UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549









FORM 10-K









FOR ANNUAL AND TRANSITION
REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934




(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, 2005
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 0-28272




AVIGEN, INC.




(Exact name of registrant as specified in its
charter)







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



1301 Harbor Bay Parkway Alameda, California
94502




(Address of principal executive offices and zip
code)




(510) 748-7150




(Registrants telephone number, including area
code)




Securities registered pursuant to Section 12(b) of the
Act:




None




Securities registered pursuant to Section 12(g) of the
Act: Common Stock, $.001 par value




(Title of class)









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 Sections 13 of 15(d) of the Securities Exchange Act of 1934 during the preceding 12
months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the
past 90 days.   Yes [X] No [  ]




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 amendments 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).




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 Act).  Yes [  ] No [X]




The aggregate market value of the
Common Stock held by non-affiliates of the registrant as of June 30, 2005, was approximately $62,074,000 based upon the closing sale price of the
registrants Common Stock as reported on the NASDAQ National Market on such date. Shares of common stock held by each officer and director have
been excluded in that such persons may be deemed to be affiliates of the registrant. Shares held by all other stockholders have not been excluded, as
no other stockholder holds a percentage of the registrants outstanding Common Stock that the registrant believes is necessary to exercise control
over the registrant, nor has any other stockholder otherwise exhibited any ability to exercise control over the registrant.




The number of outstanding shares
of the registrants Common Stock as of March 1, 2006, was 20,910,655 shares.




DOCUMENTS INCORPORATED BY REFERENCE




Portions of the
registrants definitive Proxy Statement for the 2006 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission
pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this Form 10-K, are incorporated by reference in Part
III, Items 10-14 of this Form 10-K.







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ANNUAL REPORT ON FORM 10-K




FOR THE FISCAL YEAR ENDED DECEMBER 31,
2005




TABLE OF CONTENTS







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



ii


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CAUTIONARY INFORMATION REGARDING FORWARD-LOOKING
STATEMENTS




This Annual Report on Form 10-K
contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934. These statements are based upon current expectations that involve known and unknown risks, uncertainties and other factors which may cause our
actual results, performance or achievements to be materially different from any future results, performances or achievements expressed or implied by
the forward-looking statements. These statements include, but are not limited to:


| |  | the potential of our product development programs, including
AV650 for neuromuscular spasm and spasticity, AV411 for neuropathic pain, and AV513 for the treatment of multiple bleeding disorders, including
hemophilia;
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | our expectations with respect to the clinical development of our
product candidates, our clinical trials and the regulatory approval process, including the potential acceleration of clinical development in the U.S.
of our two lead product development programs that are based on compounds with prior experience in human clinical trials outside the U.S.;
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | our intention to submit Investigational New Drug filings (INDs)
to the FDA regarding AV650 and AV411;
|- |  | -----------------------------------------------------------------------------------------------------

| |  | our expectations relating to our selection of additional disease
targets for compounds we are developing;
|- |  | ---------------------------------------------------------------------------------------------------------

| |  | our expectations with regard to our ability to expand our drug
development portfolio through a combination of internal research, acquisitions, and in-licensing opportunities from third parties;
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | our expectations regarding our receipt of future revenues based
on the development success by Genzyme Corporation in developing and commercializing gene therapy products based on rights included in our assignment
agreement;
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | our expectations regarding expense savings and cash burn rate
resulting from the reduction in our staff level, consolidation of operations, and the sublease of portions of our facilities; and
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | our expectations regarding our capital requirements, how long
our current financial resources will last, and our needs for additional financing.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------



We have identified the
forward-looking statements we make by using such terms as may, might, can, will, should,
could, would, expect, plan, seek, anticipate, believe,
estimate, project, intend, predict, potential, if and similar expressions which
imply that the statements relate to future events or expectations. These statements reflect our current views with respect to future events and are
based on assumptions and subject to risks and uncertainties. Given these uncertainties, you should not place undue reliance on these forward-looking
statements. We discuss many of these risks and uncertainties in greater detail in Item 1A Risk Factors, below. Also, these forward-looking
statements represent our estimates and assumptions only as of the date of this Form 10-K.




You should read this Form 10-K
and the documents that we incorporate by reference completely and with the understanding that our actual future results may be materially different
from what we currently expect. We may not update these forward-looking statements, even though our situation may change in the future. We qualify all
of our forward-looking statements by these cautionary statements.




1


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PART I


|Item
1. |  | Business
|------- |  | --------



Overview




Avigen is a biopharmaceutical
company with a mission to develop and commercialize small molecule therapeutics and biologics to treat serious neurological and neuromuscular
disorders. Currently, our lead product candidates (AV650 and AV411) primarily address neuromuscular spasm and spasticity and neuropathic pain. Avigen
has retained rights to commercialize our products in North America and therefore we expect, when appropriate, to build a sales and marketing
infrastructure. We will seek to out-license rights to develop and market our products outside the United States. Over the next year, we do not expect
to add products to our development portfolio; however, we will continue to opportunistically look for promising drug candidates to expand our pipeline
of compounds in the future through a number of sources, including internal research, acquisitions, and in-licensing. Avigen, Inc. is a Delaware
corporation that was incorporated on October 22, 1992 and is based in the San Francisco Bay Area.




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




We currently have in development
AV650, a compound for neuromuscular spasm and spasticity, AV411, a compound for neuropathic pain, and AV513, a compound for the treatment of multiple
bleeding disorders, including hemophilia. We also have other candidates in research, including AV333 for neuropathic pain. We have supported the
financial needs of our research and development activities since our inception primarily through public offerings and private placements of our equity
securities. We expect that we will need to obtain additional funding to support the anticipated future needs of our research and development
activities, including the costs to complete clinical trials, as well as to build an appropriate level of sales and marketing infrastructure at the
appropriate time if we determine to do so. At December 31, 2005 we had an accumulated deficit of $171.3 million and cash, cash equivalents,
available-for-sale securities, and restricted investments of approximately $70.4 million. We believe that our capital resources at December 31, 2005,
after considering our anticipated spending on our current programs, will be adequate to fund our operating needs for approximately the next three
years.




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




2


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Recent Business Highlights


| |  | Entered into an agreement with Genzyme Corporation in December
2005, conveying patent rights and other assets related to our previously developed gene therapy technologies in exchange for an initial payment of
$12.0 million, potential future development-based milestones, sublicensing fees and royalty payments, and certain diligence commitments from
Genzyme;
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Completed an in-license agreement in January 2006 for North
American rights to AV650 for neuromuscular spasm and spasticity with a division of Sanochemia, an Austrian-based pharmaceutical company;
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Reduced operating expenses associated with prior gene therapy
activities by reducing staff and subleasing portions of our facilities, and
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------

| |  | Published data from AV513, our drug candidate for hemophilia,
which was highlighted by an editorial in the January 2006 edition of Thrombosis and Haemostasis.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------



Products in Development




AV650  Neuromuscular spasm and
spasticity




Disease.  Disabling muscle spasm is a sudden, violent, painful contraction of muscles which may be caused by muscle injuries
in either acute or chronic settings. These muscle injuries, typically due to trauma or overuse, often result in severe pain and limitation of movement
for hours to days. Spasticity is more typically associated with serious neurological disorders such as Multiple Sclerosis, stroke, spinal cord injury,
and Cerebral Palsy. Spastic limbs become chronically stiff or rigid because muscles fail to relax, lacking normal regulation of contraction because of
damage to the nervous system. Both spasticity and sudden, painful muscle spasms can occur as complications of the neurologic disorders mentioned
above.




Unmet Medical
Need.  Many of the current medications have limited clinical utility because of central nervous system side effects. Acute spasms are
often treated with muscle relaxants such as Skelaxin® and Flexeril®, and other therapies. Spasticity is often treated with such medications
as baclofen, diazepam, tizanidine or clonazepam. Physical therapy regimens may include muscle stretching and range of motion exercises to help prevent
shrinkage or shortening of muscles and to reduce the severity of symptoms. Surgery may be recommended for tendon release or to sever the nerve-muscle
pathway. While muscle relaxants and antispasmodics can make it possible for patients to begin therapeutic exercise and rehabilitation, common central
nervous system side effects, especially sedation and interaction with alcohol, can impair the ability of the patient to perform normal daily
functions.




The ideal therapy for disabling
muscular spasms and for spasticity would provide excellent safety, tolerability and efficacy, a predictable mechanism of action, and minimal or no
muscle weakness, sedation or interaction with alcohol. We believe AV650 may represent such a drug.




AV650.  In
January 2006, we acquired exclusive license rights to develop and commercialize proprietary formulations of the compound tolperisone (AV650) for the
North American market. We licensed these rights from SDI Diagnostics International LTD, a division of Sanochemia Pharmazeutika AG. For ease of
reference, we refer to SDI Diagnostics throughout this document as Sanochemia. These rights include Sanochemias relevant patent
filings, as well as their clinical data relating to AV650. Sanochemia has also agreed to supply AV650 to us exclusively for the North American market.
Under the terms of the agreement, we made an upfront payment of $3 million and will make additional payments to Sanochemia based on the parties
achievement of clinical and regulatory product development milestones and sales of AV650.




AV650 is based on an orally
administered centrally-acting small molecule that is currently marketed by others for the treatment of muscular spasm and spasticity in Europe and
Asia. Avigen is developing AV650 for the North American market under a license and supply agreement with Sanochemia. Sanochemia has completed
preclinical studies which are expected to be used by Avigen to file a U.S. IND in 2006. Avigens development program is designed to build on the
extensive ex-U.S. safety and efficacy experience with this compound. AV650 is an important potential therapy for disabling neuromuscular spasms and
spasticity. Because of AV650s established record of successful use and safety in many international markets, Avigen is seeking to bring this
product to the U.S. market to provide a fast-acting muscle relaxant without sedation or alcohol interaction.




3


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Avigen is investigating the use
of AV650 in both muscle spasms and spasticity. For treating acute spasms, we believe that as a safe, non-sedating potential drug, AV650 may not only
provide pain relief, but may also prevent the changes in pain signaling pathways in the nervous system that can sometimes lead to chronic pain. For
treating chronic muscle spasms and spasticity in serious, irreversible neurologic diseases, we believe that the use of AV650 on a long-term basis may
offer both treatment and prevention of recurrent, painful muscle spasms, leading to improved function, sleep uninterrupted by pain, and better quality
of life overall.




We are currently in the process
of preparing a U.S. IND for filing and intend to initiate a clinical trial in the U.S. within the next year.




Market for Neuromuscular Spasm
and Spasticity Treatment.  The United States prescription market for treatments for neuromuscular spasm and spasticity has been estimated
to be approximately $1.6 billion despite being dominated by generic products. Retail sales of Skelaxin, the only product in this category without
generic competition, were in excess of $450 million in 2005. In Germany, a Western European country in which tolperisone is sold as a generic product,
sales of tolperisone represent approximately one third of all sales of pharmaceutical treatments for spasm and spasticity despite not being actively
promoted in that market.




AV411 Neuropathic pain and other
neurological disorders




Disease.  Neuropathic pain results from nerve injury and can be particularly difficult to treat, and often becomes chronic.
Unlike acute pain, which is usually immediate and short-lived and for which the cause can usually be identified and treated, chronic pain, is
continuous and often persists beyond the normal time for healing. It can range from mild to severe and can last months or years. The cause of chronic
pain is not always known. Although it can be associated with disorders such as cancer, arthritis, diabetes, or various infections, chronic pain may
occur in the absence of any known underlying disease or injury.




Neuropathic pain can distort
signaling in the spinal cord such that even normal sensation is perceived as painful. In addition, spontaneous pain, exaggerated responses to otherwise
mildly painful sensations, and widespread hypersensitivity extending beyond the area of original injury can become disabling. Chronic neuropathic pain
affects up to one-third of individuals with diabetes, and is common after nerve damage caused by various cancer treatments, surgical procedures,
trauma, accidental or therapeutic amputation, and as a complication of viruses which target the nervous system such as herpes zoster (the cause of
shingles) or HIV. Several hereditary conditions also are associated with neuropathic pain. While estimates of prevalence vary, more than 2 million
North Americans are believed to be afflicted with neuropathic pain, and often are inadequately treated with available therapies.




Unmet Medical
Need.  Despite a common understanding among researchers in the field of the pathophysiology and molecular biology of the condition,
patients with neuropathic pain are under-served. Current medications, including gabapentin, lidocaine, tramadol, antiepileptics, and tricyclic
antidepressants, are largely ineffective at treating a large portion of patients with neuropathic pain. With few exceptions, such medications were not
initially developed for pain, but rather other diseases such as depression and epilepsy. For many patients the drugs profiles limit their
utility, because of poor efficacy, significant central nervous system side effects, such as sedation, a short duration of action and/or addictive
properties. Other patients with severe neuropathic pain may rely on oral or injected opioids such as morphine for pain relief. Unfortunately, these
opioid therapies typically require substantial dose increases over time, and patients often must endure side effects including sedation, cognitive
impairment, severe constipation, itching and edema. Addiction and the stigma of using narcotics are also major concerns for both patients and treating
physicians.




Avigen is developing a drug to
treat neuropathic pain that we believe has a good safety profile with limited central nervous system side effects, offers good efficacy by focusing on
a new mechanism of action based on leading neuropathic pain research, provides long lasting relief (especially through the night), and is
non-addictive.




AV411.  Our
product in development is based on an approved drug that is currently marketed by others outside the U.S. for a non-pain-related illness. AV411 is an
orally administered small molecule with good human pharmacokinetic, pharmacodynamic, and safety profiles at the doses used for non-pain related
illnesses. Traditionally, the development of treatments for neuropathic pain has focused on drugs that interact directly with neural cells. Based on
our collaborative research with Linda Watkins, Ph.D., from the Center for Neuroscience at




4


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the University of Colorado at
Boulder, we believe that certain specialized cells in the nervous system known as glial cells or glia, rather than other
nervous system cells known as neurons or nerve cells, are important mediators of neurological pain states. Neurons have long
been considered the sole cell types responsible for the development and maintenance of neuropathic pain. Glia traditionally have been disregarded as
being little more than supporting cells for neurons. However, recent research has demonstrated that glia enhance the release of neurotransmitters that
relay pain information to the spinal cord, and, as is even more strikingly, release substances that increase the excitability of pain-responsive
neurons in the spinal cord. These substances, called pro-inflammatory cytokines, create and maintain exaggerated or pathological pain responses.
Blocking the activation of glia has been shown in preclinical models to reduce pro-inflammatory cytokines and reverse pathological
pain.




We believe AV411 has
glial-attenuating properties and have pursued and validated its efficacy in animal models of neuropathic pain. We have demonstrated that AV411 provides
relief of allodynia, the painful sensation of a normally innocuous stimulus, in clinically-relevant standard rodent models of neuropathic pain,
including chemotherapy- and trauma-induced neuropathic pain. AV411 represents an important potential advance towards what we believe may be an ideal
pain therapy with its established safety profile at the doses used for non-pain related illnesses, new mechanism of action in this indication, and
long-lasting, non-addictive profile. In addition, data from our preclinical studies in various models of neuropathic pain demonstrate that in certain
animals, AV411 preserves normal sensation and has minimal side effects.




We are currently in the process
of initiating a Phase I/II trial to assess safety, tolerability and preliminary efficacy in neuropathic pain patients in Europe and Australia, and have
submitted applications to the appropriate regulatory authorities. We are also in the process of undertaking non-clinical studies that may enable us to
file a U.S. IND by the end of 2006.




Market for Neuropathic Pain
Treatment.  According to the International Association for the Study of Pain and other sources, pain accounts for over 70 million office
visits per year in the United States. An American Pain Society study in 1999 found that over 50% of individuals with chronic, non-cancer-related pain
classify their pain as severe or very severe, and that fewer than half of these feel that their pain is adequately controlled by currently available
medication. In 2002, sales of oral opioids, commonly prescribed for chronic pain, were estimated to exceed $2 billion. In both 2003 and 2004, sales of
Gabapentin, which was developed to treat epilepsy, but is also commonly used to treat moderate neuropathic pain, were estimated to exceed $2.7 billion.
We are not able, however, to ascertain what portion of these sales were for the treatment of moderate neuropathic pain.




Other indications: morphine
tolerance and withdrawal.  Morphine and similar synthetic drugs are collectively known as opioids. Two major side effects of opioid use
are tolerance and withdrawal. These undesirable side effects of opioids result in the reluctance of physicians to prescribe them, and the reluctance of
patients to use them. Tolerance refers to the need of a patient to require ever-increasing doses to achieve relief from pain. Withdrawal refers to the
serious effects of ending opioid therapy due to their addictive properties. However, the appropriate use of opioids can be beneficial, since relief
from pain contributes significantly to the healing process. Accordingly, the avoidance of the tolerance and withdrawal associated with opioid therapy
represents an opportunity to achieve an equally significant but unmet medical need. Avigen has discovered that AV411 may counteract opioid tolerance
and withdrawal symptoms by blocking the activation of certain kinds of glial cells in the spinal cord. Together with our collaborators, Drs. Linda
Watkins and Mark Hutchinson at the University of Colorado, Avigen has initiated preclinical studies to demonstrate this hypothesis. Initial results
have been positive. With continued success these studies may provide guidance for the design of clinical trials to demonstrate these effects in
humans.




AV513  Bleeding disorders, including
hemophilia




Disease.  Hemophilia is an inherited blood clotting disorder characterized by the reduction or absence of a clotting factor.
There are two major forms of hemophilia: hemophilia A, in which patients are deficient in the factor VIII protein and hemophilia B, in which patients
are deficient in the factor IX protein. Due to the inability to produce sustained levels of factor VIII or factor IX in the body, patients with
hemophilia can experience frequent internal bleeding during the course of normal daily activities. Currently, patients in developed countries with a
severe form of the disease inject themselves with factor VIII or factor IX several times a week in order to prevent these bleeding
episodes.




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Unmet Medical Need. Over
the last 25 years, researchers have focused on methods of raising the levels of circulating factor VIII and IX proteins in the body in order to
stimulate a normal blood clotting response in patients with hemophilia. As a result, the primary treatment for patients with bleeding disorders
includes replacement injections of factor proteins. This approach can be effective, but has significant limitations, primarily related to the
inconvenience of intravenous injections. There are no current therapies using orally delivered medications.




AV513. We believe AV513
represents a unique asset for Avigen. While outside our strategic focus on neurological and neuromuscular disorders, AV513 leverages our extensive
experience with hemophilia. Through our research in large and small animal models of hemophilia with clinically relevant endpoints, we have identified
that low doses of certain charged polysaccharides, known to be relatively safe in animals, can stimulate coagulation, offsetting the type of poorly
controlled bleeding characteristic of hemophilia. AV513 is one variation of this kind of compound. Based on our research, we believe that AV513 has the
potential to become the first non-gene therapy and non-Factor approach to treating hemophilia A and B, and other bleeding disorders such as Factor VII
deficiency and severe von Willebrands disease. Importantly, if AV513 does become an approved therapy, it would become the first therapy for
hemophilia to be delivered orally based on approved treatments today. Our strategy is to establish safety and proof-of-concept with the compound
through early-stage human clinical trials and to pursue a possible future spin out, sale or out-license.




Data from our research on AV513
were published in the January 2006 edition of Thrombosis and Haemostasis and highlighted by an editorial in the same journal. Portions of
this publication are available on our website. No part of our website, however, is incorporated into this Annual Report on Form 10-K, including the
portions of that publication on our website.




Market for Hemophilia
Treatment.  According to data published by the National Hemophilia Foundation, hemophilia B affects approximately one in every 30,000
males and hemophilia A affects approximately one in every 10,000 males worldwide. Based on these estimates, hemophilia A and B combine to afflict an
estimated 50,000 to 65,000 individuals in developed countries, with approximately 40% to 50% of those affected with a severe form of the disease.
According to these data, the average annual amount spent by patients for currently-available factor protein exceeds $100,000 per year. In addition,
because protein therapy is often ineffective in preventing muscle, bone, or joint damage requiring surgery, patients may also require an additional
$100,000 to $150,000 in indirect medical care whenever surgery is needed. We believe that the current market for providing recombinant protein factor
VIII and IX to patients in developed countries, who have a severe form of the disease, exceeds $2.4 billion per year.




Gene Therapy Product Development
Interests




In connection with our agreement
with Genzyme Corporation, we do not have any advisory or operational obligations to support the on-going development of gene therapy products. However,
under the terms of the agreement, we retain an opportunity to receive significant additional revenues in connection with the potential successful
development by Genzyme of gene therapy products based on technologies we originally developed. The additional revenues could be from milestone
payments, sublicense fees and/or royalties. Because the transaction is based on our gene therapy intellectual property, the estimate that the potential
for us to realize additional revenues under this agreement could extend through approximately 2020, depending on when the last of the issued patents
subject to the agreement is scheduled to expire. If Genzyme fails to diligently pursue the commercialization or marketing of products using the
assigned technologies, as specified in the agreement, certain rights assigned to Genzyme under the agreement could revert back to Avigen at a future
date.




Research Programs




Neuropathic Pain




We maintain a small ongoing
preclinical research effort to identify additional opportunities to expand our product development pipeline. Our efforts primarily focus on additional
treatments for neuropathic pain and include, through external contract laboratories, a medicinal chemistry optimization effort focused on
identification of new chemical entities (NCEs) with glia-attenuating characteristics similar to those of AV411, but with improved physicochemical
properties. Additional therapeutic indications for AV411 are also being pharmacologically tested.




6


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We also continue to investigate,
through our collaborators, potential products based on the potent anti-inflammatory cytokine interleukin-10 (IL-10) and related molecules. This
research, which is also based on glial cell activation, includes our development candidate AV333. AV333 is a plasmid, or DNA sequence, that drives the
production of IL-10 within the spinal cord to reverse, we believe, the neuropathic pain resulting from glial activation. AV333 is delivered by an
intrathecal injection similar to the routine procedure used to deliver spinal analgesics. Standardized animal models have shown that AV333 is
well-tolerated and completely reverses neuropathic pain symptoms for up to ninety days from a single course of treatment. This information was
presented at the 8th International Conference on Mechanisms and Treatment of Neuropathic
Pain in 2005.




Research and Development
Expenses




We incurred research and
development expenses of approximately $13.8 million, $19.3 million, and $21.8 million in 2005, 2004, and 2003, respectively. During these years, we did
not receive any reimbursements from governmental or other research grants or any other third parties to offset our expenses. As of December 31, 2005,
we were party to one collaborative agreement with the University of Colorado, under which we have the potential to receive partial reimbursement for
certain research and development expenses under a grant by the National Institutes of Health. We do not expect future reimbursements under this
agreement to have a material impact on our financial statements.




Strategic Relationships and
Manufacturing




Research and commercial
collaborations will continue to play a significant role in our business strategy. We have built strategic relationships with recognized scientists,
clinicians and opinion leaders in the fields that our product candidates address. We feel these relationships, including our relationship with the
University of Colorado, enhance the potential of our portfolio of products by providing us with additional resources with the capacity to accelerate a
broader array of research testing and by advising us on the latest scientific advances relevant to our needs. We have also established a commercial
collaboration with Sanochemia. Under the terms of this collaboration, we have acquired North American development and marketing rights to AV650 and
have access to data from Sanochemias non-U.S. research studies that we believe may help accelerate the pace of our clinical development in the
U.S.




We also expect to rely on
strategic relationships with third-party manufacturers of the compounds used for our product candidates. We believe that third-party suppliers, such as
Sanochemia for AV650, can manufacture high quality drug substance and final drug products in a cost effective manner for use both in our clinical
trials and for commercial sale. We believe these third-party suppliers are compliant with the FDAs current good manufacturing practice
regulations.




