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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-K



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(Mark one)

|x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ------------------------------------------------------------------------------------

For the Fiscal Year Ended December 31, 2006 or



| ̈ | 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 000-30231



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TANOX, INC.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 76-0196733                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)

10301 Stella Link, Houston, Texas 77025

(Address of principal executive offices)

713-578-4000

(Registrant's telephone number, including area code)

Securities Registered Pursuant to Section 12(b) of the Act: None

Securities Registered Pursuant to Section 12(g) of the Act: Common Stock, $.01 par value Preferred Share Purchase Rights



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Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in rule 405 of the Securities
Act.    Yes ̈No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the
Act.    Yes ̈No  x

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

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.
(Check one):

Large accelerated filer ̈Accelerated filer  x    Non-accelerated filer ̈

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

The aggregate market value of the registrant's common stock held by nonaffiliates as of June 30, 2006 was $351,830,304.

Number of shares of outstanding common stock as of March 7, 2007: 45,676,599.

DOCUMENTS INCORPORATED BY REFERENCE

The information called for by Items 10, 11, 12 and 13 of Part III will be
included in the registrant's definitive proxy statement to be filed pursuant to Regulation 14A and is incorporated herein by reference.



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TABLE OF CONTENTS



|           |  |                                                                                                               |  |     
|---------- |  | ------------------------------------------------------------------------------------------------------------- |  | ----
|           |  |                                                                                                               |  | Page
|PART I     |  |                                                                                                              
|           |  |                                                                                                              
|ITEM 1.    |  | Business                                                                                                      |  | 1   
|ITEM 1A.   |  | Risk Factors                                                                                                  |  | 15  
|ITEM 1B.   |  | Unresolved Staff Comments                                                                                     |  | 28  
|ITEM 2.    |  | Properties                                                                                                    |  | 29  
|ITEM 3.    |  | Legal Proceedings                                                                                             |  | 29  
|ITEM 4.    |  | Submission of Matters to a Vote of Security Holders                                                           |  | 30  
|           | 
|PART II    |  |                                                                                                              
|ITEM 5.    |  | Market for the Companys Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |  | 31  
|ITEM 6.    |  | Selected Financial Data                                                                                       |  | 32  
|ITEM 7.    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                         |  | 33  
|ITEM 7A.   |  | Quantitative and Qualitative Disclosures About Market Risk                                                    |  | 43  
|ITEM 8.    |  | Financial Statements and Supplementary Data                                                                   |  | 44  
|ITEM 9.    |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                          |  | 70  
|ITEM 9A.   |  | Controls and Procedures                                                                                       |  | 70  
|ITEM 9B.   |  | Other Information                                                                                             |  | 70  
|           | 
|PART III   |  |                                                                                                              
|ITEM 10.   |  | Directors and Executive Officers of the Registrant                                                            |  | 71  
|ITEM 11.   |  | Executive Compensation                                                                                        |  | 71  
|ITEM 12.   |  | Security Ownership of Certain Beneficial Owners and Management                                                |  | 71  
|ITEM 13.   |  | Certain Relationships and Related Transactions                                                                |  | 71  
|ITEM 14.   |  | Principal Accounting Fees and Services                                                                        |  | 71  
|           | 
|PART IV    |  |                                                                                                              
|ITEM 15.   |  | Exhibits, Financial Statement Schedules                                                                       |  | 72  
|SIGNATURES |  | 75                                                                                                           

In this report, Tanox, the Company, we, us and
our refer to Tanox, Inc. and its subsidiaries, unless the context otherwise suggests. Common Stock refers to Tanoxs common stock, par value $0.01 per share.

Xolair®(omalizumab) anti-IgE antibody is a trademark of Novartis A.G.



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PART I



|ITEM 1. | Business
|------- | --------

Overview

Tanox discovers and develops therapeutic monoclonal antibodies to address significant unmet medical needs in the areas of immune-mediated diseases,
infectious disease, inflammation and cancer. Our products are genetically engineered antibodies that target specific molecules or antigens.

On November 9, 2006, we entered into an agreement and plan of merger with Genentech, Inc. (Genentech) and Green Acquisition Corporation, a wholly-owned subsidiary of Genentech, pursuant to which Genentech would acquire Tanox for
approximately $919 million in cash. Under the terms of the agreement, Green Acquisition will merge with and into Tanox, and the stockholders of Tanox will receive $20.00 in cash for each share held, less any applicable withholding tax. In addition,
each option to purchase Tanox common stock outstanding at the time of the merger will be canceled and the option holder entitled to receive a cash amount equal to the product of (i) the number of shares of Tanox common stock as to which the
option remains unexercised, multiplied by (ii) the amount, if any, by which $20.00 exceeds the exercise price of the option, less any applicable withholding tax. The boards of directors of both companies and the stockholders of Tanox have
approved the transaction, which remains subject to expiration of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act, the absence of a material adverse effect and the satisfaction of other customary closing conditions. We
expect that the transaction will close within the first half of 2007.

Tanox
receives royalties and other payments from the sale of Xolair®(omalizumab), an anti-IgE
antibody that was developed in collaboration with Genentech and Novartis Pharma AG (Novartis). In the United States, Xolair is labeled for treatment of adults and adolescents (12 years of age and above) with moderate-to-severe persistent asthma who
have had a positive skin test or in vitro reactivity to a perennial aeroallergen and whose symptoms are inadequately controlled with inhaled corticosteroids. Xolair was approved for use in the U.S. by the Food and Drug Administration (FDA) in
June 2003. In October 2005, Novartis announced that the European Commission had granted marketing authorization in all 25 European Union member states for Xolair. In Europe, Xolair is licensed as add-on therapy to improve asthma control in adults
and adolescents (12 years of age and above) with severe persistent allergic asthma.

Under our collaboration agreements with Genentech and
Novartis, we receive royalties on the net sales of Xolair and share in Novartis net profits from sales of Xolair in the U.S. In 2006, we recorded net royalty revenue of $40.2 million from sales of Xolair versus $29.4 million in 2005. We
recorded net profit sharing revenue of $6.7 million from Novartis in 2006 versus $1.1 million in 2005. Also under the terms of our collaboration agreements with Genentech and Novartis, we relinquished any rights to manufacture Xolair and in exchange
receive payments based on the quantity of Xolair produced, as defined in our collaboration agreement. We recorded manufacturing-rights revenue of $7.0 million from Genentech and Novartis in 2006 versus $1.1 million in 2005. Profit sharing and
manufacturing-rights revenue is calculated one quarter in arrears.

Clinical trials are ongoing to study the long-term safety profile of
Xolair. Novartis is also conducting a Phase 3 trial to study the effectiveness of Xolair in pediatric allergic asthma patients.

We have
two products in clinical development. Ibalizumab (TNX-355) is our monoclonal antibody in development to treat HIV/AIDS. In May 2006, we reported positive 48-week results from the Phase 2 clinical trial of TNX-355. We have conducted a meeting with
the FDA to discuss the clinical trial results and continued development of TNX-355. At the FDAs request, a dose-finding trial has been



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designed that explores different dosing strategies. The FDA concurred that the dose-finding trial, if appropriately designed and successful, could be
considered pivotal as part of a registration program for TNX-355 in HIV treatment-experienced patients. We are in the process of evaluating the FDAs most recent feedback on the proposed trial design.

Our other product in clinical development is TNX-650, a humanized anti-IL-13 antibody. A Phase 1 clinical trial was initiated in May 2006 to evaluate
TNX-650 as a potential treatment of Hodgkins lymphoma in patients who are refractory to chemotherapy or radiation treatment. Five patient cohorts have been enrolled to date. In early October 2006, we also began enrolling patients in a Phase 1
clinical trial of TNX-650 as a potential treatment for moderate-to-severe asthma. The trial is a randomized, double-blind, placebo-controlled, dose-escalation study of the safety, tolerability and pharmacokinetics of single doses of TNX-650 in
healthy volunteers. Enrollment of this Phase 1 study, which is taking place at a single site in the U.S., has been completed.

During the
year, we continued preclinical development of additional product candidates, including TNX-234, a humanized antibody being developed as a potential treatment for wet and/or advanced dry age-related macular degeneration (AMD), and TNX-558, a
humanized antibody being evaluated as a potential inflammatory-disease therapy. In addition, we have generated a humanized high affinity anti-IgE antibody for the potential treatment of allergic diseases, and development activities are ongoing with
Novartis for this product under our two-party Amended and Restated Development and Licensing Agreement.

Monoclonal Antibodies

Genetically engineered monoclonal antibodies are man-made antibodies that target a specific antigen. Advances in antibody production technologies, such as
high productivity cell culture has enabled manufacturers to produce antibody products more cost-effectively. Many monoclonal antibodies, including Xolair, have been approved for marketing as therapeutics by the FDA, and a large number of monoclonal
antibodies are currently under investigation in clinical trials.

Our monoclonal antibody therapeutics treat disease by altering the
function of a protein, called a drug target, which is part of the disease pathway. We have designed drugs to deactivate or reduce the activity of targets in the immune system for the treatment of allergic and autoimmune disease and to block a target
that is used by HIV to infect human cells. Our products and product candidates have either resulted from internal research, were in-licensed or were acquired.

Marketed Product

Xolair

Xolair was developed in collaboration with Genentech and Novartis and is the first anti-IgE antibody to reach the market. Xolair is also Tanoxs first commercial product. Xolair generated $425 million of sales in the U.S. in 2006. In
the U.S., Xolair was approved by the FDA in June 2003 for the treatment of adults and adolescents (12 years of age and above) with moderate-to-severe persistent asthma. Xolair was approved by the European Commission (EMEA) in October 2005 as add-on
therapy to improve asthma control in adults and adolescents (12 years of age and above) with severe persistent allergic asthma. On February 21, 2007, the FDA announced it requested that Genentech strengthen the existing warning on the potential
risk for anaphylaxis in patients receiving Xolair by adding a boxed warning to the product label and implementing a Risk Mitigation Action Plan, including providing a medication guide for patients and advice to health care providers to observe
patients for at least two hours after dosing. Genentech and Novartis have advised that they will be working with the FDA on its request.



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Genentech and Novartis, which have commercialization rights under our collaboration, market Xolair in the
U.S. with separate sales forces. The sales forces target their efforts at allergists and pulmonologists who specialize in the treatment of asthma. Xolair is being distributed by a network of specialty pharmacies. Broad insurance coverage for Xolair
has been secured. The impact of the Medicare Modernization Act on Xolair has been minimal given that Xolair has a small Medicare patient population.

Xolair is a recombinant humanized monoclonal antibody targeting IgE, one of the key inflammatory proteins implicated in allergic diseases such as asthma, allergic rhinitis and food allergy. The immune system of an
allergic individual responds to an environmental protein, or allergen, by producing IgE that reacts with the allergen. IgE initially binds to the surface of mast cells and basophils through high affinity IgE receptors on the cell surface. These
cells are found in tissue and also circulate in the blood, and they contain chemicals including histamine and leukotrienes, which provoke inflammation. When a mast cell or basophil armed with allergen specific IgE on its surface comes into contact
with its cognate allergen, the allergen will cross-link the surface-bound IgE molecules, with resultant cross-linking of the underlying IgE receptors. This event signals the mast cell or basophil to release its powerful chemicals, causing tissue
inflammation and asthma and allergy symptoms, including bronchoconstriction, wheezing, coughing, sneezing, runny nose, watery eyes and itching. Xolair works by attaching to circulating IgE and masking the binding site for the IgE receptor which
prevents IgE from binding to and arming mast cells and basophils. In this manner, Xolair reduces the inflammatory response to allergens.

Drugs in
Development

Xolair

Novartis
is conducting a Phase 3 clinical trial of Xolair in pediatric allergic asthma patients. The pediatric trial is designed as a one-year randomized, double-blind, placebo-controlled, global study, of approximately 570 patients who are between 6 and 12
years old. Enrollment of the trial has been completed. The primary objective of the study is to evaluate the safety and efficacy of Xolair in children with moderate-to-severe, persistent and inadequately controlled allergic asthma. Asthma is the
most common serious chronic disease of childhood, affecting nearly 5 million children in the U.S.

A clinical study to evaluate the
long-term safety of Xolair is also under way. The trial is comparing the effectiveness and long-term safety profile of patients with mild-to-severe persistent IgE-mediated asthma who have been treated with Xolair with patients of similar clinical
profile who have not been treated with Xolair. The study is enrolling 5,000 patients (2,500 Xolair-treated and 2,500 not treated with Xolair). Study duration is 5 years, with expected completion in 2011.

Xolair was also being studied in a Phase 2 clinical trial as a potential treatment for allergies to peanuts. Genentech, Novartis and Tanox discontinued
the study enrollment in early 2006 due to severe hypersensitivity reactions which occurred in two individuals during the oral food challenge screening portion of the trial. The decision was based on a recommendation from the studys independent
data safety monitoring committee and was not related to the safety of Xolair since neither of the patients had received Xolair. Those patients who were enrolled in that study are now receiving Xolair in an open-label safety study. Along with our
collaborators, we remain committed to determining whether or not Xolair may provide protection among patients at risk for life-threatening reactions to peanut ingestion and will be working closely with leading food allergy experts and patient
advocates to help determine a path forward.



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TNX-355

TNX-355 is our monoclonal antibody in development to treat HIV/AIDS. In May 2006, we reported positive 48-week results from the Phase 2 clinical trial of TNX-355. The results showed that TNX-355, when given in
combination with an optimized background regimen (OBR) of other antiviral therapies, produced a greater reduction in viral load in HIV-infected patients than did placebo in combination with OBR. These results, together with positive 24-week data
reported in October 2005, demonstrate the long-term antiviral and immunologic impact of TNX-355. At both the 24-week and 48-week time points, TNX-355 was well tolerated, with no serious adverse events related to the drug as assessed by study
investigators.

TNX-355 has a unique mechanism of action. Administered intravenously, TNX-355 is distinct from other viral entry inhibitors
in that it binds to the primary receptor for HIV, the CD4+ receptor. Potential advantages of TNX-355 include synergy with the entry inhibitor, enfuvirtide and activity against a broad range of resistant viruses.

Phase 1 studies, completed in 2003 and 2004, demonstrated that TNX-355 was well tolerated and resulted in a transient but clinically meaningful reduction
in viral load in treatment-experienced patients infected with HIV. These reductions in viral load were maintained approximately 2 to 4 weeks in the single-dose administration and 5 to 7 weeks in the multi-dose administration trial. TNX-355 received
Fast Track status from the FDA in October 2003. We have exclusive worldwide rights to develop and market TNX-355 through a license from Biogen Idec, Inc.

We have conducted a meeting with the FDA to discuss the clinical trial results and continued development of TNX-355. At the FDAs request, a dose-finding trial has been designed that explores different dosing
strategies. The Agency concurred that the dose-finding trial, if appropriately designed and successful, could be considered pivotal as part of a registration program for TNX-355 in HIV treatment-experienced patients. We are in the process of
evaluating the FDAs most recent feedback on the proposed trial design.

TNX-650

TNX-650 is a humanized anti-IL-13 antibody. A Phase 1 clinical trial was initiated in May 2006 to evaluate TNX-650 as a potential treatment of
Hodgkins lymphoma in patients who are refractory to chemotherapy or radiation treatment. Five patient cohorts have been enrolled to date. TNX-650 targets Interleukin 13, an important growth factor for Hodgkin's lymphoma cells. In preclinical
testing, TNX-650 inhibited the function of IL-13 and blocked the proliferation of malignant cells. The objective of the Phase 1 trial is to determine the safety, tolerability and pharmacokinetics of the agent as a monotherapy in patients who have
relapsed or are refractory to standard chemotherapy, with or without radiation therapy, and who have not responded to or are unable to undergo autologous bone marrow transplantation. There are no approved drugs for the treatment of patients with
relapsed or refractory Hodgkin's lymphoma.

In early October 2006, we also began enrolling patients in a Phase 1 clinical trial of TNX-650
as a potential treatment for moderate-to-severe asthma. The trial is a randomized, double-blind, placebo-controlled, dose-escalation study of the safety, tolerability and pharmacokinetics of single doses of TNX-650 in healthy volunteers. Enrollment
of this Phase 1 study, which is taking place at a single site in the U.S., has been completed. Preclinical studies indicate that IL-13 is a key mediator of asthma responses, including airway inflammation, obstruction and hyper-reactivity. TNX-650
has a mechanism of action unique from currently available asthma treatments, and has the potential to be a therapeutic option for patients whose disease is not currently well controlled and for non-allergic asthmatics.



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Our Preclinical and Research Programs

We are committed to identifying new drugs for treating immune-mediated disease, inflammatory disease, infectious disease and cancer. A cornerstone of our
discovery effort is our monoclonal antibody development platform which is a semi-automated, high-throughput system that generally gives us the capability to identify and optimize individual monoclonal antibody leads in a 12-18 month timeframe.
Monoclonal antibody candidates derived from mice are generally humanized to reduce the possibility of immunogenicity, which could lead to decreased activity and tolerability in patients. Additionally, fully human monoclonal antibody candidates can
be generated from phage libraries using technology licensed from Dyax Corp. (Dyax), a biotechnology company. Our antibodies are also optimized for affinity, effector function and circulating half-life to enhance their therapeutic potential. We also
have ongoing exploratory research programs.

Our preclinical programs include TNX-234, a humanized antibody, being developed as a potential
treatment for wet and/or advanced dry age-related macular degeneration (AMD). TNX-558 is being evaluated as a potential inflammatory-disease therapy. In addition, we have generated a humanized high affinity anti-IgE antibody for the potential
treatment of allergic diseases, and development activities are ongoing with Novartis for this product under our two-party Amended and Restated Development and Licensing Agreement.

Collaboration and Licensing Agreements

Collaboration with Novartis and Genentech

Our first marketed product, Xolair, was the result of a three-party collaboration with Novartis and Genentech. In 1990, we established a collaboration
with Novartis to jointly develop anti-IgE antibodies to treat allergic diseases. In connection with the settlement of a lawsuit in 1996, Genentech joined the collaboration for the purpose of developing certain anti-IgE antibodies. In February 2004,
we finalized the detailed terms of this three-party collaboration, which provides for the following:



| |  |  | Development.Novartis or Genentech are responsible for conducting clinical trials and obtaining the regulatory approval for Xolair and the other anti-IgE
products developed through the collaboration in the U.S. and Europe, and they share all related development costs. We have primary development responsibility for collaboration products in China, Hong Kong, Korea, Singapore and Taiwan (East Asia),
and we and Novartis equally share these development costs. Novartis is responsible for development and associated costs in the rest of the world.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Manufacturing.Novartis and Genentech are responsible for manufacturing Xolair and other selected anti-IgE products worldwide. Under the terms of the
three-party collaboration agreement, Tanox relinquished any rights to manufacture Xolair and in exchange receives manufacturing-rights payments based on the quantity of Xolair produced, as defined in our collaboration agreement.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Marketing. Novartis and Genentech share U.S. marketing rights, and each company has sales representatives to market Xolair in the U.S. Novartis has marketing
rights outside the U.S.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Milestone Payments. In the second quarter of 2006, Novartis submitted an application for the approval of Xolair in Japan. Under our collaboration agreement
with Novartis, the filing resulted in a $2.0 million milestone payment to Tanox, of which $1.0 million was recorded as development agreement revenue from a related party in the second quarter of 2006. The remaining $1.0 million of the milestone is
creditable to Novartis against future royalties owed Tanox and was recorded as deferred revenue. We may receive up to $3.0 million in additional Xolair-related milestone payments, of which $1.5 million would be creditable
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | against future royalty payments. If a second drug were to be developed under this collaboration agreement, we could be eligible for additional net milestone
payments of $10.5 million.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Royalties and Profit Sharing.In the U.S., we receive royalties on sales of Xolair and other collaboration products and a share of Novartis profits on
these sales. We also receive royalties on sales of Xolair and other collaboration products outside the U.S. Novartis profit sharing and rest-of-world royalty payments are net of certain credits, which had been fully used as of December 31,
2006. In addition, as a result of an adverse arbitration award, 10% of all royalties received by Tanox on sales of Xolair and certain other anti-IgE products will be payable to our former attorneys, up to a maximum of $300 million (see Item 3.
Legal Proceedings). We expect that the net amount Tanox will receive in royalties and profit sharing from Xolair sales, taking into account both the foregoing credits and the amount payable to our former attorneys, will be in the range of 8% to 12%
of net sales depending on the sales level achieved and geographic distribution of the sales.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Either Novartis or
Genentech may withdraw from the collaboration, and, in such case, rights to Xolair and any other products developed by the collaboration revert to us and the remaining collaborator (or, if Genentech is the withdrawing party, to F. Hoffman-La Roche
Ltd., if Roche exercises its option to become a collaborator), depending on which party shares rights with the withdrawing collaborator in a particular territory.

In addition to the collaboration described above, we and Genentech are parties to a cross-license agreement under which each has an option to license the other party's patents that are necessary for the manufacture,
use or sale of certain anti-IgE antibodies. This option may be exercised at any time if either party chooses to independently develop a product that does not fall within the collaboration, if our collaboration with Novartis and Genentech terminates,
or if we and Genentech mutually agree.

We are also party to an Amended and Restated Development and Licensing Agreement with Novartis
under which we have agreed to collaborate on anti-IgE antibodies that do not fall within the three-party collaboration and, in general, are either (i) invented and synthesized by Tanox or (ii) invented and synthesized by Novartis and
derived from a Tanox antibody or would infringe certain Tanox patent rights.

Other License Agreements

Biogen Idec.In 1998, we entered into an agreement to license from Biogen, Inc. (now Biogen Idec, Inc.) its anti-CD4 monoclonal antibody (renamed
TNX-355) and intellectual property on an exclusive worldwide basis with limited sublicensing rights. Biogen Idec owns issued U.S., European, Canadian, Hong Kong and Australian patents and has pending applications in Japan, which cover our TNX-355
product. We agreed to make royalty payments to Biogen Idec based on annual net sales levels. In addition to royalty payments, we may make up to an aggregate of $1.4 million (which could be increased to an aggregate of $10.4 million in the event we
merge or affiliate with a company of similar size to Biogen Idec) in product license fees and development milestone payments under this agreement, of which we have paid $200,000. The remaining development milestones would be due upon the
commencement of a Phase III clinical or equivalent pivotal trial, at the filing of a BLA and at regulatory approval as a licensed product. If commercialized, tiered royalty payments will be due to Biogen Idec based on annual net sales volume. The
license terminates on a country-by-country basis on the later of the expiration of 12 years following the first commercial product sale or the expiration or invalidity of applicable patents. The licensed patents expire in Europe in 2011 and in the
U.S. in 2016, subject to extensions.



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Wyeth. In November 2003, we entered into cross license agreements with Wyeth Pharmaceuticals
Division, a division of Wyeth, with respect to patent rights covering a new class of drugs for the treatment of osteoporosis. Under the agreements, Wyeth received a license under Tanox patents to develop a small molecule-based drug, and Tanox
received a license under Wyeths patent applications to develop an antibody-based drug. The research is based on a proprietary target gene on which Tanox holds various patent rights. Tanox may receive development milestones from Wyeth for
products developed by it in primary and expanded treatment indications and for regulatory approval in the United States and other countries. If commercialized, royalty payments will be due to Tanox based on annual net sales. Wyeth will be entitled
to a milestone payment if Tanox receives regulatory marketing authorization in the United States for an antibody-based product and royalty payments on annual net sales.

Dyax. In November 2004, we entered into an agreement with Dyax Corp. to obtain a non-exclusive license to its proprietary antibody phage display libraries. The Dyax libraries serve as a tool to help us identify
fully human monoclonal antibodies that bind with high specificity and affinity to our targets. Under the terms of the agreement, Dyax received an up front license fee of $900,000 and receives annual technology license fees. Dyax will be entitled to
clinical milestone payments if clinical trials are conducted and, if commercialized, tiered royalties on annual net sales of products based on antibodies identified from the Dyax libraries.

Patents and Proprietary Rights

Proprietary
protection for our products, processes and know-how is important to our business. Our policy is to file patent applications to protect technology, inventions, and improvements that we consider important to the development of our business. We
continually strive for technological innovations to develop and maintain our competitive position. We aggressively prosecute our patents and protect our proprietary technology to maintain our proprietary position. Our success depends in large part
on our ability to obtain, protect and enforce commercially valuable patents.

We hold or have in-licensed a number of U.S. and foreign
patents covering certain proprietary technology and products, with over 75 U.S. patents granted to date, as well as over 100 patents granted in Europe, Canada, Japan, Australia, Singapore, Hong Kong, and Korea among others. In addition we hold over
65 pending U.S. applications, and over 200 corresponding foreign applications.

One of the key families of patents we hold relates to
anti-IgE antibodies and their use in the treatment of allergy-related disease. These patents cover Xolair and are licensed to Genentech and Novartis under our three-party collaboration and to Novartis under the Amended and Restated Development and
Licensing Agreement. The patents expire between 2008 and 2013, subject to potential patent term extension. In addition, we co-own other anti-IgE related patents with Novartis. We also have additional pending applications related to the treatment of
IgE-mediated disease.

Our portfolio also includes a family of patents that was in-licensed from Biogen Idec related to anti-CD4
antibodies. These patents cover TNX-355, and the U.S. patent expires in 2016, subject to potential patent term extension as it applies to TNX-355. Foreign patents, including those in Europe, Canada, and Australia, will expire in 2011, subject to
potential patent term extension. The application in Japan is still pending.

We purchased a portfolio of patents from Sunol Molecular
Corporation in 2005, including several issued U.S. patents, and numerous pending U.S. and foreign applications related to tissue factor inhibitors, including antibodies. We also have patents related to complement pathway inhibitors and
apoptosis-regulating proteins, including Bak and SARP. Our issued patents extend for varying periods according to the date of patent application filing or grant and the legal term of the patents in the various countries where patent protection is
obtained. The actual protection afforded by a patent, which can vary from country to country, depends upon the type of patent, the scope of its coverage and the availability of legal remedies in the country.



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In addition to patents, we rely on trade secrets and proprietary know-how. We seek protection in part
through confidentiality agreements and invention assignment agreements. Our policy is to require all employees, consultants, advisors, outside scientific collaborations, sponsored researchers, and other advisors to execute confidentiality agreements
upon commencing a relationship with Tanox.

Government Regulation

Our research and development activities and the manufacture and marketing of our products are subject to rigorous regulations relating to product safety and efficacy by numerous governmental authorities in the United
States and other countries. The Federal Food, Drug and Cosmetic Act and other federal and state statutes and regulations govern, among other things, the testing, manufacture, safety, effectiveness, labeling, storage, record keeping, approval,
advertising and promotion of our products in the U.S. The lengthy process of seeking drug approvals, and the subsequent compliance with applicable statutes and regulations, require the expenditure of substantial resources. Failure to comply with
applicable regulations can result in refusal by the FDA to approve product license applications. The FDA also has the authority to revoke previously granted product approvals.

Before we may market a pharmaceutical product in the U.S., the FDA requires us to complete a series of preclinical and human clinical tests. Other
countries have similar regulations. Preclinical tests include laboratory evaluations of product chemistry and animal studies to assess the potential safety and efficacy of the product and its formulations. The results of these studies must be
submitted to the FDA as part of the investigational new drug application (IND). Human clinical trials cannot begin until the FDA has had a chance to review the IND application. Clinical testing usually involves a three-phase process. In Phase 1, a
small number of patients or healthy volunteers are tested with the drug to assess its safety profile (adverse effects), dosage tolerance, absorption, metabolism, distribution, excretion and clinical pharmacology. In Phase 2, clinical trials are
conducted with groups of patients afflicted with a specified disease to provide enough data to evaluate the preliminary efficacy, optimal dosage regimen and expanded evidence of safety. In Phase 3, the drug is tested in a larger number of patients
with a target disease to provide enough data to statistically evaluate the efficacy and safety of the product as required by the FDA. If successful, the results of the preclinical and clinical testing of the product are then submitted to the FDA in
the form of a biological license application (BLA) for marketing approval. In responding to a BLA, the FDA may grant marketing approval, request additional testing or information (either before or after approval), refuse to file the BLA if deemed
inadequate, or deny the application if it determines that the application does not provide sufficient evidence of safety and efficacy for approval. Most pharmaceutical product candidates fail to produce data sufficiently compelling to enable
progression through all stages of development and to obtain FDA approval for commercial sale (see Item 1A. Risk Factors  Regulatory Risks  Developing therapeutic monoclonal antibodies is expensive and highly uncertain).

As part of the BLA, we must demonstrate that the drug is manufactured by a controlled process. Since any approval granted by the FDA is both site and
process specific, any material change in the manufacturing process, equipment or location necessitates additional FDA review and approval. Domestic manufacturing establishments are subject to FDA inspection and must comply with current good
manufacturing practices (cGMP) for pharmaceutical products. To supply products for use in the U.S., foreign manufacturing establishments must comply with cGMP and are subject to periodic FDA or other regulatory authority inspection under reciprocal
agreements with the FDA.

