AVIGEN INC \DE - 10-Q Quarterly Report

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

FORM 10-Q

(Mark One)
x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2004

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number: 0-28272

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

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

1301 Harbor Bay Parkway
Alameda, California 94502
(Address of principal executive offices and zip code)

(510) 748-7150
(Registrant’s telephone number,
including area code)

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

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

As of May 3, 2004, the number of outstanding shares of the registrant’s Common Stock, $.001 par value, was 20,371,938.

AVIGEN, INC.
FORM 10-Q
Quarter Ended March 31, 2004

INDEX

		PAGE

PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements

	Condensed Balance Sheets at March 31, 2004 and December 31, 2003	3
	Condensed Statements of Operations For three months ended March 31, 2004 and 2003 and the period from October 22, 1992 (inception) through March 31, 2004	4
	Condensed Statements of Cash Flows For three months ended March 31, 2004 and 2003 and the period from October 22, 1992 (inception) through March 31, 2004	5

	Notes to Condensed Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	12
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	29
Item 4.	Controls and Procedures	29

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	30
Item 2.	Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities	30
Item 3.	Defaults upon Senior Securities	30
Item 4.	Submission of Matters to a Vote of Security Holders	30
Item 5.	Other Information	30
Item 6.	Exhibits and Reports on Form 8-K	31
SIGNATURES		32

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

AVIGEN, INC.
(a development stage company)

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

	March 31, 2004			December 31, 2003

	(Unaudited)			(Note 1 )
ASSETS
Current Assets:
Cash and cash equivalents	$	2,352		$	2,384
Available-for-sale securities		79,337			84,566
Accrued interest		741			774
Prepaid expenses and other current assets		431			444

Total current assets		82,861			88,168
Restricted investments		11,928			11,928
Property and equipment, net		15,004			15,641
Deposits and other assets		804			858

Total assets	$	110,597		$	116,595

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Accounts payable and other accrued liabilities	$	932		$	1,140
Accrued compensation and related expenses		1,214			477
Deferred revenue - current		500			500

Total current liabilities		2,646			2,117
Long-term loan payable		8,000			8,000
Deferred rent		998			967
Deferred revenue		1,500			1,625
Stockholders’ equity:
Preferred Stock, $0.001 par value, 5,000,000 shares authorized, none issued and outstanding		—			—
Common Stock, $0.001 par value, 50,000,000 shares authorized, 20,371,387 and 20,276,394 shares issued and outstanding at March 31, 2004 and December 31, 2003, respectively		20			20
Additional paid-in capital		236,924			236,120
Accumulated other comprehensive income		446			402
Deficit accumulated during development stage		(139,937	)		(132,656	)

Total stockholders’ equity		97,453			103,886

Total liabilities and stockholders’ equity	$	110,597		$	116,595

See accompanying notes.

AVIGEN, INC.
(a development stage company)

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

	Three Months Ended March 31,						Period from October 22, 1992 (inception) Through

	2004			2003			March 31, 2004

Revenue	$	150		$	30		$	1,400
Operating expenses:
Research and development		5,228			5,152			113,389
General and administrative		2,698			1,814			46,521
In-license fees		0			0			5,034

Total operating expenses		7,926			6,966			164,944

Loss from operations		(7,776	)		(6,936	)		(163,544	)
Interest expense		(52	)		(60	)		(2,223	)
Interest income		566			1,023			25,971
Other expense, net		(19	)		(4	)		(141	)

Net loss	$	(7,281	)	$	(5,977	)	$	(139,937	)

Basic and diluted net loss per common share	$	(0.36	)	$	(0.30	)

Shares used in basic and diluted net loss per common share calculation		20,324,618			20,121,267

See accompanying notes.

