**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

** **

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**FORM 10-Q**

x                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934

** **

**For the quarterly periodended March 31, 2006**

 

**OR**

 

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934

** **

**Commission filenumber:  0-15006**

** **

**AVANT IMMUNOTHERAPEUTICS, INC.**

(Exact name of registrant as specified in its charter)

** **
| **Delaware**              | **No. 13-3191702**               |
|---------------------------|---------------------------------------|
| (State of  Incorporation) | (I.R.S. Employer  Identification No.) |

 

**119 Fourth Avenue,Needham, Massachusetts 02494-2725**

(Address of principal executive offices) (Zip Code)

 

**(781) 433-0771**

(Registrant’s telephone number, including area code)

 

 

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

 

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 
| Large accelerated filer   o | Accelerated filer   x | Non-accelerated filer   o |
|---------------------------------------|---------------------------------|-------------------------------------|

 

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

 

As of May 3, 2006, 74,172,695 shares of commonstock, $.001 par value per share, were outstanding.

 

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**AVANTIMMUNOTHERAPEUTICS, INC.**

**FORM 10-QQuarter Ended March 31, 2006Table of Contents**
|                                                                                                           | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|------------|------------|
| **Part I — Financial  Information**                                                             |       |       |       |
|                                                                                                      |       |       |       |
| Unaudited,  Consolidated Balance Sheets at March 31, 2006 and December 31, 2005                 |       |       |       |
|                                                                                                      |       |       |       |
| Unaudited, Consolidated Statements of Operations for  the Three Months Ended March 31, 2006 and 2005 |       |       |       |
|                                                                                                      |       |       |       |
| Unaudited, Consolidated Statements of Cash Flows for  the Three Months Ended March 31, 2006 and 2005 |       |       |       |
|                                                                                                      |       |       |       |
| Notes to Unaudited, Consolidated Financial Statements                                                     |       |       |       |
|                                                                                                      |       |       |       |
| Management’s Discussion and Analysis of Financial  Condition and Results of Operations               |       |       |       |
|                                                                                                      |       |       |       |
| Quantitative and Qualitative Disclosures about Market  Risk                                               |       |       |       |
|                                                                                                      |       |       |       |
| Controls  and Procedures                                                                                  |       |       |       |
| ** **                                                                                                |       |       |       |
| **Part II — Other  Information**                                                                |       |       |       |
|                                                                                                      |       |       |       |
| Item 1A. Risk Factors                                                                                     |       |       |       |
|                                                                                                      |       |       |       |
| Item 6. Exhibits                                                                                          |       |       |       |
|                                                                                                      |       |       |       |
| Signatures                                                                                                |       |       |       |
|                                                                                                      |       |       |       |
| Certifications                                                                                            |       |       |       |

 

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 **PART I — FINANCIALINFORMATION**

**Item 1. FinancialStatements**

**AVANT IMMUNOTHERAPEUTICS, INC.CONSOLIDATED BALANCE SHEETS(Unaudited)**
| ** **                                                                                                                                                                                                      | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                                                                                                      | ** ** | ** **               | ** ** | ** **                  | ** ** |
| Current Assets:                                                                                                                                                                                                 |       |                     |       |                        |       |
| Cash and Cash Equivalents                                                                                                                                                                                       |       | $                        | 59,755,919 |                        | $          | 23,419,434 |   |
| Accounts Receivable                                                                                                                                                                                             |       | 716,219                  |       | 418,380                     |       |
| Prepaid Expenses and Other Current Assets                                                                                                                                                                       |       | 777,760                  |       | 767,082                     |       |
|                                                                                                                                                                                                            |       |                     |       |                        |       |
| Total Current Assets                                                                                                                                                                                            |       | 61,249,898               |       | 24,604,896                  |       |
|                                                                                                                                                                                                            |       |                     |       |                        |       |
| Property and  Equipment, Net                                                                                                                                                                                    |       | 6,203,757                |       | 5,743,663                   |       |
| Intangible and  Other Assets                                                                                                                                                                                    |       | 4,818,296                |       | 5,067,073                   |       |
| Goodwill                                                                                                                                                                                                        |       | 1,036,285                |       | 1,036,285                   |       |
|                                                                                                                                                                                                            |       |                     |       |                        |       |
| Total Assets                                                                                                                                                                                                    |       | $                        | 73,308,236 |                        | $          | 36,451,917 |   |
| ** **                                                                                                                                                                                                      |       |                     |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                                                                  |       |                     |       |                        |       |
| Current Liabilities:                                                                                                                                                                                            |       |                     |       |                        |       |
| Accounts Payable                                                                                                                                                                                                |       | $                        | 598,510    |                        | $          | 1,140,578 |   |
| Accrued Expenses                                                                                                                                                                                                |       | 2,857,507                |       | 2,334,708                   |       |
| Current Portion of Deferred Revenue                                                                                                                                                                             |       | 2,846,981                |       | —                      |       |
| Current Portion of Other Long-Term Liabilities                                                                                                                                                                  |       | 210,157                  |       | 217,457                     |       |
|                                                                                                                                                                                                            |       |                     |       |                        |       |
| Total Current Liabilities                                                                                                                                                                                       |       | 6,513,153                |       | 3,692,743                   |       |
|                                                                                                                                                                                                            |       |                     |       |                        |       |
| Deferred Revenue                                                                                                                                                                                                |       | 46,602,216               |       | 10,000,000                  |       |
| Other Long-Term  Liabilities                                                                                                                                                                                    |       | 2,004,333                |       | 1,870,051                   |       |
|                                                                                                                                                                                                            |       |                     |       |                        |       |
| Stockholders’ Equity:                                                                                                                                                                                      |       |                     |       |                        |       |
| Convertible Preferred Stock, 4,513,102 Shares  Authorized; None Issued  and Outstanding                                                                                                                         |       | —                   |       | —                      |       |
|                                                                                                                                                                                                            |       |                     |       |                        |       |
| Common Stock, $.001 Par Value; 100,000,000 Shares  Authorized; 74,393,014 Issued and 74,172,695 Outstanding at March 31,  2006 and 74,387,087 Issued and 74,166,768  Outstanding at December 31, 2005 |       | 74,393                   |       | 74,387                      |       |
| Additional Paid-In Capital                                                                                                                                                                                      |       | 257,185,249              |       | 258,139,855                 |       |
| Deferred Compensation                                                                                                                                                                                           |       | —                   |       | (1,225,000                  | )          |
| Less: 220,319 Common Treasury Shares at Cost                                                                                                                                                                    |       | (227,646                 | )          | (227,646                    | )          |
| Accumulated Deficit                                                                                                                                                                                             |       | (238,843,462             | )          | (235,872,473                | )          |
|                                                                                                                                                                                                            |       |                     |       |                        |       |
| Total Stockholders’ Equity                                                                                                                                                                                 |       | 18,188,534               |       | 20,889,123                  |       |
|                                                                                                                                                                                                            |       |                     |       |                        |       |
| Total  Liabilities and Stockholders’ Equity                                                                                                                                                                |       | $                        | 73,308,236 |                        | $          | 36,415,917 |   |

 

*Seeaccompanying notes to unaudited consolidated financial statements*

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**AVANT IMMUNOTHERAPEUTICS, INC.CONSOLIDATED STATEMENTS OF OPERATIONS(Unaudited)**
| ** **                                    | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|
| ** **                                    | ** ** | **March 31,  2006**         | ** ** | **March 31,  2005** | ** ** |
| **REVENUE:**                                  | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Product  Development and Licensing Agreements |       | $                                | 2,619,974  |   | $ | 71,457 |   |
| Government  Contracts and Grants              |       | 500,207                          |       | 866,087 |   |
| Product  Royalties                            |       | 586,306                          |       | 33,008 |   |
|                                          |       |                             |       |   |   |
| Total Revenue                                 |       | 3,706,487                        |       | 970,552 |   |
| ** **                                    |       |                             |       |   |   |
| **OPERATING EXPENSE:**                        |       |                             |       |   |   |
| Research and  Development                     |       | 4,348,707                        |       | 4,030,618 |   |
| General and  Administrative                   |       | 1,988,514                        |       | 1,710,784 |   |
| Amortization of  Acquired Intangible Assets   |       | 248,778                          |       | 248,778 |   |
|                                          |       |                             |       |   |   |
| Total Operating  Expense                      |       | 6,585,999                        |       | 5,990,180 |   |
|                                          |       |                             |       |   |   |
| Operating Loss                                |       | (2,879,512                       | )          | (5,019,628 | ) |
|                                          |       |                             |       |   |   |
| Investment and  Other Income, Net             |       | 280,521                          |       | 151,129 |   |
|                                          |       |                             |       |   |   |
| Loss before  Provision for Income Taxes       |       | (2,598,991                       | )          | (4,868,499 | ) |
|                                          |       |                             |       |   |   |
| Provision for  Income Taxes                   |       | 372,000                          |       | — |   |
|                                          |       |                             |       |   |   |
| Net Loss                                      |       | $                                | (2,970,991 | ) | $ | (4,868,499 | ) |
|                                          |       |                             |       |   |   |
| Basic and  Diluted Net Loss Per Common Share  |       | $                                | (0.04      | ) | $ | (0.07 | ) |
|                                          |       |                             |       |   |   |
| Weighted Average Common  Shares Outstanding   |       | 74,172,563                       |       | 74,131,999 |   |

 

###### *See accompanying notes to unauditedconsolidated financial statements*

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**AVANT IMMUNOTHERAPEUTICS, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(Unaudited)**
| ** **                                                                   | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                   | ** ** | **March 31,  2006**         | ** ** | **March 31,  2005** | ** ** |
| **Cash Flows from Operating  Activities:**                                   | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Net Loss                                                                     |       | $                                | (2,970,991 | ) | $ | (4,868,499 | ) |
| Adjustments to  Reconcile Net Loss to Net Cash Used in Operating Activities: |       |                             |       |   |   |
| Depreciation and Amortization                                                |       | 473,080                          |       | 342,351 |   |
| Stock-Based Compensation Expense                                             |       | 264,255                          |       | 121,000 |   |
| Changes in  Operating Assets and Liabilities:                                |       |                             |       |   |   |
| Accounts Receivable                                                          |       | (297,839                         | )          | 1,313,899 |   |
| Prepaid and Other Current Assets                                             |       | (10,678                          | )          | (100,829 | ) |
| Accounts Payable and Accrued Expenses                                        |       | (19,269                          | )          | (878,909 | ) |
| Deferred Revenue                                                             |       | 39,449,197                       |       | 25,795 |   |
| Other Long-Term Liabilities                                                  |       | 198,707                          |       | — |   |
|                                                                         |       |                             |       |   |   |
| Net Cash Provided by (Used in) Operating Activities                          |       | 37,086,462                       |       | (4,045,192 | ) |
| ** **                                                                   |       |                             |       |   |   |
| **Cash Flows from Investing  Activities:**                                   |       |                             |       |   |   |
| Acquisition of Property and Equipment                                        |       | (684,397                         | )          | (359,717 | ) |
| Other Non-Current Assets                                                     |       | —                           |       | 1,000 |   |
|                                                                         |       |                             |       |   |   |
| Net Cash Used in Investing Activities                                        |       | (684,397                         | )          | (358,717 | ) |
| ** **                                                                   |       |                             |       |   |   |
| **Cash Flows from Financing  Activities:**                                   |       |                             |       |   |   |
| Proceeds from Stock Issuance                                                 |       | 6,145                            |       | 2,055 |   |
| Proceeds from Exercise of Stock Options and Warrants                         |       | —                           |       | 427 |   |
| Payment of Long-Term Liabilities                                             |       | (71,725                          | )          | (30,947 | ) |
|                                                                         |       |                             |       |   |   |
| Net Cash Used in Financing Activities                                        |       | (65,580                          | )          | (28,465 | ) |
|                                                                         |       |                             |       |   |   |
| Net Increase  (Decrease) in Cash and Cash Equivalents                        |       | 36,336,485                       |       | (4,432,374 | ) |
|                                                                         |       |                             |       |   |   |
| Cash and Cash  Equivalents at Beginning of Period                            |       | 23,419,434                       |       | 31,741,494 |   |
|                                                                         |       |                             |       |   |   |
| Cash and Cash  Equivalents at End of Period                                  |       | $                                | 59,755,919 |   | $ | 27,309,120 |   |
|                                                                         |       |                             |       |   |   |
| **Supplemental Disclosure of Cash  Flow Information**                        | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Cash paid for interest                                                       |       | $                                | 35,737     |   | $ | 31,108 |   |
|                                                                         |       |                             |       |   |   |
| See Note 9.                                                                  |       |                             |       |   |   |
|                                                                         |       |                             |       |   |   |

 

*Seeaccompanying notes to unaudited consolidated financial statements*

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**AVANTIMMUNOTHERAPEUTICS, INC.Notes to Unaudited Consolidated Financial StatementsMarch 31, 2006**

**(1)           Nature of Business**

AVANTImmunotherapeutics, Inc. (the “Company” or “AVANT”) is engaged in thediscovery, development and commercialization of products that harness the humanimmune system to prevent and treat disease. The Company is developing a broadportfolio of vaccines and therapeutics against cardiovascular, viral andbacterial diseases. These include a treatment to reduce complement-mediatedtissue damage associated with cardiac by-pass surgery, single-dose oralvaccines aimed at protecting travelers and people in regions where infectiousdiseases are endemic and a proprietary vaccine candidate for cholesterolmanagement. In addition, the Company is developing the VitriLifeÒ preservation and lyophilization technologiesfor use in manufacturing AVANT’s oral vaccines and certain other non-injectableapplications. AVANT further leverages the value of its technologyportfolio through corporate, governmental and non-governmental partnerships.One successful collaboration resulted in the development of an oral humanrotavirus vaccine. Current collaborations encompass the development of vaccinesto combat threats of biological warfare and vaccines addressed to globalhealth, human food safety and animal health.

