**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 September 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                             |   | (IRS Employer           |
| of incorporation  or organization)                        |   | 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)

**Not applicable**

(Former name, formeraddress and former fiscal year, if changed since last report)

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Indicate by check markwhether the 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   Noo

Indicate by checkmarkwhether Registrant is an accelerated filer (as defined in Rule 12B-2of the Act). Yes x   Noo

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).Yes o   Nox

Thenumber of shares of the registrant’s Common Stock, $.001 par value, outstandingas of November 3, 2005 was 51,581,856.

 

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**TABLE OF CONTENTS**

|                  | ** ** | ** **                                                                                                                    | ** ** | **Page No.** |
|------------------|------------|-------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|
| **PART I**  | ** ** | **FINANCIAL INFORMATION**                                                                                                     | ** ** |              | ** ** |
| ** **       | ** ** | Item 1—Financial Statements (Unaudited)                                                                                  | ** ** |              | ** ** |
|             |       | Condensed Consolidated  Balance Sheets as of September 30, 2005 and December 31, 2004                               |       | 3                 |   |
|             |       | Condensed Consolidated  Statements of Operations for the three and nine month periods ended  September 30, 2005 and 2004 |       | 4                 |   |
|             |       | Condensed  Consolidated Statements of Cash Flows for the nine month periods ended  September 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 6—Exhibits                                                                                                          |       | 39                |   |
| **SIGNATURES**   |       | 40                                                                                                                            |       |

 

2

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**SUPERGEN, INC.CONDENSED CONSOLIDATED BALANCE SHEETS(In thousands, except share and per share amounts)**

| ** **                                                                                                                                                                                   | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                   | ** ** | **2005**               | ** ** | **2004**              | ** ** |
| ** **                                                                                                                                                                                   | ** ** | **(Unaudited)**        | ** ** | **(Note 1)**     | ** ** |
| **ASSETS**                                                                                                                                                                                   | ** ** |                   | ** ** | ** **            |       |   | ** ** | ** ** |   |
| Current assets:                                                                                                                                                                              |       |                   |       | ** **            |       |   |   | ** ** |   |
| Cash and cash  equivalents                                                                                                                                                                   |       |                   | $          | 48,989                | ** ** |   |   | $ | 38,394 | ** ** |   |
| Marketable securities                                                                                                                                                                        |       |                   | 1,693      | ** **            |       |   | 18,235 | ** ** |   |
| Accounts receivable, net                                                                                                                                                                     |       |                   | 4,290      | ** **            |       |   | 4,926 | ** ** |   |
| Development revenue  receivable from MGI PHARMA, Inc.                                                                                                                                        |       |                   | 346        | ** **            |       |   | 12,809 | ** ** |   |
| Inventories                                                                                                                                                                                  |       |                   | 2,442      | ** **            |       |   | 3,306 | ** ** |   |
| Prepaid expenses and  other current assets                                                                                                                                                   |       |                   | 1,514      | ** **            |       |   | 1,403 | ** ** |   |
| Total current assets                                                                                                                                                                         |       |                   | 59,274     | ** **            |       |   | 79,073 | ** ** |   |
| Marketable securities,  non-current                                                                                                                                                          |       |                   | 157        | ** **            |       |   | 188 | ** ** |   |
| Investment in stock of  related parties                                                                                                                                                      |       |                   | 812        | ** **            |       |   | 798 | ** ** |   |
| Due from related  parties, non-current                                                                                                                                                       |       |                   | 57         | ** **            |       |   | 93 | ** ** |   |
| Property, plant and  equipment, net                                                                                                                                                          |       |                   | 3,106      | ** **            |       |   | 3,635 | ** ** |   |
| Goodwill                                                                                                                                                                                     |       |                   | 731        | ** **            |       |   | 731 | ** ** |   |
| Other intangibles, net                                                                                                                                                                       |       |                   | 387        | ** **            |       |   | 677 | ** ** |   |
| Restricted cash and  investments, non-current                                                                                                                                                |       |                   | 9,649      | ** **            |       |   | 9,432 | ** ** |   |
| Other assets                                                                                                                                                                                 |       |                   | 30         | ** **            |       |   | 30 | ** ** |   |
| Total assets                                                                                                                                                                                 |       |                   | $          | 74,203                | ** ** |   |   | $ | 94,657 | ** ** |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                               | ** ** |                   | ** ** | ** **            |       |   | ** ** | ** ** |   |
| Current liabilities:                                                                                                                                                                         |       |                   |       | ** **            |       |   |   | ** ** |   |
| Accounts payable and  accrued liabilities                                                                                                                                                    |       |                   | $          | 2,103                 | ** ** |   |   | $ | 4,644 | ** ** |   |
| Derivative liability                                                                                                                                                                         |       |                   | 1,185      | ** **            |       |   | 1,607 | ** ** |   |
| Payable to AVI  BioPharma, Inc.                                                                                                                                                         |       |                   | 565        | ** **            |       |   | 565 | ** ** |   |
| Deferred revenue                                                                                                                                                                             |       |                   | 2,476      | ** **            |       |   | 11,572 | ** ** |   |
| Accrued payroll and  employee benefits                                                                                                                                                       |       |                   | 2,442      | ** **            |       |   | 2,129 | ** ** |   |
| Total current  liabilities                                                                                                                                                                   |       |                   | 8,771      | ** **            |       |   | 20,517 | ** ** |   |
| Deferred rent                                                                                                                                                                                |       |                   | 966        | ** **            |       |   | 927 | ** ** |   |
| Total liabilities                                                                                                                                                                            |       |                   | 9,737      | ** **            |       |   | 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; 51,415,233 and 51,127,314 shares issued  and outstanding at September 30, 2005 and December 31, 2004,  respectively |       |                   | 51         | ** **            |       |   | 51 | ** ** |   |
| Additional paid in  capital                                                                                                                                                                  |       |                   | 408,155    | ** **            |       |   | 406,789 | ** ** |   |
| Accumulated other  comprehensive gain (loss)                                                                                                                                                 |       |                   | 657        | ** **            |       |   | (99 | ) |   |
| Accumulated deficit                                                                                                                                                                          |       |                   | (344,397   | )                     |       |   | (333,528 | ) |   |
| Total stockholders’  equity                                                                                                                                                             |       |                   | 64,466     | ** **            |       |   | 73,213 | ** ** |   |
| Total liabilities and stockholders’ equity                                                                                                                                              |       |                   | $          | 74,203                | ** ** |   |   | $ | 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  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                    | ** ** | **2005**                                             | ** ** | **2004**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenues:                                                                                     |       |                                                 |       |                                                |       |   |   |   |   |
| Net product revenue                                                                           |       | $                                                    | 5,457      |                                                | $          | 3,909 |   | $ | 10,096 |   | $ | 7,642 |   |
| Development and license revenue from MGI PHARMA, Inc.                                    |       | 3,168                                                |       | 1,019                                               |       | 10,110 |   | 1,019 |   |
| Distribution agreement and other revenue                                                      |       | —                                               |       | —                                              |       | 757 |   | — |   |
| Total revenues                                                                                |       | 8,625                                                |       | 4,928                                               |       | 20,963 |   | 8,661 |   |
| Costs and  operating expenses:                                                                |       |                                                 |       |                                                |       |   |   |   |   |
| Cost of product revenue                                                                       |       | 736                                                  |       | 1,168                                               |       | 1,736 |   | 2,915 |   |
| Research and development                                                                      |       | 3,571                                                |       | 6,469                                               |       | 11,585 |   | 19,147 |   |
| Selling, general, and administrative                                                          |       | 6,761                                                |       | 7,097                                               |       | 20,159 |   | 20,240 |   |
| Total costs and operating expenses                                                            |       | 11,068                                               |       | 14,734                                              |       | 33,480 |   | 42,302 |   |
| Loss from operations                                                                          |       | (2,443                                               | )          | (9,806                                              | )          | (12,517 | ) | (33,641 | ) |
| Interest income                                                                               |       | 444                                                  |       | 116                                                 |       | 1,227 |   | 318 |   |
| Interest expense                                                                              |       | —                                               |       | (472                                                | )          | — |   | (1,918 | ) |
| Amortization of  deemed discount on convertible debt                                          |       | —                                               |       | (2,879                                              | )          | — |   | (9,778 | ) |
| Other than  temporary decline in value of investments                                         |       | —                                               |       | —                                              |       | — |   | (7,851 | ) |
| Change in  valuation of derivatives                                                           |       | (79                                                  | )          | 685                                                 |       | 421 |   | 467 |   |
| Net loss                                                                                      |       | $                                                    | (2,078     | )                                                   | $          | (12,356 | ) | $ | (10,869 | ) | $ | (52,403 | ) |
| Basic and diluted  net loss per common share                                                  |       | $                                                    | (0.04      | )                                                   | $          | (0.27 | ) | $ | (0.21 | ) | $ | (1.21 | ) |
| Weighted average shares  used in basic and diluted net loss per common share calculation |       | 51,320                                               |       | 45,904                                              |       | 51,215 |   | 43,171 |   |

