical trials in a timely fashion, if at all. Furthermore, the FDA may temporarily suspend clinical trials at any time if it believes the subjects participating in trials are being exposed to unacceptable health risks, if it finds deficiencies in the clinical trial process or conduct of the investigation, or to better analyze data surrounding any unexpected developments.

Because of the risks and uncertainties in biopharmaceutical development, our products could take a significantly longer time to gain regulatory approval than we expect or may never gain FDA approval. If we do not receive these necessary approvals from the FDA, we will not be able to generate substantial revenues or become profitable.

We may not be successful in obtaining required foreign regulatory approvals, which would prevent us from marketing our products internationally

We cannot be certain that we will obtain any regulatory approvals in other countries. In order to market our products outside of the United States, we must comply with numerous and varying foreign regulatory requirements implemented by foreign regulatory authorities. The approval procedure varies among countries and can involve additional testing. The time required to obtain approval may differ from that required to obtain FDA approval. Foreign regulatory approval process includes all of the risks associated with obtaining FDA approval set forth above, and approval by the FDA does not ensure approval by the regulatory authorities of any other country.

If we fail to comply with regulatory requirements, or if we experience unanticipated problems with our approved products, our products could be subject to restrictions or withdrawal from the market

Any product for which we obtain marketing approval from the FDA, along with the manufacturing processes, post-approval clinical data collection and promotional activities for such product, will be subject to continual review and periodic inspection by the FDA and other regulatory bodies. After approval of a product, we will have significant ongoing regulatory compliance obligations. Later discovery of previously unknown problems with our products or manufacturing processes, or failure to comply with regulatory requirements, may result in penalties or other actions, including removal of a product or products from the market.

We may need to secure additional financing to acquire and complete the development and commercialization of our potential products

At June 30, 2006 we had cash, cash equivalents, available-for-sale securities, and restricted investments of approximately $79.9 million. We anticipate that our existing capital resources as of June 30, 2006 will be adequate to fund our needs for approximately two to three years. However, beyond that, or earlier if we are successful in pursuing additional indications for compounds in our portfolio or acquiring additional product candidates, we may require additional funding to complete the research and development activities currently contemplated, to acquire new products, and to commercialize our products. Our future capital requirements will depend on many factors, including:

continued scientific progress in research and development programs;
the scope and results of preclinical studies and clinical trials;
the time and costs involved in obtaining regulatory approvals;
the costs involved in filing, prosecuting, defending and enforcing patents claims and other intellectual property rights;
the costs involved in obtaining licenses to patented technologies from third-parties that may be needed to commercialize our products;
how successful, if at all, we are at expanding our drug development portfolio through a combination of internal research, acquisitions, and in-licensing compounds, and the nature of the consideration we pay fo acquiring or in-licensing compounds;
competing technological developments;
the cost of manufacturing for clinical trials and commercialization;
the costs of marketing and commercialization activities; and
other factors which may not be within our control.

We expect to depend on third parties to manufacture compounds for our product candidates. If these manufacturers fail to meet our requirements and the requirements of regulatory authorities, our business, financial condition and results of operations could be harmed

We intend to use third parties to manufacture active pharmaceutical ingredients and supplies for our product candidates. For example, we rely entirely on Sanochemia to manufacture and supply to us AV650 for both clinical and commercial supply. We have entered into an exclusive arrangement with them for this. We have no experience in manufacturing small molecule compounds and do not have any manufacturing facilities. If we are unable to enter into supply and processing contracts with third party manufacturers or processors for our other product candidates, or even if we are able to enter into supply and processing contracts, if Sanochemia or such other manufacturers or processors are unable to or do not satisfy our requirements, or if disputes arise between us and our suppliers, we may experience a supply interruption and we may incur additional cost and delay in the clinical development or commercialization of our products. If we are required to find an additional or alternative source of supply, there may be additional cost and delay in the development or commercialization of our products. Furthermore, with AV650, while we are entitled to require Sanochemia to redundantly source certain AV650 finishing activities beginning as of the time and solely to the extent specified in the contract, we are not entitled to establish a second or independent source of AV650 supply other than under specified circumstances. In this and any future exclusive supply contracts for our full requirements, we are or will be particularly reliant on our suppliers. Additionally, the FDA inspects all commercial manufacturing facilities before approving a New Drug Application for a drug manufactured at those sites. If any of our manufacturers or processors fails to pass the FDA inspection, our clinical trials, the potential approval and eventual commercialization of our products may be delayed.