For marketing outside the U.S., we also are subject to regulatory requirements governing human clinical trials
and marketing approval for pharmaceutical products of foreign jurisdictions. The requirements governing the conduct of clinical trials, product licensing, pricing and reimbursement vary widely from country to country. Whether or not we obtain FDA
approval, we must obtain approval of a product by the comparable regulatory authorities of foreign countries before manufacturing for or



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marketing the product in those countries. The approval process and the time required for these approvals may differ substantially from that required for FDA
approval. Clinical trials we conduct in one country may not be accepted by other countries and approval in one country may not result in approval in any other country.

The levels of revenues and profitability of biopharmaceutical companies may be affected by the continuing efforts of government and third-party payers to contain or reduce the costs of health care through various
means. For example, in certain foreign markets, pricing or profitability of therapeutic and other pharmaceutical products is subject to governmental control. In the U.S. there have been, and we expect that there will continue to be, a number of
federal and state proposals to implement similar governmental control. Some of these proposals have included measures that would limit or eliminate payments for medical procedures and treatments or subject pharmaceutical product pricing to
government control. In addition, as a result of marketplace pressures, third-party payors are increasingly attempting to contain healthcare costs by limiting both coverage and the level of reimbursement of new drug products. Consequently,
significant uncertainty exists as to the reimbursement status of newly-approved healthcare products or products that may be approved in the future. If we or our collaborators succeed in bringing one or more of our products to market, we cannot
assure you that third-party payors will consider them cost effective or allow reimbursement to the consumer at price levels sufficient for us to realize an appropriate return on our investment in product development or to even realize a profit.
Significant changes in the healthcare system in the U.S. or elsewhere, including changes resulting from adverse trends in third-party reimbursement programs, could have a materially adverse effect on our revenues and profit potential of new or
existing products. Even though current insurance and Medicare/Medicaid coverage of Xolair in the U.S. is encouraging, any decreases in third-party reimbursement may negatively affect our collaborators commercialization of Xolair, which would
also adversely affect our business, financial condition and results of operations.

We are subject to various laws and regulation relating
to safe working conditions, clinical, laboratory and manufacturing practices, the experimental use of animals and the use and disposal of hazardous or potentially hazardous substances, including radioactive compounds and infectious disease agents,
used in connection with our research. The extent of government regulation applying to our business that might result from any legislative or administrative action cannot be accurately predicted.

Competition

The pharmaceutical and biotechnology
industries are characterized by rapidly evolving technology and intense competition. Many companies, including major pharmaceutical and chemical companies, as well as specialized biotechnology companies, perform activities similar to Tanoxs.
Many of these companies have substantially greater financial and other resources, larger intellectual property estates, larger research and development staffs, and greater capabilities and experience in preclinical testing, human clinical trials,
regulatory affairs, manufacturing and marketing. We chose to enter into the collaboration agreements with Novartis and Genentech, in part, to secure the benefit of their experience in these areas, as well as the contribution of their greater
financial resources. In addition, colleges, universities, governmental agencies and other public and private research organizations conduct research and may market commercial products on their own or through joint ventures. These institutions are
becoming more active in seeking patent protection and licensing arrangements to collect royalties for using technology that they have developed. We also compete with these institutions in recruiting and retaining highly qualified scientific
personnel.

The diseases that we have targeted, including asthma, allergy, inflammation, other diseases affecting the human immune system,
infectious diseases and cancer are intensely competitive areas targeted by both pharmaceutical companies and other biotechnology companies, including Novartis and Genentech. All of these companies may have competitive products on the market, may be
testing their products in clinical trials or may be focusing on product approaches that could prove to be superior to our



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approaches. For instance, we are aware that some of these companies, which may be our competitors, have filed applications for or have been issued patents
and may obtain additional patent and proprietary rights relating to products or processes used in, necessary to, competitive with or otherwise related to, our products or processes. These patents include, among other items, patents relating to
humanized monoclonal antibodies.

Our competition will be determined in part by the potential indications for which our antibodies are
developed and ultimately approved by regulatory authorities. For some of our potential products, an important factor in competition may be the timing of market introduction of our products or competitive products. Accordingly, we expect the relative
speed with which we develop our products, complete the necessary approval processes and are able to generate and market commercial quantities of the products to be important competitive factors. We expect that competition among products approved for
sale will be based, among other factors, on product efficacy and safety, timing and scope of regulatory approval, product availability, advantages over alternative treatment methods, price and cost-effectiveness, development, distribution and
marketing capabilities, third-party reimbursement and patent position.

Xolair faces competition from other asthma therapies, including
inhaled corticosteroids, long acting beta-agonists, combination products such as fixed dose inhaled corticosteroids/ long acting beta-agonists and leukotriene inhibitors, as well as oral corticosteroids and immunotherapy.

We expect our TNX-355 program will face competition from existing HIV therapies and particularly new viral entry inhibitors that target CCR5, CXCR4 and
gp120 receptors, such as Fuzeon (Roche/Trimeris), PRO-140 (Progenics), Vicriviroc (Schering-Plough) and Maraviroc (Pfizer/Millenium).

The
TNX-650 program is expected to face competition in both Hodgkins Lymphoma (HL) and asthma. In HL, the potential competitors include licensed drugs and the following products in development: GX15-070 (Gemin X Biotechnologies), SGN-30 (Seattle
Genetics), Ferritarg P (MAT Biopharma) and MDX-1401 (Medarex). In asthma, TNX-650 is expected to face competition from existing asthma therapies and other compounds in development such as CAT-354 (Cambridge Antibody Technologies/AstraZeneca),
AMG-317 (Amgen), anti-IL13 MAb (Centocor/Johnsonn Johnson), IL-4/IL-13 TRAP (Regeneron), BAY 169996 (Aerovance) and Anti-IL-13Ra1 (Merck/Zenith).

Our competitive position also depends upon our ability to:



| |  |  | discover or acquire and successfully develop new therapeutic products that successfully and safely treat human diseases;
| | - |  | ------------------------------------------------------------------------------------------------------------------------



| |  |  | develop proprietary products or processes for which we can obtain patent protection and secure necessary licenses under third party patents;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | secure sufficient capital resources to complete product development and regulatory processes;
| | - |  | ---------------------------------------------------------------------------------------------



| |  |  | build or secure manufacturing capacity and manufacture safely, efficiently and in accordance with regulatory requirements;
| | - |  | --------------------------------------------------------------------------------------------------------------------------



| |  |  | enter into collaboration and licensing agreements on acceptable terms;
| | - |  | ----------------------------------------------------------------------



| |  |  | secure licenses from third parties holding patents that may affect the manufacture or marketing of our products;
| | - |  | ----------------------------------------------------------------------------------------------------------------



| |  |  | attract and retain qualified personnel;
| | - |  | ---------------------------------------



| |  |  | build or obtain a sales organization; and
| | - |  | -----------------------------------------



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| |  |  | achieve profitable commercial production of our products.
| | - |  | ---------------------------------------------------------

Manufacturing

We have two manufacturing facilities, one owned in Houston, Texas and another leased in San Diego,
California. Our Houston facility includes a 1,500 liter bioreactor system and purification suite and occupies approximately 14,000 square feet of space. We have produced multiple lots of products for use in our Phase 1 and Phase 2 clinical trials in
this facility. In January 2005, we assumed the lease on a biologics manufacturing facility in San Diego, California. The San Diego facility occupies approximately 76,000 square feet and includes two 2,750 liter bioreactor systems, purification and
formulation suites, a small 500 liter clinical manufacturing suite, quality control laboratories, process development space and offices. We have produced late stage clinical trial material in the San Diego facility. Both the Houston and San Diego
facilities are only capable of producing bulk products. We outsource fill and finish operations to contract manufacturing organizations.

We expect that our current manufacturing facilities should provide adequate capacity for manufacturing our clinical trial materials for the foreseeable future. However, these facilities are not adequate for commercial scale manufacturing
requirements. Should TNX-355 or any of our other products succeed in clinical development and gain marketing approval, we will need commercial scale manufacturing capacity. We will evaluate alternatives for securing commercial manufacturing
capacity, including the possible construction of a commercial plant on our own or entering into long-term contract manufacturing agreements with third parties.

Research and Development

Company sponsored research and development expenses were $53.4 million, $47.9 million and $27.2
million in 2006, 2005 and 2004, respectively. In 2005, Tanox also recorded $13.7 million for acquired in-process research and development related to the acquisition of a tissue factor antagonist program. We expect that research and development
expenses will continue to increase as we seek to identify new product opportunities and expand development of our current and future product pipeline.

Marketing and Sales

Under our collaboration agreements, Novartis and Genentech have responsibility for marketing Xolair,
our only marketed product. To effectively serve the worldwide markets, we intend to continue to collaborate with major pharmaceutical companies or prominent pharmaceutical sales and distribution organizations that can successfully market our
products on a worldwide basis or within specific geographic territories. As we pursue strategic collaborations, we intend to reserve marketing rights for our products in the United States and Asia, to the extent commercially reasonable. We expect to
focus initially on markets for which our products have a clear advantage over other therapies or which we may target using a relatively small sales force. We currently do not have an internal sales and marketing capability. If we elect to retain
marketing rights, we will have to build a sales and marketing infrastructure.

For financial information about concentration of credit risk
and geographic areas, please read Note 2 and Note 13, respectively, to our consolidated financial statements included in this Form 10-K.



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Employees

At December 31, 2006, we had 197 full-time employees, all but 3 of which are based in the U.S. We do not maintain key employee life insurance on any of our personnel.

Corporate History

We were incorporated in Delaware in 2000 as the successor to a corporation formed
in 1986 under the laws of the State of Texas.

Available Information

Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports are available free of charge on or through our internet website at http://www.tanox.com as
soon as reasonably practicable after we file the reports with the Securities and Exchange Commission (SEC). Electronic filings with the SEC are also available on the SEC internet website at http://www.sec.gov.

Executive Officers of Tanox

Our executive officers
and their ages and positions with Tanox are:



|                           |  |     |  |                                              
|-------------------------- |  | --- |  | ---------------------------------------------
|Name                       |  | Age |  | Position                                     
|Danong Chen, Ph.D., M.B.A. |  | 46  |  | President and Chief Executive Officer        
|Edward Hu, M.B.A.          |  | 44  |  | Chief Operating Officer                      
|Zhengbin (Bing) Yao, Ph.D. |  | 41  |  | Vice President of Research                   
|Gregory P. Guidroz, C.P.A. |  | 54  |  | Vice President of Finance                    
|Katie-Pat Bowman, J.D.     |  | 52  |  | Vice President, General Counsel and Secretary
|Brian Kim.                 |  | 46  |  | Vice President of Quality                    
|Hugo Santos                |  | 56  |  | Vice President of Human Resources            

Danong Chen, Ph.D., M.B.A., was promoted to President and Chief Executive Officer of Tanox
in February 2006. From February 2005 through January 2006, Dr. Chen served as Vice President of Corporate Development and Project Management, a position in which she was responsible for evaluating new product opportunities, potential
acquisition transactions and overseeing corporate projects. From January 2004 through January 2005, Dr. Chen served as Director of Strategy and, from March 2002 through December 2003, as Associate Director of Strategy. Prior to joining Tanox,
Dr. Chen served as a manager in the healthcare practice of Arthur D. Little, Inc., a strategic consulting company, from 1999 to March 2002, where she managed and participated in projects ranging from benchmarking pharmaceutical research and
development, evaluating contract manufacturing organizations to multinational product launch strategy. Dr. Chen received her Ph.D. in Neuroscience from Baylor College of Medicine and an M.B.A. from the Arthur D. Little School of Management.



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Edward Hu, M.B.A., was promoted to Chief Operating Officer of Tanox in February 2006 after serving
as Vice President of Operations since January 2005. From January 2004 until January 2005, Mr. Hu served as Vice President - Financial Planning, Project & Portfolio Management, where he managed both internal and collaborative projects
and oversaw the project portfolio review process. Mr. Hu had been Director of Finance from July 2002 to January 2004 and previously served as Associate Director of Financial Planning and Analysis from the time he joined Tanox in October 2000.
From 1998 to 2000, he held the position of Manager of Financial Planning and Analysis with Biogen, Inc. (n/k/a Biogen Idec, Inc.), where he managed the business planning of Biogen's R&D and clinical operations, managed long range planning, and
provided project planning and analysis support to key development project teams. From 1996 to 1998 he was a Senior Financial Analyst with Merck & Co., Inc. Mr. Hu received his M.B.A. and completed his Ph.D. work, all but dissertation,
in Biophysics and Biochemistry at Carnegie Mellon University.

Zhengbin (Bing) Yao, Ph.D., was promoted to Vice President of
Research in April 2005. Dr. Yao has held various positions in Tanoxs research department since October 2000, most recently as Senior Director of Discovery Biology. Prior to joining, Tanox, he served as the Head of Molecular Biology and
Genomics in the Central Nerve System Diseases Group at Aventis Pharmaceuticals in Bridgewater, N.J. Between 1996 and 1998, Dr. Yao was employed by Amgen, Inc. as a research scientist. He is the inventor or co-inventor on more than 20 issued
patents and patent applications and has had more than 40 articles published in peer-reviewed journals. Dr. Yao received his doctorate in Microbiology/Immunology from the University of Iowa and completed his post-doctoral training at Immunex
Corporation.

Gregory P. Guidroz, C.P.A., has served as our Vice President of Finance since July 2002. Prior to joining Tanox,
Mr. Guidroz served as Chief Financial Officer for Integrated Diagnostic Centers, Inc., a diagnostic imaging center company, from July 1999 until July 2002. He was Co-Founder and Chief Financial Officer for NPPA of America, Inc., a multi-state
provider of nurse practitioner and physician assistant services, from April 1998 until March 1999 when it was acquired. From June 1995 until March 1998, he was a Principal with Healthcare Solutions, Inc., a healthcare management consulting firm.
From November 1975 until May 1995, Mr. Guidroz held Chief Financial Officer or Controller positions in various healthcare and software corporations. He began his career on the audit staff of Arthur Andersen after receiving a BBA from Lamar
University. Mr. Guidroz was also a Partner with Tatum CFO Partners, LLP from July 1999 through April 2004.

Katie-Pat Bowman, J.D.,has served as our Vice President, General Counsel and Secretary since July 2000. Prior to that she was Senior Corporate Counsel and Assistant Secretary for Lyondell Chemical Company from September 1999 until July 2000. She was Vice President and
General Counsel for Daniel Industries Inc., a pipeline equipment manufacturer, from September 1997 until September 1999, when it was acquired. Prior to that, she practiced law with the Houston-based law firm Fulbright & Jaworski, L.L.P.
since 1987. Ms. Bowman, a CPA, practiced public accounting and worked in industry as an accountant from 1977 through 1987. She received both a Juris Doctorate and BBA from the University of Houston.

Brian Kim was appointed Vice President of Quality in July 2005. Mr. Kim joined Tanox in October 2002 and served until March 2004 as our
Senior Director of Quality. He left Tanox to serve as Director of Quality for Allergan, Inc., a global specialty pharmaceutical company, from March 2004 until November 2004, when he rejoined Tanox. From March 2002 until October 2002, Mr. Kim
served as a consultant in the international pharma/biopharma arena. From March 2001 until February 2002, he served as Senior Director of Quality for Valentis, Inc., a biotechnology company, and from March 1998 until March 2001, he served as
Director, API Compliance and Validation for Pharmacia Corporation (now Pfizer). Mr. Kim started his career at Anthony Products Company in Arcadia, Calif., where he served for six years as supervisor, manager and director in Manufacturing and
Quality Control. He received his Masters degree in Biological Sciences from the University of Northern Colorado.



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Hugo Santos has been our Vice President of Human Resources since December 2004. Prior to joining
Tanox, Mr. Santos was co-founder and Vice President of the Human Capital Practice for HR Drivers, a consulting firm in San Francisco, California, from November 2001 until December 2004 when the firm was sold. From October 2000 until November
2001, Mr. Santos served as Executive Vice President of Human Resources for JNI Corporation in San Diego, California, a designer and supplier of enterprise storage connectivity products. From November 1994 through October 2000, Mr. Santos
was Vice President of Human Resources for Applied Biosystems Corporation in Foster City, California, a supplier of life science technology. For 10 years prior to that, Mr. Santos worked for National Semiconductor Corporation where he held a
variety of human resources positions. He received his BA in labor relations from Pace University in New York.

Scientific Advisors

An important component of our scientific strategy is to establish collaborative relationships with leading researchers in our fields of interest. Our
scientific advisors attend periodic meetings and provide us with specific expertise in both research and clinical development. In addition, we have collaborative research relationships with certain individual advisors. We do not employ our
scientific advisors, and they may have commitments to or consulting or advisory agreements with other entities. In general, our scientific advisors have been awarded stock options, may own our stock and receive financial remuneration for their
services.



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|ITEM 1A. | Risk Factors
|-------- | ------------

Our future financial condition and
results of operations, as well as any forward-looking statements, are subject to inherent risks and uncertainties, including but not limited to the risk factors set forth below, and actual results could differ materially from those projected or
assumed in the forward-looking statements due to a number of factors, including:



| |  |  | our ability to develop safe and effective drugs;
| | - |  | ------------------------------------------------



| |  |  | failure to achieve positive results in preclinical and toxicology studies in animals or clinical trials in humans;
| | - |  | ------------------------------------------------------------------------------------------------------------------



| |  |  | failure to economically and timely manufacture sufficient amounts of our products with the requisite quality for clinical trials and commercialization activities;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | failure to receive, or delay in receiving, marketing approval for our products;
| | - |  | -------------------------------------------------------------------------------



| |  |  | failure to successfully finance and commercialize our products, including gaining market acceptance;
| | - |  | ----------------------------------------------------------------------------------------------------



| |  |  | our ability to manage relationships with collaboration partners;
| | - |  | ----------------------------------------------------------------



| |  |  | our ability to obtain, maintain and successfully enforce patent and other proprietary rights protection of our products;
| | - |  | ------------------------------------------------------------------------------------------------------------------------



| |  |  | variability of royalty, license and other revenues, and potential adjustments and changes in amounts paid to us and amounts we may be required to pay to third
parties, including our former attorneys under an adverse arbitration award;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our ability to use our manufacturing capacity and facilities costs effectively and in accordance with regulatory requirements;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------



| |  |  | our ability to establish comparability of our bulk drug substances before and after manufacturing changes;
| | - |  | ----------------------------------------------------------------------------------------------------------



| |  |  | our ability to enter into future collaboration agreements to support our research and development activities;
| | - |  | -------------------------------------------------------------------------------------------------------------



| |  |  | drug withdrawal from the market due to serious adverse reactions caused by the marketed drug;
| | - |  | ---------------------------------------------------------------------------------------------



| |  |  | our ability to secure licenses from third parties holding patents that may affect the manufacture or marketing of our products;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------



| |  |  | competition and technological change;
| | - |  | -------------------------------------



| |  |  | existing and future regulations affecting our business, including the content, timing of submissions and decisions made by the FDA and other regulatory agencies;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | governmental changes affecting Medicare and the healthcare and pharmaceutical industries including policies that affect coverage and levels of reimbursement for
sales of our products;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | our ability to hire and retain experienced managers and scientists; and
| | - |  | -----------------------------------------------------------------------



| |  |  | developments with respect to the proposed merger with Genentech.
| | - |  | ----------------------------------------------------------------

The following section discusses important risks and uncertainties that could materially and adversely affect our business, results of operations and financial condition, which in turn could materially and adversely
affect the trading price of our common stock.

Risks Relating to Our Industry, Business and Strategy

We are subject to business uncertainties and contractual restrictions in connection with the proposed acquisition by Genentech that could adversely
affect our stock price and future business and operations.

On November 9, 2006, we announced that we had entered into a
definitive agreement to be acquired by Genentech in an all-cash transaction. The proposed acquisition is subject to the satisfaction of customary closing conditions, including expiration of the waiting period under the Hart-Scott-Rodino Antitrust
Improvements Act and absence of a material adverse effect with respect to Tanox. On January 29, 2007, we and Genentech received a second request from the Federal Trade Commission (FTC) in connection with the proposed acquisition, which extends
the waiting period. On February 21, 2007, the Food and Drug Administration announced that it had requested that Genentech submit draft labeling incorporating a boxed warning and other changes in the Xolair package insert. The labeling
would provide additional information to practitioners and patients of the potential risk of anaphylaxis associated with the administration of Xolair. The FDA also advised that health care providers should observe patients for at least two hours
after dosing. Genentech has requested a meeting with the FDA to discuss its request and is evaluating the effect the FDA action may have on Xolair and the merger. Genentech has advised Tanox that it has not reached any conclusions regarding such
potential effect. While we and Genentech continue to engage in active and productive discussions with the FTC and Genentech anticipates further discussions with the FDA regarding Xolair, there can be no assurance that we will be able to reach an
agreement or that the other conditions to closing will be satisfied and the merger successfully completed.

Uncertainty about the proposed
merger and its possible effect on our employees and other constituencies have had a negative effect on Tanox. Retention of certain employees has been challenging during the pendency of the merger, as employees experience uncertainty about their
future roles after the merger or the prospects of Tanox if the merger does not occur. If key employees depart because of issues relating to the uncertainty and difficulty of integration or a desire not to remain with Genentech after the merger or
with Tanox if the merger is not consummated, our business could be harmed. If the merger is not consummated, our success will depend not only on retaining our existing staff, but on our ability to attract and retain additional qualified scientific,
manufacturing, clinical and other technical personnel. There is intense competition for qualified staff, and we may not be able to attract and retain additional qualified staff to develop our business.

The merger agreement restricts us from taking specified actions without the consent of Genentech, including making certain capital expenditures, entering
into material contracts and other matters. These restrictions may prevent us from pursuing attractive business opportunities that may arise prior to the completion of the merger and may impede our growth and limit the development of our projects,
which could negatively impact our business and potential for revenues, earnings and cash flows in the event the merger does not occur.



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Finally, in the event the merger is not completed:



| |  |  | the market price of shares of our common stock may decline to the extent that the current market price of those shares reflects a market assumption that the merger
will be completed; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | we will have incurred significant transaction costs related to the proposed merger, including legal, accounting and financial advisory fees.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------

Our ability to become a profitable fully integrated biopharmaceutical company will depend on the continued commercial
success of Xolair and on the success of our products in clinical development or our success in securing, developing and commercializing new clinical candidates.

We anticipate that, in the near term, our ability to become profitable will depend in large part on the success of our collaboration partners in generating significant levels of sales of Xolair. In the longer term, an
important part of our strategy is to become a fully integrated biopharmaceutical company. Our ability to do so will depend on the successful development, approval and commercialization of TNX-355, TNX-650, or of potential new clinical-stage drug
candidates that we may develop or otherwise in-license or acquire.

All of our product candidates, other than TNX-355 and TNX-650, are in
preclinical development or in research, and we do not expect to seek regulatory approval of these candidates for many years, if ever. A significant portion of the research that we are conducting involves new and unproven technologies. Research
programs to identify new disease targets and product candidates require substantial technical, financial and human resources whether or not we ultimately identify any candidates. Our research programs may show promise initially in identifying
potential product candidates, yet fail to yield product candidates for clinical development.

In addition, if we do not achieve the
clinical endpoints in our clinical studies of TNX-355 and TNX-650, we may decide to terminate development of those products. Even if we reach our endpoints, the results of the trials may indicate that further development or commercialization of
TNX-355 and TNX-650 would not be economically viable. In that event, we would need to in-license or acquire suitable product candidates or products from third parties, and we may not be able to so for a number of reasons. The licensing and
acquisition of pharmaceutical products is highly competitive. A number of more established companies, including large pharmaceutical companies, are aggressively pursuing strategies to license or acquire products in the fields in which we are
interested. These established companies have a competitive advantage over us due to their size, cash and other resources, and greater clinical development and commercialization capabilities and experience. Other factors that may prevent us from
licensing or otherwise acquiring suitable product candidates include the following:



| |  |  | we may be unable to license or acquire the relevant technology on terms that would allow us to make an appropriate return from the product;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | companies that perceive us to be their competitors may be unwilling to assign or license their product rights to us; or
| | - |  | -----------------------------------------------------------------------------------------------------------------------



| |  |  | we may be unable to identify suitable products or product candidates within our areas of expertise.
| | - |  | ---------------------------------------------------------------------------------------------------

Even if we are successful in developing and securing marketing approval of TNX-355, TNX-650 or other in-licensed or acquired product candidates, we may
be unable to successfully launch, market or otherwise commercialize the product.

If we are unable to secure suitable potential product
candidates through internal research programs or by acquiring drugs or drug candidates from third parties, or if we are unable to successfully develop, launch, market or commercialize the product(s), our goal of becoming a fully integrated
biopharmaceutical company will not materialize, and our profit potential will be harmed.



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Failure to secure future collaboration partners for our products or failure by those partners to
develop, manufacture, market or distribute those products, or pay the royalties and other payments we expect, may delay or significantly impair our ability to generate revenues or profit.

We intend to rely on future collaboration partners to develop, manufacture, commercialize, market or distribute certain of our product candidates, both
to allocate financial risk and to secure the expertise that those partners may have in one or more of the foregoing areas. Many of our competitors are similarly seeking to develop or expand their collaboration and license arrangements with
pharmaceutical companies. The success of these efforts by our competitors could have an adverse impact on our ability to form future collaboration arrangements. Also, the pharmaceutical companies that we may target for one or more of our product
candidates might require a profit return that is greater than what our product may be able to deliver. The process of establishing collaborative relationships is difficult and time consuming and involves significant uncertainty. We may not be able
to negotiate acceptable collaboration agreements in the future. To the extent that we are unable to enter into future collaboration agreements, we would encounter increased capital requirements to undertake research, development and marketing at our
own expense, and, in some cases, may have to discontinue development of one or more products. If we continue to develop certain products on our own, we may experience significant delays in introducing our product candidates or find that the absence
of these collaboration agreements adversely affects our ability to manufacture or sell our product candidates, particularly outside the U.S.

Even if we enter into future collaborative agreements, we cannot assure you that efforts under these agreements will succeed because:



| |  |  | the contracts may fail to provide significant protection or may become unenforceable if the partners fail to perform;
| | - |  | ---------------------------------------------------------------------------------------------------------------------



| |  |  | our partners may not commit enough capital or other resources to successfully develop, market or distribute our products;
| | - |  | -------------------------------------------------------------------------------------------------------------------------



| |  |  | our partners may not continue to develop and commercialize products resulting from our collaborations; and
| | - |  | ----------------------------------------------------------------------------------------------------------



| |  |  | disputes with our partners may arise that could delay or terminate our product candidates research, development or commercialization or result in significant
litigation or arbitration.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

If any of these contingencies occur, our revenues, results of operations, product
development, productivity and business may suffer.

We face intense competition and rapid technological change that could result in
products superior to the products we are developing.

The biotechnology and pharmaceutical industries are subject to rapid and
significant technological change. We have numerous competitors in the U.S. and abroad, including, among others, major pharmaceutical and chemical companies, specialized biotechnology firms, universities and other research institutions. These
competitors may develop technologies and products that are more effective or less costly than, or otherwise preferable to, any of our current or future products, and that could render our technologies and products obsolete or noncompetitive. Many of
these competitors have substantially more resources and product development, production and marketing capabilities than we do. We cannot be certain that one or more companies will not receive patent protection that dominates, blocks or otherwise
adversely affects our product development or business. In addition, many of our competitors have significantly greater experience than we do in undertaking preclinical testing and clinical trials of



18



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##### Index to Financial Statements

pharmaceutical products and obtaining FDA and other regulatory approvals of products. If we succeed in achieving commercial sales of our products, we also
will be competing in commercial manufacturing efficiency and marketing capability, areas in which we have no experience. Our competitors may obtain FDA approval for products sooner or be more successful in manufacturing and marketing their products
than are we or our collaborators.

Xolair competes, and our drug candidates that are successfully developed and approved for marketing will
compete, with numerous existing therapies, as well as a significant number of drugs that are currently under development and will become available in the future for the treatment of allergic asthma, HIV and other diseases targeted by our product
candidates. The introduction of new products or follow-on biologics or new information about existing products may result in lost market share or lower prices. Our collaborators abilities to successfully market Xolair or expand its usage and
our ability to bring new products to the marketplace and successfully compete for market acceptance and market share among physicians, patients, healthcare payors and the medical community, will depend on many factors:



| |  |  | relative efficacy and safety of our products;
| | - |  | ---------------------------------------------



| |  |  | timing and scope of regulatory approval;
| | - |  | ----------------------------------------



| |  |  | product availability;
| | - |  | ---------------------



| |  |  | potential advantages over alternative treatment methods;
| | - |  | --------------------------------------------------------



| |  |  | development, marketing, distribution and manufacturing capabilities and support of our collaborators, if any;
| | - |  | -------------------------------------------------------------------------------------------------------------



| |  |  | reimbursement coverage from Medicare/Medicaid, insurance companies and others;
| | - |  | ------------------------------------------------------------------------------



| |  |  | price and cost-effectiveness of our products;
| | - |  | ---------------------------------------------



| |  |  | ability to produce drug candidates in commercial quantities at a reasonable cost;
| | - |  | ---------------------------------------------------------------------------------



| |  |  | scope of patent protection for our products; and
| | - |  | ------------------------------------------------



| |  |  | availability of licenses under third party technology and patent rights.
| | - |  | ------------------------------------------------------------------------

If our products are not competitive based on the foregoing or other factors, our business, financial condition and results of operations will be
materially harmed.