 

See accompanying notes to condensed consolidated financial statements

4

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**SUPERGEN, INC.CONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS(In thousands)(Unaudited)**

| ** **                                                                            | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                            | ** ** | **2005**                                            | ** ** | **2004** | ** ** |
| Operating activities:                                                                 |       |                                                |       |   |   |
| Net loss                                                                              |       | $                                                   | (10,869    | ) | $ | (52,403 | ) |
| Adjustments to reconcile net loss to net cash used in  operating activities:          |       |                                                |       |   |   |
| Depreciation                                                                          |       | 629                                                 |       | 827 |   |
| Amortization of prepaid  financing costs                                              |       | —                                              |       | 1,441 |   |
| Amortization of  intangible assets                                                    |       | 290                                                 |       | 638 |   |
| Amortization of deemed  discount on convertible debt                                  |       | —                                              |       | 9,778 |   |
| Amortization of deferred  revenue                                                     |       | (7,429                                              | )          | (244 | ) |
| Interest on convertible  debt paid in common stock                                    |       | —                                              |       | 493 |   |
| Change in valuation of  derivatives                                                   |       | (421                                                | )          | (467 | ) |
| 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               |       | 109                                                 |       | 111 |   |
| 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                               |       | 13,099                                              |       | (3,706 | ) |
| Inventories                                                                           |       | 864                                                 |       | (3 | ) |
| Prepaid expenses and  other assets                                                    |       | (111                                                | )          | (429 | ) |
| Due from related parties                                                              |       | 36                                                  |       | 96 |   |
| Restricted cash and  investments                                                      |       | 547                                                 |       | (25 | ) |
| Accounts payable and  other liabilities                                               |       | (2,189                                              | )          | 835 |   |
| Deferred revenue                                                                      |       | (167                                                | )          | 13,138 |   |
| Net cash used in  operating activities                                                |       | (6,844                                              | )          | (20,863 | ) |
| Investing activities:                                                                 |       |                                                |       |   |   |
| Purchases of marketable  securities                                                   |       | (11,585                                             | )          | (23,713 | ) |
| Sales or maturities of  marketable securities                                         |       | 28,136                                              |       | 19,059 |   |
| Purchase of intangible  assets                                                        |       | —                                              |       | (1,000 | ) |
| Release of restricted  cash from collateral account                                   |       | —                                              |       | 10,680 |   |
| Purchases of property  and equipment                                                  |       | (101                                                | )          | (235 | ) |
| Net cash provided by  investing activities                                            |       | 16,450                                              |       | 4,791 |   |
| Financing activities:                                                                 |       |                                                |       |   |   |
| Proceeds from issuance  of common stock, net of issuance costs                        |       | 989                                                 |       | 57,364 |   |
| Net cash provided by  financing activities                                            |       | 989                                                 |       | 57,364 |   |
| Net increase in cash and  cash equivalents                                            |       | 10,595                                              |       | 41,292 |   |
| Cash and cash  equivalents at beginning of period                                     |       | 38,394                                              |       | 5,055 |   |
| Cash and cash  equivalents at end of period                                           |       | $                                                   | 48,989     |   | $ | 46,347 |   |
| Supplemental Disclosure of Non-Cash Financing  Activities:                            |       |                                                |       |   |   |
| Conversion of  convertible notes into common stock                                    |       | $                                                   | —     |   | $ | (21,250 | ) |
| Valuation of warrants issued to placement agent in  connection with license agreement |       | $                                                   | —     |   | $ | 513 |   |

 

See accompanying notes to condensed consolidated financial statements

5

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

**NOTE 1.   BASIS OF 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 andnine month periods ended September 30, 2005 are not necessarily indicativeof results 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-BASED COMPENSATION**

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.”

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**SUPERGEN, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) SEPTEMBER 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 nine month periods ended September 30,2005 and 2004 had we applied the fair value method to account for stock-basedawards to employees (in thousands, except per share amounts):

| ** **                                                                                                                                                                  | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                                                                                  | ** ** | **2005**                                             | ** ** | **2004**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net loss, as  reported                                                                                                                                                      |       | $                                                    | (2,078     | )                                                   | $          | (12,356 | ) | $ | (10,869 | ) | $ | (52,403 | ) |
| Add: Stock-based  employee compensation expense included in the determination of net loss, as  reported                                                                     |       | —                                               |       | —                                              |       | 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 |       | (858                                                 | )          | (1,372                                              | )          | (4,905 | ) | (5,826 | ) |
| Pro forma net  loss                                                                                                                                                         |       | $                                                    | (2,936     | )                                                   | $          | (13,728 | ) | $ | (15,506 | ) | $ | (57,723 | ) |
| Basic and diluted net  loss per common share:                                                                                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| As reported                                                                                                                                                                 |       | $                                                    | (0.04      | )                                                   | $          | (0.27 | ) | $ | (0.21 | ) | $ | (1.21 | ) |
| Pro forma                                                                                                                                                                   |       | $                                                    | (0.06      | )                                                   | $          | (0.30 | ) | $ | (0.30 | ) | $ | (1.34 | ) |

 

**NOTE 3.   CASH, CASH EQUIVALENTS, AND MARKETABLESECURITIES**

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 September 30,2005 (in thousands):

| ** **                       | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** |
|----------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|---------------------|------------|
| U.S. corporate  debt securities  |       |                | $          | 42,541                       |       |                          |       | $                   | —     |   |   |   | $ | (6 | ) |   |   | $ | 42,535 |   |   |
| U.S. government  debt securities |       |                | 1,697      |                         |       |                          | —     |                |       |   | (4 | ) |   |   | 1,693 |   |   |
| Marketable equity  securities    |       |                | 6,577      |                         |       |                          | 677        |                |       |   | (10 | ) |   |   | 7,244 |   |   |
| Total                            |       |                | $          | 50,815                       |       |                          |       | $                   | 677        |   |   |   | $ | (20 | ) |   |   | $ | 51,472 |   |   |

 

7

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

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

The available-for-salesecurities are classified on the balance sheet as of September 30, 2005 asfollows (in thousands):

| ** **                                                  | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** |
|-------------------------------------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|---------------------|------------|
| Amounts included  in cash and cash equivalents              |       |                | $          | 42,541                       |       |                          |       | $                   | —     |   |   |   | $ | (6 | ) |   |   | $ | 42,535 |   |   |
| Marketable  securities, current .                           |       |                | 1,697      |                         |       |                          | —     |                |       |   | (4 | ) |   |   | 1,693 |   |   |
| Amounts included  in investment in stock of related parties |       |                | 120        |                         |       |                          | 12         |                |       |   | — |   |   |   | 132 |   |   |
| Amounts included  in restricted cash and investments        |       |                | 6,322      |                         |       |                          | 633        |                |       |   | — |   |   |   | 6,955 |   |   |
| Marketable  securities, non-current                         |       |                | 135        |                         |       |                          | 32         |                |       |   | (10 | ) |   |   | 157 |   |   |
| Total                                                       |       |                | $          | 50,815                       |       |                          |       | $                   | 677        |   |   |   | $ | (20 | ) |   |   | $ | 51,472 |   |   |

 