If we are able to bring our potential products to market, we will face a number of risks outside of our control as we may be dependent on others to market our products, as well as to facilitate demand for our products

Even if we are able to develop our potential products and obtain necessary regulatory approvals, we have no experience in marketing or selling any of our proposed products. We currently do not have a marketing or sales staff. If we are successful in achieving FDA approval of any product candidate, including any product that we may acquire as a result of our business development efforts, we will need to build a commercial capability. The development of a marketing and sales capability will require significant expenditures, management resources and time. We may be unable to build such a sales force, the cost of establishing such a sales force may exceed any product revenues, or our marketing and sales efforts may be unsuccessful. We may not be able to find a suitable sales and marketing partner for our products. If we are unable to successfully establish a sales and marketing capability in a timely manner or find suitable sales and marketing partners, our business and results of operations will be harmed. Even if we are able to develop a sales force or find a suitable marketing partner, we may not successfully penetrate the markets for any of our proposed products.

We intend to enter into distribution and marketing agreements with other companies for our products outside the U.S. and do not anticipate establishing our own foreign sales and marketing capabilities for any of our potential products in the foreseeable future. If any of our foreign marketing partners do not perform under future agreements, we would need to identify an alternative marketing and distribution partner, or market this product ourselves, and we may not be able to establish adequate marketing capabilities for this product.

Our success is dependent on acceptance of our products. We cannot assure you that our products will achieve significant market acceptance among patients, physicians or third-party payers, even if we obtain necessary regulatory and reimbursement approvals. Failure to achieve significant market acceptance will harm our business. In addition, we cannot assure you that these products will be considered cost-effective and that reimbursement to the consumer will be available or will be sufficient to allow us to sell our products on a profitable basis. In both the United States and elsewhere, sales of medical products and treatments are dependent, in part, on the availability of reimbursement to the consumer from third-party payers, such as government and private insurance plans. Third-party payers are increasingly challenging the prices charged for medical products and services. We cannot predict whether any legislative or regulatory proposals will be adopted or the effect that such potential proposals or managed care efforts may have on our business.

We may be unable to attract and retain the qualified employees, consultants and advisors we need to be successful

We are highly dependent on key members of our senior management and scientific staff. The loss of any of these persons could substantially impair our research and development efforts and impede our ability to develop and commercialize any of our products. Recruiting and retaining qualified scientific, technical and managerial personnel will also be critical to our success. Biotechnology and pharmaceutical personnel with these skills are in high demand. As a result, competition for and retention of personnel, particularly for employees with technical expertise, is intense and the turnover rate for these people can be high.

In addition, we rely on consultants and advisors to assist us in formulating our research and development strategy. A majority of our scientific advisors are engaged by us on a consulting basis and are employed on a full-time basis by others. We have limited control over the activities of these scientific collaborators which often limit their availability to us. Failure of any of these persons to devote sufficient time and resources to our programs could delay our progress and harm our business. In addition, some of these collaborators may have consulting or other advisory arrangements with other entities that may conflict or compete with their obligations to us.

We face the risk of liability claims which may exceed the scope or amount of our insurance coverage

The manufacture and sale of medical products entails significant risk of liability claims. We currently carry liability insurance; however, we cannot assure you that this coverage will remain in place or that this coverage will be adequate to protect us from all liabilities which we might incur in connection with the use of our products in clinical trials or the future use or sale of our products upon commercialization. In addition, we may require increased liability coverage as additional products are used in clinical trials and commercialized. This insurance is expensive and may not be available on acceptable terms in the future, if at all. A successful liability claim or series of claims brought against us in excess of our insurance coverage could harm our business. We must indemnify certain of our licensors against any liability claims brought against them arising out of products developed by us under these licenses.