The unauditedconsolidated financial statements include the accounts of AVANTImmunotherapeutics, Inc. and its wholly owned subsidiary, Megan Health, Inc.(“Megan”). All intercompany transactions have been eliminated.

**(2)           Interim Financial Statements**

The accompanyingunaudited consolidated financial statements for the three months ended March 31,2006 and 2005 include the consolidated accounts of AVANT, and have beenprepared in accordance with instructions to Form 10-Q and Article 10of Regulation S-X. In the opinion of management, the information containedherein reflects all adjustments, consisting solely of normal recurringadjustments, that are necessary to present fairly the Company’s financial positionat March 31, 2006, results of operations for the three months ended March 31,2006 and 2005, and cash flows for the three-month periods ended March 31,2006 and 2005. The results of operations for the three-month period ended March 31,2006 are not necessarily indicative of results for any future interim period orfor the full year.

Certaininformation and footnote disclosures normally included in financial statementsprepared in accordance with generally accepted accounting principles in theUnited States of America have been omitted, although the Company believes thatthe disclosures included, when read in conjunction with AVANT’s Annual Reporton Form 10-K for the year ended December 31, 2005, are adequateto make the information presented not misleading. The accompanying December 31,2005 Consolidated Balance Sheet was derived from audited financial statements,but does not include all disclosures required by accounting principlesgenerally accepted in the United States of America.

**(3)           Paul Royalty Fund**

In May 2005,AVANT entered into an agreement whereby an affiliate of Paul Royalty Fund II,L.P. (“PRF”) purchased an interest in the******net******royalties AVANT will receive onworldwide sales of RotarixÒ.RotarixÒ is licensed to GlaxoSmithKline plc (“Glaxo”). Theterms of the agreement with PRF include an upfront unconditional payment fromPRF totaling $10 million received in 2005 and the following milestone payments:(i) $40 million for product launch in the European Union received March 17,2006, and (ii) between $9 million and $11 million on product launch in theUnited States, depending on date of the launch.

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In addition, AVANTretains some participation in the worldwide net royalty stream from RotarixÒ.If worldwide net royalties on sales of RotarixÒfrom Glaxo exceed $27.5 million in any year, AVANT will receive 92.5% ofroyalties in excess of $27.5 million. Also, once PRF receives cumulativeroyalties equal to 2.45 times PRF’s aggregate cash payments to AVANT, thenAVANT will receive 92.5% of all additional royalties. If RotarixÒis not launched in the U.S. by the end of 2009, either PRF or AVANT can opt outof the U.S. portion of the agreement, and AVANT will retain all U.S.-derivedroyalties and PRF would not be obligated to make payments to AVANT upon U.S.approval.

On March 14,2006, AVANT amended its agreement with PRF to accelerate the $40 millionmilestone payment, which was received on March 17, 2006. The payment hadpreviously been due upon the first sale of RotarixÒin the European Union, which was expected to occur during the second quarter of2006. Other financial terms of the PRF agreement were not changed.

The PRF transaction qualifies as a sale in accordancewith guidance in EITF 88-18 “Sale of Future Revenues.”  The upfront unconditional payment of $10million and the $40 million milestone payment for launch in the European Unionwere recorded by AVANT as deferred revenue upon receipt. Any future milestonepayments received from PRF will also be recorded as deferred revenue. Revenueswill be recognized and calculated based on the ratio of total royaltiesreceived from Glaxo and remitted to PRF over expected total amounts to bereceived by PRF and then applying this percentage to the total cumulativeconsideration received from PRF to date. The expected total of payments to bepaid to PRF is an estimate which AVANT will update from time to time todetermine that the estimate continues to be reasonable in light of then currentevents and circumstances. In February 2006, the European Commission grantedapproval of RotarixÒ in the EuropeanUnion, which triggered a $4 million milestone payment from Glaxo, 50% of whichis creditable against future royalties. AVANT remitted $1.4 million of theGlaxo milestone payment to PRF in accordance with the PRF agreement. As aresult, in the first quarter of 2006, AVANT recognized $550,803 in productroyalty revenue related to PRF’s purchased interests in the net royalties thatAVANT receives from RotarixÒ worldwide netsales. Based on management’s best estimates of the amount and timing of Glaxoroyalties, the Company has classified $2,846,981 and $46,602,216 of the deferredrevenue balance at March 31, 2006 as short-term and long-term,respectively.

**(4)           Stock-Based Compensation**

On January 1,2006, the Company adopted Statement of Financial Accounting Standards No. 123(revised 2004), “Share-Based Payment,” (“SFAS 123(R)”) which requires themeasurement and recognition of compensation expense for all share-based paymentawards made to employees and directors including employee stock options andemployee stock purchases related to the Employee Stock Purchase Plan (“employeestock purchases”) based on estimated fair values. SFAS 123(R) supersedesthe Company’s previous accounting under Accounting Principles Board Opinion No. 25,“Accounting for Stock Issued to Employees” (“APB 25”) for periods beginning infiscal 2006. In March 2005, the Securities and Exchange Commission issuedStaff Accounting Bulletin No. 107 (“SAB 107”) relating to SFAS 123(R). TheCompany has applied the provisions of SAB 107 in its adoption of SFAS 123(R).

The Companyadopted SFAS 123(R) using the modified prospective transition method,which requires the application of the accounting standard as of January 1,2006, the first day of the Company’s fiscal year 2006. The Company’sConsolidated Financial Statements as of and for the three months ended March 31,2006 reflect the impact of SFAS 123(R). In accordance with the modifiedprospective transition method, the Company’s Consolidated Financial Statementsfor prior periods have not been restated to reflect, and do not include, theimpact of SFAS 123(R). Stock-based compensation expense recognized under SFAS123(R) for the three months ended March 31, 2006 was $264,255, whichconsisted of stock-based compensation expense related to employee stockoptions, employee stock purchases and restricted stock units of $87,552, $1,703and $175,000, respectively. There was no stock-based compensation expenserelated to employee stock options and employee stock purchases recognizedduring the three months ended March 31, 2005. Stock-based compensationexpense of $121,000 related to restricted stock unit awards was recognizedduring the three months ended March 31, 2005. Stock-based compensationexpense of $264,255 and $121,000 was reflected as operating cash flows in theConsolidated Statements of Cash Flows for the three-months ended March 31,2006 and 2005, respectively. The adoption of SFAS 123(R) had an inmaterialimpact on earnings per share. See Note 10 for additional information.

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SFAS 123(R) requirescompanies to estimate the fair value of share-based payment awards on the dateof grant using an option-pricing model. The value of the portion of the awardthat is ultimately expected to vest is recognized as expense over the requisiteservice periods in the Company’s Consolidated Statement of Operations. Prior tothe adoption of SFAS 123(R), the Company accounted for stock-based awards toemployees and directors using the intrinsic value method in accordance with APB25 as allowed under Statement of Financial Accounting Standards No. 123, “Accountingfor Stock-Based Compensation” (“SFAS 123”). Under the intrinsic value method,no stock-based compensation expense had been recognized in the Company’sConsolidated Statement of Operations because the exercise price of the Company’sstock options granted to employees and directors equaled the fair market valueof the underlying stock at the date of grant.

Stock-basedcompensation expense recognized during the period is based on the value of theportion of share-based payment awards that is ultimately expected to vestduring the period. Stock-based compensation expense recognized in the Company’sConsolidated Statement of Operations for the three months ended March 31, 2006included compensation expense for share-based payment awards granted prior to,but not yet vested as of January 1, 2006 based on the grant date fairvalue estimated in accordance with the provisions of SFAS 123 and compensationexpense for the share-based payment awards granted subsequent to January 1,2006 based on the grant date fair value estimated in accordance with theprovisions of SFAS 123(R). In conjunction with the adoption of SFAS 123(R), compensationexpense for all share-based payment awards granted prior to January 1,2006 will continue to be recognized using the straight-line method andcompensation expense for all share-based payment awards granted subsequent to January 1,2006 will also be recognized using the straight-line method. As stock-basedcompensation expense recognized in the Consolidated Statement of Operations forthe first quarter of fiscal 2006 is based on awards ultimately expected tovest, it has been reduced for estimated forfeitures. SFAS 123(R) requiresforfeitures to be estimated at the time of grant and revised, if necessary, insubsequent periods if actual forfeitures differ from those estimates. In theCompany’s pro forma information required under SFAS 123 for the periods priorto fiscal 2006, the Company accounted for forfeitures as they occurred.

Upon adoption ofSFAS 123(R), the Company retained its method of valuation for share-basedawards granted beginning in fiscal 2006 using the Black-Scholes option-pricingmodel (“Black-Scholes model”) which was previously used for the Company’s proforma information required under SFAS 123. The Company’s determination of fairvalue of share-based payment awards on the date of grant using anoption-pricing model is affected by the Company’s stock price as well asassumptions regarding a number of highly complex and subjective variables.These variables include, but are not limited to, the Company’s expected stockprice volatility over the term of the awards, and actual and projected employeestock option exercise behaviors. 

In September 2005,November 2004 and September 2003, the Company awarded Restricted Stock Units toDr. Una Ryan, its President and CEO, and recorded non-cash deferredcompensation amounting to $270,000, $832,000 and $1,104,000, respectively.  The Company determined the value ofrestricted stock unit awards base on the closing price of AVANT’s common stockon the award date.  The value of therestricted stock unit awards is being amortized over their vesting period, orfour years. Certain of the restricted stock unit awards vest over four yearsbut will vest in their entirety upon the earlier of the sale of the Company orDr. Ryan's retirement at or after age 65. The value of these restricted stockunit awards is being amortized over approximately two years until Dr. Ryanattains age 65. AVANT has applied an estimated forfeiture rate of zero to therestricted stock unit awards.

The Company hasnot recognized any tax benefits or deductions related to the tax effects ofemployee stock-based compensation as the Company carries a full deferred taxasset valuation allowance and has significant net operating loss carryforwardsavailable.

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**(5)           Trade and Other Accounts Receivable**

Trade accounts receivable are recorded at the invoiced amount and donot bear interest. The Company has not historically experienced credit lossesfrom its trade accounts receivable and therefore has not established anallowance for doubtful accounts. The Company does not have anyoff-balance-sheet credit exposure related to its customers.