In our AAV transaction with
Genzyme Corporation, we sought a company that we believed had the resources and commitment to continue the development of products using AAV-based
technologies. Through this transaction, we retained the potential for significant future financial participation in the success of AAV products through
contingent development milestones, sublicensing fees and royalty payments. In addition, we delivered on managements commitment to enable work
based on AAV technologies we developed to continue for the benefit of patients suffering from Parkinsons disease and hemophilia.




As we continue to identify new
development opportunities for compounds in our product candidate portfolio or acquire access to new product candidates, we will continue to evaluate
opportunities to increase the potential success of these investments through strategic relationships. These may take the form of additional research
and development or manufacturing and supply agreements. We may also seek to license out development and marketing rights to our existing products
outside the U.S. If we acquire access to new products or identify new development opportunities for our compounds, including through strategic
relationships, we may fund such transactions with the issuance of additional equity securities, which may further dilute our existing
stockholders.




Competition




Pharmaceutical drug development
is characterized by rapidly evolving technology and intense competition. Many companies of all sizes, including major pharmaceutical companies and
specialized biotechnology companies, engage in activities similar to our activities. Many of the companies we compete with have substantially
greater




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financial and other resources
and larger research and development and clinical and regulatory affairs staffs. We expect our products, if approved, will face competition from both
branded pharmaceuticals and generic compounds. In addition, colleges, universities, governmental agencies and other public and private research
organizations continue to conduct research and are becoming more active in seeking patent protection and licensing arrangements to collect royalties
for use of technologies that they have developed. We also must compete with these institutions in recruiting highly qualified scientific personnel.
Some of our competitors products and technologies are in direct competition with ours. In addition, we are aware that physicians may utilize
other products in an off-label manner for the treatment of disorders we attempt to target.




Neuromuscular Spasm and
Spasticity.  Therapies for acute and chronic spasm and spasticity include Skelaxin (metaxalone, King Pharmaceuticals), Flexeril
(cyclobenzaprine, McNeil Consumer & Specialty Pharmaceuticals), Zanaflex (tizanidine, Acorda Therapeutics), Lioresal (baclofen, Novartis), and Soma
(carisoprolol, Wallace Laboratories). We anticipate that our products will compete with all of these products. Controlled release formulations or other
delivery or dosage forms of these products may be in development and generic versions of many of them are also available. Although we are not aware of
any other products in development for neuromuscular spasm or spasticity, products including Sativex (GW Pharmaceuticals) are in development or marketed
for indications including the pain associated with spasm and/or spasticity.




Neuropathic Pain.
Therapies for chronic pain range from over-the-counter compounds, such as aspirin, to opioids, such as morphine. We anticipate that our products will
compete with other drugs that are currently prescribed by physicians, including anti-epileptics such as Neurontin (gabapentin, Pfizer), Lyrica
(pregabalin, Pfizer), and antidepressants, including Cymbalta, (duloxetine, Eli Lilly & Co). We are aware of additional compounds for chronic
neuropathic pain that are currently in development at numerous companies including Bayer, GlaxoSmithKline, Merck & Co., Inc., Novartis AG, Pfizer,
Cognetix, Inc., GW Pharmaceuticals plc, Indevus Pharmaceuticals, Inc., Nastech Pharmaceutical Company Inc., Renovis, Inc., Avanir Pharmaceuticals, and
Pain Therapeutics, Inc.




Companies that complete clinical
trials, obtain required regulatory approvals, and commence commercial sales of their products before their competitors may achieve a significant
competitive advantage. In order to compete successfully, we must develop proprietary or otherwise protected positions in products for therapeutic
markets that have not been satisfactorily addressed by current alternatives. These products, even if successfully tested and developed, may not be
adopted by physicians over other products and may not offer economically feasible alternatives to other therapies.




Marketing and Sales




We have retained rights to
commercialize our current portfolio of products in North America and expect to build marketing and sales capabilities using our own resources. However,
we currently do not have a marketing or sales staff. If we are successful in achieving FDA approval of any of our product candidates, we will need to
build a commercial capability. There is no assurance that we will be able to build our own commercial organization with our current
resources.




Patents and Intellectual Property




Patents and other proprietary
rights are important to our business. We seek to procure patent protection for our anticipated products, or obtain protection from the relevant patents
owned by our licensors. Our intellectual property strategy is to file patent applications that protect our technology, inventions and improvements to
our inventions that we consider commercially important to the development of our business. We also rely on a combination of trade secrets, know-how and
licensing opportunities to develop and protect intellectual property rights pertaining to our products and technology.




As of March 1, 2006, we owned,
co-owned, or held licenses to 1 issued U.S. patent and 12 pending U.S. patent applications, as well as corresponding-pending non-U.S. patent
applications. These patent applications are primarily related to our development portfolio of small molecule-based products and are currently directed
to methods of treating various indications using AV411 and formulations of AV650. If issued, all patents within our current portfolio are scheduled to
expire in the U.S. between 2019 and 2026.




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Some of the compounds used in our
development products have been previously patented by others. When we identify previously patented technologies that we believe are critical to the
development and commercialization of our products, we seek to in-license such rights under the most favorable terms. Such licenses normally last for
the life of the underlying patent. Licenses typically require us to pay license fees and royalties based on the net sales of products that fall within
the scope of the license. Some licenses require us to exercise our best efforts or another level of efforts to achieve research, clinical, and
commercial milestones and may require us to make additional payments upon the completion of such milestones. Our failure to be diligent or achieve any
required development milestones or to negotiate appropriate extensions of any of our license agreements or to make all required milestone and royalty
payments when due, and the subsequent decision of any such institution to terminate such license, could have a material adverse effect on our financial
position.




The exclusive licenses that we
feel are important to our future commercial interests in our development products are:




Sanochemia.  In
January 2006, we entered into an agreement with Sanochemia for rights to develop and market AV650 in North America. We paid an initial license fee of
$3.0 million and will make additional milestone and royalty payments based on the success of the parties development and commercialization of
AV650. Additionally, we must pay to purchase the supply of AV650 formulations from Sanochemia. The license is exclusive for the duration of the patents
and pending patent applications that may issue. Under the agreement, we must be diligent in our development of one and under certain circumstances up
to two formulations of AV650 and Sanochemia must supply us exclusively with AV650 formulations for North America.




University of
Colorado.  In November, 2003, we entered into an agreement with the University of Colorado for rights to certain intellectual property
related to the treatment of chronic pain. The license is exclusive for the duration of any issued patents embodying the licensed intellectual property,
or until approximately 2023.




We cannot assure you that the
claims in our pending patent applications will be issued as patents, that any issued patents will provide us with significant competitive advantages,
or that the validity or enforceability of any of our patents will not be challenged or, if instituted, that these challenges will not be successful.
The cost of litigation to uphold the validity and prevent infringement of our patents could be substantial. Furthermore, we cannot assure you that
others will not independently develop similar technologies or duplicate our technologies or design around the patented aspects of our technologies. We
can provide no assurance that our proposed technologies will not infringe patents or rights owned by others, the licenses to which might not be
available to us.




In addition, if we pursue patent
applications in foreign countries, their approval processes for patent applications may differ significantly from the processes in the U.S. The patent
authorities in each country administer that countrys laws and regulations relating to patents independently of the laws and regulations of any
other country and the patents must be sought and obtained separately. Therefore, issuance in one country does not necessarily indicate that it can be
obtained in other countries. Our policy is to make a case-by-case determination as to whether to file a foreign application to correspond to each of
our U.S. applications. Sometimes we decide not to do so. We make the decision with respect to each patent application on a country-by-country
basis.




Gene Therapy-Related Patents




In December 2005, we trasferred
the intellectual property rights (including in-licenses) for our AAV gene therapy-based products to Genzyme Corporation. Under the terms of the
agreement, we assigned to Genzyme our rights to certain AAV-related intellectual property, our gene therapy clinical trial programs for
Parkinsons disease and hemophilia, certain AAV-related contracts, and the use of previously manufactured clinical-grade vector materials. These
intellectual property rights included 62 U.S. and international patents owned by us. However, if Genzyme fails to diligently pursue the
commercialization and marketing of products using the assigned technology, as specified in the agreement, certain of the rights we assigned could
revert back to Avigen at a future date. Under the terms of the agreement, Avigen received a $12.0 million initial payment and could receive significant
future milestone, sublicensing fees and royalty payments based on the successful development of products by Genzyme utilizing technologies previously
developed by us.




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Government Regulation




The FDA and comparable regulatory
agencies in state and local jurisdictions and in foreign countries regulate extensively the clinical development, manufacture, distribution and sale of
pharmaceutical products. These agencies and other federal, state and local entities regulate research and development activities and the testing,
manufacture, quality control, safety, effectiveness, labeling, storage, distribution, record keeping, approval and promotion of our development
products. All of our products will require regulatory approval before commercialization. In particular, therapeutic products for human use are subject
to rigorous preclinical and clinical testing and other requirements of the Federal Food, Drug, and Cosmetic Act, implemented by the FDA, as well as
similar statutory and regulatory requirements of foreign countries and supervisory review boards affiliated with institutions that may perform our
clinical trials.




Obtaining marketing approvals and
subsequently complying with ongoing statutory and regulatory requirements is costly and time consuming. Any failure by us or our collaborators,
third-party manufacturers, licensors or licensees to obtain, or any delay in obtaining regulatory approval or in complying with other requirements,
could adversely affect the commercialization of products then being developed by us and our ability to receive product or royalty
revenues.




This process of clinically
testing drugs and seeking approval to market them can take a number of years and typically requires substantial financial resources. The results of
preclinical studies and initial clinical trials are not necessarily predictive of the results from large-scale clinical trials. All clinical trials may
be subject to additional costs, delays or modifications due to a number of factors, including the difficulty in obtaining enough subjects, clinical
investigators, drug supply, or financial support, or because of unforeseen adverse effects. In addition, as a condition of approval, the FDA also can
require further testing of the product and monitoring of the effect of commercialized products, and the agency has the power to prevent or limit
further marketing of a product based on the results of these post-marketing programs. Upon approval, a drug product may be marketed only in those
dosage forms and for those indications for which it is approved.




In addition to obtaining FDA
approval for each indication to be treated with each product, each domestic drug product manufacturing establishment must register with the FDA, list
its drug products with the FDA, comply with current Good Manufacturing Practices and pass inspections by the FDA. Manufacturers of biological products
also must comply with FDA general biological product standards. Moreover, the submission of applications for marketing approval from the FDA may
require additional time to complete manufacturing stability studies. Foreign establishments manufacturing drug products for distribution in the United
States also must list their products with the FDA and comply with current Good Manufacturing Practices. They also are subject to periodic inspection by
the FDA or by local authorities under agreement with the FDA. If we rely on strategic relationships with third-party manufacturers, with either U.S. or
foreign manufacturing establishments, as with Sanochemia, we may not be able to ensure effective compliance with these FDA requirements, which could
impact the timing and potential success of our development and commercialization of our potential products. Because our current facilities are located
in California, if we decide to manufacture any of our products in our facilities that are administered to humans, including products used for testing
in clinical trials, we would also be required to obtain a drug manufacturing license from the State of California.




Other
Regulations




In addition to regulations
enforced by the FDA, in the U.S. we are also subject to regulation under the Occupational Safety and Health Act, the Environmental Protection Act, the
Toxic Substances Control Act, the Resource Conservation and Recovery Act, and other federal, state and local regulations. Our research and development
activities involve the controlled use of hazardous materials, chemicals, biological materials, and various radioactive compounds. Although we believe
that our safety procedures for handling and disposing of these materials comply with the standards prescribed by state and federal regulations, we
could be held liable for any damages that result from accidental contamination or injury and this liability could exceed our resources. In addition,
our handling, care, and use of laboratory rodents are subject to the Guide for the Care and Use of laboratory Animals published by the National
Institutes of Health.




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Our clinical trials may also
involve subjects who reside outside of the U.S. which can involve subsequent monitoring of the subjects responses at clinical sites outside the
U.S. where other regulations apply.




Employees




As of March 1, 2006, Avigen had
32 full-time employees, including 7 with Ph.D. degrees and 2 with M.D. degrees. Approximately 18 employees are involved in our research and development
activities, including research, preclinical development, clinical and regulatory affairs, and quality assurance and quality control, and 14 employees
are involved in general administration, finance, legal, and business development activities. We also rely on a number of temporary staff positions and
third-party consultants to supplement our workforce. None of our employees are represented by a collective bargaining agreement nor have we ever
experienced a work stoppage. We believe that our relationship with our employees is good.




Revenues




Our revenues in 2005, 2004 and
2003 were $12,026,000, $2,195,000 and $463,000, respectively. Of these amounts, $12 million in 2005 was from the initial payment received from Genzyme
Corporation in December 2005 in connection with our transfer to them of certain AAV gene therapy assets. Also, $2,125,000 and $375,000 in 2004 and
2003, respectively, were from the $2.5 million payment received from Bayer Corporation in 2003 in connection with our development collaboration on a
gene therapy-based treatment for hemophilia. We terminated this agreement in December 2004. Both of these corporations are located in the United
States. All of our revenues were from companies located in the United States, and all of our long-lived assets are located in the United
States.




Available Information and Website
Address




Our website address is
www.avigen.com; however, information found on our website is not incorporated by reference into this Annual Report on Form 10-K. We file electronically
with the Securities and Exchange Commission our annual reports on Form 10-K, quarterly interim reports on Form 10-Q, current reports on Form 8-K, and
amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. We make available on or
through our website, free of charge, copies of these reports as soon as reasonably practicable after we electronically file or furnish it to the SEC.
You can also request copies of such documents by contacting our Investor Relations Department at (510) 748-7150 or sending an email to
ir@avigen.com.




Item 1A.    Risk
Factors




This section briefly discusses
certain risks that should be considered by stockholders and prospective investors in Avigen. Many of these risks are discussed in other contexts in
other sections of this report.




Risks Related to Our Business




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




Since our inception in 1992, we
have not been profitable, and we cannot be certain that we will ever achieve or sustain profitability. To date, we have been engaged in research and
development activities and have not generated any revenues from product sales. As of December 31, 2005, we had an accumulated deficit of $171.3
million. Developing new compounds will require significant additional research and development activities, including preclinical testing and clinical
trials, and regulatory approval. We expect these activities, together with our general and administrative expenses, to result in operating losses for
the foreseeable future. Our ability to achieve profitability will depend, in part, on our ability to successfully identify, acquire and complete
development of proposed products, and to obtain required regulatory approvals and manufacture and market our approved products directly or through
business partners.




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




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




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




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




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




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




We are aware that other companies
are conducting preclinical studies and clinical trials for products that could compete with products we intend to acquire or develop. See Item 1.
Business  Competition for a more detailed discussion of the competition we face.




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




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




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




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




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




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




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




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




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




At December 31, 2005 we had cash,
cash equivalents, available-for-sale securities, and restricted investments of approximately $70.4 million. We anticipate that our existing capital
resources as of December 31, 2005 will be adequate to fund our needs for approximately three years. However, beyond that, or earlier if we are
successful in pursuing additional indications for compounds in our portfolio or acquiring additional product candidates, we may require additional
funding to complete the research and development activities currently contemplated, to acquire new products, and to commercialize our products. Our
future capital requirements will depend on many factors, including:


| |  | continued scientific progress in research and development
programs;
|- |  | -------------------------------------------------------------------

| |  | the scope and results of preclinical studies and clinical
trials;
|- |  | -----------------------------------------------------------------

| |  | the time and costs involved in obtaining regulatory
approvals;
|- |  | --------------------------------------------------------------

| |  | the costs involved in filing, prosecuting and enforcing patent
claims and other intellectual property rights;
|- |  | -------------------------------------------------------------------------------------------------------------

| |  | the costs involved in obtaining licenses to patented
technologies from third parties that may be needed to commercialize our products;
|- |  | --------------------------------------------------------------------------------------------------------------------------------------

| |  | how successful, if at all, we are at expanding our drug
development portfolio through a combination of internal research, acquisitions, and in-licensing compounds, and the nature of the consideration we pay
for acquiring or in-licensing compounds;
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | competing technological developments;
|- |  | -------------------------------------

| |  | the cost of manufacturing for clinical trials and
commercialization;
|- |  | --------------------------------------------------------------------

| |  | the cost of commercialization activities; and
|- |  | ---------------------------------------------

| |  | other factors which may not be within our control.
|- |  | --------------------------------------------------



We intend to continue to seek
additional funding through public or private equity or debt financing, when market conditions allow, or through additional collaborative arrangements
with corporate partners. If we raise




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additional funds by issuing
equity securities there may be further dilution to existing stockholders. We cannot assure our investors that we will be able to enter into such
financing arrangements on acceptable terms or at all. Without such additional funding, we may be required to delay, reduce the scope of, or eliminate
one or more of our research or development programs.




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




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




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




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




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




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




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whether any legislative or
regulatory proposals will be adopted or the effect that such potential proposals or managed care efforts may have on our business.




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




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




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




Changes in board and management composition could
adversely disrupt our operations.




We have recently experienced
changes to our board of directors and senior management team, including the death of our Chariman of the Board in December 2005 and the resignation of
our Chief Financial Officer in January 2006. We have filled these two roles with members of our current board and executive staff. We are in the
process of recruiting additional candidates to fill the vacancy and expand the size of our board of directors, and hope to add to our commercialization
and clinical development expertise. These changes could be disruptive, and we may experience difficulties in attracting and retaining new directors or
in integrating members of the Board and management team into new roles with respect to our business.




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




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




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




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




15


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




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




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




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




Risks Related to Our Intellectual
Property




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




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




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




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




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




We also rely on a combination of
trade secret and copyright laws, employee and third-party nondisclosure agreements and other protective measures to protect intellectual property
rights pertaining to our products and technologies. We cannot be certain that these measures will provide meaningful protection of our trade
secrets,




16


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know-how or other proprietary
information. In addition, the laws of certain foreign countries do not protect our intellectual property rights to the same extent as do the laws of
the United States. We cannot assure you that we will be able to protect our intellectual property successfully.




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




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




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




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




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




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




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




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




17


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to us. Termination of any of
our license agreements could harm our business and force us to cease our activities with the affected product candidate or technology.




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




Risks Related to Our Stock




Anti-takeover effects of certain charter provisions and
Delaware law may negatively affect the ability of a potential buyer to purchase some or all of our stock at an otherwise advantageous price, which may
limit the price investors are willing to pay for our common stock




Certain provisions of our charter
and Delaware law may negatively affect the ability of a potential buyer to attempt a takeover of Avigen, which may have a negative effect on the price
investors are willing to pay for our common stock. For example, our board of directors has the authority to issue up to 5,000,000 shares of preferred
stock and to determine the price, rights, preferences, and privileges of those shares without any further vote or action by the stockholders. This
would enable the Board of Directors to establish a shareholder rights plan, commonly referred to as a poison pill, which would have the
effect of making it more difficult for a third party to acquire a majority of the outstanding voting stock of Avigen. In addition, our board of
directors is divided into three classes, and each year on a rotating basis the directors of one class are elected for a three-year term. This provision
could have the effect of making it less likely that a third party would attempt to obtain control of Avigen through Board representation. Furthermore,
certain other provisions of our restated certificate of incorporation may have the effect of delaying or preventing changes in control or management,
which could adversely affect the market price of our common stock. In addition, we are subject to the provisions of Section 203 of the Delaware General
Corporation Law, an anti-takeover law.




Our stock price is volatile, and as a result investing
in our common stock is very risky




From January 1, 2004 to March 1,
2006, our stock price has fluctuated between a range of $2.63 and $7.93 per share. We believe that various factors may cause the market price of our
common stock to continue to fluctuate, perhaps substantially, including announcements of:


| |  | technological innovations or regulatory approvals;
|- |  | --------------------------------------------------

| |  | results of clinical trials;
|- |  | ---------------------------

| |  | new products by us or our competitors;
|- |  | --------------------------------------

| |  | developments or disputes concerning patents or proprietary
rights;
|- |  | ------------------------------------------------------------------

| |  | achievement or failure to achieve certain developmental
milestones;
|- |  | -------------------------------------------------------------------

| |  | public concern as to the safety of pharmaceutical
products;
|- |  | -----------------------------------------------------------

| |  | health care or reimbursement policy changes by governments or
insurance companies;
|- |  | ----------------------------------------------------------------------------------

| |  | developments of significant acquisitions or in relationships
with corporate partners;
|- |  | -------------------------------------------------------------------------------------

| |  | announcements by us regarding financing transactions and/or
future sales of equity securities; or
|- |  | -------------------------------------------------------------------------------------------------

| |  | changes in financial estimates or securities analysts
recommendations.
|- |  | -----------------------------------------------------------------------



In addition, in recent years, the
stock market in general, and the shares of biotechnology and health care companies in particular, have experienced extreme price fluctuations. These
broad market and industry fluctuations may cause the market price of our common stock to decline dramatically.




18


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




Through December 31, 2005, we
measured compensation expense for our employee stock compensation plans under the intrinsic value method of accounting prescribed by Accounting
Principles Board Opinion No. 25 (APB No. 25), Accounting for Stock Issued to Employees. Beginning January 1, 2006, we are
required to measure equity compensation expense using the fair value method, which will adversely affect our results of operations by increasing our
reported losses or reducing future reported income and which may adversely affect our stock price. Had we accounted for our compensation expense under
the fair value method of accounting prescribed by FAS 123, our equity compensation expenses for 2005, 2004, and 2003 would have been significantly
higher, increasing by approximately $2.2 million, $6.4 million and $9.9 million, net of reported amounts prescribed under APB No. 25,
respectively.




Item 1B.    Unresolved Staff
Comments




We have no unresolved written
comments from the Securities and Exchange Commission.




Item
2.    Properties




Our headquarters are located in a
commercial neighborhood of Alameda, California, and consist of two leased buildings with an aggregate of 112,500 square feet. These buildings include
facilities for laboratory research and development, manufacturing and office space. One building, which represents approximately 45,000 square feet, is
under a 5-year lease that is scheduled to expire in May 2008. A second adjacent building, which represents approximately 67,500 square feet, is under a
10-year lease that is scheduled to expire in November 2010. The scheduled annual rental expense for 2006 under these leases is approximately $2.3
million. We currently sublease 15,250 square feet and 11,000 square feet, respectively, from the two buildings to two separate tenants. These subleases
run concurrent with the duration of our underlying lease terms. Under these leases, we are scheduled to receive annual sublease rental income in 2006
of approximately $0.5 million and reimbursement for a portion of the related facilities overhead costs which will be recorded as a reduction to our
operating expenses. We believe that the remaining space not under sublease in these two buildings is adequate for our projected needs for the
foreseeable future.




Item 3.    Legal
Proceedings




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




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




None.




Executive Officers of the
Registrant




Our executive officers and their
respective ages and positions as of March 14, 2006, are as follows:







|Name                            |  |  |  | Age |  | Position                                       
|------------------------------- |  |  |  | --- |  | -----------------------------------------------
|Kenneth G.
Chahine, J.D., Ph.D. |  |  |  | 41  |  | President, Chief Executive Officer and Director
|Michael D.
Coffee               |  |  |  | 60  |  | Chief
Business Officer                         
|Dawn McGuire,
M.D.              |  |  |  | 52  |  | Chief
Medical Officer                          
|Kirk Johnson,
Ph.D.             |  |  |  | 46  |  | Vice
President, Preclinical Research           
|M. Christina
Thomson, J.D.      |  |  |  | 35  |  | Vice
President, Corporate Counsel and Secretary
|Andrew A.
Sauter                |  |  |  | 39  |  | Vice
President, Finance                        



All of our officers are elected
annually by the Board of Directors. There is no family relationship between or among any of the officers or directors.




