**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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FORM 10-Q

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe Quarterly Period Ended June 30, 2005**

**or**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe transition period from                    to                    **

**Commissionfile number 0-27628**

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SUPERGEN, INC.

(Exact name of registrantas specified in its charter)
| **Delaware**                                                     | **91-1841574**                        |
|------------------------------------------------------------------|---------------------------------------|
| (State or other  jurisdiction  of incorporation or organization) | (IRS Employer  Identification Number) |
| **4140 Dublin Blvd, Suite 200, Dublin, California**         | **94568**                             |
| (Address of  principal executive offices)                        | (Zip Code)                            |

 

**(925)560 - 0100**(Registrant’s telephonenumber, including area code)

**Notapplicable**(Former name, former addressand former fiscal year, if changed since last report)

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

Indicate by checkmarkwhether Registrant is an accelerated filer (as defined in Rule 12B-2of the Act). Yes  x No o

Thenumber of shares of the registrant’s Common Stock, $.001 par value, outstandingas of August 2, 2005 was 51,254,597.

 

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**TABLE OF CONTENTS**
|                  | ** ** | ** **                                                                                                              | ** ** | **Page No.** |
|------------------|------------|-------------------------------------------------------------------------------------------------------------------------|------------|--------------|
| **PART I**  | ** ** | **FINANCIAL INFORMATION**                                                                                               | ** ** | ** **   | ** ** |
|             |       | Item 1—Financial Statements (Unaudited)                                                                            |       |         |   |
|             |       | Condensed Consolidated  Balance Sheets as of June 30, 2005 and December 31, 2004                              |       | 3            |   |
|             |       | Condensed Consolidated  Statements of Operations for the three and six month periods ended  June 30, 2005 and 2004 |       | 4            |   |
|             |       | Condensed  Consolidated Statements of Cash Flows for the six month periods ended  June 30, 2005 and 2004           |       | 5            |   |
|             |       | Notes to  Condensed Consolidated Financial Statements                                                                   |       | 6            |   |
|             |       | Item 2—Management’s  Discussion and Analysis of Financial Condition and Results of Operations                 |       | 13           |   |
|             |       | Item  3—Quantitative and Qualitative Disclosures About Market Risk                                                 |       | 38           |   |
|             |       | Item  4—Controls and Procedures                                                                                    |       | 38           |   |
| **PART II** | ** ** | **OTHER INFORMATION**                                                                                                   |       |         |   |
|             |       | Item  4—Submission of Matters to a Vote of Security Holders                                                        |       | 39           |   |
|             |       | Item 6—Exhibits                                                                                                    |       | 39           |   |
| **SIGNATURES**   |       | 40                                                                                                                      |       |

 

2

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**SUPERGEN, INC.CONDENSED CONSOLIDATED BALANCE SHEETS(In thousands, except share and per share amounts)**
| ** **                                                                                                                                                                              | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                              | ** ** | **2005**          | ** ** | **2004**              | ** ** |
| ** **                                                                                                                                                                              | ** ** | **(Unaudited)**   | ** ** | **(Note 1)**     | ** ** |
| **ASSETS**                                                                                                                                                                              | ** ** |              | ** ** | ** **            |       |   | ** ** | ** ** |   |
| Current assets:                                                                                                                                                                         |       |              |       | ** **            |       |   |   | ** ** |   |
| Cash and cash  equivalents                                                                                                                                                              |       |              | $          | 40,830                | ** ** |   |   | $ | 38,394 | ** ** |   |
| Marketable securities                                                                                                                                                                   |       |              | 12,482     | ** **            |       |   | 18,235 | ** ** |   |
| Accounts receivable, net                                                                                                                                                                |       |              | 2,121      | ** **            |       |   | 4,926 | ** ** |   |
| Development revenue  receivable from MGI PHARMA, Inc.                                                                                                                                   |       |              | 1,087      | ** **            |       |   | 12,809 | ** ** |   |
| Inventories                                                                                                                                                                             |       |              | 2,863      | ** **            |       |   | 3,306 | ** ** |   |
| Prepaid expenses and  other current assets                                                                                                                                              |       |              | 2,004      | ** **            |       |   | 1,403 | ** ** |   |
| Total current assets                                                                                                                                                                    |       |              | 61,387     | ** **            |       |   | 79,073 | ** ** |   |
| Marketable securities,  non-current                                                                                                                                                     |       |              | 152        | ** **            |       |   | 188 | ** ** |   |
| Investment in stock of  related parties                                                                                                                                                 |       |              | 796        | ** **            |       |   | 798 | ** ** |   |
| Due from related  parties, non-current                                                                                                                                                  |       |              | 75         | ** **            |       |   | 93 | ** ** |   |
| Property, plant and  equipment, net                                                                                                                                                     |       |              | 3,281      | ** **            |       |   | 3,635 | ** ** |   |
| Goodwill                                                                                                                                                                                |       |              | 731        | ** **            |       |   | 731 | ** ** |   |
| Other intangibles, net                                                                                                                                                                  |       |              | 484        | ** **            |       |   | 677 | ** ** |   |
| Restricted cash and  investments, non-current                                                                                                                                           |       |              | 9,335      | ** **            |       |   | 9,432 | ** ** |   |
| Other assets                                                                                                                                                                            |       |              | 30         | ** **            |       |   | 30 | ** ** |   |
| Total assets                                                                                                                                                                            |       |              | $          | 76,271                | ** ** |   |   | $ | 94,657 | ** ** |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                           | ** ** |              | ** ** | ** **            |       |   | ** ** | ** ** |   |
| Current liabilities:                                                                                                                                                                    |       |              |       | ** **            |       |   |   | ** ** |   |
| Accounts payable and  accrued liabilities                                                                                                                                               |       |              | $          | 1,801                 | ** ** |   |   | $ | 4,644 | ** ** |   |
| Derivative liability                                                                                                                                                                    |       |              | 1,106      | ** **            |       |   | 1,607 | ** ** |   |
| Payable to AVI  BioPharma, Inc.                                                                                                                                                    |       |              | 565        | ** **            |       |   | 565 | ** ** |   |
| Deferred revenue                                                                                                                                                                        |       |              | 4,953      | ** **            |       |   | 11,572 | ** ** |   |
| Accrued payroll and  employee benefits                                                                                                                                                  |       |              | 1,985      | ** **            |       |   | 2,129 | ** ** |   |
| Total current  liabilities                                                                                                                                                              |       |              | 10,410     | ** **            |       |   | 20,517 | ** ** |   |
| Deferred rent                                                                                                                                                                           |       |              | 953        | ** **            |       |   | 927 | ** ** |   |
| Total liabilities                                                                                                                                                                       |       |              | 11,363     | ** **            |       |   | 21,444 | ** ** |   |
| Commitments and  contingencies                                                                                                                                                          |       |              |       | ** **            |       |   |   | ** ** |   |
| Stockholders’ equity:                                                                                                                                                              |       |              |       | ** **            |       |   |   | ** ** |   |
| Preferred stock, $.001  par value; 2,000,000 shares authorized; none outstanding                                                                                                        |       |              | —     | ** **            |       |   | — | ** ** |   |
| Common stock, $.001 par  value; 150,000,000 shares authorized; 51,205,639 and 51,127,314 shares issued  and outstanding at June 30, 2005 and December 31, 2004,  respectively |       |              | 51         | ** **            |       |   | 51 | ** ** |   |
| Additional paid in  capital                                                                                                                                                             |       |              | 407,395    | ** **            |       |   | 406,789 | ** ** |   |
| Accumulated other  comprehensive loss                                                                                                                                                   |       |              | (219       | **)**                 |       |   | (99 | ) |   |
| Accumulated deficit                                                                                                                                                                     |       |              | (342,319   | **)**                 |       |   | (333,528 | ) |   |
| Total stockholders’  equity                                                                                                                                                        |       |              | 64,908     | ** **            |       |   | 73,213 | ** ** |   |
| Total liabilities and stockholders’ equity                                                                                                                                         |       |              | $          | 76,271                | ** ** |   |   | $ | 94,657 | ** ** |   |

 

See accompanying notes to condensed consolidated financial statements

3

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**SUPERGEN, INC.CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS(In thousands, except per share amounts)(Unaudited)**
| ** **                                                                                    | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                    | ** ** | **2005**                                        | ** ** | **2004**                                      | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenues:                                                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Net product revenue                                                                           |       | $                                               | 3,625      |                                          | $          | 2,636 |   | $ | 4,640 |   | $ | 3,734 |   |
| Development and license revenue from MGI PHARMA, Inc.                                    |       | 3,716                                           |       | —                                        |       | 6,941 |   | — |   |
| Distribution agreement and other revenue                                                      |       | 590                                             |       | —                                        |       | 757 |   | — |   |
| Total revenues                                                                                |       | 7,931                                           |       | 2,636                                         |       | 12,338 |   | 3,734 |   |
| Costs and  operating expenses:                                                                |       |                                            |       |                                          |       |   |   |   |   |
| Cost of product revenue                                                                       |       | 700                                             |       | 1,196                                         |       | 1,000 |   | 1,747 |   |
| Research and development                                                                      |       | 2,891                                           |       | 5,228                                         |       | 8,015 |   | 12,678 |   |
| Selling, general, and administrative                                                          |       | 7,139                                           |       | 7,595                                         |       | 13,397 |   | 13,143 |   |
| Total costs and operating expenses                                                            |       | 10,730                                          |       | 14,019                                        |       | 22,412 |   | 27,568 |   |
| Loss from operations                                                                          |       | (2,799                                          | )          | (11,383                                       | )          | (10,074 | ) | (23,834 | ) |
| Interest income                                                                               |       | 411                                             |       | 115                                           |       | 783 |   | 202 |   |
| Interest expense                                                                              |       | —                                          |       | (499                                          | )          | — |   | (1,447 | ) |
| Amortization of  deemed discount on convertible debt                                          |       | —                                          |       | (2,879                                        | )          | — |   | (6,899 | ) |
| Other than  temporary decline in value of investments                                         |       | —                                          |       | (7,851                                        | )          | — |   | (7,851 | ) |
| Change in  valuation of derivatives                                                           |       | 500                                             |       | 1,185                                         |       | 500 |   | (218 | ) |
| Net loss                                                                                      |       | $                                               | (1,888     | )                                             | $          | (21,312 | ) | $ | (8,791 | ) | $ | (40,047 | ) |
| Basic and diluted  net loss per common share                                                  |       | $                                               | (0.04      | )                                             | $          | (0.48 | ) | $ | (0.17 | ) | $ | (0.96 | ) |
| Weighted average shares  used in basic and diluted net loss per common share calculation |       | 51,183                                          |       | 44,349                                        |       | 51,162 |   | 41,789 |   |

 

See accompanying notes to condensed consolidated financial statements

4

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**SUPERGEN, INC.CONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS(In thousands)(Unaudited)**
| ** **                                                                   | ** ** | **Six months ended  June 30,** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                   | ** ** | **2005**                                      | ** ** | **2004** | ** ** |
| Operating activities:                                                        |       |                                          |       |   |   |
| Net loss                                                                     |       | $                                             | (8,791     | ) | $ | (40,047 | ) |
| Adjustments to reconcile net loss to net cash used  in operating activities: |       |                                          |       |   |   |
| Depreciation                                                                 |       | 425                                           |       | 561 |   |
| Amortization of prepaid  financing costs                                     |       | —                                        |       | 1,072 |   |
| Amortization of  intangible assets                                           |       | 193                                           |       | 476 |   |
| Amortization of deemed  discount on convertible debt                         |       | —                                        |       | 6,899 |   |
| Amortization of deferred  revenue                                            |       | (4,952                                        | )          | — |   |
| Interest on convertible  debt paid in common stock                           |       | —                                        |       | 392 |   |
| Change in valuation of  derivatives                                          |       | (500                                          | )          | 218 |   |
| Other than temporary  decline in value of investments                        |       | —                                        |       | 7,851 |   |
| Stock compensation for  modification of employee options                     |       | 268                                           |       | 506 |   |
| Expense related to stock  options and warrants granted to non-employees      |       | 66                                            |       | 32 |   |
| Milestone, license, and  research payments made in common stock              |       | —                                        |       | 700 |   |
| Cash option paid in  termination of distribution agreement                   |       | (1,500                                        | )          | — |   |
| Changes in operating assets and liabilities:                                 |       |                                          |       |   |   |
| Accounts receivable and  development revenue receivable                      |       | 14,527                                        |       | (1,677 | ) |
| Inventories                                                                  |       | 443                                           |       | (299 | ) |
| Prepaid expenses and  other assets                                           |       | (601                                          | )          | (841 | ) |
| Due from related parties                                                     |       | 18                                            |       | 88 |   |
| Restricted cash and  investments                                             |       | 18                                            |       | (14 | ) |
| Accounts payable and  other liabilities                                      |       | (2,961                                        | )          | 271 |   |
| Deferred revenue                                                             |       | (167                                          | )          | — |   |
| Net cash used in  operating activities                                       |       | (3,514                                        | )          | (23,812 | ) |
| Investing activities:                                                        |       |                                          |       |   |   |
| Purchases of marketable  securities                                          |       | (11,285                                       | )          | (22,812 | ) |
| Sales or maturities of  marketable securities                                |       | 17,035                                        |       | 13,326 |   |
| Purchase of intangible  assets                                               |       | —                                        |       | (1,000 | ) |
| Release of restricted  cash from collateral account                          |       | —                                        |       | 10,680 |   |
| Purchases of property  and equipment                                         |       | (71                                           | )          | (165 | ) |
| Net cash provided by  investing activities                                   |       | 5,679                                         |       | 29 |   |
| Financing activities:                                                        |       |                                          |       |   |   |
| Proceeds from issuance  of common stock, net of issuance costs               |       | 271                                           |       | 33,431 |   |
| Net cash provided by  financing activities                                   |       | 271                                           |       | 33,431 |   |
| Net increase in cash and  cash equivalents                                   |       | 2,436                                         |       | 9,648 |   |
| Cash and cash  equivalents at beginning of period                            |       | 38,394                                        |       | 5,055 |   |
| Cash and cash  equivalents at end of period                                  |       | $                                             | 40,830     |   | $ | 14,703 |   |
| Supplemental Disclosure of Non-Cash Financing  Activities:                   |       |                                          |       |   |   |
| Conversion of convertible notes into common stock                            |       | $                                             | —     |   | $ | 16,250 |   |

 

See accompanying notes to condensed consolidated financial statements

5

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**SUPERGEN, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 2005 (Unaudited)**

**NOTE 1.**   BASISOF PRESENTATION

The accompanying condensed unaudited consolidatedfinancial statements of SuperGen, Inc. (“we,” “SuperGen” or the “Company”)have been prepared in accordance with generally accepted accounting principlesfor interim financial information and with the instructions to Form 10-Qand Article 10 of Regulation S-X. Accordingly, they do not include all ofthe information and footnotes required by generally accepted accountingprinciples for complete financial statements. In the opinion of management, alladjustments (consisting of normal recurring adjustments) considered necessaryfor a fair presentation have been included. Operating results for the three andsix month periods ended June 30, 2005 are not necessarily indicative ofresults that may be expected for the year ending December 31, 2005.