Accounts receivable consists of the following:

|                    | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------|------------|--------------------------|------------|-----------------------------|------------|
|               |       |                     |       |                        |       |
| Trade  Receivables |       | $                        | 519,969    |                        | $          | 383,416 |   |
| Other  Receivables |       | 196,250                  |       | 34,964                      |       |
|               |       | $                        | 716,219    |                        | $          | 418,380 |   |

 

Other receivablesat March 31, 2006 represent interest receivable from a bank, a receivabledue from the Company’s Needham landlord and a receivable for the sale of excesslaboratory equipment. Other receivables at December 31, 2005 representinterest receivable from a bank.

**(6)           Property and Equipment**

Property and equipment includes the following:

|                                                 | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|-------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
|                                            |       |                     |       |                        |       |
| Laboratory  Equipment                           |       | $                        | 2,998,020  |                        | $          | 2,966,354 |   |
| Manufacturing  Equipment                        |       | 1,234,844                |       | 1,054,512                   |       |
| Office Furniture  and Equipment                 |       | 1,904,780                |       | 1,893,623                   |       |
| Leasehold  Improvements                         |       | 4,563,347                |       | 4,510,075                   |       |
| Construction in  Progress                       |       | 1,368,594                |       | 960,624                     |       |
| Total Property and Equipment                    |       | 12,069,585               |       | 11,385,188                  |       |
| Less Accumulated  Depreciation and Amortization |       | (5,865,828               | )          | (5,641,525                  | )          |
|                                            |       | $                        | 6,203,757  |                        | $          | 5,743,663 |   |

 

The Company hasrecognized $15,975 of capitalized interest costs incurred in financingleasehold improvements and laboratory and manufacturing equipment at its FallRiver and Needham facilities during the three-month period ended March 31,2006. The total amount of interest expense incurred by AVANT during thethree-month period was $26,455.

Depreciation expense related to equipment andleasehold improvements was $246,002 and $93,574 for the three months endedMarch 31, 2006 and 2005, respectively.

**(7)           Intangible and Other Assets**

Intangible and other assets include the following:
| ** **                  | ** ** | **March 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|-----------------------------|------------|------------------------------|------------|---------------------------------|------------|
| ** **                  | ** ** | **Estimated  Lives**         | ** ** | **Gross  Intangible  Assets**   | ** ** | **Accumulated  Amortization** | ** ** | **Net  Intangible  Assets** | ** ** | **Gross  Intangible  Assets** | ** ** | **Accumulated  Amortization** | ** ** | **Net  Intangible  Assets** | ** ** |
| Intangible  Assets:         |       |                         |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Collaborative Relationships |       | 5 years                      |       | $                               | 1,090,000  |   | $ | (1,090,000 | ) | $ | 3⁄4 |   | $ | 1,090,000 |   | $ | (1,090,000 | ) | $ | 3⁄4 |   |
| Core Technology             |       | 10 years                     |       | 3,786,900                       |       | (1,603,026 | ) | 2,183,874 |   | 3,786,900 |   | (1,508,352 | ) | 2,278,548 |   |
| Developed Technology        |       | 7 years                      |       | 3,263,100                       |       | (2,483,200 | ) | 779,900 |   | 3,263,100 |   | (2,366,800 | ) | 896,300 |   |
| Strategic Partner Agreement |       | 17 years                     |       | 2,563,900                       |       | (804,359 | ) | 1,759,541 |   | 2,563,900 |   | (766,656 | ) | 1,797,244 |   |
|                        |       |                         |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Total Intangible  Assets    |       |                         |       | 10,703,900                      |       | (5,980,585 | ) | 4,723,315 |   | 10,703,900 |   | (5,731,808 | ) | 4,972,092 |   |
|                        |       |                         |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Other Non Current  Assets   |       |                         |       | 94,981                          |       | 3⁄4 |   | 94,981 |   | 94,981 |   | 3⁄4 |   | 94,981 |   |
|                        |       |                         |       | $                               | 10,798,881 |   | $ | (5,980,585 | ) | $ | 4,818,296 |   | $ | 10,798,881 |   | $ | (5,731,808 | ) | $ | 5,067,073 |   |

 

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All of the Company’sintangible assets are amortized over their estimated useful lives. Totalamortization expense for intangible assets was $248,778 for the three-monthperiods ended March 31, 2006 and 2005, respectively.

The estimatedfuture amortization expense of intangible assets as of March 31, 2006 forthe remainder of fiscal year 2006 and the five succeeding years is as follows:

| Year ending December 31, | ** ** | **Estimated  Amortization  Expense** | ** ** |
|-----------------------------------------|------------|--------------------------------------|------------|
| 2006 (remaining  nine months)           |       | $                                    | 746,334    |   |
| 2007                                    |       | 960,212                              |       |
| 2008                                    |       | 529,512                              |       |
| 2009                                    |       | 529,512                              |       |
| 2010                                    |       | 514,622                              |       |
| 2011                                    |       | 350,822                              |       |
|                                         |            |                                      |            |  |

 

**(8)           Loss Per Share**

The Companycomputes and reports earnings per share in accordance with the provisions ofSFAS No. 128, “Earnings Per Share.”  The computations of basic and diluted loss percommon share are based upon the weighted average number of common sharesoutstanding and potentially dilutive securities. Potentially dilutivesecurities include stock options, warrants and restricted stock units. Optionsand warrants to purchase 3,964,060 and 3,615,528 shares of common stock andrestricted stock units totaling 1,000,000 and 800,000 shares were not includedin the computations of weighted average common shares for the periods ended March 31,2006 and 2005, respectively, because inclusion of such shares would have ananti-dilutive effect on net loss per share.

**(9)           Employee Stock Benefit Plans**

***Restricted StockUnit Awards***

On September 21, 2005, AVANT awarded Dr. Una Ryan, itsPresident and CEO, 200,000 Restricted Stock Units. The Restricted Stock Unitsvest over four years but will vest in their entirety upon the earlier ofthe sale of the Company or Dr. Ryan’s retirement at or after age 65. The Company determined the value of theRestricted Stock Units to be $270,000, based on a valuation of $1.35 per share,the closing price of AVANT’s common stock on the award date. The value of theRestricted Stock Units is being amortized over approximately 15 months untilDr. Ryan attains age 65, and is being recorded as compensation expense. Inconnection with the award, the Company has recognized $54,000 asstock-based compensation expense in the statement of operations during thethree-month period ended March 31, 2006.

In November 2004and September 2003, the Company also awarded Restricted Stock Units to Dr. Ryanand recorded non-cash deferred compensation amounting to $832,000 and$1,104,000, respectively. The value ofthe Restricted Stock Units is being amortized over their vesting period, orfour years, and is being recorded as compensation expense. In connection withthe award, the Company has recognized $121,000 as stock-basedcompensation expense in the statement of operations during the three-monthperiods ended March 31, 2006 and 2005, respectively.

***Employee StockPurchase Plan***

The 2004 Employee StockPurchase Plan (the “2004 Plan”) was adopted on May 13, 2004. All full timeemployees of AVANT are eligible to participate in the 2004 Plan. A total of150,000 shares of common

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stock are reserved for issuanceunder the 2004 Plan. Under the 2004 Plan, each participating employee maycontribute up to 15% of his or her compensation to purchase up to 500 shares ofcommon stock per year in any six-month offering period and may withdraw fromthe offering at any time before stock is purchased. Participation terminatesautomatically upon termination of employment. The purchase price per share ofcommon stock in an offering is 85% of the lower of its fair market value ateither the beginning of the offering period or the applicable exercise date. Duringthe three months ended March 31, 2006 and 2005, the Company issued 5,927and 1,202 shares, respectively, under the 2004 Plan. At March 31, 2006,132,422 shares were available for issuance under the 2004 Plan.

The 2004 Plan is acompensatory plan under SFAS 123R. The requisite service period forcompensation cost resulting from the 2004 Plan is the period over which theemployee participates in the plan and pays for the shares.  AVANT has historically established two purchaseperiods during each year—January 1 to June 30 and July 1 toDecember 31. The requisite service period begins on the enrollment date(the start of the offering period) and ends on the purchase date and isdetermined to be six months.

The current purchaseperiod began January 1, 2006. The Company has established the risk-freeinterest rate assumption to be 4.4% using the 6-month rate on a tradedzero-coupon U.S. Treasury bond. The Company used its historical volatility rateof 56% for the 6-month period preceding the grant date for the current stockpurchase period. The Company has concluded that volatility during the currentpurchase period is expected to be consistent with the calculated historicalvolatility rate. Finally, the Company established the expected term for thecurrent stock purchase period as six months. Based on these assumptions, the Company has calculated that the fairvalue for the 7,500 shares in the current stock purchase period is $3,405. Forthe three months ended March 31, 2006, stock-based compensation of $1,703 wasrecognized under SFAS 123R for the current stock purchase period under the2004 Plan.

***Employee StockOption Plans***

*StockOption Plan Description*

On May 6,1999, AVANT’s 1999 Stock Option and Incentive Plan (the “1999 Plan”) wasadopted. The 1999 Plan replaced the Amended and Restated 1991 StockCompensation Plan, which was an amendment and restatement of AVANT’s 1985Incentive Option Plan. The 1999 Plan permits the granting of incentive stockoptions (intended to qualify as such under Section 422A of the InternalRevenue Code of 1986, as amended), non-qualified stock options, stockappreciation rights, performance share units, restricted stock and other awardsof restricted stock in lieu of cash bonuses to employees, consultants andoutside directors.

The 1999 Plan, asamended in 2002, allows for a maximum of 3,500,000 shares of common stock to beissued prior to May 6, 2009. The Board of Directors determines the term ofeach option, option price, and number of shares for which each option isgranted and the rate at which each option vests. The Board of Directors hasgranted employee stock option awards with four-year vesting periods. The termof each option cannot exceed ten years (five years for options granted to holdersof more than 10% of the voting stock of AVANT) and the exercise price of stockoptions cannot be less than the fair market value of the common stock at thedate of grant (110% of fair market value for incentive stock options granted toholders of more than 10% of the voting stock of AVANT). Vesting of all employeestock option awards is accelerated upon a change in control as defined in the1999 Plan.

The 1999 Plan providesfor the automatic grant of non-qualified stock options to non-employeedirectors. Each non-employee director who is serving as a director of theCompany on the fifth business day after each annual meeting of stockholderswill automatically be granted on such day a non-qualified stock option toacquire 10,000 shares of common stock. The exercise price of each suchnon-qualified stock option is the fair market value of common stock on the dateof grant. Each such non-qualified stock option is exercisable on the first anniversaryof the grant date. Such non-qualified stock options will expire ten years fromthe date of grant. The 1999 Plan also provides for discretionary grants ofnon-qualified stock options to non-employee directors. Vesting of allnon-employee director stock option awards is accelerated upon a change incontrol as defined in the 1999 Plan.

On November 17,2005, pursuant to and in accordance with the recommendation of the CompensationCommittee, the Board of Directors of AVANT approved full acceleration of thevesting of otherwise unvested stock options that had an exercise price of $2.00or greater granted under the 1999 Plan that were held by employees, officersand non-employee directors. As a result of the Board of Directors’ action, atotal of 265,935 of such “out-of-the-money” unvested stock options, having aweighted average exercise price of $2.37 per share, became exercisableeffective November 17, 2005, rather than the later dates when such optionswould have vested in the normal course. The Company determined the value of the“out-of-the-money” unvested stock options to be $360,100. This action was takenin accordance with the applicable provisions of the 1999 Plan. The Board’sdecision to accelerate the vesting of these “out-of-the-money” stock optionswas made primarily to reduce compensation expense that otherwise would berecorded in future periods following AVANT’s adoption in the first quarter of2006 of SFAS 123R.