Available-for-salesecurities by contractual maturity are shown below (in thousands):

| ** **                             | ** ** | **Fair Value**          | ** ** |
|----------------------------------------|------------|------------------------------|------------|
| ** **                             | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
| Debt securities:                       |       |                         |       |   |   |   |   |   |   |
| Due in one year or less                |       |                         | $          | 44,228 |   |   |   | $ | 51,939 |   |   |
| Due after one year through three years |       |                         | —     |   |   |   | — |   |   |
|                                   |       |                         | 44,228     |   |   |   | 51,939 |   |   |
| Marketable equity  securities          |       |                         | 7,244      |   |   |   | 6,496 |   |   |
| Total                                  |       |                         | $          | 51,472 |   |   |   | $ | 58,435 |   |   |

 

**NOTE 4.   INVENTORIES**

Inventoriesconsist of the following (in thousands):

| ** **        | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------|------------|------------------------------|------------|-----------------------------|------------|
| Raw materials     |       |                         | $          | 80                          |       |   |   | $ | 83 |   |   |
| Work in process . |       |                         | 533        |                        |       |   | 1,040 |   |   |
| Finished goods    |       |                         | 1,829      |                        |       |   | 2,183 |   |   |
|              |       |                         | $          | 2,442                       |       |   |   | $ | 3,306 |   |   |

 

**NOTE 5.   CONVERTIBLE DEBT FINANCING DERIVATIVELIABILITY 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 the issuanceof the June Notes, we issued to the note holders warrants to purchase2,634,211 shares of 

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

**NOTE 5.**   CONVERTIBLE DEBT FINANCING DERIVATIVE LIABILITY ANDCOLLATERAL (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 September 30, 2005 and 2004, we recorded changes inthe value of this derivative of $(79,000) and $685,000, respectively. Duringthe nine months ended September 30, 2005 and 2004, we recorded changes inthe value of this derivative of $421,000 and $4,083,000, respectively. Duringthe nine months ended September 30, 2004, the change in valuation of thisderivative was offset by expense of $3,616,000 related to the change invaluation of another derivative issued in connection with a March 2004private 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 anadditional 50,000 shares of AVI, which are included in the accompanyingbalance sheet in Investment in stock of related parties. We continue to holdall of the pledged and unpledged AVI Shares and reflect temporary changes inthose share values in accumulated other comprehensive gain or loss. During thenine month period ended September 30, 2004, we recorded a write-down of $7,851,000related to an other than temporary decline in the value of our investments inAVI. We had no such write-downs during the three and nine month periods ended September 30,2005.

**NOTE 6.   STOCK PURCHASE AND LICENSE AGREEMENTSWITH MGI PHARMA, INC.**

In August 2004, we entered into three agreementswith MGI PHARMA, Inc., a Minnesota corporation (“MGI”):  (1) a common stock purchase agreement, (2) alicense agreement relating to DacogenTM (decitabine), and (3) an investorrights 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 fairvalue of 4,000,000 shares of our common stock at the time of the transaction,net of related offering costs, to equity, and allocated $12,625,000 to deferredrevenue. The deferred revenue is being amortized to license revenue over 15months, which is the period of time in which our development obligations forDacogen would transfer to MGI. During the three months ended September 30,2005 and 2004, we recorded amortization of deferred revenue of $2,476,000and  $244,000, respectively. During thenine months ended 

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

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

September 20, 2005and 2004, we recorded amortization of deferred revenue of $7,429,000 and$244,000, respectively.

Underthe terms of the license agreement, MGI is obligated to reimburse us forcertain development and allocated overhead costs of Dacogen until we receivemarketing authorization. During the three months ended September 30, 2005and 2004, we recognized $692,000 and $775,000, respectively, of developmentrevenue relating to the reimbursement under this agreement. During the ninemonths ended September 30, 2005 and 2004, we recognized developmentrevenue of $2,681,000 and $775,000, respectively.

**NOTE 7.   ACQUISITION OF NIPENT EUROPEAN MARKETINGRIGHTS**

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 $613,000and $226,000 at September 30, 2005 and 2004, respectively.

**NOTE 8.   TERMINATION OF AGREEMENT WITH ABBOTTLABORATORIES**

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 ninemonths ended September 30, 2005.

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

**NOTE 10.**   COMPREHENSIVE LOSS

For the three months ended September 30, 2005 and2004, total comprehensive losses amounted to $1,202,000 and $13,277,000,respectively. Comprehensive losses consisted primarily of the net losses andchanges in unrealized gains or losses on investments. We recorded an unrealizedgain on investments of $876,000 for the three months ended September 30,2005, and an unrealized loss of $921,000 for the three month period ended September 30,2004.

For the nine months ended September 30,2005 and 2004, total comprehensive losses amounted to $10,113,000 and$53,505,000, respectively. Comprehensive losses consisted primarily of the netlosses and changes in unrealized gains or losses on investments. We recorded anunrealized gain on investments of $756,000 for the nine months ended September 30,2005, and recorded an unrealized loss of $1,102,000 for the nine months ended September 30,2004.

**NOTE 11.   BASIC NET 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 nine months ended September 30, 2005 excludes the impact ofoptions to purchase 6,336,000shares of common stock andwarrants to purchase 7,183,000 shares of common stock at September 30,2005, as such impact would be antidilutive.

The computation of dilutednet loss per share for the three and nine months ended September 30, 2004excludes the impact of options to purchase 6,417,000 shares of common stock,warrants to purchase 7,183,000 shares of common stock, and 786,000 shares ofcommon stock issuable upon conversion of senior convertible notes at September 30,2004, as such impact would be antidilutive.

**NOTE12.   RECENT ACCOUNTING 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 will adoptSFAS 123R on January 1, 2006. Under SFAS 123R, we must determine theappropriate fair value model to be used for valuing share-based payments, theamortization method for compensation cost, and the transition method to be usedat date of adoption. The permitted transition methods include eitherretrospective or prospective adoption. Under 

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

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

the retrospective method,prior periods may be restated either as of the beginning of the year ofadoption or for all periods presented. The prospective method requires thatcompensation expense be recorded for all unvested stock options at thebeginning of the first quarter of adoption of SFAS 123R, while theretrospective methods would record compensation expense for all unvested stockoptions beginning with the first period presented. We are currently evaluatingthe requirements of SFAS 123R and expect that adoption of SFAS 123R will have amaterial impact on our consolidated financial position and results ofoperations. We have not yet determined the method of adopting SFAS 123R, and wehave not determined whether the adoption will result in amounts that aresimilar to the current pro forma disclosures under SFAS 123.

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**Item2.**

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

*You should read the following discussion together withour condensed consolidated financial statements and related notes includedelsewhere in this report. The results discussed below are not necessarilyindicative of the results to be expected in any future periods. Our disclosure and analysis in this section of thereport also contain forward-looking statements. When we use the words “anticipate,”“estimate,” “project,” “intend,” “expect,” “plan,” “believe,” “should,” “likely”and similar expressions, we are making forward-looking statements.Forward-looking statements provide our current expectations or forecastsof future events. In particular, these statements include statements such as:the timing of receiving approval of our filings for Orathecin and Dacogen; ourestimates about becoming profitable; the percentage of royalties we expect toearn on Dacogen sales under our agreement with MGI; our forecasts regarding ourresearch and development expenses; and our statements regarding the sufficiencyof our cash to meet our operating needs. Our actual results could differmaterially from those predicted in the forward-looking statements as aresult of risks and uncertainties including, but not limited to, delays andrisks associated with conducting and managing our clinical trials; developingproducts and obtaining regulatory approval; ability to establish and maintaincollaboration relationships; competition; ability to obtain funding; ability toprotect our intellectual property; our dependence on third party suppliers;risks associated with the hiring and loss of key personnel; adverse changes inthe specific markets for our products; and our ability to launch andcommercialize our products. Certain unknown or immaterial risks anduncertainties can also affect our forward-looking statements.Consequently, no forward-looking statement can be guaranteed and youshould 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 this 10-Qand other reports or documents we file from time to time with the Securitiesand 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 DrugApplication (“NDA”) to the United States Food and Drug Administration (“FDA”)for Orathecin. The filing was accepted by the FDA and indicated a targetPrescription Drug User Fee Act (“PDUFA”) date of November 26, 2004. At therequest of the FDA, we submitted during November 2004 additional clinicaldata from a trial of Orathecin as a first-line treatment for pancreatic canceras well as new analyses of data from the study in 2nd and 3rd line patients. TheFDA classified these data as a Major Amendment, which triggered an extension ofthe review period by 90 days resulting in a revised target PDUFA date of February 26,2005. Based on further discussions with and feedback from both the FDA andconsultants helping us dialog with the FDA, it was determined the currentpackage for Orathecin was not sufficient to gain approval at this time in theUnited States and we announced the withdrawal of the NDA in January 2005. Inthe first quarter of 2005, we received the findings from the FDA and are continuingto review these findings to determine the most appropriate course of action inthe future for Orathecin in the United States.