The balance sheet at December 31, 2004 has beenderived from the audited financial statements at that date, but does notinclude all the information and footnotes required by generally acceptedaccounting principles for complete financial statements.

Certain balances in the Company’s 2004 condensedconsolidated financial statements have been reclassified to conform to thepresentation in 2005.

For further information,refer to the consolidated financial statements and footnotes included in theCompany’s annual report on Form 10-K for the year ended December 31,2004.

**NOTE 2.**   STOCK-BASEDCOMPENSATION

We account for stock issued toemployees in accordance with Accounting Principles Board Opinion No. 25, “Accountingfor Stock Issued to Employees” (“APB 25”) and comply with the disclosureprovisions of Statement of Financial Accounting Standards No. 123, “Accountingfor Stock-Based Compensation” (“SFAS 123”) and Statement of FinancialAccounting Standards No. 148, “Accounting for Stock-Based Compensation—Transitionand Disclosure” (“SFAS 148”). Under APB 25, compensation expense of fixed stockoptions is based on the intrinsic value on the date of the grant, whichrepresents the difference, if any, between the fair value of the stock and theexercise price of the option.

We account for stock issued tonon-employees using the fair value approach, in accordance with the provisionsof SFAS 123 and EITF No. 96-18*,*“Accountingfor Equity Instruments That are Issued to Other Than Employees for Acquiring,or in Conjunction with Selling, Goods or Services.”

6

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**SUPERGEN, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) JUNE 30, 2005 (Unaudited)**

**NOTE 2.**   STOCK-BASED COMPENSATION (Continued)

Under the intrinsic valuemethod, when the exercise price of our employee stock options equals the marketprice of the underlying stock on the date of grant, no compensation expense isrecognized. The following table illustrates the pro forma effect on net lossand loss per share for the three and six month periods ended June 30, 2005and 2004 had we applied the fair value method to account for stock-based awardsto employees (in thousands, except per share amounts):
| ** **                                                                                                                                                                  | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                                                                                                  | ** ** | **2005**                                        | ** ** | **2004**                                      | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net loss, as  reported                                                                                                                                                      |       | $                                               | (1,888     | )                                             | $          | (21,312 | ) | $ | (8,791 | ) | $ | (40,047 | ) |
| Add: Stock-based  employee compensation expense included in the determination of net loss, as  reported                                                                     |       | —                                          |       | 77                                            |       | 268 |   | 506 |   |
| Deduct:  Stock-based employee compensation expense that would have been included in  the determination of net loss if the fair value method had been applied to  all awards |       | (861                                            | )          | (1,457                                        | )          | (4,033 | ) | (4,441 | ) |
| Pro forma net  loss                                                                                                                                                         |       | $                                               | (2,749     | )                                             | $          | (22,692 | ) | $ | (12,556 | ) | $ | (43,982 | ) |
| Basic and diluted  net loss per common share:                                                                                                                               |       |                                            |       |                                          |       |   |   |   |   |
| As reported                                                                                                                                                                 |       | $                                               | (0.04      | )                                             | $          | (0.48 | ) | $ | (0.17 | ) | $ | (0.96 | ) |
| Pro forma                                                                                                                                                                   |       | $                                               | (0.05      | )                                             | $          | (0.51 | ) | $ | (0.25 | ) | $ | (1.05 | ) |

 

**NOTE 3.**   CASH,CASH EQUIVALENTS, AND MARKETABLE SECURITIES

Cash and cash equivalents include bank demanddeposits, certificates of deposit, investments in debt securities withmaturities of three months or less when purchased, and an interest in moneymarket funds which invest primarily in U.S. government obligations andcommercial paper. These instruments are highly liquid and are subject toinsignificant risk.

Investments in marketable securities consist of equitysecurities and corporate or government debt securities that have a readilyascertainable market value and are readily marketable. We report theseinvestments at fair value. We designate all marketable securities asavailable-for-sale, with unrealized gains and losses included as a component ofequity.

Thefollowing is a summary of available-for-sale securities as of June 30,2005 (in thousands):
| ** **                       | ** ** | ** Amortized   Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | ** Fair Value ** | ** ** |
|----------------------------------|------------|---------------------------------|------------|------------------------------|------------|-------------------------------|------------|---------------------------------|------------|
| U.S. corporate  debt securities  |       |                            | $          | 42,705                       |       |                          |       | $                               | —     |   |   |   | $ | (10 | ) |   |   | $ | 42,695 |   |   |
| U.S. government  debt securities |       |                            | 5,911      |                         |       |                          | —     |                            |       |   | (11 | ) |   |   | 5,900 |   |   |
| Marketable equity  securities    |       |                            | 6,577      |                         |       |                          | 27         |                            |       |   | (225 | ) |   |   | 6,379 |   |   |
| Total                            |       |                            | $          | 55,193                       |       |                          |       | $                               | 27         |   |   |   | $ | (246 | ) |   |   | $ | 54,974 |   |   |

 

7

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**SUPERGEN, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) JUNE 30, 2005 (Unaudited)**

**NOTE 3.**   CASH, CASH EQUIVALENTS, AND MARKETABLE SECURITIES(Continued)

The available-for-salesecurities are classified on the balance sheet as of June 30, 2005 asfollows (in thousands):
| ** **                                                  | ** ** | ** Amortized   Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | ** Fair Value ** | ** ** |
|-------------------------------------------------------------|------------|---------------------------------|------------|------------------------------|------------|-------------------------------|------------|---------------------------------|------------|
| Amounts included  in cash and cash equivalents              |       |                            | $          | 36,118                       |       |                          |       | $                               | —     |   |   |   | $ | (5 | ) |   |   | $ | 36,113 |   |   |
| Marketable  securities, current                             |       |                            | 12,498     |                         |       |                          | —     |                            |       |   | (16 | ) |   |   | 12,482 |   |   |
| Amounts included  in investment in stock of related parties |       |                            | 120        |                         |       |                          | —     |                            |       |   | (4 | ) |   |   | 116 |   |   |
| Amounts included  in restricted cash and investments        |       |                            | 6,322      |                         |       |                          | —     |                            |       |   | (211 | ) |   |   | 6,111 |   |   |
| Marketable  securities, non-current                         |       |                            | 135        |                         |       |                          | 27         |                            |       |   | (10 | ) |   |   | 152 |   |   |
| Total                                                       |       |                            | $          | 55,193                       |       |                          |       | $                               | 27         |   |   |   | $ | (246 | ) |   |   | $ | 54,974 |   |   |

 

Available-for-salesecurities by contractual maturity are shown below (in thousands):
| ** **                             | ** ** | **Fair Value**     | ** ** |
|----------------------------------------|------------|-------------------------|------------|
| ** **                             | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
| Debt securities:                       |       |                    |       |   |   |   |   |
| Due in one year or less                |       | $                       | 48,595     |   |   | $ | 51,939 |   |   |
| Due after one year through three years |       | —                  |       |   | — |   |   |
|                                   |       | 48,595                  |       |   | 51,939 |   |   |
| Marketable equity  securities          |       | 6,379                   |       |   | 6,496 |   |   |
| Total                                  |       | $                       | 54,974     |   |   | $ | 58,435 |   |   |

 

**NOTE 4.**   INVENTORIES

Inventoriesconsist of the following (in thousands):
| ** **      | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-----------------|------------|-------------------------|------------|-----------------------------|------------|
| Raw materials   |       | $                       | 80         |                        |       | $ | 83 |   |   |
| Work in process |       | 565                     |       |                        | 1,040      |   |   |
| Finished goods  |       | 2,218                   |       |                        | 2,183      |   |   |
|            |       | $                       | 2,863      |                        |       | $ | 3,306 |   |   |

 

**NOTE 5.**   CONVERTIBLEDEBT FINANCING DERIVATIVE LIABILITY AND COLLATERAL

On June 24, 2003, we closed a private placementtransaction in which we issued Senior Convertible Notes (“June Notes”) inthe aggregate principal amount of $21.25 million. In connection with theissuance of the June Notes, we issued to the note holders warrants topurchase 2,634,211 shares of 

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**SUPERGEN, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) JUNE 30, 2005 (Unaudited)**

**NOTE 5.**   CONVERTIBLE DEBT FINANCING DERIVATIVE LIABILITYAND COLLATERAL (Continued)

AVI BioPharma, Inc.that we own (“AVI Shares”) at an exercise price of $5.00 per share. Thewarrants represent a derivative under SFAS 133 that must be recorded at fairvalue. Changes in the fair value of the derivative are recognized in earnings. Duringthe three months ended June 30, 2005 and 2004, we recorded changes in thevalue of this derivative of $500,000 and $1,185,000, respectively. During thesix months ended June 30, 2005 and 2004, we recorded changes in the valueof this derivative of $500,000 and $3,398,000, respectively. During the sixmonths ended June 30, 2004, the change in valuation of this derivative wasoffset by income of $3,616,000 related to the change in valuation of anotherderivative issued in connection with a March 2004 private placement.

In connection with theissuance of the warrants to acquire the 2,634,211 AVI Shares, we pledged theAVI Shares into a collateral account. The fair value of the AVI Shares isincluded in the accompanying balance sheet under non-current Restricted cashand investments. We also hold an additional 50,000 shares of AVI, whichare included in the accompanying balance sheet in Investment in stock ofrelated parties. We continue to hold all of the pledged and unpledged AVIShares and reflect temporary changes in those share values in accumulated othercomprehensive gain or loss. During the three and six month periods ended June 30,2004, we recorded a write-down of $7,851,000 related to an other than temporarydecline in the value of our investments in AVI. We had no such write-downsduring the three and six month periods ended June 30, 2005.

**NOTE 6.**   STOCKPURCHASE AND LICENSE AGREEMENTS WITH MGI PHARMA, INC.

In August 2004, we entered into three agreementswith MGI PHARMA, Inc., a Minnesota corporation (“MGI”): (1) a commonstock purchase agreement, (2) a license agreement relating to DacogenTM(decitabine), and (3) an investor rights agreement. The agreements becameeffective on September 21, 2004. Dacogen is our investigationalanti-cancer therapeutic which is currently in clinical trials for the treatmentof patients with myelodysplastic syndrome (“MDS”). Pursuant to the terms of thelicense agreement, MGI received exclusive worldwide rights to the development,commercialization and distribution of Dacogen for all indications.

In accordance with the stock purchase agreement, weissued 4,000,000 shares of our common stock to MGI at $10.00 per share, foraggregate proceeds totaling $40,000,000. We paid the placement agent $3,200,000in cash and issued the placement agent a warrant exercisable for 400,000 sharesof our common stock at an exercise price of $10.00 per share. We calculated thefair value of the warrant at $1,436,000. We allocated the aggregate proceedsand related costs of the placement agent fee and warrant valuation betweenequity, for the portion attributable to the stock purchase agreement, anddeferred revenue, for the portion attributable to the license agreement.Therefore, we allocated $23,662,000, the fair value of 4,000,000 shares of ourcommon stock at the time of the transaction, net of related offering costs, toequity, and allocated $12,625,000 to deferred revenue. The deferred revenue isbeing amortized to license revenue over 15 months, which is the period of timein which our development obligations for Dacogen would transfer to MGI. Duringthe three and six months ended June 30, 2005, we recorded amortization ofdeferred revenue of $2,476,000 and $4,952,000, respectively. We had no similaramortization during the three and six months ended June 30, 2004.

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**SUPERGEN, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) JUNE 30, 2005 (Unaudited)**

**NOTE 6.**   STOCK PURCHASE AND LICENSE AGREEMENTS WITH MGIPHARMA, INC. (Continued)

Under the terms of thelicense agreement, MGI is obligated to reimburse us for certain development andallocated overhead costs of Dacogen until we receive marketing authorization. Duringthe three and six months ended June 30, 2005, we recognized $1,240,000 and$1,989,000, respectively, of development revenue relating to the reimbursementunder this agreement. We had no similar revenue during the three and six monthsended June 30, 2004.

**NOTE 7.**   ACQUISITIONOF NIPENT EUROPEAN MARKETING RIGHTS

In February 2004, weentered into a Purchase and Sale Agreement with Pfizer Inc. to acquire Europeanmarketing rights for Nipent®, our drug that is currently approved for marketingin the United States for hairy cell leukemia. We paid Pfizer $1,000,000 underthis agreement and have classified this amount in Other intangibles in theaccompanying balance sheet. This amount is being amortized over 31 months,the estimated life of the benefit period. Accumulated amortization was $516,000and $129,000 at June 30, 2005 and 2004, respectively.

**NOTE 8.**   TERMINATIONOF AGREEMENT WITH ABBOTT LABORATORIES

In December 1999, we entered into a Nipent distribution agreement with AbbottLaboratories. Beginning March 1, 2000, Abbott became the exclusive U.S.distributor of Nipent for a period of five years. We retained U.S. marketingrights for Nipent. Under this agreement, Abbott made a $5 million cash paymentto the Company in January 2000. This amount was included in deferredrevenue and was being amortized to distribution revenue over 60 months.

In March 2003, weentered into an agreement with Abbott that allowed us to terminate the Nipentdistribution agreement, for a stated fee that decreased over time to $1,500,000at March 2005. As part of the agreement, we paid Abbott $500,000 for theright to terminate the Nipent distribution agreement at our option. The$500,000 was recorded as a reduction of the deferred revenue we initiallyreceived from Abbott for the distribution rights, and we stopped amortizing theremaining balance of deferred revenue, which was $1,667,000 at that time. In February 2005, we exercised our optionand paid Abbott $1,500,000 to terminate the Nipent distribution agreement. Thisamount was charged against deferred revenue. The remaining balance in deferredrevenue of $167,000 was recorded as distribution agreement revenue in the firstquarter of 2005.

**NOTE 9.**   DAUNORUBICINTRANSFER AGREEMENT

We received approval of anAbbreviated New Drug Application (“ANDA”) for generic daunorubicin in 2001. In April 2005,we executed a transfer agreement with American Pharmaceutical Partners, Inc.whereby we transferred the ANDA and all rights, title, and interest in theproduct for $590,000. We recorded this amount as other revenue during the threemonths ended June 30, 2005.

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**SUPERGEN, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) JUNE 30, 2005 (Unaudited)**

**NOTE 10.**   COMPREHENSIVELOSS

For the three months ended June 30, 2005 and2004, total comprehensive losses amounted to $2,441,000 and $21,557,000,respectively. Comprehensive losses consisted primarily of the net losses andchanges in unrealized gains or losses on investments. We recorded an unrealizedloss on investments of $553,000 for the three months ended June 30, 2005,and an unrealized loss of $245,000 for the three month period ended June 30,2004.