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*GeneralOption Information*

Asummary of stock option activity for the three months ended March 31, 2006and 2005 is as follows:
| ** **                                                                | ** ** | **2006**   | ** ** | ** **                                             | ** ** |
|---------------------------------------------------------------------------|------------|------------|------------|--------------------------------------------------------|------------|
| ** **                                                                | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price  Per Share** | ** ** | **Weighted  Average  Remaining  Contractual  Term** | ** ** |
| Outstanding at  January 1,                                           |       | 2,974,950  |       | $                                                      | 2.55       |   | $ | 4.86 |   |
| Granted                                                                   |       | 568,250    |       | 2.00                                                   |       | 4.14 |   |
| Exercised                                                                 |       | 3⁄4     |       | 3⁄4                                                 |       | — |   |
| Canceled/forfeited                                                        |       | (3,812     | )          | 1.78                                                   |       | — |   |
| Expired                                                                   |       | (19,772    | )          | 2.72                                                   |       | — |   |
|                                                                      |       |       |       |                                                   |       |   |   |
| Outstanding at  March 31,                                            |       | 3,519,616  |       | $                                                      | 2.46       |   | $ | 6.64 |   |
|                                                                      |       |       |       |                                                   |       |   |   |
| At March 31,                                                         |       |       |       |                                                   |       |   |   |
| Options  exercisable                                                      |       | 2,616,871  |       | $                                                      | 2.67       |   |   |   |
| Available for  grant                                                      |       | 1,306,216  |       |                                                   |       |   |   |
| Weighted average fair  value of options granted during three-month period |       |       |       | $                                                      | 1.50       |   |   |   |

 

Theaggregate intrinsic value of options outstanding at March 31, 2006 was$1,453,256, of which $968,603 related to exercisable options.

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*Valuation and Expense Informationunder SFAS 123(R)*

On January 1,2006, the Company adopted SFAS 123(R), which requires the measurement andrecognition of compensation expense for all share-based payment awards made tothe Company’s employees and directors including employee stock options andemployee stock purchases related to the 2004 Plan based on estimated fairvalues. The following table summarizes stock-based compensation expense relatedto employee stock options, employee stock purchases and restricted stock unitawards under SFAS 123(R) for the three months ended March 31, 2006which was allocated as follows:

|                                         | ** ** | **March 31,  2006** | ** ** |
|-----------------------------------------|------------|--------------------------|------------|
|                                    |       |                     |       |
| Research and  development               |       | $                        | 33,395     |   |
| General and  administrative             |       | 230,860                  |       |
| Total stock-based  compensation expense |       | $                        | 264,255    |   |

 

Stock-basedcompensation expense recognized for the three months ended March 31, 2006and 2005 included $175,000 and $121,000, respectively, related to restrictedstock unit awards, all of which were allocated to general and administrativeexpenses.

Based on basic anddiluted weighted average common shares outstanding of 74,172,563, the effect ofstock-based compensation expense recorded under SFAS 123R wasapproximately $0.004 per share.

The table belowreflects the pro forma information for the three months ended March 31,2005 as follows:
| ** **                                                                                                    | ** ** | **March 31,  2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|
| Net Loss:                                                                                                     |       |                     |       |
| As reported for prior years                                                                                   |       | $                        | 4,868,499  |   |
| Less: Stock-based employee compensation expense as  reported                                                  |       | (121,000                 | )          |
| Add: Total stock-based employee compensation expense  determined under fair value based method for all awards |       | 258,389                  |       |
| Net loss,  including the effect of stock-based compensation expense                                           |       | $                        | 5,005,888  |   |
|                                                                                                          |       |                     |       |
| Basic and  diluted net loss per share — as reported for prior periods                                    |       | $                        | 0.07       |   |
|                                                                                                          |       |                     |       |
| Basic and diluted net  loss per share, including the effect of stock-based compensation expense               |       | $                        | 0.07       |   |

 

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As of March 31,2006, total compensation cost related to non-vested stock options not yetrecognized was $1,091,241 which is expected to be recognized as expense over aweighted average period of 2.6 years. As of March 31, 2006, totalcompensation cost related to non-vested restricted stock unit awards not yetrecognized was $1,446,000 which is expected to be recognized over a weightedaverage period of 1.1 years.

Upon adoption ofSFAS 123(R), the Company began estimating the value of employee stock optionson the date of grant using the Black-Scholes model. Prior to the adoption of SFAS123(R), the value of each employee stock option was estimated on the date ofgrant also using the Black-Scholes model for the purpose of the pro formafinancial information in accordance with SFAS 123.

Thefair values of employee stock options granted during the three months ended March 31,2006 and 2005 were valued using the Black-Scholes model with the followingassumptions:
| ** **                       | ** ** | **Three months ended March 31,** | ** ** |
|----------------------------------|------------|------------------------------------------------------|------------|
| ** **                       | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| Expected stock  price volatility |       | 85                                                   | %          | 85 | % |
| Expected option  term            |       | 6.25 Years                                           |       | 5 Years |   |
| Risk-free  interest rate         |       | 4.3 — 4.8                                       | %          | 3.6 — 4.3 | % |
| Expected dividend yield          |       | None                                                 |       | None |   |

 

The Company usedits historical stock price volatility as the basis for its expected volatilityassumption consistent with SFAS 123(R) and SAB 107 for its employee stockoptions and employee stock purchases. Prior to fiscal 2006, the Company hadalso used its historical stock price volatility in accordance with SFAS 123 forpurposes of its pro forma information. The Company has assessed that itshistorical volatility is representative of expected future stock price trends.

The risk-freeinterest rate assumption is based upon observed interest rates appropriate forthe term of the Company’s employee stock options and employee stock purchases. Thedividend yield assumption is based on the Company’s history of zero dividendpayouts and expectation that no dividends will be paid in the foreseeablefuture.

The expected lifeof employee stock options represents the weighted-average period the stockoptions are expected to remain outstanding. SAB 107 provides for a simplifiedmethod for estimating expected life for “plain-vanilla” options. The simplifiedmethod is based on the vesting period and the contractual term for each grantor for each vesting tranche for awards with graded vesting. The mid-pointbetween the vesting date and the expiration date is used as the expected termunder this method. The Company has elected to follow the guidance of SAB 107and adopt this simplified method in determining expected life for its stockoption awards. The expected life assumption for employee option grants madeduring the three months ended March 31, 2006 was 6.25 years. There were nogrants to non-employee directors during the three months ended March 31, 2006. Priorto fiscal 2006, the Company used an option-pricing model to indirectly estimatethe expected life of the stock options based upon historical data.

As stock-basedcompensation expense recognized in the Consolidated Statement of Operations forthe first three months of fiscal 2006 is based on awards ultimately expected tovest, it has been reduced for estimated forfeitures. SFAS 123(R) requiresforfeitures to be estimated at the time of grant and revised, if necessary, insubsequent periods if actual forfeitures differ from those estimates. Forfeitureswere estimated based on historical experience by applying a 10 percentforfeiture rate to employee stock option awards granted during the three monthsended March 31, 2006. In the Company’s pro forma information required underSFAS 123 for the periods prior to fiscal 2006, the Company accounted forforfeitures as they occurred.

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**(10)         Income Taxes**

The $40 millionmilestone payment received from PRF during the first quarter of 2006 willresult in taxable income for the Company. The regular taxable income generatedby this transaction will be fully offset with available federal and state netoperating loss carryforwards. The Company recorded a provision of $372,000 inthe first quarter of 2006 for the alternative minimum tax that will result fromreceipt of this milestone.

**(11)         Product Development and LicensingAgreements**

AVANT’s revenuefrom product development and licensing agreements was received pursuant tocontracts with different organizations. Total revenue recognized by the Companyin connection with these contracts for the three-month periods ended March 31,2006 and 2005 were $2,619,974 and $71,457, respectively. A summary of thesecontracts follows:

*(A)         GlaxoSmithKlineplc (“Glaxo”)*

During 1997, AVANTentered into an agreement with Glaxo to collaborate on the development andcommercialization of the Company’s oral rotavirus vaccine and Glaxo assumedresponsibility for all subsequent clinical trials and all other developmentactivities. Glaxo filed for market approval with the European regulatoryauthorities in late 2004, triggering a $2 million milestone fee payable toAVANT, 50% of which is creditable against future royalties. The amount wasrecorded as revenue in 2004 as AVANT has no obligation to incur any research anddevelopment costs in connection with this agreement. AVANT licensed-in theRotarix® technology in 1995 and owes a license fee of 30% to CincinnatiChildren’s Hospital Medical Center (“CCH”) on net royalties received from Glaxo.AVANT is obligated to maintain a license with CCH with respect to the Glaxoagreement. All licensing fees are included in research and development expense.The term of the Glaxo agreement is through the expiration of the last of therelevant patents covered by the agreement, although Glaxo may terminate theagreement upon 90 days prior written notice.

In May 2005,AVANT entered into an agreement whereby an affiliate of Paul Royalty Fund II,L.P. (“PRF”) purchased an interest in the******net******royalties AVANT will receive onworldwide sales of RotarixÒ(see Note 4). Under the PRF agreement, AVANT will retain 50% of future Glaxomilestone payments beginning on the effective date of the agreement with PRF,with 70% of the remaining balance payable to PRF and 30% of the remainingbalance payable to CCH, respectively.

In February 2006,the European Commission granted approval of RotarixÒin the European Union, which triggered a $4 million milestone payment fromGlaxo, 50% of which is creditable against future royalties. Revenue of $2.6million was recorded in the first quarter of 2006 as AVANT has no continuingobligations to incur any research and development costs in connection with theGlaxo agreement and the remaining $1.4 million was remitted to PRF inaccordance with the PRF agreement. In addition, the Company recorded $600,000of research and development expense in the first quarter of 2006 for amountswhich will be payable to CCH in connection with the aforementioned 2006milestone payment. Glaxo has agreed to make further payments, which could totalup to $1.5 million, upon achievement of a specific milestone.

*(B)         PfizerInc (“Pfizer”)*

The Companyentered into a licensing agreement with Pfizer’s Animal Health Division wherebyPfizer has licensed Megan’s technology for the

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development of animalhealth and food safety vaccines. Under the agreement, AVANT may receiveadditional milestone payments of up to $3 million based upon attainment ofspecified milestones. AVANT may receive royalty payments on eventual productsales. The term of this agreement is through the expiration of the last of thepatents covered by the agreement. AVANT has no obligation to incur any researchand development costs in connection with this agreement.

*(C)         DynPortVaccine Company LLC (“DVC”)*

In October 2001,the Company granted DVC a license for exclusive rights to use certaincomponents of its anthrax vaccine technology. Under the agreement, AVANT isentitled to annual $50,000 license maintenance payments, with respect to whichAVANT has received $200,000 in the aggregate, including $50,000 received in thefirst quarter of 2005, and milestone payments of up to $700,000 in theaggregate, $100,000 of which AVANT has recognized as revenue. The annuallicense fee is recognized as revenue on a straight line basis over the year. OnAugust 5, 2005, AVANT received notice from DVC of termination of thelicense agreement, effective November 5, 2005.

In January 2003,AVANT was awarded a subcontract by DVC in the amount of $2.5 million to developfor the U.S. Department of Defense an oral combination vaccine against anthraxand plague using AVANT’s proprietary vaccine technologies. As of March 31,2006, AVANT has received a number of additional subcontract modifications fromDVC to support preclinical animal testing of vaccine constructs and the startof human clinical testing of a plague vaccine candidate being developed byAVANT for use in the oral combination vaccine. Total contract funding awardedby DVC now totals approximately $10 million. Payments under the subcontractagreement are made on a time and materials basis and receipt of the full amountis conditioned upon the project being fully funded through completion and AVANTperforming and continuing to demonstrate that it has the capability to performthe funded work. For the three months ended March 31, 2006 and 2005, AVANTrecognized $429,837 and $835,557, respectively, in government contract revenuefrom DVC. Through March 31, 2006, AVANT had received approximately $8.3million in payments under the various subcontract agreements. These agreementsexpire in 2007, although they may be terminated by DVC at any time upon 30 daysnotice.

*(D)         InflazymePharmaceuticals Ltd. (“Inflazyme,” formerly AdProTech, Ltd (“AdProTech”))*

In March 2004,AVANT granted a license to AdProTech for non-exclusive rights to use certaincomponents of its intellectual property surrounding complement inhibition. In April 2004,AVANT received an initial license payment of $1 million from AdProTech andAdProTech was acquired by Inflazyme, which assumed the license. AVANT has nocontinuing involvement or obligation under this license agreement, thus itrecognized the $1 million as revenue during the first quarter of 2004. Underthe agreement, AVANT is entitled to annual license fees, milestone payments ofup to $13.5 million in the aggregate and royalties on eventual product sales. AVANThas no obligations to incur any research and development costs in connectionwith this agreement.

