UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, DC 20549

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Form 10-K

|(Mark One)                              |                                                                                         
|--------------------------------------- | ----------------------------------------------------------------------------------------
|ý                                       | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
|For the fiscal year ended June 30, 2004
|or                                     
|o                                       | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 0-22987

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

|Delaware(State or other jurisdiction
of incorporation or organization) |  | 94-3156660(IRS Employer
Identification No.)
|---------------------------------------------------------------------- |  | -------------------------------------------
|863A Mitten Rd., Burlingame, CA(Address of principal offices)          |  | 94010(Zip Code)                            
|(650) 697-1900(Registrant's telephone number, including area code)    

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

NoneSecurities registered pursuant to Section 12(g) of the Act:

Common Stock, Par Value $.001


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

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange
Act). Yes o    No ý

The aggregate market value of the common stock held by non-affiliates of the registrant, based upon the last sale price of the common stock reported
on the Nasdaq SmallCap Market on December 31, 2003 was $14,632,051.

The
number of shares of registrant's common stock outstanding, as of September 14, 2004 was 13,089,006.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's proxy statement, which will be filed with the Commission pursuant to Regulation 14A in connection with the 2004 meeting of
stockholders within 120 days after the Registrant's fiscal year ended June 30, 2004 are incorporated herein by reference in Part III of this Report.



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VALENTIS, INC.

FORM 10-KANNUAL REPORT
FOR THE YEAR ENDED JUNE 30, 2004

TABLE OF CONTENTS

|           |         |    |                                                                                                | Page
|---------- | ------- | -- | ---------------------------------------------------------------------------------------------- | ----
|PART I     |         |   
|           | Item 1  |    | Business                                                                                       |     
|           | 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 and Related Stockholder Matters                          |     
|           | 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                                                                        |     
|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 Accounting Fees and Services                                                         |     
|PART IV    |         |   
|           | Item 15 |    | Exhibits, Financial Statement Schedules and Reports on Form 8-K                                |     
|SIGNATURES |         | 45

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PART I

ITEM 1. BUSINESS

This Annual Report on Form 10-K contains certain forward-looking statements within the meaning of Section 27A of
the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements relate to, among other things, our future financial position,
products, business development, strategy and our management's plans and objectives for future operations. Forward-looking statements generally can be identified by the use of forward-looking
terminology such as "believe," "may," "will," "intend," "expect," "estimate," "continue," "ongoing," "predict," "potential," and "anticipate" or similar expressions or the negative of those terms or
expressions. The reader is cautioned not to put undue reliance on these forward-looking statements, which reflect management's analysis only as of the date of this Annual Report. These statements
involve known and unknown risks, uncertainties and other factors, which may cause our actual results, performance or achievements to differ materially from those expressed or implied by such
forward-looking statements. We undertake no obligation to revise or update any such forward-looking statements. The reader is strongly urged to read the information set forth under the captions
"Part I, Item 1. BusinessAdditional Factors That May Affect Future Results," for a detailed description of these significant risks, uncertainties and other
factors.

COMPANY OVERVIEW

Valentis is creating innovative cardiovascular therapeutics. We begin our product development at the stage of a gene or protein with known activity and apply our
expertise in formulation, manufacturing, clinical development and regulatory affairs to create products that fill unmet medical needs.

Valentis
has a series of technologies ranging from gene delivery and expression technologies to proprietary formulation and manufacturing technologies that allow us to generate novel
therapeutics to treat a wide range of diseases. While Valentis is focusing its efforts on the development of novel
cardiovascular therapeutics, its technologies are being applied by its collaborators for the development of therapeutics to treat a variety of indications including infectious diseases and cancer.

Deltavasc,
the Company's lead product, is based on the Developmentally regulated Endothelial cell Locus-1 (Del-1) angiogenesis gene formulated with a
Valentis proprietary PINC polymer delivery system. Deltavasc is currently in Phase II clinical trials in patients with the intermittent claudication (IC) form of peripheral
arterial disease (PAD). The primary endpoint in this trial is improvement in exercise tolerance 90 days after dosing of the product. Valentis expects that the results from this Phase II trial
will be available at the end of September 2004. A positive outcome for the clinical trial demonstrating a statistically significant drug effect and safety for use in the targeted population is
critical to the continued development of Deltavasc. A negative trial outcome could have a material and adverse effect on the further development of Deltavasc, negatively
affect Valentis' ability to raise additional financing on acceptable terms, if at all, negatively impact our business and prospects and cause the price of our common stock to fall. See
"Additional Factors That May Affect Future Results" for a description of the risks related to our product development efforts, including
risks with regard to the Deltavasc PAD Phase II clinical trial.

The
merger of Megabios Corp. and GeneMedicine, Inc. in March 1999 formed Valentis Inc., a Delaware corporation. In August 1999, Valentis acquired U.K.-based
PolyMASC Pharmaceuticals plc. Valentis is located in Burlingame, California, which is the Company's headquarters, as well as the center for manufacturing, and clinical and preclinical development.

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TECHNOLOGIES

Valentis' technologies provide novel ways to achieve production of therapeutic proteins in their most natural and active forms at specific sites within the body.
Our products contain genes formulated with synthetic delivery systems that are administered to specific tissues where they enter targeted cells. These cells then produce the therapeutic protein or
vaccine antigen.

Gene Delivery

Genes provide the "instructions" for the production of proteins in the body. Specifically, a gene produces the message that a cell will then use to make a
protein. For gene-based
products to produce a therapeutic effect, the genes for the therapeutic protein of interest must be "delivered" into the nucleus of cells.

Valentis
has developed novel, chemical-based technologies for the delivery of genes. Contrary to other gene delivery approaches, Valentis' technologies do not use a live, genetically
altered virus to deliver the gene. Valentis' technologies have clear advantages over other gene delivery technologies in delivery efficiency, cost and ability to repeat dosing.



Hermes Gene Expression Systems

Valentis' Hermes expression systems are proprietary plasmids developed by the Company. A plasmid is a circle of DNA that includes the gene for a
therapeutic protein. Also included in plasmids are elements that control the production of the message from that gene. This message serves as the code or "blueprint" for the production of the
therapeutic protein by cells. Once plasmids are delivered into cells, they operate "episomally" which means they are not incorporated in the DNA of the cell.

Valentis'
plasmids have been engineered to provide increased gene expression (production of the message for protein production) and allow cost efficient manufacturing. In our plasmids,
we incorporate high expression promoters into proprietary expression cassettes. These proprietary cassettes contain novel untranslated regions with synthetically designed introns. Our plasmids have
been selected for increased yield to allow cost efficient manufacturing. Included in our library of plasmids are those with tissue specific promoters.

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GeneSwitch® Gene Regulation

Valentis' GeneSwitch® permits therapeutic protein production that is controlled via an orally administered drug. Products incorporating our
GeneSwitch® technology are delivered with a polymer delivery system along with electroporation. This results in controlled production of therapeutic proteins from muscle tissue for
prolonged periods. Detailed information is available atwww.geneswitch.com.

Current Good Manufacturing Practices Manufacturing (cGMP Manufacturing)

Valentis has developed proprietary scalable processes to manufacture plasmid DNA formulated products. Through a strategy of using a contract manufacturing
organization (CMO) for plasmid DNA
production of our products, we are able to produce drug material from lab to commercial scale using the same process. Valentis has utilized Cangene Corporation and DSM Biologics as contract
manufacturing organizations.

Technology Licenses

Valentis currently licenses technology to:



Valentis
has licensed its proprietary GeneSwitch® gene regulation technology on a non-exclusive basis to Genzyme Corporation, GlaxoSmithKline, LARNAX GmbH,
Lexicon Genetics, Pfizer Inc., Senomyx, Inc., and Wyeth-Ayerst Laboratories, in each case, for research. Further, Valentis has established a non-exclusive cross-license with
Genzyme Corporation in which Genzyme receives rights to GeneSwitch® gene regulation technology for research use, and Valentis receives certain rights to Genzyme's plasmid DNA manufacturing
technology.

Valentis
also has licensed technology from Genetronics Biomedical Corp. forin vivoelectroporation technology for use in the development
of certain gene-based products. Electroporation is a method for increasing DNA uptake by protoplasts through prior exposure to a high voltage, which results in the temporary formation of
small pores in the cell membrane.

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VALENTIS' PRODUCTS IN DEVELOPMENT, PARTNERS AND TECHNOLOGY LICENSES

Valentis is focusing on the development of the Deltavasc angiogenesis product, and licensing opportunities for its other technologies. We seek
corporate partnerships with pharmaceutical and biotechnology companies that assume responsibility for late-stage development, marketing, and commercialization. The table below summarizes
Valentis' current products and technology licensed to third parties for development as products, potential therapeutic indications, stage of development and corporate partner or licensee:

VALENTIS PIPELINE

CHART

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|Notes: |  | "Phase I"     |  | means that the compound is being tested in humans for safety in a limited patient population.                                                                                                              
|------ |  | ------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|       |  | "Phase II"    |  | means that the compound is being tested in humans for indications of efficacy in a limited patient population.                                                                                             
|       |  | "Phase III"   |  | means that the compound is being tested in humans for indications of efficacy in an expanded patient population.                                                                                           
|       |  | "Preclinical" |  | means that Valentis is conducting efficacy, pharmacology and/or toxicology testing of a gene delivery system in animal models or biochemical or cell culture assays.                                       
|       |  | "Research"    |  | includes the development of animal models and assay systems, discovery of prototype gene delivery systems and evaluation and refinement of prototype gene delivery systems in in vitro and in vivo testing.

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PRODUCTS

Valentis' lead product, Deltavasc, is currently in Phase II clinical trials in patients with peripheral arterial disease (PAD), a highly prevalent
disease with very limited treatment options.
Valentis is dependent on the successful outcome of the clinical trials of its Deltavasc product. A positive outcome for the clinical trial demonstrating a statistically significant drug
effect and safety for use in the targeted population is critical to the continued development of this lead product. A negative trial outcome could have a material and adverse effect on the further
development of Deltavasc, negatively impact our business and prospects and cause the price of our common stock to fall. See "Additional Factors That
May Affect Future ResultsWe are dependent on the successful outcomes of clinical trials of our products, particularly the Deltavasc Phase II outcome, which is expected at the
end of September 2004, and we cannot assure you that any clinical testing will demonstrate the safety and efficacy of our products."

In
addition to Valentis' cardiovascular programs, industry leaders have licensed rights to Valentis' technologies and are utilizing them for the development of therapeutics to treat a
variety of indications including infectious diseases and cancer.

DeltavascAn Angiogenic Product for Cardiovascular Disease

It is estimated that 14 to 18 million people in the United States suffer from peripheral arterial disease. Current treatments for intermittent claudication
are limited due to lack of efficacy and undesirable side effects. The estimated market for a safe and efficacious product to treat intermittent claudication is in excess of $1 billion.

Deltavasc
is an investigational product that incorporates the Developmentally regulated Endothelial cell Locus-1 (Del-1) angiogenesis gene to
stimulate new blood vessel growth. The Del-1 gene is incorporated into a proprietary plasmid and formulated with a proprietary PINC polymer delivery system. It is manufactured
using a proprietary process. The Del-1 protein from this gene plays an important role in the embryonic growth of blood vessels. After birth, Del-1 is involved in the repair of
injured tissue. Del-1 results in new blood vessels that are consistent with natural revascularization resulting in functional, tissue-sustaining blood vessels. As a result,
Deltavasc may have advantages over other therapeutic angiogenesis products in development.

Deltavasc
is currently in Phase II clinical trials in patients with the intermittent claudication (IC) form of peripheral arterial disease (PAD). These patients experience
leg pain with exercise due to poor blood flow in their legs. The strategy for this indication is to grow new vessels in the legs of these patients, restore blood flow and allow a greater capacity for
exercise. The primary endpoint in this trial is improvement in exercise tolerance 90 days after dosing of the product. Valentis expects that results from this Phase II trial will be available
at the end of September 2004.

In
June 2000, Valentis announced that its Deltavasc product elicited development of new blood vessels in studies of rabbits and mice. A single administration of
Deltavasc in muscle had similar effects on development of new blood vessels in rabbit and mouse models as a VEGF165 gene used as a comparator in both studies. Acute toxicities
observed with the VEGF165 gene in dose-response studies were not observed with the Deltavasc at similar doses, suggesting that the Deltavasc may have
safety advantages over VEGF165.

In
June 2001, Valentis initiated a Phase I clinical trial for the Deltavasc product for the treatment of PAD. The goal of this open-label, multi-center,
dose escalation trial was to evaluate safety and to determine the maximum tolerated dose of the Del-1 gene product in patients with PAD, where the patients suffer from a blockage of the
blood vessels in their legs. The secondary objective of the trial was to obtain preliminary efficacy data and evidence of angiogenic activity. For PAD, Valentis' Deltavasc product is
administered by intramuscular injection.

In
the Deltavasc PAD Phase I clinical trial, 27 patients with PAD were enrolled to determine product safety in humans. The patients, divided into seven groups, received
intra-muscular doses of

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product
ranging from 3 to 84 mg administered to a diseased leg. The results of this trial allowed the Company to choose a dose and dosing pattern for the Phase II safety and efficacy trial, which
began in June 2003.

In
June 2003, Valentis presented data from its Phase I clinical trial for the Deltavasc product at a conference. In the trial, there were no observed severe adverse
events from the drug, and Deltavasc was well tolerated at all doses levels tested. Although the number of patients in each dose group was small and the focus of the Phase I trial
was to demonstrate safety, there was an indication of dose and dosing pattern-related product activity as measured by exercise tolerance.

In
July 2003, Valentis announced the initiation of a Phase II clinical trial of its Deltavasc gene product. The trial is randomized, double blind and placebo
controlled. One hundred patients with PAD, specifically intermittent claudication, were randomized to receive either the Deltavasc product or placebo. The trial was conducted in seventeen
centers in the United States. Enrollment was completed on March 30, 2004, and data are expected at the end of September 2004.

If
results of the Phase II clinical trial justify proceeding to a Phase III clinical trial of Deltavasc, because of the size of the potential market for the product and the
number
of possible uses for the product, the Company expects to license it to a pharmaceutical company that will assume responsibility for late-stage development and commercialization.

SCIENTIFIC AND INDUSTRY BACKGROUND

Gene-based therapeutics is an approach to the treatment or prevention of certain diseases in which therapeutic genes are introduced into the body to
cause the production of specific proteins needed to bring about a therapeutic effect. For gene-based therapeutics to be effective, the therapeutic gene must be delivered to, and
transported across, the outer membrane of a targeted cell and into the nucleus where it can be expressed. The expressed protein may remain within the cell for an intracellular effect, be transported
to the cell membrane to exert a cell-surface effect, or be secreted into the bloodstream to have a systemic effect. Most gene-based therapeutics utilize a delivery system, or
vector, into which the therapeutic gene is incorporated to facilitate its delivery to, uptake by and expression in, the target cell.

Genes
provide the instructions or "code" for the productions of proteins, which determine the nature and function of cells and tissues in all living organisms. The study of genes and
their function ("genomics") provides the fundamental basis for understanding human health and disease and has led to the identification of many genes with potential therapeutic utility ("therapeutic
genes").

The
entire genetic content of an organism is known as its genome. In humans, the genome is believed to contain approximately 30,000 genes. These genes encode approximately 100,000
proteins. Proteins enable cells to carry out their normal biological functions. The process by which an organism utilizes genetic instructions and produces proteins is known as gene expression. The
expression of a defective gene, or the defective expression of a normal gene, is responsible for certain disease conditions. For example, the expression of a single defective gene is known to cause
cystic fibrosis and sickle cell anemia, and the defective expression of multiple genes is believed to be involved in the progression of diseases such as cancer, diabetes and cardiovascular and
neurological diseases.

The
worldwide effort to decipher the human genome and to understand the function of its constituent genes is yielding important insights into the roles that genes play in disease
conditions, as well as how genes may be useful in the treatment of such diseases. It is estimated that about 40% of genes have a known function, many of which have been identified as potential
therapeutic genes. Various companies and academic institutions are investing substantial financial and human resources to identify additional therapeutic genes, and Valentis believes that this process
will create future opportunities for gene therapies.

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Gene Delivery Approaches

To date, a limiting factor in gene-based therapeutics has been the lack of safe, effective gene delivery systems. A number of gene delivery approaches
are being developed. These approaches may be categorized by their mode of administration asex vivo(outside the body) orin
vivo(inside the body) and by the nature of the gene delivery system (viral or plasmid-based (synthetic)).

The
first clinical trials of potential gene therapeutics usedex vivoviral gene delivery.Ex
vivogene therapies involve procedures in which selected cells are removed from the patient, transduced with the therapeutic gene, expanded in number, cleansed of contaminants
and then reintroduced into the same patient. This lengthy and labor-intensive process significantly differs from traditional pharmaceutical administration and may result in a complex,
high-cost procedure.

Valentis
is developing its PINC delivery technologies consisting of synthetic, non-toxic, poloxamer (symmetrical block copolymer) delivery systems. Each product
consists primarily of two components: (i) a plasmid DNA (a circular segment of DNA that contains a therapeutic gene and components that regulate its expression in the cell), and
(ii) polymers, which are synthetic, non-viral agents to facilitate the delivery of the plasmid DNA into target cells following intramuscular administration. This traditional mode of
administration is familiar to physicians and may be more convenient and cost effective thanex vivoapproaches.

Valentis
believes its proprietary gene delivery systems have advantages over other gene delivery systems. DNA formulated with our PINC formulations have been shown to
produce high protein levels with decreased variability as compared to protein levels obtained after naked DNA administration. In addition, Valentis' PINC gene delivery systems can be
handled and administered like traditional pharmaceuticals. We have demonstrated that we can produce clinical-grade plasmid DNA and plasmid-based DNA formulations under controlled conditions, and we
have developed proprietary manufacturing and production methods designed to be scaled to meet commercial requirements.

We
have tested our gene delivery systems in hundreds of animal experiments and in clinical trials. Our PINC delivery systems should allow for repeat administration of our
products for the treatment of chronic diseases, such as cardiovascular disease. While the results of preclinical animal studies may not predict safety or efficacy in humans, when further clinical
trials are conducted, Valentis believes that our experience in research and development will enable us to accelerate future development of products, and thereby attract corporate partners.

We
believe our proprietary PINC delivery system may have the following benefits:



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Additional Technologies

Valentis has shown that gene delivery systems containing cationic lipids combined with neutral lipids enhance the cellular uptake of plasmid-based gene expression
systems. These lipid-based gene delivery systems have been demonstrated to enhance the entry of genes into tumor cells after intratumoral administration, and to deliver genes to the endothelium and
epithelium of the lung after intravenous administration and inhalation, respectively. Although the Company is not actively pursuing their use internally, the technologies are being
out-licensed for development by corporate partners.

To
control the level and duration of selected genes in transgenic animals and cell cultures, Valentis researchers have developed the GeneSwitch® gene regulation system. The
GeneSwitch® technology may accelerate the throughput of genomics research because it has the unique ability to control gene expression via an orally administered drug, and to assist in the
identification and characterization of the function of selected genes. This gene expression regulatory system has been licensed to a number of corporate partners who are successfully developing the
technology in a variety of applications.

CORPORATE COLLABORATIONS

Valentis is actively seeking collaborations with pharmaceutical and biotechnology companies. In entering corporate collaborations, Valentis seeks license fees,
funding for research and development, milestone payments and royalties on product sales in exchange for worldwide commercial licenses to specific gene therapeutics and access to our development
expertise. The Deltavasc product is our lead candidate for such collaboration. Also available are our delivery and plasmid expression systems as well as licensing opportunities for our
proprietary manufacturing technologies.

Since
1994, Valentis has experience with corporate research and development collaborations including Roche Holdings Ltd., Boehringer Ingelheim International GmbH, Eli
Lilly & Company and Glaxo Wellcome plc. Also, we have experience with a manufacturing collaborative license agreement with DSM Biologics and cGMP contract manufacturing at Cangene Corporation.

Cangene Corporation ("Cangene")

Since June 2001, Valentis has utilized Cangene Corporation, an established contract manufacturing organization (CMO) for the manufacture of its
Deltavasc product. Also, since October 1999, Valentis has utilized Cangene for final drug product formulation and filling for Deltavasc and other products. Valentis
has developed proprietary scalable processes to manufacture plasmid DNA formulated products. Through a strategy of using a contract manufacturing organization for plasmid DNA production of our
products, we are able to produce drug material from lab to commercial scale using the same process.

DSM Biologics ("DSM")

In September 1998, Valentis and DSM Biologics (formerly Gist-Brocades/Bio-Intermediair) announced the formation of a broad,
strategic collaboration focused on the manufacture and supply of plasmid DNA and formulated DNA to the entire gene therapy industry. In May 1999, Qiagen N.V. joined the manufacturing alliance,
referred to as the pAlliance. The goal of this alliance was to provide the emerging gene therapy and genetic vaccination industry with early access to reliable, accepted plasmid DNA
contract manufacturing services and to produce high-quality, ultra pure material for plasmid-based therapeutics on every scale, from preclinical toxicology studies to commercial products.

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Under
the agreement, Valentis licensed its proprietary manufacturing technology for use in DSM facilities in Montreal, Canada and Groningen, The Netherlands for license and milestone
fees. To date, Valentis has earned $450,000 in milestone fees under this original agreement.

In
June 2003, Valentis announced that it completed an agreement with DSM Biologics under which the license granted by Valentis to DSM Biologics for Valentis' plasmid DNA
manufacturing technology was affirmed on revised financial terms. The agreement further resolved outstanding disputes between Valentis and DSM Biologics regarding prior plasmid DNA manufacturing
services performed by DSM Biologics for Valentis.

Under
the new agreement, the pAlliance plasmid DNA contract manufacturing alliance that had included Valentis, DSM Biologics and Qiagen GmbH was dissolved. The new agreement
reinstated the license to DSM Biologics under the terms of the original agreement between Valentis and DSM Biologics, modified to add a royalty to Valentis (in addition to the previously-agreed
profit-sharing arrangement). In consideration for the license reinstatement, DSM Biologics paid a $1.3 million milestone payment. The milestone payment, net of approximately $0.6 million
of outstanding debt owed to DSM Biologics by Valentis, which had been accrued by Valentis as of June 30, 2002, was received in cash during fiscal 2003. The Company recorded an expense reversal
of approximately $0.5 million during fiscal 2003 for the remaining amount accrued by Valentis as of June 30, 2002, which the Company is no longer obligated to pay to DSM Biologics as a
result of the new agreement.

TECHNOLOGY LICENSES

Valentis has technology license agreements and is actively seeking additional licensing agreements with pharmaceutical and biotechnology companies.

Epimmune Inc. ("Epimmune")

In December 2000, Epimmune licensed Valentis' proprietary PINC gene delivery technology for Epimmune's preventive and therapeutic DNA vaccines
that are in development against the human immunodeficiency virus (HIV) and the hepatitis C virus (HCV) in exchange for up-front, milestone and royalty payments.

In
October 2002, Epimmune Inc. signed a non-exclusive license for Valentis' proprietary DNA vaccine delivery technology for use in developing treatments for
cancer. Under the terms of the agreement, Epimmune has rights to use Valentis' proprietary PINC polymer DNA delivery technology for use in up to four preventive and therapeutic DNA cancer
vaccine products. In return, Valentis received an upfront license fee and will be eligible to receive product development milestones and royalties on future product sales. Epimmune and its
collaborators will fund product development.

Innogenetics N.V. ("Innogenetics")

In June 2002, Valentis' provided Innogenetics N.V. with an option to a license for proprietary DNAVax gene delivery technology for
Innogenetics' preventive and therapeutic DNA vaccines in development against the hepatitis B virus (HBV) and the human papilloma virus (HPV) in exchange for up-front, milestone and royalty
payments.