For the six months ended June 30,2005 and 2004, total comprehensive losses amounted to $8,911,000 and$40,228,000, respectively. Comprehensive losses consisted primarily of the netlosses and changes in unrealized gains or losses on investments. We recorded anunrealized loss on investments of $120,000 for the six months ended June 30,2005, and recorded an unrealized loss of $181,000 for the six months ended June 30,2004.

**NOTE 11.**   BASICNET LOSS PER SHARE

Basic and diluted net loss per common share iscomputed by dividing net loss by the weighted average number of sharesoutstanding during the quarter.

As we have reported operating losses in each period,the effect of assuming the exercise of options and warrants would beanti-dilutive and, therefore, basic and diluted net loss per share are thesame.

The computation of diluted net loss per share for thethree and six months ended June 30, 2005 excludes the impact of options topurchase 6,609,000sharesof common stock and warrants to purchase 7,183,000 shares of common stock at June 30,2005, as such impact would be antidilutive.

The computation of dilutednet loss per share for the three and six months ended June 30, 2004 excludesthe impact of options to purchase 6,435,000 shares of common stock, warrants topurchase 7,070,000 shares of common stock, and 1,571,000 shares of common stockissuable upon conversion of senior convertible notes at June 30, 2004, assuch impact would be antidilutive.

**NOTE 12.**   RECENTACCOUNTING PRONOUNCEMENTS

In December 2004, the Financial AccountingStandards Board issued Statement of Financial Accounting Standards No. 123(revised 2004), “Share-Based Payment” (“SFAS 123R”), which replaces SFAS 123and supersedes APB 25. SFAS 123R requires all share-based payments toemployees, including grants of employee stock options, to be recognized in thefinancial statements based on their fair values. The pro forma disclosurespreviously permitted under SFAS No. 123 no longer will be an alternativeto financial statement recognition. In accordance with a Securities andExchange Commission rule issued in April 2005, companies will beallowed to implement SFAS No. 123R as of the beginning of the firstinterim or annual period that begins after June 15, 2005. We currentlyexpect that we will adopt SFAS 123R on January 1, 2006. Under SFAS 123R,we must determine the appropriate fair value model to be used for valuingshare-based payments, the amortization method for compensation cost, and thetransition method to be used at date of adoption. The permitted transitionmethods include either retrospective or prospective adoption. Under theretrospective method, prior periods may be restated either as of the beginningof the year of adoption or for all periods presented. The prospective methodrequires that 

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**SUPERGEN, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) JUNE 30, 2005 (Unaudited)**

**NOTE 12.**   RECENT ACCOUNTING PRONOUNCEMENTS(Continued)

compensation expense berecorded for all unvested stock options at the beginning of the first quarterof adoption of SFAS 123R, while the retrospective methods would recordcompensation expense for all unvested stock options beginning with the firstperiod presented. We are currently evaluating the requirements of SFAS 123R andexpect that adoption of SFAS 123R will have a material impact on ourconsolidated financial position and results of operations. We have not yetdetermined the method of adopting SFAS 123R, and we have not determined whetherthe adoption will result in amounts that are similar to the current pro formadisclosures under SFAS 123.

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**Item 2.**

**MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

*Youshould read the following discussion together with our condensed consolidatedfinancial statements and related notes included elsewhere in this report. Theresults discussed below are not necessarily indicative of the results to beexpected in any future periods. Ourdisclosure and analysis in this section of the report also contain forward-lookingstatements. When we use the words “anticipate,” “estimate,” “project,” “intend,”“expect,” “plan,” “believe,” “should,” “likely” and similar expressions, we aremaking forward-looking statements. Forward-looking statementsprovide our current expectations or forecasts of future events. In particular,these statements include statements such as: the timing of receiving approvalof our filings for Orathecin and Dacogen, including our**expectation that the Food andDrug Administration will review and act on our New Drug Application for Dacogenby September 2005; our estimatesabout becoming profitable; the percentage of royalties we might expect to earnon Dacogen sales under our agreement with MGI; our forecasts regarding ourresearch and development expenses; the impact of our outstanding indebtedness;and our statements regarding the sufficiency of our cash to meet our operatingneeds. Our actual results could differ materially from those predicted in theforward-looking statements as a result of risks and uncertaintiesincluding, but not limited to, delays and risks associated with conducting andmanaging our clinical trials; developing products and obtaining regulatoryapproval; ability to establish and maintain collaboration relationships;competition; ability to obtain funding; ability to protect our intellectual property;our dependence on third party suppliers; risks associated with the hiring andloss of key personnel; adverse changes in the specific markets for ourproducts; ability to launch and commercialize our products. Certain unknown orimmaterial risks and uncertainties can also affect our forward-lookingstatements. Consequently, no forward-looking statement can be guaranteedand you should not rely on these forward-looking statements. For adiscussion of the known and material risks that could affect our actualresults, please see “Factors Affecting Future Operating Results” in thissection of the report. We undertake no obligation to update any forward-lookingstatements, whether as a result of new information, future events or otherwise.However, readers should carefully review the risk factors set forth in this10-Q and other reports or documents we file from time to time with theSecurities and Exchange Commission.*

**Overview**

We are a pharmaceutical company dedicated to thedevelopment and commercialization of therapies for solid tumors, hematologicalmalignancies, and blood disorders. Our strategy is to commercialize products byminimizing the time, expense and technical risk associated with drug researchthrough identifying and acquiring pharmaceutical compounds in the later stagesof development. Our primary objective is to become a leading supplier oftherapies for solid tumors, hematological malignancies, and blood disorders.

Since our incorporation in 1991 we have devotedsubstantially all of our resources to our product development efforts.Currently we have three key compounds, Orathecin, Dacogen and Nipent, that arethe focus of our efforts.

*Orathecin.  *During January 2004,we submitted a New Drug Application (“NDA”) to the United States Food and DrugAdministration (“FDA”) for Orathecin. The filing was accepted by the FDA andindicated a target Prescription Drug User Fee Act (“PDUFA”) date of November 26,2004. At the request of the FDA, we submitted during November 2004additional clinical data from a trial of Orathecin as a first-line treatmentfor pancreatic cancer as well as new analyses of data from the study in 2nd and3rd line patients. The FDA classified these data as a Major Amendment, whichtriggered an extension of the review period by 90 days resulting in a revisedtarget PDUFA date of February 26, 2005. Based on further discussions withand feedback from both the FDA and consultants helping us dialog with the FDA,it was determined the current package for Orathecin was not sufficient to gainapproval at this time in the United States and we announced the withdrawal ofthe NDA in January 2005. In the first quarter of 2005, we 

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received the findings fromthe FDA and are reviewing these findings to determine the most appropriatecourse of action in the future for Orathecin in the United States.

During July 2004, we submitted a MarketingAuthorization Application (“MAA”) seeking approval of Orathecin in thetreatment of pancreatic cancer to the European Agency for the Evaluations ofMedicinal Products (“EMEA”). EMEA procedures generally provide that a decisionon the Orathecin MAA will usually occur within 12 months of acceptance ofsubmission, which could result in a decision by the EMEA in the second half of2005. Our European filing for Orathecin remains on track and is not affected bythe withdrawal of the NDA for Orathecin in the United States. There can be noguarantee that the EMEA will approve Orathecin.

*Dacogen.  *During March 2004,we reported results from our randomized Phase III study of Dacogen forinjection as a treatment for myelodysplastic syndrome (“MDS”). In October 2004,we submitted to the EMEA an MAA seeking approval of Dacogen in the treatment ofMDS. EMEA procedures generally provide that a decision on the Dacogen MAA willusually occur within 12 months of acceptance of submission, which could resultin a decision by the EMEA in the second half of 2005 or early 2006. In November 2004,we submitted an NDA to the FDA for Dacogen. The filing was accepted at the endof 2004 by the FDA and indicated a target PDUFA date of September 1, 2005.There can be no guarantee that the FDA or EMEA will approve Dacogen.

During September 2004, we executed a definitiveagreement granting MGI PHARMA, Inc. (“MGI”) exclusive worldwide rights tothe development, manufacture, commercialization and distribution of Dacogen. Underthe terms of the agreement, MGI made a $40.0 million equity investment in usand will pay us up to $45.0 million in specific regulatory andcommercialization milestones. If Dacogen is approved, we could receive aroyalty on worldwide net sales starting at 20% and escalating to a maximum of30%. MGI has also committed to fund further development costs associated withDacogen at a minimum of $15.0 million over a three-year period.

*Nipent.  *Nipent is approvedby the FDA and EMEA for the treatment of hairy cell leukemia and is marketed byus in the United States and Europe. Nipent has also shown promise in otherdiseases and we are conducting a series of post-marketing Phase IV clinicaltrials for chronic lymphocytic leukemia (“CLL”), non-Hodgkin’s lymphoma (“NHL”),cutaneous and peripheral T-cell lymphomas, and graft-versus-host disease (“GvHD”).

*Other Products.  *Ourportfolio of other products includes Partaject-delivered busulfan, andinhaled Orathecin. We also market generic mitomycin and Surface Safe. We havealso received regulatory approval to market our generic daunorubicin for avariety of acute leukemias and Mitozytrex (mitomycin for injection), for use inthe therapy of disseminated adenocarcinoma of the stomach or pancreas in provencombinations with other approved chemotherapeutic agents and as palliativetreatment when other modalities have failed. Moreover, we hold U.S. sales andmarketing rights to the cancer vaccine Avicine. We are continually evaluatingour product portfolio to determine whether it is appropriate for us to dedicatethe resources needed to commercialize these products ourselves or whether wewould be better served selling or licensing the rights to develop theseproducts to third parties. In April 2005, we executed a transfer agreement with American Pharmaceutical Partners, Inc.whereby we transferred the Abbreviated New Drug Application (“ANDA”) and allrights, title, and interest in our generic daunorubicin for $590,000 in cash.

To date, our product revenues have been limited andare derived primarily from sales of Nipent, which we are marketing in theUnited States and distributing in Europe for the treatment of hairy cellleukemia. Most of our products are still in the development stage, and we willrequire substantial additional investments in research and development,clinical trials, and in regulatory, sales and marketing activities tocommercialize current and future product candidates. Conducting clinical trialsis a lengthy, 

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time-consuming, andexpensive process involving inherent uncertainties and risks, and our studiesmay be insufficient to demonstrate safety and efficacy to support FDA approvalof any of our product candidates.

As a result of our substantial research anddevelopment expenditures and minimal product revenues, we have incurredcumulative losses of $342.3 million through June 30, 2005, and havenever generated enough funds through our operations to support our business. Weexpect to continue to incur operating losses at least through 2006.

Ultimately, our ability tobecome profitable will depend upon a variety of factors, including regulatoryapprovals of our products, the timing of the introduction and market acceptanceof our products and competing products, MGI’s success in commercializingDacogen, if approved, increases in sales and marketing expenses related to thelaunch of new products and our ability to control our costs and operatingexpenses. If the results from our clinical trials are not positive, we may notbe able to get sufficient funding to continue our trials or conduct new trials,and we would be forced to scale down or cease our business operations. Moreover,if our products are not approved or commercially accepted we will remainunprofitable for longer than we currently anticipate. Additionally, we might beforced to substantially scale down our operations or sell certain of ourassets, and it is likely the price of our stock would decline precipitously.

**Critical Accounting Policies**

Our management discussion and analysis of ourfinancial condition and results of operations is based upon our consolidatedfinancial statements, which have been prepared in accordance with accountingprinciples generally accepted in the United States. The preparation of thesefinancial statements requires us to make estimates and judgments that affectthe reported amounts of assets, liabilities, revenues and expenses, andreported disclosures. On an on-going basis, we evaluate our estimates,including those related to revenue recognition, intangible assets, valuation ofinvestments and derivative instruments. We base our estimates on historicalexperience and on various other assumptions that we believe are reasonableunder the circumstances, the results of which form the basis for makingjudgments about the carrying values of assets and liabilities that are notreadily apparent from other sources. Actual results may differ from theseestimates under different assumptions or conditions.

Our significant accountingpolicies are more fully disclosed in Note 1 to our consolidated financialstatements included in our 2004 Annual Report on Form 10-K. However, someof our accounting policies are particularly important to the portrayal of ourfinancial position and results of operations and require the application ofsignificant judgment by our management. We believe the following criticalaccounting policies, among others, affect our more significant judgments andestimates used in the preparation of our consolidated financial statements.

*Revenue Recognition*

Our net sales relate principally to Nipent and, to alesser extent, mitomycin. We recognize sales revenue upon shipment and relatedtransfer of title to customers, and collectibility is reasonably assured.Allowances are established for estimated product returns and exchanges.

Allowances for product returns and exchanges are basedon historical information and known trends from external sources. The costs ofproduct exchanges, which include actual product costs and related shippingcharges, are included in cost of product revenue. In estimating returns, weanalyze historical returns and sales patterns, the remaining shelf life ofinventory, and changes in demand. We continually assess our historicalexperience and adjust our allowances as appropriate. If actual product returnsand exchanges are greater than our estimates, additional allowances may berequired.

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Cash advance paymentsreceived in connection with distribution agreements, license agreements, orresearch grants are deferred and recognized ratably over the period of therespective agreements or until services are performed. We recognize costreimbursement revenue under collaborative agreements as the related researchand development costs are incurred. We recognize milestone fees upon completionof specified milestones according to contract terms. Deferred revenuerepresents the portion of research payments received that has not been earned.

*Intangible Assets*

We have intangible assetsrelated to goodwill and other acquired intangibles such as trademarks,covenants not to compete, and customer lists. The determination of relatedestimated useful lives and whether or not these assets are impaired involvessignificant judgment. Changes in strategy and/or market conditions couldsignificantly impact these judgments and require adjustments to recorded assetbalances. We review intangible assets, as well as other long-lived assets, forimpairment whenever events or circumstances indicate that the carrying amountmay not be fully recoverable.

*Valuation ofInvestments in Financial Instruments*

Investments in financial instruments are carried atfair value with unrealized gains and losses included in accumulated othercomprehensive income or loss in stockholders’ equity. Our investment portfolioincludes equity securities that could subject us to material market risk andcorporate obligations that subject us to varying levels of credit risk. If thefair value of a financial instrument has declined below its carrying value fora period in excess of six consecutive months or if the decline is due to asignificant adverse event, such that the carrying amount of these investmentsmay not be fully recoverable, the impairment is considered to be other thantemporary. An other than temporary decline in fair value of a financialinstrument would be subject to a write-down resulting in a charge againstearnings. The determination of whether a decline in fair value is other thantemporary requires significant judgment, and could have a material impact onour balance sheet and results of operations. Our management reviews thesecurities within our portfolio for other than temporary declines in value on aregular basis. The prices of some of our marketable securities, in particularAVI, are subject to considerable volatility. Decreases in the fair value ofthese securities may significantly impact our results of operations.