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During July 2004, wesubmitted a Marketing Authorization Application (“MAA”) seeking approval ofOrathecin in the treatment of pancreatic cancer to the European Agency for theEvaluations of Medicinal Products (“EMEA”). EMEA procedures generally providethat a decision on the Orathecin MAA will usually occur within 12 to 18 monthsof acceptance of submission, which we now estimate could result in a decisionby the EMEA in the fourth quarter of 2005. Our European filing for Orathecinremains on track and is not affected by the withdrawal of the NDA for Orathecinin the United States. There can be no guarantee that the EMEA will approveOrathecin.

*Dacogen.**  *During March 2004, we reported results from ourrandomized Phase III study of Dacogen for injection as a treatment formyelodysplastic syndrome (“MDS”). During September 2004, we executed adefinitive agreement granting MGI PHARMA, Inc. (“MGI”) exclusive worldwiderights to the development, manufacture, commercialization and distribution ofDacogen. Under the terms of the agreement, MGI made a $40.0 million equityinvestment in our Company and will pay us up to $45.0 million in specificregulatory and commercialization milestones. If Dacogen is approved, we couldreceive a royalty on worldwide net sales starting at 20% and escalating to amaximum of 30%. MGI has also committed to fund further development costsassociated with Dacogen at a minimum of $15.0 million over a three-year period.

In October 2004, wesubmitted 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 to 18 months of acceptance of submission, which couldresult in a decision by the EMEA in the fourth quarter of 2005 or early 2006. Thereview process for the MAA for Dacogen continues to be underway in Europe. Followinga meeting with EMEA staff in late October 2005, we and MGI believe thatthe potential outcomes of the MAA review may include a final opinion from theCommittee for Human Medicinal Products (“CHMP”) or the need to submitadditional data to support the application.

In November 2004, wesubmitted an NDA to the FDA for Dacogen. The filing was accepted at the end of2004 by the FDA and indicated a target PDUFA date of September 1, 2005. OnSeptember 1, 2005, we received an Approvable Letter for Dacogen from theFDA, which provides that Dacogen is approvable pending the FDA’s review of arequested analysis of the transfusion requirements of patients enrolled in thecompleted Phase III trial, submission of certain other information, andcompletion of labeling discussions. We have completed the required collectionand analysis of transfusion data in response to the Approvable Letter. Followingdiscussions with the FDA, we and MGI will finalize and submit our response tothe Approvable Letter. We believe this planned submission and response confirmsthe clinical benefit of Dacogen compared to supportive care with regard tooverall response rate, duration of response, and transfusion independence inpatients with MDS. However, there can be no guarantee that the FDA or EMEA willapprove Dacogen.

*Nipent.**  *Nipent is approved by the FDA and EMEA for thetreatment of hairy cell leukemia and is marketed by us in the United States andEurope. Nipent has also shown promise in other diseases and we are conducting aseries of post-marketing Phase IV clinical trials for chronic lymphocyticleukemia (“CLL”), non-Hodgkin’s lymphoma (“NHL”), cutaneous and peripheralT-cell lymphomas, and graft-versus-host disease (“GvHD”).

*Other Products.**  *Our portfolio of other products includes Partaject-deliveredbusulfan and inhaled Orathecin. We also market generic mitomycin and SurfaceSafe. We have also received regulatory approval to market our genericdaunorubicin for a variety of acute leukemias and Mitozytrex (mitomycin forinjection), for use in the therapy of disseminated adenocarcinoma of thestomach or pancreas in proven combinations with other approved chemotherapeuticagents and as palliative treatment when other modalities have failed. Moreover,we hold U.S. sales and marketing rights to the cancer vaccine Avicine. We arecontinually evaluating our product portfolio to determine whether it isappropriate for us to dedicate the resources needed to commercialize theseproducts ourselves or whether we would be better served selling or licensingthe rights to develop these products to third parties. In April 2005, we executed a 

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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 productrevenues have been limited and are derived primarily from sales of Nipent,which we are marketing in the United States and distributing in Europe for thetreatment of hairy cell leukemia. Most of our products are still in thedevelopment stage, and we will require substantial additional investments inresearch and development, clinical trials, and in regulatory, sales andmarketing activities to commercialize current and future product candidates. Conductingclinical trials is a lengthy, time-consuming, and expensive process involvinginherent uncertainties and risks, and our studies may be insufficient todemonstrate safety and efficacy to support FDA approval of any of our productcandidates.

As a result of oursubstantial research and development expenditures and minimal product revenues,we have incurred cumulative losses of $344.4 million through September 30,2005, and have never generated enough funds through our operations to supportour business. We expect to continue to incur operating losses at least through2006.

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.

**CriticalAccounting Policies**

Our management discussionand analysis of our financial condition and results of operations is based uponour consolidated financial statements, which have been prepared in accordancewith accounting principles generally accepted in the United States. Thepreparation of these financial statements requires us to make estimates andjudgments that affect the reported amounts of assets, liabilities, revenues andexpenses, and reported disclosures. On an on-going basis, we evaluate ourestimates, including those related to revenue recognition, intangible assets,valuation of investments and derivative instruments. We base our estimates onhistorical experience and on various other assumptions that we believe arereasonable under the circumstances, the results of which form the basis formaking judgments about the carrying values of assets and liabilities that arenot readily 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,some of our accounting policies are particularly important to the portrayal ofour financial 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.

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Allowances for productreturns and exchanges are based on historical information and known trends fromexternal sources. The costs of product exchanges, which include actual productcosts and related shipping charges, are included in cost of product revenue. Inestimating returns, we analyze historical returns and sales patterns, theremaining shelf life of inventory, and changes in demand. We continually assessour historical experience and adjust our allowances as appropriate. If actualproduct returns and exchanges are greater than our estimates, additionalallowances may be required.

Cash advance paymentsreceived in connection with distribution agreements, license agreements, orresearch grants are generally deferred and recognized ratably over the periodof the respective 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 of Investments in Financial Instruments*

Investments in financialinstruments are carried at fair value with unrealized gains and losses includedin accumulated other comprehensive income or loss in stockholders’ equity. Ourinvestment portfolio includes equity securities that could subject us tomaterial market risk and corporate obligations that subject us to varying levelsof credit risk. If the fair value of a financial instrument has declined belowits carrying value for a period in excess of six consecutive months or if thedecline is due to a significant adverse event, such that the carrying amount ofthese investments may not be fully recoverable, the impairment is considered tobe other than temporary. An other than temporary decline in fair value of afinancial instrument would be subject to a write-down resulting in a chargeagainst earnings. The determination of whether a decline in fair value is otherthan temporary requires significant judgment, and could have a material impacton our 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 equitysecurities without readily determinable fair value are carried at cost. Weperiodically review those carried costs and evaluate whether an impairment hasoccurred. The determination of whether an impairment has occurred requiressignificant judgment, as each investment may have unique market or developmentopportunities.

*Derivative Instruments*

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 September 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 assumptions 

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inputinto 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.