Kenneth G. Chahine, J.D.,
Ph.D., was appointed President, Chief Executive Officer and director of Avigen in March 2004. Dr. Chahine has served as Avigens Chief
Operating Officer since July 2002, and as Vice President, Business Development and Intellectual Property since 1998. Prior to joining Avigen, Dr.
Chahine worked at the patent law firm of Madson & Metcalf, P.C. in Salt Lake City, Utah from 1994 to 1998. From 1992 to 1993, he worked as a
research scientist at Parke-Davis Pharmaceuticals, a pharmaceutical company, and held another research




19


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scientist post at the
University of Utah Department of Human Genetics from 1994 to 1996. Dr. Chahine served as western regional news and legal correspondent for Nature
Biotechnology from 1996 to 2002. Dr. Chahine holds a J.D. from the University of Utah and a Ph.D. in biochemistry and molecular biology from the
University of Michigan.




Michael D. Coffee has
served as Avigens Chief Business Officer since February 2005. Prior to joining Avigen, Mr. Coffee co-founded the Alekta Group, LLC in 2004, a
consulting firm, to provide a comprehensive range of pharmaceutical development consulting services to emerging pharmaceutical companies. From 2001 to
2004 Mr. Coffee served as President and Chief Operating Officer of Amarin Pharmaceuticals, Inc., the U.S. drug development and marketing subsidiary of
Amarin Corporation PLC. Mr. Coffee also served as President and Chief Operating Officer of Elan Pharmaceuticals, North America from 1998 to 2001 and
held marketing and executive management positions, including President and Chief Operating Officer, of Athena Neurosciences, Inc. between 1991 and
1998. Mr. Coffee received a BS in biology from Siena College.




Dawn McGuire, M.D., has
served as Avigens Chief Medical Officer since January 2004. Dr. McGuire has provided leadership in both pharmaceutical and biotechnical corporate
settings, most recently as Chief Scientific Officer of Eunoe, Inc. (previously CSFluids, Inc.), a medical device company, from 2002 to January 2004.
She was President and Chief Executive Officer of CSFluids from 1999 to 2002. From 1999 to 2000, Dr. McGuire also served as Vice President, Medical
Affairs Worldwide at Collagen Corporation, a healthcare products company. From 1997 to 1999, Dr. McGuire served as Vice President, Clinical Research
and Medical Affairs at Elan Pharmaceuticals and was responsible for, among other programs, the development through FDA submission of ziconotide
(PrialtTM). Dr. McGuire is a board-certified neurologist and has led clinical development
programs in neuropathic pain, Alzheimers disease, AIDS dementia, Lou Gehrigs disease, Multiple Sclerosis, and stroke. She is the co-author
of over 40 scientific articles, book chapters, and invited reviews in neurotherapeutics. Since 2000, Dr. McGuire has served as a Scientific Reviewer
and Study Section Member of the National Institute of Neurological Disorders and Stroke. Dr. McGuire received her B.A. with high honors from Princeton
University, her M.D. from Columbia University College of Physicians and Surgeons, and trained in neurology at the University of California, San
Francisco, followed by an NIH-funded postdoctoral fellowship in clinical trial design and experimental therapeutics.




Kirk Johnson, Ph.D.,
joined Avigen in January 2004 and was appointed Vice President, Preclinical Development in June 2004. Prior to joining Avigen, Dr. Johnson was Senior
Director, Pharmacology & Preclinical Development and a member of the executive management team of Genesoft Pharmaceuticals from 2001 to 2004. From
1991 to 2001, Dr. Johnson was employed in both protein and small molecule therapeutic research and development at Chiron Corporation, a
biopharmaceutical company, and eventually served as Director, Pharmacology and Preclinical Research. Dr. Johnson was involved in leading IND-enabling
programs, supporting clinical development, and contributing to successful IND and NDA filings at Chiron and Genesoft. In addition to general
pharmacology and other preclinical development responsibilities, he has lead research and clinical development projects for diverse indications
including neuropathic pain, hemophilia, antibacterials, diabetes, obesity, acute inflammation and cardiovascular disease and has published more than 50
manuscripts and holds 4 U.S. patents. Dr. Johnson earned a B.S. in toxicology from U.C. Davis, and a Ph.D. in pharmacology and toxicology from the
Medical College of Virginia. He completed postdoctoral fellowships studying the mechanism of action of IL-2 from 1986-1989 with Dr. Kendall Smith at
Dartmouth College and from 1990-1991 with Dr. Marian Koshland at the University of California, Berkeley.




M. Christina Thomson,
J.D., joined Avigen in February 2000 and was appointed Vice President, Corporate Counsel in June 2004. She has also served as our Chief Compliance
Officer since March 2004 and Corporate Secretary since January 2005. Ms. Thomson is a registered patent attorney, and has managed significant growth in
Avigens patent portfolio over the last five years. Ms. Thomson also oversees the companys litigation and administrative patent proceedings,
as well as contract administration. Prior to joining Avigen, Ms. Thomson worked as a patent attorney with the law firm Knobbe Martens Olson & Bear
LLP in Newport Beach, California, as a patent agent with Madson & Metcalf, P.C. in Salt Lake City, Utah, and as a scientist for Myriad Genetic
Laboratories. Ms. Thomson holds a J.D. from the University of Utah College of Law and an M.S. in biology from the University of Utah.




20


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Andrew A. Sauter was
appointed Vice President, Finance in January 2006, having joined Avigen as Controller in November 1999. Mr. Sauter is Avigens principal financial
officer. Mr. Sauter oversees the financial reporting obligations of Avigen and has been responsible for Sarbanes-Oxley compliance. From 1992 to 1999,
Mr. Sauter worked for BankAmerica Corporation in a variety of positions, including most recently as a vice president in the Capital Markets Finance
organization. From 1989 to 1992, he worked for Ernst & Young LLP. Mr. Sauter is a certified public accountant and holds a B.A. degree in economics
from Claremont McKenna College.




PART II


|Item
5. |  | Market for Registrants Common Equity, Related Stockholder
Matters, and Issuer Purchases of Equity Securities
|------- |  | ------------------------------------------------------------------------------------------------------------



Shares of Avigens common
stock commenced trading on the NASDAQ National Market on May 22, 1996, under the symbol AVGN. As of March 1, 2006, there were approximately
133 holders of record of our common stock.




We have never paid cash dividends
and do not anticipate paying cash dividends in the foreseeable future.




The following table sets forth,
for fiscal periods indicated, the range of high and low closing sales prices available for the years ended December 31, 2004 and 2005.







|Year ended December 31, 2004 |  |  |  | High |      | Low
|---------------------------- |  |  |  | ---- | ---- | ---
|Quarter End
3/31/04          |  |  |  | $    | 7.93 |    
|Quarter End
6/30/04          |  |  |  | $    | 5.40 |    
|Quarter End
9/30/04          |  |  |  | $    | 3.79 |    
|Quarter End
12/31/04         |  |  |  | $    | 3.77 |    






|Year ended December 31, 2005 |  |  |  | High |      | Low
|---------------------------- |  |  |  | ---- | ---- | ---
|Quarter End
3/31/05          |  |  |  | $    | 3.25 |    
|Quarter End
6/30/05          |  |  |  | $    | 3.54 |    
|Quarter End
9/30/05          |  |  |  | $    | 3.70 |    
|Quarter End
12/31/05         |  |  |  | $    | 3.27 |    



On March 1, 2006, the closing
sales price of Avigen common stock was $5.84 per share.




21


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Item 6.    Selected Financial
Data




The following tables should be
read in conjunction with Managements Discussion and Analysis of Financial Condition and Results of Operations included in Item 7 of
this report and the financial statements and related notes included in Item 8 of this report.







|                                                                                       |  | Year
      Ended December 31, |           
|-------------------------------------------------------------------------------------- |  | ----------------------------- | ----------
|
|
|Revenue                                                                                |  | $                             | 12,026    
|Operating
        expenses:                                                            |  |                               |           
|Research
        and development                                                       |  |                               | 13,775    
|General
        and administrative                                                     |  |                               | 8,264     
|Impairment
        loss related to
        long-lived assets                           |  |                               | 6,130     
|In-license
        fees                                                                |  |                               |          
|Total
        operating expenses                                                       |  |                               | 28,169    
|Loss
        from operations                                                           |  |                               | (16,143   
|Interest
        expense                                                               |  |                               | (323      
|Interest
        income                                                                |  |                               | 1,682     
|Other
        income (expense), net                                                    |  |                               | 88        
|Net
        loss                                                                       |  | $                             | (14,696   
|Basic
        and diluted net loss per common share                                    |  | $                             | (0.71     
|Shares
        used in basic and diluted net loss per common
        share calculation |  |                               | 20,624,229






|                                                                                 |  |  |  | December 31, |          | June 30, | 
|-------------------------------------------------------------------------------- |  |  |  | ------------ | -------- | -------- | 
|
|Cash, cash
equivalents, available-for-sale securities and restricted investments |  |  |  | $            | 70,388   |          | 
|Working
capital                                                                  |  |  |  |              | 59,649   |          | 
|Total
assets                                                                     |  |  |  |              | 76,264   |          | 
|Long-term
obligations                                                            |  |  |  |              | 9,282    |          | 
|Deficit
accumulated during development stage                                     |  |  |  |              | (171,275 | )        | 
|Stockholders equity                                                             |  |  |  |              | 65,464   |          | 






|(1) |  | We changed our fiscal year end from June 30 to December 31,
effective December 31, 2001.
|--- |  | ----------------------------------------------------------------------------------------



22


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



This Managements
Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties.
Avigens actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause or
contribute to such differences include, but are not limited to, those discussed herein and in Item 1A  Risk
Factors.




Overview




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




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




In January 2006, we acquired
exclusive license rights to develop and commercialize proprietary formulations of the compound tolperisone (AV650) for the North American market. These
rights include relevant patent filings, as well as clinical data held by Sanochemia relating to AV650. Sanochemia has also agreed to supply AV650 to us
exclusively for the North American market. Under the terms of the agreement, we made an upfront payment of $3 million and will make additional payments
to Sanochemia, our European collaborator, based on the parties achievement of clinical and regulatory product development milestones and sales of
AV650.




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




From 2000 through 2004, we were
party to a collaboration agreement with Bayer Corporation to develop a gene therapy product for hemophilia. In 2003, Bayer paid us $2.5 million to
support our development of the product candidate. That payment was originally recorded as deferred revenue and was scheduled to be recognized ratably
as revenue over the estimated five-year development period associated with the product. In May 2004, we suspended the related clinical trial and other
development activities, and accelerated the recognition of the remaining portion of deferred revenue. We have terminated the collaboration agreement
with Bayer and do not expect to receive any additional payments associated with similar gene therapy activities.




23


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We are a development stage
company and have primarily supported the financial needs of our research and development activities since our inception through public offerings and
private placements of our equity securities. We have not received any revenue from the sale of our products in development, and we do not anticipate
generating revenue from the sale of products in the foreseeable future. As a result, we expect that we will need to obtain additional funding to
support the anticipated future needs of our research and development activities, including the costs to complete clinical trials. We expect our source
of revenue, if any, for the next several years to consist of payments under the Genzyme agreement, collaborative arrangements with third parties,
government grants, and non-gene therapy-related license fees. We have incurred losses since our inception and expect to incur substantial losses over
the next several years due to lack of any substantial revenue and the continuation of our ongoing and planned research and development efforts,
including preclinical studies and clinical trials. There can be no assurance that we will successfully develop, commercialize, manufacture, or market
our product candidates or ever achieve or sustain product revenue for profitability. At December 31, 2005 we had an accumulated deficit of $171.3
million and cash, cash equivalents, available-for-sale securities and restricted investments of approximately $70.4 million. We believe that our
capital resources at December 31, 2005, after considering our anticipated spending focus on our small molecule compound-based programs and away from
gene therapy-related activities, will be adequate to fund our operating needs for approximately the next three years.




Critical Accounting Policies and Significant Judgments
and Estimates




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




While our significant accounting
policies are more fully described under Note 1 in the Notes to our Financial Statements, we believe the following accounting policies are critical to
the process of making significant judgments and estimates in the preparation of our financial statements.




Revenue recognition




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




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




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




24


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of the development-phase time
period changes, the amount of revenue we recognize related to up-front payments for a given period will accelerate or decrease accordingly. For
example, in March 2003, we received a $2.5 million payment from Bayer under the terms of a collaboration agreement for Coagulin-B, a gene therapy
product candidate for hemophilia. The revenue associated with the payment was being recognized ratably over the development phase, which was initially
estimated to be five years. In May 2004, we suspended subject enrollment in the phase I clinical trial for this product candidate and, as a result,
ended the development phase for this product candidate and recognized as revenue $2.0 million, constituting the portion of the $2.5 million payment not
previously recognized as revenue, during the quarter ended June 30, 2004.




Valuation of investments in financial
instruments




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


| |  | the length of time and the extent to which the market value of
the security has been less than cost;
|- |  | ----------------------------------------------------------------------------------------------------

| |  | the financial condition and near-term prospects of the issuer;
and
|- |  | ------------------------------------------------------------------

| |  | our intention and ability to retain our investment in the issuer
for a period of time sufficient to allow for any anticipated recovery in market value, which could be until maturity.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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




In addition, when management
commits to holding individual securities until maturity in order to avoid the recognition of an other-than-temporary impairment, those securities would
no longer be classified as available-for-sale. In addition, such securities would be further evaluated to determine whether the security, based on the
remaining duration until its scheduled maturity, should be identified as a current or long-term asset. As of December 31, 2005, management had not
designated any individual securities as held-to-maturity for the purposes of avoiding an other-than-temporary impairment.




Impairment of property and
equipment




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


| |  | failure of manufacturing facilities and equipment to comply with
government mandated policies and procedures;
|- |  | -------------------------------------------------------------------------------------------------------------

| |  | failure of the product candidates for which the manufacturing
facilities have been constructed to receive regulatory approval; and
|- |  | ----------------------------------------------------------------------------------------------------------------------------------

| |  | the extent that facilities could be idled or abandoned due to a
decrease in the scope of our research and development activities for an other-than-temporary period, resulting in excess capacity.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



25


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




Recognition of Research and Development
Expenses




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




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




Results of Operations




Revenue







|                                      |  |  |  | Year Ended December 31, |       
|------------------------------------- |  |  |  | ----------------------- | ------
|
|Revenue                               |  |  |  | $                       | 12,026
|Percentage
increase over prior period |  |  |  |                         | 448   



Revenue in 2005 primarily
reflected the $12.0 million payment received in connection with our agreement with Genzyme Corporation. Revenue in 2004 primarily included the
acceleration of deferred revenue associated with the termination of our gene therapy collaboration with Bayer Corporation for hemophilia. We had
received a $2.5 million payment from Bayer in March 2003 in connection with our collaboration on a gene therapy product for hemophilia. The payment was
being recognized ratably over the estimated development period of the product candidate, which was estimated at five years. In May 2004, we suspended
patient enrollment in the trial, which resulted in the termination of the development of the product candidate and accelerated the recognition of all
remaining deferred revenue.




Research license fees associated
with our gene therapy technologies totaled $22,500, $64,500 and $79,000, during 2005, 2004, and 2003, respectively. These research license agreements
allowed licensees to make or use products using our patented AAV technologies for research purposes only, and did not allow for the use of
these




26


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technologies in products for
commercial sale. Royalty revenue totaled $3,200, $5,800 and $9,000 during 2005, 2004, and 2003, respectively, and was attributed to a single royalty
license that was entered into in July 2000, which allowed for the development, manufacture, use and commercial sale of research products using our
patented AAV technologies.




As a result of the assignment of
our gene therapy assets to Genzyme, and termination of the collaboration agreement with Bayer in 2004, we are no longer a direct party to most of the
license or collaboration agreements that gave rise to the revenues we recognized over the last three years. As a result, we do not expect any
significant revenues for the foreseeable future and that such revenues, if any, will consist solely of payments that may be received in connection with
the Genzyme agreement and other non-gene-therapy related activities.




Research and Development
Expenses




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




During the first half of 2004,
our research and development activities were primarily focused on our AAV-based programs for hemophilia and Parkinsons disease and our non-AAV
programs for neuropathic pain. Our staff count dedicated to research and development activities at the time averaged approximately 76 employees. In
July 2004, in connection with the suspension of a gene therapy-related clinical trial for hemophilia, we began to shift the focus of our resources
toward neurological programs, and reduced our workforce by approximately 36 percent. This reduced the number of employees dedicated to our research and
development activities to approximately 45 at December 31, 2004. In August 2005, we took additional steps to reduce our involvement with and spending
on AAV-based activities and reduced our workforce by approximately 19 positions, or 33 percent. As a result, at December 31, 2005, the staff count
associated with our current research and development activities, which focus on our portfolio of small molecule candidates for the treatment of serious
neurological and neuromuscular disorders, was approximately 20.




The costs associated with these
two primary functions of our research and development activities approximate the following:


|                                        |  |  |  | Year Ended December 31, |       
|--------------------------------------- |  |  |  | ----------------------- | ------
|
|Research and
preclinical development    |  |  |  | $                       | 9,350 
|Clinical
development                    |  |  |  |                         | 4,425 
|Total
research and development expenses |  |  |  | $                       | 13,775



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




27


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Research and preclinical
development







|                                                              |  |  |  | Year Ended December 31, |      
|------------------------------------------------------------- |  |  |  | ----------------------- | -----
|
|Personnel-related                                             |  |  |  | $                       | 2,938
|External
research and development                             |  |  |  |                         | 582  
|Other
expenses including facilities overhead and depreciation |  |  |  |                         | 5,830
|Total
research and preclinical development expenses           |  |  |  | $                       | 9,350



Comparison of Years Ended
December 31, 2005 and 2004. The decreases in our total research and preclinical development expenses for the year ended December 31, 2005, compared
to 2004, of $3.3 million, were primarily due to changes in costs for the following:


| |  | lower personnel-related expenses of $1.9 million, reflecting the
impact of a significantly lower average staff level as a result of staff reductions in July 2004 and August 2005, partially offset by higher average
salaries and higher severance expense in 2005,
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | lower expenditures for external research and development
services from third-party collaborators associated with our preclinical animal studies of $1.0 million, primarily related to our completion of
significant preclinical work with Parkinsons disease in 2004 as it transitioned into a clinical development phase, and
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | lower other expenses of $358,000, primarily reflecting a
decrease in depreciation charges as a result of the write-down of the cost basis of our long-lived assets during the year due to
impairment.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Comparison of Years Ended
December 31, 2004 and 2003. The decreases in our total research and preclinical development expenses for the year ended December 31, 2004, compared
to 2003, of $838,000, were primarily due to changes in costs for the following:


| |  | lower expenditures for external research and development
services from third-party collaborators associated with our preclinical animal studies of $569,000, primarily related to our completion of a
significant portion of our preclinical work with Parkinsons disease in 2003 and a reduction in preclinical work associated with other gene
therapy projects, primarily due to our lower staff levels in 2004,
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | lower personnel-related expenses of $135,000, primarily
reflecting a lower average staff count as a result of the staff reduction in July 2004 and lower recruiting and relocation expenses reflecting a
decline in hiring and the use of relocation payment incentives in 2004 compared to 2003, partially offset by higher severance expenses paid to
employees affected by the staff reduction in 2004 and higher bonus expenses in 2004, and
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | lower other expenses of $134,000, primarily reflecting lower
materials expenses due to a decrease in our consumption of materials to produce AAV vectors and support our other on-going research activities as a
result of the transfer of our Parkinsons program into a clinical development phase, and the general impact of our lower staff levels in
2004.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Clinical
development







|                                                              |  |  |  | Year Ended December 31, |      
|------------------------------------------------------------- |  |  |  | ----------------------- | -----
|
|Personnel-related                                             |  |  |  | $                       | 1,343
|External
research and development                             |  |  |  |                         | 543  
|Other
expenses including facilities overhead and depreciation |  |  |  |                         | 2,539
|Total
clinical development expenses                           |  |  |  | $                       | 4,425



28


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Comparison of Years Ended
December 31, 2005 and 2004. The decreases in our total clinical development expenses for the year ended December 31, 2005, compared to 2004, of
$2.3 million, were primarily due to changes in costs for the following:


| |  | lower personnel-related expenses of $846,000, reflecting a
significantly lower average staff level as a result of staff reductions in July 2004 and August 2005 and lower severance-related costs, partially
offset by higher average salaries in 2005, and
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | lower other expenses of $1.3 million, primarily due to a
decrease in depreciation charges as a result of the write-down of the cost basis of our long-lived assets during the year due to impairment, a decrease
in the amounts of materials consumed in 2005 compared to the prior year in connection with the production of clinical-grade AAV vectors to support the
needs of our clinical trials, and a decrease in other costs associated with our transition out of gene-therapy related activities.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Comparison of Years Ended
December 31, 2004 and 2003. The decreases in our total clinical development expenses for the year ended December 31, 2004, compared to 2003, of
$1.6 million, were primarily due to changes in costs for the following:


| |  | lower other expenses of $1.3 million, primarily reflecting lower
license origination fees, including $97,000 of non-cash charges in connection with the issuance of warrants in 2003, and lower materials expenses
reflecting lower levels of material consumed in 2004 for the production of clinical grade AAV vectors due to the delayed needs of our development
programs at the clinical development stage, and
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | lower personnel-related expenses of $520,000, reflecting a lower
average staff level, partially offset by higher severance expenses paid to employees affected by the staff reduction in 2004,
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



partially offset
by,


| |  | higher expenditures for external clinical development services
from third-party collaborators associated with recruiting and treating subjects in our clinical trials of $225,000, primarily related to regulatory
costs associated with the filing for FDA approval and recruiting of our first subject in our phase I/II clinical trial for AV201, our
gene-therapy-based product candidate for the treatment of Parkinsons disease.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Total research and development
expenses for 2005 were within managements expectations, taking into account the scheduled pace of subject recruitment in our gene therapy-based
Parkinsons disease clinical trial and the lengthy time periods common to negotiations with external parties. We believe delays in regulatory
approvals and scheduling of participants will continue to be factors that could limit the pace of progress in future clinical trials for our portfolio
of small molecule product candidates, albeit to a lesser degree than we experienced with gene therapy clinical trials. As a result, we have taken steps
to reduce our overhead and operating costs in order to extend the life of our financial resources. If we are successful in our efforts to develop our
product candidates, including the initiation of clinical trials, or acquire or in-license additional product candidates for development, our total
research and development spending in 2006 will be likely to remain the same or rise in order to meet the development needs of such product
candidates.




General and Administrative
Expenses







|                                                              |  |  |  | Year Ended December 31, |      
|------------------------------------------------------------- |  |  |  | ----------------------- | -----
|
|Personnel-related                                             |  |  |  | $                       | 3,434
|Legal and
professional fees                                   |  |  |  |                         | 2,219
|Non-recurring
severance                                       |  |  |  |                         | 22   
|Other
expenses including facilities overhead and depreciation |  |  |  |                         | 2,589
|Total general
and administrative expenses                     |  |  |  | $                       | 8,264
|Percentage
(decrease) increase over prior period              |  |  |  |                         | (1   



29


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Comparison of the Years Ended
December 31, 2005 and 2004. The decrease of $103,000 in our general and administrative expenses in 2005, compared to 2004, was primarily due to
changes in costs for the following:


| |  | lower severance expenses of $1.0 million, primarily related to
severance expense accrued in March 2004 in connection with the resignation of our former CEO, and
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | lower other expenses of $144,000, including savings from lower
corporate insurance premiums,
|- |  | --------------------------------------------------------------------------------------------



partially offset
by,


| |  | higher legal and professional fees of $769,000, primarily
related to an increase in costs associated with being a public company and increased use of third-party business consultants, and
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | higher personnel-related expenses of $272,000, reflecting higher
average salaries and bonuses, partially offset by a slightly lower staff level in 2005.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------



Comparison of the Years Ended
December 31, 2004 and 2003. The increase of $968,000 in our general and administrative expenses in 2004, compared to 2003, was primarily due to
severance expense of $1.0 million, approximately $900,000 of which was accrued in connection with the resignation of our former CEO in March
2004.