Investments in equity securitieswithout readily determinable fair value are carried at cost. We periodicallyreview those carried costs and evaluate whether an impairment has occurred. Thedetermination of whether an impairment has occurred requires significantjudgment, as each investment may have unique market or developmentopportunities.

*DerivativeInstruments*

In connection with our June 2003convertible debt transaction, we issued to the note holders warrants topurchase 2,634,211 shares of common stock of AVI at $5.00 per share. As of June 30,2005, we owned sufficient shares of AVI to cover the potential obligation.These warrants are considered to be a derivative and have been recorded on thebalance sheet at fair value. The accounting for derivatives is complex, andrequires significant judgments and estimates involved in determining the fairvalue in the absence of quoted market values. These estimates are based onvaluation methodologies and assumptions deemed appropriate in thecircumstances. The fair value of the warrants is based on various assumptionsinput into the Black-Scholes pricing model. These assumptions include theestimated market volatility and interest rates used in the determination offair value. The use of different assumptions may have a material effect on theestimated fair value amount and the results of operations.

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**Results of Operations**

*Three months ended June 30, 2005 compared tothree months ended June 30, 2004:*
| ** **                                | ** ** | **Three months ended  June 30,** | ** ** | **Change**                                                           | ** ** |
|-------------------------------------------|------------|-------------------------------------------------|------------|----------------------------------------------------------------------|------------|
| **Revenues**                              | ** ** | ** **                                      | ** ** | **     2005     ** | ** ** | **     2004     ** | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
| ** **                                | ** ** | **(Dollars in thousands)**            | ** ** |
| Net product  revenue                      |       |                                            | $          | 3,625                                                                |       |   |   | $ | 2,636 |   |   | $ | 989 |   |   | 37.5 | % |   |
| Development and  license revenue          |       |                                            | 3,716      |                                                                 |       |   | — |   |   | 3,716 |   |   | — |   |   |
| Distribution agreement  and other revenue |       |                                            | 590        |                                                                 |       |   | — |   |   | 590 |   |   | — |   |   |
|                                           |            |                                                 |            |                                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The increase in net product revenues for the threemonths ended June 30, 2005 was due primarily to higher sales of Nipent,our drug currently approved for the treatment of hairy cell leukemia. Net salesof Nipent were approximately $3.4 million in the three months ended June 30,2005, compared to $2.3 million in the comparable period of 2004. Nipent salesfor the three months ended June 30, 2005 included approximately $504,000in sales to Europe. We had no European sales for the comparable period in 2004.Unlike our Nipent sales efforts in the U.S. market where we call on cliniciansdirectly, our role in Europe has been limited to that of a supplier. As such,we have not had a direct influence on Nipent sales at the clinical level,making the timing and magnitude of European sales difficult to predict anddependent on the efforts of our European distributor. During the first quarterof 2004, we acquired the marketing rights for Nipent in Europe, which allows usto charge a higher unit price for Nipent in Europe compared to the unit pricescharged under the previous supply agreement.

Development and license revenue for the three monthsended June 30, 2005 relates to our license agreement entered into with MGIin September 2004. Development and license revenue included $2,476,000related to the amortization of deferred revenue in connection with the upfrontpayment received from MGI, and $1,240,000 related to reimbursement of Dacogendevelopment and allocated overhead costs.

Distributionagreement and other revenue for the three months ended June 30, 2005relates to the transfer agreement with American Pharmaceutical Partners, Inc.whereby we transferred the ANDA and all rights, title, and interest in ourgeneric daunorubicin for $590,000 in cash.
| ** **                                      | ** ** | **Three months ended  June 30,** | ** ** | **Change**                                                           | ** ** |
|-------------------------------------------------|------------|-------------------------------------------------|------------|----------------------------------------------------------------------|------------|
| **Costs and operating expenses** | ** ** | ** **                                      | ** ** | **     2005     ** | ** ** | **     2004     ** | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
| ** **                                      | ** ** | ** **                                      | ** ** | **(Dollars in thousands)**                                 | ** ** |
| Cost of product  revenue                        |       |                                            | $          | 700                                                                  |       |   |   | $ | 1,196 |   |   | $ | (496 | ) |   | (41.5 | )% |   |
| Research and  development                       |       |                                            | 2,891      |                                                                 |       |   | 5,228 |   |   | (2,337 | ) |   | (44.7 | ) |   |
| Selling, general and  administrative            |       |                                            | 7,139      |                                                                 |       |   | 7,595 |   |   | (456 | ) |   | (6.0 | ) |   |
|                                                 |            |                                                 |            |                                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Cost of product revenue as a percentage of net productrevenue was 19% in the three months ended June 30, 2005 compared to 45% inthe same period in 2004. The decrease for the three months ended June 30,2005 is due to a variation in product mix, with a larger portion of our salesbeing related to domestic Nipent, which is sold at higher margins thanmitomycin, and lower distribution costs for Nipent since we terminated ourNipent distribution agreement with Abbott in the first quarter of 2005. Currentmargins may not be indicative of future margins due to possible variations inproduct mix, average selling prices, and manufacturing costs.

The decrease in research and development expenses wasdue to lower personnel costs, primarily after a reduction in headcount ofapproximately 16% in the first quarter of 2005, and lower clinical studyexpenses and clinical supply costs for Orathecin and Dacogen, as those clinicalstudies have wound down 

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after the completion ofour FDA and European submissions for Orathecin and Dacogen during the latterhalf of 2004.

We conduct research internally and also throughcollaborations with third parties, and we intend to maintain our strongcommitment to our research and development efforts in the future. Our researchand development activities consist primarily of clinical development and therelated advancement of our existing product candidates through clinical trials.Our major research and development projects include Orathecin, Dacogen, andstudies of other indications of Nipent. Conducting clinical trials is alengthy, expensive and uncertain process. Completion of clinical trials maytake several years or more. The length of time generally varies substantiallyaccording to the type, complexity, novelty and intended use of the productcandidate. Our clinical trials may be suspended at any time if we or the FDAbelieve the patients participating in our studies are exposed to unacceptablehealth risks. We may encounter problems in our studies which will cause us orthe FDA to delay or suspend the studies. Because of these uncertainties, wecannot predict when or whether we will successfully complete the development ofour product candidates or the ultimate product development cost.

Thedecrease in selling, general and administrative expenses for the three monthsended June 30, 2005 relates primarily to reduced expenditures formarketing programs, legal fees, and investor relations activities.
| ** **                                            | ** ** | **Three months ended  June 30,** | ** ** | **Change**                                   | ** ** |
|-------------------------------------------------------|------------|-------------------------------------------------|------------|----------------------------------------------|------------|
| **Other income (expense)**                  | ** ** | ** **                                      | ** ** | **   2005   ** | ** ** | **   2004   ** | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
| ** **                                            | ** ** | ** **                                      | ** ** | **(Dollars in thousands)**         | ** ** |
| Interest income                                       |       |                                            | $          | 411                                          |       |   | $ | 115 |   | $ | 296 |   | 257.4 | % |
| Interest expense                                      |       |                                            | —     |                                         |       | (499 | ) | (499 | ) | (100.0 | ) |
| Amortization of  deemed discount on convertible debt  |       |                                            | —     |                                         |       | (2,879 | ) | (2,879 | ) | (100.0 | ) |
| Other than  temporary decline in value of investments |       |                                            | —     |                                         |       | (7,851 | ) | (7,851 | ) | (100.0 | ) |
| Change in valuation of  derivative                    |       |                                            | 500        |                                         |       | 1,185 |   | (685 | ) | (57.8 | ) |
|                                                       |            |                                                 |            |                                              |            |  |  |  |  |  |  |  |  |  |  |  |

 

The increase in interest income was due to higheravailable cash and marketable securities balances and a modest increase ininterest rates for the three months ended June 30, 2005, compared to thesame period in 2004.

Interest expense in the three months ended June 30,2004 consisted of amortization of prepaid financing costs of $370,000 andinterest of $129,000, relating to our outstanding convertible notes issued in2003. These notes were fully paid at December 31, 2004.

Non-cash amortization of deemed discount onconvertible debt in the three months ended June 30, 2004 related to theconvertible notes issued in 2003.  Thesenotes were fully paid at December 31, 2004.

In the three months ended June 30,2004, we recorded an other than temporary decline in the value of ourinvestment in AVI of $7,851,000. The fair value of this investment had declinedbelow its carrying value for a period in excess of six months. We had nosimilar decline in the comparable period in 2005.

Income from change in valuationof derivative relates to a derivative instrument connected with our June 2003convertible debt transaction. As part of the June 2003 convertible debttransaction, we issued the note holders warrants to purchase 2,634,211 sharesof AVI at $5.00 per share. These warrants represent a derivative instrument andare valued each quarter using the Black-Scholes pricing model. During the threemonths ended June 30, 2005, the value of this derivative had declined by$500,000. During the three months ended June 30, 2004, this derivative haddeclined by $1,185,000.

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*Six months ended June 30, 2005 compared to sixmonths ended June 30, 2004:*
| ** **                                | ** ** | **Six months ended  June 30,** | ** ** | **Change**                                   | ** ** |
|-------------------------------------------|------------|-----------------------------------------------|------------|----------------------------------------------|------------|
| **Revenues**                              | ** ** | ** **                                    | ** ** | **   2005   ** | ** ** | **   2004   ** | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
| ** **                                | ** ** | **(Dollars in thousands)**          | ** ** |
| Net product  revenue                      |       |                                          | $          | 4,640                                        |       |   |   | $ | 3,734 |   |   | $ | 906 |   |   | 24.3 | % |   |
| Development and  license revenue          |       |                                          | 6,941      |                                         |       |   | — |   |   | 6,941 |   |   | — |   |   |
| Distribution agreement  and other revenue |       |                                          | 757        |                                         |       |   | — |   |   | 757 |   |   | — |   |   |
|                                           |            |                                               |            |                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The increase in net product revenues for the sixmonths ended June 30, 2005 was due primarily to higher unit sales ofNipent. Net sales of Nipent were approximately $4.2 million in the first halfof 2005, compared to $3.0 million in the comparable period in 2004.  Nipent sales for the six months ended June 30,2005 included approximately $504,000 in sales to Europe, compared to $528,000in 2004. Unlike our Nipent sales efforts in the U.S. market where we call onclinicians directly, our role in Europe has been limited to that of a supplier.As such, we have not had a direct influence on Nipent sales at the clinicallevel, making the timing and magnitude of European sales difficult to predictand dependent on the efforts of our European distributor. During the firstquarter of 2004, we acquired the marketing rights for Nipent in Europe, whichallows us to charge a higher unit price for Nipent in Europe compared to theunit prices charged under the previous supply agreement.

Development and license revenue for the six monthsended June 30, 2005 relates to our license agreement entered into with MGIin September 2004. Development and license revenue included $4,952,000related to the amortization of deferred revenue in connection with the upfrontpayment received from MGI, and $1,989,000 related to reimbursement of Dacogendevelopment and allocated overhead costs.

Distributionagreement and other revenue for the six months ended June 30, 2005includes revenue from the termination of our Nipent distribution agreement withAbbott Laboratories. Upon signing this agreement in 1999, we received $5.0million from Abbott, which was recorded as deferred revenue and was beingamortized over a five-year period. In February 2005, we paid Abbott$1,500,000 to terminate this agreement, and this amount was charged against theunamortized balance of deferred revenue of $1,667,000. The remaining $167,000was recorded as distribution agreement revenue in the first quarter of 2005 asa result of the termination of the distribution agreement. The remaining$590,000 in revenue relates to the transfer agreement with American Pharmaceutical Partners, Inc.whereby we transferred the ANDA and all rights, title, and interest in ourgeneric daunorubicin.
| ** **                                      | ** ** | **Six months ended  June 30,** | ** ** | **Change**                                   | ** ** |
|-------------------------------------------------|------------|-----------------------------------------------|------------|----------------------------------------------|------------|
| **Costs and operating expenses** | ** ** | ** **                                    | ** ** | **   2005   ** | ** ** | **   2004   ** | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
| ** **                                      | ** ** | ** **                                    | ** ** | **(Dollars in thousands)**         | ** ** |
| Cost of product revenue                         |       | $                                             | 1,000      |                                         | $          | 1,747 |   | $ | (747 | ) |   | (42.8 | )% |   |
| Research and  development                       |       | 8,015                                         |       | 12,678                                       |       | (4,663 | ) |   | (36.8 | ) |   |
| Selling, general and  administrative            |       | 13,397                                        |       | 13,143                                       |       | 254 |   |   | 1.9 |   |   |
|                                                 |            |                                               |            |                                              |            |  |  |  |  |  |  |  |  |  |  |  |

 

Cost of product revenue as a percentage of net productrevenue was 22% in the six months ended June 30, 2005 compared to 47% inthe same period in 2004. The decrease for the six months ended June 30,2005 is due to a variation in product mix, with a larger portion of our salesbeing related to domestic Nipent, which is sold at higher margins thanmitomycin, and lower distribution costs for Nipent since we terminated ourNipent distribution agreement with Abbott in the first quarter of 2005. Currentmargins may not be indicative of future margins due to possible variations inproduct mix, average selling prices, and of future margins due to possiblevariations in product mix, average selling prices, and manufacturing costs.

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The decrease in research and development expenses wasdue to lower personnel costs, primarily after a reduction in headcount ofapproximately 16% in the first quarter of 2005, and lower clinical studyexpenses and clinical supply costs for Orathecin and Dacogen, as those clinicalstudies have wound down after the completion of our FDA and Europeansubmissions for Orathecin and Dacogen during the latter half of 2004. Inaddition, the expenses for the six months ended June 30, 2004 included a$500,000 non-cash charge paid in shares of our common stock to theStehlin Foundation as a milestone payment for the acceptance of the submissionof the NDA for Orathecin.

We conduct research internally and also throughcollaborations with third parties, and we intend to maintain our strongcommitment to our research and development efforts in the future. Our researchand development activities consist primarily of clinical development and therelated advancement of our existing product candidates through clinical trials.Our major research and development projects include Orathecin, Dacogen, andstudies of other indications of Nipent. Conducting clinical trials is alengthy, expensive and uncertain process. Completion of clinical trials maytake several years or more. The length of time generally varies substantiallyaccording to the type, complexity, novelty and intended use of the productcandidate. Our clinical trials may be suspended at any time if we or the FDAbelieve the patients participating in our studies are exposed to unacceptablehealth risks. We may encounter problems in our studies which will cause us orthe FDA to delay or suspend the studies. Because of these uncertainties, wecannot predict when or whether we will successfully complete the development ofour product candidates or the ultimate product development cost.