AVIGEN, INC.
(a development stage company)

CONDENSED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

	Three Months Ended March 31,						Period from October 22, 1992 (inception) through March 31, 2004




	2004			2003

Operating Activities
Net cash used in operating activities	$	(5,525	)	$	(2,944	)	$	(116,397	)
Investing Activities
Purchases of property and equipment		(263	)		(165	)		(27,974	)
Increase in restricted investments		—			—			(11,928	)
Purchases of available-for-sale securities		(34,425	)		(11,458	)		(659,840	)
Maturities of available-for-sale securities		39,698			15,190			580,951

Net cash provided by (used in) investing activities..		5,010			3,567			(118,791	)
Financing Activities
Proceeds from long-term obligations		—			—			10,133
Payments on capital lease obligations		—			—			(2,154	)
Proceeds from warrants and options exercised		483			66			14,034
Proceeds from issuance of common stock, net of issuance costs and repurchases		—			—			205,619
Other financing activities		—			—			9,908

Net cash provided by financing activities		483			66			237,540
Net (decrease) increase in cash and cash equivalents		(32	)		689			2,352
Cash and cash equivalents, beginning of period		2,384			7,879			—

Cash and cash equivalents, end of period	$	2,352		$	8,568		$	2,352

Supplemental disclosure
Issuance of warrants in connection with the extension of the building lease	$	—		$	—		$	1,738
Issuance of warrants in connection with a patent license agreement	$	97		$	—		$	97
Cash paid for interest	$	52		$	60		$	1,730

See accompanying notes.

AVIGEN, INC.
(a development stage company)

NOTES TO CONDENSED FINANCIAL STATEMENTS

1. Interim Financial Statements

Our accompanying unaudited condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments, consisting only of normal recurring adjustments and accruals, considered necessary for a fair presentation of the results for the interim periods presented have been included. Operating results reported for the three months ended March 31, 2004 are not necessarily indicative of the results that may be expected for any other interim period or for the entire year ending December 31, 2004. These unaudited interim financial statements should be read in conjunction with our audited financial statements and the notes thereto included in our Annual Report on Form 10-K for the period ended December 31, 2003, filed with the Securities and Exchange Commission on March 15, 2004.

The balance sheet at December 31, 2003 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

2. Stock-Based Compensation

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

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

	Three Months Ended March 31,

	2004			2003

Net loss - as reported	$	(7,281	)	$	(5,977	)
Add: Stock-based employee compensation included in reported net loss		220			28
Less: Total stock-based employee compensation expense determined under the fair-value-based method for all awards		(3,264	)		(3,125	)

Net loss - pro forma	$	(10,325	)	$	(9,074	)

Net loss per common share basic and diluted - as reported	$	(0.36	)	$	(0.30	)

Net loss per common share basic and diluted - pro forma	$	(0.51	)	$	(0.45	)

During the preparation of our Notes to the Financial Statements for the year ended December 31, 2003, we determined that the calculation of total stock-based employee compensation expense determined under the fair-value-based method for the period ended March 31, 2003, as reported in that period, inadvertently included data that overstated the expected volatility used in the calculation. Accordingly, the amount of the total stock-based employee compensation expense determined under the fair-value-based method reported under FAS 123 for the period ended March 31, 2003 presented in the table above, and the respective volatility for the period presented in the table below, has been revised, resulting in decreases in the previously reported amount of $625,000. This revision had no effect on our previously reported results of operations or financial condition.

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

	Three Months Ended March 31,

	2004			2003

Expected volatility		0.8271			0.9017
Risk free interest rate		2.99	%		3.00	%
Expected life of options in years		5			5
Expected dividend yield		—			—

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

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

3. Cash and Cash Equivalents, Available-for-sale Securities, and Restricted Investments

Cash and Cash Equivalents

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

Available-for-sale Securities

We invest our excess cash balances in marketable securities, primarily corporate debt securities, federal agency obligations, asset-backed securities, and municipal bonds, with the primary investment objectives of preservation of principal, a high degree of liquidity, and maximum total return. In accordance with Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” we have classified our investments in marketable securities as available-for-sale. Available-for-sale securities are reported at market value and unrealized holding gains and losses, net of the related tax effect, if any, are excluded from earnings and are reported in other comprehensive income and as a separate component of stockholders’ equity until realized. A decline in the market value of a security below its cost that is deemed other than temporary is charged to earnings, and would result in the establishment of a new cost basis for the security.