**Results of Operations**

*Three months ended September 30, 2005 compared tothree months ended September 30, 2004:*

| ** **                       | ** ** | **Three months ended  September 30,** | ** ** | **Change**                                               | ** ** |
|----------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------------|------------|
| **Revenues**                     | ** ** | ** **                                           | ** ** | **    2005    ** | ** ** | **    2004    ** | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
| ** **                       | ** ** | **(in thousands)**                              | ** ** |
| Net product  revenue             |       |                                                 | $          | 5,457                                                    |       |   |   | $ | 3,909 |   |   | $ | 1,548 |   |   | 39.6 | % |   |
| Development and license  revenue |       |                                                 | 3,168      |                                                     |       |   | 1,019 |   |   | 2,149 |   |   | 210.9 |   |   |
|                                  |            |                                                      |            |                                                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The increase in net product revenues for the threemonths ended September 30, 2005 was due primarily to higher sales ofNipent, our drug currently approved for the treatment of hairy cell leukemia. Netsales of Nipent were approximately $5.2 million in the three months ended September 30,2005, compared to $3.5 million in the comparable period of 2004. Nipent salesfor the three months ended September 30, 2004 included approximately$498,000 in sales to Europe. We had no European sales for the comparable periodin 2005. 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 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.

Developmentand license revenue relates to our license agreement entered into with MGI in September 2004.For the three months ended September 30, 2005, development and licenserevenue included $2,476,000 related to the amortization of deferred revenue inconnection with the upfront payment received from MGI, and $692,000 related toreimbursement of Dacogen development and allocated overhead costs. For thethree months ended September 30, 2004, we recorded $244,000 related to theamortization of deferred revenue and $775,000 related to the reimbursement ofDacogen development costs.

| ** **                                      | ** ** | **Three months ended  September 30,** | ** ** | **Change**                                               | ** ** |
|-------------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------------|------------|
| **Costs and operating expenses** | ** ** | ** **                                           | ** ** | **    2005    ** | ** ** | **    2004    ** | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
| ** **                                      | ** ** | **(in thousands)**                              | ** ** |
| Cost of product  revenue                        |       |                                                 | $          | 736                                                      |       |   |   | $ | 1,168 |   |   | $ | (432 | ) |   | (37.0 | )% |   |
| Research and  development                       |       |                                                 | 3,571      |                                                     |       |   | 6,469 |   |   | (2,898 | ) |   | (44.8 | ) |   |
| Selling, general and  administrative            |       |                                                 | 6,761      |                                                     |       |   | 7,097 |   |   | (336 | ) |   | (4.7 | ) |   |
|                                                 |            |                                                      |            |                                                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Cost of product revenue as a percentage of net productrevenue was 13% in the three months ended September 30, 2005 compared to30% in the same period in 2004. The decrease for the three months ended September 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 European Nipent sales, and lower distribution costs for Nipentsince we terminated our Nipent distribution agreement with Abbott in the firstquarter of 2005. Current margins may not be indicative of future margins due topossible variations in product mix, average selling prices, and manufacturingcosts.

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 September 30, 2005 relates primarily to reduced expenditures formarketing programs, legal fees, and investor relations activities, offset byincreased costs related to our Nipent commercialization scale-up efforts in ourEuropean operations.

| ** **                                           | ** ** | **Three months ended  September 30,** | ** ** | **Change**                       | ** ** |
|------------------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------|------------|
| **Other income (expense)**                 | ** ** | ** **                                           | ** ** | **  2005  ** | ** ** | **2004** | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
| ** **                                           | ** ** | **(in thousands)**                              | ** ** |
| Interest income                                      |       |                                                 | $          | 444                              |       |   | $ | 116 |   | $ | 328 |   | 282.8 | % |
| Interest expense                                     |       |                                                 | —     |                             |       | (472 | ) | (472 | ) | (100.0 | ) |
| Amortization of  deemed discount on convertible debt |       |                                                 | —     |                             |       | (2,879 | ) | (2,879 | ) | (100.0 | ) |
| Change in valuation of  derivative                   |       |                                                 | (79        | )                                |       | 685 |   | (764 | ) | (111.5 | ) |
|                                                      |            |                                                      |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |

 

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 September 30, 2005, compared tothe same period in 2004.

Interest expense in the three months ended September 30,2004 consisted of amortization of prepaid financing costs of $370,000 andinterest of $102,000, 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 September 30, 2004 related tothe convertible notes issued in 2003. These notes were fully paid at December 31,2004.

Changein valuation of derivative relates to a derivative instrument connected withour June 2003 convertible debt transaction. As part of the June 2003convertible debt transaction, we issued the note holders warrants to purchase2,634,211 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 three months ended September 30, 2005, the valueof this derivative liability had increased by $79,000. During the three monthsended September 30, 2004, this derivative liability had declined by$685,000.

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*Nine months ended September 30, 2005 compared tonine months ended September 30, 2004:*

| ** **                               | ** ** | **Nine months ended  September 30,** | ** ** | **Change** | ** ** |
|------------------------------------------|------------|-----------------------------------------------------|------------|------------|------------|
| **Revenues**                             | ** ** | ** **                                          | ** ** | **2005**   | ** ** | **2004** | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
| ** **                               | ** ** | **(in thousands)**                             | ** ** |
| Net product revenue                      |       | $                                                   | 10,096     |       | $          | 7,642 |   | $ | 2,454 |   |   | 32.1 | % |   |
| Development and license  revenue         |       | 10,110                                              |       | 1,019      |       | 9,091 |   |   | 892.2 |   |   |
| Distribution agreement and other revenue |       | 757                                                 |       | —     |       | 757 |   |   | — |   |   |
|                                          |            |                                                     |            |            |            |  |  |  |  |  |  |  |  |  |  |  |

 

The increase in netproduct revenues for the nine months ended September 30,2005 was due primarily to higher unit sales of Nipent. Net sales of Nipent wereapproximately $9.4 million in the first nine months of 2005, compared to $6.4million in the comparable period in 2004. Nipent sales for the nine monthsended September 30, 2005included approximately $504,000 in sales to Europe, compared to $1.0 million in2004. 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 licenserevenue relates to our license agreement entered into with MGI in September 2004.Development and license revenue for the nine months ended September 30, 2005 included$7,429,000 related to the amortization of deferred revenue in connection withthe upfront payment received from MGI, and $2,681,000 related to reimbursementof Dacogen development and allocated overhead costs. For the nine months ended September 30,2004, we recorded $244,000 related to the amortization of deferred revenue and$775,000 related to the reimbursement of Dacogen development costs.

Distributionagreement and other revenue for the nine months ended September 30, 2005 includes revenue from the termination ofour Nipent distribution agreement with Abbott Laboratories. Upon signing thisagreement in 1999, we received $5.0 million from Abbott, which was recorded asdeferred revenue and was being amortized over a five-year period. In February 2005,we paid Abbott $1,500,000 to terminate this agreement, and this amount wascharged against the unamortized balance of deferred revenue of $1,667,000. Theremaining $167,000 was recorded as distribution agreement revenue in the firstquarter of 2005 as a result of the termination of the distribution agreement. Theremaining $590,000 in revenue relates to the transfer agreement with AmericanPharmaceutical Partners, Inc. whereby we transferred the ANDA and allrights, title, and interest in our generic daunorubicin.

| ** **                                      | ** ** | **Nine months ended  September 30,** | ** ** | **Change** | ** ** |
|-------------------------------------------------|------------|-----------------------------------------------------|------------|------------|------------|
| **Costs and operating expenses** | ** ** | ** **                                          | ** ** | **2005**   | ** ** | **2004** | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
| ** **                                      | ** ** | **(in thousands)**                             | ** ** |
| Cost of product revenue                         |       | $                                                   | 1,736      |       | $          | 2,915 |   | $ | (1,179 | ) |   | (40.5 | )% |   |
| Research and development                        |       | 11,585                                              |       | 19,147     |       | (7,562 | ) |   | (39.5 | ) |   |
| Selling, general and administrative             |       | 20,159                                              |       | 20,240     |       | (81 | ) |   | (0.4 | ) |   |
|                                                 |            |                                                     |            |            |            |  |  |  |  |  |  |  |  |  |  |  |

 

Cost of product revenue as a percentage of net productrevenue was 17% in the nine months ended September 30,2005 compared to 38% in the same period in 2004. The decrease for the ninemonths ended September 30, 2005is due to a variation in product mix, with a larger portion of our sales beingrelated to domestic Nipent, which is sold at higher margins than mitomycin, andlower distribution costs for Nipent since we terminated our Nipent distributionagreement with Abbott in the first quarter of 2005. Current margins may not beindicative of future margins due to possible variations in product mix, averageselling prices, and of future margins due to possible variations in productmix, 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 nine months ended September 30, 2004 included a $500,000 non-cash charge paidin shares of our common stock to the Stehlin Foundation as a milestone paymentfor the acceptance of the submission of 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.