**(12)         Other Long-Term Liabilities**

In December 2003,AVANT entered into a Lease Agreement, a Secured Promissory Note: Equipment Loanand a Security Agreement with the Massachusetts Development Finance Agency (“MassDevelopment”),an economic development entity for the Commonwealth of Massachusetts, for AVANTto occupy and build-out a manufacturing facility in Fall River, Massachusetts.

*(A)         LoanPayable*

Under the LeaseAgreement, AVANT received a Specialized Tenant Improvement Loan of $1,227,800to finance the build-out of its Fall River facility. Principal and interestpayments on the loan are due monthly using an amortization period of 15 yearsand an interest rate of 5.5% per annum.

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At March 31,2006, AVANT has recorded leasehold improvement assets of $1,227,800 andcurrently has a loan payable of $1,125,483 to MassDevelopment, of which $75,032is classified as current and $1,050,451 as long-term. AVANT began amortizingthe leasehold improvement assets this quarter when the Fall River facilitybecame operational. Based on current market interest rates available to AVANTfor long-term liabilities with similar terms and maturities, the fair value ofthe loan payable is approximately $802,500 at March 31, 2006.

*(B)         NotePayable*

Under the SecuredPromissory Note: Equipment Loan, AVANT received $903,657 from MassDevelopmentto finance the purchases of equipment to be placed in its Fall River facility(the “Loan”). The Loan has a term of 84 months at an interest rate of 5.5% perannum. The Loan is collateralized by all of the equipment purchased with theprincipal amount. The net book value of these collateralized assets at March 31,2006 and December 31, 2005 was $858,245 and $880,690, respectively.

At March 31,2006, AVANT has recorded manufacturing and laboratory equipment assets of$903,657 and currently has a note payable of $762,520 to MassDevelopment, ofwhich $126,377 is classified as current and $636,143 as long-term. AVANT begandepreciating the manufacturing and laboratory equipment assets over theestimated economic lives of the assets this quarter when the Fall Riverfacility became operational. Based on current market interest rates availableto AVANT for long-term liabilities with similar terms and maturities, the fairvalue of the note payable is approximately $672,900 at March 31, 2006.

**(13)         Commitments and Contingencies**

*(A)         Commitmentsfor the Renovations of the Needham Facility and Improvements to the Fall RiverFacility*

In November 2005, AVANT entered into a Lease Amendment with thelandlord which specified terms for the complete renovation of the Company’sNeedham facility. The current projected costs for the tenantimprovements portion of the renovations project are approximately $7.7 million.As an incentive for AVANT to enter into the Lease Amendment, the landlord hasagreed to contribute up to $3.6 million towards tenant improvement costs. The Company will record the full cost of theNeedham renovation project as an asset and the amounts of landlord incentivewill be recorded as deferred rent (included under “Other Long Term Liabilities”account in the consolidated balance sheets) in accordance with FASB TechnicalBulletin 88-1 “Issues Related to Accounting for Leases.”  Amortization of the deferred rent will berecorded as a reduction of rent expense over the remaining lease term when therenovation project is complete and will be classified as an operating activityin the Consolidated Statement of Cash Flows.

In November 2005,AVANT amended the MassDevelopment lease to increase the rentable space byapproximately 2,500 square feet to approximately 14,300 square feet at the FallRiver facility. The landlord is providing a tenant incentive allowance of$49,740 against the cost of alterations and improvements required by AVANT tobe made to the expanded space. As of March 31, 2006, none of the tenantincentive allowance has been received. In April 2005, AVANT entered into a Design/Build Contract with a design/builder forthe build-out of the expanded space. The contract amount totals$345,000.

*(B)         PurchaseCommitments for Contract Manufacturing*

In April 2000,AVANT entered into a Services Agreement (the “Lonza Agreement”) with LonzaBiologics plc (“Lonza”) for process development and manufacture of its productcandidate TP10. AVANT has entered into a number of amendments to the LonzaAgreement for specific process development and scale-up work and remainingaggregate commitments as of March 31, 2006 total approximately $917,516. TheCompany has incurred $320,248 and $7,100,968, respectively, of expense relatedto the Lonza Agreement in the three-month period ended March 31, 2006 andfrom inception through March 31, 2006, of which $96,754 remained accruedat March 31, 2006.

 

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***Safe Harbor Statement under the Private SecuritiesLitigation Reform Act of 1995:****  This quarterly report on Form 10-Qincludes forward-looking statements**that are subject to a variety of risks and uncertainties and reflect AVANT’s current views withrespect to future events and financial performance. There are a number of important factors thatcould cause the actual results to differ materially from those expressed in anyforward-looking statements made by AVANT. These factors include, but are notlimited to:  (1) theintegration of multiple technologies and programs; (2) the ability to adapt AVANT’s vectoring**systems to develop new, safe and effective orally administered vaccines againstanthrax and plague or any other microbesused as bioweapons and other disease causing agents; (3) theability to successfully complete development and commercialization of TP10,CETi-1, CholeraGarde® (Peru-15), Ty800 and other products; (4) thecost, timing, scope and results of ongoing safety and efficacy trials of TP10,CETi-1, CholeraGarde® (Peru-15), Ty800 and other preclinical andclinical testing; (5) the ability to successfully complete productresearch and further development, including animal, pre-clinical and clinicalstudies of TP10, CETi-1, CholeraGarde® (Peru-15), Ty800 and otherproducts; (6) the ability of the Company to manage multiple late stageclinical trials for a variety of product candidates; (7) the volume andprofitability of product sales of Megan®Vac 1, Megan®Egg and other futureproducts; (8) the process of obtaining regulatory approval for the sale ofRotarix**Ò in majorcommercial markets, as well as the timing and success of worldwidecommercialization of Rotarix**Òby our partner, GlaxoSmithKline; (9) Glaxo’s strategy and business plansto launch and supply Rotarix® worldwide, including in the U.S. and other majormarkets;  (10)  changes in existingand potential relationships with corporate collaborators; (11) theavailability, cost, delivery and quality of clinical and commercial gradematerials supplied by contract manufacturers; (12) the timing, cost anduncertainty of obtaining regulatory approvals to use TP10, CETi-1,CholeraGarde® (Peru-15) and Ty800, among other purposes, for adultsundergoing cardiac surgery,**to raise serum HDLcholesterol levels and toprotect travelers and people in endemic regions from diarrhea causing diseases,respectively; (13) the ability to obtain substantial additional funding; (14)the ability to develop and commercialize products before competitors and thatare superior to the alternatives developed by competitors; (15) the ability toretain certain members of management; and (16) other factors detailed from timeto time in filings with the Securities and Exchange Commission. You should carefully review all of these factors,and you should be aware**that there may be otherfactors that could cause these differences. These forward-looking statementswere based on information, plans and estimates at the date of this report, andwe do not promise to update any forward-looking statements to reflect changesin underlying assumptions or factors, new information, future events or otherchanges.*

**Item 2. Management’sDiscussion and Analysis of Financial Condition And Results of Operations**

AVANT’s principal activity since our inception has been research andproduct development conducted on its own behalf, as well as through jointdevelopment programs with several pharmaceutical companies and othercollaborators. AVANT was incorporated in the State of Delaware in December 1983.

## **CRITICALACCOUNTING POLICIES**

The Company’scritical accounting policies are set forth under the heading “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” inItem 7 to our 2005 Form 10-K. Other than the adoption of Statementof Financial Accounting Standards No. 123 (revised 2004), “Share-BasedPayment,” (“SFAS 123(R)”), there has been no changes to these policies since December 31,2005. Readers are encouraged to review these critical accounting policies inconjunction with the review of this Form 10-Q.

*Stock-BasedCompensation Expense*

On January 1,2006, the Company adopted Statement of Financial Accounting Standards No. 123(revised 2004), “Share-Based Payment,” (“SFAS 123(R)”) which requires themeasurement and recognition of compensation expense for all share-based paymentawards made to its employees and directors including employee stock options andemployee stock purchases related to the 2004 Employee Stock Purchase Plan

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(“employee stockpurchases”) based on estimated fair values. The Company adopted SFAS 123(R) usingthe modified prospective transition method, which requires the application ofthe accounting standard as of January 1, 2006, the first day of theCompany’s fiscal year 2006. The Company’s Consolidated Financial Statements asof and for the three months ended March 31, 2006 reflect the impact ofSFAS 123(R). In accordance with the modified prospective transition method, theCompany’s Consolidated Financial Statements for prior periods have not beenrestated to reflect, and do not include, the impact of SFAS 123(R). Stock-basedcompensation expense recognized under SFAS 123(R) for the three monthsended March 31, 2006 was $264,255, which consisted of stock-basedcompensation expense related to employee stock options, employee stockpurchases and restricted stock units of $87,552, $1,703 and $175,000,respectively. There was no stock-based compensation expense related to employeestock options and employee stock purchases recognized during the three monthsended March 31, 2005. Stock-based compensation expense of $121,000 relatedto restricted stock unit awards was recognized during the three months ended March 31,2005. Stock-based compensation expense of $264,255 and $121,000 was reflectedas operating cash flows in the Consolidated Statements of Cash Flows for thethree-months ended March 31, 2006 and 2005, respectively. The adoption ofSFAS 123(R) had an immaterial impact on earnings per share. See Note 10 tothe Consolidated Financial Statements for additional information.

Upon adoption ofSFAS 123(R), we began estimating the value of employee stock options on thedate of grant using the Black-Scholes model. Prior to the adoption of SFAS123(R), the value of each employee stock option was estimated on the date ofgrant also using the Black-Scholes model for the purpose of the pro formafinancial information in accordance with SFAS 123. The determination of fairvalue of share-based payment awards on the date of grant using anoption-pricing model is affected by our stock price as well as assumptionsregarding a number of highly complex and subjective variables. These variablesinclude, but are not limited to the expected stock price volatility over theterm of the awards, and actual and projected employee stock option exercisebehaviors. The weighted average estimated fair value of employee stock optionsgranted during the three months ended March 31, 2006 was $1.50 per shareusing the Black-Scholes option pricing model with the following assumptions:
| ** **                       | ** ** | **Three months ended  March 31, 2006** | ** ** |
|----------------------------------|------------|------------------------------------------------------------|------------|
| Expected stock  price volatility |       | 85                                                         | %          |
| Expected option  term            |       | 6.25 Years                                                 |       |
| Risk-free  interest rate         |       | 4.3 — 4.8                                             | %          |
| Expected dividend yield          |       | None                                                       |       |

 

The Company usedits historical stock price volatility as the basis for its expected volatilityassumption consistent with SFAS 123(R) and SAB 107 for its employee stockoptions and employee stock purchases. Prior to fiscal 2006, the Company hadalso used its historical stock price volatility in accordance with SFAS 123 forpurposes of its pro forma information. The Company has assessed that itshistorical volatility is representative of expected future stock price trends.

The risk-freeinterest rate assumption is based upon observed interest rates appropriate forthe term of the Company’s employee stock options and employee stock purchases. Thedividend yield assumption is based on the Company’s history of zero dividendpayouts and expectation that no dividends will be paid in the foreseeablefuture.

The expected lifeof employee stock options represents the weighted-average period the stockoptions are expected to remain outstanding. SAB 107 provides for a simplifiedmethod for estimating expected life for “plain-vanilla” options. The simplifiedmethod is based on the vesting period and the contractual term for each grantor for each vesting tranche for awards with graded vesting. The mid-pointbetween the vesting date and the expiration date is used as the expected termunder this method. The Company has elected to follow the guidance of SAB 107and adopt this simplified method in determining expected life for its stockoption awards. The expected life assumption for employee option grants madeduring the three months ended March 31, 2006 was 6.25 years. There were nogrants to non-employee directors during the three months ended March 31, 2006.Prior to fiscal 2006, the Company used an option-pricing model to indirectlyestimate the expected life of the stock options based upon historical data.

As stock-Basedcompensation expense recognized in the Consolidated Statement of Operations forthe first three months of fiscal 2006 is based on awards ultimately expected tovest, it has been reduced for

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estimated forfeitures. SFAS123(R) requires forfeitures to be estimated at the time of grant andrevised, if necessary, in subsequent periods if actual forfeitures differ fromthose estimates. Forfeitures were estimated based on historical experience byapplying a 10 percent forfeiture rate to employee stock option awards grantedduring the three months ended March 31, 2006. In the Company’s pro formainformation required under SFAS 123 for the periods prior to fiscal 2006, theCompany accounted for forfeitures as they occurred.