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

Restricted Investments

At March 31, 2004 and December 31, 2003, $11.9 million was classified as restricted investments in long-term assets, representing the combined aggregate portion of our portfolio of available-for-sale securities that were pledged in connection with a financing arrangement, equipment operating leases, and two letters of credit serving as deposits in connection with a building lease.

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

	Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value

Cash	$	2,352	$	—	$	—		$	2,352
Corporate debt securities		42,004		282		(3	)		42,283
Federal agency obligations		22,345		73		(4	)		22,414
Asset-backed and other securities		18,146		98		(3	)		18,241
Short-term municipals		6,250		—		—			6,250
Treasury obligations		2,073		4		—			2,077

Total double	$	93,170	$	457	$	(10	)	$	93,617

Amounts reported as:
Cash and cash equivalents		2,352		—		—			2,352
Restricted investments		11,928		—		—			11,928
Available-for-sale securities		78,891		456		(10	)		79,337

Total	$	93,171	$	456	$	(10	)	$	93,617

The weighted average maturity of our investment portfolio at March 31, 2004 was 409 days, with $42.1 million carrying an effective maturity of less than twelve months, and $51.5 million carrying an effective maturity between one and three years.

The following is a summary of cash, restricted investments, and available-for-sale securities as of December 31, 2003 (in thousands):

	Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value

Cash	$	2,384	$	—	$	—		$	2,384
Corporate debt securities		45,474		232		(25	)		45,681
Federal agency obligations		24,813		81		(21	)		24,873
Asset-backed and other securities		17,048		134		(3	)		17,179
Short-term municipals		2,000		—		—			2,000
Treasury obligations		6,757		9		(5	)		6,761

Total	$	98,476	$	456	$	(54	)	$	98,878

Amounts reported as:
Cash and cash equivalents		2,384		—		—			2,384
Restricted Investments		11,928		—		—			11,928
Available-for-sale securities		84,164		456		(54	)		84,566

Total	$	98,476	$	456	$	(54	)	$	98,878

The weighted average maturity of our investment portfolio at December 31, 2003 was 405 days, with $46.3 million carrying an effective maturity of less than twelve months, and $52.5 million carrying an effective maturity between one and three years.

4. Stockholders’ Equity

We received $108,900 in cash proceeds related to the exercise of warrants for 18,000 shares of common stock.

In March 2004, the exercise period for stock options for 427,500 shares of common stock were extended and as a result we recorded a non-cash stock compensation expense of $220,000.

5. Deferred Revenue

In March 2003, we received a $2.5 million payment from Bayer Corporation under the terms of our collaboration agreement for the development of Coagulin-B, our product candidate for the treatment of hemophilia B. This amount was recorded as deferred revenue and is being recognized as revenue in our statements of operations ratably over the estimated development period for this product, which was determined to be five years, or approximately $125,000 per quarter.

6. Comprehensive Loss

Comprehensive loss is comprised of net loss and unrealized holding gains and losses on available-for-sale securities, in accordance with Statement of Financial Accounting Standards No. 130, “Reporting Comprehensive Income.”

	Three Months Ended March 31,

(Amounts in thousands)	2004			2003

Net loss	$	(7,281	)	$	(5,977	)
Net unrealized gain (loss) on available-for-sale securities		44			(181	)

Comprehensive loss	$	(7,237	)	$	(6,158	)

7. Basic and Diluted Net Loss Per Common Share

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

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

	Three Months Ended March 31,

	2004		2003

Potential dilutive stock options outstanding		925,148		538,532
Potential dilutive warrants to purchase common stock outstanding		2,481		21,040

Potential dilutive common shares		927,629		559,572

Outstanding securities excluded from the potential dilutive common shares calculation (1)		3,798,119		4,502,241

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

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion may be understood more fully by reference to the financial statements, notes to the financial statements, and management’s discussion and analysis of financial conditions and results of operations contained in our Annual Report on Form 10-K for the year ended December 31, 2003, filed with the Securities and Exchange Commission on March 15, 2004.