Thedecrease in selling, general and administrative expenses for the nine monthsended September 30, 2005relates primarily to reduced expenditures for marketing programs, legal fees,and investor relations activities, offset by increased costs related to ourNipent commercialization scale-up efforts in our European operations.

| ** **                                            | ** ** | **Nine months ended  September 30,** | ** ** | **Change** | ** ** |
|-------------------------------------------------------|------------|-----------------------------------------------------|------------|------------|------------|
| **Other income (expense)**                  | ** ** | ** **                                          | ** ** | **2005**   | ** ** | **2004** | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
| ** **                                            | ** ** | **(in thousands)**                             | ** ** |
| Interest income                                       |       | $                                                   | 1,227      |       | $          | 318 |   | $ | 909 |   | 285.9 | % |
| Interest expense                                      |       | —                                              |       | (1,918     | )          | (1,918 | ) | (100.0 | ) |
| Amortization of  deemed discount on convertible debt  |       | —                                              |       | (9,778     | )          | (9,778 | ) | (100.0 | ) |
| Other than  temporary decline in value of investments |       | —                                              |       | (7,851     | )          | (7,851 | ) | (100.0 | ) |
| Change in valuation of  derivative                    |       | 421                                                 |       | 467        |       | (46 | ) | (9.9 | ) |
|                                                       |            |                                                     |            |            |            |  |  |  |  |  |  |  |  |  |

 

The increase in interest income was due to higheravailable cash and marketable securities balances and an increase in interestrates for the nine months ended September 30,2005, compared to the same period in 2004.

Interest expense in the nine months ended September 30, 2004 consisted ofamortization of prepaid financing costs of $1,441,000 and interest of $477,000,relating to our outstanding convertible notes issued in 2003. These notes werefully paid at December 31, 2004.

Non-cash amortization of deemed discount onconvertible debt in the nine months ended September 30,2004 relates to the convertible notes issued in 2003. These notes were fullypaid at December 31, 2004.

The change in derivativevaluation of $467,000 in the nine months ended September 30, 2004 represented the change in the valuation oftwo derivatives. As part of the June 2003 convertible debt transaction, weissued to the note holders warrants to purchase 2,634,211 shares of AVI at$5.00 per share. These warrants represent a derivative instrument and arevalued each quarter using the Black-Scholes pricing model. During the firstnine months of 2004, the value of this derivative had decreased by 

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$4,083,000,which was recorded as other income. We also recorded an expense of $3,616,000related to the derivative accounting treatment of initially unregisteredwarrants issued in connection with the private placement of shares of ourcommon stock completed in March 2004, in accordance with EITF 00-19,“Accounting for Derivative Financial Instruments Indexed to, and PotentiallySettled in, a Company’s Own Stock.” In the nine months ended September 30,2005, we recorded a change in value of the derivative associated with thewarrants to purchase the AVI shares of $421,000.

**Liquidity and Capital Resources**

Our cash, cash equivalents, and both short andlong-term marketable securities totaled $50,839,000 at September 30, 2005, compared to $56,817,000 at December 31,2004. In addition, we held 2,684,211 shares of registered stock of AVI, most ofwhich are held as security for the warrants we issued to convertible debtholders to purchase the 2,634,211 AVI shares at $5.00 per share. The AVI shareshad a market value of $7,086,000 at September 30, 2005, and are classifiedon the balance sheet under non-current Restricted cash and investments, as wellas Investment in stock of related parties.

Net cash used in operating activities was $6,844,000in the nine months ended September 30,2005, and consisted primarily of the net loss of $10,869,000, plus non-cashamortization of deferred revenue of $7,429,000 from the MGI payment received inSeptember 2004, $1,500,000 paid to Abbott to terminate our U.S. Nipentdistribution agreement, a decrease in accounts payable and other liabilities of$2,189,000, offset by a decrease in accounts receivable of $13,099,000,primarily due to the receipt of milestone and development funds from MGI. Thenet cash used in operating activities in the nine months ended September 30,2004 was $20,863,000, which consisted primarily of the net loss of $52,403,000plus $3,706,000 increase in accounts receivable, less $9,778,000 non-cashamortization of deemed discount on our convertible debt, $1,441,000 amortizationof prepaid financing costs, $13,138,000 increase in deferred revenue, and$7,851,000 other than temporary decline in the value of investments.

Net cash provided by investing activities was$16,450,000 in the nine months ended September 30,2005, and consisted of $28,136,000 in proceeds from the sale or maturity ofmarketable securities, offset by $11,585,000 from the purchase of marketablesecurities. Net cash provided by investing activities was $4,791,000 in thenine months ended September 30, 2004, which consisted primarily of$10,680,000 from the release of restricted cash from the collateral accountrelated to our convertible debt, $19,059,000 in proceeds from the sale ormaturity of marketable securities, offset by $23,713,000 from the purchase ofmarketable securities and $1,000,000 paid for the purchase of European productrights for Nipent.

Net cash provided by financing activities was $989,000in the nine months ended September 30, 2005, and consisted of proceeds from exercises of stock options.Net cash provided by financing activities was $57,364,000 in the nine months ended September 30, 2004,consisting of $32,525,000 in net proceeds from the issuance of common stock ina private placement transaction, $23,662,000 in net proceeds from the issuanceof common stock to MGI, and $1,177,000 in proceeds from exercises of stockoptions.

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 at least the end of 2006. However, it is ourintention to pursue additional financing options, including the selling ofadditional shares of stock in a public or private offering and/or exploringmarketing partnership opportunities 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 

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of ourequity securities or debt, or the exercise of outstanding warrants and stockoptions by the holders of such warrants or options. However, given uncertainmarket conditions and the volatility of our stock price, we may not be able tosell our securities in public offerings or private placements at prices and/oron terms that are favorable to us, if at all. We may also choose to obtainfunding through licensing and other contractual agreements. Such arrangementsmay require us to relinquish our rights to our technologies, products ormarketing territories, or to grant licenses on terms that are not favorable tous. If we fail to obtain adequate funding in a timely manner, or at all, wewill be forced to scale back our product development activities or ouroperations in a manner that will ensure we can discharge our obligations asthey come due in the ordinary course of business at least through the end of2006.

**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 section of the report also containsforward-looking statements that involve risks and uncertainties. Our actualresults could differ materially from those anticipated in the forward-lookingstatements as a result of certain factors, including the risks described belowand elsewhere in this report.*

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

*If we do notreceive regulatory approval for Dacogen, our future revenues may be limited andour business would be harmed.*

Our NDA submission for Dacogen was accepted for filingby the FDA on December 31, 2004. On September 1, 2005, we received anApprovable Letter for Dacogen from the FDA, which provides that Dacogen isapprovable pending the FDA’s review of a requested analysis of the transfusionrequirements of patients enrolled in the completed Phase III trial, submissionof certain other information, and completion of labeling discussions. We havecompleted the required collection and analysis of transfusion data in responseto the Approvable Letter. Following discussions with the FDA, we and MGI willfinalize and submit our response to the Approvable Letter. We believe thisplanned submission and response confirms the clinical benefit of Dacogencompared to supportive care with regard to overall response rate, duration ofresponse, and transfusion independence in patients with MDS. Our Europeansubsidiary, EuroGen Pharmaceuticals Ltd., submitted an MAA for Dacogen to theEMEA, which submission was accepted for review on October 25, 2004. EMEAprocedures provide that a decision on the Dacogen MAA will usually occur within12 to 18 months of acceptance of the submission. The review process for the MAAfor Dacogen continues to be underway in Europe. Following a meeting with EMEAstaff in late October 2005, we and MGI believe that the potential outcomesof the MAA review may include a final opinion from the CHMP or the need tosubmit additional data to support the application.