Theincrease in selling, general and administrative expenses for the six monthsended June 30, 2005 relates primarily to additional expenses in connectionwith our European operations as they scale up sales and marketing effortsrelated to future commercialization of Nipent in Europe.
| ** **                                            | ** ** | **Six months ended  June 30,** | ** ** | **Change**                           | ** ** |
|-------------------------------------------------------|------------|-----------------------------------------------|------------|--------------------------------------|------------|
| **Other income (expense)**                  | ** ** | ** **                                    | ** ** | **2005**                             | ** ** | **2004** | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
| ** **                                            | ** ** | ** **                                    | ** ** | **(Dollars in thousands)** | ** ** |
| Interest income                                       |       | $                                             | 783        |                                 | $          | 202 |   | $ | 581 |   | 287.6 | % |
| Interest expense                                      |       | —                                        |       | (1,447                               | )          | (1,447 | ) | (100.0 | ) |
| Amortization of  deemed discount on convertible debt  |       | —                                        |       | (6,899                               | )          | (6,899 | ) | (100.0 | ) |
| Other than  temporary decline in value of investments |       | —                                        |       | (7,851                               | )          | (7,851 | ) | (100.0 | ) |
| Change in valuation of  derivative                    |       | 500                                           |       | (218                                 | )          | (718 | ) | (329.4 | ) |
|                                                       |            |                                               |            |                                      |            |  |  |  |  |  |  |  |  |  |

 

The increase in interest income was due to higheravailable cash and marketable securities balances and a modest increase ininterest rates for the six months ended June 30, 2005, compared to thesame period in 2004.

Interest expense in the six months ended June 30,2004 consisted of amortization of prepaid financing costs of $1,072,000 andinterest of $375,000, relating to our outstanding convertible notes issued in2003. These notes were fully paid at December 31, 2004.

Non-cash amortization of deemed discount onconvertible debt in the six months ended June 30, 2004 relates to theconvertible notes issued in 2003. These notes were fully paid at December 31,2004.

The change in derivativevaluation of $218,000 in the six months ended June 30, 2004 representedthe change in the valuation of two derivatives. As part of the June 2003convertible debt transaction, we issued to the note holders warrants topurchase 2,634,211 shares of AVI at $5.00 per share. These warrants represent aderivative instrument and are valued each quarter using the Black-Scholespricing model. During the first half of 2004, the value of this derivative haddecreased by $3,398,000, which was recorded as other income. We also recordedan expense of $3,616,000 related to the derivative accounting treatment ofinitially unregistered warrants issued in connection with the private placementof shares of our common stock completed in March 2004, in accordance withEITF 00-19, “Accounting for Derivative Financial 

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InstrumentsIndexed to, and Potentially Settled in, a Company’s Own Stock.” In the sixmonths ended June 30, 2005, we recorded a change in value of thederivative associated with the warrants to purchase the AVI shares of $500,000.

**Liquidity and Capital Resources**

Our cash, cash equivalents, and both short andlong-term marketable securities totaled $53,464,000 at June 30, 2005,compared to $56,817,000 at December 31, 2004. In addition, we held2,684,211 shares of registered stock of AVI, most of which are held as securityfor the warrants we issued to convertible debt holders to purchase the2,634,211 AVI shares at $5.00 per share. The AVI shares had a market value of$6,227,000 at June 30, 2005, and are classified on the balance sheet undernon-current Restricted cash and investments, as well as Investment in stock ofrelated parties.

Net cash used in operating activities was $3,514,000in the six months ended June 30, 2005, and consisted primarily of the netloss of $8,791,000, plus non-cash amortization of deferred revenue of$4,952,000 from the MGI payment received in September 2004, $1,500,000paid to Abbott to terminate our U.S. Nipent distribution agreement, a decrease inaccounts payable and other liabilities of $2,961,000, offset by a decrease inaccounts receivable of $14,527,000, primarily due to the receipt of milestoneand development funds from MGI. The net cash used in operating activities inthe six months ended June 30, 2004 was $23,812,000, which consistedprimarily of the net loss of $40,047,000 plus $1,677,000 increase in accountsreceivable, less $6,899,000 non-cash amortization of deemed discount on ourconvertible debt, $1,072,000 amortization of prepaid financing costs, and$7,851,000 other than temporary decline in the value of investments.

Net cash provided by investing activities was$5,679,000 in the six months ended June 30, 2005, and consisted of$17,035,000 in proceeds from the sale or maturity of marketable securities,offset by $11,285,000 from the purchase of marketable securities. Net cashprovided by investing activities was $29,000 in the six months ended June 30,2004, which consisted primarily of $10,680,000 from the release of restrictedcash from the collateral account related to our convertible debt, $13,326,000in proceeds from the sale or maturity of marketable securities, offset by$22,812,000 from the purchase of marketable securities and $1,000,000 paid forthe purchase of European product rights for Nipent.

Net cash provided by financing activities was $271,000in the six months ended June 30,2005, and consisted of proceeds from exercises of stock options. Net cashprovided by financing activities was $33,431,000 in the six months ended June 30, 2004, consisting of proceeds fromthe issuance of common stock in a private placement transaction and proceedsfrom exercises of stock options.

We have financed our operations primarily through theissuance of equity and debt securities and the receipt of milestone payments inconnection with collaborative agreements. We believe that our current cash,cash equivalents, marketable securities and other investments will satisfy ourcash requirements through 2006. However, it is our intention to pursueadditional financing options, including the selling of additional shares ofstock in a public or private offering and/or exploring marketing partnershipopportunities for Orathecin and Nipent.

We believe that our needfor additional funding will increase in the future, especially if we receiveregulatory approval for Orathecin, and that our continued ability to raisefunds from external sources will be critical to our success. We continue toactively consider future contractual arrangements that would requiresignificant financial commitments. If we experience currently unanticipatedcash requirements, we could require additional capital much sooner thanpresently anticipated. We may raise money by the sale of our equity securitiesor debt, or the exercise of outstanding warrants and stock options by theholders of such warrants or options. However, given uncertain market conditionsand the volatility of our stock price, we may not be able to sell oursecurities in public offerings or private placements at prices and/or on termsthat are favorable to us, if at all. We may also choose to obtain fundingthrough licensing and other 

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contractualagreements. Such arrangements may require us to relinquish our rights to ourtechnologies, products or marketing territories, or to grant licenses on termsthat are not favorable to us. If we fail to obtain adequate funding in a timelymanner, or at all, we will be forced to scale back our product developmentactivities or our operations in a manner that will ensure we can discharge ourobligations as they come due in the ordinary course of business at leastthrough the end of 2006.

**FactorsAffecting Future Operating Results**

*The followingsection lists some, but not all, of the risks and uncertainties that may have amaterial adverse effect on our business, financial condition and results ofoperations. You should carefully consider these risks in evaluating our companyand business. Our business operations may be impaired if any of the followingrisks actually occur, and by additional risks and uncertainties that we do notknow of or that we currently consider immaterial. In such case, the tradingprice of our common stock could decline.*

*This report also contains forward-looking statementsthat involve risks and uncertainties. Our actual results could differmaterially from those anticipated in the forward-looking statements as a resultof certain factors, including the risks described below and elsewhere in thisreport.*

***Risks Related to Orathecin, Dacogen and Nipent***

*If we do not receive regulatory approval for Dacogen,our future revenues may be limited and our business would be harmed.*

Our NDA submission for Dacogen was accepted for filingby the FDA on December 31, 2004. We expect that the FDA will review andact on the NDA by September 2005. Our European subsidiary, EuroGenPharmaceuticals Ltd., submitted an MAA for Dacogen to the EMEA, whichsubmission was accepted for review on October 25, 2004. EMEA proceduresprovide that a decision on the Dacogen MAA will usually occur within 12 monthsof acceptance of the submission.

The primary data analysis from our Phase III study ofDacogen indicates that the patients who were randomized to the Dacogen arm ofthe study had an increased time to progression to AML or death (p=0.042Wilcoxon test, p=0.198 Log-rank test), compared to patients randomized tosupportive care only. Both analyses were specified in the protocol. Althoughthe results from the Log-rank test were not statistically significant, webelieve that these data are clinically significant and, as a result, formed thebasis of our NDA submission. In addition, adverse events were reported morefrequently for patients randomized to the Dacogen arm, as compared to thosereceiving supportive care, specifically, Leucopenia, febrile neutropenia,nausea, constipation, diarrhea, vomiting, pneumonia, arthralgia, headache andinsomnia. Severe adverse events were observed more frequently in patientsrandomized to Dacogen. The mortality rate for patients in the study was 12% forDacogen and 9% for supportive care. Consequently, there is no assurance thatthe FDA will agree with our assessment that Dacogen provides a clinicallysignificant benefit, that the FDA will not take the position that the studiesfailed for statistical reasons, or that we will not be required to conductadditional large scale clinical trials. Even if this data supports thesubmission of an NDA, the approval process may take a significant amount oftime and we may never receive approval. If Dacogen is unsuccessful for anyreason, including if the results of the Phase III study are deemed insufficientfrom either a clinical or statistical basis by the FDA, our future revenueswould be limited and our business would be harmed. Additionally, we might beforced to substantially scale down our operations or sell certain of our assets,and it is likely the price of our stock would decline precipitously.

In addition, pursuant toour license agreement with MGI, we are expecting to receive payments from MGIin connection with the achievement of certain commercialization milestones. Ifthese commercialization milestones are not met, we will not receive thesepayments and our financial condition and business would be harmed.

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*Weare relying on European regulatory approval and successful commercialization ofOrathecin. If our MAA submission for Orathecin does not support regulatoryapproval by the EMEA for any reason, our business will be harmed.*

On July 1, 2004 our European subsidiary, EuroGenPharmaceuticals Ltd., submitted an MAA for Orathecin to the EMEA. Thisapplication is being reviewed under the EMEA Centralized Procedure, wheremarketing authorization is applied for in all 25 European Union member statessimultaneously. EMEA procedures provide that a decision on the Orathecin MAAwill usually occur within 12 months of acceptance of the submission.

Even though the EMEA accepted our submission forfiling, the EMEA may not ultimately approve our MAA for Orathecin. The approvalprocess may take a significant amount of time and approval of our applicationwill be based on the agency’s review of Orathecin’s safety and efficacy.Important factors that the EMEA will take into account in its review andanalysis include, among other things, time to disease progression and objectivetumor response as well as toxicities seen in patients who were treated withOrathecin.

Given the large scale of the Orathecin clinicalprogram, the complexity of the clinical trials and the inherent uncertaintiesassociated with clinical trials of such magnitude and complexity, the data andstatistical analysis from these trials may not support regulatory approval orwe may be required to perform additional studies before obtaining regulatoryapproval. For example, the design of these trials allowed patients whoinitially were being treated with gemcitabine or other therapies to cross overto treatment with Orathecin. At the time the trials were designed, we believedthat the percentage of patients who would cross over for treatment withOrathecin would be in the range of 10% to 20% of the total enrolled patients.The number of patients in our trials who actually crossed over to treatmentwith Orathecin significantly exceeded the number anticipated and was nearly 50%in two of our Phase III studies. The extent of this cross over has negativelyaffected the statistical analysis of the study, making it difficult todetermine if the product is efficacious with respect to survival.

In May 2003, we announced data from one of ourPhase III studies of Orathecin in patients with advanced pancreatic cancer,most of whom had previously failed two or more chemotherapy treatments. Thestudy randomized 409 patients to either Orathecin or “best medical therapy.”The primary study end-point was overall survival with secondaryend-points, including objective tumor response and time to disease progression.We did not meet the primary end-point, although we did meet two of thesecondary end-points. The two secondary end-points were independent of across-over effect, whereas the primary end-point was not. The released data,and the data from our other clinical trials, may not be sufficient to supportregulatory approval for Orathecin, and additional trials may be required beforewe can obtain regulatory approval.

If, for any reason, theEMEA ultimately determines not to approve our application for Orathecin, wewould be unable to proceed with our current plans for commercializing Orathecinin Europe. Additionally, we might be forced to scale down our expansion effortwith our European operations or sell certain of our assets, and it is likelythe price of our stock could decline.

*Weare currently conducting clinical trials with Orathecin as a combinationtherapy. If these clinical trials do not support regulatory approval, ourbusiness may be harmed.*

In early January 2005,we announced the withdrawal of our NDA for Orathecin based on feedback from theFDA that the data package we submitted in support of the drug would not besufficient to gain regulatory approval. However, we are continuing to conductclinical trials with Orathecin as a combination therapy while we review anddetermine whether or not we will continue to pursue regulatory approval forOrathecin. Clinical trials are expensive to conduct, time-consuming and haveuncertain outcomes. We will incur substantial expense while conducting thesestudies, and if we are unable to complete the studies, or if 

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theresults of the studies do not support regulatory approval of Orathecin as acombination therapy, we will incur significant operating losses and ourbusiness will be harmed.

*If we receive regulatory approval of Orathecin for thetreatment of patients with refractory pancreatic cancer, Orathecin may not becommercially successful.*

If Orathecin receivesregulatory approval, whether in Europe, in the United States if we pursueregulatory approval with the FDA, or ultimately as a combination therapy,patients and physicians may not readily accept it, which would result in lowerthan projected sales and substantial harm to our business. Acceptance will be afunction of Orathecin being clinically useful and demonstrating superiortherapeutic effect with an acceptable side effect profile as compared tocurrently existing or future treatments. In addition, even if Orathecin doesachieve market acceptance, we may not be able to maintain that market acceptanceover time if new products are introduced that are more favorably received thanOrathecin or render Orathecin obsolete.

*If we receive regulatory approval of Dacogen for thetreatment of patients with myelodysplastic syndromes, Dacogen may not be commerciallysuccessful.*

If Dacogen receivesregulatory approval in the United States or Europe, patients and physicians maynot readily accept it, which would result in lower than projected sales andsubstantial harm to our business through the receipt of lower royalty revenuefrom MGI.

*If we are unable to expand our clinical support foruse of Nipent to treat additional diseases our revenues will not expand asplanned.*

Part of our strategyinvolves expanding the market opportunities for our approved drugs, includingNipent, by seeking clinical support of their use for treatment of patients withadditional diseases. We are currently marketing Nipent for the treatment ofpatients with hairy cell leukemia, and revenues from selling Nipent provided 80- 90% of our revenues for the past three years. We are conducting a series ofclinical trials with Nipent, including Phase IV trials for CLL, NHL, cutaneousand peripheral T-cell lymphomas and Phase II/III studies for GvHD. If ourNipent clinical trials are not successful, we will not be able to increase ourrevenue from Nipent.

***Risks Related to Our Financial Condition and CommonStock***

*We have a history of operating losses and we expect tocontinue to incur losses for the foreseeable future.*

Since inception, we have funded our research anddevelopment activities primarily from private placements and public offeringsof our securities, milestone payments and revenues generated primarily fromsales of Nipent, which is marketed in the United States for the treatment of patientswith hairy cell leukemia. Our substantial research and development expendituresand limited revenues have resulted in significant net losses. We have incurredcumulative losses of $342.3 million from inception through June 30, 2005,and our products have not generated sufficient revenues to support our businessduring that time. We expect to continue to incur substantial operating lossesat least through 2006 and may never achieve profitability.