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements include, but are not limited to, statements about future events and results regarding our drug development programs, clinical trials, sources of revenue, receipt of regulatory approvals, expense savings and cash burn rate resulting from the implementation of our strategic plan, capital needs, intellectual property, and other events. In some cases, you can identify forward-looking statements by such terms as “may,” “will,” “should,” “could,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “project,” “intend,” “predict,” “potential,” and similar expressions which imply that the statements relate to future events and are based on assumptions and subject to risks and uncertainties. Given these uncertainties, you should not place undue reliance on these forward-looking statements. We discuss many of these risks in greater detail under the heading “Risk Factors” below and elsewhere in this report. Also, these forward-looking statements represent our estimates and assumptions only as of the date of this Form 10-Q.

Overview

We are focused on developing pharmaceutical products for the treatment of serious and chronic hematological and neurological diseases. We have developed proprietary DNA-based drug delivery technologies, including our proprietary gene-delivery platform based on adeno-associated virus (AAV) vectors. We are using our DNA-based drug delivery technologies to develop products designed to treat diseases that are difficult to treat using conventional pharmaceutical drugs.

In January 2004, we enhanced our senior management team with expertise in neurology and small molecules, as part of an ongoing strategy to accelerate the progress of our product development programs. We believe that with these additions, our current management team has a complementary breadth of industry experience to carry forward a wide range of product development programs that include gene-based drugs, proteins and small molecules. In March 2004, Kenneth Chahine was appointed as our Chief Executive Officer, President and a director following the resignation of John Monahan from these positions. Dr. Chahine previously served as our Chief Operating Officer since July 2002.

The regulatory environment for gene therapy remains challenging. Our hemophilia program has faced numerous delays, and has progressed much more slowly than is common for conventional pharmaceutical drug candidates. We are currently evaluating how to address the issues we have experienced in this trial. We see this heightened level of scrutiny and review of gene therapy trials continuing for the foreseeable future, and we are working with regulatory agencies to address their concerns and improve the overall pace of all our clinical development programs. We are also focusing our new product evaluation process toward product candidates that target life-threatening chronic diseases with a risk-benefit profile that we believe favors a more accelerated subject enrollment pace and faster clinical development timelines.

We have increased our therapeutic focus on neurological diseases with out product candidates AV201 for Parkinson’s disease and AV333 for neuropathic pain. Although AAV vector-based technologies remain a strong core competency, we are developing AV333 as a non-viral DNA-based drug. In addition, we are considering opportunities outside the gene therapy field and are evaluating several validated small molecule opportunities in the fields of hematological and neurological disorders in order to broaden out portfolio of development candidates.

We are a development stage company and have primarily supported the financial needs of our research and development activities since our inception through public offerings and private placements of our equity securities and will continue to seek additional future funding through similar financings, when market conditions allow. We have not received any revenue from the sale of our products in development, and we do not anticipate generating revenue from the sale of products in the foreseeable future. We expect our source of revenue, if any, for the next several years to consist of payments under collaborative arrangements with third parties, government grants, and license fees. We have incurred losses since our inception and expect to incur substantial losses over the next several years due to lack of any substantial revenue and the continuation of our ongoing and planned research and development efforts, including preclinical studies and clinical trials. There can be no assurance that we will successfully develop, commercialize, manufacture, or market our product candidates or ever achieve or sustain product revenues for profitability. At March 31, 2004 we had an accumulated deficit of $139.9 million and cash, cash equivalents, available-for-sale securities, and restricted investments of approximately $93.6 million. We believe that our capital resources at March 31, 2004 will be adequate to fund our current operating needs over the next three years.

Critical Accounting Policies

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

We believe the following accounting policies are critical to the process of making significant judgments and estimates in the preparation of our financial statements.

Revenue recognition

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

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

Research and development expenses

Our research and development expenses include salaries and benefits costs, fees for contractors and consultants, fees to collaborators for preclinical research studies, patient treatment costs related to clinical trials and related clinical manufacturing costs, license fees for use of third-party intellectual property rights, and an allocation of facilities and overhead costs. Research and development expenses consist of costs incurred for drug and product development, manufacturing, clinical activities, discovery research, screening and identification of drug candidates, and preclinical studies. All such costs are charged to research and development expenses as incurred, with the costs of materials and other supplies charged to research and development expense upon receipt.