Our use of hazardous materials exposes us to the risk of environmental liabilities, and we may incur substantial additional costs to comply with environmental laws in connection with the operation of our research and manufacturing facilities

We use radioactive materials and other hazardous substances in our research and development operations. As a result, we are potentially subject to substantial liabilities related to personal injuries or property damages they may cause. In addition, clean up costs associated with radioactivity or other hazardous substances, and related damages or liabilities could be significant and could harm our business. We do not believe that our current level of use of these controlled substances will require any material capital expenditures for environmental control facilities for the next few years. We are also required to comply with increasingly stringent laws and regulations governing environmental protection and workplace safety which could impose substantial fines and criminal sanctions for violations. If we were to fail to maintain compliance with these laws and regulations we could require substantial additional capital.

The testing of our potential products relies heavily on the voluntary participation of subjects in our clinical trials, which is not within our control, and could substantially delay or prevent us from completing development of such products

The development of our potential products is dependent upon collecting sufficient data from human clinical trials to demonstrate safe and effective results. We experienced delays in enrolling subjects in our previous gene therapy clinical trials, and we may experience similar difficulties with our current products in the future. Any delay or failure to recruit sufficient numbers of subjects to satisfy the level of data required to be collected under our clinical trial protocols could prevent us from developing any products we may target.

AAV Gene therapy technology is new and developing rapidly and Genzyme Corporation may face delays in developing products based on technologies included in our assignment agreement, in which case we may not receive any additional milestone, sublicensing fees or royalty revenues in connection with the agreement

Development of drug products, including gene therapy products, is unpredictable and is subject to many risks and uncertainties. We are not aware of any gene therapy products that Genzyme Corporation has fully developed or for which it has received regulatory approval for commercial sale in the U.S. As such, we face the risk that they will not be able to develop or receive regulatory approval for commercial sale of any product candidates that might utilize technologies included in our assignment agreement. Therefore, we may never receive any additional milestone, sublicensing fees or royalty revenues in connection with our previous work on AAV gene therapy activities.

Our success is dependent upon our ability to effectively protect our patents and proprietary rights, which we may not be able to do

Our success will depend to a significant degree on our ability to obtain patents and licenses to patent rights, preserve trade secrets, and to operate without infringing on the proprietary rights of others. If we are not successful in these endeavors, our business will be substantially impaired.

To date, we have filed a number of patent applications in the U.S. relating to technologies we have developed or co-developed. In addition, we have acquired licenses to certain issued patents and pending patent applications. We cannot guarantee that patents will issue from these applications or that any patent will issue on technology arising from additional research or, if patents do issue, that claims allowed will be sufficient to protect our technologies.

The patent application process takes several years and entails considerable expense. The failure to obtain patent protection on the technologies underlying certain of our proposed products may have a material adverse effect on our competitive position and business prospects. Important legal issues remain to be resolved as to the scope of patent protection for biotechnology and pharmaceutical products, and we expect that administrative proceedings, litigation, or both may be necessary to determine the validity and scope of our and others' patents. These proceedings or litigation may require a significant commitment of our resources in the future.

If patents can be obtained, we cannot assure you that any of these patents will provide us with any competitive advantage. For example, others may independently develop similar technologies or duplicate any technology developed by us, and patents may be invalidated or held unenforceable in litigation. For example, for at least one of our product candidates, the compound in it is no longer patented. For that candidate, we intend to rely (if they issue) primarily on formulation and potentially use patent claims (combined with any available regulatory exclusivity) rather than more traditional composition-of-matter patent claims on the active ingredient itself. Formulation and use coverage may not be effective in preventing others from marketing the active compound in competition with us. As another example, in our AV411 program, the compound is off-patent. We have filed and own a patent application on its use for the indications for which we are developing. However, we cannot assure you that this patent application, even if it one day issues as a patent, will effectively prevent others from marketing the same drug for the indications currently claimed by our patent application.

We also rely on a combination of trade secret and copyright laws, employee and third-party nondisclosure agreements and other protective measures to protect intellectual property rights pertaining to our products and technologies. We cannot be certain that these measures will provide meaningful protection of our trade secrets, know-how or other proprietary information. In addition, the laws of certain foreign countries do not protect our intellectual property rights to the same extent as do the laws of the United States. We cannot assure you that we will be able to protect our intellectual property successfully.