We may be subject to product liability and other claims, and our insurance coverage may not be adequate to cover
these claims.

Our business exposes us to potential product liability risks, which are inherent in testing, manufacturing, marketing
and selling pharmaceutical products. We may be held liable if any product we develop, or any product that uses or incorporates any of our technologies, causes side effects, injury or is found otherwise unsuitable during clinical testing,
manufacturing, marketing or sale. We cannot assure you that we will be able to avoid product liability exposure.

Product liability
insurance for the biopharmaceutical industry is generally expensive. Although we currently maintain product liability insurance covering our products in amounts we believe to be commercially reasonable, we cannot assure you that our coverage is
adequate or that continued coverage will be available at acceptable costs. In addition, some of our license and collaboration agreements require us to obtain product liability insurance. Future license and collaboration agreements may also



19



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##### Table of Contents

##### Index to Financial Statements

include such a requirement. Our inability to obtain sufficient insurance coverage at an acceptable cost or otherwise to protect against potential product
liability claims could prevent or inhibit us or our collaborators from commercializing our products. A successful claim in excess of our insurance coverage could materially harm our business, financial condition and results of operations. In
addition, any such claim could materially reduce our future revenues from sales of those products.

Our insurance coverage may not be
adequate to cover other claims and losses resulting from operating, manufacturing and business hazards, including natural disasters.

We
deal with hazardous materials and must comply with environmental laws and regulations, which can be expensive and restrict how we do business.

Our research and development work and manufacturing processes involve the controlled use of hazardous materials, including chemical, radioactive and biological materials. Our operations also produce hazardous waste products. We are subject
to federal, state and local laws and regulations governing how we use, manufacture, store, handle and dispose of these materials. Although we believe that we comply in all material respects with applicable environmental laws and regulations, we
cannot assure you that we will not incur significant costs to comply with environmental laws and regulations in the future. In addition, current or future environmental laws and regulations may impair our research, development or production efforts.

We could be liable for damages, penalties or other forms of censure if we are involved in a hazardous waste spill or other accident.

Despite precautionary procedures that we implement for handling and disposing of hazardous materials, we cannot eliminate the risk of
accidental contamination or discharge or any resultant injury from these materials. If a hazardous waste spill or other accident occurs, and we are held liable for damages, the liability could exceed our financial resources.

Regulatory Risks

Developing therapeutic
monoclonal antibodies is expensive and highly uncertain.

Successful development of therapeutic monoclonal antibodies is highly
uncertain. First, we must discover or otherwise acquire drug candidates. Then we must demonstrate through preclinical studies and clinical trials that our products are safe and effective for use in a particular target indication before we can obtain
regulatory approvals to sell our products commercially to that patient group. These studies and trials tend to be very costly and time consuming. Furthermore, the results of preclinical studies and initial clinical trials of our products do not
necessarily predict the results from later-stage clinical trials, which must demonstrate the desired safety and efficacy traits.

Products
that appear promising in research or early phases of development may not reach later stages of development or be submitted for marketing approval for a number of reasons, including:



| |  |  | Preclinical tests indicate that the product is toxic or otherwise lacks efficacy in animals;
| | - |  | --------------------------------------------------------------------------------------------



| |  |  | The product is found to be less effective than required or causes serious adverse reactions or side effects in patients participating in clinical trials; often
these reactions may not be detectable in small, early stage trials and can only be identified when the product is administered to a larger patient base, as in Phase 3 trials or following market approval;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The commercial introduction of competitive drugs that may have greater efficacy or safety than our product or otherwise adversely impact the risk/benefit profile of
our product;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Index to Financial Statements

| |  |  | We are unable to develop manufacturing methods that are efficient, cost-effective and capable of meeting stringent regulatory standards; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Proprietary rights of third parties may cover our products, and we are not able to secure licenses on reasonable terms.
| | - |  | -----------------------------------------------------------------------------------------------------------------------

Our products other than Xolair require significant additional laboratory development or clinical trials before they can be submitted for marketing
approval. We have limited capacity to conduct and manage clinical trials, and we rely on third parties, potentially including collaborative partners and contract research organizations, to assist us in these efforts. Our reliance on third parties
may result in delays in completing, or failing to complete, clinical trials if our collaborators or contractors fail to perform under our agreements with them. If our large-scale trials are not successful or we are otherwise unable to satisfy the
BLA filing requirements, we would not be able to recover our substantial investment in developing the product.

We may be unable to
enroll sufficient patients in a timely manner in order to complete our clinical trials.

The speed with which we are able to enroll
patients in clinical trials is an important factor in determining how quickly we may complete clinical trials and the cost of running those trials. Many factors affect patient enrollment, including the size of the patient population, the proximity
of patients to clinical sites, the eligibility criteria for the study, perceived risks and benefits of the drug under study, whether the drug will continue to be made available to the patient following completion of the trial, the success of our
personnel in making the arrangements with potential clinical sites and other ongoing trials directed at the same indication. Any of these factors may make it difficult for us to enroll enough patients to complete trials.

Delays in patient enrollment will result in increased costs and program delays, which could slow down our product development and approval process. Even
if the trials are ultimately completed and the product is approved for sale, a program delay could compromise the commercial viability of our drug relative to competitive therapies, which could materially harm our business and results of operations.

If we do not receive and maintain regulatory approvals, we will not be able to market our products.

The biotechnology and pharmaceutical industries are subject to stringent regulation with respect to product safety and efficacy by various international,
federal, state and local authorities. Of particular significance are the FDA's requirements covering research and development, testing, manufacturing, quality control, labeling and promotion of drugs for human use. A biotherapeutic cannot be
marketed in the U.S. until it has been approved by the FDA, and then can only be marketed for the indications approved by the FDA. As a result of these requirements, the length of time, the level of expenditures and the laboratory and clinical
information required for approval of a BLA, are substantial and can require a number of years.

Our collaboration partners have secured
approval to market Xolair in over 50 countries, including the U.S. and the European Union. However, there can be no assurance that Xolair will be approved for sale in other markets.

Tanox has not prepared or submitted any marketing approval applications to the FDA or any other regulatory agency for any of its products. The FDA can
delay, limit or not grant marketing approval for our products for many reasons, including:



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##### Index to Financial Statements

| |  |  | their belief that a product candidate is not safe and effective;
| | - |  | ----------------------------------------------------------------



| |  |  | their interpretation of data from preclinical testing and clinical trials may be different than our interpretation;
| | - |  | -------------------------------------------------------------------------------------------------------------------



| |  |  | failure of our manufacturing processes or facilities to meet cGMP standards; and
| | - |  | --------------------------------------------------------------------------------



| |  |  | changes in approval policies and guidelines or adoption of new regulations.
| | - |  | ---------------------------------------------------------------------------

The process of obtaining approvals to manufacture and market our products in foreign countries is subject to delay and failure for similar reasons.

Even if we or our collaboration partners secure marketing approval for a product, the approval may be conditioned, as is Xolairs, on our successful
completion of post-marketing clinical studies or may impose limitations on the indicated uses for which our products may be marketed. In addition, each marketed product and its manufacturer continue to be subject to strict conditions and regulation
after approval. Any unforeseen problems with an approved product or any violation of regulations could result in restrictions on the product, including, for example, changes in its labeling, written notices to physicians or a product recall. An
approval for a limited indication reduces the size of the potential market for the product.

Delays in receiving or failing to receive
regulatory approvals, losing previously received approvals to market Xolair or proposed Xolair label changes would delay or otherwise impact product commercialization, which would adversely affect our business, financial condition and results of
operations.

We are subject to the uncertainty related to reimbursement policies and healthcare reform measures.

In recent years, there has been legislation and numerous proposals to change the healthcare system in the U.S. Some of these measures limit or eliminate
payments for medical procedures and treatments or subject pharmaceutical product pricing to government control. In addition, as a result of marketplace pressures, third-party payors are increasingly attempting to contain healthcare costs by limiting
both coverage and the level of reimbursement of new drug products. Consequently, significant uncertainty exists as to the reimbursement status of newly approved healthcare products. If we succeed in bringing one or more of our products to market, we
cannot assure you that third-party payors will consider them cost effective or allow reimbursement to the consumer at price levels sufficient for us to realize an appropriate return on our investment in product development or to even realize a
profit.

Significant changes in the healthcare system in the U.S. or elsewhere, including changes resulting from adverse trends in
third-party reimbursement programs, could materially reduce our potential profitability and harm our ability to raise the capital we would need to continue our operations. Furthermore, any decreases in third-party reimbursement may negatively affect
our collaborators commercialization of Xolair, which would also adversely affect our business, financial condition and results of operations.

New accounting pronouncements or regulatory rulings may impact our future financial position or results of operations.

There may be new accounting pronouncements or regulatory rulings which may have an impact on our future financial position or results of operations. In December 2004, the Financial Accounting Standards Board
(FASB) issued a revision of Statement of Financial Accounting Standards (or FAS) No. 123, Accounting for Stock-Based Compensation. The revision is referred to as FAS 123R 



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##### Index to Financial Statements

Share-Based Payment (or FAS 123R), which supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, (or
APB 25) and requires companies to recognize compensation expense, using a fair-value based method, for costs related to share-based payments including stock options and stock issued under employee stock plans. Tanox adopted FAS 123R
using the modified prospective basis on January 1, 2006. The adoption of FAS 123R resulted in compensation expense that reduced earnings per share by $0.08 per share for the year 2006.

In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes 
an Interpretation of FASB Statement No. 109, (FIN 48). This interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprises financial statements in accordance with FASB Statement No. 109,
Accounting for Income Taxes. The interpretation prescribes a recognition threshold and measurement attribute for a tax position taken or expected to be taken in a tax return and also provides guidance on derecognition, classification,
interest and penalties, accounting for interim periods, disclosure and transition. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006. We are currently evaluating the impact, if any, this statement may
have on our financial statements.

Risks Associated with Manufacturing and Marketing

Our revenues are dependent on the continued market acceptance and successful commercialization of Xolair.

Our results of operations and future prospects are highly dependent on increasing the sales of our only commercial product, Xolair. Our revenues in 2006
consisted largely of revenue relating to sales of Xolair and payments based on the quantity of Xolair manufactured, and we expect that these Xolair-related revenues will constitute a larger percentage of our revenue in the next several years. While
current insurance and Medicare/Medicaid coverage of Xolair is adequate, we cannot be certain that physicians, patients and payors will continue to widely accept Xolair as a treatment for its approved indication in the U.S. or in any foreign markets.
On February 21, 2007, the FDA announced it requested that Genentech strengthen the existing warning on the potential risk for anaphylaxis in patients receiving Xolair by adding a boxed warning to the product label and implementing a Risk
Mitigation Action Plan, including providing a medication guide for patients and advice to health care providers to observe patients for at least two hours after dosing. A number of other factors may affect the rate and level of Xolair's ongoing or
continued market acceptance, including:



| |  |  | the effectiveness of Novartis' and Genentech's sales and marketing efforts;
| | - |  | ---------------------------------------------------------------------------



| |  |  | the perception by physicians and other members of the healthcare community of Xolair's safety, efficacy and benefits compared to those of competing products or
therapies;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the willingness of additional physicians to adopt a new asthma treatment regimen;
| | - |  | ---------------------------------------------------------------------------------



| |  |  | Xolair's price relative to other products or competing treatments;
| | - |  | ------------------------------------------------------------------



| |  |  | the availability of third-party reimbursement;
| | - |  | ----------------------------------------------



| |  |  | the ability to conduct the Xolair post marketing commitment studies and the impact of the study results on the labeling of Xolair;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------



| |  |  | the ability to secure marketing approval for Xolair in Asia;
| | - |  | ------------------------------------------------------------



| |  |  | regulatory developments related to manufacturing or using Xolair, including any change in labeling or advice to health care providers;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------



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##### Index to Financial Statements

| |  |  | the results of clinical development efforts for potential new indications for Xolair, and the scope and timing of additional marketing approvals and favorable
reimbursement programs for any such expanded use;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | availability of sufficient quantities of Xolair for commercial and clinical purposes;
| | - |  | -------------------------------------------------------------------------------------



| |  |  | increased competition for Xolair from new or existing products, which may demonstrate better safety, efficacy, cost-effectiveness or ease of administration than
Xolair; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | other adverse side effects or unfavorable publicity concerning Xolair.
| | - |  | ----------------------------------------------------------------------

If the level of Xolair sales declines or fails to increase, our financial condition, results of operations and future potential would be significantly
harmed.

We have limited experience in manufacturing, and manufacturing problems or delays could result in delayed clinical trials.

Manufacturing biopharmaceuticals is difficult and complex, and requires facilities specifically designed and validated for this
purpose. It can take years to design, construct, validate, and license a new biopharmaceutical manufacturing facility.

To develop
products, we require sufficient quantity and quality of manufactured product for clinical trials. Regulatory or technical manufacturing issues that we may encounter could delay clinical development of our products. Any failure to produce these
clinical requirements, either as a result of our inability to produce in accordance with cGMP or due to inadequate manufacturing capacity, can delay the commencement or continuation of our clinical trials. While we have manufactured the bulk drug
product necessary for a Phase 2b study of TNX-355, we may require additional manufacturing capacity for later trials and initial commercial launch. If we are unable to manufacture the required supplies ourselves, we may have to pursue contract
manufacturing, which could result in a significant delay and increase in cost of the development program.

Our own ability to
manufacture products on a commercial scale is uncertain.

To commercialize our products successfully, we must manufacture our products
in commercial quantities in compliance with regulatory requirements and at an acceptable cost. In order to obtain regulatory approvals and to create capacity to produce our products in sufficient quantities for commercial sale at an acceptable cost,
we will have to develop or acquire additional technology for commercial scale manufacturing and build or otherwise obtain access to adequate facilities such as contract manufacturing organizations, which will require substantial additional funds. To
the extent we utilize contract manufacturers, we must rely on them to perform in accordance with the contract terms. We cannot assure you that we, operating alone or with the assistance of others, can develop the necessary manufacturing technology
or that we will be able to fund or build an adequate commercial manufacturing facility necessary to obtain regulatory approvals and to produce adequate commercial supplies of our potential products on a timely basis.

We also must rely on third-party contract manufacturers to fill and finish and label and package our product for clinical trials. We cannot assure you
that we can secure these services on a timely basis or that the services will be performed in a manner that passes our quality assurance standards. Any failure or delay by these third parties could delay our filing for an IND or impede the progress
of a clinical trial and would increase our development costs.



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##### Index to Financial Statements

Manufacturing changes may result in delays in obtaining regulatory approval or marketing for our
products.

If we make any changes in the manufacturing process for our products and product candidates once we begin clinical
development, we may be required to demonstrate to the FDA and corresponding foreign authorities that the changes have not caused the resulting drug material to differ significantly from the drug material previously produced. Any significant
manufacturing changes for the production of our product candidates or an inability to show comparability between the older material and the newer material after making manufacturing changes could result in significant delays in development or
regulatory approvals of our product candidates.

We lack sales and marketing experience, and we depend on third parties for their
expertise in this area.

Under the terms of our collaboration agreements, Novartis and Genentech have exclusive marketing rights to
Xolair and other collaboration anti-IgE products, and the revenues we receive from Xolair will depend primarily on the marketing and sales efforts of our collaboration partners. However, commercialization rights may revert back to us if our
collaborators terminate our relationship. Furthermore, we may retain marketing rights, particularly in the U.S. and selected Asian countries, for other potential products that we can develop and sell effectively with a small, targeted sales force.
We have not yet commercialized any of our internal or in-licensed product candidates, and we currently have no sales, marketing or distribution capabilities. Our commercialization of products that may be approved for marketing is subject to several
risks, including but not limited to: difficulties in manufacturing the product on a large scale; difficulties in planning, coordinating and executing the commercial launch of the product; difficulties in marketing, distribution or sale of the
product; competition from superior products; or third party patents that may preclude us from marketing the product.

If Xolair marketing
rights revert to us or if we elect to market other products directly, we would require significant additional management expertise and have to make significant additional expenditures to develop an internal marketing function and a sales force. We
cannot assure you that we would be able to establish a successful marketing and sales force should we choose to do so. If we are unsuccessful in hiring and retaining sales and marketing personnel with appropriate technical and sales expertise or in
developing an adequate distributions capability to support them, our ability to generate product revenues will be adversely affected. To the extent we cannot or choose not to use internal resources for the marketing, sales or distribution of any
potential products in the U.S. or elsewhere, we intend to rely on collaboration partners or licensees. We may not be able to establish or maintain such relationships or, if we are able to establish them, we will depend upon their efforts, which may
not be successful.

Risks Related to Financial Results and Need for Financing

We have a history of net losses; we expect to continue to incur net losses and we may never achieve or maintain profitability.

We have incurred net losses since our inception. As of December 31, 2006, we had an accumulated deficit of approximately $115.8 million, including a
net loss of $2.6 million for the year. Our losses primarily have been the result of costs incurred in our research and development programs and from our general and administrative costs.

We have funded our operations to date principally from licensing fees, royalties, profit-sharing, milestone and manufacturing-rights payments under our
current or former collaborations, as well as with



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##### Index to Financial Statements

proceeds from private placements and an initial public offering of our common stock. We expect to continue to incur operating losses until such time, if
ever, that we are able to generate sufficient revenue from royalties, profit sharing, and manufacturing rights from Xolair and, potentially, revenues from an additional product or products to cover our expenses. Our revenues may be reduced by
adjustments and changes in amounts paid to us and amounts we may be required to pay to third parties.

Our ability to achieve and maintain
long-term profitability depends to a significant extent on the continued successful commercialization of Xolair. It will also depend on our successfully completing preclinical and clinical trials, obtaining required regulatory approvals and
successfully manufacturing and marketing our other current and future product candidates. We cannot assure you that we will be able to achieve any of the foregoing or that we will be profitable even if we successfully commercialize our products.

The market price of our common stock has been volatile.

Like other stocks of biopharmaceutical companies, the market price for our common stock has been and may continue to be volatile. Since January 1,
2005, our stock price ranged from $9.39 to $20.66. Factors that may have contributed to the volatility of our stock during this period included:



| |  |  | Reported sales volume of Xolair;
| | - |  | --------------------------------



| |  |  | Results of clinical trials;
| | - |  | ---------------------------



| |  |  | Announcement of the proposed merger with Genentech; and
| | - |  | -------------------------------------------------------



| |  |  | General market conditions, including particularly the biotechnology company segment.
| | - |  | ------------------------------------------------------------------------------------

Other factors that may have a significant impact on the market price of our common Stock include:



| |  |  | Announcements of technological innovations by us or our competitors;
| | - |  | --------------------------------------------------------------------



| |  |  | Publicity regarding actual or potential medical results relating to Xolair or products being developed by us;
| | - |  | -------------------------------------------------------------------------------------------------------------



| |  |  | Potential litigation or material contracts to which we may be a party;
| | - |  | ----------------------------------------------------------------------



| |  |  | Regulatory developments or delays concerning our products;
| | - |  | ----------------------------------------------------------



| |  |  | Issues concerning the safety or commercial viability of our products; and
| | - |  | -------------------------------------------------------------------------



| |  |  | Developments with respect to the proposed merger with Genentech.
| | - |  | ----------------------------------------------------------------

Failure by Novartis or Genentech to develop, manufacture, market or distribute Xolair would impair our ability to generate revenues.

Under the terms of our collaboration agreements, Novartis and Genentech are generally responsible for conducting clinical trials on, obtaining regulatory
approval for, and manufacturing, marketing and distributing Xolair. As a result, our ability to profit from Xolair and any other anti-IgE products covered by our collaboration agreements with Genentech and Novartis depends in large part on their
performance. We cannot control the amount and timing of resources Novartis and Genentech will devote to any of our products. If Novartis or Genentech experiences manufacturing or distribution difficulties, does not actively market Xolair or other
partnered anti-IgE products or does not otherwise perform under our collaboration agreements, our potential for revenue from these products will be dramatically reduced. Novartis and Genentech may terminate our collaboration agreements, and, in that
event, we would experience increased capital requirements to undertake development and marketing at our expense. We cannot assure you that we would be able to manufacture, market and distribute Xolair on our own.

We may need additional financing, but our access to capital funding is uncertain, and issuance of additional common stock could dilute existing
stockholders.

Our current and anticipated development projects require substantial additional capital. While we



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##### Index to Financial Statements

expect that our cash on hand, together with our revenue from Xolair, will fund our existing operations for the next four years, our future cash needs will
depend on many factors, including the commercial success of Xolair, receiving royalty, profit-sharing, milestone and manufacturing-rights payments from our collaboration partners, making progress in our clinical development of TNX-355, TNX-650 and
in our preclinical efforts, other research and development activities, and entering into additional collaboration agreements. Our capital requirements may also depend on the progress and level of costs associated with preclinical studies and
clinical trials, the costs associated with acquisitions of new product candidates by licensing or otherwise, the costs of preparing, filing, prosecuting, maintaining and enforcing patent claims and other intellectual property rights, competing
technological and market developments, changes in or terminations of existing collaboration and licensing arrangements and the cost of manufacturing scale-up and development of marketing activities, if undertaken by us. We do not have committed
external sources of funding and we may not be able to obtain additional funds on acceptable terms, if at all. If adequate funds are not available, we may be required to:



| |  |  | delay, reduce the scope of or eliminate one or more of our development programs;
| | - |  | --------------------------------------------------------------------------------



| |  |  | obtain funds through arrangements with collaboration partners or others that may require us to relinquish rights to technologies, product candidates or products
that we would otherwise seek to develop or commercialize ourselves; or
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | license rights to technologies, product candidates or products on terms that are less favorable to us than might otherwise be available.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------

We may raise additional funds by issuing shares of our stock, which would cause dilution to our stockholders and may
adversely affect the market price of our common stock. New investors could have rights superior to existing stockholders. If funding is insufficient at any time in the future, we may be unable to develop or commercialize our products, take advantage
of business opportunities or respond to competitive pressures, and our business and financial condition may be harmed.

Risks Relating to Intellectual
Property

The patentability, validity, enforceability and commercial value of our patents are highly uncertain. If our intellectual
property positions are challenged, invalidated or circumvented and we fail to prevail in resulting intellectual property litigation, our business could be adversely affected.

Our success depends in part on obtaining, maintaining and enforcing patents and maintaining trade secrets. While we file and prosecute patent
applications to protect our inventions, our pending patent applications may not result in the issuance of valid patents and our issued patents may not provide competitive advantages. Also, our patents may not prevent others from developing
competitive products using related or the same technology. We cannot assure you that pending patent applications developed by or licensed to us will result in patents being issued or that, if issued, the patents will give us an advantage over
competitors with similar technology.

We own or have licenses to certain issued patents. The patents we own that are most material to our
business are five U.S. patents and six foreign patents relating to anti-IgE antibodies. However, the patent position of biotechnology and pharmaceutical firms is highly uncertain and involves many complex legal and technical issues. There is no
clear policy involving the breadth of claims allowed or the degree of protection afforded under such patents. Issued patents can be challenged in litigation in the courts and in proceedings in the United States Patent and Trademark Office and in
courts and patent offices in foreign countries. Issuance of a patent is not conclusive as to its validity, enforceability or the scope of its claim. We cannot assure you that our patents will not be successfully challenged as to enforceability,
invalidated or limited in the scope of their coverage. Moreover, litigation to uphold the validity of patents and to prevent infringement can be very costly and can result in diverting technical and



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##### Index to Financial Statements

management personnel's time and attention, which may materially harm our business, financial condition and results of operations. If the outcome of
litigation is adverse to us, third parties may be able to use our patented technology without paying us. Moreover, we cannot assure you that our patents will not be infringed or successfully avoided through design innovation. Any of these events may
materially and adversely affect our business.

In addition to the intellectual property rights described above, we also rely on unpatented
technology, trade secrets and confidential information. We cannot assure you that others will not independently develop substantially equivalent information and techniques or otherwise gain access to our technology or disclose such technology, or
that we can effectively protect our rights in unpatented technology, trade secrets and confidential information. We require each of our employees, consultants and advisors to execute a confidentiality agreement at the commencement of an employment
or consulting relationship with us. We cannot assure you, however, that these agreements will provide effective protection if an unauthorized use or disclosure of this confidential information occurs.

If we fail to obtain any required patent license from third parties, our product development efforts could be limited.

Our commercial success depends on our ability to operate without infringing the patents and other proprietary rights of third parties. Other companies,
some of which may be our competitors, have filed applications for or have been issued patents, and may obtain additional patents and proprietary rights, relating to products or processes used in, necessary to, or otherwise related to our products
and product candidates.

For example, we are aware of broad patents owned by others relating to the manufacture, use and sale of
recombinant humanized antibodies. Many of our product candidates are genetically engineered recombinant humanized antibodies. If our antibody products or their commercial use or production meet all of the requirements of any of the claims of the
aforementioned patents, or other third party patents or patent applications, then we may need a license to one or more of these patents. We expect to seek to obtain patent licenses when, in our judgment, such licenses are needed. Even if we
determine that a license is not necessary, a patent holder could disagree and sue us for damages and seek to prevent us from manufacturing, selling or developing our products. Legal disputes can be costly and time consuming to defend. If any patent
holder successfully challenges our judgment that our products do not infringe their patents or that their patents are invalid, we could be required to pay costly damages or to obtain a license to sell or develop our drugs. If we determine that a
license is required, there can be no assurance that we will be able to obtain the license on commercially reasonable terms, if at all. If we are unable to secure a required license, we might be prevented from using certain of our technologies for
the generation and manufacture of our recombinant antibody products or from pursuing product development, manufacturing or commercialization in a particular field, and this may materially harm our business and financial prospects.

In addition to patents, we rely on trade secrets and proprietary know-how. We seek protection in part through confidentiality agreements. We cannot
assure you, however, that these agreements will provide meaningful protection of our proprietary information or trade secrets in the event of an unauthorized use or disclosure or that our valuable trade secrets will not become known to, or
independently developed, by our competitors.



|ITEM 1B. | Unresolved Staff Comments
|-------- | -------------------------

None.



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##### Index to Financial Statements

|ITEM 2. | Properties
|------- | ----------

Our research and development, process
development, administrative and pilot scale manufacturing activities are conducted out of two buildings, which we own, in Houston, Texas, having approximately 111,000 aggregate square feet. These facilities are suitably equipped, and we believe that
they are adequate for our current and near term purposes. We also own approximately 28 acres of land adjacent to these facilities in Houston.

Effective January 10, 2005, we assumed the lease on a biologics manufacturing facility located in San Diego, California. The San Diego facility occupies approximately 76,000 square feet and includes two 2,750 liter bioreactor systems,
purification and formulation suites, a small 500 liter clinical manufacturing suite, quality control laboratories, process development space and offices. We have produced late stage clinical material in the San Diego facility. Our lease extends
until September 30, 2011, with two five-year extension options. While we believe that these facilities will meet our immediate and near term needs, as our products continue to advance in development and to the extent that they are
commercialized and we retain manufacturing rights, we will likely require additional manufacturing capacity.



|ITEM 3. | Legal Proceedings
|------- | -----------------

On December 5, 2006, a
purported class action petition was filed in the District Court of Harris County, Texas in connection with the proposed acquisition of Tanox by Genentech. The petition (captioned Superior Partners v. Nancy T. Chang, Julia Brown, Heinz W. Bull,
Tse-Wen Chang, Gary Frashier, Osama Mikhail, Peter G. Traber, Danong Chen, Tanox, Inc., Genentech, Inc. and Green Acquisition Corporation, Case No. 2006-77015) names Tanox and the current members of our board of directors as defendants. The
petition also names Genentech and Green Acquisition Corporation as defendants. Among other things, the petition alleges that our directors, in approving the proposed merger, breached fiduciary duties owed to our stockholders, and that Genentech and
Green Acquisition Corporation aided and abetted those alleged breaches of fiduciary duty. The petition also alleges that the preliminary proxy statement Tanox filed in connection with the merger on November 24, 2006 contains false or misleading
statements or omissions. On December 19, 2006, Plaintiff amended the petition to allege that the definitive proxy statement, filed by Tanox on December 7, 2006, contains false and misleading statements or omissions. The amended petition
seeks class certification, damages and certain forms of equitable relief, including enjoining the consummation of the merger. Tanox and the other defendants believe the amended petition is without merit and intend to defend themselves vigorously.