Clinical development costs are a significant component of research and development expenses. We accrue costs for clinical trial activities performed by third parties based upon estimates of the percentage of work completed over the life of the individual study in accordance with agreements established with the clinical trial sites. We determine our estimates through discussions with internal clinical personnel and outside service providers as to the progress or stage of completion of trials or services and the agreed upon fee to be paid for such services. These estimates may or may not match the actual services performed by the organizations as determined by patient enrollment levels and related activities. We monitor clinical trial activities to the extent possible; however, if we underestimated activity levels associated with various studies at a given point in time, we could record significant research and development expenses in future periods.

Results of Operations

Three months ended March 31, 2004 compared to the three months ended March 31, 2003

Revenue

(Dollars in thousands)	Three Months Ended March 31,

	2004			2003

Revenue	$	150		$	30
Percentage increase over prior period		400	%

During the three months ended March 31, 2004, revenue primarily consisted of the recognition of deferred revenue from the $2.5 million payment received from Bayer in March 2003. This payment from Bayer is being recognized ratably over the estimated development period of our hemophilia B product candidate, which was estimated at five years from the date of the payment, resulting in revenue recognition of $125,000 per quarter beginning with the second quarter of 2003. During the three-month periods ended March 31, 2004 and 2003, research license fees totaled $24,000 and $28,000, respectively. Research license agreements allow the licensee to make or use products using our patented

AAV technologies for research purposes only, and do not allow for the use of our technologies in products for commercial sale. These licenses usually include initiation fees and annual maintenance fees. During the three-month periods ended March 31, 2004 and 2003, royalty revenue totaled $1,200 and $2,000, respectively, all of which was attributed to a single royalty license that was entered into in July 2000, which allows for the development, manufacture, use and commercial sale of products using our patented AAV technologies.

Research and Development Expenses

Our research and development expenses can be divided into two primary functions, costs to support research and preclinical development and costs to support preparation for and implementation of human clinical trials. Research and preclinical development costs include activities associated with general research and exploration, animal studies, production of vector for use by external collaborators in general research and exploration, and development of processes to translate research achievements into commercial scale capabilities. Clinical development costs include activities associated with preparing for regulatory approvals, maintaining regulated and controlled processes, manufacturing vector for use in human clinical trials, and supporting patient enrollment and patient administration within clinical trials.

During the three-month periods ended March 31, 2004 and 2003, our research and preclinical development expenses included activities for our development programs for hemophilia, Parkinson’s disease, neuropathic pain, and other neurological targets, and our clinical development expenses included activities to support our development programs for Coagulin-B and our product candidate for the treatment of advanced Parkinson’s disease, AV201.

We estimate that the costs associated with these two categories approximate the following (in thousands):

	Three Months Ended March 31,				Percentage increase over prior year

	2004		2003

Research and preclinical development	$	3,434	$	3,021	14%
Clinical development		1,794		2,131	(16)%
Total research and development expenses	$	5,228	$	5,152	(2)%

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

The increase of $413,000 in our research and preclinical development expenses in the first quarter of 2004, compared to the first quarter of 2003, was primarily due to changes in costs for the following:

	•	higher expenditures for services from third-party collaborators associated with our preclinical animal studies of $235,000, primarily related to our work with Parkinson’s disease and chronic neuropathic pain, but also including additional work related to our hemophilia program,

	•	higher facilities-related expenses of $248,000, related to the rise in costs under the new building lease that went into effect in June 2003 and an increase in the allocation of space to research and preclinical activities, and

	•	higher personnel-related expenses of $157,000, related to higher average salaries in 2004 compared to 2003,

partially offset by:

	•	lower materials expenses of $124,000, reflecting the benefits of operating efficiencies we have implemented over the last year in the production of our AAV vectors and the general decline in the amounts of AAV vectors needed to be produced to support our on-going research, and

	•	severance expenses of $101,000, paid to an executive in February 2003, compared to no severance expenses in the first quarter of 2004