Whether we achieveprofitability depends primarily on the following factors:

·       ourability to obtain regulatory approval for Dacogen and the successfulcommercialization of Dacogen by MGI;

·       ourability to successfully commercialize Orathecin in Europe;

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·       ourability to develop and obtain regulatory approval of Nipent for indicationsother than hairy cell leukemia;

·       ourability to bring to market other proprietary products that are advancingthrough our internal clinical development infrastructure;

·       ourability to successfully expand our product pipeline through in-licensing andproduct acquisition;

·       ourability to successfully market Nipent in Europe as planned;

·       ourresearch and development efforts, including the timing and costs of clinicaltrials;

·       ourcompetition’s ability to develop and bring to market competing products;

·       ourability to control costs and expenses associated with manufacturing,distributing and selling our products, as well as general and administrativecosts related to conducting our business;

·       costsand expenses associated with entering into licensing and other collaborativeagreements; and

·       delaysin production or inadequate commercial sales of Dacogen, Orathecin and otherproducts, once regulatory approvals have been received.

Our products and productcandidates, even if successfully developed and approved, may not generatesufficient or sustainable revenues to enable us to achieve or sustainprofitability.

*We will require additional funding to expand ourproduct pipeline, strengthen our commercialization efforts and expand our Europeanoperations, and if we are unable to raise the necessary capital or to do so onacceptable terms, our planned expansion and continued survival could be harmed.*

We will continue to spendsubstantial resources on expanding our product pipeline, strengthening ourcommercialization efforts for our existing products, developing new avenues ofrevenue for Nipent, scaling-up of European operations to market, selling anddistributing our existing and future products, and conducting research anddevelopment, including clinical trials for other products and productcandidates. We anticipate that our capital resources will be adequate to fundoperations and capital expenditures through 2006. However, if we experienceunanticipated cash requirements during this period, we could require additionalfunds much sooner. We may raise money by the sale of our equity securities ordebt, or the exercise of outstanding warrants and stock options by the holdersof such warrants and options. However, given uncertain market conditions andthe volatility of our stock price, we may not be able to sell our securities inpublic offerings or private placements at prices and/or on terms that arefavorable to us, if at all. Also, the dilutive effect of additional financingscould adversely affect our per share results. We may also choose to obtainfunding through licensing and other contractual agreements. For example, werecently licensed the worldwide rights to the development, commercializationand distribution of Dacogen to MGI. Such arrangements may require us torelinquish our rights to our technologies, products or marketing territories,or to grant licenses on terms that are not favorable to us. If we fail toobtain adequate funding in a timely manner, or at all, we will be forced toscale back our product development activities, or be forced to cease ouroperations.

*Our collaborative relationship with MGI may notproduce the financial benefits that we are anticipating, which could cause ourbusiness to suffer.*

In addition to raisingmoney by selling our equity securities to MGI in connection with the licenseagreement, we also expect to record development and license revenue frompayments made to us by MGI upon the achievement of regulatory andcommercialization milestones. However, we may fail to achieve these milestones,either because we are unable to secure regulatory approval of Dacogen or due toour inability to expend the resources to commence sales of Dacogen asprescribed by the license agreement. In 

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addition,the license agreement contemplates that MGI will pay us (i) a certainportion of revenues payable to MGI as a result of MGI sublicensing the rightsto market, sell and/or distribute Dacogen, to the extent such revenues are inexcess of the milestone payments, and (ii) a 20% royalty increasing to amaximum of 30% on annual worldwide net sales of Dacogen. We cannot guaranteethat we will ever receive these payments, as MGI may choose not to sublicenseDacogen at all, nor can we be assured that MGI will expend the resources tosell Dacogen worldwide, or be successful in doing so.

*Our equity investment in AVI exposes us to equityprice risk and any impairment charge would affect our results of operations.*

We are exposed to equity price risk on our equityinvestment in AVI. Currently we own 2,684,211 shares of AVI. During the yearended December 31, 2004, we recorded a write-down of $7.9 million relatedto other than temporary decline in the value of our equity investment in AVI,resulting in a reduction of our cost basis in the AVI shares. Under ouraccounting policy, marketable equity securities are presumed to be impaired iftheir fair value is less than their cost basis for more than six months, absentcompelling evidence to the contrary. As of June 30, 2004, the AVI shareshad been trading below our original cost basis for more than six months. Sincethere was no compelling evidence to the contrary, we recorded the impairmentcharge of $7.9 million in our results of operations. The amount of thecharge was based on the difference between the market price of the shares as ofJune 30, 2004 and our adjusted cost basis. The public trading prices ofthe AVI shares have fluctuated significantly since we purchased them and couldcontinue to do so. If the public trading prices of these shares continue totrade below their new cost basis in future periods, we may incur additionalimpairment charges relating to this investment, which in turn will affect ourresults of operations.

In addition, in connectionwith the restructuring of our February Notes and the issuance of the June Notes,we issued three-year warrants to the June Note holders exercisable into2,634,211 of our AVI shares at an exercise price of $5.00 per share, and wepledged the AVI shares to secure our obligation under the June Notes.These warrants expire on December 31, 2006.

***Product Development and Regulatory Risks***

*Before we can seek regulatory approval of any of ourproduct candidates, we must complete clinical trials, which are expensive andhave uncertain outcomes.*

Most of our products are in the developmental stageand, prior to their sale, will require regulatory approval and the commitmentof substantial resources. Before obtaining regulatory approvals for thecommercial sale of any of our product candidates, we must demonstrate throughpre-clinical testing and clinical trials that our product candidates are safeand effective for use in humans.

We have a portfolio of cancer drugs in various stagesof development, including Nipent (for indications other than hairy cellleukemia, Phase IV), Partaject busulfan (Phase I/II), inhaled Orathecin (PhaseI/II), Orathecin capsules as a combination therapy (Phase II), and we have beenconducting pre-clinical studies for VEGF and Cremophor-free paclitaxel.In addition, we expect to commence new clinical trials from time to time in thecourse of our business as our product development work continues. Conductingclinical trials is a lengthy, time consuming and expensive process and theresults are inherently uncertain. We have incurred and will continue to incursubstantial expense for, and we have devoted and expect to continue to devote asignificant amount of time to, pre-clinical testing and clinical trials.However, regulatory authorities may not permit us to undertake any additionalclinical trials for our product candidates. If we are unable to complete ourclinical trials, our business will be severely harmed and the price of ourstock will likely decline.

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We have ongoing researchand pre-clinical projects that may lead to product candidates, but we have notbegun clinical trials for these projects. If we do not successfully completeour pre-clinical trials, we could not commence clinical trials as planned.

*Our clinical trials may be delayed or terminated,which would prevent us from seeking necessary regulatory approvals.*

Completion ofclinical trials may take several years or more. The length of a clinical trialvaries substantially according to the type, complexity, novelty and intendeduse of the product candidate. For example, our three Phase III Orathecinclinical trials lasted from 1998 through the end of 2003. The length of timeand complexity of these studies make statistical analysis difficult andregulatory approval unpredictable. The commencement and rate of completion ofour clinical trials may be delayed by many factors, including:

·       ineffectivenessof the study compound, or perceptions by physicians that the compound is noteffective for a particular indication;

·       inabilityto manufacture sufficient quantities of compounds for use in clinical trials;

·       inabilityto obtain FDA approval of our clinical trial protocols;

·       slowerthan expected rate of patient recruitment;

·       inabilityto adequately follow patients after treatment;

·       difficultyin managing multiple clinical sites;

·       unforeseensafety issues;

·       lackof efficacy demonstrated during the clinical trials; or

·       governmentor regulatory delays.

If we are unable toachieve a satisfactory rate of completion of our clinical trials, our businesswill be significantly harmed.

*We may be required to suspend, repeat or terminate ourclinical trials if they are not conducted in compliance with regulatoryrequirements.*

Our clinical trials mustbe conducted in accordance with the FDA’s regulations and are subject tocontinuous oversight by the FDA and institutional review boards at the medicalinstitutions where the clinical trials are conducted. We outsource certainaspects of our research and development activities to contract researchorganizations (“CROs”). We have agreements with these CROs for certain of ourclinical programs. We and our CROs are required to comply with GCPs,regulations and guidelines enforced by the FDA for all of our products inclinical development. The FDA enforces GCPs through periodic inspections ofstudy sponsors, principal investigators, and study sites. If our CROs or wefail to comply with applicable GCPs, the clinical data generated in our studiesmay be deemed unreliable and the FDA may require us to perform additionalstudies before approving our applications. In addition, our clinical trialsmust be conducted with product candidates produced under current GMPs, and mayrequire a large number of test subjects. Our failure to comply with theseregulations may require us to repeat clinical studies, which would delay theregulatory approval process.

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*We may be required to suspend, repeat or terminate ourclinical trials if later trial results fail to demonstrate safety and efficacy,or of the results are negative, inconclusive or if they fail to demonstratesafety or efficacy.*

Our clinical trials may be suspended at any time if weor the FDA believe the patients participating in our studies are exposed tounacceptable health risks or if the FDA finds deficiencies in the conduct ofthese trials. Adverse medical events during a clinical trial could cause us toterminate or repeat a clinical trial.

We may encounter other problems and failures in ourstudies that would cause us or the FDA to delay or suspend the studies. Even ifwe achieve positive interim results in clinical trials, these results do notnecessarily predict final results, and acceptable results in early trials maynot be repeated in later trials. A number of companies in the pharmaceuticalindustry have suffered significant setbacks in advanced clinical trials, evenafter achieving promising results in earlier trials.

Negative or inconclusiveresults during a clinical trial could cause us to terminate or repeat aclinical trial. The potential failures would delay development of our productcandidates, hinder our ability to conduct related pre-clinical testing andclinical trials and further delay the commencement of the regulatory approvalprocess. Further, the failures or perceived failures in our clinical trialswould delay our product development and the regulatory approval process, damageour business prospects, make it difficult for us to establish collaboration andpartnership relationships and negatively affect our reputation and competitiveposition in the pharmaceutical industry. Finally, if we are required to conductother clinical trials for the product candidates, the additional trials wouldrequire substantial funding and time, and we may be unable to obtain funding toconduct such clinical trials.

*Our failure to obtain regulatory approvals to marketour product candidates in foreign countries would adversely affect ouranticipated revenues.*

Sales of our products in foreign jurisdictions will besubject to separate regulatory requirements and marketing approvals. Approvalin the United States, or in any one foreign jurisdiction, does not ensureapproval in any other jurisdiction. The process of obtaining foreign approvalsmay result in significant delays, difficulties and expenses for us, and mayrequire additional clinical trials. We have applied through our subsidiaryEuroGen for regulatory approval to market Orathecin, mitomycin and paclitaxelin the United Kingdom and in other countries within the European Union.Although many of the regulations applicable to our products in these foreigncountries are similar to those promulgated by the FDA, many of theserequirements also vary widely from country to country, which could delay theintroduction of our products in those countries. Failure to comply with theseregulatory requirements or to obtain required approvals would impair ourability to commercialize our products in foreign markets.

Nipent is currently soldin Europe, and in early 2004 we acquired the rights to distribute and marketNipent there directly. We plan to commence distribution and marketing Nipent inEurope in the second half of 2005 or early 2006. However, our revenue fromsales of Nipent in Europe is currently insignificant, and there is no guaranteethat our distribution and marketing efforts will result in significantlyincreased revenues. Our strategy is to obtain regulatory approvals to sell ourproducts in Europe and elsewhere, and we intend to contract with third-partylicensees or distributors for sales outside the United States. Delays inobtaining regulatory approval from foreign jurisdictions will impair thecommercialization of our products and would delay anticipated revenues.

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*Even if we obtain regulatory approval, we willcontinue to be subject to extensive government regulation that may cause us todelay the introduction of our products or withdraw our products from themarket.*

Even if regulatory approval of our products is obtained,later discovery of previously unknown problems may result in restrictions of aproduct, including withdrawal of that product from the market. Further,governmental approval may subject us to ongoing requirements for post-marketingstudies. For example, despite receipt of governmental approval, the facilitiesof our third-party manufacturers are still subject to unannouncedinspections by the FDA and must continue to comply with GMPs and otherregulations. These regulations govern all areas of production, record keeping,personnel and quality control. In the past, our third-party manufacturershave experienced delayed FDA approval, which adversely affected our ability tosupply Nipent in 2002. If we or our third-party manufacturers fail tocomply with any of the manufacturing regulations, we may be subject to, amongother things, product seizures, recalls, fines, injunctions, suspensions orrevocations of marketing licenses, operating restrictions and criminalprosecution.

Physicians may prescribedrugs for uses that are not described in a product’s labeling for uses thatdiffer from those tested by us and approved by the FDA. While such “off-label”uses are common and the FDA does not regulate physicians’ choice of treatments,the FDA does restrict a manufacturer’s communications on the subject ofoff-label use. Companies cannot actively promote FDA-approved drugs foroff-label uses, but they may disseminate to physicians articles published inpeer-reviewed journals. To the extent allowed by law, we intend to disseminatepeer-reviewed articles on our products to our physician customers. If, however,our promotional activities fail to comply with the FDA’s regulations orguidelines, we may be subject to warnings and/or enforcement action by the FDA.For example, in November 2002 we issued a press release announcing our receiptof FDA approval to market Mitozytrex. In March 2003, the FDA issued a “TalkPaper” regarding this press release, taking the position that we made certainunsupported claims about the drug and did not disclose the serious side effectssuch as suppression of bone marrow activity. We revised our internal proceduresto help ensure our promotional activities and public disclosure will meetregulatory requirements. Nonetheless, any warning or enforcement actions by theFDA could harm our reputation in the market, result in significant fines orhave other results that would harm our business.

*The continuing efforts of government and third-partypayers to contain or reduce the costs of healthcare may adversely affect ourrevenues.*

Sales of our products depend in part upon theavailability of reimbursement from third-party payers, such as healthadministration authorities like Medicare/Medicaid, managed care providers andprivate health insurers. Third-party payers are increasingly challengingthe price and examining the cost effectiveness of medical products andservices, which may effectively limit physicians’ ability to select productsand procedures.

In addition, significantuncertainty exists as to the reimbursement status of newly approved healthcareproducts. For example, currently Medicare does not reimburse self-administeredproducts, which could cover some of our product candidates. Adequate third-partyreimbursement may not be available to enable us to maintain price levelssufficient to realize an appropriate return on our investment in a particularproduct. In addition, we believe government agencies will continue to proposeand pass legislation designed to reduce the cost of healthcare, which couldfurther limit reimbursement for pharmaceuticals, and we anticipate that therewill continue to be proposals in the United States to implement governmentcontrol over the pricing or profitability of prescription pharmaceuticals, asis currently the case in many foreign markets. If our current and proposedproducts are not considered cost-effective, reimbursement to the consumer maynot be available or be sufficient to allow us to sell products on a competitivebasis. The failure of the government and third-party payers to provideadequate coverage and reimbursement rates 

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for ourproduct candidates could adversely affect the market acceptance of ourproducts, our competitive position and our financial performance.