We were engaged in a legal proceeding in connection with a fee dispute with the law firms that represented us in litigation with Genentech
during the mid-1990s relating to, among other things, the intellectual property rights surrounding the development of anti-IgE technology. In 1999, an arbitration panel issued an award entitling the attorneys to receive (1) approximately $3.5
million, including interest, (2) payments ranging from 33-1/3% to 40% of the future milestone payments, in excess of the first $1 million, we would receive from Genentech following product approval, and (3) 10% of the royalties that we
would receive on all sales of certain anti-IgE products, including Xolair. The arbitrators award was reduced to a final judgment in the 11th District Court of Harris County, Texas, on March 28, 2000. On February 7, 2007, the former
attorneys (Akin Gump, Strauss, Hauer & Feld, LLP, Robinson Law Firm, Williams, Birnberg & Anderson, LLP, Michael Madigan, Michael J. Mueller, Kenneth M. Robinson and Gerald M. Birnberg) filed with the Harris County District Court a Motion
for Remand to the Arbitration Panel claiming: (i) that certain net profit interests payable by Novartis on sales of anti-IgE products in the U.S. fall within the award; and (ii) that they are entitled to additional fees related to certain
manufacturing payments made to Tanox and the forgiveness by Novartis of certain debt owed by Tanox. We dispute the claims of the former attorneys. The Court has not yet ruled on the Motion, nor has a hearing been held.



29



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##### Table of Contents

##### Index to Financial Statements

|ITEM 4. | Submission of Matters to a Vote of Security Holders
|------- | ---------------------------------------------------

No matters were submitted to a vote of security holders of the Company, through solicitation of proxies or otherwise, during the last quarter of 2006.



30



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##### Table of Contents

##### Index to Financial Statements

PART II



|ITEM 5. | Market for the Companys Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
|------- | -------------------------------------------------------------------------------------------------------------

Market Price and Dividends

Our common stock trades on
The NASDAQ Stock Market under the symbol TNOX. The table below provides the high and low sales prices of our common stock for the periods indicated, as reported by the NASDAQ Stock Market.



|                              |  |      |       |     |   |      
|----------------------------- |  | ---- | ----- | --- | - | -----
|                              |  | High |       | Low
|Year Ended December 31, 2005: |  |      |       |     |   |      
|First quarter                 |  | $    | 14.93 |     | $ | 9.60 
|Second quarter                |  |      | 11.80 |     |   | 9.39 
|Third quarter                 |  |      | 14.69 |     |   | 11.98
|Fourth quarter                |  |      | 16.96 |     |   | 11.72
|                              |  |     
|Year Ended December 31, 2006: |  |      |       |     |   |      
|First quarter                 |  | $    | 20.66 |     | $ | 16.53
|Second quarter                |  |      | 18.65 |     |   | 12.45
|Third quarter                 |  |      | 15.01 |     |   | 11.75
|Fourth quarter                |  |      | 19.90 |     |   | 11.78

On March 7, 2007, the last reported sale price of our common stock on the NASDAQ Stock Market
was $19.16. As of March 7, 2007, there were 45,676,599 shares of common stock outstanding and 170 shareholders of record of our common stock, one of which is Cede & Co., a nominee for Depository Trust Company (or DTC). All of the
shares of Common Stock held by brokerage firms, banks and other financial institutions as nominees for beneficial owners are deposited into participant accounts at DTC, and therefore considered to be held of record by Cede & Co. as one
stockholder.

We have never declared or paid any cash dividends on our common stock and do not anticipate paying such cash dividends in the
foreseeable future. We currently anticipate that we will retain all of our future earnings for use in our research and product development activities and for general corporate purposes. Any determination to pay dividends in the future will be at the
discretion of our Board of Directors and will depend upon our results of operations, financial condition and other factors as the Board of Directors, in its discretion, deems relevant.

We did not repurchase any shares of our common stock during the fourth quarter of 2006.



31



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##### Table of Contents

##### Index to Financial Statements

|ITEM 6. | Selected Financial Data
|------- | -----------------------

The statement of
operations data for the years ended December 31, 2006, 2005 and 2004 and the balance sheet data as of December 31, 2006 and 2005 have been derived from our audited financial statements included elsewhere in this annual report on Form 10-K.
The statements of operations data for the years ended December 31, 2003 and 2002, and the balance sheet data as of December 31, 2004, 2003 and 2002 have been derived from our audited financial statements not included in this annual report
on Form 10-K. Our historical results are not necessarily indicative of results to be expected for any future period. The data presented below has been derived from financial statements that have been prepared in accordance with accounting principles
generally accepted in the United States and should be read with our financial statements, including the notes, and with Managements Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this
annual report on Form 10-K.



|                                                            |  |                                       |          |   |      |   |          |      |  |   |         |   |  |      |         |   |  |   |         |  
|----------------------------------------------------------- |  | ------------------------------------- | -------- | - | ---- | - | -------- | ---- |  | - | ------- | - |  | ---- | ------- | - |  | - | ------- | -
|                                                            |  | Year Ended December 31,               |         
|                                                            |  | 2006                                  |          |   | 2005 |   |          | 2004 |  |   | 2003    |   |  | 2002 |        
|                                                            |  | (In thousands, except per share data) |         
|STATEMENT OF OPERATIONS DATA:                               |  |                                       |          |   |      |   |          |      |  |   |         |   |  |      |         |   |  |   |         |  
|Revenues                                                    |  | $                                     | 56,137   |   |      | $ | 44,687   |      |  | $ | 20,506  |   |  | $    | 18,487  |   |  | $ | 560     |  
|                                                            |  |                                       |          |   |      |   |          |      |  |   |         |   |  |      |         |   |  |   |         |  
|Research and development [2]                                |  |                                       | 53,409   |   |      |   | 47,898   |      |  |   | 27,200  |   |  |      | 21,037  |   |  |   | 22,651  |  
|Acquired in-process research and development                |  |                                       |         |   |      |   | 13,680   |      |  |   |        |   |  |      |        |   |  |   |        |  
|General and administrative [2]                              |  |                                       | 13,465   |   |      |   | 7,152    |      |  |   | 7,033   |   |  |      | 7,337   |   |  |   | 10,677  |  
|Restructuring charge                                        |  |                                       |         |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   | (268    | )
|                                                            |  |                                       |          |   |      |   |          |      |  |   |         |   |  |      |         |   |  |   |         |  
|Total operating costs and expenses                          |  |                                       | 66,874   |   |      |   | 68,730   |      |  |   | 34,233  |   |  |      | 28,374  |   |  |   | 33,060  |  
|                                                            |  |                                       |          |   |      |   |          |      |  |   |         |   |  |      |         |   |  |   |         |  
|Loss from operations                                        |  |                                       | (10,737  | ) |      |   | (24,043  | )    |  |   | (13,727 | ) |  |      | (9,887  | ) |  |   | (32,500 | )
|Other income, net                                           |  |                                       | 8,169    |   |      |   | 4,619    |      |  |   | 3,437   |   |  |      | 5,021   |   |  |   | 6,478   |  
|                                                            |  |                                       |          |   |      |   |          |      |  |   |         |   |  |      |         |   |  |   |         |  
|Loss before income tax benefit                              |  |                                       | (2,568   | ) |      |   | (19,424  | )    |  |   | (10,290 | ) |  |      | (4,866  | ) |  |   | (26,022 | )
|Income tax benefit                                          |  |                                       |         |   |      |   |         |      |  |   |        |   |  |      | 228     |   |  |   |        |  
|                                                            |  |                                       |          |   |      |   |          |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net loss                                                    |  | $                                     | (2,568   | ) |      | $ | (19,424  | )    |  | $ | (10,290 | ) |  | $    | (4,638  | ) |  | $ | (26,022 | )
|                                                            |  |                                       |          |   |      |   |          |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net loss per share  basic and diluted                      |  | $                                     | (0.06    | ) |      | $ | (0.43    | )    |  | $ | (0.23   | ) |  | $    | (0.11   | ) |  | $ | (0.59   | )
|                                                            |  |                                       |          |   |      |   |          |      |  |   |         |   |  |      |         |   |  |   |         |  
|Shares used in computing loss per share  basic and diluted |  |                                       | 44,916   |   |      |   | 44,675   |      |  |   | 44,020  |   |  |      | 43,979  |   |  |   | 43,911  |  
|                                                            |  |                                       |          |   |      |   |          |      |  |   |         |   |  |      |         |   |  |   |         |  
|                                                            | 
|                                                            |  | December 31,                          |         
|                                                            |  | 2006                                  |          |   | 2005 |   |          | 2004 |  |   | 2003    |   |  | 2002 |        
|                                                            |  | (In thousands)                        |         
|BALANCE SHEET DATA:                                         |  |                                       |          |   |      |   |          |      |  |   |         |   |  |      |         |   |  |   |         |  
|Cash, cash equivalents and investments [1]                  |  | $                                     | 185,081  |   |      | $ | 164,501  |      |  | $ | 202,511 |   |  | $    | 227,434 |   |  | $ | 227,990 |  
|Working capital                                             |  |                                       | 178,797  |   |      |   | 169,080  |      |  |   | 164,425 |   |  |      | 154,566 |   |  |   | 127,592 |  
|Total assets                                                |  |                                       | 232,108  |   |      |   | 229,936  |      |  |   | 238,553 |   |  |      | 251,856 |   |  |   | 251,211 |  
|Notes payable                                               |  |                                       |         |   |      |   |         |      |  |   | 5,000   |   |  |      | 15,000  |   |  |   | 15,000  |  
|Accumulated deficit                                         |  |                                       | (115,827 | ) |      |   | (113,259 | )    |  |   | (93,835 | ) |  |      | (83,545 | ) |  |   | (78,907 | )
|Total stockholders' equity                                  |  |                                       | 220,203  |   |      |   | 213,441  |      |  |   | 224,198 |   |  |      | 222,657 |   |  |   | 225,516 |  

---

|[1] | Includes restricted cash and investments of $5,000, $15,967 and $14,441 in 2004, 2003 and 2002, respectively.
|--- | -------------------------------------------------------------------------------------------------------------

|[2] | Includes share-based compensation expense of $3,695 in 2006, of which $1,574 was included in research and development expense and $2,121 was included in general and administrative
expense.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

##### Index to Financial Statements

|ITEM 7. | Managements Discussion and Analysis of Financial Condition and Results of Operations
|------- | -------------------------------------------------------------------------------------

Overview

Tanox discovers and develops therapeutic monoclonal antibodies to address significant unmet
medical needs in the areas of immune-mediated diseases, infectious disease, inflammation and cancer. Our products are genetically engineered antibodies that target a specific molecule or antigen.

On November 9, 2006, we entered into an agreement and plan of merger with Genentech and Green Acquisition Corporation, a wholly-owned subsidiary of
Genentech, pursuant to which Genentech would acquire Tanox for approximately $919 million in cash. Under the terms of the agreement, Green Acquisition will merge with and into Tanox, and the stockholders of Tanox will receive $20.00 in cash for each
share held, less any applicable withholding tax. In addition, each option to purchase Tanox common stock outstanding at the time of the merger will be canceled and the option holder entitled to receive a cash amount equal to the product of
(i) the number of shares of Tanox common stock as to which the option remains unexercised, multiplied by (ii) the amount, if any, by which $20.00 exceeds the exercise price of the option, less any applicable withholding tax. The boards of
directors of both companies and the stockholders of Tanox have approved the transaction, which remains subject to expiration of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act and the satisfaction of other customary closing
conditions. On January 29, 2007, we and Genentech announced that we had received a Request for Additional Information and Documentary Materials, commonly referred to as a "second request," from the FTC in connection with the proposed
acquisition, which extends the waiting period. Genentech continues to engage in active and productive discussions with the FTC, and we expect that the transaction will close within the first half of 2007, subject to expiration of the waiting period
and the satisfaction of other customary closing conditions, including the absence of any material adverse effect having occurred in respect of Tanox.

Marketed Product - Xolair

Xolair was developed in collaboration with Genentech and Novartis. In the U.S., Xolair is labeled
for treatment of adults and adolescents (12 years of age and above) with moderate-to-severe persistent asthma who have a positive skin test or in vitro reactivity to a perennial aeroallergen and whose symptoms are inadequately controlled with
inhaled corticosteroids. In Europe, Xolair is licensed as add-on therapy to improve asthma control in adults and adolescents (12 years of age and above) with severe persistent allergic asthma. Xolair was approved for use in the U.S. by the Food and
Drug Administration (FDA) in June 2003 and approved for use in Europe in October 2005. On February 21, 2007, the FDA announced it requested that Genentech strengthen the existing warning on the potential risk for anaphylaxis in patients
receiving Xolair by adding a boxed warning to the product label and implementing a Risk Mitigation Action Plan, including providing a medication guide for patients and advice to health care providers to observe patients for at least two hours after
dosing. Genentech and Novartis have advised that they will be working with the FDA on its request.

Under our collaboration agreements with
Genentech and Novartis, we receive royalties on the net sales of Xolair and share in Novartis net profits from sales of Xolair in the U.S. For the year 2006, we recorded net royalty revenue of $40.2 million from sales of Xolair versus $29.4
million for the year 2005. We recorded net profit sharing revenue of $6.7 million from Novartis for the fourth quarter of 2005 and the first three quarters of 2006, as the profit-sharing calculation is one quarter in arrears. We recorded net profit
sharing revenue of $1.1 million in 2005, resulting from profits made in the first three quarters of 2005. Over the next several years, we expect that the net amount we will receive in royalties and profit-sharing payments from sales of Xolair,
taking into account both credits and the amounts payable to our former attorneys, will be in the range of 8% to 12% of net sales, depending on the sales level achieved and geographic distribution of sales.



33



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##### Table of Contents

##### Index to Financial Statements

For the year 2006, we recorded manufacturing rights revenue of $7.0 million, compared to manufacturing
rights revenue of $1.1 million for the year 2005. Under the terms of the February 25, 2004 Tripartite Cooperation Agreement (TCA) among Tanox, Genentech and Novartis, Tanox relinquished any rights to manufacture Xolair and in exchange receives
payments based on the quantity of Xolair produced. Manufacturing rights revenue is based on the quantity of Xolair produced each quarter, as defined in our collaboration agreement, and is calculated and recorded one quarter in arrears.

Novartis is conducting a Phase 3 clinical trial to study the effectiveness of Xolair in pediatric allergic asthma patients. Enrollment of the trial
has been completed. In the second quarter of 2006, Novartis submitted an application for the approval of Xolair in Japan. Under our collaboration agreement with Novartis, the filing resulted in a $2.0 million milestone payment to Tanox, of which
$1.0 million was recorded as development agreement revenue from a related party in the second quarter of 2006. The $1.0 million of the milestone recorded as deferred revenue is creditable to Novartis against future royalties owed Tanox.

Development agreement revenue in 2006 also includes $1.0 million earned as reimbursement by Novartis of a portion of Tanoxs 2006 development
costs for a high affinity anti-IgE program.

Clinical Development Programs

We have two products in clinical development.

TNX-355

TNX-355 is our monoclonal antibody in development to treat HIV/AIDS. In May 2006, we reported positive 48-week results from the Phase 2
clinical trial of TNX-355. The results showed that TNX-355, when given in combination with an optimized background regimen (OBR) of other antiviral therapies, produced a greater reduction in viral load in HIV-infected patients than did placebo in
combination with OBR. These results, together with positive 24-week data reported in October 2005, demonstrate the long-term antiviral and immunologic impact of TNX-355. At both the 24-week and 48-week time points, TNX-355 was well tolerated, with
no serious adverse events related to the drug as assessed by study investigators.

We have conducted a meeting with the FDA to discuss the
clinical trial results and continued development of TNX-355. At the FDAs request, a dose-finding trial has been designed that explores different dosing strategies. The Agency concurred that the dose-finding trial, if appropriately designed and
successful, could be considered pivotal as part of a registration program for TNX-355 in HIV treatment-experienced patients. We are in the process of evaluating the FDAs most recent feedback on the proposed trial design.

TNX-650

TNX-650 is a humanized anti-IL-13 antibody.
A Phase 1 clinical trial was initiated in May 2006 to evaluate TNX-650 as a potential treatment of Hodgkins lymphoma in patients who are refractory to chemotherapy or radiation treatment. Five patient cohorts have been enrolled to date.

In early October 2006, we also began enrolling patients in a Phase 1 clinical trial of TNX-650 as a potential treatment for
moderate-to-severe asthma. The trial is a randomized, double-blind, placebo-controlled, dose-escalation study of the safety, tolerability and pharmacokinetics of single doses of TNX-650 in healthy volunteers. Enrollment of this Phase 1 study, which
is taking place at a single site in the U.S., has been completed. Preclinical studies indicate that IL-13 is a key mediator of asthma responses, including airway inflammation, obstruction and hyper-reactivity.



34



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##### Table of Contents

##### Index to Financial Statements

Preclinical Programs

TNX-234, a humanized antibody, is being developed as a potential treatment for wet and/or advanced dry age-related macular degeneration (AMD). TNX-558 is being evaluated as a potential inflammatory-disease therapy. In
addition, we have generated a humanized high affinity anti-IgE antibody for the potential treatment of allergic diseases, and development activities are ongoing with Novartis under our two-party Amended and Restated Development and Licensing
Agreement.

Manufacturing

Our San
Diego, California manufacturing facility has received a Drug Manufacturing License from the State of California.

Critical Accounting Policies

Use of Estimates

The
preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and
footnotes thereto. Actual results may differ from those estimates.

Revenue Recognition

Under our collaboration agreements with Genentech and Novartis, we receive a royalty on the net sales of Xolair worldwide and share in Novartis net
profits from Xolair sales in the U.S. Royalty revenue is recorded monthly based on contractual terms and information provided by Genentech and Novartis. Royalties are reconciled and adjusted if actual results differ from those previously reported to
us and are subject to audit by Tanox. Our interest in Novartis U.S. net profits is calculated and recorded one quarter in arrears. Manufacturing rights revenue represents amounts received from Genentech and Novartis in consideration of our
relinquishment, under the collaboration agreements, of our rights to manufacture Xolair. Manufacturing rights revenue is based on the quantity of Xolair produced, as defined in our collaboration agreement, and is calculated and recorded one quarter
in arrears. Revenues from development agreements include payments for milestone achievements and sponsored research and development costs. Milestone payments are received under best efforts contracts and are not refundable. They are recognized as
revenue when the milestones are achieved and there are no remaining performance obligations. Revenues for sponsored research and development are recognized as revenue as we complete our obligations related to such activities. Any revenue contingent
upon future performance is deferred and recognized as the performance is completed. Revenues recognized are net of certain credits and amounts due to our former attorneys under an arbitration award.

Research and Development

Research and
development expenses consist of direct costs and indirect overhead costs, including facilities costs, salaries, related benefit costs and material and supply costs. Expenses may also include upfront fees and milestones paid to licensors and
collaborative partners. Such amounts are expensed as incurred. Research and development costs also include estimates for clinical trial costs, which are based on patient enrollment and clinical trial progress. Actual costs may differ from estimates.



35



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##### Table of Contents

##### Index to Financial Statements

Share-based Compensation

Tanox adopted FAS 123R, Share-Based Payment on January 1, 2006 using the modified prospective transition method, which requires that share-based compensation is recognized for all awards granted,
modified or settled after the effective date as well as for all awards granted to employees prior to the effective date that remain unvested as of the effective date. Prior to the adoption of FAS 123R, we accounted for our share-based compensation
expense under the recognition and measurement provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees. Under the intrinsic value method described in APB Opinion No. 25, no compensation expense was recognized
if the exercise price of the employee stock option equaled the market price of the underlying stock on the date of grant.

Tanox estimates
the fair value of stock options using the Black-Scholes-Merton option pricing model. The assumptions used under this model are as follows: 1) the expected term of the options is estimated using historical option exercise data; 2) the expected
volatility is estimated based on historical stock price volatility; 3) the risk-free interest rate is based on the U.S. Treasury zero-coupon issues with a remaining term equal to the expected term of the option; and 4) a zero percent dividend yield.
Under FAS 123R, the fair value of stock options granted is recognized as expense over the service period, net of estimated forfeitures, which we base on historical data. To the extent actual forfeitures differ from our current estimates, cumulative
adjustments to share-based compensation expense will be recorded in the period that estimates are revised.

Recent Accounting Pronouncement

In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, Accounting for Uncertainty in
Income Taxes  an Interpretation of FASB Statement No. 109, (FIN 48). This interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprises financial statements in accordance with FASB
Statement No. 109, Accounting for Income Taxes. The interpretation prescribes a recognition threshold and measurement attribute for a tax position taken or expected to be taken in a tax return and also provides guidance on
derecognition, classification, interest and penalties, accounting for interim periods, disclosure and transition. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006. We are currently evaluating the impact,
if any, this statement may have on our financial statements.



36



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##### Table of Contents

##### Index to Financial Statements

Results of Operations

This discussion of our Results of Operations contains forward-looking statements regarding revenue, research and development expenses and general and administrative expenses. For a discussion of the risks and
uncertainties associated with our forward looking statements, please see the Item 1A. Risk Factors section in this Form 10-K.

Years
Ended December 31, 2006, 2005 and 2004

Revenues. For the years ended December 31, 2006, 2005 and 2004, revenues
consist of the following:



|                                                                   |  |                                 |        |      |   |        |  |   |       
|------------------------------------------------------------------ |  | ------------------------------- | ------ | ---- | - | ------ |  | - | ------
|                                                                   |  | For the year ended December 31,
|                                                                   |  | 2006                            |        | 2005 |   | 2004  
|                                                                   |  | (in thousands)                 
|Royalties, net                                                     |  | $                               | 38,218 |      | $ | 29,104 |  | $ | 13,240
|Royalties from related party, net                                  |  |                                 | 1,942  |      |   | 258    |  |   | 71    
|Profit share from related party, net                               |  |                                 | 6,710  |      |   | 1,139  |  |   |      
|Development agreements, license fees and manufacturing rights, net |  |                                 | 7,205  |      |   | 14,132 |  |   | 3,725 
|Development agreements from related party, net                     |  |                                 | 2,062  |      |   | 54     |  |   | 3,470 
|                                                                   |  |                                 |        |      |   |        |  |   |       
|Total revenues                                                     |  | $                               | 56,137 |      | $ | 44,687 |  | $ | 20,506
|                                                                   |  |                                 |        |      |   |        |  |   |       

Revenues are recorded net of credits and amounts payable to our former attorneys under an
arbitration award.

Royalty revenue increased $10.8 million in 2006 from 2005, and $16.1 million in 2005 versus 2004, as a result of
increased Xolair sales.

In addition to Xolair royalty revenue, Tanox recorded Xolair net profit sharing revenue of $6.7 million from
Novartis for the fourth quarter of 2005 and the first three quarters of 2006, as the profit-sharing calculation is one quarter in arrears. We recorded net profit sharing revenue of $1.1 million in 2005, resulting from profits made in the first three
quarters of 2005. Under our collaboration agreements, Tanox shares in Novartis net profits from sales of Xolair in the U.S.

For the
year 2006, we recorded manufacturing rights revenue of $7.0 million, compared to manufacturing rights revenue of $1.1 million for the year 2005. Under the terms of the TCA among Tanox, Genentech and Novartis, Tanox relinquished any rights to
manufacture Xolair and in exchange receives payments based on the quantity of Xolair produced. Manufacturing rights revenue is based on the quantity of Xolair produced each quarter, as defined in our collaboration agreement, and is calculated and
recorded one quarter in arrears.

In the second quarter of 2006, Novartis submitted an application for the approval of Xolair in Japan.
Under our collaboration agreement with Novartis, the filing resulted in a $2.0 million milestone payment to Tanox, of which $1.0 million was recorded as development agreement revenue from a related party in the second quarter of 2006. The remaining
$1.0 million of the milestone is creditable to Novartis against future royalties due Tanox and was recorded as deferred revenue.

Development agreement revenue in 2006 also includes $1.0 million earned as reimbursement by Novartis of a portion of Tanoxs 2006 development costs for a high affinity anti-IgE program.



37



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##### Table of Contents

##### Index to Financial Statements

Development agreement revenue in 2005 includes $12.8 million in milestone revenue associated with Xolair
annual sales achieving $300 million in the U.S. The $20.0 million gross milestone was reduced by $7.2 million which was due to our former attorneys under an arbitration award. Development agreement revenue for 2004 includes a one-time reimbursement
of $6.6 million received under the terms of our collaboration agreements, representing reimbursement by Genentech and Novartis of a portion of the TNX-901 development costs incurred by Tanox in previous years.

Research and Development Expenses. Research and development expense consists of costs incurred for product development and discovery research
programs. Research and development expenses consist of direct costs and indirect overhead costs, including facilities costs, salaries, related benefit costs and material and supply costs. At December 31, 2006, our research and development
clinical stage programs include TNX-355 for HIV/AIDS, TNX-650 for Hodgkins lymphoma and TNX-650 for Asthma. Research and preclinical stage programs include TNX-234 for AMD, TNX-558 for inflammatory disease, the high affinity anti-IgE program
and other discovery and exploratory research projects. For the years ended December 31, 2006, 2005 and 2004, costs associated with research and development programs, including allocated overhead, were:



|                                        |  |                                 |        |      |   |        |  |   |       
|--------------------------------------- |  | ------------------------------- | ------ | ---- | - | ------ |  | - | ------
|                                        |  | For the year ended December 31,
|                                        |  | 2006                            |        | 2005 |   | 2004  
|                                        |  | (in thousands)                 
|Clinical stage programs                 |  | $                               | 38,365 |      | $ | 36,064 |  | $ | 18,698
|Research and preclinical stage programs |  |                                 | 15,044 |      |   | 11,834 |  |   | 8,502 
|                                        |  |                                 |        |      |   |        |  |   |       
|Total research and development expenses |  | $                               | 53,409 |      | $ | 47,898 |  | $ | 27,200
|                                        |  |                                 |        |      |   |        |  |   |       

Research and development expenses increased $5.5 million in 2006 from 2005. The increase in
research and development costs was attributed primarily to expenses associated with manufacturing activities in preparation for planned clinical trials, the write-off of $1.4 million in prepaid expense related to future creditable amounts with a
third party manufacturer, increased spending for preclinical programs and employee share-based compensation expense.

Research and
development expenses increased $20.7 million in 2005 from 2004. Approximately $16.3 million of this increase was attributable to the costs associated with the re-commissioning of our San Diego manufacturing facility in 2005. The remainder of the
2005 increase relates primarily to increased clinical trial costs associated with the TNX-355 Phase 2 study and increased personnel costs.

Acquired in-process research and development.On March 31, 2005, we acquired a tissue factor antagonist program for the potential treatment of ALI/ARDS. We issued an aggregate of 800,000 shares of our common stock and paid $6.0
million in cash for the program, resulting in a fair value of $13.7 million. As of the acquisition date, the acquired program was still in early stage development and had not reached technological feasibility. We determined that no alternative
future use existed for this program, and, accordingly, the $13.7 million acquisition price was recorded as acquired in-process research and development expense.



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##### Index to Financial Statements

General and Administrative Expenses.For the years ended December 31, 2006, 2005 and 2004,
the cost associated with general and administrative activities were:



|                                    |  |                                 |        |      |   |       |  |   |      
|----------------------------------- |  | ------------------------------- | ------ | ---- | - | ----- |  | - | -----
|                                    |  | For the year ended December 31,
|                                    |  | 2006                            |        | 2005 |   | 2004 
|                                    |  | (in thousands)                 
|General and administrative expenses |  | $                               | 13,465 |      | $ | 7,152 |  | $ | 7,033
|                                    |  |                                 |        |      |   |       |  |   |      

General and administrative expenses increased $6.3 million in 2006 from 2005. The increase in
general and administrative costs was attributed primarily to transaction related expenses in connection with the proposed merger with Genentech and employee share-based compensation expense.

Other Income. For the years ended December 31, 2006, 2005 and 2004, other income was:



|             |  |                                 |       |      |   |       |  |   |      
|------------ |  | ------------------------------- | ----- | ---- | - | ----- |  | - | -----
|             |  | For the year ended December 31,
|             |  | 2006                            |       | 2005 |   | 2004 
|             |  | (in thousands)                 
|Other Income |  | $                               | 8,169 |      | $ | 4,619 |  | $ | 3,437
|             |  |                                 |       |      |   |       |  |   |      

Other income for the year ended December 31, 2006 increased $3.6 million from 2005, and $1.2
million in 2005 versus 2004, primarily due to an increase in interest income resulting from higher average interest rates on investments.