The decrease of $337,000 in our clinical development expenses for the first quarter of 2004, compared to the first quarter of 2003, was primarily due to changes in costs for the following:

	•	lower materials expenses of $227,000, reflecting lower levels of materials consumed for the production of clinical grade AAV vectors due to the delayed needs of our development programs at the clinical development stage,

	•	severance expenses of $136,000, paid to an executive in February 2003, compared to no severance expenses in the first quarter of 2004, and

	•	lower facilities and other expenses of $64,000,

partially offset by,

•

higher expenditures to third-party collaborators associated with treating and monitoring subjects in our clinical trial of $91,000, reflecting an increase in costs for recruiting, screening, treating and monitoring patients in our clinical development programs.

Total research and development expenses for the three months ended March 31, 2004 were lower than management expected due to delays in treating new patients in our Coagulin-B clinical trial and the delay in the anticipated initiation of a clinical trial for AV201. We believe regulatory approvals and patient scheduling and coordination will continue to be factors that could cause delays in the progress in our clinical trials; however, we do expect to expand our development activities for our preclinical and clinical development programs. As a result, we expect our total research and development spending for the full-year ending December 31, 2004 to increase over our fiscal-year 2003 levels as we conduct our clinical trial activities and to the extent we enhance our manufacturing capabilities and expand our research and development programs for additional product candidates.

General and Administrative Expenses

(Dollars in thousands)

	Three Months Ended March 31,

	2004			2003

General and administrative expenses	$	2,698		$	1,814
Percentage increase over prior period		49	%

The increase in general and administrative expenses between the three months ended March 31, 2004 and 2003 was primarily due to accrued severance of approximately $900,000 in connection with the resignation of John Monahan in March 2004. This accrued severance includes scheduled salary and benefits payments of approximately $680,000 through December 2005 and a non-cash charge of approximately $220,000 related to the extension of the exercise period through December 2007 for certain stock options. The increase in general and administrative expenses for the three months ended March 31, 2004, compared to the same period in 2003, also reflected a rise in other personnel-related expenses of $60,000, which was partially offset by lower depreciation of $40,000 and lower professional service expenses for legal support and information technology consulting of $40,000.

We expect our general and administrative expenses to be higher for the fiscal-year ending December 31, 2004 above that of 2003 as a result of the accrued CEO severance, but to otherwise remain steady with 2003 levels.

Interest Income

(Dollars in thousands)

	Three Months Ended March 31,

	2004			2003

Interest Income	$	566		$	1,023
Percentage change over prior period		(45	)%

Almost all of our interest income is generated from our investments in high-grade marketable securities of government and corporate debt. The decline in interest income for the three months ended March 31, 2004 as compared to the same period in 2003 was primarily due to the decrease in outstanding interest-bearing cash and securities balances due to resources having been used to fund our on-going operations during the last year, as well as the general decline in market interest rates between the two periods.

Liquidity and Capital Resources

Since our inception in 1992, cash expenditures have significantly exceeded our revenue. We have funded our operations primarily through public offerings and private placements of our equity securities. Subsequent to our initial public offering in May 1996, we have raised $189 million from private placements and public offerings of our common stock and warrants to purchase our common stock, and we received $2.5 million in research support from Bayer Corporation in March 2003.

In addition to funding our operations through sales of our common stock, we have attempted to contain costs and reduce cash flow requirements by renting scientific equipment and facilities, contracting with third parties to conduct research and development and using consultants, where appropriate. We expect to incur additional future expenses, resulting in significant additional cash expenditures, as we continue to expand our research and development activities and undertake additional preclinical studies and clinical trials of our product candidates. We also expect to incur substantial additional expenses relating to the filing, prosecution, maintenance, defense and enforcement of patent and other intellectual property claims.

At March 31, 2004, we had cash, cash equivalents, available-for-sale securities, and restricted investments of approximately $93.6 million, compared to approximately $98.9 million at December 31, 2003. At March 31, 2004 and December 31, 2003, $11.9 million was pledged to secure certain long-term liabilities. At March 31, 2004, these long-term liabilities included $10.0 million for our line of credit, $1.5 million for equipment operating leases, and approximately $428,000 for letters of credit which serve as security deposits on our building lease. Our restricted investments are reported as a long-term asset and would not be considered a current source of additional liquidity.