Innogenetics'
genetic vaccines contain DNA sequences from HBV or HPV, which code for protein fragments (epitopes) that stimulate cytotoxic and helper T cell responses. These immune
responses are important defenses against infection.

In
March 2004, Genencor International, Inc. agreed to sell its therapeutic vaccine program to Innogenetics N.V., which may enhance Innogenetics' capabilities in its
preventive and therapeutic DNA development program.

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Genetronics Biomedical Corp. ("Genetronics")

In November 2001, Valentis obtained a non-exclusive license toin vivoelectroporation
technology from Genetronics for use in the development of certain products. Electroporation enhances the ability of cells to take up large molecules such as DNA. When combined with Valentis'
GeneSwitch® gene regulation system, electroporation allows researchers to control the level and duration of gene expression for up to several months.

Genzyme Corporation ("Genzyme")

In January 2002, Valentis entered into a non-exclusive cross-license agreement with Genzyme Corporation in which Genzyme receives
non-exclusive rights to Valentis' GeneSwitch® gene regulation technology for research use, and Valentis receives certain rights to Genzyme's plasmid DNA manufacturing
technology.

In
September 2004, Valentis expanded its existing license agreement with Genzyme Corp. by granting Genzyme increased use of Valentis' GeneSwitch® gene regulation
technology. In return, Valentis received certain rights to Genzyme's static mixer technologies that are useful in plasmid DNA manufacturing.

Valentis'
GeneSwitch® system allows researchers to control the level and duration of expression of selected genes by oral administration of a small molecule drug. Genzyme
plans to use the GeneSwitch® technology for its internal product research. Genzyme's manufacturing technology allows Valentis to improve the yield of large-scale produced plasmid DNA. The
technology is useful for Valentis' internal manufacturing requirements and potentially for commercial manufacturing.

Invitrogen Corporation ("Invitrogen")

In November 1999, Valentis and Invitrogen Corporation announced the commercial launch of Valentis' proprietary GeneSwitch® gene regulation
system to the life sciences research market. The GeneSwitch® gene regulation system is a technology that allows researchers to control the level and duration of expression of selected
genes by oral administration of a small molecule drug. Valentis recorded minimal royalties from the license agreement with Invitrogen amounting to approximately $2,000, $3,000 and $2,000 for the
periods ended June 30, 2004, 2003 and 2002, respectively.

Juvaris BioTherapeutics ("Juvaris")

In May 2003, Valentis and Juvaris BioTherapeutics entered into a broad, non-exclusive licensing agreement in which Juvaris will use Valentis'
proprietary plasmid backbone and cationic lipid delivery technologies for the development and commercialization of therapeutic vaccine products. Under terms of the agreement, Valentis will receive an
initial cash payment from Juvaris and be eligible for future product development milestones and royalties on sales. Juvaris is responsible for the development, manufacturing and commercialization of
products and bears all related program expenses.

In
June 2004, Valentis and Juvaris entered into an exclusive agreement with increased payments to Valentis.

Prolong Pharmaceuticals ("Prolong")

In February 2003, Valentis entered into a broad licensing agreement with Prolong Pharmaceuticals for use of its proprietary PEGylation technology in the
development and commercialization of PEGylated protein therapeutics. Under terms of the agreement, Valentis received an initial cash payment from Prolong and is eligible for future product development
milestones and royalties on sales. Prolong is responsible for the development, manufacturing and commercialization of products and bears all related program expenses.

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Valentis' GeneSwitch® Gene Regulation System

In July 2001, additional GeneSwitch® technology licenses were completed with Lexicon Genetics and Pfizer. In May 2002, Valentis entered into a
GeneSwitch® technology license with MediGene A.G., which was assigned to LARNAX GmbH in May 2003. All licenses are non-exclusive licenses for research purposes only, and
Valentis maintains all rights to clinical gene therapy applications of the GeneSwitch® technology.

In
January 2003, Valentis expanded its April 2001 license agreement with GlaxoSmithKline for use of the Company's GeneSwitch® gene regulation technology. Under the
terms of the amended non-exclusive license, GlaxoSmithKline will have the ability to use the GeneSwitch® technology for research purposes in all of its facilities for a period
of up to 10 years. In consideration of this expansion, Valentis received a $1 million payment.

Also
in December 2003, Valentis and Schering AG, Germany, signed a multi-product license and option agreement to develop and commercialize gene-based therapeutic products.
Under terms of the agreement, Schering obtained exclusive, world-wide rights to Valentis' PINC polymer based synthetic gene delivery and the GeneSwitch® gene
regulation technologies for use with up to two genes proprietary to Schering, and an option for non-exclusive rights to the PINC technology for a third gene. Schering made an
initial payment of $1.1 million in cash to Valentis in license and option fees.

In
August 2004, Schering paid Valentis an additional $1 million license fee when it elected to exercise its option under the terms of the agreement to develop the
GeneSwitch® gene regulation technology with a second gene proprietary to Schering.

In
fiscal 2004, Valentis had ongoing GeneSwitch® technology licenses. All licenses are non-exclusive licenses for research purposes only, and Valentis maintains
all rights to clinical gene therapy applications of the GeneSwitch® technology.

ACADEMIC LICENSES

Valentis actively monitors, investigates and licenses technologies under development at academic and other research institutions. We believe that such
institutions are an important source of breakthrough technologies, and we intend to enter into additional licensing arrangements to expand our core technologies if suitable resources are available.

Baylor College of Medicine ("Baylor")

Valentis has three license agreements with Baylor College of Medicine pursuant to which Valentis has exclusive and non-exclusive rights to certain
current and future gene therapy technologies related to gene expression, gene delivery and gene regulation, including the GeneSwitch® gene regulation system, and gene delivery to fluid
spaces including the vitreous of the eye and the synovium of the joint. Baylor and Valentis co-developed certain synthetic promoters useful in muscle specific expression. We are required
to pay Baylor a royalty based on amounts received by Valentis for the commercialization of the patented technology. Baylor has the ability to terminate the license for a material violation or material
failure to perform any covenant under the license.

University of Pittsburgh ("Pittsburgh")

Valentis has a license agreement with the University of Pittsburgh for the development of a gene-based therapy intended for the protection of cancer
patients from damage due to toxic species resulting from treatment with radiation or chemotherapy. In particular, under the terms of the license agreement with the University of Pittsburgh (the
Pittsburgh License), Valentis has paid a license fee and will be obligated to pay milestone fees upon completion of certain clinical milestones and royalty payments on sales of products, if any. Also,
under the Pittsburgh License, we have certain diligent

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development
obligations. The Pittsburgh has the ability to terminate the license if we fail to meet the diligence milestones. In addition, the Pittsburgh has the ability to terminate the license for a
material violation or material failure to perform any covenant under the license. This product is currently entering a physician-sponsored Phase I clinical trial for the use of a lipid formulated
MnSOD gene for the protection of normal tissues of the esophagus during radiation treatment for lung cancer.

Stanford University ("Stanford")

Valentis has a license agreement with Stanford University for the development of Nitric Oxide Synthetase ("NOS") gene-based therapies intended to
prevent myointimal hyperplasia following vessel wall injury as well as prevention of leukocyte adherence and NO-dependent vasodilation. Under the terms of the Stanford License, Valentis is
obligated to make payments upon the achievement of certain milestones, to share revenue received from sublicensing, and to make royalty payments on sales of products, if any. Stanford may terminate
the license if we fail to satisfy certain requirements for diligent development of licensed products. In addition, Stanford may terminate the license upon 60 days notice for a material
violation or material failure to perform any covenant under the license.

Vanderbilt University ("Vanderbilt")

Valentis has an exclusive license from Vanderbilt covering Vanderbilt's interest in the Del-1 gene and protein. Valentis acquired the Vanderbilt
License in conjunction with the purchase in April 1999 by Valentis of Del-1 rights held by Progenitor. Rights to patents covering the Del-1 gene and protein are
co-owned by Valentis and Vanderbilt. Under the terms of the Vanderbilt License, Valentis is obligated to make payments upon the achievement of certain milestones, to share revenue received
from sublicensing at a specified rate, and to make royalty payments on sales of products, if any. Vanderbilt may terminate the license if we fail to satisfy certain requirements for diligent
development of licensed products. In addition, Vanderbilt may terminate the license upon 60 days notice for a material violation or material failure to perform any covenant under the license.

PATENTS AND PROPRIETARY TECHNOLOGIES

Patents and other proprietary rights are important to Valentis' business. Our policy is to file patent applications and protect inventions and improvements to
inventions that are commercially important to the development of our business. Valentis also relies on trade secrets, know-how, confidentiality agreements, continuing technology
innovations and licensing opportunities to protect its technology and develop and maintain its competitive position. To date, Valentis has filed, or participated as a licensee in the filing of,
numerous patent applications in the United States relating to our technology, as well as counterparts of certain of these applications in many foreign countries. Our failure to obtain patent
protection or otherwise protect our proprietary technology or proposed products may have a material adverse effect on Valentis' competitive position and business prospects. The patent application
process takes several years and entails considerable expense. There is no assurance that additional patents will issue from these applications or, if patents do issue, that the claims allowed will be
sufficient to protect our technology.

Valentis
has numerous patents and patent applications worldwide covering its gene expression and delivery technology, and PEGylation technology, as well as use patents for various
therapeutic applications, and patents and patent applications on its manufacturing technology. In addition to patents and patent applications filed and owned by Valentis, we have exclusive rights
under our licenses with Baylor College of Medicine, Stanford University, University of Pittsburgh and Vanderbilt University to patents and patent applications worldwide. Valentis has an exclusive
license from Roche Biosciences for rights under certain U.S. and foreign patents claiming the use of the cationic lipids, DOTMA, forin vivogene
delivery. Valentis is also licensed exclusively by Roche Biosciences under a

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single
related U.S. patent claiming the use of cationic lipids forin vivogene delivery without limitations to DOTMA.

A
number of the biopharmaceuticals that Valentis and its corporate partners are investigating, or may use in its products are, or, may become patented by others. As a result, Valentis or
its corporate partners may be required to obtain licenses to gene sequences, proteins, or other technology to which it currently has no proprietary rights in order to use or market such products. In
addition, some of the products based on our delivery systems may require the use of multiple proprietary technologies. Consequently, Valentis or its corporate partners may be required to make
cumulative royalty payments to several third parties. Such cumulative royalties could reduce amounts paid to Valentis or be commercially prohibitive. In connection with our efforts to obtain rights to
gene sequences, proteins, or other proprietary technology, Valentis may find it necessary to convey rights to its technology to others. There can be no assurance that Valentis or its corporate
partners will be able to obtain any required licenses on commercially reasonable terms or at all. If required licenses are not available to Valentis, we may not be able to develop or market certain
products.

The
patent positions of pharmaceutical and biotechnology firms are often uncertain and involve complex legal and factual questions. Furthermore, the breadth of claims allowed in
biotechnology patents is unpredictable. Valentis cannot be certain that others have not filed patent applications for technology covered by our pending applications or that we were the first to invent
the technology that is the subject of such patent applications. Competitors may have filed applications for, or may have received, patents and may obtain additional patents and proprietary rights
relating to compounds, products or processes that block or compete with those of Valentis. Valentis is aware of patent applications filed and patents issued to third parties relating to genes, gene
delivery technologies and gene therapeutics, and there can be no assurance that any patent applications or patents will not have a material adverse effect on products Valentis or its corporate
partners are developing or may seek to develop in the future. There can be no assurance that third parties will not assert patent or other intellectual property infringement claims against Valentis
with respect to its products or technology or other matters.

Patent
litigation is widespread in the biotechnology industry. Litigation may be necessary to defend against or assert claims of infringement, to enforce patents issued to Valentis, to
protect trade secrets or know-how owned or licensed by Valentis, or to determine the scope and validity of the proprietary rights of third parties. Although no third party has asserted
that Valentis is infringing
such third party's patent rights or other intellectual property, there can be no assurance that litigation asserting such claims will not be initiated, that Valentis would prevail in any such
litigation or that Valentis would be able to obtain any necessary licenses on reasonable terms, if at all. Any such claims against Valentis, with or without merit, as well as claims initiated by
Valentis against third parties, can be time-consuming and expensive to defend or prosecute and to resolve. If other companies prepare and file patent applications in the United States that
claim technology also claimed by Valentis, we may have to participate in interference proceedings to determine priority of invention which could result in substantial cost to Valentis even if the
outcome is favorable to us.

There
can be no assurance that third parties will not independently develop equivalent proprietary information or techniques, will not gain access to Valentis' trade secrets or disclose
such technology to the public or that we can maintain and protect unpatented proprietary technology. Valentis typically requires its employees, consultants, collaborators, advisors and corporate
partners to execute confidentiality agreements upon commencement of employment or other relationships with Valentis. There can be no assurance, however, that these agreements will provide meaningful
protection or adequate remedies for Valentis technology in the event of unauthorized use or disclosure of such information, that the parties to such agreements will not breach such agreements or that
Valentis' trade secrets will not otherwise become known or be discovered independently by its competitors. For a description of our current patent litigation, see "Item 3. Legal Proceedings" later in
this document.

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MANUFACTURING AND COMMERCIALIZATION

Valentis' commercialization strategy is based on establishing corporate collaborations with pharmaceutical and biotechnology companies whereby we will primarily
pursue development up through Phase II clinical trials, while our partners will be responsible for late stage clinical trials, sales, marketing and large-scale clinical and commercial manufacturing.

Valentis
intends that its large scale manufacturing of plasmid DNA will be conducted either through contract manufacturing organizations (CMOs) or at our corporate partners' site after
technology transfer. Through previous work at several CMOs, we have demonstrated that we can manufacture plasmid DNA at scales required for clinical trials using conventional and proprietary
fermentation and purification processes. The facilitating agents of Valentis' gene delivery systems can be synthesized using readily scalable, organic synthesis procedures. To date, we have obtained
access to manufacturing of facilitating agents through arrangements with CMOs. Preparation of the final formulations has been carried out at our pilot manufacturing facility and at contract
manufacturers.

Valentis'
intends that manufacturing, if any, of PEGylation products will be conducted with CMOs or at potential corporate partner facilities.

Valentis
itself does not currently operate manufacturing facilities for commercial production of its products. We have no experience in, and currently lack the resources and capability
needed for, the manufacture or marketing of any of our products on a commercial scale. Accordingly, Valentis will be dependent initially on corporate partners, licensees or other third parties for
commercial-scale manufacturing of our products. We are not aware of third parties that have demonstrated sustained large-scale commercial manufacturing of gene therapeutics. There can be no assurance
that our corporate partners will be able to develop adequate manufacturing capabilities for production of commercial-scale quantities of our products.

GOVERNMENT REGULATION

The production and marketing of Valentis' products and our research and development activities are subject to extensive regulation for safety, efficacy and
quality by numerous governmental authorities in the United States and other countries. In the United States, pharmaceutical products are subject to rigorous regulation by the United States Food and
Drug Administration (FDA). We believe that the FDA and comparable foreign regulatory bodies will regulate the commercial uses of our products as biologics. Biologics are regulated under certain
provisions of the Public Health Service Act and the Federal Food, Drug, and Cosmetic Act. These laws and the related regulations govern, among other things, the testing, manufacturing, safety,
efficacy, labeling, storage, record keeping, and the promotion, marketing and distribution of biological products. At the FDA, the Center for Biologics Evaluation and Research is responsible for the
regulation of biological products and has handled the FDA's regulation of most gene therapeutics to date. Gene therapy, however, is a relatively new technology, and it is uncertain whether any unique
regulatory requirements may be imposed upon gene therapeutics. We are not aware of any gene therapeutics that have received marketing approval from the FDA or any comparable foreign authorities.

The
necessary steps to take before a new biological product may be marketed in the United States include the following: (i) laboratory tests and animal studies; (ii) the
submission to the FDA of an Investigational New Drug (IND) application for clinical testing, which must become effective before clinical trials commence; (iii) under certain circumstances,
approval by a special advisory committee convened to review clinical trial protocols involving gene therapeutics; (iv) adequate and well-controlled clinical trials to establish the
safety and efficacy of the product; (v) the submission to the FDA of a Biologics License Application (BLA); and (vi) FDA approval of the BLA prior to any commercial sale or shipment of
the biologic.

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Facilities
used for the manufacture of biologics are subject to periodic inspection by the FDA and other authorities, where applicable, and must comply with the FDA's Good Manufacturing
Practice (GMP) regulations. Manufacturers of biologics also must comply with the FDA's general biological product
standards and may also be subject to state regulation. Failure to comply with GMP or other applicable regulatory requirements may result in withdrawal of marketing approval, criminal prosecution,
civil penalties, recall or seizure of products, warning letters, total or partial suspension of production, suspension of clinical trials, FDA refusal to review pending marketing approval applications
or supplements to approved applications, or injunctions, as well as other legal or regulatory action against Valentis or its corporate partners.

Clinical
trials are conducted in three sequential phases, but the phases may overlap. In Phase I (the initial introduction of the product into human subjects or patients), the drug is
tested to assess safety, metabolism, pharmacokinetics and pharmacological actions associated with increasing doses. Phase II usually involves studies in a limited patient population to
(i) determine the efficacy of the potential product for specific, targeted indications, (ii) determine dosage tolerance and optimal dosage, and (iii) further identify possible
adverse effects and safety risks. If a compound is found to be effective and to have an acceptable safety profile in Phase II evaluations, Phase III trials are undertaken to further evaluate clinical
efficacy and test for safety within a broader patient population at geographically dispersed clinical sites. There can be no assurance that Phase I, Phase II or Phase III testing will be completed
successfully within any specific time period, if at all, with respect to any of Valentis' or its corporate partners' products subject to such testing. In addition, after marketing approval is granted,
the FDA may require post-marketing clinical studies that typically entail extensive patient monitoring and may result in restricted marketing of the product for an extended period of time.

The
results of product development, preclinical animal studies, and human studies are submitted to the FDA as part of the BLA. The BLA must also contain extensive manufacturing
information, and each manufacturing facility must be inspected and approved by the FDA before the BLA will be approved. Similar regulatory approval requirements exist for the marketing of these
products outside the United States (e.g., Europe and Japan). The testing and approval process is likely to require substantial time, effort and financial and human resources, and there can be no
assurance that any approval will be granted on a timely basis, if at all, or that any product developed by Valentis and its corporate partners will prove safe and effective in clinical trials or will
meet all the applicable regulatory requirements necessary to receive marketing approval from the FDA or the comparable regulatory body of other countries. Data obtained from preclinical studies and
clinical trials are subject to interpretations that could delay, limit or prevent regulatory approval. The FDA may deny the BLA if applicable regulatory criteria are not satisfied, require additional
testing or information, or require post-marketing testing and surveillance to monitor the safety or efficacy of a product. Moreover, if regulatory approval of a biological product is
granted, such approval may entail limitations on the indicated uses for which it may be marketed. Finally, product approvals may be withdrawn if compliance with regulatory standards is not maintained
or if problems occur following initial marketing. Among the conditions for BLA approval is the requirement that the prospective manufacturer's quality control and manufacturing procedures conform to
the appropriate GMP regulations, which must be followed at all times. In complying with standards set forth in these regulations, manufacturers must continue to expend time, financial resources and
effort in the area of production and quality control to ensure full compliance.

For
clinical investigation and marketing outside the United States, Valentis and our corporate partners may be subject to FDA as well as regulatory requirements of other countries. The
FDA regulates the export of biological products, whether for clinical investigation or commercial sale. In Europe, the approval process for the commencement of clinical trials varies from country to
country. The regulatory approval process in other countries includes requirements similar to those associated

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with
FDA approval set forth above. Approval by the FDA does not ensure approval by the regulatory authorities of other countries.

Valentis'
research and development processes involve the controlled use of hazardous materials, chemicals and radioactive materials and produce waste products. We are subject to federal,
state and local laws and regulations governing the use, manufacture, storage, handling and disposal of such materials and waste products. Although we believe that our safety procedures for handling
and disposing of such materials comply with the standards prescribed by such laws and regulations, the risk of accidental contamination or injury from these materials cannot be eliminated completely.
In the event of such an accident, Valentis could be held liable for any damages that result, and any such liability could exceed our resources. Although we believe that we are in compliance in all
material respects with applicable environmental laws and regulations, there can be no assurance that we will not be required to incur significant costs to comply with environmental laws and
regulations in the future or that any of the operations, business or assets of Valentis will not be materially adversely affected by current or future environmental laws or regulations.

COMPETITION

Gene delivery and gene-based therapeutics are relatively new, rapidly evolving areas of science in which significant and unexpected technological
advances are likely. Rapid technological development could result in our products or technologies becoming obsolete before we recover a significant portion of our related research, development and
capital expenditures. We are aware that several pharmaceutical and biotechnology companies are actively engaged in research and development in areas related to gene therapy or have commenced clinical
trials of gene therapeutics. Many of these companies are addressing diseases that have been targeted by Valentis or our corporate partners. Valentis also may experience competition from companies that
have acquired or may acquire gene technology from universities and other research institutions. As competitors develop their technologies, they may develop proprietary positions in certain aspects of
gene delivery and gene therapeutics that may materially and adversely affect us. In addition, we face and will continue to face competition from other companies for corporate collaborations with
pharmaceutical and biotechnology companies, for establishing relationships with academic and research institutions and for licenses to proprietary technology, including intellectual property related
to gene delivery systems. Corporate partners may also elect to internally develop gene therapeutics that compete with our products. Lastly, other companies are developing non-gene
therapies to treat these same diseases.

The
pharmaceutical and biotechnology industries are highly competitive. We are aware of several pharmaceutical and biotechnology companies that are pursuing gene-based
therapeutics For example, we are aware that AnGes MG, Aventis Pharma SA, Avigen, Inc., Cell Genesys, Inc., Corautus Genetics, Daiichi Pharmaceutical Corporation, Gencell SAS,
GenVec, Inc., Introgen Therapeutics, Inc., Schering AG, Targeted Genetics Corp., and Vical Inc. are also engaged in developing gene-based therapies. Many of these
companies are addressing diseases that have been targeted by us directly or through our corporate partners, and many of them may have more experience in these areas.

We
also face competition from biotechnology and pharmaceutical companies using more traditional approaches to treating human diseases. Our competitors may develop safer, more effective
or less costly biologic delivery systems, gene-based therapeutics or chemical-based therapies. In addition, competitors may achieve superior patent protection or obtain regulatory approval
or product commercialization earlier than we do.

Many
of our competitors and potential competitors have substantially greater product development capabilities and financial, scientific, manufacturing, managerial and human resources
than Valentis. There can be no assurance that research and development by others will not render our gene delivery systems, or the products developed by corporate partners using our gene delivery
systems obsolete, or

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non-competitive,
or that any product we or our corporate partners develop will be preferred to any existing or newly developed technologies. In addition, there can be no assurance that our
competitors will not develop safer, more effective or less costly gene delivery systems, gene therapeutics, non-gene therapies, or other therapies, achieve superior patent protection or
obtain regulatory approval or product commercialization earlier than Valentis, any of which could have a material adverse effect on our business, financial condition or results of operations.

PRODUCT LIABILITY INSURANCE

The manufacture and sale of human therapeutic products involve an inherent risk of product liability claims and associated adverse publicity. Valentis currently
has only limited product liability insurance, and there can be no assurance that we will be able to maintain existing or obtain additional product liability insurance on acceptable terms or with
adequate coverage against potential liabilities. Such insurance is expensive, difficult to obtain and may not be available in the future on acceptable terms, or at all. An inability to obtain
sufficient insurance coverage on reasonable terms or to otherwise protect against potential product liability claims could prevent or inhibit the commercialization of products by Valentis. A product
liability claim brought against us in excess of our insurance coverage, if any, or a product withdrawal, could have a material adverse effect upon our business, financial condition and results of
operations.