Income Taxes. There was no provision for income taxes in 2006, 2005 or 2004, due to pre-tax losses of $2.6 million, $19.4 million and $10.3 million, respectively.

Share-Based Compensation. We adopted FAS 123R on January 1, 2006. Prior to the adoption, we disclosed such expenses on a pro forma basis in
the notes to our financial statements. For the year ended December 31, 2006, we recorded approximately $3.7 million of share-based compensation expense, of which $1.6 million was included in research and development expense and $2.1 million was
included in general and administrative expense. The adoption of FAS 123R resulted in an increase in net loss per share of $0.08 for the year ended December 31, 2006. (See Note 11 Capital Stock in our Notes to Consolidated Financial
Statements.)

Net Loss. For the year ended December 31, 2006, we recorded a net loss of $2.6 million, or $0.06 net loss per
share, compared to a net loss of $19.4 million, or $0.43 net loss per share for same period in 2005. The decrease in net loss in 2006 was due primarily to increased revenue associated with Xolair and the one-time acquired in-process research and
development expense for the purchase of the tissue factor antagonist program in 2005. The net loss increased to $19.4 million in 2005 or $0.43 net loss per share, as compared to $10.3 million or $0.23 net loss per share in 2004. The increase in net
loss in 2005 was due primarily to the acquired in-process research and development expense for the purchase of a tissue factor antagonist program, re-commissioning costs associated with our San Diego manufacturing facility and the increase in other
research and development expenses. This was partially offset by increased revenue associated with Xolair.



39



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##### Index to Financial Statements

Liquidity and Capital Resources

We have financed our operations since inception primarily through sales of equity securities, development and licensing fee revenues, interest income and, beginning in 2003, revenue related to Xolair. During the year
ended December 31, 2000, we sold approximately 8.6 million shares of common stock in an initial public offering for net proceeds of $225.8 million. As of December 31, 2006, we had $185.1 million in cash, cash equivalents and
investments, of which $173.2 million were classified as current assets.

Cash, cash equivalents and investments increased by $20.6 million
for the year ended December 31, 2006 to $185.1 million from $164.5 million at December 31, 2005. The net increase in funds was attributed primarily to the receipt of a one-time net milestone payment of $12.8 million based on Xolair
achieving sales of more than $300 million for the first time, and Xolair royalty, profit sharing and manufacturing rights revenue received in 2006, partially offset by the funding of operating activities.

Net cash provided by operating activities was $17.5 million for the year ended December 31, 2006 compared to net cash used in operating activities
of $17.3 million for 2005. The increase in cash during 2006 was due primarily to the receipt of the one-time Xolair net milestone payment of $12.8 million and Xolair royalty, profit sharing and manufacturing rights revenue received. The 2005 use of
cash was comprised mainly of a net loss of $19.4 million and an increase in receivables and other assets of $22.8 million related to the Xolair milestone, offset by acquired in-process research and development of $13.7 million.

Net cash used in investing activities was $16.2 million for the year ended December 31, 2006 compared to net cash provided by investing activities
of $62.3 million for 2005. In 2006, investment purchases exceeded maturities by $13.8 million, compared to an excess investment maturities over purchases of $74.0 million in 2005. In 2005, $6.0 million of cash was paid for acquired in-process
research and development and $5.6 million was used to purchase manufacturing assets from Biogen Idec.

Net cash provided by financing
activities was $6.2 million for the year ended December 31, 2006 compared to net cash used in financing activities of $3.6 million for 2005. The increase in net cash from financing activities during 2006 was due to stock option exercises, while
the decrease in cash for 2005 was due to the repayment of a note to a bank of $5.0 million partially offset by an increase in cash of $1.4 million from stock option exercises.

Pursuant to a Lease Assignment and Asset Purchase Agreement dated December 9, 2004, between Biogen Idec and Tanox, on January 10, 2005, Tanox
acquired from Biogen Idec certain manufacturing, process development and quality control equipment, related documentation and furniture and fixtures housed in a 76,000 square foot leased facility located in San Diego, California. The Company paid
Biogen Idec approximately $5.6 million for the assets and allocated $4.6 million as property, plant and equipment and $1.0 million as an intangible asset for manufacturing equipment documentation, included in other assets on the balance sheet. Tanox
also agreed to assume the obligations of Biogen Idec under a lease for the facility, which extends until September 30, 2011. The lease has two five-year extension options and escalating annual lease payments of approximately 4%. As partial
consideration for our agreement to the extension of the lease term to September 30, 2011, Biogen Idec agreed to make two payments to us, each in the amount of $2.4 million, on September 30, 2007 and November 30, 2008. We expect the
total lease obligation of Tanox for this lease assignment through 2011, net of the Biogen Idec payments, will be approximately $24.6 million.

On March 31, 2005, the Company acquired a tissue factor antagonist program for the potential treatment of acute lung injury (ALI)/acute respiratory distress syndrome (ARDS) from Sunol Molecular Corporation (Sunol). In consideration for
the tissue factor antagonist program, the Company issued an aggregate of 800,000 shares of its common stock and paid $6.0 million in cash to Sunol. Of the shares issued, 275,000 are being held in escrow for up to three years after closing to secure
indemnification



40



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##### Table of Contents

##### Index to Financial Statements

obligations under the Asset Purchase Agreement. Based upon the closing price of the Companys common stock on March 31, 2005, the fair value of the
acquired assets was $13.7 million, including the $6 million paid in cash. As of the acquisition date, the acquired program was still in early development stage, had not reached technological feasibility and had no alternative future use.
Accordingly, the Company recorded the $13.7 million purchase price as an acquired in-process research and development expense in the first quarter of 2005.

Tanox and a third party manufacturer began discussions in the fourth quarter of 2004 related to revisions to a manufacturing and supply agreement because we determined that we would produce TNX-355 clinical trial
materials in the newly-leased San Diego manufacturing facility. In February 2005, a letter agreement with the third party manufacturer was reached to suspend all provisions of the manufacturing and supply agreement for a period to be determined by
us, but not to exceed 30 months. Under the terms of the letter agreement, Tanox paid a total of $1.7 million, and recorded $1.4 million as prepaid expense which would have been creditable against future work performed by the third party manufacturer
on or before August 30, 2007, subject to certain limitations. During the period ended September 30, 2006, we expensed the $1.4 million as it is unlikely that we will have contract manufacturing needs for TNX-355 before August 2007.

On February 25, 2004, Tanox, Genentech and Novartis entered into the TCA to settle all then outstanding litigation and arbitrations
among the parties and to finalize the detailed terms of the three-party collaboration, begun in 1996, to develop and commercialize certain anti-IgE antibodies, including Xolair and TNX-901. Under the terms of the three-party collaboration agreement,
Genentech and Novartis each reimbursed Tanox $3.3 million for a portion of its TNX-901 development costs, and Tanox relinquished any rights to manufacture Xolair in exchange for the right to receive payments tied to the quantity of Xolair produced.

We were engaged in litigation in connection with a fee dispute with the law firms that represented us in litigation with Genentech
relating to, among other things, the intellectual property rights surrounding the development of anti-IgE technology. In 1999, an arbitration panel issued an award entitling the attorneys to receive (1) approximately $3.5 million, including
interest, (2) payments ranging from 33-1/3% to 40% of the future milestone payments, in excess of the first $1 million, we would receive from Genentech following product approval, and (3) 10% of the royalties that we would receive on all
sales of certain anti-IgE products, including Xolair. During the appeals process, we were required to place amounts in escrow to secure payment of the award, and had escrowed $9.7 million with the Harris County District Court as of December 31,
2003. These funds were released to the former attorneys in February 2004. The payment due to the attorneys in the amount of 10% of the royalties we receive on Xolair sales is required to be paid within 30 days of the end of each calendar quarter in
which the royalty payments are received by Tanox. On February 7, 2007, the former attorneys filed with the Harris County District Court a Motion for Remand to the Arbitration Panel claiming: (i) that certain net profit interests payable by
Novartis on sales of anti-IgE products in the U.S. fall within the award; and (ii) that they are entitled to additional fees related to certain manufacturing payments made to Tanox and the forgiveness by Novartis of certain debt owed by Tanox.
We dispute the claims of the former attorneys.

In September 2002, we entered into a $16.0 million Revolving Line of Credit Note Agreement
(LOC Agreement) with a bank. We repaid $5 million outstanding under the LOC Agreement and terminated the agreement on December 28, 2005. The company has alternative sources of capital at more favorable terms and determined not to replace or
renegotiate the credit agreement at this time.



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##### Index to Financial Statements

The following table represents Tanoxs contractual obligations as of December 31, 2006:



|                            |  |                                       |        |                  |   |              |  |              |       |                  |   |       |  |  
|--------------------------- |  | ------------------------------------- | ------ | ---------------- | - | ------------ |  | ------------ | ----- | ---------------- | - | ----- |  | -
|                            |  | Payments due by period (in thousands)
|Contractual Obligations (1) |  | Total                                 |        | Less than 1 year |   | 1 to 3 years |  | 3 to 5 years |       | More than 5years
|Operating Leases            |  | $                                     | 16,896 |                  | $ | 1,944        |  | $            | 6,581 |                  | $ | 8,371 |  | 
|                            |  |                                       |        |                  |   |              |  |              |       |                  |   |       |  |  
|Total                       |  | $                                     | 16,896 |                  | $ | 1,944        |  | $            | 6,581 |                  | $ | 8,371 |  | 
|                            |  |                                       |        |                  |   |              |  |              |       |                  |   |       |  |  

---

|(1) | The table above includes
non-cancelable future commitments and liabilities under agreements with third parties, and excludes contingent liabilities for which we cannot reasonably predict future payment amounts and timing. Therefore, this table excludes obligations relating
to milestone and royalty payments which are contingent upon certain future events as described in our collaboration and license footnote (See Note 6). If all of the milestones were met, the Company would be required to make an aggregate of $11.7
million in additional product license fees and development milestone payments under the agreements described in Note 6.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Our current and anticipated development projects require substantial additional capital to complete. Although we generated positive cash flow from operations in 2006, we anticipate that if the merger agreement is not completed the amount of
cash we need to fund operations, including research and development, manufacturing and other costs, and for capital expenditures, will increase in the future as our projects move from research to clinical development to commercialization. We may
make additional acquisitions of businesses or intellectual property assets and also expect that we will need to expand our clinical development, manufacturing capacity, facilities, business development and marketing activities to support the future
development of our programs. Based on cash projections, we expect that cash on hand and revenue from operations will be sufficient to fund our existing operations for at least the next four years. However, our future capital needs will depend on
many factors, including the continued successful commercialization of Xolair, progress in our research and product development activities, the size and design of our clinical trials, commercialization activities, the costs and magnitude of product
or technology acquisitions, the cost of preparing, filing, prosecuting, maintaining and enforcing patent claims and other intellectual property rights, competing technological and market developments, changes in or terminations of existing
collaboration and licensing arrangements, establishing additional collaboration and licensing arrangements, potential merger and acquisition activities, potential litigation surrounding any of the foregoing, and manufacturing scale-up costs and
marketing activities, if we undertake those activities. Consequently, we may need to raise additional funds and we may issue additional shares of common stock or other equity securities.

We filed a universal shelf Registration Statement with the Securities and Exchange Commission (SEC) in May 2005, which permits us to sell up to $100
million of equity or debt securities in one or more offerings. We would expect to use the net proceeds from any sales of securities under this shelf registration statement to provide funds for development of products in our drug development
pipeline, potential product acquisition or licensing opportunities and general corporate purposes. The terms of any offering of securities will be made public in a subsequent filing with the SEC at the time of any such sale.

Pursuant to the terms of a registration rights agreement entered into with Sunol in connection with the acquisition of the tissue factor antagonist
program, we filed a Registration Statement with the SEC in May 2005 covering the resale of up to 525,000 shares of our common stock by Sunol and its shareholders to whom a portion of those shares have been distributed.



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##### Index to Financial Statements

|ITEM 7A. | Quantitative and Qualitative Disclosures About Market Risk
|-------- | ----------------------------------------------------------

We are exposed to a variety of risks, including changes in interest rates and foreign currency exchange fluctuations. In the normal course of business, we have established policies and procedures to manage these risks.

Foreign Currency Exchange Rates. We are subject to foreign currency exchange risk because we conduct minimal operations through one foreign
subsidiary in China.

Interest Rate Risk.Cash, cash equivalents and investments were approximately $185.1 million at
December 31, 2006. These assets were primarily invested in investment grade corporate bonds, commercial paper, government agency securities and money market funds with maturities of less than three years, which we have the ability and intent to
hold to maturity. We also invest in auction securities which are classified as available for sale securities. We do not invest in derivative securities. Although our portfolio and related interest income is subject to fluctuations in interest rates
and market conditions, no gain or loss on any security would actually be recognized in earnings unless we sell the asset.



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##### Index to Financial Statements

|ITEM 8. | Financial Statements and Supplementary Data
|------- | -------------------------------------------

Tanox, Inc.

Index to Consolidated Financial Statements



|                                                                                                                  |  |     
|----------------------------------------------------------------------------------------------------------------- |  | ----
|                                                                                                                  |  | PAGE
|Report of Independent Registered Public Accounting Firm                                                           |  | 45  
|                                                                                                                  | 
|Report of Independent Registered Public Accounting Firm                                                           |  | 46  
|                                                                                                                  | 
|Consolidated Balance Sheets as of December 31, 2006 and 2005                                                      |  | 47  
|                                                                                                                  | 
|Consolidated Statements of Operations and Comprehensive Loss for the Years Ended December 31, 2006, 2005 and 2004 |  | 48  
|                                                                                                                  | 
|Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 2006, 2005 and 2004.             |  | 49  
|                                                                                                                  | 
|Consolidated Statements of Cash Flows for the Years Ended December 31, 2006, 2005 and 2004                        |  | 50  
|                                                                                                                  | 
|Notes to Consolidated Financial Statements.                                                                       |  | 51  



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Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders of Tanox, Inc.

We have audited the accompanying consolidated balance sheets of Tanox, Inc. and Subsidiaries as of December 31, 2006 and 2005, and the related consolidated
statements of operations, changes in stockholders equity, and cash flows for each of the three fiscal years in the period ended December 31, 2006. These financial statements are the responsibility of the Companys management. Our
responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred
to above present fairly, in all material respects, the consolidated financial position of Tanox, Inc. and Subsidiaries at December 31, 2006 and 2005, and the consolidated results of their operations and their cash flows for each of the three
fiscal years in the period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles.

As discussed in note 2 to the
consolidated financial statements, in 2006 Tanox, Inc. changed its method of accounting for stock-based compensation in accordance with guidance provided in the Statement of Financial Standards No. 123(R), Share-Based Payment.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Tanox,
Inc.s internal control over financial reporting as of December 31, 2006, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our
report dated March 12, 2007 expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP

Houston, Texas

March 12, 2007



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Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders of Tanox, Inc.

We have audited managements assessment, included in the accompanying Managements Report on Internal Control Over Financial Reporting, that Tanox, Inc.
maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission
(the COSO criteria). Tanox, Inc.s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to
express an opinion on managements assessment and an opinion on the effectiveness of the companys internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about
whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating managements assessment, testing and
evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

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

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, managements assessment that Tanox, Inc. maintained effective internal control over financial reporting as of December 31, 2006, is fairly
stated, in all material respects, based on the COSO criteria. Also, in our opinion, Tanox, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets
of Tanox, Inc. and Subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of operations, changes in stockholders equity, and cash flows for each of the three fiscal years in the period ended
December 31, 2006 of Tanox, Inc. and Subsidiaries and our report dated March 12, 2007 expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP

Houston, Texas

March 12, 2007



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##### Index to Financial Statements

TANOX, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except shares and per share data)



|                                                                                                                                                                                                                        |  |              |          |   |      |   |          |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | -------- | - | ---- | - | -------- | -
|                                                                                                                                                                                                                        |  | December 31, |         
|                                                                                                                                                                                                                        |  | 2006         |          |   | 2005 |  
|ASSETS                                                                                                                                                                                                                  |  |              |          |   |      |   |          |  
|CURRENT ASSETS:                                                                                                                                                                                                         |  |              |          |   |      |   |          |  
|Cash and cash equivalents                                                                                                                                                                                               |  | $            | 54,150   |   |      | $ | 46,732   |  
|Short-term investments                                                                                                                                                                                                  |  |              | 119,079  |   |      |   | 106,228  |  
|Interest receivable                                                                                                                                                                                                     |  |              | 998      |   |      |   | 799      |  
|Accounts receivable                                                                                                                                                                                                     |  |              | 11,747   |   |      |   | 29,335   |  
|Accounts receivable from related party                                                                                                                                                                                  |  |              | 1,887    |   |      |   | 122      |  
|Prepaid expenses and other                                                                                                                                                                                              |  |              | 1,841    |   |      |   | 2,359    |  
|                                                                                                                                                                                                                        |  |              |          |   |      |   |          |  
|Total current assets                                                                                                                                                                                                    |  |              | 189,702  |   |      |   | 185,575  |  
|                                                                                                                                                                                                                        |  |             
|LONG-TERM INVESTMENTS                                                                                                                                                                                                   |  |              | 11,852   |   |      |   | 11,541   |  
|                                                                                                                                                                                                                        |  |             
|PROPERTY, PLANT AND EQUIPMENT, NET                                                                                                                                                                                      |  |              | 29,227   |   |      |   | 31,214   |  
|                                                                                                                                                                                                                        |  |             
|OTHER ASSETS                                                                                                                                                                                                            |  |              | 1,327    |   |      |   | 1,606    |  
|                                                                                                                                                                                                                        |  |              |          |   |      |   |          |  
|Total assets                                                                                                                                                                                                            |  | $            | 232,108  |   |      | $ | 229,936  |  
|                                                                                                                                                                                                                        |  |              |          |   |      |   |          |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                                                    |  |              |          |   |      |   |          |  
|CURRENT LIABILITIES:                                                                                                                                                                                                    |  |              |          |   |      |   |          |  
|Accounts payable                                                                                                                                                                                                        |  | $            | 1,379    |   |      | $ | 2,615    |  
|Accrued liabilities                                                                                                                                                                                                     |  |              | 7,133    |   |      |   | 4,913    |  
|Accrued arbitration award                                                                                                                                                                                               |  |              | 2,393    |   |      |   | 8,967    |  
|                                                                                                                                                                                                                        |  |              |          |   |      |   |          |  
|Total current liabilities                                                                                                                                                                                               |  |              | 10,905   |   |      |   | 16,495   |  
|                                                                                                                                                                                                                        |  |              |          |   |      |   |          |  
|LONG-TERM LIABILITIES:                                                                                                                                                                                                  |  |              |          |   |      |   |          |  
|Deferred Revenue                                                                                                                                                                                                        |  |              | 1,000    |   |      |   |         |  
|                                                                                                                                                                                                                        |  |              |          |   |      |   |          |  
|Total long-term liabilities                                                                                                                                                                                             |  |              | 1,000    |   |      |   |         |  
|                                                                                                                                                                                                                        |  |              |          |   |      |   |          |  
|STOCKHOLDERS EQUITY:                                                                                                                                                                                                   |  |              |          |   |      |   |          |  
|Preferred stock, $.01 par value; 10,000,000 shares authorized; none outstanding                                                                                                                                         |  |              |         |   |      |   |         |  
|Common stock, $.01 par value; 120,000,000 shares authorized; 46,065,563 and 45,466,957 shares issued in 2006 and 2005, respectively;
45,510,863 shares and 44,912,257 shares outstanding in 2006 and 2005, respectively |  |              | 461      |   |      |   | 455      |  
|Additional paid-in capital                                                                                                                                                                                              |  |              | 341,771  |   |      |   | 331,822  |  
|Treasury stock, at cost; 554,700 shares in 2006 and 2005                                                                                                                                                                |  |              | (6,261   | ) |      |   | (6,261   | )
|Accumulated other comprehensive income                                                                                                                                                                                  |  |              | 59       |   |      |   | 684      |  
|Accumulated deficit                                                                                                                                                                                                     |  |              | (115,827 | ) |      |   | (113,259 | )
|                                                                                                                                                                                                                        |  |              |          |   |      |   |          |  
|Total stockholders equity                                                                                                                                                                                              |  |              | 220,203  |   |      |   | 213,441  |  
|                                                                                                                                                                                                                        |  |              |          |   |      |   |          |  
|Total liabilities and stockholders equity                                                                                                                                                                              |  | $            | 232,108  |   |      | $ | 229,936  |  
|                                                                                                                                                                                                                        |  |              |          |   |      |   |          |  

The accompanying notes are an integral part of these consolidated financial statements.



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##### Table of Contents

##### Index to Financial Statements

TANOX, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(In thousands, except per share data)



|                                                                   |  |                                 |         |   |      |   |         |      |  |   |         |  
|------------------------------------------------------------------ |  | ------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                   |  | For the Year Ended December 31, |        
|                                                                   |  | 2006                            |         |   | 2005 |   |         | 2004 | 
|REVENUES:                                                          |  |                                 |         |   |      |   |         |      |  |   |         |  
|Royalties, net                                                     |  | $                               | 38,218  |   |      | $ | 29,104  |      |  | $ | 13,240  |  
|Royalties from related party, net                                  |  |                                 | 1,942   |   |      |   | 258     |      |  |   | 71      |  
|Profit share from related party, net                               |  |                                 | 6,710   |   |      |   | 1,139   |      |  |   |        |  
|Development agreements, license fees and manufacturing rights, net |  |                                 | 7,205   |   |      |   | 14,132  |      |  |   | 3,725   |  
|Development agreements from related party, net                     |  |                                 | 2,062   |   |      |   | 54      |      |  |   | 3,470   |  
|                                                                   |  |                                 |         |   |      |   |         |      |  |   |         |  
|Total revenues                                                     |  |                                 | 56,137  |   |      |   | 44,687  |      |  |   | 20,506  |  
|                                                                   |  |                                 |         |   |      |   |         |      |  |   |         |  
|OPERATING COSTS AND EXPENSES:                                      |  |                                 |         |   |      |   |         |      |  |   |         |  
|Research and development                                           |  |                                 | 53,409  |   |      |   | 47,898  |      |  |   | 27,200  |  
|Acquired in-process research and development                       |  |                                 |        |   |      |   | 13,680  |      |  |   |        |  
|General and administrative                                         |  |                                 | 13,465  |   |      |   | 7,152   |      |  |   | 7,033   |  
|                                                                   |  |                                 |         |   |      |   |         |      |  |   |         |  
|Total operating costs and expenses                                 |  |                                 | 66,874  |   |      |   | 68,730  |      |  |   | 34,233  |  
|                                                                   |  |                                 |         |   |      |   |         |      |  |   |         |  
|LOSS FROM OPERATIONS                                               |  |                                 | (10,737 | ) |      |   | (24,043 | )    |  |   | (13,727 | )
|                                                                   |  |                                 |         |   |      |   |         |      |  |   |         |  
|OTHER INCOME (EXPENSES):                                           |  |                                 |         |   |      |   |         |      |  |   |         |  
|Interest income                                                    |  |                                 | 8,271   |   |      |   | 4,954   |      |  |   | 3,754   |  
|Interest expense                                                   |  |                                 |        |   |      |   | (218    | )    |  |   | (166    | )
|Other, net                                                         |  |                                 | (102    | ) |      |   | (117    | )    |  |   | (151    | )
|                                                                   |  |                                 |         |   |      |   |         |      |  |   |         |  
|Total other income                                                 |  |                                 | 8,169   |   |      |   | 4,619   |      |  |   | 3,437   |  
|                                                                   |  |                                 |         |   |      |   |         |      |  |   |         |  
|NET LOSS                                                           |  | $                               | (2,568  | ) |      | $ | (19,424 | )    |  | $ | (10,290 | )
|                                                                   |  |                                 |         |   |      |   |         |      |  |   |         |  
|NET LOSS PER SHARE  Basic and diluted                             |  | $                               | (0.06   | ) |      | $ | (0.43   | )    |  | $ | (0.23   | )
|                                                                   |  |                                 |         |   |      |   |         |      |  |   |         |  
|SHARES USED IN COMPUTING NET LOSS PER SHARE  Basic and diluted    |  |                                 | 44,916  |   |      |   | 44,675  |      |  |   | 44,020  |  
|                                                                   |  |                                 |         |   |      |   |         |      |  |   |         |  
|COMPREHENSIVE LOSS:                                                |  |                                 |         |   |      |   |         |      |  |   |         |  
|Net loss                                                           |  | $                               | (2,568  | ) |      | $ | (19,424 | )    |  | $ | (10,290 | )
|Foreign currency translation adjustment                            |  |                                 | 4       |   |      |   | 3       |      |  |   |        |  
|Unrealized gain (loss) on available-for-sale securities            |  |                                 | (629    | ) |      |   | (497    | )    |  |   | 484     |  
|                                                                   |  |                                 |         |   |      |   |         |      |  |   |         |  
|TOTAL COMPREHENSIVE LOSS                                           |  | $                               | (3,193  | ) |      | $ | (19,918 | )    |  | $ | (9,806  | )
|                                                                   |  |                                 |         |   |      |   |         |      |  |   |         |  

The accompanying notes are an integral part of these consolidated financial statements.