Our commitments under leases and other obligations as of March 31, 2004 was not materially different from that as of December 31, 2003. As of December 31, 2003, we had commitments under leases and other obligations totaling $ 24.1 million, payable in varying amounts over more than five years, as more fully described in Item 7 of our Annual Report on From 10-K filed with the SEC on March 15, 2004.

During the three months ended March 31, 2004, net cash used in operating activities was $5.5 million. The cash used in operating activities was primarily used to support our internal research and development activities, as well as preclinical studies and clinical trials performed by third parties. The level of cash used for operating activities during the quarter ended March 31, 2004 was in line with management’s expectations.

During the three months ended March 31, 2003, net cash used in operating activities was $2.9 million. The cash used in operating activities was primarily used to support our internal research and development activities, as well as preclinical studies and clinical trials performed by third parties and also included the receipt of a $2.5 million payment from Bayer Corporation in March 2003, which was recorded as deferred revenue. The level of cash used for operating activities during the quarter ended March 31, 2003 was in line with management’s expectations

During the three months ended March 31, 2004, $5.0 million and $483,000 was provided by investing and financing activities, respectively. The cash provided by investing activities consisted primarily of maturities, net of purchases, of available-for-sale securities, offset to a small degree by purchases of property and equipment of $263,000. The cash provided by financing activities consisted of proceeds from the exercise of stock options and warrants during the period.

We believe that we will continue to require substantial additional funding in order to complete the research and development activities currently contemplated and to commercialize our proposed products. We believe that our capital resources at March 31, 2004 will be adequate to fund our current operating needs over the next three years. However, this forward-looking statement is based upon our current plans and assumptions regarding our future operating and capital requirements, which may change. Our future operating and capital requirements will depend on many factors, including:

	•	continued scientific progress in research and development programs;

	•	the scope and results of preclinical studies and clinical trials;

	•	the time and costs involved in obtaining regulatory approvals;

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

	•	competing technological developments;

	•	the cost of manufacturing scale-up;

	•	the cost of commercialization activities; and

	•	other factors which may not be within our control.

We intend to continue to seek additional funding through public or private equity or debt financing, when market conditions allow, or through additional collaborative arrangements with corporate partners. If we raise additional funds by issuing equity securities, there may be further dilution to existing stockholders. We cannot assure our investors that we will be able to enter into such financing arrangements on acceptable terms or at all. Without such additional funding, we may be required to delay, reduce the scope of, or eliminate one or more of our research or development programs.

RISK FACTORS

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

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

Since our inception in 1992, we have not been profitable, and we cannot be certain that we will ever achieve or sustain profitability. To date, we have been engaged in research and development activities and have not generated any revenues from product sales. As of March 31, 2004, we had an accumulated deficit of $139.9 million. Developing our products will require significant additional research and development, preclinical testing and clinical trials, as well as regulatory approval. We expect these activities, together with our general and administrative expenses, to result in operating losses for the foreseeable future. Our ability to achieve profitability will depend, in part, on our ability to successfully complete development of our proposed products, obtain required regulatory approvals and manufacture and market our products directly or through business partners.

Our clinical trials to date for Coagulin-B for the treatment of hemophilia B have been conducted with a small number of patients over a short period of time, and the results reported may not be indicative of future results in a larger number of patients or have lasting effects

Our current Coagulin-B clinical trial studies are based upon the evaluations of very small groups of patients and any reported progress or results may not be indicative of subsequent progress or results achieved from larger populations. As our Coagulin-B clinical trial is still in a very early stage, we do not yet know if any favorable results achieved will have a lasting effect. Further, we have experienced difficulties in obtaining positive results in humans reflective of the positive results we obtained in animal models. If a larger population of patients does not experience positive results, or any favorable results do not demonstrate a lasting effect, this product candidate may not receive approval from the FDA for further studies or commercialization. If we are not able to proceed with or decide to abandon our Coagulin-B development program, our business prospects would be substantially impaired.