We may not be able to patent certain formulations of our products in development and may need to rely on protections under the Hatch-Waxman Act to prevent generics from copying our product candidates

Certain of our products in development are molecules that are in the public domain. While we are working to obtain patent protection for our formulations, manufacturing processes, and uses of these molecules, there is no guarantee that we will be able to do so. In cases where no patent protection can be obtained, regulatory exclusivity providing protection against generic competition can be obtained under the Hatch-Waxman Act if we are the first to obtain regulatory approval to market these compounds. There is no guarantee that we will be able to do so. Biotechnology or pharmaceutical companies with greater financial and personnel resources may be able to obtain regulatory approval to market one or more of these compounds prior to our obtaining such approval. Failure to obtain patent protection or regulatory exclusivity will adversely impact our ability to commercialize our products and realize a positive return on our investment.

Other persons may assert rights to our proprietary technology, which could be costly to contest or settle

Third parties may assert patent or other intellectual property infringement claims against us with respect to our products, technologies, or other matters. Any claims against us, with or without merit, as well as claims initiated by us against third parties, can be time-consuming and expensive to defend or prosecute and resolve. There may be third-party patents and other intellectual property relevant to our products and technology which are not known to us. We have not been accused of infringing any third party's patent rights or other intellectual property, but we cannot assure you that litigation asserting claims will not be initiated, that we would prevail in any litigation, or that we would be able to obtain any necessary licenses on reasonable terms, if at all. If our competitors prepare and file patent applications in the U.S. that claim technology also claimed by us, we may have to participate in interference proceedings declared by the Patent and Trademark Office to determine priority of invention, which could result in substantial cost to us, even if the outcome is favorable to us. In addition, to the extent outside collaborators apply technological information developed independently by them or by others to our product development programs or apply our technologies to other projects, disputes may arise as to the ownership of proprietary rights to these technologies.

We may be required to obtain rights to proprietary genes and other technologies to further develop our business, which may not be available or may be costly

We currently investigate and use certain gene sequences or proteins encoded by those sequences, including the IL-10 gene, and manufacturing processes that are or may become patented by others. As a result, we may be required to obtain licenses to these gene sequences or proteins or other technology in order to test, use or market products. We may not be able to obtain these licenses on terms favorable to us, if at all. In connection with our efforts to obtain rights to these gene sequences or proteins or other technology, we may find it necessary to convey rights to our technology to others. Some of our products may require the use of multiple proprietary technologies. Consequently, we may be required to make cumulative royalty payments to several third parties. These cumulative royalties could become commercially prohibitive. We may not be able to successfully negotiate these royalty adjustments to a cost effective level, if at all.

If we do not fulfill our obligations under our in-license agreements, including our in-license for AV650, we may not be able to retain our rights under those agreements and may be forced to cease our activities with the affected product candidate or technology

We have entered into license agreements with third parties for technologies related to our product development programs. Typically, we have obligations under these agreements to diligently pursue commercialization of products using the technologies licensed to us, among other obligations including payment, patent prosecution, information-sharing and licensing obligations. We have these kinds of obligations to Sanochemia under our AV650 agreement with them. If we fail to fulfill our obligations under these agreements and fail to obtain a waiver of any material failure to fulfill such obligations, the licensor may terminate these license agreements with relatively short notice to us. Termination of any of our license agreements could harm our business and force us to cease our activities with the affected product candidate or technology.

Similarly, if disputes arise between us and our licensors, our rights to the licensed product candidates and technologies could be threatened. In addition, any such dispute could harm us through taking our management’s time and attention to resolve the dispute.

Our future financial results will be affected by changes in the accounting rules governing the recognition of stock-based compensation expense.

Through December 31, 2005, we measured share-based compensation expense for our employee stock compensation plans under the intrinsic value method of accounting prescribed by Accounting Principles Board Opinion No. 25 (“APB No. 25”), “Accounting for Stock Issued to Employees.” Beginning January 1, 2006, we measure share-based compensation expense using the fair value method, which adversely affects our results of operations by increasing our reported losses or reducing future reported income and which may adversely affect our stock price. Had we accounted for our compensation expense under the fair value method of accounting prescribed by FAS 123, our equity compensation expenses for 2005 would have been significantly higher, increasing by approximately $2.2 million for the year, net of reported amounts prescribed under APB No. 25.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Our market risk disclosures set forth in Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2005, have not changed significantly. We have evaluated the risk associated with our portfolios of investments in marketable securities and have deemed this market risk to be immaterial. If market interest rates were to increase by 100 basis points, or 1%, from their June 30, 2006 levels, we estimate that the fair value of our securities portfolio would decline by approximately $651,000 compared to our estimated exposure of $533,000 at December 31, 2005, primarily due to the increase in size of our overall portfolio.