48



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##### Table of Contents

##### Index to Financial Statements

TANOX, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY

For the Years Ended December 31, 2006, 2005 and 2004

(In thousands, except share data)



|                                                                                      |  |              |  |                           |     |               |   |         |                                        |   |        |                    |  |   |                            |   |  |   |          |   |  |   |         |  
|------------------------------------------------------------------------------------- |  | ------------ |  | ------------------------- | --- | ------------- | - | ------- | -------------------------------------- | - | ------ | ------------------ |  | - | -------------------------- | - |  | - | -------- | - |  | - | ------- | -
|                                                                                      |  | Common Stock |  | Additional Paid-inCapital |     | TreasuryStock |   |         | Accumulated Other Comprehensive Income |   |        | AccumulatedDeficit |  |   | Total Stockholders Equity |  
|                                                                                      |  | Shares       |  | Par Value                 |     |               |   |         |                                       
|BALANCES, December 31, 2003                                                           |  | 44,470,446   |  | $                         | 445 |               | $ | 311,324 |                                        | $ | (6,261 | )                  |  | $ | 694                        |   |  | $ | (83,545  | ) |  | $ | 222,657 |  
|Exercise of stock options, net                                                        |  | 61,552       |  |                           |    |               |   | 551     |                                        |   |       |                    |  |   |                           |   |  |   |         |   |  |   | 551     |  
|Stock option compensation to non-employees                                            |  |             |  |                           |    |               |   | 54      |                                        |   |       |                    |  |   |                           |   |  |   |         |   |  |   | 54      |  
|Unrealized gain on available-for-sale securities                                      |  |             |  |                           |    |               |   |        |                                        |   |       |                    |  |   | 484                        |   |  |   |         |   |  |   | 484     |  
|Capital contribution from forgiveness of loan principal and interest by related party |  |             |  |                           |    |               |   | 10,742  |                                        |   |       |                    |  |   |                           |   |  |   |         |   |  |   | 10,742  |  
|Net loss                                                                              |  |             |  |                           |    |               |   |        |                                        |   |       |                    |  |   |                           |   |  |   | (10,290  | ) |  |   | (10,290 | )
|                                                                                      |  |              |  |                           |     |               |   |         |                                        |   |        |                    |  |   |                            |   |  |   |          |   |  |   |         |  
|BALANCES, December 31, 2004                                                           |  | 44,531,998   |  |                           | 445 |               |   | 322,671 |                                        |   | (6,261 | )                  |  |   | 1,178                      |   |  |   | (93,835  | ) |  |   | 224,198 |  
|Exercise of stock options, net                                                        |  | 134,959      |  |                           | 2   |               |   | 1,434   |                                        |   |       |                    |  |   |                           |   |  |   |         |   |  |   | 1,436   |  
|Stock option compensation to non-employees                                            |  |             |  |                           |    |               |   | 45      |                                        |   |       |                    |  |   |                           |   |  |   |         |   |  |   | 45      |  
|Unrealized loss on available-for-sale securities                                      |  |             |  |                           |    |               |   |        |                                        |   |       |                    |  |   | (497                       | ) |  |   |         |   |  |   | (497    | )
|Common stock issued for purchase of in-process research and development               |  | 800,000      |  |                           | 8   |               |   | 7,672   |                                        |   |       |                    |  |   |                           |   |  |   |         |   |  |   | 7,680   |  
|Foreign currency translation adjustment                                               |  |             |  |                           |    |               |   |        |                                        |   |       |                    |  |   | 3                          |   |  |   |         |   |  |   | 3       |  
|Net loss                                                                              |  |             |  |                           |    |               |   |        |                                        |   |       |                    |  |   |                           |   |  |   | (19,424  | ) |  |   | (19,424 | )
|                                                                                      |  |              |  |                           |     |               |   |         |                                        |   |        |                    |  |   |                            |   |  |   |          |   |  |   |         |  
|BALANCES, December 31, 2005                                                           |  | 45,466,957   |  |                           | 455 |               |   | 331,822 |                                        |   | (6,261 | )                  |  |   | 684                        |   |  |   | (113,259 | ) |  |   | 213,441 |  
|Exercise of stock options, net                                                        |  | 598,606      |  |                           | 6   |               |   | 6,156   |                                        |   |       |                    |  |   |                           |   |  |   |         |   |  |   | 6,162   |  
|Stock option compensation to employees                                                |  |             |  |                           |    |               |   | 3,695   |                                        |   |       |                    |  |   |                           |   |  |   |         |   |  |   | 3,695   |  
|Stock option compensation to non-employees                                            |  |             |  |                           |    |               |   | 98      |                                        |   |       |                    |  |   |                           |   |  |   |         |   |  |   | 98      |  
|Unrealized loss on available-for-sale securities                                      |  |             |  |                           |    |               |   |        |                                        |   |       |                    |  |   | (629                       | ) |  |   |         |   |  |   | (629    | )
|Foreign currency translation adjustment                                               |  |             |  |                           |    |               |   |        |                                        |   |       |                    |  |   | 4                          |   |  |   |         |   |  |   | 4       |  
|Net loss                                                                              |  |             |  |                           |    |               |   |        |                                        |   |       |                    |  |   |                           |   |  |   | (2,568   | ) |  |   | (2,568  | )
|                                                                                      |  |              |  |                           |     |               |   |         |                                        |   |        |                    |  |   |                            |   |  |   |          |   |  |   |         |  
|BALANCES, December 31, 2006                                                           |  | 46,065,563   |  | $                         | 461 |               | $ | 341,771 |                                        | $ | (6,261 | )                  |  | $ | 59                         |   |  | $ | (115,827 | ) |  | $ | 220,203 |  
|                                                                                      |  |              |  |                           |     |               |   |         |                                        |   |        |                    |  |   |                            |   |  |   |          |   |  |   |         |  

The accompanying notes are an integral part of these consolidated financial statements



49



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##### Table of Contents

##### Index to Financial Statements

TANOX, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)



|                                                                                           |  |                                 |          |   |      |   |          |      |  |   |          |  
|------------------------------------------------------------------------------------------ |  | ------------------------------- | -------- | - | ---- | - | -------- | ---- |  | - | -------- | -
|                                                                                           |  | For the Year Ended December 31, |         
|                                                                                           |  | 2006                            |          |   | 2005 |   |          | 2004 | 
|CASH FLOWS FROM OPERATING ACTIVITIES:                                                      |  |                                 |          |   |      |   |          |      |  |   |          |  
|Net loss                                                                                   |  | $                               | (2,568   | ) |      | $ | (19,424  | )    |  | $ | (10,290  | )
|Adjustments to reconcile net loss to net cash provided by (used in) operating activities - |  |                                 |          |   |      |   |          |      |  |   |          |  
|Depreciation and amortization                                                              |  |                                 | 4,441    |   |      |   | 3,922    |      |  |   | 2,609    |  
|Amortization of intangible                                                                 |  |                                 | 152      |   |      |   | 152      |      |  |   |         |  
|Compensation expense related to stock options                                              |  |                                 | 3,793    |   |      |   | 45       |      |  |   | 54       |  
|Loss on sale of equipment                                                                  |  |                                 |         |   |      |   |         |      |  |   | 39       |  
|Acquired in-process research and development                                               |  |                                 |         |   |      |   | 13,680   |      |  |   |         |  
|Changes in operating assets and liabilities -                                              |  |                                 |          |   |      |   |          |      |  |   |          |  
|(Increase) decrease in receivables and other assets                                        |  |                                 | 16,269   |   |      |   | (22,812  | )    |  |   | (5,319   | )
|(Decrease) increase in current liabilities                                                 |  |                                 | (5,590   | ) |      |   | 7,140    |      |  |   | (4,102   | )
|Increase in long term liabilities                                                          |  |                                 | 1,000    |   |      |   |         |      |  |   |         |  
|                                                                                           |  |                                 |          |   |      |   |          |      |  |   |          |  
|Net cash provided by (used in) operating activities                                        |  |                                 | 17,497   |   |      |   | (17,297  | )    |  |   | (17,009  | )
|                                                                                           |  |                                 |          |   |      |   |          |      |  |   |          |  
|CASH FLOWS FROM INVESTING ACTIVITIES:                                                      |  |                                 |          |   |      |   |          |      |  |   |          |  
|Purchase of investments                                                                    |  |                                 | (179,364 | ) |      |   | (198,365 | )    |  |   | (249,139 | )
|Maturities and sales of investments                                                        |  |                                 | 165,573  |   |      |   | 272,326  |      |  |   | 252,844  |  
|Cash paid for acquisition of in-process research and development                           |  |                                 |         |   |      |   | (6,000   | )    |  |   |         |  
|Additions to property, plant and equipment                                                 |  |                                 | (2,454   | ) |      |   | (9,630   | )    |  |   | (8,949   | )
|Purchase of intangible                                                                     |  |                                 |         |   |      |   | (1,025   | )    |  |   |         |  
|Decrease in restricted cash                                                                |  |                                 |         |   |      |   | 5,000    |      |  |   | 5,536    |  
|                                                                                           |  |                                 |          |   |      |   |          |      |  |   |          |  
|Net cash provided by (used in) investing activities                                        |  |                                 | (16,245  | ) |      |   | 62,306   |      |  |   | 292      |  
|                                                                                           |  |                                 |          |   |      |   |          |      |  |   |          |  
|CASH FLOWS FROM FINANCING ACTIVITIES:                                                      |  |                                 |          |   |      |   |          |      |  |   |          |  
|Repayment of note payable to bank                                                          |  |                                 |         |   |      |   | (5,000   | )    |  |   |         |  
|Proceeds from issuance of common stock                                                     |  |                                 | 6,162    |   |      |   | 1,436    |      |  |   | 551      |  
|                                                                                           |  |                                 |          |   |      |   |          |      |  |   |          |  
|Net cash provided by (used in) financing activities                                        |  |                                 | 6,162    |   |      |   | (3,564   | )    |  |   | 551      |  
|                                                                                           |  |                                 |          |   |      |   |          |      |  |   |          |  
|IMPACT OF EXCHANGE RATES ON CASH AND CASH EQUIVALENTS                                      |  |                                 | 4        |   |      |   | 3        |      |  |   |         |  
|                                                                                           |  |                                 |          |   |      |   |          |      |  |   |          |  
|INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                                           |  |                                 | 7,418    |   |      |   | 41,448   |      |  |   | (16,166  | )
|                                                                                           |  |                                 |         
|CASH AND CASH EQUIVALENTS, beginning of year                                               |  |                                 | 46,732   |   |      |   | 5,284    |      |  |   | 21,450   |  
|                                                                                           |  |                                 |          |   |      |   |          |      |  |   |          |  
|CASH AND CASH EQUIVALENTS, end of year                                                     |  | $                               | 54,150   |   |      | $ | 46,732   |      |  | $ | 5,284    |  
|                                                                                           |  |                                 |          |   |      |   |          |      |  |   |          |  
|SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:                                          |  |                                 |          |   |      |   |          |      |  |   |          |  
|Capital contribution from forgiveness of note payable by a related party                   |  |                                 |         |   |      |   |         |      |  |   | 10,000   |  
|Capital contribution from forgiveness of interest by a related party                       |  |                                 |         |   |      |   |         |      |  |   | 742      |  
|Common stock issued for purchase of in-process research and development                    |  |                                 |         |   |      |   | 7,680    |      |  |   |         |  
|Unrealized gain (loss) on available-for-sale security                                      |  |                                 | (629     | ) |      |   | (497     | )    |  |   | 484      |  
|Cash paid during the year for interest                                                     |  |                                 |         |   |      |   | (218     | )    |  |   | (127     | )

The accompanying notes are an integral part of these consolidated financial statements.



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##### Index to Financial Statements

Tanox, Inc. and Subsidiaries

Notes to Consolidated Financial Statements  (Continued)



1. ORGANIZATION AND BUSINESS

Tanox, Inc. (Tanox or the Company) is a biotechnology company specializing in the discovery and development of biotherapeutics based on monoclonal antibody technology. The Company develops
innovative therapeutic agents for the treatment of immune-mediated diseases, inflammation, infectious disease and cancer. Tanox was formerly known as Tanox Biosystems, Inc. and was incorporated as a Texas corporation on March 19, 1986. Tanox
was reincorporated in January 2000 as a Delaware corporation.

On November 9, 2006, we entered into an agreement and plan of merger
with Genentech, Inc. (Genentech) and Green Acquisition Corporation, a wholly-owned subsidiary of Genentech, pursuant to which Genentech would acquire Tanox for approximately $919 million in cash. Under the terms of the agreement, Green Acquisition
will merge with and into Tanox, and the stockholders of Tanox will receive $20.00 in cash for each share held, less any applicable withholding tax. In addition, each option to purchase Tanox common stock outstanding at the time of the merger will be
canceled and the option holder entitled to receive a cash amount equal to the product of (i) the number of shares of Tanox common stock as to which the option remains unexercised, multiplied by (ii) the amount, if any, by which $20.00
exceeds the exercise price of the option, less any applicable withholding tax. The boards of directors of both companies and the stockholders of Tanox have approved the transaction, which remains subject to expiration of the waiting period under the
Hart-Scott-Rodino Antitrust Improvements Act, the absence of a material adverse effect and the satisfaction of other customary closing conditions. We expect that the transaction will close within the first half of 2007.

Tanox entered into a development and licensing agreement with the predecessor to Novartis Pharma AG (Novartis) in May 1990, in which Tanox and Novartis
agreed to jointly develop, produce and market certain products for IgE-mediated diseases, including asthma and allergy. Tanox received an initial milestone payment upon signing the agreement and has received additional milestone payments and
reimbursement of designated expenses. Under separate agreements, Novartis purchased 6,373,732 shares of Tanox common stock and loaned Tanox $10.0 million for the construction of a pilot manufacturing facility. Under the terms of the Amended and
Restated Development and Licensing Agreement, dated February 25, 2004, the principal and accrued interest on this loan were forgiven in full by Novartis and recorded by Tanox as a capital infusion. Because the shares owned by Novartis represent
approximately 14.0% of Tanoxs outstanding common stock at December 31, 2006, Novartis is considered a related party in Tanoxs financial statements.

Tanox, Novartis and Genentech entered into a binding agreement-in-principle (Three-Party Collaboration) in July 1996 to combine their existing anti-IgE antibody programs into a cooperative effort to develop and
commercialize selected anti-IgE antibodies. On June 20, 2003, Xolair was approved for treating adults and adolescents with moderate to severe persistent asthma by the Food and Drug Administration (FDA). Tanox receives royalty payments on net
sales of Xolair pursuant to the Three-Party Collaboration, participates in Novartis net profits on Xolair in the U.S., shares net losses and net profits with Novartis on the development and commercialization of Xolair in certain far East
countries and earns milestone payments upon the occurrence of specified development and commercialization events. Tanox relinquished any rights it had to manufacture Xolair and in exchange receives payments based on the quantity of Xolair produced,
as defined in our collaboration agreement. Tanox, Novartis and Genentech finalized the detailed terms of the Three-Party Collaboration agreements in February 2004 with the execution of the Tripartite Cooperation Agreement (TCA).



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##### Index to Financial Statements

Tanox, Inc. and Subsidiaries

Notes to Consolidated Financial Statements  (Continued)



Tanox engages in research and development activities which involve a high degree of risk and
uncertainty. Tanox has not generated any revenues from product sales, only royalty, profit-sharing, manufacturing-rights and development revenue. The ability of Tanox to successfully develop, manufacture and market its products is dependent upon
many factors. These factors could include, but are not limited to, the need for additional financing, the ability to maintain or obtain additional manufacturing capabilities and the ability to develop or obtain sales and marketing capabilities or
collaborative arrangements. Additional factors could include uncertainties as to patents and proprietary technologies, efficacy and safety of its products, competition, governmental regulations and regulatory approval.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of
Presentation

The accompanying consolidated financial statements include the accounts of Tanox and its wholly owned subsidiaries,
Tanox Pharma International, Inc. Tanox Biotech (Shanghai) Ltd. and Tanox West, Inc. Intercompany transactions and balances are eliminated in consolidation.

Use of Estimates

The preparation of consolidated financial statements in conformity with U.S. generally accepted
accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and footnotes thereto. Actual results may differ from those estimates.

Revenue Recognition

Under our collaboration
agreements with Genentech and Novartis, we receive a royalty on the net sales of Xolair worldwide and share in Novartis net profits from Xolair sales in the U.S. Royalty revenue is recorded monthly based on contractual terms and information
provided by Genentech and Novartis. Royalties are reconciled and adjusted if actual results differ from those previously reported to us and are subject to audit by Tanox. Our interest in Novartis U.S. net profits is calculated and recorded one
quarter in arrears. Manufacturing rights revenue represents amounts received from Genentech and Novartis in consideration of our relinquishment, under the collaboration agreements, of our rights to manufacture Xolair. Manufacturing rights revenue is
based on the quantity of Xolair produced, as defined in our collaboration agreement, and is calculated and recorded one quarter in arrears. Revenues from development agreements include payments for milestone achievements and sponsored research and
development costs. Milestone payments are received under best efforts contracts and are not refundable. They are recognized as revenue when the milestones are achieved and there are no remaining performance obligations. Revenues for sponsored
research and development are recognized as revenue as we complete our obligations related to such activities. Any revenue contingent upon future performance is deferred and recognized as the performance is completed. Revenues recognized are net of
certain credits and amounts due to our former attorneys under an arbitration award.

Cash Equivalents, Short-term and Long-term Investments

Cash equivalents consist of highly-liquid investments with original maturities of three months or less. Management determines the
appropriate classification of its cash equivalents, short-term investments and long-term investments at the time of purchase. Investments consist of investment grade corporate bonds, commercial paper, certificates of deposit, auction-rate securities
and government agency



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##### Index to Financial Statements

Tanox, Inc. and Subsidiaries

Notes to Consolidated Financial Statements  (Continued)



securities with maturities of less than three years from the balance sheet date. Certain investments are classified as held-to-maturity and carried at
amortized cost in the accompanying consolidated financial statements. The Companys available-for-sale securities are stated at fair value based on the quoted market price of the investment. Unrealized gains and losses on available-for-sale
securities are reported as other comprehensive income (loss), which is a separate component of stockholders equity.

Restricted Cash and
Investments

Tanox was required to maintain restricted cash or investments to collateralize borrowings under a Revolving Line of
Credit Note Agreement. We repaid the $5 million outstanding under the LOC Agreement and terminated the agreement on December 28, 2005.

Fair
Value of Financial Instruments

Carrying amounts of certain of the Companys financial instruments, including cash, cash
equivalents and short-term investments, approximate fair value due to their short maturities (See Note 3. Investments).

Concentration of Credit Risk

Financial instruments that potentially subject the Company to concentrations of credit risk are primarily cash equivalents, short
and long-investments in short and long-term securities and trade receivables. Cash equivalents and short and long-term investments consist of money market funds, investment grade corporate bonds, commercial paper, certificates of deposit,
auction-rate securities and government agency securities. All cash, cash equivalents and short and long-term investments are maintained with financial institutions that management believes are credit worthy. The Companys investment policy,
approved by the Board of Directors, limits the amount the Company may invest in any one type of investment, thereby reducing credit risk concentrations. At December 31, 2006 and 2005, receivables from Genentech, a large biopharmaceutical
company located in the U.S., were 86.0% and 99.6%, respectively, of total receivables. Revenues from Genentech for the same periods were 68.2% and 93.9%, respectively, of total revenues. The Company has not experienced any significant credit losses
to date and, at December 31, 2006, management believes that the Company has no significant concentrations of credit risk.

Property, Plant and
Equipment

Property, plant and equipment is carried at cost and depreciated on a straight-line basis over the estimated useful
economic lives of the assets or, in the case of leasehold improvements, over the shorter of the asset useful life or the remaining term of the lease. The estimated useful lives used in computing depreciation and amortization are:



|                                               |  |                 |  | 
|---------------------------------------------- |  | --------------- |  | 
|                                               |  | Useful lives    |  | 
|Buildings and improvements                     |  | 10 to 20 years  |  | 
|Manufacturing, laboratory and office equipment |  | 3 to 7 years    |  | 
|Leasehold improvements                         |  | Length of lease |  | 
|Furniture and fixtures                         |  | 7 years         |  | 

When property is retired or otherwise disposed of, the cost and accumulated depreciation are
removed from the accounts and any resulting gain or loss is included in other income (expenses). Maintenance and repair expenditures are charged to expense when incurred.



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##### Index to Financial Statements

Tanox, Inc. and Subsidiaries

Notes to Consolidated Financial Statements  (Continued)



Property, plant and equipment balances at December 31, 2006 and 2005 are summarized below (in
thousands):



|                                                |  |      |         |   |      |   |         |  
|----------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|                                                |  | 2006 |         |   | 2005 |  
|Land                                            |  | $    | 4,332   |   |      | $ | 4,332   |  
|Building and improvements                       |  |      | 18,452  |   |      |   | 17,481  |  
|Manufacturing, laboratory and office equipment  |  |      | 24,637  |   |      |   | 22,553  |  
|Leasehold improvements                          |  |      | 530     |   |      |   | 439     |  
|Furniture and fixtures                          |  |      | 888     |   |      |   | 881     |  
|Construction in progress                        |  |      | 1,270   |   |      |   | 2,009   |  
|                                                |  |      |         |   |      |   |         |  
|                                                |  |      | 50,109  |   |      |   | 47,695  |  
|Less: Accumulated depreciation and amortization |  |      | (20,882 | ) |      |   | (16,481 | )
|                                                |  |      |         |   |      |   |         |  
|Net property, plant and equipment               |  | $    | 29,227  |   |      | $ | 31,214  |  
|                                                |  |      |         |   |      |   |         |  

The estimated cost to complete the construction in progress projects at December 31, 2006 is
$483,000.

Impairment of Long-Lived Assets, Including Intangibles

Management periodically reviews long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be
recoverable. If the carrying amount of the asset is greater than its undiscounted future operating cash flow, an impairment loss would be recognized.

Research and Development

Research and development expenses consist of direct costs and indirect overhead costs,
including facilities costs, salaries and related benefit costs and material and supply costs. Expenses may also include upfront fees and milestones paid to licensors and collaborative partners. Such amounts are expensed as incurred. Research and
development costs also include estimates for clinical trial costs, which are based on patient enrollment and clinical trial progress. Actual costs may differ from estimates.

Income Taxes

Tanox accounts for income taxes using the liability method prescribed by
Statement of Financial Accounting Standards (FAS) No. 109, "Accounting for Income Taxes." Under this method, deferred income tax assets and liabilities reflect the impact of temporary differences between the financial accounting and tax bases
of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.

Foreign Currency Transactions and Translations

The balance sheet accounts of Tanoxs foreign subsidiaries are
translated into U.S. dollars at exchange rates in effect on reporting dates. Foreign currency translation adjustments are reflected in other comprehensive loss. Statement of Operations items are translated at average exchange rates in effect during
the financial statement period. Gains and losses resulting from foreign currency transactions denominated in currency other than the functional currency are classified as other income (expenses).



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Tanox, Inc. and Subsidiaries

Notes to Consolidated Financial Statements  (Continued)



Net Loss Per Share

FAS No. 128, "Earnings Per Share," requires dual presentation of basic and diluted net loss per share (EPS). Basic EPS is computed by dividing net loss by the weighted average number of shares of common stock
outstanding during the year. Diluted EPS is computed in the same manner as basic EPS, except that diluted EPS reflects the potential dilution that would occur if outstanding options were exercised. Tanox incurred net losses for the years ended
December 31, 2006, 2005 and 2004; therefore, all options outstanding for each of the years were excluded from the computation of diluted EPS because they would have been antidilutive.

Segment Information

The Company currently
operates in one business segment, that being the development and commercialization of novel antibody drugs. The Company is managed and operated as one business. The entire business is comprehensively managed by a single management team that reports
to the Chief Executive Officer. The Company does not operate separate lines of business or separate business entities with respect to its products or product candidates. Accordingly, the Company does not accumulate discrete financial information
with respect to separate product areas and does not have separately reportable segments as defined by FAS No. 131, Disclosure about Segments of an Enterprise and Related Information.

Share-Based Compensation

Tanox adopted FAS
123R, Share-Based Payment on January 1, 2006 using the modified prospective transition method, which requires that share-based compensation is recognized for all awards granted, modified or settled after the effective date as well
as for all awards granted to employees prior to the effective date that remain unvested as of the effective date. Prior to the adoption of FAS 123R, we accounted for our share-based compensation expense under the recognition and measurement
provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees. Under the intrinsic value method described in APB Opinion No. 25, no compensation expense was recognized if the exercise price of the employee stock
option equaled the market price of the underlying stock on the date of grant.

Tanox estimates the fair value of stock options using the
Black-Scholes-Merton option pricing model. The assumptions used under this model are as follows: 1) the expected term of the options is estimated using historical option exercise data; 2) the expected volatility is estimated based on historical
stock price volatility; 3) the risk-free interest rate is based on the U.S. Treasury zero-coupon issues with a remaining term equal to the expected term of the option; and 4) a zero percent dividend yield. Under FAS 123R, the fair value of stock
options granted is recognized as expense over the service period, net of estimated forfeitures, which we base on historical data. To the extent actual forfeitures differ from our current estimates, cumulative adjustments to share-based compensation
expense will be recorded in the period that estimates are revised.

Recent Accounting Pronouncement

In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes 
an Interpretation of FASB Statement No. 109, (FIN 48). This interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprises financial statements in accordance with FASB Statement No. 109,
Accounting for Income Taxes. The interpretation prescribes a recognition threshold and measurement attribute for a tax position taken or expected to be taken in a tax return and also provides guidance on derecognition, classification,
interest



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##### Index to Financial Statements

Tanox, Inc. and Subsidiaries

Notes to Consolidated Financial Statements  (Continued)



and penalties, accounting for interim periods, disclosure and transition. The provisions of FIN 48 are effective for fiscal years beginning after
December 15, 2006. We are currently evaluating the impact, if any, this statement may have on our financial statements.

3. INVESTMENTS

Short-term and long-term investments at December 31, 2006 consist of the following (in thousands):



|                                                            |  |           |         |                      |   |                      |  |   |                     |   |  |   |        
|----------------------------------------------------------- |  | --------- | ------- | -------------------- | - | -------------------- |  | - | ------------------- | - |  | - | -------
|                                                            |  | BookValue |         | Gross UnrealizedGain |   | Gross UnrealizedLoss |  |   | Estimated FairValue
|Certificates of Deposit:                                    |  |           |         |                      |   |                      |  |   |                     |   |  |   |        
|One year or less                                            |  | $         | 3,500   |                      | $ |                     |  | $ | (3                  | ) |  | $ | 3,497  
|Commercial Paper:                                           |  |           |         |                      |   |                      |  |   |                     |   |  |   |        
|One year or less                                            |  |           | 3,179   |                      |   |                     |  |   |                    |   |  |   | 3,179  
|Corporate Debt Securities:                                  |  |           |         |                      |   |                      |  |   |                     |   |  |   |        
|One year or less                                            |  |           | 41,565  |                      |   |                     |  |   | (30                 | ) |  |   | 41,535 
|Greater than 1 year and less than 3 years                   |  |           | 9,342   |                      |   |                     |  |   | (14                 | ) |  |   | 9,328  
|Euro Dollar Bonds:                                          |  |           |         |                      |   |                      |  |   |                     |   |  |   |        
|One year or less                                            |  |           | 5,502   |                      |   |                     |  |   | (3                  | ) |  |   | 5,499  
|Greater than 1 year and less than 3 years                   |  |           | 1,010   |                      |   |                     |  |   | (2                  | ) |  |   | 1,008  
|Government/Agency Securities:                               |  |           |         |                      |   |                      |  |   |                     |   |  |   |        
|One year or less                                            |  |           | 11,500  |                      |   |                     |  |   | (43                 | ) |  |   | 11,457 
|Greater than 1 year and less than 3 years                   |  |           | 1,500   |                      |   |                     |  |   | (4                  | ) |  |   | 1,496  
|                                                            |  |           |         |                      |   |                      |  |   |                     |   |  |   |        
|Total Securities held to maturity                           |  |           | 77,098  |                      |   |                     |  |   | (99                 | ) |  |   | 76,999 
|Available-for-sale investments*                             |  |           | 53,781  |                      |   | 52                   |  |   |                    |   |  |   | 53,833 
|                                                            |  |           |         |                      |   |                      |  |   |                     |   |  |   |        
|Total short- and long-term investments at December 31, 2006 |  | $         | 130,879 |                      | $ | 52                   |  | $ | (99                 | ) |  | $ | 130,832
|                                                            |  |           |         |                      |   |                      |  |   |                     |   |  |   |        

---

|* | For the year ended December 31, 2006, the fair value of our available-for-sale investments decreased by $629,000 and an unrealized loss is included as a component of
stockholders equity.
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Index to Financial Statements

Tanox, Inc. and Subsidiaries

Notes to Consolidated Financial Statements  (Continued)



Short-term and long-term investments at December 31, 2005 consist of the following (in
thousands):



|                                                            |  |           |         |                      |   |                      |  |   |                      |   |  |   |        
|----------------------------------------------------------- |  | --------- | ------- | -------------------- | - | -------------------- |  | - | -------------------- | - |  | - | -------
|                                                            |  | BookValue |         | Gross UnrealizedGain |   | Gross UnrealizedLoss |  |   | Estimated Fair Value
|Certificates of Deposit:                                    |  |           |         |                      |   |                      |  |   |                      |   |  |   |        
|One year or less                                            |  | $         | 3,000   |                      | $ |                     |  | $ | (21                  | ) |  | $ | 2,979  
|Commercial Paper:                                           |  |           |         |                      |   |                      |  |   |                      |   |  |   |        
|One year or less                                            |  |           | 13,039  |                      |   |                     |  |   | (3                   | ) |  |   | 13,036 
|Corporate Debt Securities:                                  |  |           |         |                      |   |                      |  |   |                      |   |  |   |        
|One year or less                                            |  |           | 15,056  |                      |   |                     |  |   | (34                  | ) |  |   | 15,022 
|Greater than 1 year and less than 3 years                   |  |           | 2,525   |                      |   |                     |  |   | (7                   | ) |  |   | 2,518  
|Euro Dollar Bonds:                                          |  |           |         |                      |   |                      |  |   |                      |   |  |   |        
|One year or less                                            |  |           | 2,536   |                      |   |                     |  |   | (15                  | ) |  |   | 2,521  
|Greater than 1 year and less than 3 years                   |  |           | 3,016   |                      |   |                     |  |   | (1                   | ) |  |   | 3,015  
|Government/Agency Securities:                               |  |           |         |                      |   |                      |  |   |                      |   |  |   |        
|One year or less                                            |  |           | 27,500  |                      |   |                     |  |   | (228                 | ) |  |   | 27,272 
|Greater than 1 year and less than 3 years                   |  |           | 6,000   |                      |   |                     |  |   | (91                  | ) |  |   | 5,909  
|                                                            |  |           |         |                      |   |                      |  |   |                      |   |  |   |        
|Total Securities held to maturity                           |  |           | 72,672  |                      |   |                     |  |   | (400                 | ) |  |   | 72,272 
|Available-for-sale investments*                             |  |           | 44,416  |                      |   | 681                  |  |   |                     |   |  |   | 45,097 
|                                                            |  |           |         |                      |   |                      |  |   |                      |   |  |   |        
|Total short- and long-term investments at December 31, 2005 |  | $         | 117,088 |                      | $ | 681                  |  | $ | (400                 | ) |  | $ | 117,369
|                                                            |  |           |         |                      |   |                      |  |   |                      |   |  |   |        

---

|* | For the year ended December 31, 2005, the fair value of our available-for-sale investments decreased by $497,000 and an unrealized loss is included as a component of
stockholders equity.
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

4. REVENUES

Royalties and Profit Sharing. Under its collaboration agreements with Genentech, Tanox receives a royalty on the net sales of Xolair worldwide and shares in Novartis net profits from Xolair sales in the
U.S. Royalty revenue of $40.2 million and $29.4 million on the net sales of Xolair for the years ended December 31, 2006 and 2005, respectively, were calculated based on net sales reported to Tanox by Genentech and Novartis. Royalty revenue is
net of amounts which are payable by Tanox to its former attorneys (see Note 12. Commitments and Contingencies).

Tanox recorded net profit
sharing revenue of $6.7 million from Novartis for the fourth quarter of 2005 and the first three quarters of 2006, as the profit-sharing calculation is one quarter in arrears. We recorded net profit sharing revenue of $1.1 million in 2005, resulting
from profits made in the first three quarters of 2005.