We expect our general and
administrative expenses for 2006 to decrease below our 2005 levels, primarily due to lower average staff and overhead costs. However, if we are
successful in the clinical development of our products, including increasing awareness of the market potential for our drug candidates, or expand our
portfolio of development candidates through additional strategic relationships and collaborations, our expected general and administrative spending
levels may increase in connection with the changing needs of the company.




Impairment Loss Related to
Long-Lived Assets







|                                             |  |  |  | Year Ended December 31, |      
|-------------------------------------------- |  |  |  | ----------------------- | -----
|
|Impairment
loss related to long-lived assets |  |  |  | $                       | 6,130



The carrying value of long-lived
assets is reviewed for impairment whenever events or changes in circumstances indicate that the asset may not be recoverable. An impairment loss is
recognized when the total of estimated future cash flows expected to result from the use of the asset and its eventual disposition are less than its
carrying amount or appraised value, as appropriate.




During 2005, we recorded
impairment charges of $6.1 million related to leasehold improvements and equipment associated with approximately 40,000 square feet of manufacturing,
laboratory, and office space under lease through May 2008 and approximately 11,000 square feet of similar space we have under lease through November
2010. These charges were based on our assessments of changes in the scope of our research and development activities at June 30 and September 30, 2005,
and the determination that it was not cost effective to re-engineer facilities that had been designed to support our AAV-based gene therapy programs.
Based on these assessments, we have consolidated our operations and entered into sublease agreements for portions of these facilities. Under rental
market conditions at the time of each assessment, we determined we would not receive incremental rents above the cost of our underlying lease
obligations. Therefore, we adjusted the cost basis of the long-lived assets associated with these facilities to zero, to reflect their estimated fair
value. These charges do not impact our cash flow and represent an acceleration of depreciation expenses that were scheduled to be recognized over the
next three to five years. As a result of the recognition of these charges, future depreciation expenses for these long-lived assets will
decrease.




Interest
Income







|                                      |  |  |  | Year Ended December 31, |      
|------------------------------------- |  |  |  | ----------------------- | -----
|
|Interest
income                       |  |  |  | $                       | 1,682
|Percentage
decrease over prior period |  |  |  |                         | (12  



Almost all of our interest income
is generated from our investments in high-grade marketable securities of government and corporate debt. The decline in interest income between 2005 and
2004 was primarily due to the




30


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decrease in our outstanding
interest-bearing cash and securities balances, due to the use of such resources to fund our on-going operations during the year, partially offset by a
rising average yield earned on our portfolio of investments. The decline in interest income between 2004 and 2003 was due to the decrease in our
outstanding interest-bearing cash and securities balance combined with a declining average yield earned on our portfolio of investments during the
period.




Recently Issued Accounting
Standards




See Note 1, Summary of
Significant Accounting Policies  New Accounting Pronouncements, in the Notes to Consolidated Financial Statements for a discussion
of recent accounting pronouncements and their effect, if any, on Avigen, which discussion is incorporated by reference here.




Deferred Income Tax Assets




In accordance with FAS 109,
Accounting for Income Taxes, which is described in the Notes to our Financial Statements, we have calculated a deferred tax asset
based on the potential future tax benefit we may be able to realize in future periods as a result of the significant tax losses experienced since our
inception. However, the value of such deferred tax asset must be calculated using the tax rates expected to apply to the taxable income in the years in
which such income occurs. Since we have no history of earnings, and cannot reliably predict when we might create taxable income, if at all, we have
recorded a valuation allowance for the full amount of our calculated deferred tax asset.




Liquidity and Capital Resources




Since our inception in 1992, cash
expenditures have significantly exceeded our revenue. We have funded our operations primarily through public offerings and private placements of our
equity securities. After our initial public offering in May 1996, we raised $189 million from private placements and public offerings of our common
stock and warrants to purchase our common stock. After our initial public offering, we also received additional funds as a result of exercises of
previously issued warrants and options to purchase our common stock, including an additional $1.5 million during the three-year-period ended December
31, 2005. The timing of and amounts realized from the exercise of these warrants and options are determined by the decisions of the respective warrant
and option holders, and are not controlled by us. Therefore, funds received from exercises of stock options and warrants in past periods should not be
considered an indication of additional funds to be received in the future periods. In addition, a significant percentage of options and warrants
currently outstanding have exercise prices that exceed the current trading price of our common stock, and so unless the trading price of our common
stock increases significantly, those options and warrants may never be exercised.




In addition to funding our
operations through sales of our common stock, in March 2003, we received $2.5 million in research support from Bayer Corporation in connection with our
collaboration on a gene therapy product for hemophilia. In December 2005, we received a $12.0 million payment from Genzyme Corporation in connection
with the agreement transferring to Genzyme rights to most of our AAV-based intellectual property, our gene therapy clinical trial programs for
Parkinsons disease and hemophilia, and clinical-grade vector materials.




We also have attempted to contain
costs and reduce cash flow requirements by renting facilities, contracting with third parties to conduct research and development and using
consultants, where appropriate. We expect to incur additional future expenses, resulting in significant additional cash expenditures, as we continue
our research and development activities, including our efforts to develop, manufacture, and commercialize our current drug candidates, expand our
product portfolio with additional development candidates through internal research, acquisition or in-licensing, and undertake additional preclinical
studies and clinical trials of our product candidates. We also expect to incur substantial additional expenses relating to the filing, prosecution,
maintenance, defense and enforcement of patent and other intellectual property claims.




At December 31, 2005, we had
cash, cash equivalents, available-for-sale securities, and restricted investments, of approximately $70.4 million, compared to approximately $76.2
million at December 31, 2004 and $98.9 million at December 31, 2003. At December 31, 2005, 2004 and 2003, $10.4 million, $11.9 million, and $11.9
million, respectively, of restricted investments were pledged to secure certain long-term liabilities. The reduction of




31


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$1.5 million in restricted investments at December 31, 2005, was directly
associated with the reduction in our pledge to collateralize certain equipment operating leases. At December 31, 2005 and 2004, the portion of our
investment portfolio pledged as collateral, which we refer to as restricted investments, includes $10.0 million for our line of credit and
approximately $428,000 for letters of credit which serve as security deposits on a building lease. Our restricted investments would not be considered a
current source of additional liquidity.



Operating
Activities.  Net cash used for operating activities was $6.0 million for 2005 compared to $21.8 million for 2004. The decrease in cash
used for operating activities is primarily due to the receipt of $12.0 million in 2005 in connection with our transaction with Genzyme, and $5.6
million in lower 2005 research and development expenses as described previously.




Net cash used for operating
activities in 2004 was $21.8 million compared to $19.3 million for 2003. The increase in the amount of cash used in 2004 compared to 2003 is primarily
due to the $2.5 million payment received from Bayer in 2003 in connection with our collaboration agreement.




The cash used in operating
activities for these years was primarily used to support our internal research and development activities, as well as preclinical studies and clinical
trials performed by third parties, and our evaluation of potential in-license product opportunities. The level of cash used in operating activities in
2005 was in line with managements expectations. The level of cash used for operating activities during 2004 was slightly lower than
managements expectations due to the general delays in the progress of our clinical trials.




Investing and Financing
Activities. Net cash provided by investing and financing activities in 2005 was $14.0 million and $286,000, respectively, compared to $22.1 million
and $512,000, respectively, for the same activities in 2004. The cash provided by investing activities consisted primarily of sales and maturities, net
of purchases, of available-for-sale securities and the reduction in restricted investments, offset to a small degree by purchases of property and
equipment of $277,000 in 2005 and $467,000 in 2004. During 2005, cash provided by investing activities also included $182,000 proceeds from our sale of
laboratory and office equipment and furniture in connection with our consolidation of facilities previously used for our gene therapy activities. The
cash provided by financing activities consisted of proceeds from the exercise of stock options and warrants during the period.




Net cash provided by investing
and financing activities in 2003 was $13.1 million and $718,000, respectively. The cash provided by investing activities consisted primarily of sales
and maturities, net of purchases, of available-for-sale securities, offset to a small degree by purchases of property and equipment of $555,000 and an
increase in restricted investments of $428,000. The cash provided by financing activities consisted of proceeds from the exercise of stock options and
warrants during the period.




During 2005, in connection with
our decision to discontinue funding of our gene therapy programs, we took steps to reduce expenses by reducing our staff level and consolidating our
operations in order to reduce overhead and sublease portions of our facilities. At December 31, 2005, we had reduced our full-time employee staff level
to 35 from 60 at the end of the previous year, and completed sublease agreements for approximately 26,250 square feet of our leased facilities, or 23
percent. We believe that the future annual savings in personnel costs, including salaries, benefits, and temporary staffing, related to the impact of
the August 2005 staff reduction will approximate $2.2 million per year, and that the sum of scheduled sublease income and related reimbursement of a
portion of our facilities overhead costs from our subtenants will approximate $3.7 million over the remaining lease terms.




The following are contractual
commitments at December 31, 2005 associated with debt obligations, lease obligations net of sublease income, and contractual commitments to fund
third-party research (in thousands):







|                                   |  |  |  | Payments Due by Period |       
|---------------------------------- |  |  |  | ---------------------- | ------
|
|Operating
leases                   |  |  |  | $                      | 10,153
|Sublease
income                    |  |  |  |                        | (1,989
|Net operating
leases               |  |  |  |                        | 8,164 
|Revolving
line of credit           |  |  |  |                        | 8,000 
|Research
funding for third-parties |  |  |  |                        | 510   
|Total                              |  |  |  | $                      | 16,674



32


---



In June 2004, we amended the
terms of our $10.0 million revolving line of credit which had been put in place with Wells Fargo Bank in June 2000, to provide support for
construction-related activities, and was subsequently amended in June 2002. Under the terms of the current amendment, the expiration date of the
borrowing was extended from June 1, 2005 to June 1, 2007, thereby deferring the timetable to repay principal borrowed for two years. The debt
instrument bears interest at a floating rate based on the London Inter-Bank Offered Rate, which is reset in three-month increments after the date of
each drawdown, until such expiration. As of December 31, 2005 and 2004, the average annual rate of interest charged on the borrowing was approximately
4.97% and 2.70%, respectively. Also under the terms of this agreement, we pledged a portion of our portfolio of available for sale securities as
collateral and have identified the amount of the pledged securities as restricted investments on our balance sheets. The amount of the pledged
securities is equal to the amount of utilized borrowing capacity on the line of credit. At December 31, 2005, we had borrowed $8.0 million from the
line of credit and had reserved the remaining $2.0 million in borrowing capacity to secure a letter of credit in connection with the property lease
entered into in November 2000. As a result, at December 31, 2005, we have no more borrowing capacity under this facility.




Our current office and facility
includes approximately 112,500 square feet of space. Of this, approximately 45,000 square feet of space is leased through May 2008 and approximately
67,500 square feet of space is leased through November 2010. We have completed sublease agreements for approximately 26,250 square feet of these leased
facilities. Payments scheduled under these lease commitments and sublease agreements are included in the table above under operating leases and
sublease income.




We enter into commitments to fund
collaborative research and clinical work performed by third parties. While these contracts are cancelable by either party, we expect the research
studies and clinical work to be completed as defined in the terms of the agreements, and all amounts paid when due. Payments scheduled to be made under
these contracts are included in the table above under research funding for third-parties.




We believe we will continue to
require substantial additional funding in order to complete the research and development activities currently contemplated and to commercialize our
proposed products. We believe that with the reductions in our staff over the past two years, our efforts to reduce other legacy gene therapy-related
spending, the receipt of $12 million from Genzyme in connection with the assignment of rights to our gene therapy interests, and the consolidation of
our operations and sublease of portions of our facilities, our financial resources at December 31, 2005 will be adequate to fund our projected
operating needs for approximately three years. However, this forward-looking statement is based upon our current plans and assumptions regarding our
future operating and capital requirements, which may change. Our future operating and capital requirements will depend on many factors,
including:


| |  | continued scientific progress in research and development
programs;
|- |  | -------------------------------------------------------------------

| |  | the scope and results of preclinical studies and clinical
trials;
|- |  | -----------------------------------------------------------------

| |  | the time and costs involved in obtaining regulatory
approvals;
|- |  | --------------------------------------------------------------

| |  | the costs involved in filing, prosecuting and enforcing patents
claims and other intellectual property rights;
|- |  | --------------------------------------------------------------------------------------------------------------

| |  | the costs involved in obtaining licenses to patented
technologies from third-parties that may be needed to commercialize our product candidates;
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------

| |  | competing technological developments;
|- |  | -------------------------------------

| |  | the cost of manufacturing our product candidates for clinical
trials and sales;
|- |  | -------------------------------------------------------------------------------

| |  | the costs of marketing and commercialization
activities;
|- |  | --------------------------------------------------------

| |  | how successful, if at all, we are at acquiring or in-licensing
additional compounds, and the nature of the consideration we pay for acquired or in-licensed compounds; and
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | other factors which may not be within our control.
|- |  | --------------------------------------------------



We intend to continue to seek
additional funding through public or private equity or debt financing, when market conditions allow, or through additional collaborative arrangements
with corporate partners. We may consider issuing equity securities under our October 2000 shelf registration statement. The balance of securities
available for sale under




33


---



the existing shelf
registration agreement is approximately $26.4 million. If we raise additional funds by issuing equity securities, there may be further dilution to
existing stockholders. We cannot assure our investors that we will be able to enter into such financing arrangements on acceptable terms or at all.
Without such additional funding, we may be required to delay, reduce the scope of, or eliminate one or more of our research or development
programs.




Item 7A.    Quantitative and
Qualitative Disclosures About Market Risk




Our exposure to market rate risk
for changes in interest rates relates primarily to our investment portfolio and our long-term debt. We do not hold derivative financial investments,
derivative commodity investments or other financial investments or engage in foreign currency hedging or other transactions that expose us to other
market risks. None of our investments are held for trading purposes. Our investment objectives are focused on preservation of principal and liquidity.
By policy, we manage our exposure to market risks by limiting investments to high quality issuers and highly liquid instruments with effective
maturities of less than five years, and an average aggregate portfolio duration of approximately one to three years. Our entire portfolio is classified
as available-for-sale and, as of December 31, 2005, consisted of 100% fixed-rate securities. This compares to approximately 95% fixed-rate securities
and 5% variable-rate securities at December 31, 2004.




We have evaluated the risk
associated with our portfolios of investments in marketable securities and have deemed this market risk to be immaterial. If market interest rates were
to increase by 100 basis points, or 1%, from their December 31, 2005 levels, we estimate that the fair value of our securities portfolio would decline
by approximately $533,000. Our estimated exposure at December 31, 2005 is lower than our estimated $740,000 exposure at December 31, 2004 due to the
reduction in size of our overall portfolio. The modeling technique used measures duration risk sensitivity to estimate the potential change in fair
value arising from an immediate hypothetical shift in market rates and quantifies the ending fair market value including principal and accrued
interest.




Our long-term debt includes a
$10.0 million revolving line of credit due June 1, 2007, of which we have drawn down $8.0 million in cash that will need to be repaid. Interest charged
on the borrowing is based on LIBOR and is reset in three-month increments based on the date of each original drawdown. As of December 31, 2005, the
average annual rate of interest charged on the borrowing was approximately 4.97% compared to 2.70% as of December 31, 2004.




34


---



Item 8.    Financial Statements
and Supplementary Data




INDEX TO FINANCIAL STATEMENTS




The following financial
statements are filed as part of this Report on Form 10-K. Condensed supplementary data for each of the quarters in the years ended December 31, 2005
and 2004 are set forth under Note 14 of our financial statements.







|                                                        |  |  |  | Page
|------------------------------------------------------- |  |  |  | ----
|Report of
Independent Registered Public Accounting Firm |  |  |  | 36  
|Balance
Sheets                                          |  |  |  | 37  
|Statements of
Operations                                |  |  |  | 38  
|Statements of
Stockholders Equity                      |  |  |  | 39  
|Statements of
Cash Flows                                |  |  |  | 45  
|Notes to
Financial Statements                           |  |  |  | 46  



35


---



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM




The Board of Directors and
Stockholders of Avigen, Inc.




We have audited the accompanying
balance sheets of Avigen, Inc. (a development stage company) as of December 31, 2005 and 2004, and the related statements of operations,
stockholders equity and cash flows for each of the three years in the period ended December 31, 2005 and for the period from inception (October
22, 1992) through December 31, 2005. 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 financial position of Avigen, Inc. at December 31, 2005 and 2004, and the
results of its operations and its cash flows for each of the three years in the period ended December 31, 2005 and for the period from inception
(October 22, 1992) through December 31, 2005, in conformity with U.S. generally accepted accounting principles.




We also have audited, in
accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Avigen Inc.s internal
control over financial reporting as of December 31, 2005, 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 14, 2006 expressed an unqualified opinion
thereon.




/s/ ERNST & YOUNG
LLP




Palo Alto, California March 14, 2006




36


---





Item 1.    Financial
Statements




AVIGEN, INC.(a development stage
company)




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


|                                                                                                                                                                      |  |  |  | December 31, |         
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  |  |  | ------------ | --------
|
|ASSETS                                                                                                                                                                |  |  |  |              |         
|Current
Assets:                                                                                                                                                       |  |  |  |              |         
|Cash and cash
equivalents                                                                                                                                             |  |  |  | $            | 11,510  
|Available-for-sale securities                                                                                                                                         |  |  |  |              | 48,450  
|Accrued
interest                                                                                                                                                      |  |  |  |              | 470     
|Prepaid
expenses and other current assets                                                                                                                             |  |  |  |              | 737     
|Total current
assets                                                                                                                                                  |  |  |  |              | 61,167  
|Restricted
investments                                                                                                                                                |  |  |  |              | 10,428  
|Property and
equipment, net                                                                                                                                           |  |  |  |              | 3,929   
|Deposits and
other assets                                                                                                                                             |  |  |  |              | 740     
|Total
assets                                                                                                                                                          |  |  |  | $            | 76,264  
|                                                                                                                                                                     
|LIABILITIES
AND STOCKHOLDERS EQUITY                                                                                                                                  |  |  |  |              |         
|Current
Liabilities:                                                                                                                                                  |  |  |  |              |         
|Accounts
payable and other accrued liabilities                                                                                                                        |  |  |  | $            | 984     
|Accrued
compensation and related expenses                                                                                                                             |  |  |  |              | 534     
|Total current
liabilities                                                                                                                                             |  |  |  |              | 1,518   
|Long-term loan
payable                                                                                                                                                |  |  |  |              | 8,000   
|Deferred rent
and other liabilities                                                                                                                                   |  |  |  |              | 1,282   
|Commitments                                                                                                                                                           |  |  |  |              |         
|Stockholders equity:                                                                                                                                                 |  |  |  |              |         
|Preferred
Stock, $0.001 par value, 5,000,000 shares authorized, none issued and outstanding in 2005 and 2004                                                          |  |  |  |              |        
|Common Stock,
$0.001 par value, 50,000,000 shares authorized, and 20,907,273 and 20,381,250 shares issued and outstanding at December 31, 2005 and 2004,
respectively |  |  |  |              | 21      
|Additional
paid-in capital                                                                                                                                            |  |  |  |              | 237,258 
|Accumulated
other comprehensive loss                                                                                                                                  |  |  |  |              | (540    
|Deficit
accumulated during development stage                                                                                                                          |  |  |  |              | (171,275
|Total
stockholders equity                                                                                                                                            |  |  |  |              | 65,464  
|Total
liabilities and stockholders equity                                                                                                                            |  |  |  | $            | 76,264  



See accompanying notes.




37


---



AVIGEN, INC. (a development stage
company)




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


|                                                                       |  |  |  | Year Ended December 31, |            | Period fromOctober
22,1992(inception)through | 
|---------------------------------------------------------------------- |  |  |  | ----------------------- | ---------- | -------------------------------------------- | 
|
|Revenue                                                                |  |  |  | $                       | 12,026     |                                              | 
|Operating
expenses:                                                    |  |  |  |                         |            |                                              | 
|Research and
development                                               |  |  |  |                         | 13,775     |                                              | 
|General and
administrative                                             |  |  |  |                         | 8,264      |                                              | 
|Impairment
loss related to long-lived assets                           |  |  |  |                         | 6,130      |                                              | 
|In-license
fees                                                        |  |  |  |                         |           |                                              | 
|Total
operating expenses                                               |  |  |  |                         | 28,169     |                                              | 
|Loss from
operations                                                   |  |  |  |                         | (16,143    | )                                            | 
|Interest
expense                                                       |  |  |  |                         | (323       | )                                            | 
|Interest
income                                                        |  |  |  |                         | 1,682      |                                              | 
|Other income
(expense), net                                            |  |  |  |                         | 88         |                                              | 
|Net
loss                                                               |  |  |  | $                       | (14,696    | )                                            | 
|Basic and
diluted net loss per common share                            |  |  |  | $                       | (0.71      | )                                            | 
|Shares used
in basic and diluted net loss per common share calculation |  |  |  |                         | 20,624,229 |                                              | 



See accompanying notes.




38


---





AVIGEN, INC. (a development stage
company)




STATEMENTS OF STOCKHOLDERS
EQUITY




Period from October 22, 1992 (inception) through December
31, 2005 (in thousands, except for share information)







|                                                                                                                                                                 |  | Preferred
      Stock |           | Common
      Stock |  | Class
      B
      Convertible
      Common Stock |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------- | --------- | ------------------ |  | -------------------------------------------------- | -
|
|Balance
        at October 22, 1992 (inception)                                                                                                                  |  |                       |          |                    |  | $                                                  | 
|Issuance
        of common stock at $.004 per share in November and December 1992                                                                                |  |                       |          |                    |  |                                                    | 
|Issuance
        of common stock at $.554 per share from January to June 1993 for services
        rendered                                                      |  |                       |          |                    |  |                                                    | 
|Issuance
        of common stock at $.004 to $.222 per share from November 1992 to March
        1993 for cash                                                   |  |                       |          |                    |  |                                                    | 
|Issuance
        of Class B common stock at $.004 per share in December 1992 for cash                                                                            |  |                       |          |                    |  |                                                    | 
|Issuance
        of Series A preferred stock at $4.43 per share from March to June 1993
        for cash (net of issuance costs of $410,900)                     |  |                       | 678,865   |                    |  |                                                    | 1
|Issuance
        of Series A preferred stock at $3.85 per share in March 1993 for cancellation
        of note payable and accrued interest                      |  |                       | 68,991    |                    |  |                                                    | 
|Issuance
        of common stock at $.004 per share in November 1993 pursuant to antidilution
        rights                                                     |  |                       |          |                    |  |                                                    | 
|Issuance
        of Series A preferred stock at $4.43 per share from July to November 1993
        for cash and receivable (net of issuance costs of $187,205)   |  |                       | 418,284   |                    |  |                                                    | 
|Issuance
        of Series B preferred stock at $5.54 per share in March 1994 for cash
        (net of issuance costs of $34,968)                                |  |                       | 128,031   |                    |  |                                                    | 
|Issuance
        of Series C preferred stock at $4.87 per share from July 1994 to June
        1995 for cash and receivables (net of issuance costs of $259,620) |  |                       | 739,655   |                    |  |                                                    | 1
|Issuance
        of Series C preferred stock at $4.87 per share in June 1995 for cancellation
        of notes payable                                           |  |                       | 35,500    |                    |  |                                                    | 
|Net
        loss and comprehensive loss from inception to June 30, 1995                                                                                          |  |                       |          |                    |  |                                                    | 
|Balance
        at June 30, 1995 (carried forward)                                                                                                               |  |                       | 2,069,326 |                    |  | $                                                  | 2



See accompanying notes.