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, leukopenia, febrile neutropenia,nausea, constipation, diarrhea, vomiting, pneumonia, arthralgia, headache andinsomnia. Severe adverse events were observed more frequently in patientsrandomized to Dacogen. The 

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mortality rate forpatients in the study was 12% for Dacogen and 9% for supportive care. Consequently,there is no assurance that the FDA will agree with our assessment that Dacogenprovides a clinically significant benefit, that the FDA will not take theposition that the studies failed for statistical reasons, or that we will notbe required to conduct additional large scale clinical trials. Even if thisdata supports the submission of an NDA, the approval process may take asignificant amount of time and we may never receive approval. If Dacogen isunsuccessful for any reason, including if the results of the Phase III studyare deemed insufficient from either a clinical or statistical basis by the FDA,our future revenues would be limited and our business would be harmed. Additionally,we might be forced to substantially scale down our operations or sell certainof our assets, and it is likely the price of our stock would declineprecipitously.

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.

*We are relying onEuropean regulatory approval and successful commercialization of Orathecin. Ifour MAA submission for Orathecin does not support regulatory approval by theEMEA for any reason, our business will be harmed.*

On July 1, 2004, EuroGen submitted an MAA forOrathecin to the EMEA. This application is being reviewed under the EMEACentralized Procedure, where marketing authorization is applied for in all 25 EuropeanUnion member states simultaneously. EMEA procedures provide that a decision onthe Orathecin MAA will usually occur within 12 to 18 months of acceptance ofthe 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.” Theprimary study end-point was overall survival with secondary end-points,including objective tumor response and time to disease progression. We did notmeet the primary end-point, although we did meet two of the secondaryend-points. The two secondary end-points were independent of a cross-overeffect, whereas the primary end-point was not. The released data, and the datafrom our other clinical trials, may not be sufficient to 

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support regulatoryapproval for Orathecin, and additional trials may be required before we canobtain 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.

*We are currentlyconducting clinical trials with Orathecin as a combination therapy. If theseclinical trials do not support regulatory approval, our business 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 the results of thestudies do not support regulatory approval of Orathecin as a combinationtherapy, we will incur significant operating losses and our business will beharmed.

*Even if we receiveregulatory approval of Orathecin for the treatment of patients with refractorypancreatic cancer, Orathecin may not be commercially successful.*

If Orathecin receivesregulatory approval, whether in Europe, in the United States if we pursue regulatoryapproval with the FDA, or ultimately as a combination therapy, patients andphysicians may not readily accept it, which would result in lower thanprojected 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 marketacceptance over time if new products are introduced that are more favorablyreceived than Orathecin or render Orathecin obsolete.

*If we receiveregulatory approval of Dacogen for the treatment of patients withmyelodysplastic syndromes, Dacogen may not be commercially successful.*

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 toexpand our clinical support for use of Nipent to treat additional diseases ourrevenues will not expand as planned.*

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 product revenues for the past three years. We are conducting aseries of clinical trials with Nipent, including Phase IV trials for CLL, NHL,cutaneous and peripheral T-cell lymphomas and Phase II/III studiesfor GvHD. If our Nipent clinical trials are not successful, we will not be ableto increase our revenue from Nipent.

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

*We have a historyof operating losses and we expect to continue to incur losses for theforeseeable 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 ofpatients with hairy cell leukemia. Our substantial research and developmentexpenditures and limited revenues have resulted in significant net losses. Wehave incurred cumulative losses of $344.4 million from inception through September 30,2005, and our products have not generated sufficient revenues to support ourbusiness during that time. We expect to continue to incur substantial operatinglosses at 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 obtain regulatory approval for and successfully commercializeOrathecin in Europe;

·       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 clinical trials;

·       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 requireadditional funding to expand our product pipeline, strengthen ourcommercialization efforts and expand our European operations, and if we areunable to raise the necessary capital or to do so on acceptable terms, ourplanned 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 holders ofsuch warrants and options. However, given uncertain market conditions and thevolatility of our stock price, we may not be able to sell 

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oursecurities in public offerings or private placements at prices and/or on termsthat are favorable to us, if at all. Also, the dilutive effect of additionalfinancings could adversely affect our per share results. We may also choose toobtain funding through licensing and other contractual agreements. For example,we recently 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 collaborativerelationship with MGI may not produce the financial benefits that we areanticipating, which could cause our business 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 addition, the license agreementcontemplates that MGI will pay us (i) a certain portion of revenuespayable to MGI as a result of MGI sublicensing the rights to market, selland/or distribute Dacogen, to the extent such revenues are in excess of themilestone payments, and (ii) a 20% royalty increasing to a maximum of 30%on annual worldwide net sales of Dacogen. We cannot guarantee that we will everreceive these payments, as MGI may choose not to sublicense Dacogen at all, norcan we be assured that MGI will expend the resources to sell Dacogen worldwide,or be successful in doing so.

*Our equityinvestment in AVI exposes us to equity price risk and any impairment chargewould 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.

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***Product Development and Regulatory Risks***

*Before we can seekregulatory approval of any of our product candidates, we must complete clinicaltrials, which are expensive and have 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 additional clinicaltrials for our product candidates. If we are unable to complete our clinicaltrials, our business will be severely harmed and the price of our stock willlikely decline.

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 trialsmay be delayed or terminated, which would prevent us from seeking necessaryregulatory 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 and regulatoryapproval unpredictable. The commencement and rate of completion of our clinicaltrials 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 to achieve a satisfactory rate ofcompletion of our clinical trials, our business will be significantly harmed.

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*We may be requiredto suspend, repeat or terminate our clinical trials if they are not conductedin compliance with regulatory requirements.*

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.

*We may be requiredto suspend, repeat or terminate our clinical trials if later trial results failto demonstrate safety and efficacy, or of the results are negative,inconclusive or if they fail to demonstrate safety 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 toobtain regulatory approvals to market our product candidates in foreigncountries would adversely affect our anticipated 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 

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products in thosecountries. Failure to comply with these regulatory requirements or to obtainrequired approvals would impair our ability to commercialize our products inforeign markets.

Nipent is currently soldin Europe, and in early 2004 we acquired the rights to market Nipent theredirectly. We plan to commence marketing Nipent in Europe in 2006. However, ourrevenue from sales of Nipent in Europe is currently insignificant, and there isno guarantee that our marketing efforts will result in significantly increasedrevenues. Our strategy is to obtain regulatory approvals to sell our productsin 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.

*Even if we obtainregulatory approval, we will continue to be subject to extensive governmentregulation that may cause us to delay the introduction of our products orwithdraw our products from the market.*

Even if regulatory approval of our products isobtained, later discovery of previously unknown problems may result inrestrictions of a product, including withdrawal of that product from themarket. Further, governmental approval may subject us to ongoing requirements forpost-marketing studies. For example, despite receipt of governmental approval,the facilities of our third-party manufacturers are still subject tounannounced inspections by the FDA and must continue to comply with GMPs andother regulations. These regulations govern all areas of production, recordkeeping, personnel and quality control. In the past, our third-partymanufacturers have experienced delayed FDA approval, which adversely affectedour ability to supply Nipent in 2002. If we or our third-partymanufacturers fail to comply with any of the manufacturing regulations, we maybe subject to, among other things, product seizures, recalls, fines,injunctions, suspensions or revocations of marketing licenses, operatingrestrictions and criminal prosecution.

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 enforcement action by the FDA. For example, inJune 2005 we received a Warning Letter from the FDA regarding certainpromotional materials we disseminated for Nipent. The FDA asserted that thesematerials were false or misleading because they failed to present any risk information,contained an unsubstantiated claim regarding the mechanism of action, andoverstated the safety and efficacy of the drug. In response, we recalled thesematerials from the field and we are currently revising our internal proceduresto ensure that the Nipent marketing materials and our promotional activitiesmeet regulatory requirements. We will also be sending a correctivecommunication to physicians who received the violative Nipent materials. TheFDA has accepted our remedial actions, nonetheless, any further Warning Lettersor enforcement actions by the FDA could harm our reputation in the market,result in significant fines or have other affects that could harm our business.

*The continuingefforts of government and third-party payers to contain or reduce thecosts of healthcare may adversely affect our revenues.*

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.