EMPLOYEES

As of September 10, 2004, Valentis employed 22 individuals full-time, including 6 who hold doctoral degrees. Of our total work force, 16
employees are engaged in or directly support research and development activities, and 6 are engaged in business development, finance and administrative activities. Valentis employees are not
represented by a collective bargaining agreement. We believe our relationships with our employees are good.

ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS

The following risk factors outline certain risks and uncertainties concerning future results and should be read in conjunction with the information contained in
this Annual Report on Form 10-K. Any of these risk factors could materially and adversely affect our business, operating results financial condition and the future growth prospects.
Additional risks and uncertainties not presently known to us, or those we currently deem immaterial, may also materially harm our business, operating results financial condition and future growth
prospects.

Our products are subject to regulatory approval by the FDA and others, including with regard to completion of our clinical trials, which is expensive,
time consuming and uncertain, and failure to obtain regulatory approval may cause us to delay or withdraw the introduction of our products and could materially adversely affect our business and
prospects.

We are subject to significant regulatory requirements, including the successful completion of clinical trials, prior to the commercialization of our products.
Under the Federal Food, Drug and Cosmetic Act, the Public Health Services Act, and related regulations, the Food and Drug Administration, or FDA, regulates the development, clinical testing,
manufacture, labeling, sale, distribution and promotion of drugs and biologics in the United States. Prior to market introduction in the United States, a potential drug or biological product must
undergo rigorous clinical trials that meet the requirements of the FDA in order to demonstrate safety and efficacy in humans. Depending upon the type, novelty and effects of the drug and the nature of
the disease or disorder to be treated, the FDA approval process can take several years, require extensive clinical testing and result in significant expenditures.

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Our lead product, Deltavasc is currently undergoing Phase II clinical trials in the United States, and based on the completion of patient enrollment in March 2004, we
expect the results from that Phase II clinical trial to be available at the end of September 2004. Deltavasc is a novel cardiovascular product designed to grow new blood vessels in
patients suffering from peripheral arterial disease and will require significant additional clinical testing. Clinical trials and the FDA approval process are long, expensive and uncertain processes,
which require substantial time effort and financial and human resources.

We
have limited experience in conducting clinical trials, and we may encounter problems or fail to demonstrate the efficacy or safety that cause us to delay, suspend or terminate the
development of our Deltavasc product. Although Deltavasc was well tolerated at all dose levels tested and there was an indication of dose and dosing pattern-related product
activity as measured by exercise tolerance during the Phase I trials, Deltavasc may fail to show the desired safety and efficacy despite having progressed through initial clinical
trials. Even if we successfully complete Phase II clinical trials of our Deltavasc product, the FDA will require additional Phase III clinical testing of
Deltavasc, which involve significantly greater resources, commitments and expertise that may require us to enter into a collaborative relationship with a pharmaceutical company that would
assume responsibility for late-stage development and commercialization.

This
process may take a number of years. We cannot assure you that our clinical testing will be completed within any specific time period, if at all. There can be no assurance that any
FDA approval will be granted on a timely basis, if at all, or that any of our products will prove safe and effective in all required clinical trials or will meet all applicable regulatory requirements
necessary to receive marketing approval from the FDA. In addition, after marketing approval is granted, we may be required to conduct post-marketing clinical studies that typically entail
extensive patient monitoring and may also result in restricted marketing of our product or products for an extended period of time.

Even
if we successfully obtain FDA approval, we may not be able to obtain the regulatory approvals necessary to market our Deltavasc and other products outside the United
States since the commercialization of our products outside the United States will be subject to separate regulations imposed by foreign government agencies. The approval procedures for marketing
outside the United States vary among countries and can involve additional testing. Accordingly, we cannot predict with any certainty how long it will take or how much it will cost to obtain regulatory
approvals for manufacturing and marketing our products within and outside the United States or whether we will be able to obtain those regulatory approvals at all. Our failure to successfully complete
our clinical trials, obtain FDA and any applicable foreign government approvals or any delays in receipt of such approvals could have a material effect on our business, results of operations and
financial condition.

We are dependent on the successful outcomes of clinical trials of our products, particularly the Deltavasc Phase II outcome, which is
expected at the end of September 2004, and we cannot assure you that any clinical testing will demonstrate the safety and efficacy of our products.

In order to introduce and market our products, we must be able to, among other things, demonstrate safety and efficacy with substantial evidence from
well-controlled clinical trials. We are currently supporting, in particular, the ongoing Deltavasc Phase II clinical trial, among other clinical trials. The
Deltavasc clinical trial is a multi-center, placebo-controlled, randomized trial conducted at approximately 17 centers in the United States. This is our most advanced clinical program and
represents a substantial portion of our clinical development activities. The clinical trial is a study performed within the regulations and guidelines of the FDA, regarding whether patients suffering
from peripheral arterial disease can increase blood flow to their legs after being treated with Deltavasc compared to patients given the placebo. Should the Deltavasc PAD
Phase II clinical trial fail to demonstrate a statistically significant drug effect and that it is safe for the targeted patient population, our business and prospects could be harmed and the
market price of our common stock could fall. The

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failure
of the Phase II clinical trial to demonstrate the safety and efficacy of our Deltavasc product could materially and adversely affect our ability to commercialize our
Deltavasc product, if at all. If the future results of any clinical trial regarding our products, including our Deltavasc product, fail to validate the safety and
effectiveness of treatments using our products, our ability to generate revenues from those products could be adversely affected, delayed or prevented entirely and our business could be harmed. In
addition, we may not be able to obtain additional financing on acceptable terms, or at all. Any failure to obtain an adequate and timely amount of additional capital on commercially reasonable terms
may have a material adverse effect on our business and financial condition, including our viability as an enterprise. As a result of these concerns, management may pursue strategic alternatives, which
may include the sale or merger of the business, the sale of certain assets or other actions.

The results of early Phase I and Phase II clinical trials are based on a small number of patients over a short period of time, and our success may not
be indicative of results in a large number of patients or long-term efficacy.

The results in early phases of clinical testing are based upon limited numbers of patients and a limited follow-up period. For example, the results
from the Phase II clinical trial of our Deltavasc product are expected to be available at the end of September 2004. The primary end point of the trial is improvement of exercise
tolerance measured at 90 days. Typically, our Phase I clinical trials for indications of safety enroll less than 50 patients. Our Phase II clinical trials for efficacy typically enroll
approximately 100 patients. Actual results with more data points may not confirm favorable results from our earlier stage trials. A number of companies in the pharmaceutical and biotechnology
industries have suffered significant setbacks in late stage clinical trials even after
achieving promising results in earlier stage clinical trials. In addition, we do not yet know if early results will have a lasting effect. If a larger population of patients does not experience
positive results, or if these results do not have a lasting effect, our products may not receive approval from the FDA. Failure to demonstrate the safety and effectiveness of our gene based products,
including our Deltavasc product in larger patient populations could have a material adverse effect on our business that would cause our stock price to decline significantly.

We have received a "going concern" opinion from our independent auditors, which may negatively impact our business.

We have received a report from our independent auditors regarding the consolidated financial statements for the fiscal year ended June 30, 2004 that
included an explanatory paragraph which stated that the financial statements have been prepared assuming we will continue as a going concern. The explanatory paragraph stated that our recurring
operating losses and need for additional financing have raised substantial doubt about our ability to continue as a going concern. Any failure to dispel any continuing doubts about our ability to
continue as a going concern could adversely affect our ability to enter into collaborative relationships with business partners and our ability to sell our products and could have a material adverse
effect on our business, financial condition and results of operations.

Adverse events in the field of gene therapy may negatively impact regulatory approval or public perception of our potential products.

The death in 2000 of a patient undergoing a physician-sponsored, viral-based gene therapy trial has been widely publicized. Following this death and publicity
surrounding the field of gene therapy, the FDA appears to have become more restrictive regarding the conduct of gene therapy clinical trials. This approach by the FDA can lead to delays in the
timelines for regulatory review, as well as potential delays in the conduct of our gene therapy clinical trials. In addition, the negative publicity around the field of gene therapy appears to have
affected patients' willingness to participate in some gene therapy

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clinical
trials. If fewer patients are willing to participate in our clinical trials, the timelines for recruiting patients and conducting the trials will be delayed. The commercial success of our
potential products will depend in part on public acceptance of the use of gene therapy for the prevention or treatment of human diseases. Negative public reaction to gene therapy in general could
result in stricter labeling requirements of gene therapy products, including any of our products, and could cause a decrease in the demand for products we may develop.

Our stock price has been and may continue to be volatile and an investment in our common stock could suffer a decline in value.

The trading price of the shares of our common stock has been and may continue to be highly volatile. We receive only limited attention by securities analysts and
may experience an imbalance between supply and demand for our common stock resulting from low trading volumes. The market price of our common stock may fluctuate significantly in response to a variety
of factors, most of which are beyond our control, including the following:



The
stock market has, from time to time, experienced extreme price and volume fluctuations, which have particularly affected the market prices for emerging biotechnology and
biopharmaceutical companies and which have often been unrelated to their operating performance. These broad market fluctuations may adversely affect the market price of our common stock. In addition,
sales of substantial amounts of our common stock in the public market could lower the market price of our common stock.

Our stock price could be adversely affected by dispositions of our shares pursuant to registration statements currently in effect.

Some of our current stockholders hold a substantial number of shares, which they are currently able to sell in the public market under certain registration
statements currently in effect, or otherwise. Sales of a substantial number of our shares or the perception that these sales may occur, could cause the trading price of our common stock to fall and
could impair our ability to raise capital through the sale of additional equity securities.

As
of September 14, 2004, we had issued and outstanding 13,089,006 shares of our common stock. This amount does not include, as of September 14, 2004:



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These
shares of common stock, if and when issued, may be sold in the public market assuming the applicable registration statements continue to remain effective and subject in any case to
trading restrictions to which our insiders holding such shares may be subject from time to time. If these options or warrants are exercised and sold, our stockholders may experience additional
dilution and the market price of our common stock could fall.

We must be able to continue to secure additional financing in order to continue our operations, which might not be available or which, if available, may
be on terms that are not favorable to us.

The continued development and clinical testing of our potential products will require substantial additional financial resources. Our future funding requirements
will depend on many factors, including:



We
may have insufficient working capital to fund our cash needs unless we are able to raise additional capital in the future. We have financed our operations to date primarily through
the sale of equity securities and through corporate collaborations. We do not anticipate generating revenues for the foreseeable future and may be required fund our operations through additional third
party financing. If we raise additional funds by issuing equity securities, substantial dilution to existing stockholders may result. We may not be able to obtain additional financing on acceptable
terms, or at all. Any failure to obtain an adequate and timely amount of additional capital on commercially reasonable terms will have a material adverse effect on our business, financial condition
and results of operations.

We
may also take actions to conserve our cash resources through reductions in our personnel, delaying or scaling back our development programs or relinquishing greater or all rights to
products at an earlier stage of development or on less favorable terms than we otherwise would. Any or all of these actions could have a material adverse affect on our business.

The future success of our business depends on our ability to attract and retain corporate partners to develop, introduce and market our gene therapy and
other products.

Our business strategy is to attract business partners to fund or conduct research and development, clinical trials, manufacturing, marketing and sales of our gene
therapy and other products. We currently have no corporate partners for our Deltavasc product, and may be required to enter into a collaborative relationship with a pharmaceutical company
with significantly greater resources than we have in order to continue to develop, if at all, our Deltavasc product, as well as introduce and market our Deltavasc product. We
face intense competition from many other companies in the pharmaceutical and biotechnology industry for corporate collaborations, as well as for establishing

21

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relationships
with academic and research institutions and for obtaining licenses to proprietary technology. If we are unable to attract and retain corporate partners to develop, introduce and market
our products, our business may be materially and adversely affected.

Our
strategy and any reliance on corporate partners, if we are able to establish such collaborative relationships, are subject to additional risks. Our partners may not devote sufficient
resources to the development, introduction and marketing of our products or may not pursue further development and commercialization of products resulting from collaborations with us. If a corporate
partner elects to terminate its relationship with us, our ability to develop, introduce and market our products may be significantly impaired and we may be forced to discontinue the product
altogether. We may not be able to negotiate alternative corporate partnership agreements on acceptable terms, if at all. The failure of any future collaboration efforts could have a material adverse
effect on our ability to develop, introduce and market our products and, consequently, could have a material adverse effect on our business, results of operations and financial condition.

We have a history of losses and may never be profitable.

We have engaged in research and development activities since our inception. We incurred losses from operations of approximately $6.5 million,
$15.7 million and $34.5 million, for our fiscal years ended June 30, 2004, 2003 and 2002, respectively. As of June 30, 2004, we had an accumulated deficit totaling
approximately $213.6 million. The development and sale of our products will require completion of clinical trials and significant additional research and development activities. We expect to
incur net losses for the foreseeable future as we continue with the research, development and commercialization of our gene-based products, including our Deltavasc product.
Our ability to achieve profitability depends on successful completion of clinical trials, our additional research and development efforts, our ability to successfully commercially introduce our
products, market acceptance of our products, the competitive position of our products and the other risk factors set forth in this report. Even if we do achieve profitability, we may not be able to
sustain or increase profitability on a quarterly or annual basis.

Our ability to achieve profitability depends upon our research and development efforts and whether we can successfully develop and commercially
introduce our products, which may never result in successful products.

Our future success is dependent upon, among other factors, our ability to develop working products, including our Deltavasc product, successful
completion of clinical trials, our ability to commercially introduce our products and the competitive position of our products. All of our potential products currently are in research, preclinical
development or the early stages of clinical testing, and commercialization of those products will not occur for at least the next several years, if at all. The development of new drugs is a highly
risky undertaking and there can be no assurance that our research and development efforts will be successful. Gene therapeutics is a new field and may not lead to commercially viable pharmaceutical
products. All of our products will require extensive additional research and development prior to any commercial introduction. If our product and development efforts are unsuccessful, we may not
achieve profitability and our results of operations and business would be adversely affected.

We face strong competition in our market and competition from alternative treatments in the biopharmaceuticals market.

The pharmaceutical and biotechnology industries are highly competitive. We are aware of several pharmaceutical and biotechnology companies that are pursuing
gene-based therapeutics. For example, we are aware that AnGes MG, Aventis Pharma SA, Avigen, Inc., Cell Genesys, Inc., Corautus Genetics, Daiichi Pharmaceutical Corporation,
Gencell SAS, GenVec, Inc., Introgen Therapeutics, Inc., Schering AG, Targeted Genetics Corp., and Vical Inc. are also engaged in developing gene-based

22

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therapies.
Many of these companies are addressing diseases that have been targeted by us directly or indirectly. Our competitive position depends on a number of factors, including safety, efficacy,
reliability, marketing and sales efforts, the existence of competing products and treatments and general economic conditions. Some competitors have substantially greater financial, research, product
development, manufacturing, marketing and technical resources than we do. Some companies also have greater name recognition than us and long-standing collaborative relationships. In
addition, gene therapy is a new and rapidly evolving field and is expected to continue to undergo significant and rapid technological change, which could render our products obsolete.

We
also face competition from biotechnology and pharmaceutical companies using more traditional approaches to treating human diseases. Our competitors, academic and research institutions
or others may develop safer, more effective or less costly biologic delivery systems, gene-based therapeutics or chemical-based therapies. In addition, competitors may achieve superior
patent protection or obtain regulatory approval or product commercialization earlier than we do. Any such developments could seriously harm our business, financial condition and results of operations.

If we are unable to obtain rights to proprietary genes, proteins or other technologies, we will be unable to operate our business.

Our gene-based products involve multiple component technologies, many of which may be patented by others. For example, our products use gene
sequences, some of which have been, or may be, patented by others. As a result, we may be required to obtain licenses to those gene sequences, proteins or other technologies. We may not be able to
obtain a license to those technologies on reasonable terms, if at all. As a consequence, we might be prohibited from developing potential products or we might have to make cumulative royalty payments
to several companies. These cumulative royalties would reduce amounts paid to us or could make our products too expensive to develop or market.

We rely on patents and other proprietary rights to protect our intellectual property and any inability to protect our intellectual property rights would
adversely impact our business.

We rely on a combination of patents, trade secrets, trademarks, proprietary know-how, nondisclosure and other contractual agreements and technical
measures to protect our intellectual property rights. We file patent applications to protect processes, practices and techniques related to our gene-therapy products that are significant
to the development of our business. We have been issued 58 United States patents and 73 foreign patents on the technologies related to our products and processes. We have approximately 19 pending
patent applications in the United States and 71 foreign pending patent applications. Our patent applications may not be approved. Any patents granted now or in the future may offer only limited
protection against potential infringement and development by our competitors of competing products. Moreover, our competitors, many of which have substantial resources and have made substantial
investments in competing technologies, may seek to apply for and obtain patents that will prevent, limit or interfere with our ability to make, use or sell our products either in the United States or
in international markets.

In
addition to patents, we rely on trade secrets and proprietary know-how, which we seek to protect, in part, through proprietary information agreements with employees,
consultants and other parties. Our proprietary information agreements with our employees and consultants contain industry standard provisions requiring such individuals to assign to us, without
additional consideration, any intellectual property conceived or reduced to practice by them while employed or retained by us, subject to customary exceptions. Proprietary information agreements with
employees, consultants and others may be breached, and we may not have adequate remedies for any breach. Also, our trade secrets may become known to, or independently developed by, competitors. Any
failure to protect our

23

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intellectual
property would significantly impair our competitive position and adversely affect our results of operations and business.

We could become subject to litigation regarding our intellectual property rights, which could seriously harm our business.

In previous years, there has been significant litigation in the United States involving patents and other intellectual property rights. Competitors in the
biotechnology industry may use intellectual property litigation against us to gain advantage. In the future, we may be a party to litigation to protect our intellectual property or as a result of an
alleged infringement of others' intellectual property. These claims and any resulting lawsuit, if successful, could subject us to significant liability for damages and invalidation of our proprietary
rights. Any potential intellectual property litigation, if successful, also could force us to stop selling, incorporating or using our products that use the challenged intellectual property; obtain
from the owner of the infringed intellectual property right a license to sell or use the
relevant technology, which license may not be available on reasonable terms, or at all; or redesign our products that use the technology. We may also be required in the future to initiate claims or
litigation against third parties for infringement of our intellectual property rights to protect these rights or determine the scope or validity of our intellectual property or the rights of our
competitors. The pursuit of these claims could result in significant expenditures and the diversion of our technical and management personnel. If we are forced to take any of these actions, our
business may be seriously harmed.

Any
claims, with or without merit, and regardless of whether we prevail in the dispute, would be time-consuming, could result in costly litigation and the diversion of
technical and management personnel and could require us to develop non-infringing technology or to enter into royalty or licensing agreements. An adverse determination in a judicial or
administrative proceeding and failure to obtain necessary licenses or develop alternate technologies could prevent us from developing and selling our products, which would have a material adverse
effect on our business, results of operations and financial condition.

We must rely on our partners to demonstrate large-scale manufacturing capabilities in order to be successful.

Our limited cGMP manufacturing experience makes our ability to successfully introduce our potential products more difficult than it would be otherwise. Although
we have a license agreement with DSM Biologics (DSM) for manufacturing and supplying plasmid DNA to the gene therapy industry, neither DSM nor any third party has successfully manufactured plasmid DNA
on a sustained large-scale commercial basis. We will depend on our contract manufacturing organization (CMO), Cangene Corporation (Cangene), another CMO or a future corporate partner for
commercial-scale manufacturing of our products. Cangene and/or our corporate partners may be unable to develop adequate manufacturing capabilities for commercial-scale quantities of gene products. If
Cangene or third parties are unable to establish and maintain large scale manufacturing capabilities, we will be unable to introduce sufficient products to sustain our business.

We may experience delays in the commercial introduction, manufacture or regulatory approval of our products as a result of failures by our contract
manufacturers to comply with FDA manufacturing practices and requirements.

Drug-manufacturing facilities regulated by the FDA must comply with the FDA's good manufacturing practice regulations, which include quality control
and quality assurance requirements, as well as maintenance of records and documentation. Manufacturers of biologics also must comply with the FDA's general biological product standards and may be
subject to state regulation as well. Such manufacturing facilities are subject to ongoing periodic inspections by the FDA and corresponding state agencies, including unannounced inspections, and must
be licensed as part of the product approval

24

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process
before being utilized for commercial manufacturing. Noncompliance with the applicable requirements can result in, among other things, fines, injunctions, civil penalties, recall or seizure of
products, total or partial suspension of production, withdrawal of marketing approvals, and criminal prosecution. Any of these actions by the FDA would materially and adversely affect our ability to
continue clinical trials and adversely affect our business. We cannot assure you that our contract manufacturers will attain or maintain compliance with current or future good manufacturing practice
requirements. As we have experienced, the failure of our contract manufacturer to comply with good manufacturing practice requirements could cause significant delay of important clinical trials. For
example, in August 2001, we discovered manufacturing issues at our contract manufacturer that resulted in a delay in our Deltavasc peripheral arterial disease, or PAD, clinical
trial. When we discovered the issues, we postponed enrollment in the clinical trial until we could fully assess their impact. We also informed the FDA of the issues. On September 19, 2001, the
FDA placed a clinical hold on our Deltavasc PAD clinical trial. On February 12, 2002, the FDA allowed us to proceed with our PAD safety trial using newly manufactured material.
Since that time, we have had new material manufactured at another manufacturing site. If we were to discover other problems, the FDA could suspend or further delay our clinical trials, the commercial
introduction and manufacture of our products or place restrictions on our ability to conduct clinical trials or commercialize our products, including the mandatory withdrawal of the product from the
clinical trials.

Our research and development processes involve the controlled use of hazardous materials, chemicals and radioactive materials and produce waste products
that could subject us to unanticipated environmental liability and would adversely affect our results of operations.

Our research and development processes involve the controlled use of hazardous materials, chemicals and radioactive materials and produce waste products. We are
subject to federal, state and local environmental laws and regulations governing the use, manufacture, storage, handling and disposal of such materials and waste products. Although we believe that our
safety procedures for handling and disposing of such materials comply with the standards prescribed by such laws and regulations, the risk of accidental contamination or injury from these materials
cannot be eliminated completely. In the event of such an accident, we could be held liable for any damages that result, and any such liability could exceed our resources. Although we believe that we
are in compliance in all material respects with
applicable environmental laws and regulations, there can be no assurance that we will not be required to incur significant costs to comply with environmental laws and regulations in the future or that
any of our operations, business or assets will not be materially adversely affected by current or future environmental laws or regulations.

We depend on key personnel to develop our products and, if we are unable to hire additional personnel due to the intense competition in the Bay Area and
other obstacles in recruiting qualified personnel for key management, scientific and technical positions, our business may suffer.

Our ability to attract and retain management, scientific and technical staff to develop our potential products and formulate our research and development strategy
is a critical factor in determining whether we will be successful in the future. The San Francisco Bay Area, where our corporate headquarters and clinical development center is located, is home to a
large number of biotechnology and pharmaceutical companies, and there is a limited number of qualified individuals to fill key scientific and technical positions. Competition for highly skilled
personnel is intense and we may not be successful in attracting and hiring qualified personnel to fulfill our current or future needs.