Item 4. Controls and Procedures

Evaluation of disclosure controls and procedures. With the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we have evaluated the effectiveness of our disclosure controls and procedures (as defined in the Securities Exchange Act of 1934, Rules 13a-15(e) and 15(d)-15(e)), as of June 30, 2006. Based on that evaluation, the principal executive officer and principal financial officer have concluded that these disclosure controls and procedures were effective to ensure, at a reasonable assurance level, that the information required to be disclosed by us in reports we file with the SEC is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and instructions for such reports.

Changes in Internal Control over Financial Reporting. There were no changes in our internal control over financial reporting during the quarter ended June 30, 2006, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

As of August 1, 2006, we were not involved in any legal proceedings.

Item 1A. Risk Factors

We include in Part I, Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risks Related to Our Business” a description of risk factors related to our business in order to enable readers to assess, and be appropriately apprised of, many of the risks and uncertainties applicable to the forward-looking statements made in this Quarterly Report on Form 10-Q. We do not claim that the risks and uncertainties set forth in that section are all of the risks and uncertainties facing our business, but do believe that they reflect the more important ones.

The risk factors set forth in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2005, as filed with the SEC on March 16, 2006, have not substantively changed, except for the following risk factors, which have been restated as set forth in Part I, Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risks Related to Our Business” of this Quarterly Report on Form 10-Q:

	1.		We have updated the risk factors “We expect to continue to operate at a loss and we may never achieve profitability” and “We may need to secure additional financing to acquire and complete the development and commercialization of our potential products” to reflect our June 30, 2006 financial results; and

	2.		We have updated the risk factor “We may need to secure additional financing to acquire and complete the development and commercialization of our potential products” to reflect our assessment that our existing capital resources as of June 30, 2006 will be adequate to fund our needs for approximately two to three years.

	3.		We have removed the risk factor “Changes in board and management composition could adversely disrupt our operations” to reflect our assessment that we have not experienced difficulties in integrating new members of our board and management team into new roles with respect to our business.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Avigen completed a private placement which raised $21.2 million in gross proceeds in May 2006. After incurring approximately $1.8 million in expenses for placement agent fees and commissions and other transaction expenses, the net proceeds were approximately $19.4 million. RBC Capital Markets acted as placement agent in the private placement. Aggregate placement agent fees were $1.7 million.

Pursuant to the common stock purchase agreement dated as of May 10, 2006, Avigen offered and sold 3,939,760 shares of common stock, par value $0.001 per share, at a price of $5.37 per share. The closing of the private placement occurred on May 12, 2006. The securities were issued to nineteen institutional investment funds associated with registered investment advisors in reliance on Rule 506 of Regulation D and Section 4(2) under the Securities Act of 1933, as amended.

Item 3. Defaults Upon Senior Securities

None.

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

Our 2006 Annual Meeting of Stockholders was held on May 31, 2006.
The matters voted upon at the Annual Meeting and the voting of stockholders with respect thereto are as follows:

Each of John K.A. Prendergast, Ph.D. and Richard J. Wallace, were elected as a Class II director to hold office until our 2009 Annual Meeting of Stockholders and until his successor is elected and has qualified, or until his earlier death, resignation or removal. The voting results were as follows:

John K.A. Prendergast, Ph.D.
	For	17,943,714
	Withhold	516,283
Richard J. Wallace
	For	18,235,115
	Withhold	224,882

Our Class I directors, Yuichi Iwaki, M.D., Ph.D. and Zola Horovitz, Ph.D., will each continue to serve on our Board of Directors until our 2008 Annual Meeting of Stockholders and until his successor is elected and has qualified, or until his earlier death, resignation or removal. Our Class III directors, Kenneth G. Chahine, Ph.D., J.D. and Daniel Vapnek, Ph.D., will each continue to serve on our Board of Directors until our 2007 Annual Meeting of Stockholders and until his successor is elected and has qualified, or until his earlier death, resignation or removal.