39


---



AVIGEN, INC. (a development stage
company)




STATEMENTS OF STOCKHOLDERS EQUITY
(Continued)




Period from October 22, 1992 (inception) through December
31, 2005 (in thousands, except for share information)







|                                                                                                                                                                                                        |  | Preferred
      Stock |            | Common
      Stock |  | Class
      B
      Convertible
      Common Stock |   
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------- | ---------- | ------------------ |  | -------------------------------------------------- | --
|
|Balance
        at June 30, 1995 (brought forward)                                                                                                                                                      |  |                       | 2,069,326  |                    |  | $                                                  | 2 
|Issuance
        of Series C preferred stock at $4.87 per share in July 1995 for cash (net
        of issuance costs of $26,000)                                                                        |  |                       | 41,042     |                    |  |                                                    |  
|Issuance
        of Series D preferred stock at $7.09 per share from October 1995 to February
        1996 for cash (net of issuance costs of $25,279)                                                  |  |                       | 205,351    |                    |  |                                                    |  
|Issuance
        of Series D preferred stock at $7.09 per share in March 1996 in settlement
        of accounts payable                                                                                 |  |                       | 22,574     |                    |  |                                                    |  
|Issuance
        of common stock at $.004 per share in March 1996 pursuant to antidilution
        rights                                                                                               |  |                       |           |                    |  |                                                    |  
|Issuance
        of stock options in February 1996 in settlement of certain accrued liabilities                                                                                                         |  |                       |           |                    |  |                                                    |  
|Conversion
        of Class B common stock to common stock                                                                                                                                              |  |                       |           |                    |  |                                                    |  
|Issuance
        of warrants to purchase common stock in connection with 1996 bridge financing
        in March 1996                                                                                    |  |                       |           |                    |  |                                                    |  
|Conversion
        of preferred stock to common stock in May 1996                                                                                                                                       |  |                       | (2,338,293 | )                  |  |                                                    | (2
|Issuance
        of common stock at $8.00 per share in connection with the May 1996 initial
        public offering (net of issuance costs of $798,414 and underwriting discount
        of $1,500,000) |  |                       |           |                    |  |                                                    |  
|Proceeds
        from exercise of options at $0.44 per share in June 1996                                                                                                                               |  |                       |           |                    |  |                                                    |  
|Repurchase
        of common stock                                                                                                                                                                      |  |                       |           |                    |  |                                                    |  
|Deferred
        compensation                                                                                                                                                                           |  |                       |           |                    |  |                                                    |  
|Amortization
        of deferred compensation                                                                                                                                                           |  |                       |           |                    |  |                                                    |  
|Net
        loss and comprehensive loss                                                                                                                                                                 |  |                       |           |                    |  |                                                    |  
|Balance
        at June 30, 1996 (carried forward)                                                                                                                                                      |  |                       |           |                    |  | $                                                  |  



See accompanying notes.




40


---



AVIGEN, INC. (a development stage
company)




STATEMENTS OF STOCKHOLDERS EQUITY
(Continued)




Period from October 22, 1992 (inception) through December
31, 2005 (in thousands, except for share information)







|                                                                                                                                                                                                   |  | Preferred
      Stock |   | Common
      Stock |  | Class
      B
      Convertible
      Common Stock |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------- | - | ------------------ |  | -------------------------------------------------- | -
|
|Balance
        at June 30, 1996 (brought forward)                                                                                                                                                 |  |                       |  |                    |  | $                                                  | 
|Issuance
        of common stock at $8.00 per share in July 1996 in connection with the
        exercise of underwriters over-allotment option (net of underwriting
        discount of $150,000) |  |                       |  |                    |  |                                                    | 
|Proceeds
        from exercise of options at $0.44 to $0.71 per share                                                                                                                              |  |                       |  |                    |  |                                                    | 
|Amortization
        of deferred compensation                                                                                                                                                      |  |                       |  |                    |  |                                                    | 
|Net
        loss and comprehensive loss                                                                                                                                                            |  |                       |  |                    |  |                                                    | 
|Balance
        at June 30, 1997                                                                                                                                                                   |  |                       |  |                    |  |                                                    | 
|Proceeds
        from exercise of options at $0.44 to $0.71 per share                                                                                                                              |  |                       |  |                    |  |                                                    | 
|Amortization
        of deferred compensation                                                                                                                                                      |  |                       |  |                    |  |                                                    | 
|Compensation
        expense related to options granted for services                                                                                                                               |  |                       |  |                    |  |                                                    | 
|Net
        loss and comprehensive loss                                                                                                                                                            |  |                       |  |                    |  |                                                    | 
|Balance
        at June 30, 1998                                                                                                                                                                   |  |                       |  |                    |  |                                                    | 
|Proceeds
        from exercise of options at $0.44 to $4.31 per share                                                                                                                              |  |                       |  |                    |  |                                                    | 
|Amortization
        of deferred compensation                                                                                                                                                      |  |                       |  |                    |  |                                                    | 
|Issuance
        of common stock at $2.25$2.94 per share and warrants in August to
        September 1998 in connection with a Private Placement (net of issuance
        cost of $233,584)       |  |                       |  |                    |  |                                                    | 
|Issuance
        of common stock at $3.81$4.88 per share and warrants in December
        1998 in connection with a Private Placement (net of issuance cost of $438,183)                          |  |                       |  |                    |  |                                                    | 
|Issuance
        of common stock at $5.50$6.00 per share and warrants in February
        to April 1999 in connection with a Private Placement (net of issuance
        cost of $1,033,225)       |  |                       |  |                    |  |                                                    | 
|Net
        loss and comprehensive loss                                                                                                                                                            |  |                       |  |                    |  |                                                    | 
|Balance
        at June 30, 1999 (carried forward)                                                                                                                                                 |  |                       |  |                    |  | $                                                  | 



See accompanying notes.




41


---



AVIGEN, INC. (a development stage
company)




STATEMENTS OF STOCKHOLDERS EQUITY
(Continued)




Period from October 22, 1992 (inception) through December
31, 2005 (in thousands, except for share information)







|                                                                                                                                                                                                     |  | Preferred
      Stock |   | Common
      Stock |  | Class
      B
      Convertible
      Common Stock |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------- | - | ------------------ |  | -------------------------------------------------- | -
|
|Balance
        at June 30, 1999 (brought forward)                                                                                                                                                   |  |                       |  |                    |  | $                                                  | 
|Proceeds
        from exercise of options at $0.44 to $15.50                                                                                                                                         |  |                       |  |                    |  |                                                    | 
|Proceeds
        from exercise of warrants at $2.81 to $31.95                                                                                                                                        |  |                       |  |                    |  |                                                    | 
|Amortization
        of deferred compensation                                                                                                                                                        |  |                       |  |                    |  |                                                    | 
|Compensation
        expense related to options granted for services                                                                                                                                 |  |                       |  |                    |  |                                                    | 
|Warrants
        granted for patent licenses                                                                                                                                                         |  |                       |  |                    |  |                                                    | 
|Warrants
        granted for building lease                                                                                                                                                          |  |                       |  |                    |  |                                                    | 
|Issuance
        of common stock at $16.19 to $25.56 per share and warrants in October
        and November 1999 in connection with a Private Placement (net of issuance
        cost of $2,804,255) |  |                       |  |                    |  |                                                    | 
|Issuance
        of common stock at $26 per share in April and May 2000 in connection with
        a Public Offering (net of issuance cost of $2,288,966)                                            |  |                       |  |                    |  |                                                    | 
|Comprehensive loss:                                                                                                                                                                                 
|Net
        loss                                                                                                                                                                                     |  |                       |  |                    |  |                                                    | 
|Net
        unrealized loss on available-for-sale securities                                                                                                                                         |  |                       |  |                    |  |                                                    | 
|Comprehensive
        loss                                                                                                                                                                           |  |                       |   |                    |  |                                                    |  
|Balance
        at June 30, 2000 (carried forward)                                                                                                                                                   |  |                       |  |                    |  | $                                                  | 



See accompanying notes.




42


---



AVIGEN, INC. (a development stage
company)




STATEMENTS OF STOCKHOLDERS EQUITY
(Continued)




Period from October 22, 1992 (inception) through December
31, 2005 (in thousands, except for share information)







|                                                                                                                                             |  | Preferred
      Stock |   | Common
      Stock |  | Class
      B
      Convertible
      Common Stock |  
|-------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------- | - | ------------------ |  | -------------------------------------------------- | -
|
|Balance
        at June 30, 2000 (brought forward)                                                                                           |  |                       |  |                    |  | $                                                  | 
|Proceeds
        from exercise of options at $0.44 to $34.00 per share                                                                       |  |                       |  |                    |  |                                                    | 
|Proceeds
        from exercise of warrants at $2.18 to $23.43                                                                                |  |                       |  |                    |  |                                                    | 
|Compensation
        expense related to options granted for services                                                                         |  |                       |  |                    |  |                                                    | 
|Issuance
        of common stock at $37.50 to $45.06 per share in November 2000 Public
        Offering (net of issuance cost of $4,622,188) |  |                       |  |                    |  |                                                    | 
|Issuance
        of common stock at $47.82 per share in February 2001 pursuant to a collaboration
        agreement                          |  |                       |  |                    |  |                                                    | 
|Comprehensive loss:                                                                                                                         
|Net
        loss                                                                                                                             |  |                       |  |                    |  |                                                    | 
|Net
        unrealized gain on available-for-sale securities                                                                                 |  |                       |  |                    |  |                                                    | 
|Comprehensive
        loss                                                                                                                   |  |                       |   |                    |  |                                                    |  
|Balance
        at June 30, 2001                                                                                                             |  |                       |  |                    |  |                                                    | 
|Proceeds
        from exercise of options at $2.13 to $6.75 per share                                                                        |  |                       |  |                    |  |                                                    | 
|Proceeds
        from exercise of warrants $7.50 per share                                                                                   |  |                       |  |                    |  |                                                    | 
|Compensation
        expense related to options granted for services                                                                         |  |                       |  |                    |  |                                                    | 
|Comprehensive loss:                                                                                                                         
|Net
        loss                                                                                                                             |  |                       |  |                    |  |                                                    | 
|Net
        unrealized gain on available-for-sale securities                                                                                 |  |                       |  |                    |  |                                                    | 
|Comprehensive
        loss                                                                                                                   |  |                       |   |                    |  |                                                    |  
|Balance
        at December 31, 2001                                                                                                         |  |                       |  |                    |  |                                                    | 
|Proceeds
        from exercise of options at $1.875 to $8.525 per share                                                                      |  |                       |  |                    |  |                                                    | 
|Proceeds
        from exercise of warrants at $7.50 per share                                                                                |  |                       |  |                    |  |                                                    | 
|Compensation
        expense related to options granted for services                                                                         |  |                       |  |                    |  |                                                    | 
|Comprehensive loss:                                                                                                                         
|Net
        loss                                                                                                                             |  |                       |  |                    |  |                                                    | 
|Net
        unrealized loss on available-for-sale securities                                                                                 |  |                       |  |                    |  |                                                    | 
|Comprehensive
        loss                                                                                                                   |  |                       |   |                    |  |                                                    |  
|Balance
        at December 31, 2002 (carried forward)                                                                                       |  |                       |  |                    |  | $                                                  | 



See accompanying notes.




43


---



AVIGEN, INC. (a development stage
company)




STATEMENTS OF STOCKHOLDERS EQUITY
(Continued)




Period from October 22, 1992 (inception) through December
31, 2005 (in thousands, except for share information)







|                                                                        |  | Preferred
      Stock |   | Common
      Stock |  | Class
      B
      Convertible
      Common Stock |  
|----------------------------------------------------------------------- |  | --------------------- | - | ------------------ |  | -------------------------------------------------- | -
|
|Balance
        at December 31, 2002 (brought forward)                  |  |                       |  |                    |  | $                                                  | 
|Proceeds
        from exercise of options at $2.12 to $6.50 per share   |  |                       |  |                    |  |                                                    | 
|Proceeds
        from exercise of warrants at $2.47 to $6.09 per share  |  |                       |  |                    |  |                                                    | 
|Compensation
        expense related to options granted for services    |  |                       |  |                    |  |                                                    | 
|Comprehensive loss:                                                    
|Net
        loss                                                        |  |                       |  |                    |  |                                                    | 
|Net
        unrealized loss on available-for-sale securities            |  |                       |  |                    |  |                                                    | 
|Comprehensive
        loss                                              |  |                       |   |                    |  |                                                    |  
|Balance
        at December 31, 2003                                    |  |                       |  |                    |  |                                                    | 
|Proceeds
        from exercise of options at $0.443 to $6.313 per share |  |                       |  |                    |  |                                                    | 
|Proceeds
        from exercise of warrants at $6.05 per share           |  |                       |  |                    |  |                                                    | 
|Compensation
        expense related to options granted for services    |  |                       |  |                    |  |                                                    | 
|Warrants
        granted for patent licenses                            |  |                       |  |                    |  |                                                    | 
|Comprehensive loss:                                                    
|Net
        loss                                                        |  |                       |  |                    |  |                                                    | 
|Net
        unrealized loss on available-for-sale securities            |  |                       |  |                    |  |                                                    | 
|Comprehensive
        loss                                              |  |                       |   |                    |  |                                                    |  
|Balance
        at December 31, 2004                                    |  |                       |  |                    |  |                                                    | 
|Proceeds
        from exercise of options at $0.487 to $3.53 per share  |  |                       |  |                    |  |                                                    | 
|Compensation
        expense related to options granted for services    |  |                       |  |                    |  |                                                    | 
|Comprehensive loss:                                                    
|Net
        loss                                                        |  |                       |  |                    |  |                                                    | 
|Net
        unrealized loss on available-for-sale securities            |  |                       |  |                    |  |                                                    | 
|Comprehensive
        loss                                              |  |                       |   |                    |  |                                                    |  
|Balance
        at December 31, 2005                                    |  |                       |  |                    |  | $                                                  | 



See accompanying notes.




44


---



AVIGEN, INC. (a development stage
company)




STATEMENTS OF CASH FLOWS (in
thousands)







|                                                                                                     |  |  |  | Year Ended December 31, |        
|---------------------------------------------------------------------------------------------------- |  |  |  | ----------------------- | -------
|
|Operating Activities                                                                                
|Net
loss                                                                                             |  |  |  | $                       | (14,696
|Adjustments to reconcile net loss to net cash used in operating activities:                         
|Depreciation
and amortization                                                                        |  |  |  |                         | 2,549  
|Gain on
disposal of property and equipment                                                           |  |  |  |                         | (65    
|Impairment
loss related to long-lived assets                                                         |  |  |  |                         | 6,130  
|Amortization
of deferred compensation                                                                |  |  |  |                         |       
|Non-cash rent
expense for warrants issued in connection with the extension of the building lease     |  |  |  |                         | 217    
|Amortization of
deferred rent                                                                        |  |  |  |                         | 3      
|Non-cash
compensation expense for common stock, warrants, and stock options issued for services      |  |  |  |                         | 13     
|Warrants
issued for patent license                                                                   |  |  |  |                         |       
|Changes in operating assets and liabilities:                                                        
|Accrued
interest                                                                                     |  |  |  |                         | 238    
|Prepaid
expenses and other current assets                                                            |  |  |  |                         | (294   
|Deposits and
other assets                                                                            |  |  |  |                         | (316   
|Accounts
payable, other accrued liabilities and accrued compensation and related expenses            |  |  |  |                         | 167    
|Deferred
revenue                                                                                     |  |  |  |                         |       
|Net cash used
in operating activities                                                                |  |  |  | $                       | (6,054 
|Investing Activities                                                                                
|Purchases of
property and equipment                                                                  |  |  |  |                         | (277   
|Proceeds from
disposal of property and equipment                                                     |  |  |  |                         | 231    
|Decrease
(increase) in restricted investments                                                        |  |  |  |                         | 1,500  
|Purchases of
available-for-sale securities                                                           |  |  |  |                         | (66,475
|Maturities of
available-for-sale securities                                                          |  |  |  |                         | 79,082 
|Net cash
provided by (used in) investing activities                                                  |  |  |  |                         | 14,061 
|Financing Activities                                                                                
|Proceeds from
long-term obligations                                                                  |  |  |  |                         |       
|Repayment of
long-term obligations                                                                   |  |  |  |                         |       
|Proceeds from
bridge financing                                                                       |  |  |  |                         |       
|Repayment of
bridge financing                                                                        |  |  |  |                         |       
|Payments on
capital lease obligations                                                                |  |  |  |                         |       
|Proceeds from
sale-leaseback of equipment                                                            |  |  |  |                         |       
|Proceeds from
issuance preferred stock, net of issuance costs                                        |  |  |  |                         |       
|Proceeds from
warrants and options exercised                                                         |  |  |  |                         | 286    
|Proceeds from
issuance of common stock, net of issuance costs and repurchases                        |  |  |  |                         |       
|Net cash
provided by financing activities                                                            |  |  |  |                         | 286    
|Net increase
(decrease) in cash and cash equivalents                                                 |  |  |  |                         | 8,293  
|Cash and cash
equivalents, beginning of period                                                       |  |  |  |                         | 3,217  
|Cash and cash
equivalents, end of period                                                             |  |  |  | $                       | 11,510 
|Supplemental disclosure                                                                             
|Issuance of
warrants in connection with building lease extension                                     |  |  |  | $                       |       
|Issuance of
preferred stock for cancellation of accounts payable, notes payable and accrued interest |  |  |  |                         |       
|Issuance of
stock options for repayment of certain accrued liabilities                               |  |  |  |                         |       
|Issuance of
warrants in connection with bridge financing                                             |  |  |  |                         |       
|Issuance of
warrants in connection with the extension of the building lease                          |  |  |  |                         |       
|Deferred
compensation related to stock option grants                                                 |  |  |  |                         |       
|Purchase of
property and equipment under capital lease financing                                     |  |  |  |                         |       
|Cash paid for
interest                                                                               |  |  |  | $                       | 323    



See accompanying notes.




45


---



AVIGEN, INC.(a development stage company)NOTES TO
FINANCIAL STATEMENTS


|1. |  | Summary of Significant Accounting Policies
|-- |  | ------------------------------------------



Description of Business and
Basis of Presentation




Avigen, Inc. was incorporated on
October 22, 1992 in Delaware and is focused on developing and commercializing small molecule therapeutics and biologics to treat serious neurological
and neuromuscular disorders. Our current product candidates primarily address neuromuscular spasm and spasticity and neuropathic pain. Since our
inception, our activities have consisted principally of acquiring product rights, raising capital, establishing facilities and performing research and
development. Accordingly, we are considered to be in the development stage. We operate in a single segment.




At December 31, 2005, we had an
accumulated deficit of $171.3 million and expect to continue to incur substantial losses over the next several years while we continue in this
development stage. Our operations are subject to certain risks and uncertainties frequently encountered by companies in the early stages of operations,
particularly in the evolving market for small biotech and specialty pharmaceuticals companies. Such risks and uncertainties include, but are not
limited to, timing and uncertainty of achieving milestones in clinical trials and in obtaining approvals by the FDA and regulatory agencies in other
countries. Our ability to generate revenues in the future will depend substantially the timing and success of reaching development milestones and in
obtaining regulatory approvals and market acceptance of our products, assuming the FDA approves our new drug applications. We plan to meet our future
capital requirements primarily through issuances of equity securities, payments under collaborative agreements with third parties, government grants,
and license fees. We intend to seek additional funding through public or private equity or debt financing, when market conditions allow. There can be
no assurance that we will be able to enter into financing arrangements on acceptable terms in the future, if at all.




Use of
Estimates




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




Cash and Cash
Equivalents




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




Available-for-Sale
Securities




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




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




46


---



AVIGEN, INC.(a development stage company)NOTES TO
FINANCIAL STATEMENTS  (Continued)




Fair value of financial
instruments




The fair value of our cash
equivalents and available-for-sale securities is based on quoted market prices. The fair value of our loans payable is based on current interest rates
available to us for debt instruments with similar terms, degrees of risk, and remaining maturities. The carrying amount of our cash equivalents,
available-for-sale securities and loan payable are considered to be representative of their respective fair value at December 31, 2005 and
2004.




Restricted
Investments




In June 2000, we initially
entered into a financing arrangement to support construction related activities. Under this arrangement, we have pledged $10.0 million of our portfolio
of available-for-sale securities to secure this long-term obligation.




In January 2002, we also entered
into equipment operating leases for certain research and development equipment. Under the terms of these leases, we pledged $1.5 million of our
portfolio of available-for-sale securities to secure these equipment operating leases. These leases were terminated in December 2005 and the associated
pledge removed.




In May 2003, we secured two
letters of credit to serve as security deposits in connection with a building lease that became effective July 1, 2003. This building lease was
executed in February 2000 and replaced our previous building lease and sublease on the same premises that expired June 30, 2003 under the original
terms of the agreements. Under the terms of these letters of credit, we have pledged $428,000 of our portfolio of available-for-sale securities to
secure these letters of credit.




At December 31, 2005 and 2004,
$10.4 million and $11.9 million, respectively, were classified as restricted investments in long term assets, representing the combined aggregate
portion of our portfolio of available-for-sale securities that were pledged in connection with these long-term liabilities.




Concentration of Credit
Risk




Cash, cash equivalents,
available-for-sale securities and restricted investments consist of financial instruments that potentially subject us to concentrations of credit risk
to the extent of the value of the assets recorded on the balance sheet. We believe that we have established guidelines for investment of our excess
cash that maintain safety and liquidity through our policies on diversification among asset classes and issuers, as well as across investment
maturities.




Impairment of Long-Lived
Assets




All long-lived assets are
reviewed for potential impairment whenever events or changes in business circumstances indicate that the carrying value of an asset may not be fully
recoverable under Statement of Financial Account Standards No. 144 Accounting for Impairment or Disposal of Long-Lived Assets. Impairment
is determined by comparing future projected undiscounted cash flows to be generated by the asset to its carrying value. If impairment is identified, a
loss would be recognized and reflected in net loss to the extent that the carrying amount of the asset exceeds its estimated fair value determined by
discounted cash flow analyses or comparable fair valued or similar assets.




Property and
Equipment




Property and equipment are stated
at cost, less accumulated depreciation. Depreciation and amortization are provided using the straight-line method over the estimated useful lives of
the respective assets, or in the case of leasehold improvements, over the lesser of the estimated useful lives or the remaining lease terms. The
estimated useful lives of our property and equipment range from three to seven years.




47


---



AVIGEN, INC.(a development stage company)NOTES TO
FINANCIAL STATEMENTS  (Continued)




Expenses for repairs and
maintenance are charged to operations as incurred. Upon retirement, disposition, or sale, the cost of the property and equipment disposed of and the
related accumulated depreciation are deducted from the accounts, and any resulting gain or loss is credited or charged to operations.




Revenue
Recognition




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




Revenues from the License or
Assignment of Intellectual Property Rights




We recognize non-refundable
license or assignment fees, including development milestone payments associated with license or assignment agreements, for which we have no further
significant performance obligations and no continuing involvement requirements related to product development, on the earlier of the dates on when the
payments are received or when collection is assured.