Although
we have programs in place to retain personnel, including programs to create a positive work environment and competitive compensation packages, none of our officers or key
employees are bound by an employment agreement for any specific term and these individuals may terminate their employment at any time. Our future success depends upon the continued services of our
executive

25

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officers
and other key scientific, marketing, manufacturing and support personnel. As of September 10, 2004, we had a total of 22 full-time employees, including 16 employees
supporting our research and development efforts. We do not have "key person" life insurance policies covering any of our employees and the loss of services of any of our key employees would adversely
affect our business. Additionally, after the corporate reorganization announced in January 2002 that resulted in the termination of 47 positions and the subsequent corporate reorganization
announced in October 2002 that resulted in the termination of 34 positions, it may be more difficult for us to recruit personnel in the future. If we do not attract and retain qualified
personnel, our research and development programs could be delayed, which could materially and adversely affect the development of our products and our business.

There are no assurances that we can maintain our listing on The Nasdaq SmallCap Market and the failure to maintain listing could adversely affect the
liquidity and price of our common stock.

On January 31, 2003, our common stock began trading on The Nasdaq SmallCap Market pursuant to an exception from delisting. Nasdaq has notified us that in
the event we fail to demonstrate compliance, as
well as an ability to sustain compliance, with all requirements for continued listing on The Nasdaq SmallCap Market, including Nasdaq's corporate governance criteria, our securities will be delisted
from The Nasdaq Stock Market. If our securities are delisted from The Nasdaq Stock Market, the trading of our common stock is likely to be conducted on the OTC Bulletin Board. The delisting of our
common stock from The Nasdaq SmallCap Market will result in decreased liquidity of our outstanding shares of common stock and a resulting inability of our stockholders to sell our common stock or
obtain accurate quotations as to their market value, which would reduce the price at which our shares trade. The delisting of our common stock could also deter broker-dealers from making a market in
or otherwise generating interest in our common stock and would adversely affect our ability to attract investors in our common stock. Furthermore, our ability to raise additional capital would be
severely impaired. As a result of these factors, the value of the common stock would decline significantly, and our stockholders could lose some or all of their investment.

The concentration of ownership among our executive officers, directors and their affiliates may delay or prevent a change in our corporate control.

Our executive officers, directors and their affiliates beneficially own or control in excess of approximately 25% of outstanding common shares, warrants or
options to purchase common stock, with over approximately 15% of outstanding common shares, warrants and options to purchase common stock held by two such entities, Perseus-Soros BioPharmaceutical
Fund, L.P. and Diaz & Altschul Capital Management, LLC. As a result, these stockholders will be able to exercise significant control over all matters requiring stockholder approval, including
the election of directors and approval of significant corporate transactions, which could delay or prevent an outside party from acquiring or merging with us, which could in turn reduce our stock
price.

If we fail to manage growth effectively, our business could be disrupted, which could harm our operating results.

If any of our products successfully complete clinical trials and receive FDA approval, we may experience growth in our business. We must be prepared to expand our
workforce and to train, motivate and manage additional employees as the need for additional personnel arises. Failure to attract and retain sufficient numbers of additional employees could impede our
growth. In addition, our ability to manage our growth effectively could require us to make significant investments and expenditures to enhance our operational, management and financial infrastructure,
information systems and procedures. Any failure to effectively manage future growth could have a material adverse effect on our business, results of operations and financial condition.

26

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If our facilities were to experience an earthquake or other catastrophic loss, our operations would be seriously harmed.

Our facilities could be subject to a catastrophic loss such as fire, flood or earthquake. All of our research and development activities, our corporate
headquarters and other critical business operations are located near major earthquake faults in Burlingame, California. Any such loss at any of our facilities could disrupt our operations, delay
development of our products and result in large expense to repair and replace our facilities. We currently do not maintain insurance policies protecting against catastrophic loss, except for fire
insurance with coverage amounts normally obtained in our industry.

ITEM 2. PROPERTIES

As of September 2004, Valentis leases approximately 45,000 square feet in Burlingame, California (The Burlingame Facility), which was fully occupied as of
June 30, 2004. The facilities have been built to Valentis' specifications to accommodate our laboratory, support and administrative needs and include manufacturing facilities designed to supply
material required for preclinical research and development and initial clinical trials.

As
a result of its restructuring (see Note 14 "Corporate Restructuring" in our Notes to Consolidated Financial Statements), the Company exited The Woodlands facility in
June 2003. In September 2003, the Company entered into a lease termination agreement with the landlord of The Woodlands facility. Pursuant to the lease termination agreement, The
Woodlands facility lease was terminated on September 4, 2003, and on the same date, the Company paid to the landlord a termination fee of (i) a cash payment of $232,000 and
(ii) the issuance of 185,000 shares of the Company's common stock, together with certain registration rights for, and the Company's option to repurchase, those shares.

In
addition, the Company exited 7,500 square feet of the Burlingame facility in October 2003 pursuant to a lease termination agreement with the landlord of the Burlingame
facility, executed in July 2003. In consideration for the lease termination, the Company paid to the landlord a cash termination fee of $115,000.

The
term of the lease for approximately 35,000 square feet at the Burlingame Facility expires in 2006, at which time Valentis has options to renew the lease for up to an additional
period of six years. An additional 10,600 square feet of the Burlingame Facility has been built-out for use as a pilot manufacturing facility. The term of the lease for this portion of the
facility expires in 2007, at which time Valentis has the option to renew the lease for an additional period of five years.

Valentis
believes that its facilities are adequate to meet its needs for the foreseeable future. Should it need additional space, management believes it will be able to secure such space
on reasonable terms.

ITEM 3. LEGAL PROCEEDINGS

In July 2003, PolyMASC Pharmaceuticals plc, a wholly owned subsidiary of Valentis, Inc., announced that it settled its patent infringement
litigation against ALZA Corporation, a unit of Johnson & Johnson. Under the settlement, PolyMASC received $6.5 million, and granted a worldwide license to ALZA under its
PEG-liposome patents. The agreement settles pending patent infringement litigation in the United States and Germany, as well as Opposition proceedings in Japan and before the European
Patent Office.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not Applicable.

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PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS

The Company's common stock trades on the Nasdaq SmallCap Market under the symbol "VLTS." The following table sets forth, for the calendar periods indicated, the
high and low sales prices of the common stock reported by Nasdaq.

High

Low2001First Quarter

$
260.70

$
133.20Second Quarter


212.40


108.90Third Quarter


185.70


81.00Fourth Quarter


135.00


67.502002First Quarter


112.50


39.60Second Quarter


99.90


37.80Third Quarter


47.10


8.10Fourth Quarter


12.0


3.002003First Quarter


7.20


3.15Second Quarter


5.40


2.45Third Quarter


4.05


2.00Fourth Quarter


2.25


3.452004First Quarter


8.44


2.60Second Quarter


7.95


3.75Third Quarter (through September 14, 2004)


10.43


4.83


On
September 14, 2004 the last sale price reported on the Nasdaq SmallCap Market for Valentis' common stock was $6.07 per share. At that date, there were approximately 533
stockholders of record of our common stock.

During
the period covered by this Annual Report on Form 10-K, we sold and issued the following securities, which were not registered under the Securities Act of 1933:

In
December 2003 and January 2004, pursuant to the terms of a securities purchase agreement, we issued and sold a total of 4,878,047 shares of our common stock at a
purchase price of $2.05 per share
and warrants to purchase 1,951,212 shares of our common stock with an exercise price of $3.00 per shares to a group of accredited investors, for gross proceeds to us of approximately
$10.0 million. The sale of our common stock and warrants was exempt from the registration requirements pursuant to under the Securities Act and all of the securities were issued and sold solely
to accredited investors, as defined in Rule 501 of Regulation D pursuant to the Securities Act.

In
June 2004, pursuant to the terms of a securities purchase agreement, we issued and sold a total of 2,234,779 shares of our common stock and warrants to purchase 670,431 shares
of our common stock to a group of accredited investors at a combined unit price of $5.4075 per unit, for aggregate gross cash proceeds to us of approximately $12.03 million. The warrant issued
to each purchaser is exercisable for up to 30% of the number of shares of our common stock purchased at an exercise price equal to $6.98 per share. In addition, we issued a warrants exercisable for up
to 223,478 shares of our common stock at an exercise price of $5.4075 per share and warrants exercisable for up to 110,000

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shares
of our common stock at an exercise price of $6.98 per share. The issuance of our common stock and warrants was exempt from the registration requirements pursuant to under the Securities Act and
all of the securities were issued solely to accredited investors, as defined in Rule 501 of Regulation D pursuant to the Securities Act.

Valentis
has never paid any cash dividends on its common stock.

Information
regarding securities authorized for issuance under the Company's equity compensation plans will be included in our definitive Proxy Statement with respect to our 2004 Annual
Meeting of Stockholders, under the caption "Equity Compensation Plan Information", and is hereby incorporated by reference.

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ITEM 6. SELECTED FINANCIAL DATA

The data set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the
Consolidated Financial Statements and related Notes included elsewhere in this report.

|                                                                                         |                                                                      | Year Ended June 30, |       
|---------------------------------------------------------------------------------------- | -------------------------------------------------------------------- | ------------------- | ------
|
|
|Consolidated Statements of Operations Data:                                              |                                                                      |                     |       
|Collaborative research and development revenue                                           |                                                                      | $                   |      
|License and milestone revenue                                                            |                                                                      |                     | 7,284 
|Other revenue                                                                            |                                                                      |                     | 194   
|                                                                                         |                                                                      |                     |       
|                                                                                         | Total revenue                                                        |                     |       
|Operating expenses:                                                                      |                                                                      |                     |       
|                                                                                         | Research and development                                             |                     |       
|                                                                                         | General and administrative                                           |                     |       
|                                                                                         | Restructuring charges                                                |                     |       
|                                                                                         | Acquired in-process research and development                         |                     |       
|                                                                                         | Amortization of goodwill and other acquired intangible assets        |                     |       
|                                                                                         |                                                                      |                     |       
|                                                                                         | Total operating expenses                                             |                     |       
|                                                                                         |                                                                      |                     |       
|                                                                                         | Loss from operations                                                 |                     |       
|Other income and interest expense, net                                                   |                                                                      |                     | 4     
|                                                                                         |                                                                      |                     |       
|Net loss                                                                                 |                                                                      |                     | (6,484
|Deemed dividend                                                                          |                                                                      |                     |      
|Adjustment resulting from the reduction in the Series A Preferred stock conversion price |                                                                      |                     |      
|Dividends on convertible preferred stock                                                 |                                                                      |                     |      
|                                                                                         |                                                                      |                     |       
|Net loss applicable to common stockholders                                               |                                                                      | $                   | (6,484
|                                                                                         |                                                                      |                     |       
|Basic and diluted net loss per share applicable to common stockholders                   |                                                                      | $                   | (0.81 
|                                                                                         |                                                                      |                     |       
|                                                                                         | Shares used in computing basic and diluted net loss per common share |                     |       
|                                                                                         |                                                                      |                     |       

|                                 |                                                     | June 30, |  
|-------------------------------- | --------------------------------------------------- | -------- | -
|
|
|Consolidated Balance Sheet Data: |                                                     |          |  
|                                 | Cash, cash equivalents and short-term investments   |          | $
|                                 | Working capital                                     |          |  
|                                 | Total assets                                        |          |  
|                                 | Long-term debt                                      |          |  
|                                 | Convertible redeemable preferred stock              |          |  
|                                 | Accumulated deficit                                 |          |  
|                                 | Total stockholders' equity (net capital deficiency) |          |  

30

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The discussion in"Management's Discussion and Analysis of Financial Condition and Results
of Operations" contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as
amended. These forward-looking statements include, without limitation, statements containing the words "believes," "anticipates," "expects," "intends," "projects," and other words of similar import or
the negative of those terms or expressions. Forward-looking statements in this section include, but are not limited to, expectations of future
levels of research and development spending, general and administrative spending, levels of capital expenditures and operating results, and our intention to seek revenue from the licensing of our
proprietary manufacturing technologies. Forward-looking statements subject to certain known and unknown risks, uncertainties and other factors that may cause our actual results, performance or
achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Factors that could affect our actual results
include the early stage of Deltavasc development, uncertainties related to the timing of completing clinical trials, the need for additional capital and whether clinical trial results
will validate and support the safety and efficacy of our Deltavasc product. Further, there can be no assurance that the necessary regulatory approvals will be obtained, that we will be
able to develop commercially viable gene-based product or that any of our programs will be partnered with pharmaceutical partners. Actual results may differ materially from those projected
in such forward-looking statements as a result of the "Additional Factors That May Affect Future Results" described previously and other risks detailed in our reports filed with the Securities and
Exchange Commission. We undertake no obligation to revise or update any such forward-looking statements.

COMPANY OVERVIEW

Valentis is creating innovative cardiovascular therapeutics. We begin our product development at the stage of a gene or protein with known activity and apply our
expertise in formulation, manufacturing, clinical development and regulatory affairs to create products that fill unmet medical needs.

Valentis
has a series of technologies ranging from gene delivery and expression technologies to proprietary formulation and manufacturing technologies that allow us to generate novel
therapeutics to treat a wide range of diseases. While Valentis is focusing its efforts on the development of novel cardiovascular therapeutics, its technologies are being applied by its collaborators
for the development of therapeutics to treat a variety of indications including infectious diseases and cancer.

Deltavasc,
the Company's lead product, is based on the Developmentally regulated Endothelial cell Locus-1 (Del-1) angiogenesis gene formulated with a
Valentis proprietary PINC polymer delivery system. Deltavasc is currently in Phase II clinical trials in patients with the intermittent claudication (IC) form of peripheral
arterial disease (PAD). The primary endpoint in this trial is improvement in exercise tolerance 90 days after dosing of the product. Valentis expects that results from this Phase II
trial will be available at the end of September 2004. A positive outcome for the clinical trial demonstrating a statistically significant drug effect and safety for use in the targeted
population is critical to the continued development of Deltavasc. A negative trial outcome could have a material and adverse effect on the further development of Deltavasc,
negatively affect Valentis' ability to raise additional financing on acceptable terms, if at all, negatively impact our business and prospects and cause the price of our common stock to fall. See
"Additional Factors That May Affect Future Results" for a description of the risks related to our product development efforts, including
risks with regard to the Deltavasc PAD Phase II clinical trial.

If
results of the Phase II clinical trial justify proceeding to a Phase III clinical trial of Deltavasc, because of the size of the potential market for the product and the
number of possible uses for the

31

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product,
the Valentis expects to license it to a pharmaceutical company that will assume responsibility for late-stage development and commercialization.

Results of Operations

Fiscal Years Ended June 30, 2004, 2003 and 2002

Revenue

Revenue recognized in the fiscal years ended June 30, 2004, 2003 and 2002 is as follows (in thousands):

|                                                |                                                        | Year ended June 30,
|----------------------------------------------- | ------------------------------------------------------ | -------------------
|
|Collaborative research and development revenue: |                                                        |                    
|                                                | Roche Holdings, Ltd.                                   |                    
|                                                |                                                        |                    
|                                                |                                                        |                    
|License and milestone revenue:                  |                                                        |                    
|                                                | GeneSwitch® licenses                                   |                    
|                                                | DNAVax gene delivery technology license and milestone |                    
|                                                | PINC gene delivery technology licenses                |                    
|                                                | Manufacturing technology milestone                     |                    
|                                                | PEGylation technology licenses                         |                    
|                                                |                                                        |                    
|                                                |                                                        |                    
|Other Revenue                                   |                                                        |                    
|                                                |                                                        |                    
|Total Revenue                                   |                                                        | $                  
|                                                |                                                        |                    

Changes
in revenue for each of the fiscal years ended June 30, 2004, 2003 and 2002 are explained below:



32

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Revenue
derived from corporate collaborations and licenses helps us fund our operations and may increase in the future if we are successful in establishing new collaborations and
additional licensing of our technology. We expect revenue to decline in fiscal 2005 compared to fiscal 2004 due to the recognition of the non-recurring license revenue from ALZA in fiscal
2004. If we are unsuccessful in establishing new collaborations, additional licensing and grants, revenues may decline. Therefore, a reduction in revenue funds for conducting our research and
development, clinical trial, manufacturing, marketing and sales efforts may occur.

Expenses

Research and development expenses were $10.1 million, $10.0 million and $23.7 million for the fiscal years ended June 30, 2004, 2003
and 2002, respectively. The increase in expenses in fiscal 2004 compared to 2003 primarily reflects increased clinical trial expenses for the Deltavasc PAD Phase II clinical trial, which
was initiated in July 2003. The increase was partially offset by decreased expenses resulting from staff reductions in October 2002. The decrease in expenses in fiscal 2003 compared to
2002 was primarily attributable to staff reductions and savings resulting from the reduction of preclinical product development efforts and suspension of clinical programs in oncology in
January 2002, and lower expenditures resulting from the further reduction of staff in October 2002. Valentis expects its total annual research and development expenses to increase in the
future reflecting expanded manufacturing and clinical trial expenses associated with advancing the Deltavasc PAD product to Phase III clinical testing. However, research and development
expenses may increase or decrease depending on the outcome of the Deltavasc PAD Phase II clinical trial and if the Company is successful in securing additional new funding and strategic
partnerships to support increased spending levels. The results of the trial are expected at the end of September 2004.

The
scope and magnitude of future research and development expenses are difficult to predict at this time given the number of studies that will need to be conducted for any of our
potential products. In general, biopharmaceutical development involves a series of stepsbeginning with identification of a potential target and including, among others, proof of concept
in animal studies and Phase I, II, and III clinical studies in humanseach of which is typically more expensive than the previous step. Our research and development expenses currently
include costs for scientific personnel, animal studies, supplies, equipment, consultants, patent filings, overhead allocation, human clinical trials and sponsored research at academic and research
institutions.

General
and administrative expenses were $3.9 million, $8.9 million and $7.9 million for the fiscal years ended June 30, 2004, 2003 and 2002, respectively.
The decrease in expenses in fiscal 2004 compared to 2003 and 2002 was attributable primarily to savings resulting from staff reductions in October and January 2002, and lower clinical support
costs as a result of reductions in preclinical product development and suspended clinical programs in oncology in January 2002. The decrease in expenses in fiscal 2004 compared to 2003 was also
related in large part to reduced professional fees and other expenses discussed in the following sentence. The increase in fiscal 2003 compared to fiscal 2002 was primarily attributable to increased
professional fees resulting from the Company's capital restructuring efforts, the patent infringement lawsuit with ALZA Corporation and lease exit expenses in fiscal 2003, partially offset by savings
resulting from the reduction of general and administrative staff associated with our restructuring actions. We expect our annual general and administrative expenses to

33

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increase
in the future reflecting support of expanded manufacturing and clinical trial activities associated with advancing the Deltavasc PAD product to Phase III clinical testing and
expenses associated with increased corporate governance principally associated with Sarbanes-Oxley. However, general and administrative expenses may increase or decrease depending on the outcome of
the Deltavasc PAD Phase II clinical trial and if the Company is successful in securing additional new funding and strategic partnerships to support increased spending levels.

Valentis
recorded $4.9 million for amortization of goodwill and other acquired intangible assets during fiscal 2002, which is associated with the acquisitions of GeneMedicine in
fiscal 1999 and PolyMASC in fiscal 2000. We adopted Statement of Financial Accounting Standards No. 142, ("SFAS 142") "Goodwill and Other Intangible Assets" on July 1, 2002. As of
June 30, 2004 and 2003, the Company had goodwill of approximately $409,000, which is no longer being amortized but is subject to an impairment analysis on at least an annual basis in accordance
with the requirements of SFAS 142. We performed the required impairment analyses during fiscal 2003 and fiscal 2004, and determined that goodwill was not impaired.

Corporate Restructuring

In conjunction with the Company's announcement in January 2002 that it would suspend clinical development of its cancer immunotherapy products, Valentis
implemented a restructuring plan to better align the Company's cost structure with market conditions. This plan significantly reduced the Company's preclinical product development efforts and
suspended its clinical programs in oncology in an effort to lower future expenditures and conserve cash. A total of 47 positions, primarily in preclinical and manufacturing research and development,
and associated general and administrative staff, were eliminated as a result of the restructuring. For the fiscal year ended June 30, 2002, we recorded restructuring and related charges of
approximately $1.8 million.

On
October 8, 2002, the Company announced that it had further reduced its staff and planned expenditures to allow it to continue the development of its lead product,
Del-1 for the
treatment of a variety of cardiovascular diseases including peripheral arterial disease (PAD) and ischemic heart disease (IHD). In addition, the Company will continue to advance its the
GeneSwitch® gene regulation technology through the licensing to other companies. In connection therewith, the Company reduced staff by 34 individuals in order to reduce the Company's cash
expenditures. For the fiscal year ended June 30, 2003, we recorded restructuring and related charges of approximately $832,000.

Interest Income and Other Income and Expense, net

Interest income and other income and expense, net was approximately $4,000, $0.8 million and $1.4 million in fiscal 2004, 2003 and 2002,
respectively. The decrease in interest income and interest expense and other, net in fiscal 2004 compared to 2003, as well as 2003 compared to 2002, resulted primarily from decreased interest income
derived from lower investment balances, partially offset by decreased interest expense derived form lower loan balances and favorable foreign currency exchange rates. Interest expense for fiscal 2004,
2003 and 2002 were approximately zero, $9,000 and $112,000, respectively.

Deemed Dividends Related to Series A Redeemable Convertible Preferred Stock

The deemed dividends related to Series A redeemable convertible preferred stock (see Note 11 "Redeemable Convertible Preferred Stock and
Stockholders' Equity" in our Notes to Consolidated Financial Statements) include the accretion of warrants, the accretion of a beneficial conversion feature and the accretion of related issuance
costs.

Upon
conversion of the Series A preferred stock to common stock in January 2003, the remaining $3.5 million of unaccreted deemed dividend representing the balance of
amounts attributed to common stock purchase warrants, beneficial conversion feature and issuance costs related to the Series A

34

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preferred
stock was fully accreted and recorded as a deemed dividend and included in the amounts discussed in the paragraphs below related to accretion of the warrants, beneficial conversion feature
and issuance costs. This deemed dividend, along with a deemed dividend of approximately $200,000 accreted during January 2003, was included in the calculation of net loss applicable to common
stockholders for the fiscal year ended June 30, 2003.

The
accretion of warrants for the fiscal years ended June 30, 2003 and 2002 was approximately $3.3 million and $1.7 million, respectively. The accretion of the
beneficial conversion feature for the
fiscal years ended June 30, 2003 and 2002 was approximately $592,000 and $314,000, respectively. The aggregate accretion value associated with the warrants and beneficial conversion feature
were included in the calculation of net loss applicable to common stockholders.

Issuance
costs of approximately $1.9 million were accounted for as a discount on the Series A preferred stock and were accreted over the 3.5-year redemption
period. Accretion of approximately $1.0 million and $550,000 for the fiscal years ended June 30, 2003 and 2002, respectively, was included in the calculation of net loss applicable to
common stockholders.

Additionally,
as a result of the simultaneous conversion of the Series A preferred stock to common stock and the reduction in the Series A preferred stock conversion price,
the excess of the fair value of the common stock issued to the Series A preferred stockholders over the fair value of the common stock issuable pursuant to the original conversion terms was
approximately $22.3 million. This amount also was included in the calculation of net loss applicable to common stockholders for the fiscal year ended June 30, 2003.

Dividends on Series A Redeemable Convertible Preferred Stock

Dividends on the Series A preferred stock (see Note 11 "Redeemable Convertible Preferred Stock and Stockholders' Equity" in our Notes to
Consolidated Financial Statements) were calculated at value at the rate of 5% per annum, and were approximately $882,000 and $1.6 million for the fiscal years ended June 30, 2003 and
2002, respectively, and were charged against additional-paid-in-capital and included in the calculation of net loss applicable to common stockholders. There were no
dividends paid on the Series A preferred stock during fiscal 2004 because all of the outstanding shares of Series A preferred stock were converted into common stock in
January 2003.