Novartis profit sharing and rest-of-world royalty payments are net of certain
credits, all of which had been used at December 31, 2006.

Development Agreements, License Fees and Manufacturing Rights. For
the year 2006, we recorded manufacturing rights revenue of $7.0 million, compared to manufacturing rights revenue of $1.1 million for the year 2005. Under the TCA, Tanox relinquished any rights to manufacture Xolair and in exchange receives payments
based on the quantity of Xolair produced. Manufacturing rights revenue is based on the quantity of Xolair produced each quarter, as defined in our collaboration agreement, and is calculated and recorded one quarter in arrears.



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Tanox, Inc. and Subsidiaries

Notes to Consolidated Financial Statements  (Continued)



In the second quarter of 2006, Novartis submitted an application for the approval of Xolair in Japan.
Under our collaboration agreement with Novartis, the filing resulted in a $2.0 million milestone payment to Tanox, of which $1.0 million was recorded as development agreement revenue from a related party in the second quarter of 2006. The remaining
$1.0 million of the milestone is creditable to Novartis against future royalties owed Tanox and was recorded as deferred revenue.

Development agreement revenue in 2006 also includes $1.0 million earned as reimbursement by Novartis of a portion of Tanoxs 2006 development costs for a high affinity anti-IgE program.

Development agreement revenue in 2005 includes $12.8 million in milestone revenue associated with Xolair annual sales achieving $300 million in the U.S.
The $20.0 million gross milestone was reduced by $7.2 million which was due to our former attorneys under an arbitration award. Development agreement revenue for 2004 includes a one-time reimbursement of $6.6 million received under the terms of the
TCA, representing reimbursement by Genentech and Novartis of a portion of the TNX-901 development costs incurred by Tanox in previous years.

5.
ACQUISITIONS

Manufacturing Assets and Long-term Lease.Pursuant to a Lease Assignment and Asset Purchase Agreement
dated December 9, 2004, between Biogen Idec, Inc. and Tanox, on January 10, 2005, Tanox acquired from Biogen Idec certain manufacturing, process development and quality control equipment, related documentation and furniture and fixtures
housed in a 76,000 square foot leased facility located in San Diego, California. The Company paid Biogen Idec approximately $5.6 million for the assets and allocated $4.6 million as property, plant and equipment and $1.0 million as an intangible
asset for manufacturing equipment documentation, included in other assets on the balance sheet. The gross carrying amount and accumulated amortization for the intangible asset is $1.0 million and $304,000 respectively. The weighted average
amortization period is 81 months. The Companys estimated straight-line amortization expense related to the intangible is $721,000 for the next five years.

Tanox also agreed to assume the obligations of Biogen Idec under the triple net lease for the facility, which extends until September 30, 2011. The lease has two five-year extension options with escalating annual
lease payments of approximately 4%. As partial consideration for Tanoxs agreement to the extension of the lease term to September 30, 2011, Biogen Idec agreed to make two payments to Tanox, each in the amount of approximately $2.4
million, on September 30, 2007 and November 30, 2008. We expect the total future lease obligation of Tanox for this lease assignment through 2011, net of the Biogen Idec payments, will be approximately $16.8 million.

Anti-Tissue Factor Program.On March 31, 2005, the Company acquired a tissue factor antagonist program for the potential
treatment of acute lung injury (ALI)/acute respiratory distress syndrome (ARDS) from Sunol Molecular Corporation (Sunol). In consideration for the tissue factor antagonist program, the Company issued an aggregate of 800,000 shares of its common
stock and paid $6.0 million in cash to Sunol. Of the shares issued, 275,000 are being held in escrow for up to three years after closing to secure indemnification obligations under the Asset Purchase Agreement. Based upon the closing price of the
Companys common stock on March 31, 2005, the fair value of the acquired assets



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##### Index to Financial Statements

Tanox, Inc. and Subsidiaries

Notes to Consolidated Financial Statements  (Continued)



was $13.7 million, including the $6 million paid in cash. As of the acquisition date, the acquired program was still in early development stage, had not
reached technological feasibility and had no alternative future use. Accordingly, the Company recorded the $13.7 million purchase price as an acquired in-process research and development expense in the first quarter of 2005.

6. COLLABORATION AND LICENSE AGREEMENTS

Genentech
Inc. and Novartis Pharma, AG.In 1990, Tanox entered into a Development and Licensing Agreement with Ciba Geigy, AG (now Novartis Pharma AG) to jointly develop anti-IgE antibodies to treat allergic diseases. In connection with the settlement of
a lawsuit in 1996, Genentech joined the collaboration for the purpose of developing certain anti-IgE antibodies. Under the collaboration agreements Tanox may receive up to an additional $3.0 million in Xolair-related milestone payments of which $1.5
million would be creditable against future royalty payments. If a second drug were to be developed under the collaboration, Tanox could be eligible for additional net milestone payments of $10.5 million.

In the U.S., Tanox receives royalties on sales of Xolair and other collaboration products and receives a share of Novartis net profits on these
sales. Tanox also receives royalties from Novartis on sales of Xolair in Europe and the rest of the world. Tanox shares equally with Novartis the net profits and the net losses from the development and commercialization of Xolair and other
collaboration products in China, Hong Kong, Korea, Singapore and Taiwan (East Asia). Novartis profit sharing and rest-of-world royalty payments are net of certain credits, all of which had been used at December 31, 2006. In addition, 10% of all
royalties received by Tanox from sales of Xolair and certain other collaboration products will be payable to Tanoxs former attorneys, up to a maximum of $300.0 million, as a result of the arbitration award (see Note 12. Commitments and
Contingencies).

Novartis and Genentech are responsible for manufacturing Xolair and other selected anti-IgE products worldwide. Under the
terms of the three-party collaboration agreement, Tanox relinquished any rights it had to manufacture Xolair and in exchange receives payments based on the quantity of Xolair produced, as defined in our collaboration agreement.

We are also party to an Amended and Restated Development and Licensing Agreement with Novartis under which we have agreed to collaborate on anti-IgE
antibodies that do not fall within the three-party collaboration and, in general, are either (i) invented and synthesized by Tanox or (ii) invented and synthesized by Novartis and derived from a Tanox antibody or would infringe certain
Tanox patent rights.

Biogen Idec, Inc.In 1998, Tanox entered into an agreement to license from Biogen, Inc. (now Biogen Idec,
Inc.) its anti-CD4 monoclonal antibody (renamed TNX-355) and intellectual property on an exclusive worldwide basis. Biogen Idec owns issued U.S., European, Canadian and Australian patents and has pending applications in Japan, which cover our
TNX-355 product. The Company paid Biogen Idec a license fee and agreed to make additional development milestone payments and royalty payments to Biogen Idec based on annual net sales revenue levels. If certain milestones are met, the Company may
make up to an aggregate of $1.4 million (or $10.4 million in the event Tanox merges or affiliates with a company similar in size to Biogen) in product license fees and development milestone payments under this agreement, of which the Company has
paid $200,000. The remaining development milestones will be due upon the commencement of a Phase III clinical or equivalent pivotal trial, at the filing of a BLA and at regulatory approval as a licensed product. If commercialized, tiered royalty
payments will be due to Biogen Idec based on annual net sales volume. The license terminates on a country-by-country basis on the later of the expiration of 12 years following the first commercial product sale or the expiration or invalidity of
applicable patents.



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Tanox, Inc. and Subsidiaries

Notes to Consolidated Financial Statements  (Continued)



Wyeth.In November 2003, the Company entered into cross licensing agreements with Wyeth
Pharmaceuticals, a division of Wyeth, with respect to patent rights covering a new class of drugs for the treatment of osteoporosis and/or other non-oncologic bone-related diseases or disorders. Under the agreements, Wyeth received a license under
Tanox patents to develop a small molecule-based drug, and Tanox received a license under Wyeths patent applications to develop an antibody-based drug. The research is based on a Tanox patented proprietary target gene. Tanox may receive
development milestones from Wyeth for products developed by it in primary and expanded treatment indications and for regulatory approval in the United States and other countries. If commercialized, royalty payments will be due to Tanox based on
annual net sales. Wyeth will be entitled to a milestone payment if Tanox receives regulatory marketing authorization in the United States for an antibody-based product and royalty payments on annual net sales.

Dyax Corp. In November 2004, the Company entered into an agreement with Dyax Corp. (Dyax) to obtain a non-exclusive license to its proprietary
antibody phage display libraries. The Dyax libraries serve as a tool to help Tanox identify fully human monoclonal antibodies that bind with high specificity and affinity to its targets. Under the terms of the agreement, Dyax received an up front
license fee of $900,000 and receives annual technology license fees. Dyax will be entitled to clinical milestone payments if clinical trials are conducted and, if commercialized, tiered royalties on annual net sales of products based on antibodies
identified from the Dyax libraries.

7. ACCRUED LIABILITIES

Accrued liabilities at December 31, 2006 and 2005, consist of the following (in thousands):



|                             |  |      |       |      |   |      
|---------------------------- |  | ---- | ----- | ---- | - | -----
|                             |  | 2006 |       | 2005
|Payroll                      |  | $    | 2,715 |      | $ | 2,082
|Vacation                     |  |      | 728   |      |   | 495  
|Property and franchise taxes |  |      | 857   |      |   | 837  
|Legal and professional fees  |  |      | 791   |      |   | 504  
|Clinical trial costs         |  |      | 601   |      |   | 796  
|Other                        |  |      | 1,441 |      |   | 199  
|                             |  |      |       |      |   |      
|                             |  | $    | 7,133 |      | $ | 4,913
|                             |  |      |       |      |   |      

8. NOTES PAYABLE

Note Payable to Bank. Tanox borrowed $5.0 million in September 2002 from a bank under a $16.0 million Revolving Line of Credit Note Agreement (LOC Agreement). Tanox repaid $5.0 million outstanding under the LOC
Agreement and terminated the agreement on December 28, 2005. The Company determined not to replace or renegotiate the credit agreement.

Note Payable to Related Party. From 1994 through 1998, Novartis advanced Tanox $10.0 million, pursuant to a loan agreement, to finance the construction of our pilot plant manufacturing facility. Under the terms of the Amended and
Restated Development and Licensing Agreement entered into between Tanox and Novartis in February 2004, the principal and accrued interest of $10,742,000 on this loan were forgiven in full by Novartis and recorded by Tanox as a capital infusion since
Novartis is a related party for accounting purposes.



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Tanox, Inc. and Subsidiaries

Notes to Consolidated Financial Statements  (Continued)



9. INCOME TAXES

Tanoxs pretax loss consists of the following (in thousands):



|        |  |      |        |   |      |   |         |      |  |   |         |  
|------- |  | ---- | ------ | - | ---- | - | ------- | ---- |  | - | ------- | -
|        |  | 2006 |        |   | 2005 |   |         | 2004 | 
|U.S.    |  | $    | (557   | ) |      | $ | (13,358 | )    |  | $ | (2,821  | )
|Foreign |  |      | (2,011 | ) |      |   | (6,066  | )    |  |   | (7,469  | )
|        |  |      |        |   |      |   |         |      |  |   |         |  
|        |  | $    | (2,568 | ) |      | $ | (19,424 | )    |  | $ | (10,290 | )
|        |  |      |        |   |      |   |         |      |  |   |         |  

For 2006, 2005 and 2004 the effective income tax provision varied from that computed at the
statutory federal income tax rate of 35% primarily due to an increase in the valuation allowance and nondeductible foreign losses. Foreign pretax losses relate to Tanox wholly owned subsidiaries.

Significant components of Tanoxs deferred tax assets at December 31, 2006 and 2005 are as follows (in thousands):



|                                         |  |      |         |   |      |   |         |  
|---------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|                                         |  | 2006 |         |   | 2005 |  
|Federal NOL carryforwards                |  | $    | 35,344  |   |      | $ | 34,878  |  
|Foreign NOL carryforwards                |  |      |        |   |      |   | 10,972  |  
|Research and development tax credit      |  |      | 6,512   |   |      |   | 4,893   |  
|Alternative minimum tax credit           |  |      | 20      |   |      |   | 20      |  
|Accruals not currently deductible        |  |      | 829     |   |      |   | 378     |  
|Deferred revenue                         |  |      | 350     |   |      |   |        |  
|Non-qualified stock options              |  |      | 980     |   |      |   |        |  
|Capitalized research                     |  |      |        |   |      |   | 875     |  
|Other, net                               |  |      | 431     |   |      |   | 302     |  
|                                         |  |      |         |   |      |   |         |  
|Total deferred tax assets                |  |      | 44,466  |   |      |   | 52,318  |  
|Differences in book and tax depreciation |  |      | (497    | ) |      |   | (558    | )
|Deferred tax valuation allowance         |  |      | (43,969 | ) |      |   | (51,760 | )
|                                         |  |      |         |   |      |   |         |  
|Net deferred taxes                       |  | $    |        |   |      | $ |        |  
|                                         |  |      |         |   |      |   |         |  

At December 31, 2006, Tanox had federal regular tax NOL carryforwards and alternative minimum
tax NOL carryforwards of approximately $101.0 million and $97.1 million, respectively, which will begin to expire in 2019. Additionally, Tanox has an unused U.S. research and development tax credit carryforward at December 31, 2006, of
approximately $6.5 million, which began to expire in 2002. Tanox also has alternative minimum tax credit carryforwards of approximately $20,000 as of December 31, 2006 and 2005. As Tanox has incurred cumulative losses to date and there is no
assurance of future taxable income, a valuation allowance has been established to fully offset the net deferred tax asset at December 31, 2006 and 2005. Tanoxs valuation allowance decreased to $44.0 million at December 31, 2006.
Approximately $15.1 million of the valuation allowance relates to tax benefits for stock option deductions included in the net operating loss carryforward, which when realized will be allocated directly to contributed capital to the extent the
benefits exceed amounts attributable to deferred compensation expense.



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##### Index to Financial Statements

Tanox, Inc. and Subsidiaries

Notes to Consolidated Financial Statements  (Continued)



10. LEASE OBLIGATIONS

Tanox leases equipment and a manufacturing facility under non-cancelable operating leases. These leases expire at various dates through 2011. Future minimum lease obligations under non-cancelable leases at
December 31, 2006, are as follows (in thousands):



|                         |  |   |       
|------------------------ |  | - | ------
|Year ending December 31- |  |  
|2007                     |  | $ | 1,944 
|2008                     |  |   | 2,039 
|2009                     |  |   | 4,542 
|2010                     |  |   | 4,723 
|2011 and thereafter      |  |   | 3,648 
|                         |  |   |       
|Total                    |  | $ | 16,896
|                         |  |   |       

Tanox incurred rent expense of $3.9 million, $3.8 million and $171,000 in 2006, 2005 and 2004,
respectively.

In January 2005, Tanox assumed the lease from Biogen Idec of a 76,000 square foot manufacturing facility located in San
Diego, California, which extends until October 2011, with two five-year extension options. The lease payments will increase annually at a rate of approximately 4%. As partial consideration for Tanoxs agreement to the extension of the lease
term to September 30, 2011, Biogen Idec agreed to make two payments to the Company, each in the amount of approximately $2.4 million, on September 30, 2007 and November 30, 2008. The total lease obligation of Tanox for this lease
assignment through 2011, net of the Biogen Idec payments, will be approximately $24.6 million.

In May 2005, Tanox Biotech (Shanghai), Ltd,
a wholly owned subsidiary of Tanox Pharma International, Inc. entered into an agreement with the Institute of Health Science in Shanghai, China, to establish a joint research laboratory. The total lease obligation under this agreement, which expires
in April 2008, is $240,000.

Tanoxs corporate administrative offices previously occupied approximately 13,100 square feet in Houston,
Texas under a lease that expired on March 31, 2004.

11. CAPITAL STOCK

Preferred Stock

Tanox is authorized to issue up to 10,000,000 shares of $.01 par value
preferred stock. The board of directors has the authority to issue these shares in one or more series and to establish the rights, preferences and dividends for the shares. No shares of preferred stock have been issued.

Stockholder Rights Agreement

On July 27,
2001, the board of directors of Tanox declared a dividend of one right for each outstanding share of the common stock at the close of business on August 10, 2001. Each right entitles the registered holder to purchase a unit consisting of one
one-hundredth of a share (a Fractional Share) of Series A Junior Participating Preferred Stock, par value $0.01 per share, at a purchase price of $140 per Fractional Share, subject to adjustment. The rights generally become exercisable if an
acquiring party accumulates 20% or more of the common stock and, in such event, the holders of the rights (other than the acquiring person) would be entitled to purchase either Tanoxs stock or shares in an acquiring entity at half of market
value. Tanox is generally entitled to redeem the rights at $0.01 per right at any time until the tenth day following the time the rights become exercisable. The rights will expire on August 10, 2011.



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##### Index to Financial Statements

Tanox, Inc. and Subsidiaries

Notes to Consolidated Financial Statements  (Continued)



On November 9, 2006, the Company amended the Rights Agreement between Tanox and American Stock
Transfer & Trust Company, as Rights Agent, to permit the execution and performance of the merger agreement with Genentech and Green Acquisition Corp, including consummation of the merger, without triggering the separation or exercise of the
rights or any adverse event under the rights agreement.

Treasury Stock

In September 2001, the board of directors of Tanox authorized the repurchase, at management's discretion, of up to $4.0 million of Tanox common stock. In
June 2002, the board authorized the purchase of an additional $3.0 million pursuant to the stock repurchase program. As of December 31, 2005, the Company has purchased a total of 554,700 shares at an aggregate cost of $6.3 million. The average
repurchased share price was $11.29.

Share-Based Compensation

In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (FAS) No. 123 (revised 2004, or FAS 123R), Share-Based Payment. FAS 123R supersedes
Accounting Principals Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and requires companies to recognize compensation expense, using a fair-value based method, for costs related to share-based payments,
including stock options and employee stock purchase plans. FAS 123R permits public companies to adopt its requirements using either the modified prospective or modified retrospective transition method.

The Company adopted FAS 123R on January 1, 2006 using the modified prospective transition method which requires that share-based compensation is
recognized for all awards granted, modified or settled after the effective date as well as for all awards granted to employees prior to the effective date that remain unvested as of the effective date. For the year ended December 31, 2006, the
Company recorded approximately $3.7 million of share-based compensation expense, of which $1.6 million was included in research and development expense and $2.1 million was included in general and administrative expense. Included in the general and
administrative expense for the year ended December 31, 2006, was $239,000 related to the acceleration of vesting of options previously granted to our board of directors and $340,000 related to the 2006 annual grant options to our board of
directors, which vested immediately on the grant date. The adoption of FAS 123R resulted in an increased loss of $0.08 per share on the Companys net income or loss per share for the year ended December 31, 2006. The adoption of FAS 123R
had no impact on cash flow from operations and cash flow from financing activities for the year ended December 31, 2006. Share-based compensation for all non-vested options outstanding as of December 31, 2006 was $7.4 million, which will
be recognized over a weighted-average period of 1.6 years. The Company amortizes share-based compensation expense on a straight-line basis over the expected life of the vesting period (See Note 15. Subsequent Events).



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##### Index to Financial Statements

Tanox, Inc. and Subsidiaries

Notes to Consolidated Financial Statements  (Continued)



The Company estimates the fair value of stock options at the date of the grant using the
Black-Scholes-Merton option pricing model, with the following weighted average assumptions:



|                         |  |                         |  |         |   |  |         |  
|------------------------ |  | ----------------------- |  | ------- | - |  | ------- | -
|                         |  | Year ended December 31, | 
|                         |  | 2006                    |  | 2005    |   |  | 2004    |  
|Risk-free interest rate  |  | 4.57% - 5.11%           |  | 4.30    | % |  | 3.46    | %
|Expected dividend yield  |  | 0%                      |  | 0       | % |  | 0       | %
|Expected life            |  | 7 years                 |  | 5 years |   |  | 4 years |  
|Expected volatility      |  | 62% - 63%               |  | 64      | % |  | 69      | %
|Expected forfeiture rate |  | 31%                     |  | 10      | % |  | 8       | %

The expected term of the options was estimated using historical option exercise data. The expected
volatility was based on the Companys historical stock price volatility. The risk-free interest rate was based on the U.S. Treasury zero-coupon issues with a remaining term equal to the expected term of the option. The Company assumed a zero
percent dividend yield. Under FAS 123R, the fair value of stock options granted is recognized as expense over the service period, net of estimated forfeitures. Based on historical data, the Company calculated an estimated forfeiture rate, which it
believes is a reasonable assumption to estimate forfeitures. To the extent actual forfeitures differ from our current estimates, cumulative adjustments to share-based compensation expense will be recorded in the period that estimates are revised.

Prior to the adoption of FAS 123R on January 1, 2006, Tanox accounted for its share-based compensation expense under the recognition
and measurement provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees. Under the intrinsic value method described in APB Opinion No. 25, no compensation expense was recognized if the exercise price of the
employee stock option equaled the market price of the underlying stock on the date of grant. Assuming the compensation cost for the stock option plans had been determined pursuant to the fair value method under FAS No. 123, Tanoxs pro
forma net loss for the years ended December 31, 2005 and 2004 would have been as follows (in thousands, except per share data):



|                                                                            |  |                         |         |   |      |   |         |  
|--------------------------------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | -
|                                                                            |  | Year ended December 31, |        
|                                                                            |  | 2005                    |         |   | 2004 |  
|Net loss:                                                                   |  |                         |         |   |      |   |         |  
|As reported                                                                 |  | $                       | (19,424 | ) |      | $ | (10,290 | )
|Stock option compensation expense if the fair value method had been applied |  |                         | (5,915  | ) |      |   | (5,282  | )
|                                                                            |  |                         |         |   |      |   |         |  
|Pro forma net loss                                                          |  | $                       | (25,339 | ) |      | $ | (15,572 | )
|                                                                            |  |                         |         |   |      |   |         |  
|Loss per share  Basic and Diluted                                          |  |                         |         |   |      |   |         |  
|As reported                                                                 |  | $                       | (0.43   | ) |      | $ | (0.23   | )
|Pro forma                                                                   |  | $                       | (0.57   | ) |      | $ | (0.35   | )



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##### Index to Financial Statements

Tanox, Inc. and Subsidiaries

Notes to Consolidated Financial Statements  (Continued)



At December 31, 2006, the Company has the following share-based compensation plans:

The 1987 Stock Option Plan (the 1987 Plan) was established to cover key employees, officers and directors of Tanox. Under the terms of the 1987 Plan, as
amended, the number of shares of common stock eligible for issuance was 4,320,000. Options issued under the 1987 Plan were generally granted at a purchase price equal to the fair market value at the date of grant, generally expired ten years after
date of grant and were generally completely exercisable five years after the grant date. At December 31, 2006, options to purchase 20,000 shares of common stock were outstanding under the 1987 Plan. The 1987 Plan expired in 1997.

The 1997 Stock Plan (the 1997 Plan) was established to grant options to purchase up to 8,000,000 shares of common stock to employees, directors, advisors
and consultants. The 1997 Plan provides for several types of grants including incentive stock options, non-qualified stock options, stock appreciation rights, stock awards, stock purchases and performance units. Incentive stock options provide the
right to purchase common stock at a price not less than 100% of the fair value of common stock on the date of the grant. Non-qualified stock options provide the right to purchase common stock at a price not less than 50% of the fair value of the
common stock on the date of the grant. The options granted under the 1997 Plan generally expire ten years after date of grant. Options granted under the 1997 Plan prior to February 2004 are generally completely exercisable five years after the grant
date, while options granted in February 2004 and after are generally completely exercisable four years after the grant date. At December 31, 2006, options to purchase 2,158,000 shares of common stock were outstanding under the 1997 Plan, and
4,995,467 shares were available for future grants. The 1997 Plan will expire on October 31, 2007.

The 1992 Non-Employee Directors
Stock Option Plan (the 1992 Directors Plan) was established to grant options to purchase up to 480,000 shares of common stock to non-employee directors of the Company. Options granted under the 1992 Directors Plan generally vested one-third annually
from the date of grant and generally expired ten years from the date of grant. The exercise price of the options granted was determined by a committee appointed by Tanoxs board of directors. At December 31, 2006, options to purchase
17,500 shares of common stock were outstanding under the 1992 Directors Plan. The 1992 Directors Plan expired in 2002.

The 2000
Non-Employee Directors Stock Option Plan (the 2000 Directors Plan) was established to grant options to purchase up to 500,000 shares of common stock to non-employee directors of the Company. Under the terms of the 2000 Directors Plan, as
amended, non-employee directors receive, upon initial election to the Board, an option to acquire 20,000 shares of common stock. Following each annual meeting of stockholders at which directors are elected, the non-employee directors continuing in
office receive options to acquire 10,000 shares of common stock. New directors who received their initial option grant within six months prior to the first annual meeting after their appointment would not be eligible for an option following such
meeting. All grants under the 2000 Directors Plan have a term of ten years, are issued at fair market value and vest 1/36 per month from the date of grant over three years, in the case of the 20,000-share initial grant options, or immediately, in
the case of the 10,000-share annual grant options. At December 31, 2006, options to purchase 234,900 shares of common stock were outstanding under the 2000 Directors Plan, and 247,800 shares were available for future grants.