If factors changeand we employ different assumptions in the application of SFAS 123(R) infuture periods, the compensation expense that we record under SFAS 123(R) maydiffer significantly from what we have recorded in the current period.

## **OVERVIEW**

AVANT’s focus isunlocking the power of the immune system to prevent and treat disease. TheCompany has assembled a broad portfolio of technologies and intellectualproperty that gives it a strong competitive position in vaccines andimmunotherapeutics. These include an oral human rotavirus vaccine, which gainedits first marketing approval in Mexico in July 2004 and is being targetedfor marketing by Glaxo worldwide. Six of AVANT’s products are in clinicaldevelopment. The Company’s goal is to become a leading developer of innovativevaccines and immunotherapeutics that address health care needs on a globalbasis.

The Company hasactively developed and acquired innovative technologies — especially novelapproaches to vaccine creation. The development of immunotherapeutic vaccineslike the CETP vaccine and the marriage of innovative bacterial vector deliverytechnologies with unique manufacturing processes offer the potential for a newgeneration of vaccines. In addition, AVANT’s vaccine technologies can providerapid protection against bacterial illnesses which may prove useful forimproving and expanding America’s vaccine arsenal against microbial agents usedin war or terrorist attacks.

AVANT is targetingits efforts where it can add the greatest value to the development of itsproducts and technologies. Its goal is to demonstrate clinical proof-of-conceptfor each product, and then seek excellent partners to help see those productsthrough to commercialization. This approach allows AVANT to maximize theoverall value of its technology and product portfolio while best ensuring the expeditiousdevelopment of each individual product.

## **RESEARCHAND DEVELOPMENT ACTIVITIES**

AVANT is currentlyfocused on the development of a number of immunotherapeutic and vaccine productcandidates which are in various stages of clinical trials. AVANT expects that alarge percentage of its research and development expenses will be incurred insupport of its current and future clinical trial programs.

Duringthe past five years through the end of 2005, AVANT incurred an aggregate of$74 million in research and development costs. During the three monthsended March 31, 2006, AVANT incurred an aggregate of $4.3 million inresearch and development costs. The following table indicates the amountincurred for each of AVANT’s material research programs and for otheridentified research and development activities during the two years ended December 31,2005 and 2004 and the three-month periods ended March 31, 2006 and 2005.The amounts disclosed in the following table and in “Program Developments”below reflect direct research and development costs, license fees associatedwith the underlying technology and an allocation of indirect research anddevelopment costs to each program.

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| ** **                                       | ** ** | **Three Months Ended  March 31,** | ** ** | **Years Ended  December 31,** | ** ** |
|--------------------------------------------------|------------|----------------------------------------|------------|------------------------------------|------------|
| ** **                                       | ** ** | **2006**                               | ** ** | **2005**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| *Bacterial Vaccines:*                            |       |                                   |       |                               |       |   |   |   |   |
| CholeraGardeÒ                               |       | $678,500                               |       | $92,100                            |       | $1,257,200 |   | $123,100 |   |
| Ty800                                            |       | 102,700                                |       | 130,500                            |       | 404,500 |   | 688,300 |   |
| Other                                            |       | 361,400                                |       | 116,600                            |       | 528,900 |   | 332,500 |   |
| *BioDefense Vaccines:*                           |       | 572,900                                |       | 565,800                            |       | 2,470,700 |   | 3,082,800 |   |
| *Cholesterol Management Vaccine:*                |       |                                   |       |                               |       |   |   |   |   |
| CETi-1                                           |       | 360,100                                |       | 155,000                            |       | 650,800 |   | 816,900 |   |
| *Complement Inhibitors:*                         |       |                                   |       |                               |       |   |   |   |   |
| TP10/TP20                                        |       | 1,117,400                              |       | 2,686,400                          |       | 8,327,200 |   | 7,706,300 |   |
| *Food Safety & Animal Health Vaccines:* |       | 4,600                                  |       | 700                                |       | 9,900 |   | 12,600 |   |
| *Viral Vaccines:*                                |       |                                   |       |                               |       |   |   |   |   |
| RotarixÒ  vaccine                           |       | 648,600                                |       | 3⁄4                             |       | — |   | 500,000 |   |
| Avian Flu                                        |       | 141,400                                |       | 3⁄4                             |       | 3⁄4 |   | 3⁄4 |   |
| TheraporeÒ/HIV                              |       | 3⁄4                                 |       | 1,500                              |       | 11,800 |   | 184,900 |   |
| *Other Programs:*                                |       | 361,100                                |       | 282,000                            |       | 402,300 |   | 426,400 |   |
|                                             |       |                                   |       |                               |       |   |   |   |   |
| *Total R&D Expense*                          |       | $4,348,700                             |       | $4,030,600                         |       | $14,063,300 |   | $13,873,800 |   |

 

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**PROGRAM DEVELOPMENTS**

*RotavirusVaccine:*  Rotavirus isa major cause of diarrhea and vomiting in infants and children. In 1997, AVANTlicensed its oral rotavirus vaccine to Glaxo. All of the ongoing developmentfor this program is being conducted and funded by Glaxo. Glaxo gained approvalfor RotarixÒ in Mexico in July 2004, which representsthe first in an expected series of worldwide approvals and commercial launchesfor the product. Glaxo has launched in additional Latin American and AsiaPacific countries during 2005 and 2006. Additionally, Glaxo filed for marketapproval with the European regulatory authorities in late 2004, which triggereda $2 million milestone payment to AVANT. In February 2006, the EuropeanCommission granted approval of RotarixÒ in the EuropeanUnion, which triggered a $4 million milestone payment from Glaxo. Glaxo hasagreed to make further payments, which could total up to $1.5 million, uponachievement of a specific milestone. AVANT licensed-in the Rotarix ® technologyin 1995 and owes a license fee of 30% to Cincinnati Children’s Hospital medicalCenter (“CCH”) on net royalties received from Glaxo. In May 2005, AVANTentered into an agreement whereby an affiliate of PRF purchased an interest inthe******net******royaltiesAVANT will receive on worldwide sales of RotarixÒ(see Note 4 of our unaudited consolidated financial statements). Under the PRFagreement, AVANT will retain 50% of future Glaxo milestone payments, with thebalance payable to PRF and CCH.

On March 14,2006, AVANT amended its agreement with PRF to accelerate the $40 millionmilestone payment, which was received on March 17, 2006. The payment hadpreviously been due upon the first sale of RotarixÒin the European Union, which was expected to occur during the second quarter of2006. Other financial terms of the PRF agreement were not changed.

*ComplementInhibitors:*  TP10, asoluble form of naturally occurring Complement Receptor 1, has effectivelyshown to inhibit the activation of the complement cascade in animal models. AVANTbelieves that regulating the complement system could have therapeutic andprophylactic applications in several acute and chronic conditions, includingreperfusion injury from surgery or ischemic disease, organ transplant, multiplesclerosis, rheumatoid arthritis, and myasthenia gravis. AVANT has elected to develop TP10 for cardiac surgery. In February 2002,AVANT announced that TP10 had not achieved a significant reduction in theprimary endpoint of a Phase 2 adult cardiac surgery trial conducted in 564patients. However, further analysis of the study data demonstrated an importanttreatment benefit in male patients participating in the trial directly relatedto mortality, which was impressive, but, with no treatment benefit observed infemale patients. In February 2004, AVANT started a Phase 2b double-blind,placebo-controlled trial of TP10 in approximately 300 women undergoingcardiopulmonary by-pass surgery. The trial examined the effect of TP10 versusplacebo at approximately 30 sites throughout the United States. The goals ofthe trial were to clarify the treatment effect that TP10 has for womenundergoing high risk cardiac surgery, as well as augment the safety data forthat patient population to allow for the design of a subsequentregistration-directed trial. In February 2006, AVANT reported that thefemales-only study did not meet the primary

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endpoint, thus confirmingthe results for female subjects in the previous TP10 trial. Therefore, giventhe strong efficacy data in males shown in this previous study, AVANT believesthere is a clear clinical development pathway for a males-only indication forTP10 in cardiac bypass surgery. Males represent 75% of the U.S. marketopportunity in cardiac bypass surgery. AVANT believes that the TP10 program isnow well positioned for a males-only cardiac bypass surgery indication. AVANT plans to seek a corporate partner tocomplete development and to commercialize TP10.

During the period January 1,2001 through December 31, 2005, AVANT incurred approximately$32.3 million in research, development, contract manufacturing andclinical costs. During the three months ended March 31, 2006, the Companyincurred approximately $1.1 million in research, development, contractmanufacturing and clinical costs associated with its complement inhibitorprogram.

*BacterialVaccines:*  AVANT’s goalis to become a leading developer of innovative vaccines that address healthcare needs on a global basis. In this regard, AVANT acquired VitriLife®, atechnology with the potential to reduce manufacturing costs and improve productstability, eliminating the need for vaccine refrigeration during shipping andstorage. With this and other drying and preservation technologies and AVANT’s *Cholera*- and *Salmonella*-vectored deliverytechnologies, named VibrioVecÒ and SalmoVecTM, theCompany can now develop a new generation of vaccines that have an ideal productprofile: safe, effective, oral, single-dose, rapidly protective and increasedthermostability.

Development of a safe, effective cholera vaccine isthe first step in establishing AVANT’s single-dose, oral bacterial vaccinefranchise. During 2002, AVANT completed a Phase 2 dose-ranging study withCholeraGarde® which confirmed the safety and activity of this vaccine andsupported the start of Phase 2 trials in December 2002 with theInternational Vaccine Institute (“IVI”) in Bangladesh where cholera isendemic. In July 2005, Bangladesh study results in children and infantsshowed CholeraGarde® to be well tolerated and highly immunogenic, with 77% ofchildren aged 9 months to 5 years generating protective immune responses. Previouslypublished results showed the vaccine to be well tolerated and immunogenicagainst the cholera organism in the adult portion of this trial. AVANT ispreparing for a CholeraGarde®Phase 3 clinical study in the U.S. planned for early2007.

In July 2005,AVANT reported that it and Harvard Medical School would receive approximately$500,000 from the National Institutes of Health to apply AVANT’s VitriLife®formulation to CholeraGarde®. In the future, AVANT plans to utilize VitriLife®,a proprietary technology that confers thermostability to live bacterialvaccines, and other drying and preservation technologies at the Fall Riverfacility for its other bacterial vaccines.

During the period January 1,2001 through December 31, 2005, AVANT incurred approximately$10.4 million in research, development and clinical costs on itsCholeraGarde® program. During the three months ended March 31, 2006, AVANTincurred approximately $678,500 in research, development and clinical costs onits CholeraGarde® program.

AVANT is alsodeveloping an oral typhoid fever vaccine, Ty800, for global health needs. TheNational Institute of Allergy and Infectious Disease (“NIAID”) of the NationalInstitutes of Health (“NIH”) and AVANT agreed for the NIAID to conduct a Phase1/2 in-patient dose-ranging clinical trial aimed at demonstrating the safetyand immunogenicity of the Ty800 vaccine. NIAID funded the production of Ty800vaccine for clinical testing and initiated the Phase 1/2 trial at a NIH-fundedclinical site in February 2006. The NIAID trial seeks to confirm thesafety and immunogenicity of the Ty800 oral vaccine observed in an earlierphysician-sponsored Ty800 vaccine study. During the period January 1,2001 through December 31, 2005, AVANT incurred approximately$5.3 million in research, development, contract manufacturing and clinicalcosts on its Ty800 program. During the three months ended March 31, 2006,AVANT incurred approximately $102,700 in research, development and clinicalcosts on its Ty800 program.

Finally, AVANT isdeveloping three additional bacterial vaccines against enterotoxigenic *E. coli*(“ETEC”), *Shigella*and *Campylobacter*—all importantcauses of serious diarrheal diseases worldwide.