New Accounting Pronouncements

In November 2002, the FASB issued Emerging Issues Task Force Issue No. 00-21 ("EITF 00-21"), Revenue Arrangements with
Multiple Deliverables. EITF 00-21 addresses certain aspects of the accounting by a company for arrangements under which it will perform multiple revenue- generating activities. EITF
00-21 addresses when and how an arrangement involving multiple deliverables should be divided into separate units of accounting. The provisions of EITF 00-21l apply to revenue
arrangements entered into in fiscal periods beginning after June 15, 2003. The Company's adoption of EITF 00-21 did not have a material impact on our results of operations,
financial position or cash flows.

In
May 2003, the FASB issued Statement No. 150 ("FAS 150"), Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.
FAS 150 establish standards on the classification and measurement of financial instruments with characteristics of both liabilities and equity. FAS 150 is effective for financial
instruments entered into or modified after May 31, 2003. The Company's adoption of FAS 150 did not have a material impact on our results of operations, financial position or cash flows.

35

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Liquidity and Capital Resources

As discussed elsewhere in this report, including further below, we have received a report from our independent auditors regarding the consolidated financial
statements for the fiscal year ended June 30, 2004 that includes an explanatory paragraph stating that the financial statements have been prepared assuming Valentis will continue as a going
concern. The explanatory paragraph states the following conditions which raise substantial doubt about our ability to continue as a going concern: (i) we have incurred recurring operating
losses since inception, including a net loss of $6.5 million for the fiscal year ended June 30, 2004, and our accumulated deficit was $213.6 million at June 30, 2004 and
(ii) we anticipate requiring additional financial resources to enable us to fund our operations at least through June 30, 2005. Management's plans as to these matters are also described
in Note 1 to the consolidated financial statements.

Since
its inception, Valentis has financed its operations principally through public and private issuances of its common and preferred stock and funding from collaborative arrangements.

In
June 2004, we completed a private placement, in which we issued and sold 2,234,779 shares of common stock and warrants, exercisable for a five-year period, to
purchase 670,431 shares of common stock at $5.4075 per unit, resulting in net proceeds of approximately $11.2 million. The warrants are exercisable at $6.98 per share. In addition, we issued to
Jefferies & Company, Inc., the placement agent of the private placement, warrants to purchase 223,478 shares of common stock at $5.4075 per share, exercisable for a five-year
period ("June 2004 Private Placement").

In
January 2004, we completed a private placement of 4,878,047 shares of common stock at $2.05 per share along with warrants, exercisable for a five-year period, to
purchase 1,951,220 shares of common stock at $3.00 per share, resulting in net proceeds of approximately $9.4 million ("January 2004 Private Placement").

Pursuant
to a purchase agreement under the January 2004 Private Placement, in the event that we issue additional shares of common stock within one year of the closing in certain
non-exempt transactions for a price less than the average of the closing bid prices per share of its common stock on the Nasdaq SmallCap Market during the 5 trading days immediately
preceding such issuance (the "Threshold Price"), then we will be obligated to issue additional shares to the purchasers of our common stock and warrants in the January 2004 Private Placement. We will
not receive any proceeds from the issuance of these additional shares. The number of these additional shares which would be
issuable to each purchaser under this provision would be equal to the difference between the purchase price of $2.05 per share and the Threshold Price, divided by the Threshold Price, multiplied by
the number of shares of our common stock the purchaser has purchased in the January 2004 Private Placement. In addition, in that event, the exercise price of the warrants would be proportionally
reduced. The shares of our common stock and warrants issued in the January 2004 Private Placement, as well as the shares issuable upon exercise of the warrants are restricted securities as that term
is defined in the Securities Act of 1933, as amended.

We
entered into registration rights agreements with the purchasers in the January 2004 Private Placement and the June 2004 Private Placement. Pursuant to the registration
rights agreements, we filed with the Securities and Exchange Commission registration statements related to the shares issued to the purchasers and shares issuable upon the exercise of the warrants
under the private placements. The registration statements were declared effective by the Securities and Exchange Commission on March 4, 2004, and August 13, 2004 for the shares issued to
the purchasers and shares issuable upon the exercise of the warrants under the January 2004 Private Placement and the June 2004 Private Placement, respectively.

In
the event we must suspend use of the registration statements for greater than 20 consecutive days or a total of 40 days in the aggregate during the time we are required to keep
the registration

36

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statement
effective under the registration rights agreements, then we must pay to each purchaser in cash 1.0% of the purchaser's aggregate purchase price of the shares for the first month, as well as
an additional 1.5% of the purchaser's aggregate purchase price for each additional month thereafter, while the use of the registration statements has been suspended. We currently expect to be required
to maintain availability of the registration statement for at least two years following the closing. In addition, if we issue any additional shares under the antidilution provisions of the
January 2004 Private Placement's purchase agreement, we would be required to register those shares as well.

In
July 2003, our wholly owned subsidiary, PolyMASC Pharmaceuticals plc, announced that it settled its patent infringement litigation against ALZA Corporation, a unit of
Johnson & Johnson. Under the settlement, PolyMASC received $6.5 million, and granted a worldwide license to ALZA under its PEG-liposome patents. The agreement settles pending
patent infringement litigation in the United States and Germany, as well as Opposition proceedings in Japan and before the European Patent Office.

We
have used and expect to continue to use the net proceeds from the sale of the common stock for general corporate purposes, which may include funding research, development and product
manufacturing, increasing our working capital, reducing indebtedness, acquisitions or investments in businesses, products or technologies that are complementary to our own, and capital expenditures.

We
lease our facilities and under operating leases. These leases expire between November 2006 and October 2007 with renewal options at the end of the initial terms of the
facilities leases.

Minimal
annual rental commitments under the operating leases at June 30, 2004 are as follows (in thousands):

Fiscal Year ended June 30,2005

$
9142006


1,1772007


6502008


65$
2,806


Our
capital expenditures were $7,000 in fiscal 2004, $31,000 in fiscal 2003 and $136,000 in fiscal 2002. We expect our capital expenditures to increase in the future reflecting expanded
manufacturing and clinical trial expenses associated with advancing the Deltavasc PAD product to Phase III clinical testing. However, capital expenditures may increase or decrease
depending on the outcome of the Deltavasc PAD Phase II clinical trial at the end of September 2004 and if we are successful in securing additional new funding and strategic
partnerships to support increased spending levels.

Net
cash used in operating activities decreased approximately $11.7 million and $24.5 million to approximately $3.9 million in fiscal 2004 compared to fiscal 2003
and fiscal 2002, respectively. The decreases were primarily attributable to the decreased net losses and lower cash disbursements resulting from staff reductions in January and October 2002,
and decreased legal expenses due to the resolution of the patent infringement litigation against ALZA. These decreases were offset in part by increased clinical trial expenditures.

Net
cash used in investing activities was approximately $10.9 million for the fiscal year ended June 30, 2004, which primarily related to the purchases of marketable
securities. Net cash provided by investing activities was approximately $8.2 million and $15.4 million for the fiscal year ended June 30, 2003 and 2002, respectively, which
primarily reflects the maturities of available-for-sale investments.

Net
cash provided by financing activities was approximately $21.1 million for the fiscal year ended June 30, 2004, which consisted primarily of net proceeds received from
the private placements of

37

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common
stock completed in January and June 2004. Net cash used in financing activities was approximately $498,000 for the fiscal year ended June 30, 2003, which related primarily to the
payments of preferred stock dividends. Net cash provided by financing activities was approximately $10.6 million for the fiscal year ended June 30, 2002, which consisted primarily of net
proceeds received from the underwritten public offering of our common stock in December 2001, partially offset set by payments on long-term debt.

Except
for the quarter ended September 30, 2003, in which we reported net income of approximately $3.4 million resulting principally from the $6.5 million
non-recurring license revenue recognized under the license and settlement agreement with ALZA Corporation (see Note 15), we have experienced net losses since our inception through
June 30, 2004, and reported a net loss of $6.5 million for the fiscal year ended June 30, 2004. Our accumulated deficit was $213.6 million at June 30, 2004. We
expect such losses to continue into the foreseeable future as we proceed with the research, development and commercialization of our technologies. Depending on the outcome of the
Deltavasc PAD Phase II clinical trial at the end of September 2004, spending levels for research and development and general and administrative expenses may increase above current
levels, to reflect increases in manufacturing and clinical trial efforts to advance the Deltavasc PAD product to Phase III testing. At June 30, 2004, we had $20.5 million in
cash, cash equivalents and investments, and we anticipate that we will require additional financial resources to advance Deltavasc and continue our planned operations at least through
June 30, 2005.

We
are currently supporting the ongoing Deltavasc Phase II clinical trial. This multicenter, randomized, placebo-controlled clinical trial conducted at approximately
17 centers in the United States is a study performed within the FDA regulations and guidelines regarding whether patients suffering from peripheral arterial disease can increase blood flow in their
legs after being treated with Deltavasc compared to patients given the placebo. The results of the Phase II trial are expected at the end of September 2004. Should the
outcome of the Deltavasc PAD Phase II clinical trial demonstrate a statistically significant drug effect and is safe for the targeted population, we may seek additional financing
and pursue corporate partners, to advance Deltavasc PAD to Phase III clinical testing. Should the outcome of the Deltavasc PAD Phase II clinical trial fail to
demonstrate a statistically significant drug effect and is safe for the targeted population, our business and reputation could be harmed and the market price of our Common Stock could fall. We may not
be able to obtain additional financing and pursue corporate partners on acceptable terms, or at all. Any failure to obtain an adequate and timely amount of additional capital on commercially
reasonable terms may have a material adverse
effect on our business, financial condition and results of operations, including our viability as an enterprise. As a result of these concerns, management may pursue strategic alternatives, which may
include the sale of securities, the sale or merger of the business, the sale of certain assets or other actions.

The
accompanying consolidated financial statements have been prepared assuming that we will continue as a going concern. The financial statements do not include any adjustments to
reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the matters discussed above.

Critical Accounting Policies



Valentis believes the accrual for clinical trial expense represents its most significant estimate used in the preparation of the consolidated financial
statements. Valentis' accruals for clinical trial expenses are based in part on estimates of services received and efforts expended pursuant to agreements established with clinical research
organizations and clinical trial sites. We have a history of contracting with third parties that perform various clinical trial activities on behalf of the Company in the ongoing

38

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development
of our biopharmaceutical drugs. The financial terms of these contracts are subject to negotiations and may vary from contract to contract and may result in uneven payment flows. The
Company determines its estimates through discussion with internal clinical personnel and outside service providers as to progress or stage of completion of trials or services and the agreed upon fee
to be paid for such services. The objective of Valentis' clinical trial accrual policy is to reflect the appropriate trial expenses in our financial statements by matching period expenses with period
services and efforts expended. In the event of early termination of a clinical trial, we accrue expenses associated with an estimate of the remaining, non-cancelable obligations associated
with the winding down of the trial. Our estimates and assumptions for clinical trial expenses have been reasonably accurate in the past.



Revenue arrangements with multiple elements are divided into separate units of accounting if certain criteria are met, including whether the delivered item has
value to the customer on a stand-alone basis and whether there is objective and reliable evidence of the fair value of the undelivered items. Consideration received is allocated among the separate
units of accounting based on their respective fair values, and the applicable revenue recognition criteria are considered separately for each of the separate units.

Non-refundable
up-front payments received in connection with research and development collaboration agreements, including technology advancement funding that is
intended for the development of the Company's core technology, are deferred and recognized on a straight-line basis over the relevant periods specified in the agreement, generally the
research term.

Revenue
related to collaborative research with the Company's corporate collaborators is recognized as research services are performed over the related funding periods for each contract.
Under these agreements, the Company is required to perform research and development activities as specified in each respective agreement. The payments received under each respective agreement are not
refundable and are generally based on a contractual cost per full-time equivalent employee working on the project. Research and development expenses under the collaborative research
agreements approximate or exceed the revenue recognized under such agreements over the terms of the respective agreements. Deferred revenue may result when the Company does not incur the required
level of effort during a specific period in comparison to funds received under the respective contracts. Payments received relative to substantive, at-risk incentive milestones, if any,
are recognized as revenue upon achievement of the incentive milestone event because the Company has no future performance obligations related to the payment. Incentive milestone payments are triggered
either by results of the Company's research efforts or by events external to the Company, such as regulatory approval to market a product.

The
Company also has licensed technology to various biotechnology and pharmaceutical companies. Under these arrangements, the Company receives nonrefundable license payments in cash.
These payments are recognized as revenue when received, provided the Company has no future performance or delivery obligations under these agreements. Otherwise, revenue is deferred until performance
or delivery is satisfied. Certain of these license agreements also provide the licensee an option to acquire additional licenses or technology rights for a fixed period of time. Fees received for such
options are deferred and recognized at the time the option is exercised or expires unexercised. Additionally, certain of these license agreements involve technology that the Company has licensed or
otherwise acquired through arrangements with third parties pursuant to which the Company is required to pay a royalty equal to a fixed percentage of amounts received by the Company as a result of
licensing this technology to others. Such royalty obligations are recorded as a reduction of the related revenue.

39

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Valentis' exposure to market risk for changes in interest rates relates primarily to our investment portfolio. We maintain a strict investment policy that ensures
the safety and preservation of invested funds by limiting default risk, market risk, and reinvestment risk. Our cash and cash equivalents consist of cash and money market accounts. Our investments
consist primarily of commercial paper, medium term notes, U.S. Treasury notes and obligations of U.S. Government agencies and corporate bonds. The table below presents notional amounts and related
weighted-average interest rates by calendar year of maturity for our investment portfolio (in thousands, except percentages).

|                                                 |              | 2004 |        | 2005  |  
|------------------------------------------------ | ------------ | ---- | ------ | ----- | -
|Cash equivalents                                 |              |      |        |       |  
|                                                 | Fixed rate   |      | $      | 8,798 |  
|                                                 | Average rate |      |        | 1.40  | %
|Short-term investments                           |              |      |        |       |  
|                                                 | Fixed rate   |      | $      | 6,086 |  
|                                                 | Average rate |      |        | 1.25  | %
|                                                 |              |      |        |       |  
|Total cash equivalents and investment securities |              | $    | 14,884 |       | $
|Average rate                                     |              |      | 1.34   | %     |  

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Valentis' Financial Statements and notes thereto appear on pages 47 to 70 of this Annual Report on Form 10-K.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

Not Applicable.

ITEM 9A. CONTROLS AND PROCEDURES

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company's Exchange Act
reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and that such information is accumulated and
communicated to the Company's management, including its Chief Executive Officer and principal finance and accounting officer, as appropriate, to allow timely decisions regarding required disclosure.
In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable
assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and
procedures.

Our
management have evaluated, with the participation of our Chief Executive Officer, who is our principal executive officer, and our Senior Director of Finance and Controller, who is
our principal financial officer, the effectiveness of our "disclosure controls and procedures" (as defined in Rules 13a-15(e) and 15(d)-15(e) of the Securities and
Exchange Act of 1934, as amended) as of the end of the period covered by this Annual Report on Form 10-K. Based on that evaluation, our Chief Executive Officer and our Senior
Director of Finance and Controller concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under
the Securities and Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commission rules and forms.

40

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There
have been no significant changes in the Company's internal controls over financial reporting during the Company's most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the Company's internal controls over financial reporting.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by this item concerning our directors and executive officers is incorporated by reference from Valentis' definitive proxy statement to be
filed not later than 120 days following the close of the fiscal year (the "Definitive Proxy Statement").

ITEM 11. EXECUTIVE COMPENSATION

The information required by this item is hereby incorporated by reference from the Definitive Proxy Statement.

ITEM 12. SECURITY OWNERSHIP CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by this item is hereby incorporated by reference from the Definitive Proxy Statement.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this item is hereby incorporated by reference from the Definitive Proxy Statement.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required by this item is hereby incorporated by reference from the Definitive Proxy Statement.

41

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PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a)(1)    Index
to Financial Statements

The
Financial Statements and report of independent auditors required by this item are submitted in a separate section beginning on page 47 of this Report.

Page No.Report of Ernst & Young LLP, Independent Registered Public Accounting Firm

47Consolidated Balance Sheets

48Consolidated Statements of Operations

49Consolidated Statement of Redeemable Convertible Preferred Stock and Stockholders' Equity (Net Capital Deficiency)

50Consolidated Statements of Cash Flows

51Notes to Consolidated Financial Statements

52


(a)(2)    No
schedules have been filed, as they were not required or are inapplicable and therefore have been omitted.

(a)(3)    Exhibits

|Exhibit
Footnote |  | Exhibit
Number |  | Description of Document                                                                                                          
|---------------- |  | -------------- |  | ---------------------------------------------------------------------------------------------------------------------------------
|(12)             |  | 3.1            |  | Amended and Restated Certificate of Incorporation of the Registrant.                                                             
|(1)              |  | 3.2            |  | Bylaws of the Registrant.                                                                                                        
|(5)              |  | 3.3            |  | Certificate of Designations of Series A Convertible Redeemable Preferred Stock.                                                  
|(6)              |  | 3.4            |  | Certificate of Amendment to the Bylaws of the Registrant.                                                                        
|                 |  | 4.1            |  | Reference is made to Exhibits 3.1 and 3.2.                                                                                       
|(1)              |  | 4.2            |  | Specimen stock certificate.                                                                                                      
|(1)              |  | 4.3            |  | Amended and Restated Investor Rights Agreement, dated as of May 23, 1997, between the Registrant and the investors named therein.
|(1)              |  | 4.4            |  | Preferred Stock Warrant issued to Imperial Bank, dated June 1, 1995.                                                             
|(1)              |  | 4.5            |  | Series C Preferred Stock Warrant issued to Phoenix Leasing Incorporated, dated April 30, 1996.                                   
|(1)              |  | 4.6            |  | Stock purchase Agreement between Registrant and Pfizer Inc., dated May 30, 1996.                                                 
|(5)              |  | 4.7            |  | Form of Common Stock Purchase Warrant, Class A.                                                                                  
|(5)              |  | 4.8            |  | Form of Common Stock Purchase Warrant, Class B.                                                                                  
|(12)             |  | 4.9            |  | Stock Issuance and Restriction Agreement between the Registrant and The Woodlands, dated September 4, 2003.                      
|(6)              |  | 10.1           |  | Amended and Restated 1997 Equity Incentive Plan.                                                                                 
|(1)              |  | 10.2           |  | Form of Incentive Stock Option Grant.                                                                                            
|(1)              |  | 10.3           |  | Form of Non-Incentive Stock Option.                                                                                              
|(1)              |  | 10.4           |  | 1997 Employee Stock Purchase Plan.                                                                                               
|(1)              |  | 10.5           |  | Form of Indemnification Agreement entered into between the Registrant and its directors and executive officers.                  
|(1)              |  | 10.6           |  | Letter Agreement between the Registrant and Benjamin F. McGraw, III, Pharm.D.                                                    
|(3)              |  | 10.8           |  | Letter Agreement between the Registrant and Bennet Weintraub.                                                                    
|(1)              |  | 10.10          |  | Lease Agreement between the Registrant and Provident Life and Accident Insurance Company (Provident), dated December 21, 1993.   
|(1)              |  | 10.11          |  | First Amendment to Lease Agreement between the Registrant and SFO Associates LLC (successor in interest to Provident).           
|                 |  |                |  |                                                                                                                                  

42

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|(1)  |   | 10.12 |  | Lease Agreement between the Registrant and SFO Associates LLC, dated March 18, 1997.                                                                                                                                                                 
|---- | - | ----- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1)  |   | 10.13 |  | Credit Agreement between the Registrant and Imperial Bank, dated as of August 31, 1995.                                                                                                                                                              
|(1)  |   | 10.14 |  | Lease Agreement between the Registrant and LMSI, dated May 13, 1994, as amended as of May 13, 1994.                                                                                                                                                  
|(1)  |   | 10.15 |  | Senior Loan and Security Agreement between the Registrant and Phoenix Leasing Incorporated, dated as of April 22, 1996.                                                                                                                              
|(1)  | * | 10.16 |  | Research and License Agreement between the Registrant and Glaxo Wellcome Group Limited, dated April 11, 1994, as amended as of May 31, 1996.                                                                                                         
|(1)  | * | 10.17 |  | Exclusive License Agreement between the Registrant and Regents of the University of California, dated May 9, 1996, as amended May 15, 1997.                                                                                                          
|(3)  |   | 10.21 |  | Promissory Note for $8,000,000 from Megabios Corp. to Imperial Bank, dated May 13, 1998.                                                                                                                                                             
|(2)  | * | 10.22 |  | First Amendment and Restatement of License Agreement between Registrant and Baylor College of Medicine dated March 7, 1994.                                                                                                                          
|(2)  | * | 10.23 |  | First Amendment and Restatement of License AgreementWoo between Registrant and Baylor College of Medicine dated March 7, 1994.                                                                                                                      
|(2)  | * | 10.24 |  | First Amendment and Restatement of License AgreementGeneSwitch® between Registrant and Baylor College of Medicine dated March 7, 1994.                                                                                                              
|(2)  |   | 10.30 |  | Lease Agreement between Registrant and The Woodlands Corporation dated October 29, 1993.                                                                                                                                                             
|(2)  | * | 10.31 |  | Collaborative Alliance Agreement between Registrant and Syntex (U.S.A.) Inc. dated April 8, 1994.                                                                                                                                                    
|(2)  | * | 10.32 |  | License Agreement between Registrant and Syntex (U.S.A.) Inc. dated April 8, 1994.                                                                                                                                                                   
|(4)  | * | 10.33 |  | Alliance Agreement between Registrant and Corange International Ltd. effective February 3, 1995. Exhibit 10.21 to GeneMedicine's Form 10-Q for the quarter ended September 30, 1995 is incorporated herein by
reference.                             
|(5)  |   | 10.34 |  | Form of Subscription Agreement between the Registrant and each of the selling security holders, dated as of November 20, 2000.                                                                                                                       
|(8)  |   | 10.35 |  | Amended and Restated 1998 Non-Employee Directors' Stock Option Plan.                                                                                                                                                                                 
|(6)  |   | 10.36 |  | Amended and Restated 2001 Nonstatutory Incentive Plan.                                                                                                                                                                                               
|(7)  |   | 10.37 |  | Form of Amendment, Consent and Waiver Regarding the Subscription Agreement and Certificate of Designations for the Series A Preferred Stock by and among the Company and each holder of the Company's Series A Convertible
Redeemable Preferred Stock
|(9)  | * | 10.38 |  | Form of License and Option Agreement, effective as of December 19, 2002, by and between the Company and Schering AG.                                                                                                                                 
|(12) |   | 10.39 |  | Lease Termination Agreement between the Company and The Woodlands, dated September 4, 2003.                                                                                                                                                          
|(8)  |   | 10.40 |  | Amendment to the Amended and Restated 1997 Equity Incentive Plan.                                                                                                                                                                                    
|(8)  |   | 10.41 |  | 2003 Employee Stock Purchase Plan.                                                                                                                                                                                                                   
|(10) |   | 10.42 |  | Securities Purchase Agreement, dated as of December 2, 2003, by and among Valentis, Inc. and the purchasers identified on the signature pages thereto.                                                                                               
|(10) |   | 10.43 |  | Form of Warrant to purchase Common Stock.                                                                                                                                                                                                            
|(10) |   | 10.44 |  | Registration Rights Agreement, dated as of December 2, 2003, by and among Valentis, Inc. and the Purchasers signatory thereto.                                                                                                                       
|(11) |   | 10.45 |  | Securities Purchase Agreement, dated June 7, 2004, by and among Valentis, Inc. and the Purchasers signatory thereto.                                                                                                                                 
|(11) |   | 10.46 |  | Form of Warrant to purchase Common Stock.                                                                                                                                                                                                            
|(11) |   | 10.47 |  | Registration Rights Agreement, made and entered into as of June 7, 2004, by and among Valentis, Inc. and the Purchasers signatory thereto.                                                                                                           
|     |   |       |  |                                                                                                                                                                                                                                                      

43

---



| |  | 21.1 |  | As of August 30, 1999, PolyMASC Pharmaceuticals plc (PolyMASC) became a subsidiary of the Registrant. PolyMASC is incorporated under the laws of England and Wales.
| |  | ---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 23.1 |  | Consent of Ernst & Young LLP, Registered Public Accounting Firm.                                                                                                   
| |  | 24.1 |  | Power of Attorney (included on signature page herewith)                                                                                                            
| |  | 31.1 |  | Certification of Principal Executive Officer Section 302.                                                                                                          
| |  | 31.2 |  | Certification of Principal Financial Officer Section 302.                                                                                                          
| |  | 32.1 |  | Certification of Principal Executive Officer Section 906.                                                                                                          
| |  | 32.2 |  | Certification of Principal Financial Officer Section 906.                                                                                                          

---

On
June 14, 2004, Valentis filed a current report on Form 8-K regarding the completion of its private placement, the sale and issuance of
approximately 2.2 million shares of its common stock and warrants exercisable for up to approximately 670,000 additional shares of common stock at $5.4075 per unit, for aggregate gross proceeds
of approximately $12 million. The warrants are exercisable at $6.98 per share.