*If we are unable tocomply with environmental laws and regulations, our business may be harmed.*

We are subject to federal, state and local laws andregulations governing the use, manufacture, storage, handling and disposal ofhazardous materials and waste products. We currently maintain a supply ofbiohazardous materials at our facilities. We believe our safety procedures forthese materials comply with all applicable environmental laws and regulations,and we carry insurance coverage we believe is adequate for the size of ourbusiness. However, we cannot entirely eliminate the risk of accidentalcontamination or injury from these materials. If an accident or environmentaldischarge occurs, we could be held liable for any resulting damages, whichcould exceed our insurance coverage and financial resources.

We currently outsourcecertain of our research and development programs involving the controlled useof biohazardous materials. We believe our collaborators have in place safetyprocedures for these materials that comply with governmental standards.Nevertheless, if an accident does occur, our research and product developmentwill be negatively affected.

***Additional Risks Associated with Our Business***

*If the third-party manufacturers upon whom werely fail to produce our products in the volumes that we require on a timelybasis, or fail to comply with stringent regulations applicable topharmaceutical drug manufacturers, we may face delays in the delivery of, or beunable to meet demand for, our products.*

Because we have nomanufacturing facilities, we rely on third parties for manufacturing activitiesrelated to all of our products. As we develop new products and increase salesof our existing products, we must establish and maintain relationships withmanufacturers to produce and package sufficient supplies of our finishedpharmaceutical products, including Nipent. Reliance on third partymanufacturing presents the following risks:

·       delaysin scale-up to quantities needed for multiple clinical trials, or failure to(a) manufacture such quantities to our specifications or (b) deliversuch quantities on the dates we require, which could cause delay or suspensionof clinical trials, regulatory submissions and commercialization of ourproducts;

·       inabilityto fulfill our commercial needs if market demand for our products increasessuddenly, which would require us to seek new manufacturing arrangements and mayresult in substantial delays in meeting market demand;

·       potentialrelinquishment or sharing of intellectual property rights to any improvementsin the manufacturing processes or new manufacturing processes for our products;and

·       unannouncedongoing inspections by the FDA and corresponding state agencies for compliancewith GMPs, regulations and foreign standards, and failure to comply with any ofthese regulations and standards may subject us to, among other things, productseizures, recalls, fines, injunctions, suspensions or revocations of marketinglicenses, operating restrictions and criminal prosecution.

Any of these factors could delay clinical trials orcommercialization of our product candidates under development, interfere withcurrent sales and entail higher costs. For example, a failed production batchof Nipent in the second quarter of 2003 affected our ability to supply Nipent andadversely affected our sales.

Currently we store themajority of the unpurified, bulk form of Nipent at the manufacturer’s location.Improper storage, fire, natural disaster, theft or other conditions at thislocation may lead to the loss or destruction of the bulk concentrate. Even ifthe manufacturer’s and our insurance coverage is adequate, 

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suchevent would inevitably cause delays in distribution and sales of our productsand harm our operating results.

*Our business may beharmed if the manufacture of our products is interrupted or discontinued.*

We may be unable tomaintain our relationships with our third-party manufacturers. If we needto replace or seek new manufacturing arrangements, we may have difficultylocating and entering into arrangements with qualified contract manufacturerson acceptable terms, if at all. We are aware of only a limited number ofcompanies on a worldwide basis who operate manufacturing facilities in whichour products can be manufactured to our specifications and in compliance withGMPs. It could take several months, or significantly longer, for a new contractmanufacturing facility to obtain FDA approval and to develop substantiallyequivalent processes for the production of our products. We may not be able tocontract with any of these companies on acceptable terms, if at all. Forexample, the company that had been purifying Nipent filed for reorganizationunder Chapter 11 and ceased operations in late 2004. We are in the process ofcontracting with another manufacturer for the purification of Nipent. If thenew manufacturer is not qualified by the FDA or if the new manufacturer shouldgo out of business, we may not have adequate inventory levels to sustain ourbusiness while we identify and contract with another manufacturer for thepurification of Nipent.

*If our supplierscannot provide the components we require, our product sales and revenue couldbe harmed.*

We rely on third-party suppliers to provide uswith numerous components used in our products under development, includingOrathecin and Dacogen. Relying on third-party suppliers makes usvulnerable to component failures and interruptions in supply, either of whichcould impair our ability to conduct clinical trials or to ship our products toour customers on a timely basis. Using third-party suppliers makes itdifficult and sometimes impossible for us to maintain quality control, manageinventory and production schedules and control production costs. Vendor leadtimes to supply us with ordered components vary significantly and can exceedsix months or more. Both now and as we expand our need for manufacturingcapacity, we cannot be sure that our suppliers will furnish us with requiredcomponents when we need them. These factors could make it difficult for us toeffectively and efficiently manufacture our products, and could adverselyimpact our clinical trials, product development and sales of our products.

Some suppliers are our only source for a particularcomponent, which makes us vulnerable to cost increases and supply interruptions.We generally rely on one manufacturer for each product. We rely on onemanufacturer for Nipent, a sole source supplier for the processing ofpentostatin, which is used in the manufacturing of Nipent, and a sole sourcesupplier for the ingredient used in the purification of pentostatin. We alsorely on sole source suppliers for mitomycin products and Surface Safe.

Vendors may decide tolimit or eliminate sales of certain products to the medical industry due toproduct liability or other concerns. For example, one component used in thepurification of pentostatin is no longer commercially available. In the eventone of our sole source suppliers decides not to manufacture the component, goesout of business, or decides to cut off our supply, we may be unable to locatereplacement supply sources, or the sources that we may locate may not provideus with similar reliability or pricing and our business could suffer. If wecannot obtain a necessary component, we may need to find, test and obtain regulatoryapproval for a replacement component, produce the component or redesign therelated product, which would cause significant delay and could increase ourmanufacturing costs. Any of these events could adversely impact our sales andresults of operations.

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*We have limited sales and marketing capabilities andmay not be able to successfully commercialize our products.*

We currently have limited sales and marketingresources. Although we have approximately 37 sales, marketing and sales supportpersonnel focusing on the sale of our products to hospitals and hospital buyinggroups, we must expand our sales and marketing organization to supportcommercialization of our new products. Building up our sales capabilities willrequire significant expenditures. We may not succeed in expanding and enhancingour sales and marketing capabilities or have sufficient resources to do so. Ifwe do develop such capabilities, we will compete with other companies that haveexperienced and well-funded sales and marketing operations. We may not be ableto upgrade our in-house sales expertise which may limit our ability to gainmarket acceptance for our products worldwide and generate revenues. If we failto establish successful sales and marketing capabilities, we will not be able tomarket or sell our products effectively and our business, financial conditionand results of operations will be materially and adversely affected.

We intend to enter intostrategic partnerships for the commercialization of our products outside of theUnited States. However, we may not be able to negotiate acceptable arrangementswith partners, if at all. Moreover, such arrangements may involve sharing ofprofits from sales, requirements to relinquish certain of our rights to ourproducts or marketing territories and impositions of other limitations on ouroperations.

*If we are not able to maintain and successfullyestablish new collaborative and licensing arrangements with third parties, ourproduct development and business will be harmed.*

Our business model is based on establishingcollaborative relationships with other parties both to license compounds uponwhich our products and technologies are based and to manufacture our productsor our collaborators’ products. It is critical that we gain access to compoundsand technologies to license for further development. For example, we licensedthe exclusive worldwide royalty-bearing rights to Orathecin from TheStehlin Foundation for Research. Due to the expense of the drug approvalprocess we must have relationships with established pharmaceutical companies tooffset some of our development costs in exchange for a combination ofdevelopment, marketing and distribution rights.

From time to timewe enter into discussions with various companies regarding the establishment ofnew collaborations. If we are not successful in establishing new partners forour product candidates, we may not be able to pursue further development ofsuch product candidates and/or may have to reduce or cease our currentdevelopment programs, which would materially harm our business. Even if we aresuccessful in establishing new collaborations, they are subject to numerousrisks and uncertainties including:

·       ourability to negotiate acceptable collaborative arrangements;

·       thecollaboration making us less attractive to potential acquirers;

·       freedomof our collaborative partners to pursue alternative technologies either ontheir own or with others, including our competitors, for the diseases targetedby our programs and products;

·       thepotential failure of our partners to fulfill their contractual obligations ortheir decision to terminate our relationships, in which event we may berequired to seek other partners, or expend substantial resources to pursuethese activities independently; and

·       ourability to manage, interact and coordinate our timelines and objectives withour collaborative partners may not be successful.

In addition, ourcollaborators may undergo business combinations, which could have the effect ofmaking a collaboration with us less attractive to them for a number of reasons.For example, if an existing 

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collaboratorpurchases a company that is one of our competitors, that company may be lesswilling to continue its collaboration with us. A company that has a strategy ofpurchasing companies with attractive technologies might have less incentive toenter into a collaboration agreement with us. Moreover, disputes may arise withrespect to the ownership of rights to any technology or products developed withany current or future collaborator. Lengthy negotiations with potentialcollaborators or disagreements between us and our collaborators may lead todelays in or termination of the research, development or commercialization ofproduct candidates or result in time consuming and expensive litigation orarbitration.

*Our collaborative relationships with third partiescould cause us to expend significant funds on development costs with noassurance of financial return.*

From time to time we enter into collaborativerelationships with third parties to co-develop and market products. Forexample, we entered into an agreement with Peregrine Pharmaceuticals inFebruary 2001, pursuant to which we licensed a drug-targeting technologyknown as Vascular Targeting Agent, which is a proprietary platform designed tospecifically target a tumor’s blood supply and subsequently destroy the tumorwith various attached therapeutic agents. The licensed technology isspecifically related to VEGF. Under the agreement, we made an up-front equityinvestment in Peregrine of $600,000 and will be obligated to make subsequentmilestone payments that could ultimately total $8.25 million. In addition,we will pay royalties to Peregrine based on the net revenues of any drugs wecommercialize using the VEGF technology.

These relationshipsrequire substantial financial commitments from us, and at the same time theproduct developments are subject to the same regulatory requirements, risks anduncertainties associated with the development of our other product candidates.The compounds that are the subject of these collaborative agreements may proveto be ineffective, may fail to receive regulatory approvals, may beunprotectable by patents or other intellectual property rights, or may not beotherwise commercially viable. If these collaborative relationships are notsuccessful, our product developments will be adversely affected, and ourinvestments and efforts devoted to the product developments will be wasted.

*Our ability to protect our intellectual propertyrights will be critically important to the success of our business, and we maynot be able to protect these rights in the United States or abroad.*

The success of our operations depends in part on ourability to obtain patents, protect trade secrets, operate without infringingthe proprietary rights of others and enforce our proprietary rights againstaccused infringers.

We actively pursue a policy of seeking patentprotection when applicable for our proprietary products and technologies,whether they are developed in-house or acquired from third parties. Weattempt to protect our intellectual property position by filing United Statesand foreign patent applications related to our proprietary technology,inventions and improvements that are important to the development of ourbusiness. To date, we have acquired licenses to or assignments of over 40 U.S.patents covering various aspects of our proprietary drugs and technologies,including 37 patents for various aspects of Orathecin and related products,five patents under our Nipent product portfolio, although none covers the useof Nipent for the treatment of patients with hairy cell leukemia, six patentsfor our paclitaxel related products, one patent for Dacogen used in combinationwith an anti-neoplastic agent for the treatment of cancer, and twopatents for our Surface Safe product. These issued United States patents willbegin to expire in October 2012. We have been granted patents and have receivedpatent licenses relating to our proprietary formulation technology, non-oncologyand Partaject technologies, among which at least five patents are issued orlicensed to us. In addition, we are prosecuting a number of patent applicationsfor drug candidates that we are not actively developing at this time.

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We also have patents, licenses to patents and pendingpatent applications in Europe, Australia, Japan, Canada, Mexico and NewZealand, among other countries. In addition, we have patent applicationspending in China, Hungary and Israel. Limitations on patent protection, and thedifferences in what constitutes patentable subject matter, may limit theprotection we have on patents issued or licensed to us in these countries. Inaddition, laws of foreign countries may not protect our intellectual propertyto the same extent as would laws in the United States. To minimize our costsand expenses and to maintain effective protection, we focus our patent andlicensing activities within the European Union, Canada and Japan. Indetermining whether or not to seek patent protection or to license any patentin a foreign country, we weigh the relevant costs and benefits, and consider,among other things, the market potential and profitability, the scope of patentprotection afforded by the law of the jurisdiction and its enforceability, andthe nature of terms with any potential licensees. Failure to obtain adequatepatent protection for our proprietary drugs and technology would impair ourability to be commercially competitive in these markets.

The pharmaceutical industry is characterized by alarge number of patent filings involving complex legal and factual questions,and therefore we cannot predict with certainty whether our patents will beenforced effectively. Competitors may have filed applications for, or beenissued patents on, products or processes that compete with or are similar toours. We may not be aware of all of the patents potentially adverse to ourinterests which may have been issued to others. In addition, third parties maychallenge, invalidate or circumvent any of our patents. Thus, any patents thatwe own or license from third parties may not provide adequate protectionagainst competitors, if at all. Our pending patent applications and those wemay file in the future, or those we may license from third parties, may notresult in patents being issued with adequate claim scope, if at all.

In addition to pursuing patent protection inappropriate instances, we also rely on trade secret protection or regulatorymarketing exclusivity for unpatented proprietary technology. However, tradesecrets are difficult to protect. Our trade secrets or those of ourcollaborators may become known or may be independently discovered by others.

In the pharmaceutical industry there has been, and webelieve that there will continue to be, significant litigation regarding patentand other intellectual property rights. Claims may be brought against us in thefuture based on patents held by others. These persons could bring legal actionsagainst us claiming damages and seeking to enjoin clinical testing,manufacturing and marketing of the affected product. If we become involved inlitigation, it could consume a substantial portion of our resources, regardlessof the outcome of the litigation. If a lawsuit against us is successful, inaddition to any potential liability for damages, we could be required to obtaina license to continue to manufacture or market the affected product. We cannotassure you that we would prevail in a lawsuit filed against us or that we couldobtain any licenses required under any patents on acceptable terms, if at all.

Our proprietary productsare dependent upon compliance with numerous licenses and agreements. Theselicenses and agreements require us to make royalty and other payments,reasonably exploit the underlying technology of the applicable patents, andcomply with regulatory filings. If we fail to comply with these licenses andagreements, we could lose the underlying rights to one or more of thesepotential products, which would adversely affect our product development andharm our business.

*If we fail tocompete effectively against other pharmaceutical companies, our business willsuffer.*

The pharmaceutical industry in general and theoncology sector in particular is highly competitive and subject to significantand rapid technological change. Our competitors and probable competitorsinclude companies such as Aventis SG, Berlex Laboratories, Bristol-MyersSquibb Company, Eli Lilly & Co., GlaxoSmithKline, Novartis AG, Pfizer,Pharmion Corp. and others.