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These three programs arein pre-clinical development. In 2006,AVANT expects to allocate resources to further the development of a two-vaccinecombination product containing ETEC and Shigella or Campylobacter addressed tothe travelers’ market. In April 2005, AVANT was awarded a Phase ISmall Business Innovation Research (“SBIR”) grant to support the development ofa live attenuated salmonella vaccine against campylobacter. The NIAID awardprovides approximately $131,000 in funding and work was started by AVANT duringthe third quarter of 2005. During the period January 1, 2001 through December 31,2005, AVANT incurred approximately $1.2 million in research, development,contract manufacturing and clinical costs on these pre-clinical programs. Duringthe three months ended March 31, 2006, AVANT incurred approximately$361,400 in research, development and clinical costs on these pre-clinicalprograms.

*BioDefenseVaccines:*  Theattenuated live bacteria used to create AVANT’s single-dose oral vaccines canalso serve as vectors for the development of vaccines against other bacterialand viral diseases. By engineering key disease antigens into the DNA of thevector organisms, AVANT expects to be able to extend the protective ability ofits single-dose oral vaccines to a wide variety of illnesses. AVANT believesthat its vector technologies may prove useful for improving and expandingAmerica’s vaccine arsenal against microbial agents used in war or terroristattacks.

In October 2001,AVANT granted DVC LLC (“DVC,” formerly DynPort Vaccine Company LLC) (“DVC”) alicense for exclusive rights to use certain components of AVANT’s anthraxvaccine technology. In October 2002, DVC announced the initiation of aPhase 1 clinical trial of a new injectable recombinant anthrax vaccine in approximately70 volunteers. The vaccine candidate consists of a highly purifiedprotein—Protective Antigen—derived from the anthrax bacterium using recombinantDNA technology and production processes licensed from AVANT. The study willevaluate tolerability, safety and immunogenicity of DVC’s new vaccine. On August 5,2005, AVANT received notice from DVC of termination of the license agreement,effective November 5, 2005. DVC plans to complete the ongoing Phase Iclinical trial.

Further,in January 2003, AVANT was awarded a subcontract by DVC in the amount of$2.5 million to develop for the U.S. Department of Defense an oral combinationvaccine against anthrax and plague using AVANT’s proprietary vaccinetechnologies. As of March 31, 2006, AVANT has received a number ofadditional subcontract modifications from DVC to support pre-clinical animaltesting of vaccine constructs and the start of human clinical testing of aplague vaccine candidate being developed by AVANT for use in the oralcombination vaccine. Total contract funding awarded by DVC now totalsapproximately $10 million. Payments under the subcontract agreement are made ona time and materials basis and receipt of the full amount is conditioned uponthe project being fully funded through completion and AVANT performing andcontinuing to demonstrate that it has the capability to perform the funded work.For the three months ended March 31, 2006 and 2005, AVANT recognized $429,837and $835,557, respectively, in government contract revenue from DVC. Through March 31,2006, AVANT had received approximately $8.3 million in payments under thesubcontract agreements. These agreements expire in 2007, although they may beterminated by DVC at any time upon 30 days notice.

During the period January 1,2001 through December 31, 2005, AVANT incurred approximately$9.3 million in research and development costs on its biodefense vaccineprogram. During the three months ended March 31, 2006, AVANT incurredapproximately $572,900 in research and development costs on its biodefensevaccine program.

*FoodSafety and Animal Health Vaccines:*  AVANT has partnered with Pfizer Inc. (“Pfizer”),who will apply AVANT’s vaccine technologies to animal health and human foodsafety markets. The Pfizer research program achieved an important milestone inlate 2002, which resulted in a payment of $500,000 to AVANT. During the period January 1,2001 through December 31, 2005, AVANT incurred approximately$1.5 million in research and development costs on its food safety andanimal health vaccines program. During the three months ended March 31,2006, AVANT incurred approximately $4,600 in research and development costs onits food safety and animal health vaccines program.

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*CholesterolManagement Vaccine:* AVANT is developing an immunotherapeutic vaccine against endogenouscholesteryl ester transfer protein (“CETP”), which may be useful in reducingrisks associated with atherosclerosis. CETP is a key intermediary in the balanceof HDL (high-density lipoprotein) and LDL (low-density lipoprotein). TheCompany is developing this vaccine, CETi-1, to stimulate an immuneresponse against CETP, which it believes may improve the ratio of HDL to LDLcholesterol and reduce the progression of atherosclerosis, which often leads toheart attack.

In October 2003, AVANT completed a Phase 2 efficacy study inapproximately 200 patients with low levels of HDL cholesterol. The results of the study demonstratedproof-of-concept in humans confirming that blocking cholesterol transfer couldraise HDL levels. In addition, the CETi-1 vaccine worked asdesigned to elicit anti-CETP antibodies in a high percentage of patientstreated, approximately 90%. In recent pre-clinical testing, AVANT hasidentified a new adjuvanted formulation for the vaccine that, when combinedwith a more immunogenic peptide sequence, elicits more than a 10-foldincrease in anti-CETP antibody titers when compared to the previous vaccineformulation. We have contracted for the production of GMP peptide for the newlyformulated vaccine and we expect to complete toxicology, release and stabilitystudies in 2006. During the period January 1, 2001 through December 31,2005, AVANT incurred approximately $10.4 million in research, developmentand clinical costs associated with the CETP program. During the three monthsended March 31, 2006, AVANT incurred approximately $360,100 in research,development and clinical costs associated with the CETP program. AVANT plans toseek a corporate partner to complete development and to commercialize the CETPvaccine.

## **TECHNOLOGYLICENSING**

AVANT has adopteda business strategy of out-licensing technology that does not match itsdevelopment focus or where it lacks sufficient resources for the technology’s efficientdevelopment or where certain uses of the technology are outside of AVANT’sfocus. For example, when AVANT acquired Megan, it also signed an agreement withPfizer to leverage the value of Megan’s oral vaccine technology in asignificant market opportunity (animal health and human food safety) outside ofAVANT’s own focus on human health care.

*Inflazyme(formerly AdProTech, Ltd. (“AdproTech”)): *In March 2004, AVANT granted a license toAdProTech for non-exclusive rights to use certain components of itsintellectual property surrounding complement inhibition. Financial terms of theagreement with AdProTech include license fees, milestone payments and royalties.In April 2004, AdProTech was acquired by Inflazyme, which assumed thelicense.

**RESULTS OF OPERATIONS**

**Three-Month Period Ended March 31, 2006 as Compared**** with the Three-Month Period Ended March 31,2005**

AVANT reportedconsolidated net loss of $2,970,991, or $.04 per share, for the first quarterended March 31, 2006, compared with a net loss of $4,868,499, or $.07 pershare, for the first quarter ended March 31, 2005. The weighted average common shares outstanding used to calculate net lossper common share was 74,172,563 in 2006 and 74,131,999 in 2005.

*Revenue:*  Total revenue increased $2,735,935 to $3,706,487for the first quarter of 2006 compared to $970,552 for the first quarter of2005.

Product development and licensing revenue increased $2,548,517 to$2,619,974 in 2005 from $71,457 in 2005. In February 2006, theEuropean Commission granted approval of RotarixÒin the European Union, which triggered a one-time $4 million milestone paymentfrom Glaxo, 50% of which is creditable against future royalties. Product development and licensing revenueof $2.6 million was recorded in the first quarter of 2006 and the remaining$1.4 million was remitted to PRF in accordance with the PRF agreement. In thefirst quarter of 2006, AVANT recognized $550,803 in product royalty revenuerelated to PRF’s purchased interests in the net royalties that AVANT receivesfrom RotarixÒworldwide net sales.

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AVANT has receiveda number of subcontracts from its partner, DVC, to develop anthrax and plaguevaccines for the U.S. Department of Defense. AVANT will be reimbursed by DVC ona time and materials basis for vaccine development research work performed byAVANT. Under these agreements and several SBIR grants, AVANT recognized$500,207 and $866,087 in government contract and grant revenue during the firstquarters of 2006 and 2005, respectively, for work performed. The decrease inrevenue in 2006 compared to 2005 primarily reflects reduced levels of vaccinedevelopment work billable to DVC in 2006. AVANT expects the amount of researchwork to be performed for DVC during the remainder of 2006 to approximate theamount of research work performed during the comparable period in 2005.

Marketing and distribution of the Megan poultry product line is performedby AVANT’s partner, Lohmann Animal Health International (“LAHI”), and AVANTreceives a royalty percentage of all Megan®Vac 1 and Megan®Egg product sales. Royaltypayments received during the first quarter of 2006 and 2005 totaled $35,503 and$33,008, respectively. We expect royalty payments from LAHI to increase in 2006compared to 2005.

*OperatingExpense:*  Total operating expense increased $595,819,or 9.9%, to $6,585,999 for the first quarter of 2006 compared to $5,990,180 forthe first quarter of 2005.

Research and development expense increased $318,089, or 7.9%, to$4,348,707 from $4,030,618 in 2005. The increase in 2006 compared to 2005 isprimarily due to $600,000 of license fee expense recorded in the firstquarter of 2006 for amounts which will be payable to CCH in connection with theaforementioned 2006 Glaxo milestone payment. The Company also experienced increases in research and developmentpersonnel and related costs of $456,745 and non-personnel operating andfacility-related costs of $115,230 associated with operations of the Fall Riverfacility in 2006 compared to 2005. Theseincreases were offset in part by declines in contract manufacturing costs incurred for process developmentand scale-up work of $413,115 andclinical trials costs of $370,528, both associatedwith the TP10 program, as a result of reduced development activities and thecompletion of the TP10 Phase 2 female clinical trial. AVANT expectsresearch and development expense to increase substantially in 2006 as AVANTprepares for a CholeraGardeÒ Phase 3 trialstarting in early 2007 and as the Fall River facility runs at full operationalstatus.

General and administrative expense increased $277,730, or 16.2%, to$1,988,514 in 2006 compared to $1,710,784 in 2005 and is primarily attributedto increases in personnel and related costs of $162,891 and legal and otherprofessional fees of $59,918. AVANT expects general and administrative expenseto continue at this level for the remainder of 2006.

 Amortization expense of acquired intangible assets was $248,778 in2006 and 2005.

*Investment and Other Income, Net:*  Interest and other income increased $129,392to $280,521 for the first quarter of 2006 compared to $151,129 for the firstquarter of 2005. The increase is primarily due to higher interest rates andaverage cash balances during the first quarter of 2006 compared to the firstquarter of 2005. During the first quarters of 2006 and 2005, the averagemonth-end cash balances were $33,676,633 and $29,465,071, respectively. Theeffective interest rates during the first quarters of 2006 and 2005 were 4.28%and 2.33%, respectively.

*Provision for Income Taxes:*  The $40 million milestone payment receivedfrom PRF during the first quarter of 2006 will result in taxable income for theCompany. The regular taxable income generated by this transaction has beenfully offset with available federal and state net operating loss carryforwards.The Company recorded a provision of $372,000 in the first quarter of 2006 forthe alternative minimum tax that will result from receipt of this milestone.

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**Stock-basedCompensation Expense**

On January 1,2006, we adopted SFAS 123(R), which requires the measurement and recognition ofcompensation expense for all share-based payment awards made to employees anddirectors including employee stock options, employee stock purchases andrestricted stock unit awards based on estimated fair values. The followingtable summarizes stock-based compensation expense related to employee stockoptions and employee stock purchases under SFAS 123(R) for the threemonths ended March 31, 2006 which was allocated as follows:

|                                         | ** ** | **March 31,  2006** | ** ** |
|-----------------------------------------|------------|--------------------------|------------|
|                                    |       |                     |       |
| Research and  development               |       | $                        | 33,395     |   |
| General and administrative              |       | 230,860                  |       |
| Total stock-based  compensation expense |       | $                        | 264,255    |   |

 

Stock-basedcompensation expense recognized for the three months ended March 31, 2006and 2005 included $175,000 and $121,000, respectively, related to restrictedstock unit awards, all of which were allocated to general and administrativeexpense.