On
May 26, 2004, Valentis filed a current report on Form 8-K regarding the appointment of George M. Lasezkay, Pharm.D., J.D., to the Company's Board of
Directors. Dr. Lasezkay's appointment to the Board of Directors was effective May 24, 2004.

On
May 17, 2004, Valentis filed a current report on Form 8-K regarding the announcement of results for its third fiscal quarter ended March 31, 2004.

44

---





SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the Registrant has duly caused this Annual Report on
Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized, on September 15, 2004.

| |  | VALENTIS, INC.
| |  | --------------
| |  | By:           

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Benjamin F. McGraw III and Joseph A. Markey, 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 (including post-effective amendments) to this Annual Report, 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/BENJAMIN F. MCGRAWBenjamin F. McGraw, III, Pharm.D. |  | Chairman of the Board of Directors, President and Chief Executive Officer (Principal Executive Officer) |  | September 15, 2004
|/s/JOSEPH A. MARKEYJoseph A. Markey                    |  | Senior Director of Finance and Controller (Principal Financial and Accounting Officer)                  |  | September 15, 2004
|/s/PATRICK G. ENRIGHTPatrick G. Enright                |  | Director                                                                                                |  | September 15, 2004
|/s/REINALDO M. DIAZReinaldo M. Diaz                    |  | Director                                                                                                |  | September 15, 2004
|/s/GEORGE M. LASEZKAYGeorge M. Lasezkay                |  | Director                                                                                                |  | September 15, 2004
|                                                       |  |                                                                                                         |  |                   

45

---



|/s/MARK MCDADEMark McDade             |  | Director |  | September 15, 2004
|------------------------------------- |  | -------- |  | ------------------
|/s/ALAN C. MENDELSONAlan C. Mendelson |  | Director |  | September 15, 2004
|/s/DENNIS J. PURCELLDennis J. Purcell |  | Director |  | September 15, 2004
|/s/JOHN SCHROEDERJohn Schroeder, M.D. |  | Director |  | September 15, 2004

46

---





REPORT OF ERNST & YOUNG LLP, INDEPENDENT REGISTERED  PUBLIC ACCOUNTING FIRM

The
Board of Directors and Stockholders
Valentis, Inc.

We
have audited the accompanying consolidated balance sheets of Valentis, Inc. as of June 30, 2004 and 2003, and the related consolidated statements of operations,
redeemable convertible preferred stock and stockholders' equity (net capital deficiency) and cash flows for each of the three years in the period ended June 30, 2004. These financial statements
are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

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

In
our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Valentis, Inc. as of June 30,
2004 and 2003, and the consolidated results of its operations and its cash flows for each of the three years in the period ended June 30, 2004, in conformity with U.S. generally accepted
accounting principles.

The
accompanying consolidated financial statements have been prepared assuming that Valentis, Inc. will continue as a going concern. As more fully described in Note 1, the
Company has incurred losses since inception, including a net loss of $6.5 million for the year ended June 30, 2004 and its accumulated deficit was $213.6 million at
June 30, 2004. Additionally, the Company anticipates requiring additional financial resources to fund its operations at least through June 30, 2005. These conditions raise substantial
doubt about the Company's ability to continue as a going concern. Management's plans as
to these matters are also described in Note 1. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets
or the amounts and classification of liabilities that may result from the outcome of this uncertainty.

As
discussed in Note 1 to the consolidated financial statements, in 2003 the Company changed its method of accounting for goodwill and other intangible assets.

|                      |  |                      
|--------------------- |  | ---------------------
|                      |  | /s/ ERNST & YOUNG LLP
|                      |  |                      
|Palo Alto, California |  |                      
|August 12, 2004       |  |                      

47

---





VALENTIS, INC.        CONSOLIDATED BALANCE SHEETS        (in thousands, except share and per share amounts)

|                                     |                                                                                                                                                              | June 30,                   |                                           
|------------------------------------ | ------------------------------------------------------------------------------------------------------------------------------------------------------------ | -------------------------- | ------------------------------------------
|
|ASSETS                               |                                                                                                                                                              |                            |                                           
|Current assets:                      |                                                                                                                                                              |                            |                                           
|                                     | Cash and cash equivalents                                                                                                                                    |                            | $                                         
|                                     | Short-term investments                                                                                                                                       |                            |                                           
|                                     | Interest and other receivables                                                                                                                               |                            |                                           
|                                     | Prepaid expenses and other current assets                                                                                                                    |                            |                                           
|                                     |                                                                                                                                                              |                            |                                           
|                                     |                                                                                                                                                              | Total current assets       |                                           
|                                     | Property and equipment, net                                                                                                                                  |                            |                                           
|                                     | Goodwill                                                                                                                                                     |                            |                                           
|                                     | Other assets                                                                                                                                                 |                            |                                           
|                                     |                                                                                                                                                              |                            |                                           
|                                     |                                                                                                                                                              | Total assets               |                                           
|                                     |                                                                                                                                                              |                            |                                           
|LIABILITIES AND STOCKHOLDERS' EQUITY |                                                                                                                                                              |                            |                                           
|Current liabilities:                 |                                                                                                                                                              |                            |                                           
|                                     | Accounts payable                                                                                                                                             |                            | $                                         
|                                     | Accrued compensation                                                                                                                                         |                            |                                           
|                                     | Accrued clinical trial costs                                                                                                                                 |                            |                                           
|                                     | Other accrued liabilities                                                                                                                                    |                            |                                           
|                                     | Deferred revenue                                                                                                                                             |                            |                                           
|                                     | Current portion of long-term debt                                                                                                                            |                            |                                           
|                                     |                                                                                                                                                              |                            |                                           
|                                     |                                                                                                                                                              | Total current liabilities  |                                           
|Stockholders' equity:                |                                                                                                                                                              |                            |                                           
|                                     | Common stock, $.001 par value, 190,000,000 shares authorized; 12,996,607 and 5,555,708 shares issued and outstanding at June 30, 2004 and 2003, respectively |                            |                                           
|                                     | Additional paid-in capital                                                                                                                                   |                            |                                           
|                                     | Accumulated other comprehensive loss                                                                                                                         |                            |                                           
|                                     | Accumulated deficit                                                                                                                                          |                            |                                           
|                                     |                                                                                                                                                              |                            |                                           
|                                     |                                                                                                                                                              | Total stockholders' equity |                                           
|                                     |                                                                                                                                                              |                            |                                           
|                                     |                                                                                                                                                              |                            | Total liabilities and stockholders' equity
|                                     |                                                                                                                                                              |                            |                                           

See
accompanying notes.

48

---



VALENTIS, INC.        CONSOLIDATED STATEMENTS OF OPERATIONS        (in thousands, except per share amounts)

|                                                                                         |                                                               | Year ended June 30,      |       
|---------------------------------------------------------------------------------------- | ------------------------------------------------------------- | ------------------------ | ------
|
|Collaborative research and development revenue                                           |                                                               | $                        |      
|License and milestone revenue                                                            |                                                               |                          | 7,284 
|Other revenue                                                                            |                                                               |                          | 194   
|                                                                                         |                                                               |                          |       
|                                                                                         |                                                               | Total revenue            |       
|Operating expenses:                                                                      |                                                               |                          |       
|                                                                                         | Research and development                                      |                          |       
|                                                                                         | General and administrative                                    |                          |       
|                                                                                         | Restructuring charges                                         |                          |       
|                                                                                         | Amortization of goodwill and other acquired intangible assets |                          |       
|                                                                                         |                                                               |                          |       
|                                                                                         |                                                               | Total operating expenses |       
|                                                                                         |                                                               |                          |       
|Loss from operations                                                                     |                                                               |                          | (6,488
|Interest income                                                                          |                                                               |                          | 90    
|Other income and expense, net                                                            |                                                               |                          | (86   
|                                                                                         |                                                               |                          |       
|Net loss                                                                                 |                                                               |                          | (6,484
|Deemed dividend                                                                          |                                                               |                          |      
|Adjustment resulting from the reduction in the Series A preferred stock conversion price |                                                               |                          |      
|Dividends on convertible preferred stock                                                 |                                                               |                          |      
|                                                                                         |                                                               |                          |       
|Net loss applicable to common stockholders                                               |                                                               | $                        | (6,484
|                                                                                         |                                                               |                          |       
|Basic and diluted net loss per share applicable to common stockholders                   |                                                               | $                        | (0.81 
|                                                                                         |                                                               |                          |       
|Shares used in computing basic and diluted net loss per common share                     |                                                               |                          | 8,024 
|                                                                                         |                                                               |                          |       

See
accompanying notes.

49

---





VALENTIS, INC.

CONSOLIDATED STATEMENT OF REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY

(in thousands, except share amounts)

|                                                                                  |  | Redeemable
Convertible
Preferred Stock |   |   |         |   |            |  |   |    |  |   |         |   |   | Total
Stockholders'
Equity
(net capital
deficiency) |  
|--------------------------------------------------------------------------------- |  | -------------------------------------- | - | - | ------- | - | ---------- |  | - | -- |  | - | ------- | - | - | --------------------------------------------------- | -
|
|
|
|Balance at June 30, 2001                                                          |  | 31,500                                 |   | $ | 23,895  |   | 991,311    |  | $ | 1  |  | $ | 172,991 |   | $ | (10                                                 | )
|Exercise of stock options                                                         |  |                                       |   |   |        |   | 1,054      |  |   |   |  |   | 46      |   |   |                                                    |  
|Stock options granted to non-employees for services rendered                      |  |                                       |   |   |        |   |           |  |   |   |  |   | 349     |   |   |                                                    |  
|Issuance of common stock pursuant to Employee Stock Purchase Plan and 401(k) Plan |  |                                       |   |   |        |   | 6,692      |  |   |   |  |   | 569     |   |   |                                                    |  
|Conversion of redeemable convertible preferred stock into common stock            |  | (700                                   | ) |   | (657    | ) | 2,592      |  |   |   |  |   | 657     |   |   |                                                    |  
|Accretion of redeemable convertible preferred stock warrants                      |  |                                       |   |   | 1,726   |   |           |  |   |   |  |   | (1,726  | ) |   |                                                    |  
|Accretion of redeemable convertible preferred stock beneficial conversion feature |  |                                       |   |   | 314     |   |           |  |   |   |  |   | (314    | ) |   |                                                    |  
|Accretion of redeemable convertible preferred stock issuance costs                |  |                                       |   |   | 550     |   |           |  |   |   |  |   | (550    | ) |   |                                                    |  
|Redeemable convertible preferred stock dividends                                  |  |                                       |   |   |        |   |           |  |   |   |  |   | (1,557  | ) |   |                                                    |  
|Redeemable convertible preferred stock dividends paid in common stock             |  |                                       |   |   |        |   | 21,037     |  |   |   |  |   | 1,557   |   |   |                                                    |  
|Amortization of deferred compensation                                             |  |                                       |   |   |        |   |           |  |   |   |  |   |        |   |   | 10                                                  |  
|Issuance of common stock in public offering, net of issuance costs of $356        |  |                                       |   |   |        |   | 204,337    |  |   |   |  |   | 12,609  |   |   |                                                    |  
|Net loss                                                                          |  |                                       |   |   |        |   |           |  |   |   |  |   |        |   |   |                                                    |  
|Net unrealized gain on available-for-sale securities                              |  |                                       |   |   |        |   |           |  |   |   |  |   |        |   |   |                                                    |  
|Foreign currency translation adjustment                                           |  |                                       |   |   |        |   |           |  |   |   |  |   |        |   |   |                                                    |  
|                                                                                  |  |                                        |   |   |         |   |            |  |   |    |  |   |         |   |   |                                                     |  
|Total comprehensive loss                                                          |  |                                        |   |   |         |   |            |  |   |    |  |   |         |   |   |                                                     |  
|                                                                                  |  |                                        |   |   |         |   |            |  |   |    |  |   |         |   |   |                                                     |  
|Balance at June 30, 2002                                                          |  | 30,800                                 |   |   | 25,828  |   | 1,227,023  |  |   | 1  |  |   | 184,631 |   |   |                                                    |  
|Issuance of common stock pursuant to Employee Stock Purchase Plan                 |  |                                       |   |   |        |   | 178        |  |   |   |  |   | 4       |   |   |                                                    |  
|Issuance of common stock pursuant to a license agreement                          |  |                                       |   |   |        |   | 2,106      |  |   |   |  |   | 250     |   |   |                                                    |  
|Accretion of redeemable convertible preferred stock warrants                      |  |                                       |   |   | 3,332   |   |           |  |   |   |  |   | (3,332  | ) |   |                                                    |  
|Accretion of redeemable convertible preferred stock beneficial conversion feature |  |                                       |   |   | 593     |   |           |  |   |   |  |   | (593    | ) |   |                                                    |  
|Accretion of redeemable convertible preferred stock issuance costs                |  |                                       |   |   | 1,047   |   |           |  |   |   |  |   | (1,047  | ) |   |                                                    |  
|Redeemable convertible preferred stock dividends                                  |  |                                       |   |   |        |   |           |  |   |   |  |   | (882    | ) |   |                                                    |  
|Redeemable convertible preferred stock dividends paid in common stock             |  |                                       |   |   |        |   | 84,336     |  |   |   |  |   | 573     |   |   |                                                    |  
|Conversion of redeemable convertible preferred stock into common stock            |  | (30,800                                | ) |   | (30,800 | ) | 4,242,065  |  |   | 5  |  |   | 30,795  |   |   |                                                    |  
|Net loss                                                                          |  |                                       |   |   |        |   |           |  |   |   |  |   |        |   |   |                                                    |  
|Foreign currency translation adjustment                                           |  |                                       |   |   |        |   |           |  |   |   |  |   |        |   |   |                                                    |  
|                                                                                  |  |                                        |   |   |         |   |            |  |   |    |  |   |         |   |   |                                                     |  
|Total comprehensive loss                                                          |  |                                        |   |   |         |   |            |  |   |    |  |   |         |   |   |                                                     |  
|                                                                                  |  |                                        |   |   |         |   |            |  |   |    |  |   |         |   |   |                                                     |  
|Balance at June 30, 2003                                                          |  |                                       |   |   |        |   | 5,555,708  |  |   | 6  |  |   | 210,399 |   |   |                                                    |  
|Issuance of common stock pursuant to Employee Stock Purchase Plan and 401(k) Plan |  |                                       |   |   |        |   | 77,351     |  |   |   |  |   | 237     |   |   |                                                    |  
|Issuance of common stock pursuant to a license termination agreement              |  |                                       |   |   |        |   | 185,000    |  |   |   |  |   | 433     |   |   |                                                    |  
|Stock options granted to non-employees for services rendered                      |  |                                       |   |   |        |   |           |  |   |   |  |   | 80      |   |   |                                                    |  
|Disgorgement of Short-Swing Profits                                               |  |                                       |   |   |        |   |           |  |   |   |  |   | 133     |   |   |                                                    |  
|Exercise of warrants                                                              |  |                                       |   |   |        |   | 65,722     |  |   |   |  |   | 197     |   |   |                                                    |  
|Private placement of common stock, net of issuance costs of $2,358                |  |                                       |   |   |        |   | 7,112,826  |  |   | 7  |  |   | 20,658  |   |   |                                                    |  
|Net loss                                                                          |  |                                       |   |   |        |   |           |  |   |   |  |   |        |   |   |                                                    |  
|Net unrealized loss on available for sale securities                              |  |                                       |   |   |        |   |           |  |   |   |  |   |        |   |   |                                                    |  
|Foreign currency translation adjustment                                           |  |                                       |   |   |        |   |           |  |   |   |  |   |        |   |   |                                                    |  
|                                                                                  |  |                                        |   |   |         |   |            |  |   |    |  |   |         |   |   |                                                     |  
|Total comprehensive loss                                                          |  |                                        |   |   |         |   |            |  |   |    |  |   |         |   |   |                                                     |  
|                                                                                  |  |                                        |   |   |         |   |            |  |   |    |  |   |         |   |   |                                                     |  
|Balance at June 30, 2004                                                          |  |                                       |   | $ |        |   | 12,996,607 |  | $ | 13 |  | $ | 232,137 |   | $ |                                                    |  
|                                                                                  |  |                                        |   |   |         |   |            |  |   |    |  |   |         |   |   |                                                     |  

See accompanying notes.

50

---



VALENTIS, INC.        CONSOLIDATED STATEMENTS OF CASH FLOWS        (in thousands)

|                                                     |                                                                                                                | Year ended June 30,                                               |                                                             
|---------------------------------------------------- | -------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------- | ------------------------------------------------------------
|
|Cash flows from operating activities                 |                                                                                                                |                                                                   |                                                             
|                                                     | Net loss                                                                                                       |                                                                   | $                                                           
|                                                     |                                                                                                                | Adjustments to reconcile net loss to net cash used in operations: |                                                             
|                                                     |                                                                                                                |                                                                   | Depreciation                                                
|                                                     |                                                                                                                |                                                                   | Loss (gain) on disposal of assets                           
|                                                     |                                                                                                                |                                                                   | Amortization of goodwill and other intangibles              
|                                                     |                                                                                                                |                                                                   | Amortization of deferred compensation                       
|                                                     |                                                                                                                |                                                                   | Stock options granted to non-employees for services rendered
|                                                     |                                                                                                                |                                                                   | 401(k) stock contribution matching expense                  
|                                                     |                                                                                                                |                                                                   | Changes in operating assets and liabilities:                
|                                                     |                                                                                                                |                                                                   |                                                             
|                                                     |                                                                                                                |                                                                   |                                                             
|                                                     |                                                                                                                |                                                                   |                                                             
|                                                     |                                                                                                                |                                                                   |                                                             
|                                                     |                                                                                                                |                                                                   |                                                             
|                                                     |                                                                                                                |                                                                   |                                                             
|                                                     |                                                                                                                |                                                                   |                                                             
|                                                     |                                                                                                                |                                                                   |                                                             
|                                                     |                                                                                                                |                                                                   |                                                             
|Cash flows from investing activities                 |                                                                                                                |                                                                   |                                                             
|                                                     | Purchase of property and equipment                                                                             |                                                                   |                                                             
|                                                     | Proceeds from sale of property and equipment                                                                   |                                                                   |                                                             
|                                                     | Purchases of available-for-sale investments                                                                    |                                                                   |                                                             
|                                                     | Maturities of available-for-sale investments                                                                   |                                                                   |                                                             
|                                                     |                                                                                                                |                                                                   |                                                             
|                                                     |                                                                                                                |                                                                   |                                                             
|                                                     |                                                                                                                |                                                                   |                                                             
|Cash flows from financing activities                 |                                                                                                                |                                                                   |                                                             
|                                                     | Payments on long-term debt                                                                                     |                                                                   |                                                             
|                                                     | Preferred stock dividends paid in cash                                                                         |                                                                   |                                                             
|                                                     | Proceeds from issuance of common stock, net of repurchases                                                     |                                                                   |                                                             
|                                                     |                                                                                                                |                                                                   |                                                             
|                                                     |                                                                                                                |                                                                   |                                                             
|                                                     |                                                                                                                |                                                                   |                                                             
|Net increase (decrease) in cash and cash equivalents |                                                                                                                |                                                                   | 6,226                                                       
|Cash and cash equivalents, beginning of year         |                                                                                                                |                                                                   | 3,290                                                       
|                                                     |                                                                                                                |                                                                   |                                                             
|Cash and cash equivalents, end of year               |                                                                                                                | $                                                                 | 9,516                                                       
|                                                     |                                                                                                                |                                                                   |                                                             
|Supplemental disclosure of cash flow information:    |                                                                                                                |                                                                   |                                                             
|                                                     | Interest paid                                                                                                  |                                                                   | $                                                           
|                                                     |                                                                                                                |                                                                   |                                                             
|                                                     | Franchise and other tax paid                                                                                   |                                                                   | $                                                           
|                                                     |                                                                                                                |                                                                   |                                                             
|Schedule of non-cash transactions:                   |                                                                                                                |                                                                   |                                                             
|                                                     | Stock issued for prior year accrued 401(k) matching contributions                                              |                                                                   | $                                                           
|                                                     |                                                                                                                |                                                                   |                                                             
|                                                     | Stock issued for prior year accrued lease termination fees                                                     |                                                                   | $                                                           
|                                                     |                                                                                                                |                                                                   |                                                             
|                                                     | Accretion of redeemable convertible preferred stock warrants, beneficial conversion feature and issuance costs |                                                                   | $                                                           
|                                                     |                                                                                                                |                                                                   |                                                             
|                                                     | Conversion of redeemable convertible preferred stock into common stock                                         |                                                                   | $                                                           
|                                                     |                                                                                                                |                                                                   |                                                             
|                                                     | Preferred stock dividends declared                                                                             |                                                                   | $                                                           
|                                                     |                                                                                                                |                                                                   |                                                             
|                                                     | Preferred stock dividends paid in common stock                                                                 |                                                                   | $                                                           
|                                                     |                                                                                                                |                                                                   |                                                             
|                                                     | Stock issued in partial consideration for a license agreement                                                  |                                                                   | $                                                           
|                                                     |                                                                                                                |                                                                   |                                                             

See accompanying notes.

51

---





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS        June 30, 2004

1. ORGANIZATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and Basis of Presentation

Valentis, Inc. ("Valentis", "the Company", "we" or "us") was formed from the merger of Megabios Corp. and GeneMedicine, Inc. ("GeneMedicine") in
March 1999. In August 1999, the Company acquired PolyMASC Pharmaceuticals plc ("PolyMASC"). We believe Valentis is a leader in the field of biopharmaceutical delivery. Valentis is
converting biologic discoveries into innovative products by combining our proprietary delivery technologies with biologics to create novel therapeutic products. The Company's lead product, DeltavascTM
is based on the Del-1 angiogenesis gene, formulated with a Valentis PINC (Polymeric, non-condensing) proprietary polymer delivery system. The Company has three
technologies that it utilizes for the development of novel therapeutics: (i) proprietary synthetic, non-viral gene delivery systems, (ii) proprietary plasmid expression
systems; and, (iii) GeneSwitch® gene regulation technologies that permits therapeutic protein production that is controlled via an orally administered drug. The Company's commercial
strategy is to enter into corporate collaborations for full-scale clinical development, marketing and sales of products. Valentis is incorporated in the State of Delaware.