Revenues from Collaborative
Research and Development Agreements




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




Royalty Revenues




We record royalty revenue from
license agreements as earned in accordance with the contract terms when third-party results can be reliably determined and collectibility is reasonably
assured. We have recorded approximately $38,000 in royalty revenue since our inception in connection with sales from a third party of products that
utilize our gene therapy technologies. These products were sold for research purposes only and were primarily sold within the U.S. As of December 31,
2005, we no longer were directly entitled to collect royalty revenue on these products under the license agreements under which we previously collected
them. This is because we have assigned our rights under those agreements to Genzyme. However, we may be entitled to collect from Genzyme sublicensing
fees and royalties on these products potentially at different or lower rates than we previously collected as a party to the third-party
licenses.




Grant Revenue




We record grant revenue in the
period in which the revenue is earned as defined by the grant agreement. Since our inception, we have recognized approximately $690,000 of grant
revenue, which includes amounts earned pursuant to reimbursements under government grants, of which all have come from the National Institutes of
Health.




48


---



AVIGEN, INC.(a development stage company)NOTES TO
FINANCIAL STATEMENTS  (Continued)




Deferred
Rent




We record our obligations under
facility operating lease agreements as rent expense. We recognize rent expense on a straight-line basis over the term of the operating lease. The
difference in actual amounts paid and amounts recorded as rent expense during the fiscal year has been recorded as deferred rent. Amounts classified as
deferred rent totaled $1.1 million at both December 31, 2005 and 2004.




Comprehensive
Loss




Components of other comprehensive
loss, including unrealized gains and losses on available-for-sale investments, were included as part of total comprehensive loss. For all periods
presented, we have disclosed comprehensive loss in the statement of stockholders equity.




Research and Development
Expenses




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




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




Income
Taxes




Income taxes are accounted for in
accordance with FAS 109, Accounting for Income Taxes, which requires the use of the liability method. Deferred tax assets and liabilities are
provided for temporary differences between the financial reporting and the tax bases of existing assets and liabilities. To date, we have no history of
earnings. Therefore, our net deferred tax assets are reduced by a valuation allowance to the extent that realization of the related deferred tax asset
is not assured. We have recorded a valuation allowance for the full amount of our calculated deferred tax asset as of December 31, 2005 and
2004.




Basic and Diluted Net Loss Per
Common Share




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




49


---



AVIGEN, INC.(a development stage company)NOTES TO
FINANCIAL STATEMENTS  (Continued)




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


|                                                                                          |  |  |  | Year Ended December 31, |          
|----------------------------------------------------------------------------------------- |  |  |  | ----------------------- | ---------
|
|Potential
dilutive stock options outstanding                                              |  |  |  |                         | 273,667  
|Outstanding
securities excluded from the potential dilutive common shares calculation (1) |  |  |  |                         | 3,756,850






|(1) |  | For purposes of computing the potential dilutive common shares,
we have excluded outstanding stock options and warrants to purchase common stock whose exercise prices exceed the average of the closing sale prices of
our common stock as reported on the NASDAQ National Market for the period.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



New Accounting
Pronouncements




In May 2005, the FASB issued FASB
Statement No. 154, (FAS 154), Accounting Changes and Error Corrections. FAS 154 establishes retrospective application as the
required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to the newly adopted
accounting principle. FAS 154 also provides guidance for determining whether retrospective application of a change in accounting principle is
impracticable and for reporting a change when retrospective application is impracticable. FAS 154 becomes effective for accounting changes and
corrections of errors made in fiscal years beginning after December 15, 2005. We do not expect the adoption of FAS 154 to have a material impact on our
financial position, cash flows or results of operations.




In December 2004, the FASB issued
FASB Statement No. 123(R), (FAS 123(R)), Share-Based Payment, which is a revision of FASB Statement No. 123 (FAS
123), Accounting for Stock-Based Compensation. FAS 123(R) supercedes APB Opinion No. 25, (APB 25), Accounting for
Stock Issued to Employees, and amends FASB Statement No. 95, Statement of Cash Flows. FAS 123(R) requires all share-based
payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values at the date
of grant and to record that cost as compensation expense over the period during which the employee is required to perform service in exchange for the
award (generally over the vesting period of the award). Excess tax benefits, as defined by FAS 123(R), will be recognized as an addition to common
stock. In April 2005, the SEC adopted a new rule that amends the compliance dates for FAS 123(R). In accordance with the new rule, we are required to
implement FAS 123(R) at the beginning of our fiscal year that begins January 1, 2006. The Commissions new rule does not change the accounting
required by FAS 123(R); it changes only the dates of compliance.




In November 2005, the FASB issued
FASB Staff Position No. FAS 123(R)-3, Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards. The
alternative transition method includes simplified methods to establish the beginning balance of the additional paid-in capital pool (APIC
pool) related to the tax effects of employee share-based compensation, and to determine the subsequent impact on the APIC pool and consolidated
statements of cash flows of the tax effects of employee share-based compensation awards that are outstanding upon adoption of SFAS 123(R). An entity
may make a one-time election to adopt the transition method described in this guidance and may take up to one year from the later of its initial
adoption of SFAS 123(R) or the effective date of this guidance, which was November 11, 2005. We are in the process of determining whether to adopt the
alternative transition method provided in FAS 123(R)-3 for calculating the tax effects of share-based compensation pursuant to SFAS
123(R).




50


---



AVIGEN, INC.(a development stage company)NOTES TO
FINANCIAL STATEMENTS  (Continued)




Effective January 1, 2006, we
will adopt FAS 123(R) using the modified prospective transition method, which provides for certain changes to the method for valuing share-based
compensation. The valuation provisions of FAS 123(R) apply to new awards and to awards that are outstanding at the effective date and subsequently
modified or cancelled. Estimated compensation expense for awards outstanding at January 1, 2006 will be recognized over the remaining service period
using the compensation cost calculated for pro forma disclosure purposes under FAS 123. In accordance with the modified prospective transition method,
our statements of operations for periods prior to January 1, 2006 will not be restated to reflect the impact of FAS 123(R).




Our calculation of share-based
compensation expense in future periods will be calculated using the Black-Scholes option valuation model and will include the portion of share-based
payment awards that is ultimately expected to vest during the period and therefore will be adjusted to reflect estimated forfeitures. SFAS 123(R)
requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those
estimates. In our pro forma information required under SFAS 123 for the periods prior to 2006, we accounted for forfeitures as they occurred. For share
awards granted after January 1, 2006, expenses will be amortized under the straight-line attribution method. For share awards granted prior to 2006,
expenses are amortized under the straight-line single option method prescribed by SFAS 123. We expect that our adoption of FAS 123(R) in 2006 will have
a material impact on our results of operations and net loss per share.




Stock-Based
Compensation




Until FAS 123(R) becomes
effective for Avigen on January 1, 2006, we choose to continue to account for stock options granted to our employees and directors in accordance with
APB Opinion 25, Accounting for Stock Issued to Employees (APB 25) and related interpretations. Under APB 25, when the exercise price of our
employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized.




The information regarding net
loss and loss per common share as required by FAS 123 has been determined as if we had accounted for our employee stock options under the fair value
method prescribed by FAS 123. The resulting effect on net loss and loss per common share pursuant to FAS 123 is not likely to be representative of the
effects on net loss and loss per common share pursuant to FAS 123 in future years, because future years are likely to include additional grants and
because of the variable impact of future years vesting.




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







|                                                                                                                  |  |  |  | Year Ended December 31, |        
|----------------------------------------------------------------------------------------------------------------- |  |  |  | ----------------------- | -------
|
|Net loss
 as reported                                                                                            |  |  |  | $                       | (14,696
|Add:
Stock-based employee compensation included in reported net loss                                              |  |  |  |                         |       
|Less: Total
stock-based employee compensation expense determined under the fair-value-based method for all awards |  |  |  |                         | (2,219 
|Net loss
 pro forma                                                                                              |  |  |  | $                       | (16,915
|Net loss per
common share basic and diluted  as reported                                                         |  |  |  | $                       | (0.71  
|Net loss per
common share basic and diluted  pro forma                                                           |  |  |  | $                       | (0.82  



51


---



AVIGEN, INC.(a development stage company)NOTES TO
FINANCIAL STATEMENTS  (Continued)




For purposes of disclosure
pursuant to FAS 123, as amended by FAS 148, the estimated fair value of our employee stock options is amortized to expense on a straight-line basis
over the vesting period of the options, generally over four years. We use the Black-Scholes option valuation model to estimate the fair value of our
options on the date of grant. Options that were granted during the years ended December 31, 2005, 2004 and 2003 were valued with the following weighted
average assumptions:







|                                  |  |  |  | Year Ended December 31, |       
|--------------------------------- |  |  |  | ----------------------- | ------
|
|Expected
volatility               |  |  |  |                         | 0.6670
|Risk free
interest rate           |  |  |  |                         | 4.05  
|Expected life
of options in years |  |  |  |                         | 4.5   
|Expected
dividend yield           |  |  |  |                         |      



The Black-Scholes option
valuation model was developed for use in estimating the fair value of traded options and warrants that have no vesting restrictions and are fully
transferable. In addition, option valuation models, including Black-Scholes, require the input of highly subjective assumptions, including the expected
stock price volatility. Because our stock options and warrants are not traded, they have characteristics significantly different from those of traded
options and warrants, and because changes in the subjective input assumptions can materially affect the fair value estimate, in our opinion, the
existing option valuation models, including Black-Scholes, do not necessarily provide a reliable single measure of the fair value of our stock options
and warrants.




Our employee stock options are
granted at a price equal to the fair market value of our stock on the date of the grant. The weighted-average estimated fair values of stock options
granted during the fiscal years ended December 31, 2005, 2004, and 2003 as calculated using the Black-Scholes option pricing model were $1.80, $2.63,
and $2.60, respectively.




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


|2. |  | Cash, Available-for-Sale Securities and Restricted
Investments
|-- |  | --------------------------------------------------------------



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







|                                  |  |  |  | Cost |        | Gross Unrealized Gains |  | Gross Unrealized Losses |   | Fair Value
|--------------------------------- |  |  |  | ---- | ------ | ---------------------- |  | ----------------------- | - | ----------
|Cash                              |  |  |  | $    | 11,510 |                        |  | $                       |  |           
|Corporate
debt securities         |  |  |  |      | 21,415 |                        |  |                         |  |           
|Federal
agency obligations        |  |  |  |      | 26,013 |                        |  |                         |  |           
|Asset-backed
and other securities |  |  |  |      | 9,882  |                        |  |                         | 5 |           
|Treasury
obligations              |  |  |  |      | 2,108  |                        |  |                         |  |           
|Total                             |  |  |  | $    | 70,928 |                        |  | $                       | 5 |           
|Amounts reported as:             
|Cash and cash
equivalents         |  |  |  | $    | 11,510 |                        |  | $                       |  |           
|Restricted
investments            |  |  |  |      | 10,428 |                        |  |                         |  |           
|Available for
sale securities     |  |  |  |      | 48,990 |                        |  |                         | 5 |           
|Total                             |  |  |  | $    | 70,928 |                        |  | $                       | 5 |           



52


---



AVIGEN, INC.(a development stage company)NOTES TO
FINANCIAL STATEMENTS  (Continued)




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




The following is a summary of
cash, restricted investments, and available-for-sale securities as of December 31, 2004 (in thousands):


|                                  |  |  |  | Cost |        | Gross Unrealized Gains |  | Gross Unrealized Losses |   | Fair Value
|--------------------------------- |  |  |  | ---- | ------ | ---------------------- |  | ----------------------- | - | ----------
|Cash                              |  |  |  | $    | 3,217  |                        |  | $                       |  |           
|Corporate
debt securities         |  |  |  |      | 33,438 |                        |  |                         | 1 |           
|Federal
agency obligations        |  |  |  |      | 27,362 |                        |  |                         |  |           
|Asset-backed
and other securities |  |  |  |      | 3,200  |                        |  |                         |  |           
|Auction rate
certificates         |  |  |  |      | 3,350  |                        |  |                         |  |           
|Treasury
obligations              |  |  |  |      | 6,176  |                        |  |                         |  |           
|Total                             |  |  |  | $    | 76,743 |                        |  | $                       | 1 |           
|Amounts reported as:             
|Cash and cash
equivalents         |  |  |  | $    | 3,217  |                        |  | $                       |  |           
|Restricted
investments            |  |  |  |      | 11,928 |                        |  |                         |  |           
|Available-for-sale securities     |  |  |  |      | 61,598 |                        |  |                         | 1 |           
|Total                             |  |  |  | $    | 76,743 |                        |  | $                       | 1 |           



The weighted average maturity of
our investment portfolio at December 31, 2004 was 354 days, with $42.7 million carrying an effective maturity of less than twelve months, and $33.5
million carrying an effective maturity between one and three years.




Net realized loss was
approximately $32,000 for the year ended December 31, 2005, and net realized gains were $119,000, and $444,000 for the years ended December 31, 2004
and 2003, respectively.




At December 31, 2005 and 2004, we
had the following available-for-sale securities that were in a continuous unrealized loss position but were not deemed to be other-than-temporarily
impaired (in thousands):







|                                  |  |  |  | Less Than 12 Months |      | 12 Months or Greater | 
|--------------------------------- |  |  |  | ------------------- | ---- | -------------------- | 
|
|December
31, 2005                 |  |  |  |                     |      |                      | 
|Corporate
debt securities         |  |  |  | $                   | (108 | )                    | 
|Federal
agency obligations        |  |  |  |                     | (101 | )                    | 
|Asset-backed
and other securities |  |  |  |                     | (4   | )                    | 
|Treasury
obligations              |  |  |  |                     | (8   | )                    | 
|Total                             |  |  |  | $                   | (221 | )                    | 






|                                  |  |  |  | Less Than 12 Months |      | 12 Months or Greater | 
|--------------------------------- |  |  |  | ------------------- | ---- | -------------------- | 
|
|December
31, 2004                 |  |  |  |                     |      |                      | 
|Corporate
debt securities         |  |  |  | $                   | (96  | )                    | 
|Federal
agency obligations        |  |  |  |                     | (50  | )                    | 
|Asset-backed
and other securities |  |  |  |                     | (34  | )                    | 
|Treasury
obligations              |  |  |  |                     | (25  | )                    | 
|Total                             |  |  |  | $                   | (205 | )                    | 



53


---



AVIGEN, INC.(a development stage company)NOTES TO
FINANCIAL STATEMENTS  (Continued)




The gross unrealized losses
reported above for 2005 and 2004 were caused by rises in market interest rates during those periods. No significant facts or circumstances have
occurred to indicate that these unrealized losses are related to any deterioration in the creditworthiness of the issuers of the marketable securities
we own. Based on our review of these securities, including our assessment of the duration and severity of the related unrealized losses, we have not
recorded any other-than-temporary impairments on these investments.


|3. |  | Property and Equipment
|-- |  | ----------------------



Property and equipment consist of
the following (in thousands):


|                                               |  |  |  | December 31, |       
|---------------------------------------------- |  |  |  | ------------ | ------
|
|Leasehold
improvements                         |  |  |  | $            | 6,742 
|Laboratory
equipment                           |  |  |  |              | 1,551 
|Office furniture
and equipment                 |  |  |  |              | 1,702 
|                                               |  |  |  |              | 9,995 
|Less accumulated
depreciation and amortization |  |  |  |              | (6,066
|Property and
equipment, net                    |  |  |  | $            | 3,929 



Total depreciation and
amortization expense for the years ended December 31, 2005, 2004 and 2003, was $2.5 million, $3.6 million, and $3.6 million, respectively. For the year
ended December 31, 2005, the decreases in the balances of leasehold improvements, laboratory equipment, and office furniture and equipment reflect
reductions in our cost basis for these long-lived assets due to impairment charges recorded during the year of $11.7 million, $5.4 million, and
$260,000, respectively. Similarly, for the year ended December 31, 2005, accumulated depreciation was reduced by $11.2 million, primarily in connection
with the recognition of the impairment charges.


|4. |  | Impairment Loss related to Long-Lived Assets
|-- |  | --------------------------------------------



During 2005, we took steps to
discontinue funding of our AAV-based programs in order to focus our development efforts and financial resources on our non-gene therapy product
candidates. As a result, we determined that our future operations would not require the full capacity of our currently leased facilities. Therefore, at
June 30, 2005, we evaluated the ongoing value of the leasehold improvements and equipment associated with approximately 40,000 square feet of
manufacturing, laboratory, and office space, which we have under lease through July 2008. In September 2005, we took additional steps to consolidate
our operations in order to sublease additional portions of our leased facilities. As a result, at September 30, 2005, we evaluated the ongoing value of
the leasehold improvements associated with 11,000 square feet of manufacturing, laboratory, and office space we have under lease through November
2010.




Based on these evaluations, we
determined that long-lived assets with a net carrying value of $6.1 million were no longer recoverable and were in fact impaired. For the year ended
December 31, 2005, we recorded an impairment loss related to long-lived assets in the facilities and wrote down the related carrying value of the
leasehold improvements, laboratory and office equipment and furniture to approximate their estimated fair value.




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




54


---



AVIGEN, INC.(a development stage company)NOTES TO
FINANCIAL STATEMENTS  (Continued)


|5. |  | Termination Costs Associated with Exit
Activities
|-- |  | -------------------------------------------------



In August 2005, we took steps to
reduce our research and development spending attributable to gene therapy activities. As a result, we reduced the level of our total staff by
approximately 19 positions, primarily in research and development. This action qualified as an exit activity under FAS 146, Costs Associated with
Exit or Disposal Activities. In connection with this reduction in staff, we incurred approximately $646,000 in severance and other
termination-related benefits. Approximately $624,000 of the costs associated with the workforce reduction are included in research and development
expenses and approximately $22,000 are included in general and administrative expenses for year ended December 31, 2005. At December 31, 2005,
approximately $25,000 was unpaid and included on our balance sheet under accrued compensation and related expenses. These accrued amounts primarily
represent deferred severance payments and extended health care benefits for certain impacted employees. We do not expect to incur any additional costs
associated with the workforce reduction.


|6. |  | Collaboration Agreement  Bayer
Corporation
|-- |  | -------------------------------------------



In March 2003, we received a $2.5
million payment from Bayer Corporation under the terms of a collaboration agreement for the development of an AAV-based gene therapy product for
hemophilia. This amount was recorded as deferred revenue and was being recognized as revenue ratably at approximately $125,000 per quarter over the
estimated development period for this product, which was determined to be five years. In May 2004, we suspended subject enrollment in the phase I
clinical trial, which resulted in the termination of the development of the product candidate associated with the Bayer payment. As a result, we
accelerated the recognition of the remaining $2.0 million of deferred revenue in our statements of operations during the year ended December 31,
2004.


|7. |  | AAV Gene Therapy Assignment Agreement  Genzyme
Corporation
|-- |  | -----------------------------------------------------------



In December 2005, we entered into
an agreement with Genzyme Corporation which included the assignment of certain of our intellectual property to previously developed gene therapy
technologies, rights to our gene therapy clinical trial programs for Parkinsons disease and hemophilia, and certain clinical-grade materials,
subject to the potential reversion to us of specified rights under specified conditions. Under the terms of the agreement, we received a $12 million
initial payment and could receive significant additional development-based milestone, sublicensing fees and royalty payments. The initial payment was
non-refundable and as of December 31, 2005, and Avigen did not have any significant performance obligations associated with the agreement. Because we
could receive significant future cash flows in connection with this agreement, if Genzyme is successful in developing products using patents included
in the agreement, we have not accounted for this transaction as discontinued operations. As such, we recognized the entire initial payment as revenue
in 2005 and expect that any future payments we receive under the terms of the agreement will also be recorded as revenue.


|8. |  | Loan Payable
|-- |  | ------------



In June 2000, we entered into a
financing arrangement to support construction related activities. Under this arrangement, we had the right to borrow up to $10.0 million through June
1, 2003. This revolving line of credit was amended in June 2002 to extend the expiration date to June 1, 2005, and amended again in June 2004 to extend
the expiration date to June 1, 2007. Accordingly, the loan continues to be classified as long term. Amounts borrowed under this arrangement bear
interest at the London Inter-Bank Offered Rate plus a margin adjustment that varies between 0.5% and 1.0% on the date of each drawdown based on the
market value of our investment portfolio held with a subsidiary of Wells Fargo. This interest rate is subsequently reset every three months. The
weighted average interest rate for all outstanding drawdowns on this long-term obligation was 4.97% and 2.70% at December 31, 2005 and 2004,
respectively. We have pledged a portion of our portfolio of available-for-sale securities equal to the amount of outstanding borrowings to secure this
long-term obligation, and have identified these pledged assets as restricted investments on our balance sheets. As of both December 31, 2005 and 2004,
we had borrowed $8.0 million from the line of credit. Payments of interest only are due monthly through June 1, 2007, at which time a balloon payment
of outstanding principal is due. In November 2000, we reserved $2.0 million in borrowing




55


---



AVIGEN, INC.(a development stage company)NOTES TO
FINANCIAL STATEMENTS  (Continued)




capacity from the line of
credit to secure a letter of credit. The letter of credit was established pursuant to the terms required under a ten-year property lease entered into
in November 2000, and was issued in favor of the property owner. As a result of the cash borrowings and the establishment of the letter of credit, we
did not have any remaining borrowing capacity under the line of credit at December 31, 2005.


|9. |  | Stockholders Equity
|-- |  | --------------------



Common
Stock




In August and September 1998, we
issued an aggregate of 1,306,505 shares of our common stock at $2.25 to $2.94 per share to selected institutional investors. The offering was completed
through a private placement. As part of the transaction, we issued warrants to purchase 261,301 shares of our common stock with an exercise price of
$2.18 to $3.67 per share. The exercise price was 125% of the fair market value per share of our underlying stock on the corresponding closing day and
the warrants carry a five-year term. After deducting commissions and fees from the gross proceeds of $2,969,000, net proceeds from this transaction
approximated $2,735,000.




In December 1998, we issued
1,367,280 shares of our common stock at $3.81 to $4.88 per share to selected institutional investors. The offering was completed through a private
placement. As part of this transaction, we issued warrants to purchase 273,456 shares of our common stock with an exercise price ranging from $4.76 to
$6.09 per share. The exercise price was 125% of the fair market value per share of our underlying stock on the corresponding closing day and the
warrants carry a five-year term. After deducting commissions and fees from the gross proceeds of $5,635,000, net proceeds from this transaction
approximated $5,197,000.




In February and April 1999, we
issued an aggregate of 2,198,210 shares of our common stock at $5.50 to $6.00 per share to selected institutional investors. The offering was completed
through a private placement. As part of this transaction, we issued warrants to purchase 439,642 shares of our common stock with an exercise price of
$6.87 to $7.50 per share. The exercise price was 125% of the fair market value per share of the underlying stock on the corresponding closing day and
the warrants carry a five-year term. After deducting commissions and fees from the gross proceeds of $13,189,000, net proceeds from this transaction
approximated $12,156,000.




In October and November 1999, we
issued an aggregate of 2,033,895 shares of our common stock at $16.19 to $25.56 per share to selected institutional investors. The offering was
completed through a private placement. As part of this transaction, we issued warrants to purchase 406,779 shares of our common stock with an exercise
price of $20.25 to $31.95 per share. The exercise price was 125% of the fair market value per share of our underlying stock on the corresponding
closing day and the warrants carry a five-year term. After deducting commissions and fees from the gross proceeds of $40,028,000, net proceeds from
this transaction approximated $37,222,000.




In March 2000, we issued a
warrant to purchase 40,000 shares of our common stock as partial consideration for the extension of our building lease. The fair value of this warrant
at the date of issuance was approximately $1,738,000. This fair value is being amortized over the life of the lease extension, or May 2008. This
warrant was issued with an exercise price equal to the fair market value per share of our underlying stock at the time of issuance, or $56.00, and
carried a five-year term. In March 2005, this warrant expired unexercised.