**LIQUIDITY AND CAPITAL RESOURCES**

At March 31,2006, AVANT’s principal sources of liquidity consisted of cash and cashequivalents of $59,755,919. AVANT’s cash and cash equivalents are highly liquidinvestments with a maturity of three months or less at the date of purchase andconsist of time deposits and investments in money market mutual funds withcommercial banks and financial institutions, short-term commercial paper, andU.S. Government and other investment grade debt securities. Also, the Companymaintains cash balances with financial institutions in excess of insured limits.AVANT does not anticipate any losses with respect to such cash balances.

The use of AVANT’scash flows for operations has primarily consisted of salaries and wages for itsemployees, facility and facility-related costs for its offices, laboratoriesand manufacturing facility, fees paid in connection with preclinical studies,clinical studies, contract manufacturing, laboratory supplies and services,consulting fees, and legal fees. To date, the primary sources of cash flowsfrom operations have been payments received from the Company’s collaborativepartners and from government entities. In general, AVANT’s sources of cashflows from operations for the foreseeable future will be upfront licensepayments, payments for the achievement of milestones, product royalty payments,payments under government contracts and grants and funded research anddevelopment under collaboration agreements that AVANT may receive. The timingof any new collaboration agreements, government contracts or grants and anypayments under these agreements, contracts or grants cannot be easily predictedand may vary significantly from quarter to quarter.

Net cash providedby operating activities increased to $37,086,462 for the first quarter of 2006compared to net cash used in operating activities of $4,045,192 for the firstquarter of 2005. The increase is primarily attributed to the net increase indeferred revenue of $39,449,197 related to the $40 million PRF milestonepayment received in the first quarter of 2006, a decrease in net loss incurredin 2006 compared to 2005 because of the Glaxo milestone payment and a decreasein accounts payable and accrued expenses due to timing of payments. Theseamounts were offset partly by the decrease in accounts receivable. Other thanthe effect of receiving the $40 million milestone payment from PRF, AVANTexpects that cash used in operations will continue to increase in 2006 as theCompany continues to develop its products in clinical trials, contracts for themanufacture of clinical materials, runs its Fall River facility at fulloperational status and advances new products into preclinical development. Theexpected increase in cash used would be partially offset by anticipatedpayments made under the Company’s government contracts and grants andanticipated product royalty payments.

Cash used ininvesting activities increased to $684,397 for the first quarter of 2006compared to $358,717 for the first quarter of 2005. The increase is due to increased investment in property and

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equipmentin 2006 primarily towards the renovations of the Needham facility and for theFall River facility compared to 2005. AVANT expects it will continue touse cash in its investing activities as the Company expands its infrastructureat the Fall River facility and begins full-scale renovations of its Needhamfacility.

Net cash used infinancing activities was $65,580 for the first quarter of 2006 compared to$28,465 for the first quarter of 2005. The increase in net cash used infinancing activities is primarily due to increases in payments of long-termliabilities.

**AGGREGATE CONTRACTUAL OBLIGATIONS**

The following table summarizesAVANT’s contractual obligations at March 31, 2006 and the effect suchobligations and commercial commitments are expected to have on its liquidityand cash flow in future years. These obligations, commitments and supportingarrangements represent payments based on current operating forecasts, which aresubject to change:
| ** **                    | ** ** | **Total** | ** ** | **2006** | ** ** | **2007-2009** | ** ** | **2010-2011** | ** ** | **Thereafter** | ** ** |
|-------------------------------|------------|-----------|------------|----------|------------|---------------|------------|---------------|------------|----------------|------------|
| Contractual  obligations:     |       |      |       |     |       |          |       |          |       |           |       |
| Operating lease  obligations  |       | $         | 20,521,200 |     | $          | 2,103,300     |       | $             | 5,805,100  |           | $          | 3,545,200 |   | $ | 9,067,600 |   |
| **Loan Payable*******         |       | 1,559,900 |       | 95,600   |       | 404,900       |       | 247,000       |       | 812,400        |       |
| **Note Payable*******         |       | 874,100   |       | 118,100  |       | 531,500       |       | 224,500       |       | 3⁄4         |       |
| Licensing  obligations        |       | 573,800   |       | 63,800   |       | 255,000       |       | 170,000       |       | 85,000         |       |
| Construction  contracts       |       | 150,900   |       | 150,900  |       | 3⁄4        |       | 3⁄4        |       | 3⁄4         |       |
| Total contractual obligations |       | $         | 23,679,900 |     | $          | 2,531,700     |       | $             | 6,996,500  |           | $          | 4,186,700 |   | $ | 9,965,000 |   |
|                          |       |      |       |     |       |          |       |          |       |           |       |
| Commercial  commitments:      |       |      |       |     |       |          |       |          |       |           |       |
| Clinical  development         |       | $         | 387,900    |     | $          | 387,900       |       | $             | —     |           | $          | — |   | $ | — |   |
| Manufacturing  development    |       | 917,500   |       | 917,500  |       | 3⁄4        |       | —        |       | —         |       |
| Total commercial commitments  |       | $         | 1,305,400  |     | $          | 1,305,400     |       | $             | 3⁄4     |           | $          | — |   | $ | — |   |

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* includes interestobligations

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**Item 3.  Quantitative and Qualitative Disclosuresabout Market Risk**

AVANTowns financial instruments that are sensitive to market risk as part of itsinvestment portfolio. The Company investment portfolio is used to preserve itscapital until it is used to fund operations, including its research anddevelopment activities. None of these market-risk sensitive instruments areheld for trading purposes. AVANT invests its cash primarily in money marketmutual funds and U.S. Government and other investment grade debt securities. Theseinvestments are evaluated quarterly to determine the fair value of theportfolio. The Company’s investment portfolio includes only marketablesecurities with active secondary or resale markets to help insure liquidity. AVANThas implemented investment policies regarding the amount and credit ratings ofinvestments. Because of the short-term nature of these investments, AVANT doesnot believe it has material exposure due to market risk. The impact to AVANT’sfinancial position and results of operations from likely changes in interest ratesis not material.

AVANT does not utilize derivative financialinstruments. The carrying amounts reflected in the consolidated balance sheetof cash and cash equivalents, accounts receivables and accounts payableapproximates fair value at March 31, 2006 due to the short-term maturitiesof these instruments.

**Item 4.  Controls andProcedures**

*Evaluation of disclosure controls and procedures*.

As required by Rule 13a-15 under the Securities Exchange Actof 1934 (the “Exchange Act”), as of March 31, 2006, we carried out anevaluation under the supervision and with the participation of our management,including our Chief Executive Officer and Chief Financial Officer, of theeffectiveness of the design and operation of our disclosure controls andprocedures as of the period covered by this report. In designing and evaluatingour disclosure controls and procedures, we and our management recognize thatany controls and procedures, no matter how well designed and operated, canprovide only reasonable assurance of achieving the desired control objectives,and our management necessarily was required to apply its judgment in evaluatingand implementing possible controls and procedures. Based upon that evaluation,our Chief Executive Officer and Chief Financial Officer have concluded that asof March 31, 2006, as a result of the material weakness discussed below, ourdisclosure controls and procedures were not effective to ensure thatinformation required to be disclosed by us in the reports we file or submitunder the Exchange Act is recorded, processed, summarized, accumulated,communicated and reported, within the time periods specified in the Securitiesand Exchange Commission’s rules and forms. We will continue to review anddocument our disclosure controls and procedures on an ongoing basis, and mayfrom time to time make changes aimed at enhancing their effectiveness and toensure that our disclosure controls and procedures evolve with our business.

*Changes inInternal Control Over Financial Reporting.*

Management has determined that the Company did notmaintain effective controls over the completeness and accuracy of therecognition of revenue deferred pursuant to an agreement with Paul Royalty Fund(“PRF”) with respect to the sale of an interest in future net royalties fromGlaxoSmithKline (“GSK”), certain of which should have been recognized uponreceipt of a milestone payment from GSK in the first quarter of 2006.Notwithstanding that management had correctly determined the accountingtreatment for the PRF transaction, an operational failure in internal controloccurred in that revenue recognition was not triggered upon receipt of themilestone payment. Therefore, recognition of previously deferred royaltyrevenue was not completely and accurately recorded in the proper period inaccordance with accounting principles generally accepted in the United States.This was identified as a deficiency in internal control in the first quarter of2006 which constitutes a “material weakness.” A material weakness is a controldeficiency, or combination of control deficiencies that results in more than aremote likelihood that a material misstatement of the annual or interimfinancial statements will not be prevented or detected. This control deficiencyresulted in an audit adjustment to the unaudited interim consolidated financialstatements for the quarter ended March 31, 2006 affecting deferred revenue andproduct royalties.

Management is in the process of reviewing and, asnecessary, revising its policies and procedures with respect to its controlsover the accounting for deferred royalty revenue to ensure that all reasonablesteps will be taken to correct this material weakness. As part of this process,management expects to further train the Company’s accounting personnel, add additionalrevenue recognition review and approval controls, and possibly add staff tofacilitate a more timely completion of such internal controls. The deficiencywill not be considered remediated until the new internal controls areoperational for a period of time and are tested, and management has concludedthat the controls are operating effectively. Until it is remediated, theidentified control deficiency could result in a misstatement in the deferredrevenue and product royalties balances that would not be prevented or detected.

There was no change in our internal control overfinancial reporting (as defined in Rules 13a-15(f) and 15d-15(f) underthe Exchange Act) that occurred during the period covered by this QuarterlyReport on Form 10-Q, other than the material weakness describedabove, that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

**PART II — OTHER INFORMATION**

## **Item 1A.      RiskFactors**

In addition to theother information set forth in this report, you should carefully consider thefactors discussed in Part I, “Item 1A. Risk Factors” in our Annual Reporton Form 10-K for the year ended December 31, 2005, which couldmaterially affect our business, financial condition or future results. Therisks described in our Annual Report on Form 10-K are not the onlyrisks facing the Company. Additional risks and uncertainties not currentlyknown to the Company or that the Company currently deems to be

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immaterial also maymaterially adversely affect the Company’s business, financial condition and/oroperating results.

## **Item 6.         Exhibits**

|   | 10.1 |   | Amendment Agreement to Purchase Agreement between  the Company and PRF Vaccine Holdings LLC, dated as of March 14, 2006,  incorporated herein by reference to Exhibit 10.1 to the Company’s  Current Report on Form 8-K filed with the Securities and Exchange  Commission on March 15, 2006. |
|--------|------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | 31.1 |   | Certification of President and Chief Executive  Officer                                                                                                                                                                                                                                                                |
|   | 31.2 |   | Certification of Senior Vice President and Chief  Financial Officer                                                                                                                                                                                                                                                    |
|   | 32.1 |   | Section 1350 Certifications                                                                                                                                                                                                                                                                                       |

 

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
|                          |                               |
|--------------------------|------------------------------------|
|                     | **AVANT IMMUNOTHERAPEUTICS, INC.** |
|                     |                               |
|                     | BY:                                |
|                     |                               |   |
|                     |                               |   |
|                     |                               | /s/ UNA S.  RYAN |
| Dated: May 10, 2006 |                               | Una S. Ryan, Ph. D. |
|                     |                               | President and Chief Executive Officer |
|                     |                               | (Principal Executive Officer) |
|                     |                               |   |
|                     |                               |   |
|                     |                               | /s/ AVERY W. CATLIN |
| Dated: May 10, 2006 |                               | Avery W. Catlin |
|                     |                               | Senior Vice President, Treasurer |
|                     |                               | and Chief Financial Officer |
|                     |                               | (Principal Financial and |
|                     |                               | Accounting Officer) |

 

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**EXHIBITINDEX**
| Exhibit No. | ** ** | ** **                                                                                                                                                                                                                                                                                                            | ** ** | Description | ** ** |
|------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------|------------|
| 10.1             |       | Amendment  Agreement to Purchase Agreement between the Company and PRF Vaccine Holdings  LLC, dated as of March 14, 2006, incorporated herein by reference to Exhibit 10.1  to the Company’s Current Report on Form 8-K filed with the  Securities and Exchange Commission on March 15, 2006 |       |
| 31.1             |       | Certification of  President and Chief Executive Officer                                                                                                                                                                                                                                                               |       |
| 31.2             |       | Certification of Senior  Vice President and Chief Financial Officer                                                                                                                                                                                                                                                   |       |
| 32.1             |       | Section 1350 Certifications                                                                                                                                                                                                                                                                                      |       |

 

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