The
consolidated financial statements include the accounts of Valentis and its wholly owned subsidiary, PolyMASC. The Company translates the assets and liabilities of its foreign
subsidiary stated in local functional currency to U.S. dollars at the rates of exchange in effect at the end of the period. Revenues
and expenses are translated using rates of exchange in effect during the period. Gains and losses from currency translation are included in other comprehensive income (loss).

Except
for the quarter ended September 30, 2003, in which we reported net income of approximately $3.4 million resulting principally from the $6.5 million
non-recurring license revenue recognized under the license and settlement agreement with ALZA Corporation (see Note 15), we have experienced net losses since our inception through
June 30, 2004, and reported a net loss of $6.5 million for the fiscal year ended June 30, 2004. Our accumulated deficit was $213.6 million at June 30, 2004. We
expect such losses to continue into the foreseeable future as we proceed with the research, development and commercialization of our technologies. Depending on the outcome of the
Deltavasc PAD Phase II clinical trial at the end of September 2004, spending levels for research and development and general and administrative expenses may increase above current
levels, to reflect increases in manufacturing and clinical trial efforts to advance the Deltavasc PAD product to Phase III testing. At June 30, 2004, we had $20.5 million in
cash, cash equivalents and investments, and we anticipate that we will require additional funding to advance Deltavasc and continue our planned operations at least through June 30,
2005.

We
are currently supporting the ongoing Deltavasc Phase II clinical trial. This multicenter, randomized, placebo-controlled clinical trial conducted at approximately
17 centers in the United States is a study performed within the FDA regulations and guidelines regarding whether patients suffering from peripheral arterial disease can increase blood flow in their
legs after being treated with Deltavasc compared to patients given the placebo. The results of the Phase II trial are expected at the end of September 2004. Should the
outcome of the Deltavasc PAD Phase II clinical trial demonstrate a statistically significant drug effect and is safe for the targeted population, we may seek additional financing
and pursue corporate partners, to advance Deltavasc PAD to Phase III clinical testing. Should the outcome of the Deltavasc PAD Phase II clinical trial fail to
demonstrate a statistically significant drug effect and is safe for the targeted population, our business and reputation could be harmed and the market price of our Common Stock could fall. We may not
be able to obtain additional financing and pursue corporate partners on acceptable terms, or at all. Any failure to obtain

52

---



an
adequate and timely amount of additional capital on commercially reasonable terms will have a material adverse effect on our business, financial condition and results of operations, including our
viability as an enterprise. As a result of these concerns, management may pursue strategic alternatives, which may include the sale of securities, the sale or merger of the business, the sale of
certain assets or other actions.

The
accompanying consolidated financial statements have been prepared assuming that we will continue as a going concern. The financial statements do not include any adjustments to
reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the matters discussed above.

Revenue Recognition

Revenue arrangements with multiple elements are divided into separate units of accounting if certain criteria are met, including whether the delivered item has
value to the customer on a stand-alone basis and whether there is objective and reliable evidence of the fair value of the undelivered items. Consideration received is allocated among the separate
units of accounting based on their respective fair values, and the applicable revenue recognition criteria are considered separately for each of the separate units.

Non-refundable
up-front payments received in connection with research and development collaboration agreements, including technology advancement funding that is
intended for the development of the Company's core technology, are deferred and recognized on a straight-line basis over the relevant period specified in the agreement, generally the
research term.

Revenue
related to collaborative research with the Company's corporate collaborators is recognized as research services are performed over the related funding periods for each contract.
Under these agreements, the Company is required to perform research and development activities as specified in each respective agreement. The payments received under each respective agreement are not
refundable and are generally based on a contractual cost per full-time equivalent employee working on the project. Research and development expenses under the collaborative research
agreements approximate or exceed the revenue recognized under such agreements over the terms of the respective agreements. Deferred revenue may result when the Company does not incur the required
level of effort during a specific period in comparison to funds received under the respective contracts. Payments received relative to substantive, at-risk incentive milestones, if any,
are recognized as revenue upon achievement of the incentive milestone event because the Company has no future performance obligations related to the payment. Incentive milestone payments are triggered
either by results of the Company's research efforts or by events external to the Company, such as regulatory approval to market a product.

The
Company also has licensed technology to various biotechnology and pharmaceutical companies. Under these arrangements, the Company receives nonrefundable license payments in cash.
These payments are recognized as revenue when received, provided the Company has no future performance or delivery obligations under these agreements. Otherwise, revenue is deferred until performance
or delivery is satisfied. Certain of these license agreements also provide the licensee an option to acquire additional licenses or technology rights for a fixed period of time. Fees received for such
options are deferred and recognized at the time the option is exercised or expires unexercised. Additionally, certain of these license agreements involve technology that the Company has licensed or
otherwise acquired through arrangements with third parties pursuant to which the Company is required to pay a royalty equal to a fixed percentage of amounts received by the Company as a result of
licensing this technology to others. Such royalty obligations are recorded as a reduction of the related revenue.

53

---



Critical Accounting Estimates

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

Valentis
believes the accrual for clinical trial expense represents its most significant estimate used in the preparation of its consolidated financial statements. Valentis' accruals for
clinical trial expenses are based in part on estimates of services received and efforts expended pursuant to agreements established with clinical research organizations and clinical trial sites. The
Company has a history of contracting with third parties that perform various clinical trial activities on behalf of Valentis in the ongoing development of its biopharmaceutical drugs. The financial
terms of these contracts are subject to negotiations and may vary from contract to contract and may result in uneven payment flows. The Company determines its estimates through discussion with
internal clinical personnel and outside service providers as to progress or stage of completion of trials or services and the agreed upon fee to be paid for such services. The objective of Valentis'
clinical trial accrual policy is to reflect the appropriate trial expenses in its consolidated financial statements by matching period expenses with period services and efforts expended. In the event
of early termination of a clinical trial, the Company accrue expenses associated with an estimate of the remaining, non-cancelable obligations associated with the winding down of the
trial.

Research and Development Expenses

Research and development expenses, which consist of costs incurred for independent and collaborative research and development and include direct and research-
related overhead expenses and the costs of funding clinical studies, are expensed as incurred.

Cash, Cash Equivalents and Investments

Cash equivalents consist of highly liquid investments with original maturities at the date of purchase of three months or less. Short-term investments
mature in less than one year from the balance sheet date.

Valentis
classifies for its cash equivalents and investments as "available-for-sale." Such investments are recorded at fair value, determined based on quoted
market prices, and unrealized gains and losses, which are considered to be temporary, are recorded as other comprehensive income (loss) in a separate component of stockholders' equity until realized.
The cost of securities sold is based on the specific identification method.

The
Company places its cash, cash equivalents, and investments with financial institutions with high credit quality, in commercial paper and corporate debt with high credit ratings, and
in U.S. government and government agency securities. Therefore, the Company believes that its exposure due to concentration of credit risk is minimal and has not experienced credit losses on
investments in these instruments to date.

Depreciation and Amortization

Property and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation is provided using the straight-line method
over the estimated useful lives of the respective assets (generally three to seven years). Leasehold improvements are amortized over the shorter of the estimated useful lives of the assets or the
applicable lease term.

54

---



Goodwill and Intangible Assets

Goodwill consists of the goodwill related to Valentis' acquisition of PolyMASC. Prior to July 1, 2002, amortization of goodwill and purchased intangibles
was calculated on the straight-line basis over the estimated useful lives of the intangible assets of three years, and amortization of assembled workforce and goodwill was included as a
separate item on the Consolidated Statements of Operations. Effective July 1, 2002, assembled workforce and goodwill are no longer being amortized but are subject to an impairment analysis on
at least an annual basis in accordance with the requirements of Statement of Financial Accounting Standards No. 142, ("SFAS 142") "Goodwill and Other Intangible Assets".

Long-Lived Assets

Valentis accounts for its long-lived assets under Statement of Financial Accounting Standards No. 144 ("SFAS 144"), "Accounting for the
Impairment or Disposal of Long-Lived Assets". In accordance with SFAS 144, Valentis identifies and records impairment losses, as circumstances dictate, on long-lived
assets used in operations when events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying
amounts of those assets. The Company's long-lived assets consist primarily of machinery and equipment and leasehold improvements.

Stock-Based Compensation

Valentis has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related
interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under SFAS 123, "Accounting for Stock-Based
Compensation", requires use of valuation models that were not developed for use in valuing employee stock options. Under APB 25, if the exercise price of Valentis' employee stock options equals or
exceeds the market price of the underlying stock on the date of grant, no compensation expense is recognized.

Pro
forma net loss and net loss per share information is required by SFAS 148, "Accounting for Stock-Based CompensationTransition and Disclosure an amendment of FASB
Statement No. 123" which also requires that the information be determined as if Valentis has accounted for its employee stock options under the fair value method of SFAS 123. The fair
value for these options was estimated at the date of grant using a Black-Scholes option-pricing model.

For
purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting periods using the graded vesting method. Valentis' pro
forma information follows (in thousands except for net loss per share information):

Year ended June 30,2004

2003

2002Net loss applicable to common stockholdersas reported

$
(6,484
)
$
(43,007
)
$
(37,237
)Add back: Deferred compensation expense








10Deduct: Stock-based employee stock compensation expense determined under SFAS 123


(1,880
)

(545
)

(2,884
)Net loss applicable to common stockholderspro forma

$
(8,364
)
$
(43,552
)
$
(40,110
)Net loss applicable to common stockholders per shareas reported

$
(0.81
)
$
(13.86
)
$
(33.61
)Net loss applicable to common stockholders per sharepro forma

$
(1.04
)
$
(14.04
)
$
(36.20
)


55

---



All
stock-based awards to non-employees are accounted for at fair value, as calculated using the Black-Scholes option-pricing model, in accordance with SFAS 123 and
Emerging Issues Task Force ("EITF") 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" ("EITF
96-18"). Stock-based awards to non-employees not immediately vested are subject to periodic revaluation over their vesting terms.

Net Loss Per Share

Basic earnings per share is computed by dividing income or loss applicable to common stockholders by the weighted-average number of shares of common stock
outstanding during the period, net of certain common shares outstanding that are held in escrow or subject to Valentis' right of repurchase. Diluted earnings per share include the effect of options
and warrants, if dilutive. Diluted net loss per share has not been presented separately as, given our net loss position for all periods presented, the result would be anti-dilutive.

A
reconciliation of shares used in the calculation of basic and diluted net loss per share follows (in thousands, except per share amounts):

Year ended June 30,2004

2003

2002Net loss applicable to common stockholders

$
(6,484
)
$
(43,007
)
$
(37,237
)Basic and Diluted:Weighted average shares of common stock outstanding


8,211


3,105


1,108Less: Shares in escrow, subject to return


(2
)

(2
)

Less: Shares subject to repurchase


(185
)




Weighted-average shares of common stock used in computing net loss per share


8,024


3,103


1,108Basic and diluted net loss per share

$
(0.81
)
$
(13.86
)
$
(33.61
)


The
computation of basic net loss per share excludes the following shares of common stock, which are outstanding but are held in escrow or subject to Valentis' right to repurchase:



The
following options and warrants have been excluded from the calculation of diluted net loss per share because the effect of inclusion would be antidilutive.



56

---





The
options, common stock purchase warrants, shares of common stock held in escrow and shares of outstanding common stock subject to our right of repurchase will be included in the
calculation of income per share at such time as the effect is no longer antidilutive, as calculated using the treasury stock method for options and warrants.

401(k) Plan

In April 1997, the Board of Directors adopted the 1997 Valentis, Inc. 401(k) Plan (the "401(k) Plan") in accordance with Section 401(k) of
the Internal Revenue Code. All employees who complete at least 1,000 hours of service during the year are eligible to participate in the 401(k) Plan. Participants may elect to have up to 20% of
their annual salary, not to exceed the annual dollar limit set by law, deferred and contributed to the 401(k) Plan. In December 2002, the Board of Directors approved the restatement of the
401(k) Plan. Pursuant to the restated 401(k) Plan, all employees are eligible to participate in the 401(k) Plan, and may elect to have up to 75% of their annual salary, not to exceed the annual dollar
limit set by law, deferred and contributed to the 401(k) Plan. Valentis has the discretion to make a matching contribution in common stock each year for every dollar contributed to the 401(k) Plan.
The stock match vests according to the employee's years of employment with the Company (see Note 11).

Current Vulnerability to Certain Concentrations

Valentis has contracted with third-party manufacturers to produce GMP (Good Manufacturing Practices) biopharmaceuticals. The Company has also contracted for drug
formulation filling and finishing. Should the Company not be able to obtain sufficient quantities of GMP biopharmaceuticals, or sufficient drug formulation and finishing capacity from its third-party
suppliers, or additional third-party GMP contract manufacturing organizations or drug formulation filling and finishing suppliers, certain development and clinical activities may be delayed.

Recent Accounting Pronouncements

In November 2002, the FASB issued Emerging Issues Task Force Issue No. 00-21 ("EITF 00-21"), Revenue Arrangements with
Multiple Deliverables. EITF 00-21 addresses certain aspects of the accounting by a company for arrangements under which it will perform multiple revenue- generating activities. EITF
00-21 addresses when and how an arrangement involving multiple deliverables should be divided into separate units of accounting. The provisions of EITF 00-21l apply to revenue
arrangements entered into in fiscal periods beginning after June 15, 2003. The Company's adoption of EITF 00-21 did not have a material impact on our results of operations,
financial position or cash flows.

In
May 2003, the FASB issued Statement No. 150 ("FAS 150"), Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.
FAS 150 establish standards on the classification and measurement of financial instruments with characteristics of both liabilities and equity. FAS 150 is effective for financial
instruments entered into or modified after May 31, 2003. The Company's adoption of FAS 150 did not have a material impact on our results of operations, financial position ore cash flows.

Business Segments

The Company operates in one business segment, the research and development of biopharmaceutical products and associated delivery systems.

57

---



Reclassifications

Certain prior year amounts have been reclassified in the Consolidated Statements of Operations, Consolidated Statements of Cash Flows and in Notes to Consolidated
Financial Statements to conform to current year presentation, including the presentation of revenue and other accrued liabilities.

2. FINANCIAL INSTRUMENTS

At June 30, 2004, financial instruments held by the Company consist of the following (in thousands):

Amortized
Cost

Unrealized
Gain/(Loss)

Estimated
Fair ValueJune 30, 2004Money market mutual funds

$
4,801

$


$
4,801Commercial paper

$
3,997




$
3,997Corporate debt securities


10,947


(13
)

10,93419,745


(13
)

19,732Less amounts classified as cash equivalents


(8,798
)




(8,798
)Total short-term investments

$
10,947

$
(13
)
$
10,934


At
June 30, 2003, the Company had approximately $2.2 million invested in money market mutual funds, classified as cash equivalents, and there was no unrealized gain or loss
at that date.

Unrealized
gains or losses have not been material and have been presented net. There were no realized gains or losses in any period presented. The Company's cash and cash equivalents,
interest and other receivables, and accounts payable are carried at historical cost, which approximates fair value because of the short-term nature of these accounts.

3. ACCUMULATED OTHER COMPREHENSIVE LOSS

Comprehensive loss is comprised of net loss and other comprehensive loss. Other comprehensive loss includes certain changes to stockholders' equity of the Company
that are excluded from net loss. The components of accumulated other comprehensive loss are as follows (in thousands):

June 30, 2004

June 30, 2003Unrealized loss on available-for-sale securities

$
(13
)
$
Foreign currency translation adjustments


(693
)

(746
)Accumulated other comprehensive loss

$
(706
)
$
(746
)


58

---



4. COLLABORATIVE, LICENSE, AND RESEARCH AGREEMENTS

Revenue recognized in the years ended June 30, 2004, 2003 and 2002 is as follows (in thousands):

Year ended June 30,2004

2003

2002Collaborative research and development revenue:Roche Holdings, Ltd.

$


$


$
3,333





3,333License and milestone revenue:GeneSwitch® licenses


284


1,888


430DNAVax gene delivery technology license and milestone


500





PINC gene delivery technology licenses





570


Manufacturing technology milestone





1,500


PEGylation technology licenses


6,500





577,284


3,958


487Other Revenue


194





17Total Revenue

$
7,478

$
3,958

$
3,837


To
date, substantially all revenue has been generated by collaborative research and development agreements, from corporate partners, and from licensees, and only minimal revenue has been
generated from royalties on sales of the GeneSwitch® gene regulation system to the research market. Under the terms of corporate collaborations, Valentis historically received research and
development funding on a quarterly basis in advance of associated research and development costs.

Roche Holdings Ltd. ("Roche")

Pursuant to the merger with GeneMedicine in March 1999, Valentis acquired the rights under a corporate collaboration agreement with a subsidiary of Roche,
originally signed in February 1995. The agreement provided for research and development of GeneMedicine products to treat head and neck tumors and melanoma. Revenue recognized under the
collaborative research agreement with Roche was $3.3 million (87% of total revenue) for the years ended June 30, 2002. In January 2002, the Company suspended clinical development
of its cancer immunotherapy products following release of clinical data from a Phase II clinical trial of an IL-2 GeneMedicine product. Consistent with these developments and a decision by
Roche not to initiate a Phase III clinical trial, the Company's alliance with Roche ended in accordance with terms of the agreement.

DSM Biologics ("DSM")

In September 1998, Valentis and DSM Biologics (formerly Gist-Brocades/Bio-Intermediair) announced the formation of a broad,
strategic collaboration focused on the manufacture and supply of plasmid DNA and formulated DNA to the entire gene therapy industry. In May 1999, Qiagen N.V. joined the manufacturing alliance,
referred to as the pAlliance. The goal of this alliance was to provide the emerging gene therapy and genetic vaccination industry with early access to reliable, accepted plasmid DNA
contract manufacturing services and to produce high-quality, ultra pure material for plasmid-based therapeutics on every scale, from preclinical toxicology studies to commercial products.

59

---



Under
the agreement, Valentis licensed its proprietary manufacturing technology for use in DSM facilities in Montreal, Canada and Groningen, The Netherlands for license and milestone
fees. To date, Valentis has earned $450,000 in milestone fees under this original agreement.

In
June 2003, Valentis announced that it has completed an agreement with DSM Biologics under which the license granted by Valentis to DSM Biologics for Valentis' plasmid DNA
manufacturing technology is affirmed on revised financial terms. The agreement further resolves outstanding disputes between Valentis and DSM Biologics regarding prior plasmid DNA manufacturing
services performed by DSM Biologics for Valentis.

Under
the new agreement, the pAlliance plasmid DNA contract manufacturing alliance that had included Valentis, DSM Biologics and Qiagen GmbH is dissolved. The new agreement
reinstates the license to DSM Biologics under the terms of the original agreement between Valentis and DSM Biologics, modified to add a royalty to Valentis (in addition to the previously-agreed
profit-sharing arrangement). In consideration for the license reinstatement, DSM Biologics paid a $1.3 million milestone payment. The amount of this milestone payment, net of approximately
$0.6 million of outstanding debt owed to DSM Biologics by Valentis, which had been accrued by Valentis as of June 30, 2002, was received in cash during fiscal 2003. The Company recorded
an expense reversal of approximately $0.5 million during fiscal 2003 for the remaining amount accrued by Valentis as of June 30, 2002, which the Company is no longer obligated to pay to
DSM Biologics as a result of the new agreement. In fiscal 2004, the Company recognized approximately $194,000 of profit sharing and royalty revenue under this agreement.

Other license-out agreements

Valentis has licensed-out its proprietary GeneSwitch® gene regulation technology on a non-exclusive basis to Wyeth-Ayerst
Laboratories, GlaxoSmithKline, Lexicon Genetics, Pfizer Inc. and Schering AG for functional genomics research. In addition, the Company has licensed its gene delivery technology on a
non-exclusive basis to Schering AG, Innogenetics N.V. and Epimmune, Inc.. These agreements generally include (i) up front payments and annual maintenance fees, which are
non-cancelable and recognized at the time of contract signing; and, (ii) milestone and royalty payments. Revenues, in aggregate, recognized from these agreements were approximately
$784,000, $2.5 million and $430,000 for the fiscal year ended June 30, 2004, 2003 and 2002, respectively. The Company has also granted a license to ALZA Corporation under a license and
settlement agreement related to its PEGylation technology. Valentis recognized $6.5 million of license revenue in fiscal 2004 under this agreement. (see Note 15)

Valentis
has established a non-exclusive cross license with Genzyme Corporation in which Genzyme receives rights to GeneSwitch® gene regulation technology for
research use and Valentis receives certain rights to Genzyme's plasmid DNA manufacturing technology.

Sponsored research agreements

Valentis has entered into several sponsored research agreements with universities. These agreements are generally cancelable by either party upon written notice
and may be extended by mutual consent of both parties. Research and development expenses are recognized as the related services are performed, generally ratably over the period of service. Expenses
under these agreements were approximately $55,000, $208,000 and $735,000 for the fiscal years ended June 30, 2004, 2003 and 2002, respectively.

5. OTHER ACQUIRED TECHNOLOGY

In April 1999, Valentis acquired rights to intellectual property related to the Del-1 gene and protein. Del-1 is a novel
extracellular matrix protein involved in early growth and development of blood

60

---



vessels
and bone that has been demonstrated to have potential application in the treatment of certain vascular diseases by stimulating angiogenesis. Valentis is obligated to make payments to
Vanderbilt University upon the achievement of certain milestones, to share revenue received from sublicensing at a specified rate, and to make royalty payments on sales of products, if any. As of
June 30, 2004, no revenues have been derived from the license of this technology.

6. PROPERTY AND EQUIPMENT

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

June 30,2004

2003Machinery and equipment

$
6,279

$
6,349Furniture and fixtures


1,251


1,254Leasehold improvements


9,868


9,86717,398


17,470Less accumulated depreciation and amortization


(17,319
)

(15,959
)Property and equipment, net

$
79

$
1,511


Property
and equipment at June 30, 2004 and 2003 includes assets under equipment financing agreements of approximately $367,000. Accumulated amortization related to these assets
was approximately $367,000 at June 30, 2004 and $294,000 at June 30, 2003.

7. GOODWILL

At June 30, 2004 and 2003, acquired intangible assets consist of approximately $409,000 of net goodwill. The Company performed impairment analyses in
accordance with SFAS 142 as of each date, and determined that in each case goodwill was not impaired.

8. OTHER ACCRUED LIABILITIES

Other accrued liabilities consist of the following (in thousands):

June 30,2004

2003Accrued research and development expenses

$
125

$
111Accrued rent


95


174Accrued lease exit costs





665Accrued property and use taxes


441


503Accrued legal expenses


179


339Other


280


489Total

$
1,120

$
2,281


9. LONG-TERM DEBT

In October 1998, Valentis entered into an equipment financing agreement with a financing company. The Company financed $367,000 in equipment purchases
under this agreement structured as a loan. The equipment loan was being repaid over 43 months at an interest rate of 10.1% and was secured by the related equipment. The loan was fully repaid in
July 2003. Valentis has fully utilized the borrowing
capacity under this agreement. Interest expense for fiscal 2004, 2003 and 2002 was approximately zero, $9,000 and $112,000, respectively.

61

---



10. COMMITMENTS

Operating Lease

Valentis leases its facilities under operating leases. These leases expire between November 2006 and October 2007 with renewal options at the end of
the initial terms of the facilities leases.