Also, in March 2000, we issued a
warrant to purchase 50,000 shares of our common stock as partial consideration for the acquisition of certain patent licenses previously used in our
gene therapy-related research and development activities. The fair value of this warrant at the date of issuance was approximately $3,182,000 and was
fully expensed in the year ended June 30, 2000. This warrant was issued with an exercise price equal to the fair market value per share of our
underlying stock at the time of issuance, or $82.00, and carried a five-year term. In March 2005, this warrant expired unexercised.




56


---



AVIGEN, INC.(a development stage company)NOTES TO
FINANCIAL STATEMENTS  (Continued)




In April and May 2000, we issued
an aggregate of 1,150,000 shares of our common stock at $26.00 per share through a public offering. After deducting commissions and fees from the gross
proceeds of $29,900,000, net proceeds from this transaction totaled $27,611,000.




In November 2000, we issued an
aggregate of 2,291,239 shares of our common stock between $37.50 and $45.06 per share through a public offering. After deducting combined commissions
and fees from the gross proceeds of $90,706,000, net proceeds from this transaction totaled $86,086,000.




In February 2001, we issued
313,636 shares of common stock at $47.82 per share to Bayer AG, in connection with a collaboration agreement entered into with Bayer Corporation dated
November 17, 2000. Net proceeds from this transaction totaled $15,000,000.




In March 2004, we issued a
warrant to purchase 15,000 shares of our common stock as partial consideration for the acquisition of certain intellectual property rights used in our
research and development activities. The fair value of this warrant was approximately $97,000 when we entered into the corresponding license agreement
in October 2003. The fair value of the warrant was fully expensed and recorded in accounts payable and other accrued liabilities as of December 31,
2003. Upon issuance, the fair value of the warrant was reclassified to additional paid in capital for the year ended December 31, 2004. This warrant
was issued with an exercise price equal to the fair market value per share of our underlying stock at the time of issuance, or $6.50, and carries a
ten-year term. At December 31, 2005, this was the only issued warrant Avigen had that was outstanding.




During the year ended December
31, 2005, we received $286,000 in cash proceeds related to the exercise of stock options for 526,023 shares of common stock.




Shares Reserved for Future
Issuance




We have reserved shares of our
common stock for future issuance as follows:







|                                                  |  |  |  | December 31, 2005
|------------------------------------------------- |  |  |  | -----------------
|Stock options
outstanding                         |  |  |  |                  
|Stock options
available for grant                 |  |  |  |                  
|Warrants to
purchase common stock                 |  |  |  |                  
|Shares
available for Employee Stock Purchase Plan |  |  |  |                  
|                                                  |  |  |  |                  

|10. |  | Stock Options and Stock Purchase Plan
|--- |  | -------------------------------------



Employee Stock Option
Plans




Under the 1993 Stock Option Plan
(the 1993 Plan), prior to March 1996, incentive and nonqualified stock options could be granted to our key employees, directors and
consultants to purchase up to 1,500,000 shares of common stock. Under the 1993 Plan, options could be granted at a price per share not less than the
fair market value at the date of grant. In March 1996, the Board determined to grant no further options under the 1993 Plan and adopted the 1996 Equity
Incentive Plan. At December 31, 2005, there were options to purchase 24,458 shares outstanding under the 1993 Plan, with no further shares available
for grant. These options were scheduled to expire in February 2006.




The 1996 Equity Incentive Plan
(1996 Plan) provides for grants of incentive and nonqualified stock options, restricted stock purchase awards, stock bonuses and stock
appreciation rights to our employees, directors and consultants. The Plan originally authorized the grant of options to purchase up to 600,000 shares
of common stock. As a result of a series of amendments which were approved by stockholders, prior to December 31, 2005, there




57


---



AVIGEN, INC.(a development stage company)NOTES TO
FINANCIAL STATEMENTS  (Continued)




were 3,500,000 shares
authorized for grant under the 1996 Plan. Under the 1996 Plan, incentive stock options may be granted at a price per share not less than the fair
market value at the date of grant, and nonqualified stock options may be granted at a price per share not less than 85% of the fair market value at the
date of grant. Options granted generally have a maximum term of 10 years from the grant date and become exercisable over four years. At December 31,
2005, there were options to purchase 1,213,161 shares outstanding under the 1996 Plan and 1,537,137 shares available for grant. This Plan is scheduled
to expire in March 2006. At that time, the Plan would no longer have any options available for future grant.




In June 2000, the Board of
Directors adopted the 2000 Equity Incentive Plan (2000 Plan) which provides for grants of nonqualified stock options, restricted stock
purchase awards, and stock bonuses to our employees, directors and consultants to purchase up to 5,000,000 shares of common stock; provided, however,
that generally only up to 40% of the shares subject to grants under the 2000 Plan may be made to our directors and officers. Under the 2000 Plan,
options may be granted at a price per share not less than 85% of the fair market value at the date of grant. Options granted generally have a maximum
term of 10 years from the grant date and become exercisable over four years. At December 31, 2005, there were options to purchase 1,967,252 shares
outstanding under the 2000 Plan and 3,018,792 shares available for grant.




Employee Stock Purchase
Plan




In September 1997, we adopted the
1997 Employee Stock Purchase Plan (Purchase Plan). A total of 360,000 shares of our common stock have been reserved for issuance under the
Purchase Plan. As of December 31, 2005, there have been no employee contributions to the Purchase Plan.




Non-employee Stock
Options




In July 1995, we granted the
Chairman of our Board of Directors an option to purchase 515,248 shares of our common stock at $0.49 per share, exercisable for 10 years from the date
of grant. Such grant was made outside of any of our stock option plans. In July 2005, the option was fully exercised and was no longer
outstanding.




The 1996 Non-Employee
Directors Stock Option Plan (the Directors Plan) provides for automatic grants of options to purchase shares of our common
stock to our non-employee directors. The Plan originally authorized the grant of options to purchase up to 200,000 shares of common stock. As a result
of a series of amendments which were approved by stockholders, prior to December 31, 2005, there were 550,000 shares authorized for grant under the
Directors Plan at December 31, 2005. As of December 31, 2005, nonqualified options to purchase approximately 327,383 shares of common stock
between $2.00 and $40.75 per share, exercisable for 10 years from the date of grant, have been granted under the Directors Plan, of which options
to purchase 282,383 shares remained outstanding. At December 31, 2005, there were 242,617 shares available for grant under the Directors Plan.
This Plan is scheduled to expire in March 2006. At that time, the Plan would no longer have any options available for future grant.




58


---



AVIGEN, INC.(a development stage company)NOTES TO
FINANCIAL STATEMENTS  (Continued)




The following table summarizes
option activity with regard to all stock options:







|                                 |  |  |  | Outstanding Options |           
|-------------------------------- |  |  |  | ------------------- | ----------
|
|Outstanding at
December 31, 2002 |  |  |  |                     | 4,144,488 
|Granted                          |  |  |  |                     | 685,800   
|Canceled                         |  |  |  |                     | (404,100  
|Exercised                        |  |  |  |                     | (63,746   
|Outstanding at
December 31, 2003 |  |  |  |                     | 4,362,442 
|Granted                          |  |  |  |                     | 1,111,150 
|Canceled                         |  |  |  |                     | (962,008  
|Exercised                        |  |  |  |                     | (86,856   
|Outstanding at
December 31, 2004 |  |  |  |                     | 4,424,728 
|Granted                          |  |  |  |                     | 658,366   
|Canceled                         |  |  |  |                     | (1,069,817
|Exercised                        |  |  |  |                     | (526,023  
|Outstanding at
December 31, 2005 |  |  |  |                     | 3,487,254 



The following table summarizes
information with regard to total stock options outstanding under all stock option plans at December 31, 2005:







|                |  |  |  | Options Outstanding |           | Options Exercisable | 
|--------------- |  |  |  | ------------------- | --------- | ------------------- | 
|
|$ 0.71
 $ 3.13 |  |  |  |                     | 469,633   |                     | 
|3.14    3.31   |  |  |  |                     | 180,929   |                     | 
|3.38    3.38   |  |  |  |                     | 365,625   |                     | 
|3.45    3.53   |  |  |  |                     | 458,362   |                     | 
|3.63    6.00   |  |  |  |                     | 362,950   |                     | 
|6.16    8.53   |  |  |  |                     | 459,249   |                     | 
|8.88   14.36   |  |  |  |                     | 124,374   |                     | 
|14.63
  14.63  |  |  |  |                     | 496,632   |                     | 
|15.44
  38.19  |  |  |  |                     | 527,000   |                     | 
|40.75
  47.63  |  |  |  |                     | 42,500    |                     | 
|$ 0.71
 $47.63 |  |  |  |                     | 3,487,254 |                     | 



The numbers of options
exercisable at December 31, 2004 and 2003 were 2,720,885 and 2,787,690, respectively, with a weighted average exercise price of $13.32 and $14.28,
respectively.




In August 2005, in connection
with the resignation of an executive, we modified the expiration terms for options representing 107,500 shares of common stock, but did not extend the
maximum contractual term. At the time of this modification, there was no intrinsic value as the exercise price for these stock options exceeded the
market price. As a result, we did not record any compensation expense in connection with the modification. At December 31, 2005, these options expired
unexercised.




59


---



AVIGEN, INC.(a development stage company)NOTES TO
FINANCIAL STATEMENTS  (Continued)




In March 2004, in connection with
the resignation of an executive, we modified the vesting and expiration terms for options representing 473,000 shares of common stock, but did not
extend the maximum contractual term. These modifications resulted in the recognition of $220,000 in non-cash compensation expense during
2004.




In February 2003, in connection
with the resignation of two executives, we modified the vesting and expiration terms for options representing 276,872 shares of common stock, but did
not extend the maximum contractual term. These modifications resulted in the recognition of $28,000 in non-cash compensation expense during
2003.


|11. |  | Employee Profit Sharing/401(k) Plan
|--- |  | -----------------------------------



In January 1996, we adopted a Tax
Deferred Savings Plan under Section 401(k) of the Internal Revenue Code (the Plan) for all full-time employees. Under the Plan, our
eligible employees can contribute amounts to the Plan via payroll withholding, subject to certain limitations. Our matching contributions to the Plan
are discretionary and can only be made in cash. Effective July 1, 2001, we began matching 25% of an employees contributions up to $2,500 per Plan
year. These matching contributions vest ratably over a five-year period based on the employees initial hire date. Our matching contributions for
all employees for the years ended December 31, 2005, 2004 and 2003 were approximately $76,000, $100,000 and $112,000, respectively.


|12. |  | Commitments and Sublease Accounting
|--- |  | -----------------------------------



We lease an aggregate of 112,000
square feet of laboratory, manufacturing, and office facilities from two adjacent buildings in Alameda, California under two non-cancelable operating
lease agreements which expire in May 2008 and November 2010. Our lease for 45,000 square feet from one building which expires in May 2008, contains an
extension option for five years under the same terms and conditions as the original lease agreement. As security for performance of future obligations
under these leases, we have pledged $2.4 million of our available-for-sale securities to secure letters of credit that serve as deposits. These amounts
are classified as restricted investments in our balance sheets.




As of December 31, 2005,
approximately 26,250 square feet of our aggregate facilities is subleased to two separate corporate tenants not affiliated with Avigen. The sublease
agreements run concurrent with the respective duration of our underlying lease term on each building.




At December 31, 2005, our future
minimum commitments under non-cancelable facilities operating leases, net of sublease income, are a follows (in thousands):


|                         |  |  |  | Minimum Lease Commitments |        | Sublease Income |  | Net Lease Commitments
|------------------------ |  |  |  | ------------------------- | ------ | --------------- |  | ---------------------
|Year ending December 31:
|2006                     |  |  |  | $                         | 2,437  |                 |  | $                    
|2007                     |  |  |  |                           | 2,543  |                 |  |                      
|2008                     |  |  |  |                           | 2,007  |                 |  |                      
|2009                     |  |  |  |                           | 1,624  |                 |  |                      
|2010 and
thereafter      |  |  |  |                           | 1,542  |                 |  |                      
|Total                    |  |  |  | $                         | 10,153 |                 |  | $                    



Expenses and income associated
with operating leases and subleases were as follows (in millions):







|                     |  |  |  | Year Ended December 31, |     
|-------------------- |  |  |  | ----------------------- | ----
|
|Rent
Expense         |  |  |  | $                       | 2.6 
|Sublease
income, net |  |  |  |                         | (0.1



60


---



AVIGEN, INC.(a development stage company)NOTES TO
FINANCIAL STATEMENTS  (Continued)




In 2005, we recorded an
investment in deferred financing leases of approximately $220,000 and recorded unearned income of approximately $155,000. This deferred financing lease
was related to equipment sold to one of our subtenants and carries a term equal to the related sublease agreement, or 30 months. Unearned income will
be recognized ratably over the term of the lease, or approximately $5,200 per month.




In the ordinary course of
business, we enter into commitments to fund collaborative research and clinical work performed by third parties. While these contracts are cancelable,
we expect the research studies and clinical work to be completed as defined in the terms of the agreements, and all amounts paid when due. At December
31, 2005, the estimated costs related to these commitments totaled approximately $510,000, all of which is expected to be paid within the next twelve
to twenty-four months.




Sublease
Accounting




We have entered into sublease
agreements for portions of our leased laboratory and office facilities. Based on the terms of the agreements, the fair value of our remaining lease
liability is less than the scheduled sublease income. As a result, in the period ended December 31, 2005, we did not record any lease exit costs
associated with the sublease of our operating facilities located at 1201 and 1301 Harbor Bay Parkway. In connection with the sublease agreements, we
recorded initial direct costs of $114,000 in commission expenses. We amortize initial direct costs to operating expenses on a straight-line basis over
the term of the sublease.


|13. |  | Income Taxes
|--- |  | ------------



Significant components of our
deferred tax assets are as follows (in thousands):


|                                     |  |  |  | December 31, |        
|------------------------------------ |  |  |  | ------------ | -------
|
|Net operating
loss carryforward      |  |  |  | $            | 56,000 
|Research and
development credits     |  |  |  |              | 7,600  
|Capitalized
research and development |  |  |  |              | 7,100  
|Depreciation                         |  |  |  |              | 3,200  
|Capitalized
patents                  |  |  |  |              | 500    
|Other                                |  |  |  |              | 3,300  
|Gross deferred
tax assets            |  |  |  |              | 77,700 
|Valuation
allowance                  |  |  |  |              | (77,700
|Net deferred tax
assets              |  |  |  | $            |       



No provision has been made for
income taxes because we have incurred losses since our inception. Deferred income taxes reflect the net tax effects of temporary differences between
the carrying value of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.




We have increased our valuation
allowance by $6.8 million, $10.0 million and $11.0 million in 2005, 2004 and 2003, respectively, to provide a full valuation allowance for deferred tax
assets since the realization of these benefits is not considered more likely than not.




At December 31, 2005, we had
unused net operating loss carryforwards of $159.0 million available to reduce federal taxable income expiring on various dates from 2008 through 2025
and $33.0 million available to reduce state taxable income expiring on various dates from 2006 through 2015. We also have federal and state research
tax credits of $5.2 million and $3.7 million, respectively, available to offset federal and state income taxes, which expire on various dates from 2012
through 2025. Deferred tax assets related to carryforwards at December 31, 2005 include approximately $2.0 million associated with stock option
activity for which any subsequently recognized benefits will be credited directly to stockholders equity. Our net operating losses and tax
credit




61


---



AVIGEN, INC.(a development stage company)NOTES TO
FINANCIAL STATEMENTS  (Continued)




carryforwards may be subject
to the annual limitation provisions of Internal Revenue Code (IRC) Sections 382 and 383 if we incur a change in ownership.


|14. |  | Condensed Quarterly Financial Information
(Unaudited)
|--- |  | -----------------------------------------------------

|                                      |  |  |  | Year Ended December 31, 2005 |       
|------------------------------------- |  |  |  | ---------------------------- | ------
|
|Total
revenue                         |  |  |  | $                            | 9     
|Net
loss                              |  |  |  |                              | (5,190
|Net loss per
share, basic and diluted |  |  |  |                              | (0.25 

|                                      |  |  |  | Year Ended December 31, 2004 |       
|------------------------------------- |  |  |  | ---------------------------- | ------
|
|Total
revenue                         |  |  |  | $                            | 150   
|Net
loss                              |  |  |  |                              | (7,281
|Net loss per
share, basic and diluted |  |  |  |                              | (0.36 

|15. |  | Subsequent Event  Sanochemia-License
Agreement
|--- |  | -----------------------------------------------



In January 2006, we entered into
a license agreement with SDI Diagnostics International LTD, a division of Sanochemia Pharmazeutika AG (Sanochemia). Under the terms of the agreement,
Avigen received an exclusive license to develop and commercialize the compound tolperisone in North America. This compound is the active pharmaceutical
ingredient in our product candidate, AV650, for the treatment of neuromuscular spasm and spasticity. Under the terms of the agreement, Avigen paid
Sanochemia $3.0 million in initial license costs and will make additional future payments based on successful clinical and regulatory product
development milestones and royalty payments on sales. The companies have also entered into a long-term supply agreement under which Sanochemia will
manufacture the AV650 product for Avigen. We will also owe payments for clinical and commercial supply.


|16. |  | Subsequent Event  Severance
|--- |  | ----------------------------



In January 2006, our Chief
Financial Officer resigned from the Company. In connection with his resignation, Avigen has agreed to pay severance benefits including base salary for
a period of one year and continued health benefits for up to twelve months. As a result of this separation, we expect to report a charge in the quarter
ending March 31, 2006 of approximately $290,000. In addition, Avigen agreed to modify outstanding stock options held by the executive to allow for six
months of additional vesting and an extended period to exercise all vested stock options for up to two years. As a result of this modification, we
expect to report a charge for non-cash compensation expense for the quarter ending March 31, 2006.




62


---



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



None.




Item 9A. Controls and
Procedures




Evaluation of disclosure
controls and procedures.    With the supervision and with the participation of our management, including our principal
executive officer and principal financial officer, we have evaluated the effectiveness of our disclosure controls and procedures (as defined in the
Securities Exchange Act of 1934, Rules 13a-15(e) and 15(d)-15(e)), as of December 31, 2005. Based on that evaluation, the principal executive officer
and principal financial officer have concluded that these disclosure controls and procedures were effective to ensure, at a reasonable assurance level,
that the information required to be disclosed by us in reports we file with the SEC is recorded, processed, summarized and reported within the time
periods specified in the SECs rules and instructions for such reports.




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 our principal financial officer, we conducted an evaluation of the
effectiveness of our internal control over financial reporting as of December 31, 2005. In making this assessment, our management used the criteria set
forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control  Integrated Framework. Our
management has concluded that, as of December 31, 2005, our internal control over financial reporting was effective based on these
criteria.




Our managements assessment
of the effectiveness of our internal control over financial reporting as of December 31, 2005 has been audited by Ernst & Young LLP, the
independent registered public accounting firm that audited our financial statements included in this Annual Report on Form 10-K, as stated in their
report, a copy of which is included on the next page.




Changes in Internal Control
over Financial Reporting.    There were no changes in our internal control over financial reporting during the quarter
ended December 31, 2005 that have materially affected, or are reasonably likely to materially affect, our internal control over financial
reporting.




63


---



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM




The Board of Directors and
Stockholders of Avigen Inc.




We have audited managements
assessment, included in the accompanying Managements Report on Internal Controls over Financial Reporting, that Avigen, Inc. maintained effective
internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control  Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Avigen 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 Avigen, Inc. maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material
respects, based on the COSO criteria. Also, in our opinion, Avigen, Inc. maintained, in all material respects, effective internal control over
financial reporting as of December 31, 2005, based on the COSO criteria.




We also have audited, in
accordance with the standards of the Public Company Accounting Oversight Board (United States), the balance sheets of Avigen, Inc. as of December 31,
2005 and 2004, and the related statements of operations, stockholders equity, and cash flows for each of the three years in the period ended
December 31, 2005 and the period from inception (October 22, 1992) through December 31, 2005 of Avigen, Inc. and our report dated March 14, 2006
expressed an unqualified opinion thereon.




Palo Alto, California March 14, 2006




64


---



Item 9B.    Other
Information




On December 19, 2005, Avigen,
Inc. entered into an agreement under which Genzyme Corporation would acquire Avigens non-pain related AAV gene therapy assets. Under the terms of
the agreement, Avigen sold the rights to its extensive patent estate based on adeno-associated virus technologies, rights to its clinical development
program for Parkinsons disease, which includes the related phase I/II clinical trial currently underway at University of California, San
Francisco, and the rights to a clinical collaboration in hemophilia with Dr. Katharine High of the University of Pennsylvania School of
Medicine.




Avigen received an upfront
payment from Genzyme of $12.0 million and will receive additional milestone and royalty payments and license fees based on the development, approval
and sale of all products developed by Genzyme that rely on intellectual property purchased from Avigen. However, if Genzyme fails to diligently pursue
the commercialization or marketing of products using the assigned technology, as specified in the agreement, certain of the rights Avigen assigned
could revert back to Avigen at a future date. The agreement is filed as Exhibit 10.58 to this Annual Report on Form 10-K.




The $12.0 million received from
Genzyme was booked as revenue for the quarter ending December 31, 2005, and increased Avigens cash at December 31, 2005 by $12.0 million and
correspondingly decreased its deficit accumulated during the development stage by $12.0 million. Other than these items, the transaction has no other
impact on Avigens balance sheet as of December 31, 2005 or statement of operations for the quarter or year ended December 31,
2005.




PART III




Item 10.    Directors and
Executive Officers of the Registrant




The information required by this
Item with respect to Executive Officers may be found under the caption, Executive Officers of the Registrant at the end of Part I of this
Annual Report on Form 10-K. The information required by this Item with respect to Directors, including information with respect to audit committee
financial experts, is incorporated herein by reference from the information under the caption, Proposal 1  Election of Directors
appearing in the definitive Proxy Statement to be delivered to Avigens stockholders in connection with the solicitation of proxies for
Avigens 2006 Annual Meeting of Stockholders to be held on May 31, 2006 (the Proxy Statement).




Section
16(a) Beneficial Ownership Reporting Compliance




The information required by this
Item with respect to compliance with Section 16(a) of the Exchange Act is incorporated herein by reference from the section captioned Section
16(a) Beneficial Ownership Reporting Compliance contained in the Proxy Statement.




Code of
Business Conduct and Ethics




The information required by this
Item with respect to our code of ethics is incorporated herein by reference from the section captioned Proposal 1  Election of Directors
 Code of Business Conduct and Ethics contained in the Proxy Statement.


|Item
11. |  | Executive Compensation
|-------- |  | ----------------------



The information required by this
Item is set forth in the Proxy Statement under the captions, Executive Compensation and Compensation Committee Interlocks and Insider
Participation. Such information is incorporated herein by reference.


|Item
12. |  | Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters
|-------- |  | ----------------------------------------------------------------------------------------------



The information required by this
Item with respect to security ownership of certain beneficial owners and management is set forth in the Proxy Statement under the caption,
Security Ownership of Certain Beneficial Owners and Management. Such information is incorporated herein by reference.




The information required by this
Item with respect to securities authorized for issuance under our equity compensation plans is set forth in the Proxy Statement under the caption
Proposal 2  Approval of the Avigen,




65


---



Inc. 2006 Equity Incentive
Plan  Equity Compensation Plan Information. Such information is incorporated herein by reference.


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



The information required by this
Item is set forth in the Proxy Statement under the heading Certain Relationships and Related Transactions. Such information is incorporated
herein by reference.


|Item
14. |  | Principal Accountant Fees and Services
|-------- |  | --------------------------------------



The information required by this
Item is set forth in the Proxy Statement under the heading Proposal 3  Ratification of Selection of Independent Registered Public
Accounting Firm. Such information is incorporated herein by reference.