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Many of our competitors and research institutions areaddressing the same diseases and disease indications and working on products totreat such diseases as we are, and have substantially greater financial,research and development, manufacturing and marketing experience and resourcesthan we do. Some of our competitors have received regulatory approval of, orare developing or testing product candidates that compete directly with, ourproduct candidates. For example, while we received orphan drug status forOrathecin and there is currently no competitor in the oral delivery market forthe treatment of pancreatic cancer, there are approved drugs for the treatmentof pancreatic cancer, including gemcitabine by Eli Lilly. In addition, BerlexLaboratories’ fludarabine competes with Nipent in the leukemia market, andDacogen faces potential competition from Pharmion’s Vidaza, which was approvedby the FDA in the first half of 2004.

Many of these competitors have significantly greaterexperience than we do in developing products, undertaking pre-clinical testingand clinical trials, obtaining FDA and other regulatory approvals, andmanufacturing and marketing products. Accordingly, our competitors may succeedin obtaining patent protection, receiving FDA approval or commercializingproducts before we do. If we commence sales of our product candidates, we willbe competing against companies with greater marketing expertise andmanufacturing capabilities, areas in which we have limited or no experience.

We also face intense competition from other companiesfor collaborative relationships, for establishing relationships with academicand research institutions, and for licenses to proprietary technology.

Our competitive positionsin our generic drugs are uncertain and subject to risks. The market for genericdrugs, including the pricing for generic drugs, is extremely competitive. As aresult, unless our generic drugs are the first or among the initial few tolaunch, there is a high risk that our products would not gain meaningful marketshare, or we would not be able to maintain our price and continue the productline. Moreover, marketing of generic drugs is also subject to regulatoryapproval, and if we were not able to obtain such approval before ourcompetitors, we would lose our competitive advantage. Failure to maintain ourcompetitive position could have a material adverse effect on our business andresults of operations.

*The pharmaceutical industry in general and theoncology sector in particular is subject to significant and rapid technologicalchange. Developments by competitors may render our product candidates ortechnologies obsolete or non-competitive.*

Our competitors may succeed in developing technologiesor products that are more effective than ours. Additionally, our products thatare under patent protection face intense competition from competitors’proprietary products. This competition may increase as new products enter themarket.

A number of ourcompetitors have substantially more capital, research and development, regulatory,manufacturing, marketing, human and other resources and experience than wehave. As a result, our competitors may:

·       developproducts that are more effective or less costly than any of our current orfuture products or that render our products obsolete;

·       produceand market their products more successfully than we do;

·       establishsuperior proprietary positions; or

·       obtainFDA approval for labeling claims that are more favorable than those for ourproducts.

We will also faceincreasing competition from lower-cost generic products after patents on ourproprietary products expire. Loss of patent protection typically leads to arapid decline in sales for that product and could affect our future results. Asnew products enter the market, our products may become 

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obsoleteor our competitors’ products may be more effective or more effectively marketedand sold than our products. Technological advances, competitive forces and lossof intellectual property protection rights for our products may render our productsobsolete.

*We are developing products based upon compounds thatmay be covered by patents held by third parties that are expected to expire oralready expired. These compounds may also be the subject of method,formulation, and manufacturing process patents held by third parties. If thesepatents do not expire as anticipated or are expanded in scope, we will not beable to develop our products as planned.*

We developed, or are in the process of developing, andare planning to market several generic and proprietary formulation productsbased on existing compounds. Specifically, with respect to our genericproducts, we received approval of ANDA’s for our generic mitomycin for solidtumors for our generic paclitaxel.

Our proprietary formulation technology is a platformtechnology that employs the use of an inert chemical excipient, cyclodextrin,combined with a drug. Most anti-cancer drugs are cytotoxic, and most mustbe administered intravenously. If a vein is missed on injection, the drug canleak to surrounding tissue, causing ulceration that sometimes requires plasticsurgery to correct. Our proprietary formulation technology is designed to “shield”the drug from the injection site, thus providing the patient protection fromtissue ulceration. This technology may increase the relative solubility ofhard-to-dissolve anti-cancer drugs, hence increasing its stability orshelf life. However, each of these benefits must be supported by appropriatedata and approved by the FDA before we can make any claim in this regard. Ourfirst product utilizing our proprietary formulation technology, a formulationof generic mitomycin, was approved by the FDA in November 2002 asMitozytrex (mitomycin for injection) for use in the therapy of disseminatedadenocarcinoma of the stomach or pancreas in proven combinations with otherapproved chemotherapeutic agents and as palliative treatment when othermodalities have failed. We cannot promote Mitozytrex as providing any injectionsite ulceration protection, nor can we promote any increased stability,solubility or shelf life extension, as compared to generic mitomycin. We wouldbe required to develop and submit additional data to the FDA and receive FDAapproval before we could make these claims.

Through June 30, 2005, we have spent approximately$6.4 million on developing and marketing our generic and proprietaryformulation products. We have completed our pre-commercial investment indeveloping Mitozytrex, and as of now we have not committed to an internalbudget for additional proprietary formulation development programs. Inaddition, we have no further generic drug development commitments, as we arefocusing on developing our proprietary drug candidates.

We do not hold anyintellectual property rights as to the underlying compounds on which ourgeneric or proprietary formulation products are based. We may in the futureevaluate the generic drug market and develop additional generic or proprietaryproducts based on these compounds, which may also be the subject of method,formulation and manufacturing process patents held by third parties. Ourdevelopment of generic or proprietary products may also take place prior to,but in anticipation of, the expected expiration of existing patent protectionfor drugs developed by third parties. However, if existing patent protection onsuch products is otherwise maintained, extended or expanded, it is unlikelythat we will be able to market our own generic or proprietary formulationproducts without obtaining a license from the patent owner, which may not beavailable on commercially acceptable terms, if at all.

*We may be subjectto product liability lawsuits and our insurance may be inadequate to coverdamages.*

Clinical trials andcommercial use of our current and potential products may expose us to liabilityclaims from the use or sale of these products. Consumers, healthcare providers,pharmaceutical companies and others selling such products might make claims ofthis kind. We may experience financial losses in the 

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futuredue to product liability claims. We have obtained limited product liabilityinsurance coverage for our products and clinical trials, under which thecoverage limits are $10.0 million per occurrence and $10.0 million inthe aggregate. We do not know whether this coverage will be adequate to protectus in the event of a claim. We may not be able to obtain or maintain insurancecoverage in the future at a reasonable cost or in sufficient amounts to protectus against losses. If third parties bring a successful product liability claimor series of claims against us for uninsured liabilities or in excess ofinsured liabilities, we may not have sufficient financial resources to completedevelopment or commercialization of any of our product candidates and ourbusiness and results of operations will be adversely affected.

*If we are unable to attract and retain additional,highly skilled personnel required for the expansion of our activities, ourbusiness will suffer.*

Further, our success isdependent on key personnel, including members of our senior management andscientific staff. If any of our executive officers decides to leave and wecannot locate a qualified replacement in time to allow a smooth transition, ourbusiness operation may be adversely affected. To successfully expand ouroperations, we will need to attract and retain additional highly skilledindividuals, particularly in the areas of sales, marketing, clinicaladministration, manufacturing and finance. We compete with other companies forthe services of existing and potential employees, however to the extent theseemployees favor larger, more established employers, we may be at adisadvantage.

*Earthquake or other natural or man-made disasters andbusiness interruptions could adversely affect our business.*

Our operations arevulnerable to interruption by fire, power loss, floods, telecommunicationsfailure and other events beyond our control. In addition, our operations aresusceptible to disruption as a result of natural disasters such as earthquakes.So far we have never experienced any significant disruption of our operationsas a result of earthquakes or other natural disasters. Although we have acontingency recovery plan, any significant business interruption could causedelays in our drug development and sales and harm our business.

*Provisions in our certificate of incorporation, bylawsand applicable Delaware law may prevent or discourage third parties orstockholders from attempting to replace our management.*

Anti-takeoverprovisions of our certificate of incorporation and bylaws make it moredifficult for a third party to acquire us, even if doing so would be beneficialto our stockholders. These provisions include:

·       authorizationof the issuance of up to 2,000,000 shares of our preferred stock;

·       eliminationof cumulative voting; and

·       eliminationof stockholder action by written consent.

Our bylaws establish procedures, including noticeprocedures, with regard to the nomination, other than by or at the direction ofour board of directors, of candidates for election as directors or forstockholder proposals to be submitted at stockholder meetings.

We are also subject to Section 203 of theDelaware General Corporation Law, an anti-takeover provision. In general,Section 203 of the Delaware General Corporation Law prevents a stockholderowning 15 percent or more of a corporation’s outstanding voting stock fromengaging in business combinations with a Delaware corporation for three yearsfollowing the date the stockholder acquired 15 percent or more of acorporation’s outstanding voting stock. This restriction is subject toexceptions, including the approval of the board of directors and of the holdersof at least two-thirds of the outstanding shares of voting stock not owned bythe interested stockholder.

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We believe that thebenefits of increased protection of our potential ability to negotiate with theproponents of unfriendly or unsolicited proposals to acquire or restructure usoutweigh the disadvantages of discouraging those proposals because, among otherthings, negotiation of those proposals could result in an improvement of theirterms. Nevertheless, these provisions are expected to discourage differenttypes of coercive takeover practices and inadequate takeover bids and toencourage persons seeking to acquire control of our company to first negotiatewith us, and may have the effect of preventing or discouraging third parties orstockholders from attempting to replace our management.

**Item 3.**                        Quantitativeand Qualitative Disclosures About Market Risk

Due to the short-term nature of our interestbearing assets, which consist primarily of certificates of deposit, U.S.corporate obligations, and U.S. government obligations, we believe that ourexposure to interest rate market risk would not significantly affect our operations.

Our investment policy is tomanage our marketable securities portfolio to preserve principal and liquiditywhile maximizing the return on the investment portfolio. Our marketablesecurities portfolio is primarily invested in corporate debt securities with anaverage maturity of under one year and a minimum investment grade rating of Aor A-1 or better to minimize credit risk. Although changes in interest ratesmay affect the fair value of the marketable securities portfolio and causeunrealized gains or losses, such gains or losses would not be realized unlessthe investments were to be sold prior to maturity.

As part of our June 2003 convertible debt transaction,we issued to the note holders warrants to purchase 2,634,211 shares of commonstock of AVI at $5.00 per share. These warrants are considered a derivative andwere valued on the balance sheet at $10.1 million using the Black-Scholesmethod on June 24, 2003. On June 30, 2005, the value of the derivative haddeclined to $1.1 million. As the fair valueof the common stock of AVI has fluctuated significantly in the past two years,the valuation of the derivative may have a significant impact on our results ofoperations.

Weoperate primarily in the United States and all product sales are denominated inU.S. dollars. Accordingly, we do not have any exposure to foreign currency ratefluctuations.

**Item 4.**                        ControlsAnd Procedures

(a)           Evaluationof disclosure controls and procedures.

Our management evaluated, with the participation of our chief executiveofficer and our chief financial officer, the effectiveness of our disclosurecontrols and procedures as of the end of the period covered by this quarterlyreport on Form 10-Q. Based on this evaluation, our chief executive officer andour chief financial officer have concluded that our disclosure controls andprocedures are effective to ensure that information we are required to disclosein reports that we file or submit under the Securities Exchange Act of 1934 isrecorded, processed, summarized and reported within the time periods specifiedin Securities and Exchange Commission rules and forms.

(b)          Changesin internal control over financial reporting.

There was no change in ourinternal control over financial reporting that occurred during the period coveredby this Quarterly Report on Form 10-Q that has materially affected, or isreasonably likely to materially affect, our internal control over financialreporting.

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**SUPERGEN,INC.PART II—OTHER INFORMATION**

**Item 4.**                        Submissionof Matters to a Vote of Security Holders

The Company’sAnnual Meeting of Stockholders was held on May 12, 2005. The results ofthe voting were as follows:

Proposal1:   Election of the Board of Directors of the Company.
| ** **            | ** ** | ** ** | ** ** | **Votes**          | ** ** |
|-----------------------|------------|------------|------------|--------------------|------------|
| **Nominee**           | ** ** | ** ** | ** ** | **Votes For** | ** ** | **Withheld** | ** ** |
| James S.J. Manuso     |       | 42,912,412 |       | 3,485,453          |       |
| Charles J.  Casamento |       | 43,416,773 |       | 2,981,092          |       |
| Thomas V. Girardi     |       | 39,539,133 |       | 6,858,732          |       |
| Allan R. Goldberg     |       | 43,407,641 |       | 2,990,224          |       |
| Walter J. Lack        |       | 43,041,892 |       | 3,355,973          |       |
| Michael D. Young      |       | 43,428,183 |       | 2,969,682          |       |
|                       |            |            |            |                    |            |  |  |

 

Proposal 2:   Ratification of Ernst &Young LLP as independent auditors for the year ending December 31, 2005:
| Votes For:        |   | 45,094,265 |   |
|-------------------|--------|------------|--------|
| Votes Against:    |   | 1,195,043  |   |
| Votes Abstaining: |   | 108,557    |   |
| Broker Non-Votes: |   | —     |   |

 

Proposal3:   Approval of amendments to the Company’s 2003 Stock Plan, including anincrease in the number of shares of common stock authorized for issuance by2,000,000 shares for a total of 5,500,000 shares reserved under the Plan:
| Votes For:        |   | 14,523,692 |   |
|-------------------|--------|------------|--------|
| Votes Against:    |   | 5,510,051  |   |
| Votes Abstaining: |   | 272,311    |   |
| Broker Non-Votes: |   | 26,091,811 |   |

 

**Item 6.**                        Exhibits
|      | **Exhibit No.** | ** **                                                                                                                                                                                  | ** ** | **Description of Document** |
|------|-----------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|
| 31.1 |            | Certification of Chief  Executive Officer under Section 302(a) of the Sarbanes-Oxley Act of  2002                                                                                 |
| 31.2 |            | Certification of Chief  Financial Officer under Section 302(a) of the Sarbanes-Oxley Act of  2002                                                                                 |
| 32.1 |            | Certifications of Chief  Executive Officer and Chief Financial Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley  Act Of 2002 |

y

 

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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.
|          |                | SUPERGEN, INC. |
|----------|---------------------|---------------------|
| Date:    | August 9, 2005 |                | By: |   | /s/ JAMES S.J. MANUSO |
|     |                |                |   | James S.J. Manuso, Ph.D. |
| * * |                |                |   | *President and Chief Executive Officer (Principal  Executive Officer)* |
|     |                | By:                 |   | /s/ MICHAEL MOLKENTIN |
|     |                |                |   | Michael Molkentin |
| * * |                |                |   | *Chief Financial Officer* |
| * * |                |                |   | *(Principal Financial and Accounting Officer)* |
|          |                     |                     |  |  |  |

 

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