Minimal
annual rental commitments under the operating leases at June 30, 2004 are as follows (in thousands):

Year ended June 30,2005

$
9142006


1,1772007


6502008


65$
2,806


The
Company leased an approximately 38,000 square-foot building in The Woodlands, Texas. The term of The Woodlands facility lease, which began in January 1995, was
10 years. However, during the fourth quarter of fiscal 2003, the Company ceased using the facility and in September 2003, the Company entered into a lease termination agreement with the
landlord of the facility. Pursuant to the lease termination agreement, The Woodlands facility lease was terminated on September 4, 2003, and on the same date, the Company paid to the landlord a
termination fee consisting of (i) $232,000 in cash, and (ii) 185,000 shares of the Company's common stock, together with certain registration rights for, and the Company's option to
repurchase, those shares. The Company recorded the termination fee in the year ended June 30, 2003, as lease exit cost of $232,000 for the cash payment and approximately $433,000 for the
issuance of 185,000 shares of its common stock, as it ceased using the facility during the fourth quarter of fiscal 2003. This lease exit cost is included in general and administrative expenses for
fiscal 2003.

In
addition, the Company exited 7,500 square feet of its leased Burlingame, CA facility in October 2003. In July 2003, the Company entered into a lease termination
agreement with the landlord of the Burlingame facility. Pursuant to the lease termination agreement, the Burlingame facility lease terminated on October 6, 2003. In consideration for the lease
termination, the Company paid to the landlord a cash termination fee of $115,000, which was recorded as a lease exit cost and included in general and administrative expenses for fiscal 2004.

Aggregate
future minimum sublease income to be received under the Company's facility subleases as of June 30, 2004 totals approximately $502,000, which will offset rent expense in
the fiscal years ended June 30, 2005, 2006 and 2007 by approximately $281,000, $156,000 and $65,000, respectively. Gross rent expense for the fiscal years ended June 30, 2004, 2003 and
2002 was approximately $677,000, $1.8 million and $1.7 million, respectively. Gross sublease income for the fiscal years ended June 30, 2004, 2003 and 2002 was approximately
$502,000, $549,000 and $475,000, respectively.

Restricted Cash

At June 30, 2004, the Company had approximately $57,000 of restricted cash, which is required by its bank for the establishment of a standby letter of
credit related to the Company's utility services. The restricted cash of approximately $57,000 is included in other assets in the consolidated balance sheet for the fiscal year ended June 30,
2004.

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11. REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY

Redeemable Convertible Preferred Stock and Common Stock Warrants

On December 5, 2000, Valentis completed the private placement of 31,500 shares of Series A redeemable convertible preferred stock and common stock
purchase warrants. On January 24, 2003, all outstanding shares of Series A preferred stock were converted into shares of common stock.

Prior
to the conversion of the Series A preferred stock to Common Stock on January 24, 2003, the Series A preferred stockholders were entitled to cumulative
dividends, which accrued at an annual rate of 5%, payable quarterly, in cash or, at the Company's election, in shares of common stock. If the Company elected to pay dividends in shares of its common
stock, those shares were valued at the average closing bid price for Valentis common stock during the twenty consecutive trading days ending on and including the trading day immediately prior to the
dividend payment date. The number of shares of common stock issued for dividends during the fiscal year ended June 30, 2003 and 2002 were 84,338 shares and 21,037 shares, respectively.

Summary of Certain Preferred Stock and Warrant Accounting

The total cash proceeds from the sale of Series A preferred stock and common stock purchase warrants of $31.5 million were discounted by
approximately $6.0 million, representing the value assigned to the Class A and B warrants exercisable for an aggregate of 42,226 shares of common stock issued in the private placement.
The $6.0 million value of the warrants was subject to accretion over the 3.5-year redemption period. After reducing the proceeds by the value of the warrants, the remaining proceeds
were used to compute a discounted conversion price in accordance with EITF 00-27, "Application of EITF Issue No. 98-5, Accounting for Convertible Securities with
Beneficial Conversion Features or Contingently Adjustable Conversion Ratios to Certain Convertible Instruments." The discounted conversion price was compared to the fair market value of the Valentis
common stock on December 5, 2000 (the date of issuance of the Series A preferred stock) resulting in a beneficial conversion feature of approximately $1.1 million which represents
the difference between the fair market value of Valentis' common stock and the discounted conversion price, and was subject to accretion over the 3.5-year redemption period.

Upon
conversion of the Series A preferred stock to common stock in January 2003, the remaining $3.5 million of unaccreted deemed dividend representing the balance of
amounts attributed to common stock purchase warrants, beneficial conversion feature and issuance costs related to the Series A
preferred stock was fully accreted and recorded as a deemed dividend and included in the amounts discussed in the paragraphs below related to accretion of the warrants, beneficial conversion feature
and issuance costs. This deemed dividend, along with a deemed dividend of approximately $200,000 accreted during January 2003, was included in the calculation of net loss applicable to common
stockholders for the fiscal year ended June 30, 2003.

The
accretion of warrants for the fiscal years ended June 30, 2003 and 2002 was approximately $3.3 million and $1.7 million, respectively. The accretion of the
beneficial conversion feature for the fiscal years ended June 30, 2003 and 2002 was approximately $592,000 and $314,000, respectively. The aggregate accretion value associated with the warrants
and beneficial conversion feature were included in the calculation of net loss applicable to common stockholders.

Issuance
costs of approximately $1.9 million were accounted for as a discount on the Series A preferred stock and were accreted over the 3.5-year redemption
period. Accretion of approximately $1.0 million and $550,000 for the years ended June 30, 2003 and 2002, respectively, was included in the calculation of net loss applicable to common
stockholders.

Additionally,
as a result of the simultaneous conversion of the Series A preferred stock to common stock and the reduction in the Series A preferred stock conversion price
(see below), the excess of the

63

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fair
value of the common stock issued to the Series A preferred stockholders over the fair value of the common stock issuable pursuant to the original conversion terms was approximately
$22.3 million. This amount also was included in the calculation of net loss applicable to common stockholders for the fiscal year ended June 30, 2003.

Dividends
on the Series A preferred stock, calculated at value at the rate of 5% per annum, were approximately $0.9 million and $1.6 million for the fiscal year
ended June 30, 2003 and 2002, respectively, and were charged against additional-paid-in-capital and included in the calculation of net loss applicable to
common stockholders.

Common Stock

In December 2001, Valentis completed an underwritten public offering of 204,333 shares of its common stock at $67.50 per share, resulting in net proceeds
to the Company of approximately $12.6 million.

In
January 2003, the Company received stockholder approval for, and completed, its proposed capital restructuring. Specifically, the Company effected the conversion of all
outstanding shares of its Series A preferred stock into common stock and, immediately thereafter, effected a reverse stock split of its common stock at a ratio of
one-for-thirty. All share and per share amounts have been restated to reflect this reverse stock split.

The
conversion and reverse stock split were approved by the holders of the Company's common stock on January 23, 2003. The stockholders approved the Company's Amended and Restated
Certificate of Incorporation (the "Restated Certificate"), which provided for the following: (i) an increase in the authorized shares of Common Stock from 65 million to
190 million; (ii) the elimination of all redemption rights of the Series A preferred stock; (iii) an adjustment of the conversion price of the Series A preferred
stock from $270.00 to $7.26 (these conversion prices reflect the impact of the reverse stock split); (iv) the automatic conversion into common stock of all outstanding shares of Series A
preferred stock (plus accrued and unpaid dividends and arrearage interest on unpaid dividends) on the filing date of the Restated Certificate; and (v) a reverse stock split of the Company's
outstanding Common Stock on the filing date of the Restated Certificate, in the range of 1:5 to 1:40, as determined at the discretion of the Board of Directors of the Company.

The
Board of Directors authorized a one-for-thirty reverse stock split whereby each outstanding share of common stock automatically converted into
one-thirtieth of a share of common stock. As a result of the conversion of the Series A preferred stock (and the payment of accrued and unpaid dividends and arrearage interest on
unpaid dividends), the Company issued approximately 4.3 million shares after giving effect to the reverse stock split. In lieu of fractional shares of common stock, stockholders received a cash
payment based on the closing price of the common stock on January 23, 2003. The par value of the common stock remains $0.001.

In
January 2004, Valentis completed a private placement of 4,878,047 shares of common stock at $2.05 per share along with warrants, exercisable for a five-year period,
to purchase 1,951,220 shares of common stock at $3.00 per share, resulting in net proceeds to the Company of approximately $9.4 million.

In
June 2004, the Company completed another private placement, in which the Company issued and sold 2,234,779 shares of common stock and warrants, exercisable for a
five-year period, to purchase 670,431 shares of common stock at $5.4075 per unit, resulting in net proceeds of approximately $11.2 million. The warrants are exercisable at $6.98 per
share. In addition, the Company issued to Jefferies & company, Inc., the placement agent of the private placement, warrants to purchase 223,478 shares of common stock at $5.4075 per
share, exercisable for a five-year period.

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Equity Incentive Plan

The 1997 Equity Incentive Plan (the "Incentive Plan"), as amended and restated in December 2003, provides for grants of options to employees, directors and
consultants of Valentis. The exercise price of options granted under the Incentive Plan is determined by the Board of Directors but cannot be less than 100% of the fair market value of the common
stock on the date of the grant. Options under the Incentive Plan generally vest 25% one year after the date of grant and on a pro rata basis over the following 36 months and expire ten years
after the date of grant or 90 days after termination of employment. Options granted under the plan cannot be repriced without the prior approval of Valentis' stockholders. As of June 30,
2004, an aggregate of 1.7 million shares have been authorized for issuance and options to purchase approximately 1.1 million shares of common stock had been granted under this plan.

Pursuant
to the terms of the 1998 Non-Employee Directors' Plan (the "Directors' Plan"), as amended and restated in December 2003, each non-employee
director, other than a non-employee director who currently serves on the Board, automatically shall be granted, upon his or her initial election or appointment as a
non-employee director, an option to purchase 26,000 shares of common stock, and commencing with the annual meeting of stockholders for the fiscal year 2003, each person who is serving as a
non-employee director on the day following each Annual Meeting of Stockholders automatically shall be granted an option to purchase 2,600 shares of common stock. As of June 30,
2004, an aggregate of 375,000 shares have been authorized for issuance under this plan, and options to purchase 193,325 shares of common stock had been granted to non-employee directors
under this plan.

The
merger with GeneMedicine in 1999 included the conversion of outstanding GeneMedicine stock options into options to purchase 50,000 shares of Valentis common stock. These options
relate to Valentis' assumption of GeneMedicine's 1993 Stock Option Plan referred to as the "GeneMedicine Plan." Under the terms of the GeneMedicine Plan, eligible key employees, directors and
consultants received options to purchase shares of GeneMedicine's previously outstanding common stock at prices not less than 100% and 85% for incentive stock and nonqualified options, respectively,
of the fair value on the date of grant as determined by GeneMedicine's Board of Directors. Options under the GeneMedicine Plan typically vest over a four-year period and expire ten years
after the date of grant or 90 days after termination of employment. The GeneMedicine Plan expired in March 2004.

In
May 2001, the Board of Directors adopted the 2001 Nonstatutory Incentive Plan (the "NQ Plan") covering 100,000 shares of common stock of Valentis. An additional 590,000 shares
were added to the plan as approved by the Board of Directors in May 2003, when the plan was amended and restated. The NQ Plan provides for grants of Nonstatutory stock options to employees,
directors and consultants of Valentis. The exercise price of options granted under the NQ Plan is determined by the Board of Directors but cannot be less than 100% of the fair market value of the
common stock on the date of the grant. Options under the NQ Plan generally vest 25% one year after the date of grant and on a pro rata basis over the following 36 months and expire ten years
after the date of grant or 90 days after termination of employment. Options granted under the plan cannot be repriced without the prior approval of Valentis' stockholders. As of June 30,
2004, options for 478,552 shares had been granted under this plan.

65

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Activity
under all option plans was as follows:

Outstanding Stock OptionsShares
Available
for Grant

Number
of
Shares

Price
Per Share

Weighted
Average
Exercise
PriceBalance at June 30, 2001

176,147

102,516

$
9.00

-

$
485.99

$
226.20Options granted

(62,062
)
62,062

$
61.50

-

$
176.10

$
108.60Options exercised



(1,054
)
$
23.10

-

$
45.00

$
43.80Options forfeited

26,299

(26,299
)
$
66.00

-

$
446.70

$
159.00Balance at June 30, 2002

140,384

137,225

$
9.00

-

$
485.99

$
178.80Additional authorization

1,381,666Options granted

(925,388
)
925,388

$
3.19

-

$
44.40

$
4.25Options exercised



Options forfeited

60,286

(60,286
)
$
31.20

-

$
466.88

$
102.24Balance at June 30, 2003

656,948

1,002,327

$
3.19

-

$
485.99

$
22.04Additional authorization

1,100,000Options granted

(779,450
)
779,450

$
3.20

-

$
5.35

$
4.46Options exercised



Options forfeited

37,497

(37,497
)
$
3.39

-

$
485.99

$
165.86Plans expired

(30,012
)
Balance at June 30, 2004

984,983

1,744,280

$
3.19

-

$
465.00

$
11.24


The
options outstanding at June 30, 2004 have been segregated into ranges for additional disclosure as follows:

Exercise
Price
Per Share

Options
Outstanding

Weighted Average
Remaining
Contractual Life
(in years)

Options Vested and
Exercisable

Weighted
Average
Exercise
Price$
3.19

-

$
3.52

1,069,900

9.00

269,469

$
3.38$
4.70

-

$
5.35

599,450

9.77




$
9.00

-

$
96.90

22,374

7.42

12,436

$
51.97$
112.50

-

$
190.31

29,008

5.64

26,672

$
154.02$
200.31

-

$
292.50

12,440

5.66

12,242

$
260.12$
303.75

-

$
465.00

11,108

4.83

11,076

$
356.721,744,280

9.14

331,895

$
38.60


The
weighted average fair value of options granted in fiscal 2004, 2003 and 2002 was $2.98, $3.55 and $90.50, respectively.

Stock Purchase Plan

In July 1997, the Board of Directors adopted the 1997 Employee Stock Purchase Plan covering an aggregate of 6,666 shares of common stock. An additional
6,666 shares was added to the plan as approved by the stockholders in December 2000. The 1997 Employee Stock Purchase Plan is qualified under Section 423 of the Internal Revenue Code.
The Purchase Plan is designed to allow eligible employees of Valentis to purchase shares of common stock through periodic payroll deductions. The price of common stock purchased under the Purchase
Plan must be equal to at least 85% of the lower of the fair market value of the common stock on the commencement date of each offering period or

66

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the
specified purchase date. None of the 13,332 shares reserved under the plan remain available for issuance at June 30, 2004.

In
May 2003, the Board of Directors adopted the 2003 Employee Stock Purchase Plan (the "Purchase Plan") covering an aggregate of 600,000 shares of common stock. The Purchase Plan
was approved by stockholders in May 2003 and is qualified under Section 423 of the Internal Revenue Code. The Purchase Plan is designed to allow eligible employees of Valentis to
purchase shares of common stock through periodic payroll deductions. The price of common stock purchased under the Purchase Plan must be equal to at least 85% of the lower of the fair market value of
the common stock on the commencement date of each offering period or the specified purchase date. 569,078 shares reserved under the plan remain available for issuance as of June 30, 2004.

Stock Issued Under the Valentis Inc. 401(k) Plan

Pursuant to the Valentis, Inc. 401(k) Plan (the "4011(k) Plan"), the Company made matching contributions to all eligible participants who had elective
deferrals during 2003, 2002 and 2001, equal to 25% of each such eligible participant's elective deferrals during such year in the form of shares of the Company's Common Stock. In fiscal 2002, Valentis
contributed 1,305 shares of its common stock to the 401(k) Plan as the Company's fiscal 2002 matching contributions. In fiscal 2004, Valentis contributed 9,927 and 36,502 shares of its common stock to
the 401(k) Plan as the Company's fiscal 2004 and 2003 matching contributions. Compensation expense related to this match was approximately $55,000, $113,000, and $138,000 in fiscal 2004, 2003 and
2002, respectively.

Stock-Based Compensation Pro Forma Information

Pro forma net loss and net loss per share information is required by SFAS 123, which also requires that the information be determined as if Valentis has
accounted for employee stock options and the Purchase Plan under the fair market value method of that statement (see Note 1 for such pro forma information). The fair value for these options was
estimated at the date of grant using a Black-Scholes option-pricing model with the following weighted-average assumptions:

Employee Stock OptionsPurchase Plan SharesYears ended June 30,2004

2003

2002

2004

2003

2002Expected life (in years)

2.5

4.6

4.9

0.5

0.5

0.5Risk-free interest rate

4.19
%
4.47
%
3.98
%
1.61
%
1.04
%
1.67
%Volatility

0.98

1.20

1.31

0.87

1.63

1.28Dividend yield














The
Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition,
option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because Valentis' employee stock options and employee stock purchase plans
have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair market value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options and shares issued pursuant to the employee stock purchase plan, nor do
they necessarily represent the effects of employee stock options and employee stock purchase plans on reported net income for future years.

Stock-Based Awards to Non-Employees

In fiscal years 2004 and 2002, Valentis granted options to consultants to purchase 152,000 and 4,000 shares of common stock, respectively. Options granted to
consultants are periodically revalued as

67

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they
vest in accordance with SFAS 123 and EITF 96-18 using the Black-Scholes option-pricing model. Assumptions used for valuing the options for 2004 were an estimated volatility of
0.90, risk free interest rate of 4.29%, no dividend yield and an expected life of each option of 10 years. Assumptions used for valuing the options for 2002 were an estimated volatility of
1.28, risk free interest rate of 3.99%, no dividend yield and an expected life of each option of 10 years. Expenses of approximately $80,000 and $349,000 were recognized in fiscal 2004 and
2002, respectively, related to these grants. The Company did not recognize expense related to stock-based awards to non-employees in fiscal 2003 because the value of shares vested during
the year was immaterial.

Shares of Common Stock Reserved for Issuance

At June 30, 2004, shares of common stock reserved for future issuance are as follows:

Number of
sharesCommon stock warrants

2,821,625401(k) Plan

203,571Employee stock purchase plan

569,078Stock option plans

2,804,705Total

6,398,979


12. INCOME TAXES

For financial reporting purposes, income (loss) before taxes includes the following components (in thousands):

Year ended June 30,2004

2003

2002Pre-tax income (loss):United States

$
(14,596
)
$
(14,860
)
$
(32,414
)Foreign


8,112





(676
)Total pre-tax loss

$
(6,484
)
$
(14,860
)
$
(33,090
)


There
is no provision for income taxes because the Company has incurred operating losses. Deferred income taxes reflect the net tax effects of operating loss and tax credit carryovers
and temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's
deferred tax assets are as follows (in thousands):

June 30,2004

2003Deferred tax assets:Net operating loss

$
69,300

$
59,500Research and development credits


3,300


2,900Capitalized research and development


22,000


15,500Other


300


700Total deferred tax assets


94,900


78,600Valuation allowance


(94,900
)

(78,600
)Net deferred tax assets

$


$



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Realization
of deferred tax assets is dependent upon future earnings, if any, the timing and amount of which are uncertain. Accordingly, the net deferred tax assets have been fully
offset by a valuation allowance. The valuation allowance increased by approximately $16.3 million and $4.4 million during 2004 and 2003, respectively.

As
of June 30, 2004, the Company had net operating loss carryforwards for federal income tax purposes of approximately $187 million, which expire in the years 2006 through
2024, and federal research and development tax credits of approximately $2.6 million, which expire in the years 2008 through 2024.

As
of June 30, 2004, the Company had net operating loss carryforwards for state income tax purposes of approximately $70.0 million, which expire in the years 2005 through
2014, and state research, and development tax credits of approximately $1.1 million, which do not expire.

Utilization
of the net operating losses and credit carryforwards may be subject to a substantial annual limitation due to the "change in ownership" provisions of the Internal Revenue
Code of 1986. The annual limitation may result in the expiration of net operating losses and credits before utilization.

13. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

|                                                                                         |  | Quarter |       
|---------------------------------------------------------------------------------------- |  | ------- | ------
|
|2004                                                                                     |  |         |       
|Revenue                                                                                  |  | $       | 6,709 
|Operating expenses                                                                       |  |         | 3,240 
|Net income (loss)                                                                        |  |         | 3,440 
|Net income (loss) applicable to common stockholders                                      |  |         | 3,440 
|Basic net income (loss) per share applicable to common stockholders                      |  |         | 0.62  
|Diluted net income (loss) per share applicable to common stockholders                    |  |         | 0.61  
|2003                                                                                     |  |         |       
|Revenue                                                                                  |  | $       | 339   
|Operating expenses (excluding restructuring and other charges)                           |  |         | 5,264 
|Restructuring charges                                                                    |  |         |      
|Net loss                                                                                 |  |         | (4,652
|Deemed dividend                                                                          |  |         | (644  
|Adjustment resulting from the reduction in the Series A Preferred Stock conversion price |  |         |      
|Dividends on redeemable, convertible preferred stock                                     |  |         | (385  
|Net loss applicable to common stockholders                                               |  |         | (5,681
|Basic and diluted net loss per share applicable to common stockholders                   |  |         | (4.63 

---

14. CORPORATE RESTRUCTURING

In conjunction with the Company's announcement in January 2002 that it would suspend clinical development of its cancer immunotherapy products, Valentis
implemented a restructuring plan to better

69

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align
the Company's cost structure with market conditions. This plan significantly reduced the Company's preclinical product development efforts and suspended its clinical programs in oncology in an
effort to lower future expenditures and conserve cash. A total of 47 positions, primarily in preclinical and manufacturing research and development, and associated general and administrative staff,
were eliminated as a result of the restructuring. For the year ended June 30, 2002, we recorded restructuring and related charges of approximately $1.8 million.

On
October 8, 2002, the Company announced that it had further reduced its staff and planned expenditures to allow it to continue the development of its lead product,
Del-1 for the treatment of a variety of cardiovascular diseases including peripheral arterial disease (PAD) and ischemic heart disease (IHD). In addition, the Company will continue to
advance its the GeneSwitch® gene regulation technology through the licensing to other companies. In connection therewith, the Company reduced staff by 34 individuals in order to reduce the
Company's cash expenditures. For the year ended June 30, 2003, we recorded restructuring and related charges of approximately $832,000.

15. ALZA LICENSE AND SETTLEMENT AGREEMENT

In July 2003, our wholly owned subsidiary, PolyMASC Pharmaceuticals, announced that it settled its patent infringement litigation against ALZA Corporation,
a unit of Johnson & Johnson. Under the license and settlement agreement, PolyMASC received $6.5 million, and granted a worldwide license to ALZA under its PEG-liposome
patents. The agreement resolves pending patent infringement litigation in the United States and Germany, as well as Opposition proceedings in Japan and before the European Patent Office. The
$6.5 million payment received under the license and settlement agreement was recorded as license revenue in the first quarter of fiscal 2004.

16. SUBSEQUENT EVENT (unaudited)

In August 2004, Valentis received a $1 million license fee from the Company's collaboration with Schering AG, Germany (Schering). The fee was earned
as a result of Schering's decision to utilize Valentis' PINC and GeneSwitch® technologies in an additional product development program. This represents the second gene
proprietary to Schering.

In
December 2002, Valentis and Schering AG signed a multi-product license and option agreement to develop and commercialize products that incorporate Valentis' proprietary
PINC polymer based gene delivery system and the GeneSwitch® gene regulation technologies. Under terms of the agreement, Schering has exclusive, world-wide rights
to the PINC and GeneSwitch® technologies for use with up to two genes proprietary to Schering, and an option for non-exclusive rights to the PINC
technology for a third gene.

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