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##### Index to Financial Statements

Tanox, Inc. and Subsidiaries

Notes to Consolidated Financial Statements  (Continued)



The following table summarizes stock option transactions since December 31, 2003:



|                               |  |                  |   |  |                |               |                                 |   |      
|------------------------------ |  | ---------------- | - |  | -------------- | ------------- | ------------------------------- | - | -----
|                               |  | Number of Shares |   |  | Exercise Price |               | Weighted Average Exercise Price
|Outstanding, December 31, 2003 |  | 2,049,512        |   |  | $              | 1.04  48.00  |                                 | $ | 17.24
|Granted                        |  | 687,465          |   |  |                | 13.31  18.34 |                                 |   | 15.94
|Exercised                      |  | (61,552          | ) |  |                | 1.04  17.52  |                                 |   | 9.00 
|Canceled                       |  | (287,019         | ) |  |                | 8.06  47.31  |                                 |   | 24.42
|                               |  |                  |   |  |                |               |                                 |   |      
|Outstanding, December 31, 2004 |  | 2,388,406        |   |  |                | 4.06  48.00  |                                 |   | 16.21
|Granted                        |  | 855,350          |   |  |                | 9.40  16.91  |                                 |   | 11.93
|Exercised                      |  | (134,959         | ) |  |                | 4.06  16.55  |                                 |   | 10.64
|Canceled                       |  | (707,488         | ) |  |                | 8.06  36.31  |                                 |   | 16.74
|                               |  |                  |   |  |                |               |                                 |   |      
|Outstanding, December 31, 2005 |  | 2,401,309        |   |  |                | 7.50  48.00  |                                 |   | 14.84
|Granted                        |  | 824,065          |   |  |                | 12.53  20.55 |                                 |   | 17.56
|Exercised                      |  | (598,606         | ) |  |                | 7.50  17.52  |                                 |   | 10.29
|Canceled                       |  | (196,368         | ) |  |                | 8.06  27.96  |                                 |   | 14.82
|                               |  |                  |   |  |                |               |                                 |   |      
|Outstanding, December 31, 2006 |  | 2,430,400        |   |  | $              | 7.50  48.00  |                                 | $ | 16.88
|                               |  |                  |   |  |                |               |                                 |   |      
|Exercisable, December 31, 2006 |  | 1,067,521        |   |  | $              | 7.50  48.00  |                                 | $ | 18.80
|                               |  |                  |   |  |                |               |                                 |   |      

The following table summarizes information about fixed-price stock options outstanding at
December 31, 2006:



|                         |  |                                          |  |                                                    |  |                               |       |                                            |           |                               |   |      
|------------------------ |  | ---------------------------------------- |  | -------------------------------------------------- |  | ----------------------------- | ----- | ------------------------------------------ | --------- | ----------------------------- | - | -----
|                         |  | Options Outstanding at December 31, 2006 |  | Options Exercisable at December 31, 2006          
|Range of Exercise Prices |  | No. ofSharesSubject toOptions            |  | Weighted AverageRemainingContractual Life (in Yrs) |  | WeightedAverageExercise Price |       | No. of Shares Subject toExercisableOptions |           | WeightedAverageExercise Price
|$ 7.50  10.00           |  | 266,524                                  |  | 6.29                                               |  | $                             | 8.60  |                                            | 144,159   |                               | $ | 8.59 
|$10.01  12.50           |  | 380,105                                  |  | 7.89                                               |  |                               | 11.77 |                                            | 140,725   |                               |   | 11.72
|$12.51  15.00           |  | 505,832                                  |  | 7.59                                               |  |                               | 13.73 |                                            | 251,786   |                               |   | 13.99
|$15.01  20.00           |  | 1,067,139                                |  | 7.83                                               |  |                               | 17.80 |                                            | 332,551   |                               |   | 16.82
|$20.01  48.00           |  | 210,800                                  |  | 4.11                                               |  |                               | 39.47 |                                            | 198,300   |                               |   | 40.66
|                         |  |                                          |  |                                                    |  |                               |       |                                            |           |                               |   |      
|                         |  | 2,430,400                                |  | 7.30                                               |  |                               | 16.88 |                                            | 1,067,521 |                               |   | 18.80
|                         |  |                                          |  |                                                    |  |                               |       |                                            |           |                               |   |      

The number and weighted average fair value of options granted in 2006, 2005 and 2004 is as
follows:



|                                                     |  |         |  |                             |       |        |         |                             |   |        |  |                             |  |   |      
|---------------------------------------------------- |  | ------- |  | --------------------------- | ----- | ------ | ------- | --------------------------- | - | ------ |  | --------------------------- |  | - | -----
|                                                     |  | 2006    |  | 2005                        |       | 2004  
|                                                     |  | Shares  |  | Weighted Average Fair Value |       | Shares |         | Weighted Average Fair Value |   | Shares |  | Weighted Average Fair Value
|Option exercise price equals fair market value       |  | 824,065 |  | $                           | 11.61 |        | 855,350 |                             | $ | 11.93  |  | 687,465                     |  | $ | 15.94
|Option exercise price greater than fair market value |  |        |  | $                           |      |        |        |                             | $ |       |  |                            |  | $ |     
|Option exercise price less than fair market value    |  |        |  | $                           |      |        |        |                             | $ |       |  |                            |  | $ |     



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##### Index to Financial Statements

Tanox, Inc. and Subsidiaries

Notes to Consolidated Financial Statements  (Continued)



The following table summarizes nonvested stock option activity for the year ended December 31,
2006:



|                             |  |                 |   |  |                            |      
|---------------------------- |  | --------------- | - |  | -------------------------- | -----
|                             |  | Number ofShares |   |  | Weighted Average FairValue
|Nonvested, December 31, 2005 |  | 1,267,222       |   |  | $                          | 7.27 
|Granted                      |  | 824,065         |   |  |                            | 11.61
|Vested                       |  | (583,916        | ) |  |                            | 7.72 
|Forfeited                    |  | (144,492        | ) |  |                            | 8.02 
|                             |  |                 |   |  |                            |      
|Nonvested, December 31, 2006 |  | 1,362,879       |   |  | $                          | 9.63 
|                             |  |                 |   |  |                            |      

Reserved Shares

The Company has reserved shares of common stock for future issuance of stock options under plans, all of which have been approved by stockholders, as follows at December 31, 2006:



|                           |  |          
|-------------------------- |  | ---------
|Outstanding options        |  | 2,430,400
|Reserved for future grants |  | 5,243,267
|                           |  |          
|                           |  | 7,673,667
|                           |  |          

12. COMMITMENTS AND CONTINGENCIES

Tanox had been engaged in litigation in connection with a fee dispute with the law firms that
represented the Company in litigation with Genentech relating to, among other things, the intellectual property rights surrounding the development of anti-IgE technology. An arbitration panel issued an award entitling the attorneys to receive
(1) approximately $3.5 million, including interest, (2) payments ranging from 33-1/3% to 40% of the
future milestone payments, in excess of the first $1 million, Tanox would receive from Genentech following product approval and (3) 10% of the royalties that Tanox would receive on sales of certain anti-IgE products, including Xolair. The 10%
of royalties received by Tanox is required to be paid to the attorneys within 30 days of the end of the calendar quarter in which the royalty payments are received by Tanox. At December 31, 2006, Tanox had an accrued liability of $2.4 million
with respect to amounts that would be payable to the attorneys on royalties received or receivable by Tanox on net sales of Xolair. On February 7, 2007, the former attorneys filed with the Harris County District Court a Motion for Remand to the
Arbitration Panel claiming: (i) that certain net profit interests payable by Novartis on sales of anti-IgE products in the U.S. fall within the award; and (ii) that they are entitled to additional fees related to certain manufacturing
payments made to Tanox and the forgiveness by Novartis of certain debt owed by Tanox. We dispute the claims of the former attorneys. The Court has not yet ruled on the Motion, nor has a hearing been held.

On December 5, 2006, a purported class action petition was filed in the District Court of Harris County, Texas in connection with the proposed
acquisition of Tanox by Genentech. The petition (captioned Superior Partners v. Nancy T. Chang, Julia Brown, Heinz W. Bull, Tse-Wen Chang, Gary Frashier, Osama Mikhail, Peter G. Traber, Danong Chen, Tanox, Inc., Genentech, Inc. and Green Acquisition
Corporation, Case No.2006-77015) names Tanox and the current members of the Tanox board of directors as defendants. The petition also names Genentech and Green Acquisition Corporation as defendants. Among other things, the petition alleges that
Tanoxs directors, in approving the proposed merger, breached fiduciary duties owed to Tanox stockholders, and that Genentech and Green Acquisition Corporation aided and abetted those alleged breaches of fiduciary duty. The petition also
alleges that the preliminary proxy statement Tanox filed in connection with the merger on November 24, 2006 contains false or misleading statements or omissions. On December 19, 2006, Plaintiff amended the petition to



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##### Index to Financial Statements

Tanox, Inc. and Subsidiaries

Notes to Consolidated Financial Statements  (Continued)



allege that the definitive proxy statement, filed by Tanox on December 7, 2006, contains false and misleading statements or omissions. The amended
petition seeks class certification, damages and certain forms of equitable relief, including enjoining the consummation of the merger. Tanox and the other defendants believe the amended petition is without merit and intend to defend themselves
vigorously.

401(k) Plan

Effective January 1, 1992, Tanox adopted a qualified retirement plan (the 401(k) Plan) covering all of Tanoxs U.S. employees who are at least 21 years of age and have completed at least 90 days of service with Tanox. Pursuant to
the 401(k) Plan, employees may elect to reduce their current compensation by up to the statutorily prescribed annual limit and have the amount of such reduction contributed to the 401(k) Plan. The 401(k) Plan permits, but does not require,
additional matching contributions by Tanox on behalf of all participants in the 401(k) Plan. Tanoxs matching contributions to the 401(k) Plan totaled approximately $515,000, $430,000 and $389,000 in 2006, 2005 and 2004, respectively.

13. GEOGRAPHIC AREAS

Tanox operates
in a single business segment. Tanox's operations by geographic area for the years ended December 31, 2006, 2005 and 2004, are presented below (in thousands):



|                              |  |                |        |          |   |         |                    |  |   |        
|----------------------------- |  | -------------- | ------ | -------- | - | ------- | ------------------ |  | - | -------
|                              |  | Total Revenues |        | Net Loss |   |         | IdentifiableAssets
|Year Ended December 31, 2006- |  |                |        |          |   |         |                    |  |   |        
|Americas                      |  | $              | 53,911 |          | $ | (2,286  | )                  |  | $ | 231,895
|Europe                        |  |                | 1,684  |          |   |        |                    |  |   |       
|Asia                          |  |                | 2      |          |   | (282    | )                  |  |   | 213    
|Rest of the world             |  |                | 540    |          |   |        |                    |  |   |       
|Interarea eliminations        |  |                |       |          |   |        |                    |  |   |       
|                              |  |                |        |          |   |         |                    |  |   |        
|                              |  | $              | 56,137 |          | $ | (2,568  | )                  |  | $ | 232,108
|                              |  |                |        |          |   |         |                    |  |   |        
|Year Ended December 31, 2005- |  |                |        |          |   |         |                    |  |   |        
|Americas                      |  | $              | 44,359 |          | $ | (19,351 | )                  |  | $ | 229,656
|Europe                        |  |                | 212    |          |   |        |                    |  |   |       
|Asia                          |  |                | 1      |          |   | (73     | )                  |  |   | 280    
|Rest of the world             |  |                | 115    |          |   |        |                    |  |   |       
|Interarea eliminations        |  |                |       |          |   |        |                    |  |   |       
|                              |  |                |        |          |   |         |                    |  |   |        
|                              |  | $              | 44,687 |          | $ | (19,424 | )                  |  | $ | 229,936
|                              |  |                |        |          |   |         |                    |  |   |        
|Year Ended December 31, 2004- |  |                |        |          |   |         |                    |  |   |        
|Americas                      |  | $              | 20,435 |          | $ | (10,290 | )                  |  | $ | 238,553
|Europe                        |  |                | 71     |          |   |        |                    |  |   |       
|Asia                          |  |                |       |          |   |        |                    |  |   |       
|Interarea eliminations        |  |                |       |          |   |        |                    |  |   |       
|                              |  |                |        |          |   |         |                    |  |   |        
|                              |  | $              | 20,506 |          | $ | (10,290 | )                  |  | $ | 238,553
|                              |  |                |        |          |   |         |                    |  |   |        

See Note 2 for disclosure of major customers that comprise greater than 10% of total revenue.



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##### Index to Financial Statements

Tanox, Inc. and Subsidiaries

Notes to Consolidated Financial Statements  (Continued)



14. QUARTERLY FINANCIAL DATA (Unaudited) (in thousands except per share data)



|                              |  |                    |        |   |         |   |        |              |  |   |             |   |  |   |       
|----------------------------- |  | ------------------ | ------ | - | ------- | - | ------ | ------------ |  | - | ----------- | - |  | - | ------
|                              |  | Three Months Ended
|2006                          |  | March 31           |        |   | June 30 |   |        | September 30 |  |   | December 31
|Revenues                      |  | $                  | 9,815  |   |         | $ | 12,746 |              |  | $ | 15,293      |   |  | $ | 18,283
|Income (loss) from operations |  |                    | (6,940 | ) |         |   | (4,197 | )            |  |   | (1,809      | ) |  |   | 2,209 
|Net income (loss)             |  |                    | (5,181 | ) |         |   | (2,273 | )            |  |   | 376         |   |  |   | 4,510 
|Net income (loss) per share:  |  |                    |        |   |         |   |        |              |  |   |             |   |  |   |       
|Basic                         |  |                    | (0.12  | ) |         |   | (0.05  | )            |  |   | 0.01        |   |  |   | 0.10  
|Diluted                       |  |                    | (0.12  | ) |         |   | (0.05  | )            |  |   | 0.01        |   |  |   | 0.10  



|                                  |  |                    |         |   |         |   |        |              |  |   |             |   |  |   |       
|--------------------------------- |  | ------------------ | ------- | - | ------- | - | ------ | ------------ |  | - | ----------- | - |  | - | ------
|                                  |  | Three Months Ended
|2005                              |  | March 31           |         |   | June 30 |   |        | September 30 |  |   | December 31
|Revenues                          |  | $                  | 5,928   |   |         | $ | 7,378  |              |  | $ | 8,347       |   |  | $ | 23,034
|Income (loss) from operations [1] |  |                    | (21,425 | ) |         |   | (6,459 | )            |  |   | (4,570      | ) |  |   | 8,411 
|Net income (loss)                 |  |                    | (20,462 | ) |         |   | (5,417 | )            |  |   | (3,383      | ) |  |   | 9,838 
|Net income (loss) per share:      |  |                    |         |   |         |   |        |              |  |   |             |   |  |   |       
|Basic                             |  |                    | (0.46   | ) |         |   | (0.12  | )            |  |   | (0.08       | ) |  |   | 0.23  
|Diluted                           |  |                    | (0.46   | ) |         |   | (0.12  | )            |  |   | (0.08       | ) |  |   | 0.23  

---

|[1] | Income (loss) from operations for the three months ended March 31, 2005 includes $13.7 million in acquired research and development costs related to acquisition of the
tissue-factor antagonist program.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

15. SUBSEQUENT EVENTS

At a special meeting of stockholders held in Houston, Texas on January 15, 2007, the stockholders of Tanox voted to adopt the merger agreement providing for the merger of the Company and a wholly owned subsidiary
of Genentech, Inc. Under the terms of the merger agreement, promptly following the closing of the merger, Tanox stockholders will receive $20.00 in cash for each share of Tanox common stock held. The merger is anticipated to close in the first half
of 2007, subject to expiration of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act, the absence of a material adverse effect and satisfaction of other customary closing conditions. The proposed merger agreement was announced
on November 9, 2006.

Under the terms of employee and director stock option agreements, the approval of the merger agreement was a
change in control which resulted in all options outstanding under the agreements becoming fully vested on the date of the approval. The accelerated vesting of the options will result in a charge to stock compensation expense of $7.4 million in
January 2007. The stockholder approval also constitutes a change in control as defined in the employment and change of control agreements between Tanox and its chairman of the board and executive officers.



69



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##### Index to Financial Statements

|ITEM 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
|------- | ------------------------------------------------------------------------------------

None.



|ITEM 9A. | Controls and Procedures
|-------- | -----------------------

Conclusion Regarding
the Effectiveness of Disclosure Controls and Procedures.Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure
controls and procedures, as such term is defined under Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act). Based on this evaluation, our principal executive officer and our principal
financial officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this annual report.

Managements Report on Internal Control Over Financial Reporting.Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules
13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over
financial reporting based on the framework in Internal Control - Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control -
Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2006.

Our managements assessment of the effectiveness of our internal control over financial reporting as of December 31, 2006 has been audited by Ernst & Young LLP, an independent registered public accounting firm that
audited our consolidated financial statements included in this annual report, as stated in their report which is included elsewhere herein.

Changes in Internal Control Over Financial Reporting. There have been no changes in the Companys internal control over financial reporting that occurred during the fourth quarter of fiscal 2006 that have materially affected, or
are reasonably likely to materially affect, the Companys internal control over financial reporting.



|ITEM 9B. | Other Information
|-------- | -----------------

None.



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##### Index to Financial Statements

PART III



|ITEM 10. | Directors and Executive Officers of the Registrant
|-------- | --------------------------------------------------

The information regarding directors that is required by this item is incorporated by reference from the discussion in the Proxy Statement for our 2007 annual meeting of stockholders (Proxy Statement) captioned Proposal 1 
Election of Directors and Beneficial Ownership Table. Information concerning our executive officers is set forth under Part I of this Form 10-K.



|ITEM 11. | Executive Compensation
|-------- | ----------------------

The information that is
required by this item is incorporated by reference from the discussion in the Proxy Statement captioned Executive Compensation.



|ITEM 12. | Security Ownership of Certain Beneficial Owners and Management
|-------- | --------------------------------------------------------------

The information that is required by this item is incorporated by reference from the discussion in the Proxy Statement captioned Beneficial Ownership Table.



|ITEM 13. | Certain Relationships and Related Transactions
|-------- | ----------------------------------------------

The
information that is required by this item, if any, is incorporated by reference from the discussion in the Proxy Statement captioned Certain Relationships and Related Transactions.



|ITEM 14. | Principal Accounting Fees and Services
|-------- | --------------------------------------

The
information that is required by this item is incorporated by reference from the discussion in the Proxy Statement captioned Principal Accounting Fees and Services.



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##### Index to Financial Statements

PART IV



|ITEM 15. | Exhibits, Financial Statement Schedules
|-------- | ---------------------------------------



|    |  |    |  |                                                                                                                                                                                      
|--- |  | -- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) |  | 1. |  | Index to Financial Statements.                                                                                                                                                       
|    |  |   
|    |  |    |  | Report of Independent Auditors                                                                                                                                                       
|    |  |    |  | Consolidated Balance Sheets as of December 31, 2006 and 2005                                                                                                                         
|    |  |    |  | Consolidated Statements of Operations and Comprehensive Loss for the years ended December 31, 2006, 2005 and 2004                                                                    
|    |  |    |  | Consolidated Statements of Stockholders Equity for the years ended December 31, 2006, 2005 and 2004                                                                                 
|    |  |    |  | Consolidated Statements of Cash Flows for the years ended December 31, 2006, 2005 and 2004                                                                                           
|    |  |    |  | Notes to Consolidated Financial Statements                                                                                                                                           
|    |  |   
|    |  | 2. |  | Financial Statement Schedules.                                                                                                                                                       
|    |  |   
|    |  |    |  | All schedules are omitted because they are not applicable or not required, or because the required information is included in the consolidated financial
statements or notes thereto.
|    |  |   
|    |  | 3. |  | Exhibits.                                                                                                                                                                            



|        |  |                                                                                                                                                                                                                                  
|------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|2.1     |  | Agreement and Plan of Merger by and among Genentech, Inc., Green Acquisition Corporation and Tanox, Inc. dated as of November 9, 2006.                                                                                           
|        | 
|3(i).1  |  | Amended and Restated Certificate of Incorporation of the Registrant, as amended. (1)                                                                                                                                             
|        | 
|3(i).2  |  | Certificate of Designations of Series A Junior Participating Preferred Stock. (2)                                                                                                                                                
|        | 
|3(ii).1 |  | Bylaws of the Registrant, as currently in effect. (3)                                                                                                                                                                            
|        | 
|4.1     |  | Specimen of Common Stock Certificate, $.01 par value, of the Registrant. (1)                                                                                                                                                     
|        | 
|10.1    |  | Stock Purchase Agreement, dated July 14, 1987, by and among the Registrant and Tse Wen Chang, Nancy T. Chang, Alafi Capital Company, Shireen Alafi, Joseph Heskel, Trustee for Christopher Alafi,
and Invitron Corporation. (1)  
|        | 
|10.2    |  | License for Winter Patent, dated June 26, 1989, by and between Medical Research Council and the Registrant. (1) (4)                                                                                                              
|        | 
|10.3    |  | Amendment to the License for Winter Patent, dated February 9, 1990, by and between Medical Research Council and the Registrant. (1) (4)                                                                                          
|        | 
|10.4    |  | Outline of Terms for Settlement of the Litigations Among Genentech, Inc., Genentech International, Ltd., the Registrant and Ciba-Geigy Limited Relating to Anti-IgE Inhibiting Monoclonal
Antibodies, dated July 8, 1996. (1) (4)
|        | 
|10.5    |  | Settlement and Cross-Licensing Agreement, dated July 8, 1996, by and between the Registrant and Genentech, Inc. and Genentech International Limited. (1) (4)                                                                     
|        | 
|10.6    |  | Amendment No. 1 to the Settlement and Cross-Licensing Agreement dated as of February 25, 2004, by and between Genentech, Inc. and the Registrant. (4) (5)                                                                        
|        | 
|10.7    |  | Settlement and Participation Agreement, dated July 8, 1996, by and between the Registrant and F. Hoffman-La Roche, Ltd., Hoffman-La Roche, Inc., Roche Holding Ltd. and Roche Holdings, Inc. (1)
(4)                             
|        | 
|10.8    |  | Tripartite Collaboration Agreement dated as of February 25, 2004, by and between Novartis Pharma AG, Genentech, Inc. and the Registrant. (4) (5)                                                                                 
|        | 
|10.9    |  | Amended and Restated Development and Licensing Agreement dated as of February 25, 2004, by and between the Registrant and Novartis Pharma AG. (4) (5)                                                                            



72



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##### Index to Financial Statements

|      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|----- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.10 |  | Ancillary Development and Licensing Agreement dated as of February 25, 2004, by and between the Registrant and Novartis Pharma AG. (4) (5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|      | 
|10.11 |  | License Agreement, dated June 1, 1998, by and between Biogen, Inc. and the Registrant. (1) (4)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|      | 
|10.12 |  | Rights Agreement dated as of July 27, 2001 between the Registrant and American Stock Transfer & Trust Company, as Rights Agent, which includes as Exhibit A the form of Rights Certificate and
as Exhibit B the Summary of Rights to Purchase Common Stock. (6)                                                                                                                                                                                                                                                                                                                                                            
|      | 
|10.13 |  | Amendment to Rights Agreement dated as of November 9, 2006 between the Registrant and American Stock Transfer & Trust Company, as Rights Agent. (7)                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|      | 
|10.14 |  | Lease Assignment and Asset Purchase Agreement dated December 9, 2004, by and between the Registrant and Biogen Idec, Inc. (8)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|      | 
|10.15 |  | Fourth Lease Amendment and Assignment Agreement dated December 9, 2004 by and between TSI, L.P., Biogen Idec, Inc. and the Registrant, including the Lease Agreement dated July 9, 1992 by and
between Torrey Sorrento, Inc. (TSI and n/k/a TSI, L.P.) and IDEC Pharmaceuticals Corporation (IDEC and n/k/a Biogen Idec, Inc.), First Amendment to Lease Agreement dated November 9, 1992 by and between TSI and IDEC, Second Amendment to Lease
Agreement dated December 30, 1994 by and between TSI and IDEC, and Third Lease Amendment Agreement dated April 22, 2004 by and between TSI, L.P. and Biogen Idec, Inc. (8)
|      | 
|10.16 |  | Asset Purchase and License Agreement dated March 25, 2005 among Tanox, Inc., Sunol Molecular Corporation and Altor Bioscience Corporation. (9)                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|      | 
|10.17 |  | Stockholder and Registration Rights Agreement dated March 31, 2005 among Tanox, Inc. and Sunol Molecular Corporation. (9)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|      | 
|10.18 |  | Form of Indemnification Agreement between the Registrant and its officers and directors. (1) (10)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|      | 
|10.19 |  | 1987 Stock Option Plan of the Registrant, as amended. (1) (10)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|      | 
|10.20 |  | 1992 Non-employee Directors Stock Option Plan of the Registrant. (1) (10)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|      | 
|10.21 |  | 1997 Stock Plan of the Registrant. (1) (10)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|      | 
|10.22 |  | First Amendment to the Tanox, Inc. 1997 Stock Plan. (10) (11)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|      | 
|10.23 |  | 2000 Non-Employee Directors' Stock Option Plan. (1) (10)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|      | 
|10.24 |  | First Amendment to the 2000 Non-Employee Directors Stock Option Plan. (10) (12)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|      | 
|10.25 |  | Second Amendment to the 2000 Non-Employee Directors Stock Option Plan. (8) (10)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|      | 
|10.26 |  | Third Amendment to the 2000 Non-Employee Directors Stock Option Plan. (10) (13)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|      | 
|10.27 |  | Fourth Amendment to the 2000 Non-Employee Directors Stock Option Plan. (10)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|      | 
|10.28 |  | Form of Stock Option Agreement (Officer Version). (8) (10)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|      | 
|10.29 |  | Form of Stock Option Agreement (Director Version). (8) (10)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|      | 
|10.30 |  | Form of Director Stock Option Agreement. (10) (14)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|      | 
|10.31 |  | Employment Agreement between Tanox, Inc. and Danong Chen, Chief Executive Officer dated September 8, 2006. (10) (15)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|      | 
|10.32 |  | Employment Agreement between Tanox, Inc. and Nancy T. Chang, Ph.D. dated September 12, 2006. (10) (15)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|      | 
|10.33 |  | Benefits Waiver dated November 9, 2006, by and between the Registrant and Nancy T. Chang. (7) (10)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|      | 
|10.34 |  | Form of Agreement Regarding Change of Control or Separation of Service dated September 8, 2006 (entered into between Tanox, Inc. and each of Edward Hu, Senior Vice President and Chief Operating
Officer; Zhengbin Yao, Vice President  Research; Gregory Guidroz, Vice President  Finance; Katie-Pat Bowman, Vice President and General Counsel; Brain Kim, Vice President  Quality; and Hugo Santos, Vice President  Human
Resources). (10) (15)                                                                                                                                                                    
|      | 
|21.1  |  | List of Subsidiaries of the Registrant.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|      | 
|23.1  |  | Consent of Independent Registered Public Accounting Firm.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  



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##### Index to Financial Statements

|     |  |                                                                                                                                                                                 
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|     | 
|31.1 |  | Certification of Chief Executive Officer pursuant to Section 13a-14(a) and Rule 15d-14(a) of the Securities Act, as amended.                                                    
|     | 
|31.2 |  | Certification of Vice President of Finance Pursuant to Section 13a-14(a) and Rule 15d-14(a) of the Securities Act, as amended.                                                  
|     | 
|32   |  | Certification of Chief Executive Officer and Chief Financial Officer Furnished Pursuant to 18 W.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.

---

|(1) | Filed as an exhibit to our Registration Statement on Form S-1 (no. 333-90625) and incorporated herein by reference.
|--- | -------------------------------------------------------------------------------------------------------------------

|(2) | Filed as an exhibit to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2002, and incorporated herein by reference.
|--- | -----------------------------------------------------------------------------------------------------------------------------------

|(3) | Filed as an exhibit to our Current Report on Form 8-K dated November 20, 2003.
|--- | ------------------------------------------------------------------------------

|(4) | Certain information in this exhibit is subject to a request for confidential treatment. In accordance with Rule 24b-2 under the Exchange Act, this information has been redacted and
provided separately to the Securities and Exchange Commission.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | Filed as an exhibit to our Quarterly Report on Form 10-Q for the quarter ended March 31, 2004, and incorporated herein by reference.
|--- | ------------------------------------------------------------------------------------------------------------------------------------

|(6) | Filed as an exhibit to our Current Report on Form 8-K dated August 2, 2001.
|--- | ---------------------------------------------------------------------------

|(7) | Filed as an exhibit to our Current Report on Form 8-K dated November 16, 2006.
|--- | ------------------------------------------------------------------------------

|(8) | Filed as an exhibit to our Annual Report on Form 10-K for the year ended December 31, 2004, and incorporated herein by reference.
|--- | ---------------------------------------------------------------------------------------------------------------------------------

|(9) | Filed as an exhibit to our Quarterly Report on Form 10-Q for the quarter ended March 31, 2005, and incorporated herein by reference.
|--- | ------------------------------------------------------------------------------------------------------------------------------------

|(10) | Management contract or compensatory plan.
|---- | -----------------------------------------

|(11) | Filed as an exhibit to our Quarterly Report on Form 10-Q for the quarter ended September 30, 2000, and incorporated herein by reference.
|---- | ----------------------------------------------------------------------------------------------------------------------------------------

|(12) | Filed as an exhibit to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2001, and incorporated herein by reference.
|---- | -----------------------------------------------------------------------------------------------------------------------------------

|(13) | Filed as an exhibit to our Quarterly Report on Form 10-Q for the quarter ended March 31, 2006, and incorporated herein by reference.
|---- | ------------------------------------------------------------------------------------------------------------------------------------

|(14) | Filed as an exhibit to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2006, and incorporated herein by reference.
|---- | -----------------------------------------------------------------------------------------------------------------------------------

|(15) | Filed as an exhibit to our Quarterly Report on Form 10-Q for the quarter ended September 30, 2006, and incorporated herein by reference.
|---- | ----------------------------------------------------------------------------------------------------------------------------------------



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##### Index to Financial Statements

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized as of March 16, 2007.



TANOX, INC.By:

/s/ Danong ChenDanong ChenPresident and Chief Executive Officer


Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
signed by the following persons on behalf of the registrant in the capacities and on the dates indicated:



|                                          |  |                                                                        |  |               
|----------------------------------------- |  | ---------------------------------------------------------------------- |  | --------------
|Signature                                 |  | Title                                                                  |  | Date          
|                                          |  |                                                                       
|/s/ Danong Chen Danong Chen               |  | President, Chief Executive Officer                                     |  | March 16, 2007
|                                          |  |                                                                       
|                                          |  |                                                                        |  |               
|                                          |  |                                                                       
|/s/ Gregory P. Guidroz Gregory P. Guidroz |  | Vice President of Finance (Principal Financial and Accounting Officer) |  | March 16, 2007
|                                          |  |                                                                       
|                                          |  |                                                                        |  |               
|                                          |  |                                                                       
|/s/ Nancy T. Chang Nancy T. Chang         |  | Chairman of the Board                                                  |  | March 16, 2007
|                                          |  |                                                                       
|                                          |  |                                                                        |  |               
|                                          |  |                                                                       
|/s/ Osama Mikhail Osama Mikhail           |  | Director                                                               |  | March 16, 2007
|                                          |  |                                                                       
|                                          |  |                                                                        |  |               
|                                          |  |                                                                       
|/s/ Tse Wen Chang Tse Wen Chang           |  | Director                                                               |  | March 16, 2007
|                                          |  |                                                                       
|                                          |  |                                                                        |  |               
|                                          |  |                                                                       
|/s/ Gary E. Frashier Gary E. Frashier     |  | Director                                                               |  | March 16, 2007
|                                          |  |                                                                       
|                                          |  |                                                                        |  |               
|                                          |  |                                                                       
|/s/ Heinz W. Bull Heinz W. Bull           |  | Director                                                               |  | March 16, 2007
|                                          |  |                                                                       
|                                          |  |                                                                        |  |               
|                                          |  |                                                                       
|/s/ Peter G. Traber Peter G. Traber       |  | Director                                                               |  | March 16, 2007
|                                          |  |                                                                       
|                                          |  |                                                                        |  |               
|                                          |  |                                                                       
|/s/ Julia R. Brown Julia R. Brown         |  | Director                                                               |  | March 16, 2007



75