Consistent with Section 10A(i)(2)
of the Securities Exchange Act of 1934, as added by Section 202 of the Sarbanes-Oxley Act of 2002, we are responsible for listing the non-audit
services approved by our Audit Committee to be performed by Ernst & Young LLP, our external auditor. Non-audit services are defined as services
other than those provided in connection with an audit or a review of our financial statements. The Audit Committee has not approved, and Ernst &
Young LLP has not provided, any non-audit services other than those that Avigen has disclosed in previous SEC filings.




PART IV




Item 15. Exhibits and Financial Statement
Schedules


|(a) |  | The following documents are filed as part of this Annual Report
on Form 10-K:
|--- |  | -----------------------------------------------------------------------------

|(1) |  | Financial Statements:
|--- |  | ---------------------



Report of Independent Registered
Public Accounting Firm Balance Sheets Statements of Operations Statements of Stockholders Equity Statements of Cash Flows
Notes to Financial Statements


|(2) |  | Financial Statement Schedules
|--- |  | -----------------------------



Financial statement schedules
have been omitted from this Annual Report on Form 10-K because they are either not applicable or the required information is provided in the financial
statements or the notes thereto.




66


---

|(3) |  | Exhibits
|--- |  | --------

|ExhibitNumber |  |  |  | Exhibits                                                                                                            
|------------- |  |  |  | --------------------------------------------------------------------------------------------------------------------
|2.1           |  |  |  | See
Exhibit 10.58                                                                                                   
|3.1(1)        |  |  |  | Amended and Restated Certificate of Incorporation                                                                   
|3.1.1(13)     |  |  |  | Certificate of Amendment to Certificate of Incorporation                                                            
|3.2
(1)       |  |  |  | Restated Bylaws of the Registrant                                                                                   
|4.1(1)        |  |  |  | Specimen Common Stock Certificate                                                                                   
|10.2(1,
2)    |  |  |  | 1993
Stock Option Plan                                                                                              
|10.3 (2,
17)  |  |  |  | 1996
Equity Incentive Plan, as amended                                                                              
|10.4(1,
2)    |  |  |  | Form
of Incentive Stock Option Grant for 1996 Equity Incentive Plan                                                 
|10.5(1,
2)    |  |  |  | Form
of Nonstatutory Stock Option Grant for 1996 Equity Incentive Plan                                              
|10.6(2,
14)   |  |  |  | 1996
Non-Employee Directors Stock Option Plan, as amended                                                          
|10.7(2,
4)    |  |  |  | 1997
Employee Stock Purchase Plan                                                                                   
|10.8(1,
2)    |  |  |  | Form
of Indemnification Agreement between Avigen and its directors and executive officers.                          
|10.10(2,
5)   |  |  |  | 2000
Equity Incentive Plan                                                                                          
|10.11(2,
12)  |  |  |  | Form
of Nonstatutory Stock Option Grant for 2000 Equity Incentive Plan                                              
|10.14(2,
15)  |  |  |  | Form
of Incentive Stock Option Grant for 1993 Stock Option Plan                                                     
|10.15(2,
15)  |  |  |  | Form
of Nonstatutory Stock Option Grant for 1993 Stock Option Plan                                                  
|10.16(2,
24)  |  |  |  | Form
of Nonstatutory Stock Option Grant for 1996 Non-Employee Directors Stock Option Plan, as amended              
|10.17(2,
25)  |  |  |  | Compensation Agreements with Named Executive Officers                                                               
|10.29(2,
6)   |  |  |  | Employment Agreement dated August 14, 1996, between Avigen and Thomas J. Paulson.                                   
|10.32(15)     |  |  |  | Revolving line of credit note signed November 2, 2000 with Wells Fargo Bank.                                        
|10.33(15)     |  |  |  | Letter Agreement to the revolving line of credit note signed November 2, 2000 with Wells Fargo Bank.                
|10.36(2,
8)   |  |  |  | Management Transition Plan                                                                                          
|10.41(10)     |  |  |  | Property Lease Agreement between ARE-1201 Harbor Bay, LLC and Avigen, dated February 29, 2000                       
|10.45(13)     |  |  |  | Office Lease Agreement between Lincoln-RECP Empire OPCO, LLC and Avigen, Inc., dated November 2, 2000.              
|10.46(13)     |  |  |  | First Amendment to Lease Agreement between Lincoln-RECP Empire OPCO, LLC and Avigen, Inc., dated December 1, 2000.  
|10.47(13)     |  |  |  | Second Amendment to Lease Agreement between Lincoln-RECP Empire OPCO, LLC and Avigen, Inc., dated February 12, 2001.
|10.49(16)     |  |  |  | Revolving line of credit note with Wells Fargo Bank, dated June 1, 2002.                                            
|10.50(16)     |  |  |  | Letter of Agreement to the revolving line of credit note signed June 1, 2002 with Wells Fargo Bank.                 
|10.51(11, 23) |  |  |  | License Agreement, dated November 21, 2003, by and between University of Colorado and Avigen                        



67


---

|ExhibitNumber |  |  |  | Exhibits                                                                                                                                          
|------------- |  |  |  | --------------------------------------------------------------------------------------------------------------------------------------------------
|10.52
(2, 22) |  |  |  | Separation Agreement dated March 8, 2004 between Avigen and John Monahan                                                                          
|10.53
(20)    |  |  |  | Revolving line of credit note with Wells Fargo Bank, dated June 1, 2004                                                                           
|10.54
(20)    |  |  |  | Amendment to Letter of Agreement to the revolving line of credit note signed June 1, 2004 with Wells Fargo Bank                                   
|10.55
(2, 21) |  |  |  | Arrangement Regarding Non-Employee Director Compensation                                                                                          
|10.56
(26)    |  |  |  | Sublease Lease Agreement, dated November 4, 2005, between Pepgen Corporation and Avigen                                                           
|10.57
(27)    |  |  |  | Sublease Lease Agreement, dated November 29, 2005, between Advanced Cell Technology, Inc. and Avigen                                              
|10.58
(3)     |  |  |  | Assignment Agreement, dated December 19, 2005, by and between Genzyme Corporation and Avigen                                                      
|10.59
(3)     |  |  |  | License Agreement, dated January 12, 2006, by and between SDI Diagnostics International LTD, a division of Sanochemia Pharmazeutika AG, and
Avigen
|10.60
(2)     |  |  |  | Separation Agreement, dated January 6, 2006, between Avigen and Thomas J. Paulson, together with Amendment No. 1 thereto dated February 3,
2006.  
|23.1          |  |  |  | Consent of Independent Registered Public Accounting Firm                                                                                          
|24.1          |  |  |  | Power of Attorney (included on the signature pages hereto)                                                                                        
|31.1          |  |  |  | CEO
Certification required by Rule 13a-14(a) or Rule 15d-14(a)                                                                                    
|31.2          |  |  |  | CFO
Certification required by Rule 13a-14(a) or Rule 15d-14(a)                                                                                    
|32.1(19)      |  |  |  | Certification required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C.
§1350) 








Keys to Exhibits:


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

|(2) |  | Management Contract or Compensation Plan.
|--- |  | -----------------------------------------

|(3) |  | Confidential treatment has been requested for portions of this
exhibit.
|--- |  | -----------------------------------------------------------------------

|(4) |  | Incorporated by reference from such document filed with the SEC
as an exhibit to Avigens Annual Report on Form 10-K for the year ended June 30, 1999, as filed with the SEC (Commission File No.
000-28272).
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) |  | Incorporated by reference from such document filed with the SEC
as an exhibit to Avigens Registration Statement on Form S-8 (Registration No. 333-42210) filed with the SEC on July 25, 2000.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) |  | Incorporated by reference from such document filed with the SEC
as an exhibit to Avigens Annual Report on Form 10-K for the year ended June 30, 1997, as filed with the SEC (Commission File No.
000-28272).
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(8) |  | Incorporated by reference from such document filed with the SEC
as an exhibit to Avigens Current Report on Form 8-K filed with the SEC on May 31, 2005 (Commission File No. 000-28272).
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

|(11) |  | Portions of this exhibit have been omitted pursuant to a grant
of confidential treatment.
|---- |  | -----------------------------------------------------------------------------------------

|(12) |  | Incorporated by reference from such document filed with the SEC
as an exhibit to Avigens Annual Report on Form 10-K for the year ended June 30, 2000, as filed with the SEC on September 27, 2000 (Commission
File No. 000-28272).
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



68


---

|(13) |  | Incorporated by reference from such document filed with the SEC
as an exhibit to Avigens Quarterly Report on Form 10-Q for the quarter ended December 31, 2000, as filed with the SEC (Commission File No.
000-28272).
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(14) |  | Incorporated by reference from such document filed with the SEC
as an exhibit to Avigens Registration Statement on Form S-8 (Registration No. 333-56274) filed with the SEC on June 22, 2004.
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(15) |  | Incorporated by reference from such document filed with the SEC
as an exhibit to Avigens Annual Report on Form 10-K for the year ended June 30, 2001, as filed with the SEC on September 27, 2001 (Commission
File No. 000-28272).
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(16) |  | Incorporated by reference from such document filed with the SEC
as an exhibit to Avigens Quarterly Report on Form 10-Q for the quarter ended June 30, 2002, as filed with the SEC (Commission File No.
000-28272).
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(17) |  | Incorporated by reference from such document filed with the SEC
as an exhibit to Avigens Registration Statement on Form S-8 (Registration No. 333-90504) filed with the SEC on June 14, 2002.
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(19) |  | This certification accompanies the Form 10-K to which it
relates, is not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of Avigen under the
Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended (whether made before or after the date of the Form 10-K),
irrespective of any general incorporation language contained in such filing.
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(20) |  | Incorporated by reference from such document filed with the SEC
as an exhibit to Avigens Quarterly Report on Form 10-Q for the quarter ended June 30, 2004, as filed with the SEC (Commission File No.
000-28272).
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(21) |  | Incorporated by reference from the disclosure contained in Item
1.01 of Avigens Current Report on Form 8-K filed with the SEC on February 21, 2006 discussing such compensation (Commission File No.
000-28272).
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(22) |  | Incorporated by reference from such document filed with the SEC
as an exhibit to Avigens Quarterly Report on Form 10-Q for the quarter ended March 31, 2004, as filed with the SEC (Commission File No.
000-28272).
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(23) |  | Incorporated by reference from such document filed with the SEC
as an exhibit to Avigens Annual Report on Form 10-K for the year ended December 31, 2003, as filed with the SEC on March 15, 2004 (Commission
File No. 000-28272).
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(24) |  | Incorporated by reference from such document filed with the SEC
as an exhibit to Avigens Annual Report on Form 10-K for the year ended December 31, 2004, as filed with the SEC on March 15, 2004 (Commission
File No. 000-28272).
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(25) |  | Incorporated by reference from the disclosure contained in Item
1.01 of Avigens Current Reports on Form 8-K filed with the SEC on May 31, 2005 and February 28, 2006 (Commission File No. 000-28272).
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(26) |  | Incorporated by reference from such document filed with the SEC
as an exhibit to Avigens Current Report on Form 8-K filed with the SEC on November 28, 2005 (Commission File No. 000-28272).
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(27) |  | Incorporated by reference from such document filed with the SEC
as an exhibit to Avigens Current Report on Form 8-K filed with the SEC on December 16, 2005 (Commission File No. 000-28272).
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



69


---



SIGNATURES




Pursuant to the requirements of
Section 13 of 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.




AVIGEN, INC.


|By: |  | /s/ KENNETH G.
CHAHINE Kenneth G. Chahine, J.D., Ph.D.President
and Chief Executive Officer
|--- |  | -------------------------------------------------------------------------------------------



Dated: March 14, 2006




POWER OF ATTORNEY




KNOW ALL PERSONS BY THESE
PRESENTS, that each person whose signature appears below constitutes and appoints Kenneth Chahine and Andrew A. Sauter, and each or any one of them,
his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him and in his name, place and stead, in any
and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto, and other
documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full
power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents
and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or their or
his substitutes or substitute, may lawfully do or cause to be done by virtue hereof.




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







|Signature                       |  |  |  | Title                                           |  | Date          
|------------------------------- |  |  |  | ----------------------------------------------- |  | --------------
|                                |  |  |  |                                                 |  |               
|/s/ KENNETH G. CHAHINE          |  |  |  | President, Chief Executive Officer and Director |  | March 14,
2006
|Kenneth G.
Chahine, J.D., Ph.D. |  |  |  | (Principal Executive Officer)                   |  |               
|                                |  |  |  |                                                 |  |               
|/s/ ANDREW A. SAUTER            |  |  |  | Vice
President, Finance                         |  | March 14,
2006
|Andrew A.
Sauter                |  |  |  | (Principal Financial and Accounting Officer)    |  |               
|                                |  |  |  |                                                 |  |               
|/s/ ZOLA HOROVITZ,              |  |  |  | Chairman of the Board                           |  | March 14,
2006
|Zola Horovitz,
Ph.D.            |  |  |  |                                                 |  |               
|                                |  |  |  |                                                 |  |               
|/s/ YUICHI IWAKI                |  |  |  | Director                                        |  | March 14,
2006
|Yuichi Iwaki,
M.D., Ph.D.       |  |  |  |                                                 |  |               
|                                |  |  |  |                                                 |  |               
|/s/ JOHN K.A. PRENDERGAST       |  |  |  | Director                                        |  | March 14,
2006
|John K.A.
Prendergast, Ph.D.    |  |  |  |                                                 |  |               
|                                |  |  |  |                                                 |  |               
|/s/ DANIEL VAPNEK               |  |  |  | Director                                        |  | March 14,
2006
|Daniel Vapnek,
Ph.D.            |  |  |  |                                                 |  |               



70


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EXHIBIT INDEX







|ExhibitNumber |  |  |  | Exhibits                                                                                                            
|------------- |  |  |  | --------------------------------------------------------------------------------------------------------------------
|2.1           |  |  |  | See
Exhibit 10.58                                                                                                   
|3.1(1)        |  |  |  | Amended and Restated Certificate of Incorporation                                                                   
|3.1.1(13)     |  |  |  | Certificate of Amendment to Certificate of Incorporation                                                            
|3.2
(1)       |  |  |  | Restated Bylaws of the Registrant                                                                                   
|4.1(1)        |  |  |  | Specimen Common Stock Certificate                                                                                   
|10.2(1,
2)    |  |  |  | 1993
Stock Option Plan                                                                                              
|10.3 (2,
17)  |  |  |  | 1996
Equity Incentive Plan, as amended                                                                              
|10.4(1,
2)    |  |  |  | Form
of Incentive Stock Option Grant for 1996 Equity Incentive Plan                                                 
|10.5(1,
2)    |  |  |  | Form
of Nonstatutory Stock Option Grant for 1996 Equity Incentive Plan                                              
|10.6(2,
14)   |  |  |  | 1996
Non-Employee Directors Stock Option Plan, as amended                                                          
|10.7(2,
4)    |  |  |  | 1997
Employee Stock Purchase Plan                                                                                   
|10.8(1,
2)    |  |  |  | Form
of Indemnification Agreement between Avigen and its directors and executive officers.                          
|10.10(2,
5)   |  |  |  | 2000
Equity Incentive Plan                                                                                          
|10.11(2,
12)  |  |  |  | Form
of Nonstatutory Stock Option Grant for 2000 Equity Incentive Plan                                              
|10.14(2,
15)  |  |  |  | Form
of Incentive Stock Option Grant for 1993 Stock Option Plan                                                     
|10.15(2,
15)  |  |  |  | Form
of Nonstatutory Stock Option Grant for 1993 Stock Option Plan                                                  
|10.16(2,
24)  |  |  |  | Form
of Nonstatutory Stock Option Grant for 1996 Non-Employee Directors Stock Option Plan, as amended              
|10.17(2,
25)  |  |  |  | Compensation Agreements with Named Executive Officers                                                               
|10.29(2,
6)   |  |  |  | Employment Agreement dated August 14, 1996, between Avigen and Thomas J. Paulson.                                   
|10.32(15)     |  |  |  | Revolving line of credit note signed November 2, 2000 with Wells Fargo Bank.                                        
|10.33(15)     |  |  |  | Letter Agreement to the revolving line of credit note signed November 2, 2000 with Wells Fargo Bank.                
|10.36(2,
8)   |  |  |  | Management Transition Plan                                                                                          
|10.41(10)     |  |  |  | Property Lease Agreement between ARE-1201 Harbor Bay, LLC and Avigen, dated February 29, 2000                       
|10.45(13)     |  |  |  | Office Lease Agreement between Lincoln-RECP Empire OPCO, LLC and Avigen, Inc., dated November 2, 2000.              
|10.46(13)     |  |  |  | First Amendment to Lease Agreement between Lincoln-RECP Empire OPCO, LLC and Avigen, Inc., dated December 1, 2000.  
|10.47(13)     |  |  |  | Second Amendment to Lease Agreement between Lincoln-RECP Empire OPCO, LLC and Avigen, Inc., dated February 12, 2001.
|10.49(16)     |  |  |  | Revolving line of credit note with Wells Fargo Bank, dated June 1, 2002.                                            
|10.50(16)     |  |  |  | Letter of Agreement to the revolving line of credit note signed June 1, 2002 with Wells Fargo Bank.                 
|10.51(11, 23) |  |  |  | License Agreement, dated November 21, 2003, by and between University of Colorado and Avigen                        



71


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|ExhibitNumber |  |  |  | Exhibits                                                                                                                                          
|------------- |  |  |  | --------------------------------------------------------------------------------------------------------------------------------------------------
|10.52
(2, 22) |  |  |  | Separation Agreement dated March 8, 2004 between Avigen and John Monahan                                                                          
|10.53
(20)    |  |  |  | Revolving line of credit note with Wells Fargo Bank, dated June 1, 2004                                                                           
|10.54
(20)    |  |  |  | Amendment to Letter of Agreement to the revolving line of credit note signed June 1, 2004 with Wells Fargo Bank                                   
|10.55
(2, 21) |  |  |  | Arrangement Regarding Non-Employee Director Compensation                                                                                          
|10.56
(26)    |  |  |  | Sublease Lease Agreement, dated November 4, 2005, between Pepgen Corporation and Avigen                                                           
|10.57
(27)    |  |  |  | Sublease Lease Agreement, dated November 29, 2005, between Advanced Cell Technology, Inc. and Avigen                                              
|10.58
(3)     |  |  |  | Assignment Agreement, dated December 19, 2005, by and between Genzyme Corporation and Avigen                                                      
|10.59
(3)     |  |  |  | License Agreement, dated January 12, 2006, by and between SDI Diagnostics International LTD, a division of Sanochemia Pharmazeutika AG, and
Avigen
|10.60
(2)     |  |  |  | Separation Agreement, dated January 6, 2006, between Avigen and Thomas J. Paulson, together with Amendment No. 1 thereto dated February 3,
2006.  
|23.1          |  |  |  | Consent of Independent Registered Public Accounting Firm                                                                                          
|24.1          |  |  |  | Power of Attorney (included on the signature pages hereto)                                                                                        
|31.1          |  |  |  | CEO
Certification required by Rule 13a-14(a) or Rule 15d-14(a)                                                                                    
|31.2          |  |  |  | CFO
Certification required by Rule 13a-14(a) or Rule 15d-14(a)                                                                                    
|32.1(19)      |  |  |  | Certification required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C.
§1350) 








Keys to Exhibits:


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

|(2) |  | Management Contract or Compensation Plan.
|--- |  | -----------------------------------------

|(3) |  | Confidential treatment has been requested for portions of this
exhibit.
|--- |  | -----------------------------------------------------------------------

|(4) |  | Incorporated by reference from such document filed with the SEC
as an exhibit to Avigens Annual Report on Form 10-K for the year ended June 30, 1999, as filed with the SEC (Commission File No.
000-28272).
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) |  | Incorporated by reference from such document filed with the SEC
as an exhibit to Avigens Registration Statement on Form S-8 (Registration No. 333-42210) filed with the SEC on July 25, 2000.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) |  | Incorporated by reference from such document filed with the SEC
as an exhibit to Avigens Annual Report on Form 10-K for the year ended June 30, 1997, as filed with the SEC (Commission File No.
000-28272).
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(8) |  | Incorporated by reference from such document filed with the SEC
as an exhibit to Avigens Current Report on Form 8-K filed with the SEC on May 31, 2005 (Commission File No. 000-28272).
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

|(11) |  | Portions of this exhibit have been omitted pursuant to a grant
of confidential treatment.
|---- |  | -----------------------------------------------------------------------------------------

|(12) |  | Incorporated by reference from such document filed with the SEC
as an exhibit to Avigens Annual Report on Form 10-K for the year ended June 30, 2000, as filed with the SEC on September 27, 2000 (Commission
File No. 000-28272).
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



72


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|(13) |  | Incorporated by reference from such document filed with the SEC
as an exhibit to Avigens Quarterly Report on Form 10-Q for the quarter ended December 31, 2000, as filed with the SEC (Commission File No.
000-28272).
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(14) |  | Incorporated by reference from such document filed with the SEC
as an exhibit to Avigens Registration Statement on Form S-8 (Registration No. 333-56274) filed with the SEC on June 22, 2004.
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(15) |  | Incorporated by reference from such document filed with the SEC
as an exhibit to Avigens Annual Report on Form 10-K for the year ended June 30, 2001, as filed with the SEC on September 27, 2001 (Commission
File No. 000-28272).
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(16) |  | Incorporated by reference from such document filed with the SEC
as an exhibit to Avigens Quarterly Report on Form 10-Q for the quarter ended June 30, 2002, as filed with the SEC (Commission File No.
000-28272).
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(17) |  | Incorporated by reference from such document filed with the SEC
as an exhibit to Avigens Registration Statement on Form S-8 (Registration No. 333-90504) filed with the SEC on June 14, 2002.
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(19) |  | This certification accompanies the Form 10-K to which it
relates, is not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of Avigen under the
Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended (whether made before or after the date of the Form 10-K),
irrespective of any general incorporation language contained in such filing.
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(20) |  | Incorporated by reference from such document filed with the SEC
as an exhibit to Avigens Quarterly Report on Form 10-Q for the quarter ended June 30, 2004, as filed with the SEC (Commission File No.
000-28272).
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(21) |  | Incorporated by reference from the disclosure contained in Item
1.01 of Avigens Current Report on Form 8-K filed with the SEC on February 21, 2006 discussing such compensation (Commission File No.
000-28272).
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(22) |  | Incorporated by reference from such document filed with the SEC
as an exhibit to Avigens Quarterly Report on Form 10-Q for the quarter ended March 31, 2004, as filed with the SEC (Commission File No.
000-28272).
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(23) |  | Incorporated by reference from such document filed with the SEC
as an exhibit to Avigens Annual Report on Form 10-K for the year ended December 31, 2003, as filed with the SEC on March 15, 2004 (Commission
File No. 000-28272).
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(24) |  | Incorporated by reference from such document filed with the SEC
as an exhibit to Avigens Annual Report on Form 10-K for the year ended December 31, 2004, as filed with the SEC on March 15, 2004 (Commission
File No. 000-28272).
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(25) |  | Incorporated by reference from the disclosure contained in Item
1.01 of Avigens Current Reports on Form 8-K filed with the SEC on May 31, 2005 and February 28, 2006 (Commission File No. 000-28272).
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(26) |  | Incorporated by reference from such document filed with the SEC
as an exhibit to Avigens Current Report on Form 8-K filed with the SEC on November 28, 2005 (Commission File No. 000-28272).
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(27) |  | Incorporated by reference from such document filed with the SEC
as an exhibit to Avigens Current Report on Form 8-K filed with the SEC on December 16, 2005 (Commission File No. 000-28272).
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



73


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