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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 for our product candidates couldadversely affect the market acceptance of our products, our competitiveposition 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-partymanufacturers upon whom we rely fail to produce our products in the volumesthat we require on a timely basis, or fail to comply with stringent regulationsapplicable to pharmaceutical drug manufacturers, we may face delays in thedelivery of, or be unable 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) manufacturesuch quantities to our specifications or (b) deliver such quantities onthe dates we require, which could cause delay or suspension of clinical trials,regulatory submissions and commercialization of our products;

·       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

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·       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 Nipentand adversely 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, such event wouldinevitably cause delays in distribution and sales of our products and harm ouroperating 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. Relying on third-party suppliers makes us vulnerable tocomponent failures and interruptions in supply, either of which could impairour ability to conduct clinical trials or to ship our products to our customerson a timely basis. Using third-party suppliers makes it difficult andsometimes impossible for us to maintain quality control, manage inventory andproduction schedules and control production costs. Vendor lead times to supplyus with ordered components vary significantly and can exceed six months ormore. Both now and as we expand our need for manufacturing capacity, we cannotbe sure that our suppliers will furnish us with required components when weneed them. These factors could make it difficult for us to effectively andefficiently manufacture our products, and could adversely impact our clinicaltrials, product development and sales of our products.

Some suppliers are our only source for a particularcomponent, which makes us vulnerable to cost increases and supplyinterruptions. We generally rely on one manufacturer for each product. We relyon one manufacturer for Nipent, a sole source supplier for the processing ofpentostatin, which is used in the manufacturing of Nipent, and a sole source supplierfor the ingredient used in the purification of pentostatin. We also rely onsole 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 

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thecomponent, goes out of business, or decides to cut off our supply, we may beunable to locate replacement supply sources, or the sources that we may locatemay not provide us with similar reliability or pricing and our business couldsuffer. If we cannot obtain a necessary component, we may need to find, testand obtain regulatory approval for a replacement component, produce thecomponent or redesign the related product, which would cause significant delayand could increase our manufacturing costs. Any of these events could adverselyimpact our sales and results of operations.

*We have limitedsales and marketing capabilities and may not be able to successfullycommercialize our products.*

We currently have limited sales and marketingresources. Although we have approximately 36 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 ableto market or sell our products effectively and our business, financialcondition and 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 ableto maintain and successfully establish new collaborative and licensingarrangements with third parties, our product development and business will beharmed.*

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 current developmentprograms, which would materially harm our business. Even if we are successfulin establishing new collaborations, they are subject to numerous risks anduncertainties 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;

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·       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 collaborator purchases a company that is one of ourcompetitors, that company may be less willing to continue its collaborationwith us. A company that has a strategy of purchasing companies with attractivetechnologies might have less incentive to enter into a collaboration agreementwith us. Moreover, disputes may arise with respect to the ownership of rightsto any technology or products developed with any current or futurecollaborator. Lengthy negotiations with potential collaborators ordisagreements between us and our collaborators may lead to delays in ortermination of the research, development or commercialization of productcandidates or result in time consuming and expensive litigation or arbitration.

*Our collaborativerelationships with third parties could cause us to expend significant funds ondevelopment costs with no assurance of financial return.*

From time to time we enter into collaborative relationshipswith third parties to co-develop and market products. For example, we enteredinto an agreement with Peregrine Pharmaceuticals in February 2001,pursuant to which we licensed a drug-targeting technology known as VascularTargeting Agent, which is a proprietary platform designed to specificallytarget a tumor’s blood supply and subsequently destroy the tumor with variousattached therapeutic agents. The licensed technology is specifically related toVEGF. Under the agreement, we made an up-front equity investment in Peregrineof $600,000 and will be obligated to make subsequent milestone payments thatcould ultimately total $8.25 million. In addition, we will pay royaltiesto Peregrine based on the net revenues of any drugs we commercialize using theVEGF 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 toprotect our intellectual property rights will be critically important to thesuccess of our business, and we may not be able to protect these rights in theUnited 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 

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products, one patent forDacogen used in combination with an anti-neoplastic agent for thetreatment of cancer, and two patents for our Surface Safe product. These issuedUnited States patents will begin to expire in October 2012. We have beengranted patents and have received patent licenses relating to our proprietaryformulation technology, non-oncology and Partaject technologies, amongwhich at least five patents are issued or licensed to us. In addition, we areprosecuting a number of patent applications for drug candidates that we are notactively developing at this time.

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 property tothe same extent as would laws in the United States. To minimize our costs andexpenses 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 been issuedpatents on, products or processes that compete with or are similar to ours. Wemay not be aware of all of the patents potentially adverse to our interestswhich may have been issued to others. In addition, third parties may challenge,invalidate or circumvent any of our patents. Thus, any patents that we own orlicense from third parties may not provide adequate protection againstcompetitors, if at all. Our pending patent applications and those we may filein the future, or those we may license from third parties, may not result inpatents 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.

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*If we fail to compete effectively against other pharmaceuticalcompanies, our business will suffer.*

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.

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 experiencethan we have. 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;

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·       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 obsolete or our competitors’products may be more effective or more effectively marketed and sold than ourproducts. Technological advances, competitive forces and loss of intellectualproperty protection rights for our products may render our products obsolete.

*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 solid tumors 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, solubilityor shelf life extension, as compared to generic mitomycin. We would be requiredto develop and submit additional data to the FDA and receive FDA approvalbefore we could make these claims.

Through September 30, 2005, we have spentapproximately $6.4 million on developing and marketing our generic andproprietary formulation products. We have completed our pre-commercialinvestment in developing Mitozytrex, and as of now we have not committed to aninternal budget 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 our genericor proprietary formulation products are based. We may in the future evaluatethe generic drug market and develop additional generic or proprietary productsbased on these compounds, which may also be the subject of method, formulationand manufacturing process patents held by third parties. Our development ofgeneric or proprietary products may also take place prior to, but inanticipation of, the expected expiration of existing patent protection fordrugs 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.

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*We may be subject to product liability lawsuits andour insurance may be inadequate to cover damages.*

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 future due to productliability claims. We have obtained limited product liability insurance coveragefor our products and clinical trials, under which the coverage limits are$10.0 million per occurrence and $10.0 million in the aggregate. Wedo not know whether this coverage will be adequate to protect us in the eventof a claim. We may not be able to obtain or maintain insurance coverage in thefuture at a reasonable cost or in sufficient amounts to protect us againstlosses. If third parties bring a successful product liability claim or seriesof claims against us for uninsured liabilities or in excess of insuredliabilities, 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 for stockholderproposals 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 203of the Delaware General Corporation Law prevents a stockholder 

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owning 15 percent ormore of a corporation’s outstanding voting stock from engaging in businesscombinations with a Delaware corporation for three years following the date thestockholder acquired 15 percent or more of a corporation’s outstandingvoting stock. This restriction is subject to exceptions, including the approvalof the board of directors and of the holders of at least two-thirds of theoutstanding shares of voting stock not owned by the interested stockholder.

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 ouroperations.

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 interestrates may affect the fair value of the marketable securities portfolio andcause unrealized gains or losses, such gains or losses would not be realizedunless the investments were to be sold prior to maturity.

As part of our June 2003 convertible debttransaction, we issued to the note holders warrants to purchase 2,634,211shares of common stock of AVI at $5.00 per share. These warrants are considereda derivative and were valued on the balance sheet at $10.1 million using theBlack-Scholes method on June 24, 2003. On September 30, 2005, thevalue of the derivative had declined to $1.2 million. As the fair value of the common stock of AVI has fluctuated significantlyin the past two years, the valuation of the derivative may have a significantimpact on our results of operations.

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)    Evaluation of disclosurecontrols 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 executiveofficer and our chief financial officer have concluded that our disclosurecontrols and procedures are effective to ensure that information we arerequired to disclose in reports that we file or submit under the SecuritiesExchange Act of 1934 is recorded, processed, summarized and reported within thetime periods specified in Securities and Exchange Commission rules andforms.

(b)   Changes in internal controlover financial reporting.

There was no change in ourinternal control over financial reporting that occurred during the periodcovered by this Quarterly Report on Form 10-Q that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

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

**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 |

 

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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:    | November 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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