The approval of Avigen’s 2006 Equity Incentive Stock Option Plan, which was an amendment and restatement of our currently existing 2000 Equity Incentive Stock Option Plan, was approved. The voting results were as follows:

For	14,415,551
Against	3,983,980
Abstain	60,466
Broker non-votes	-0-

The selection of Ernst & Young LLP as our independent auditors for our fiscal year ending December 31, 2006 was ratified. The voting results were as follows:

For	18,248,882
Against	204,951
Abstain	6,165
Broker non-votes	-0-

Item 5. Other Information

None.

Item 6. Exhibits

The following exhibits are included herein:

Exhibit Number		Exhibits
2.1	(2)	Assignment Agreement, dated December 19, 2005, by and between Genzyme
		Corporation and Avigen
3.1	(1)	Amended and Restated Certificate of Incorporation
3.1	.1(3)	Certificate of Amendment to Certificate of Incorporation
3.2	(1)	Restated Bylaws of the Registrant
4.1	(1)	Specimen Common Stock Certificate
10.1		Common Stock Purchase Agreement, dated as of May 10, 2006, among the
		registrant and the purchasers
10.1	2	2006 Incentive Stock Option Plan
31.1		CEO Certification required by Rule 13a-14(a) or Rule 15d-14(a)
31.2		CFO Certification required by Rule 13a-14(a) or Rule 15d-14(a)
32.1	(4)	Certification required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of
		Chapter 63 of Title 18 of the United States Code (18 U.S.C. §1350)

____________________

(1)		Filed as an exhibit to the Registrant’s Registration Statement on Form S-1 (No. 333-03220) and incorporated herein by reference.

(2)		Incorporated by reference from such document filed with the SEC as an exhibit to Avigen’s Annual Report on Form 10-K for the year ended December 31, 2005, as filed with the SEC on March 16, 2006 (Commission File No. 000-28272).

(3)		Incorporated by reference from such document filed with the SEC as an exhibit to Avigen’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2000, as filed with the SEC (Commission File No. 000- 28272).

(4)		This certification accompanies the Form 10-K to which it relates, is not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of Avigen under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended (whether made before or after the date of the Form 10-K), irrespective of any general incorporation language contained in such filing.

SIGNATURES

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

	AVIGEN, INC.



Date: August 3, 2006	By:	/s/ KENNETH G. CHAHINE
		Kenneth G. Chahine
		Chief Executive Officer and President



Date: August 3, 2006	By:	/s/ ANDREW A. SAUTER
		Andrew A. Sauter
		Vice President, Finance

		EXHIBIT INDEX
Exhibit Number		Exhibits
2.1	(2)	Assignment Agreement, dated December 19, 2005, by and between Genzyme
		Corporation and Avigen
3.1	(1)	Amended and Restated Certificate of Incorporation
3.1	.1(3)	Certificate of Amendment to Certificate of Incorporation
3.2	(1)	Restated Bylaws of the Registrant
4.1	(1)	Specimen Common Stock Certificate
10.1		Common Stock Purchase Agreement, dated as of May 10, 2006, among the
		registrant and the purchasers.
10.1	2	2006 Incentive Stock Option Plan
31.1		CEO Certification required by Rule 13a-14(a) or Rule 15d-14(a)
31.2		CFO Certification required by Rule 13a-14(a) or Rule 15d-14(a)
32.1	(4)	Certification required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of
		Chapter 63 of Title 18 of the United States Code (18 U.S.C. §1350)

____________________

(1)		Filed as an exhibit to the Registrant’s Registration Statement on Form S-1 (No. 333-03220) and incorporated herein by reference.

(2)		Incorporated by reference from such document filed with the SEC as an exhibit to Avigen’s Annual Report on Form 10-K for the year ended December 31, 2005, as filed with the SEC on March 16, 2006 (Commission File No. 000-28272).

(3)		Incorporated by reference from such document filed with the SEC as an exhibit to Avigen’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2000, as filed with the SEC (Commission File No. 000- 28272).

(4)		This certification accompanies the Form 10-K to which it relates, is not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of Avigen under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended (whether made before or after the date of the Form 10-K), irrespective of any general incorporation language contained in such filing.