The success of our technology in animal models does not guarantee that the same results will be replicated in humans

Even though our product candidates have shown successful results in mouse, dog, and non-human primate models, animals are different than humans and results in animal models may not be replicated in our clinical trials with humans. For example, while the results of our gene therapy treatment for hemophilia B were favorable and demonstrated sustained long-term expression in both dogs and mice for multiple years, the one human subject who demonstrated therapeutic levels of circulating factor IX when given a comparable dose size to that used in the successful animal studies was not able to sustain steady factor IX expression beyond five weeks. In addition, this human subject experienced a mild, temporary elevation of two liver enzymes, which was not seen in any of the animal models. Further, we have observed an immune system response in subjects treated with Coagulin-B that was not observed in the animal models, which we have not yet been able to, and may not be able to, adequately address. Consequently, you should not rely on the results in any of our animal models as being predictive of the results that we will see in our clinical trials with humans.

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

The commercial success of our potential products will depend in part on public acceptance of the use of gene therapy for the prevention or treatment of human diseases. Public attitudes may be influenced by claims that gene therapy is unsafe, and consequently our products may not gain the acceptance of the public or the medical community. Negative public reaction to gene therapy in general could result in greater government regulation and stricter labeling requirements of gene therapy products, including any of our products, and could cause a decrease in the demand for any products we may develop.

Our stock price is also influenced by public perception. For example, in January 2003, a report of serious adverse events in a retroviral trial for infants with severe combined immune deficiency (SCID) in France and subsequent FDA actions putting related trials on hold in the United States had a significant impact on the public perception and stock price of all companies involved in gene therapy. Avigen’s stock declined despite the fact that we do not work with retroviruses or with infants with SCID and our clinical trial was not affected by the FDA’s actions in this case.

Other potential adverse events in the field of gene therapy may occur in the future that could result in greater governmental regulation of our potential products and potential regulatory delays relating to the testing or approval of our potential products.

AAV technology is new and developing rapidly; there is limited clinical data and new information may arise which may cause delays in designing our protocols, submitting applications that satisfy all necessary regulatory review requirements, and ultimately completing the clinical trials of our products

Clinical trials are governed by regulations enforced by the FDA. Our technology is fairly new, and we have limited historical data from preclinical studies or clinical trials that are often necessary to satisfy the FDA’s regulatory review process. In addition, as new information about the technology becomes available, it may change perceptions of previously accepted data, which could require additional periods of time to review and interpret these data. For example, while animals in preclinical studies do not appear to develop antibodies to the AAV vector or the expressed protein, further clinical testing is required to confirm to what extent our product candidates might cause human patients to develop antibodies to these potential products or the proteins produced by these potential products. Such antibodies could make our product ineffective or lead to unwanted side effects. In addition, we have observed in our clinical trial, the mild, temporary elevation of two liver enzymes, which were not seen in any of the animal models and the inability to sustain steady factor IX expression beyond five weeks. Consequently, we may encounter deficiencies in the design or application stages while developing our clinical trial studies, or in the subsequent implementation stages of such studies, which could cause us or the FDA to delay, suspend or terminate our trials at any time.

Because our product candidates are in an early state of development, there is a high risk that they may never be commercialized

All of our product candidates are in early stages of development. We do not have any product candidates that have received regulatory approval for commercial sale, and we face the risk that none of our product candidates will ever receive regulatory approval. We have one product candidate in clinical trials, Coagulin-B for the treatment of hemophilia B. This product candidate is only in phase I of the clinical trial process. We have applied for an IND for our second product candidate, AV201 for the treatment of Parkinson’s disease, and are currently responding to requests from the FDA for additional information. We are not aware of any other gene therapy products of other companies that have received regulatory approval for commercial sale in the United States, and do not expect any of our prospective products, including Coagulin-B and AV201, to be commercially available for at least several years. As results of future stages of clinical trials become available and are evaluated, we may decide at any time to discontinue any further development of one or more of our product candidates.

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

The development of our potential products is dependent upon collecting sufficient data from human clinical trials to demonstrate safe and effective results. At times, we have experienced delays in enrolling patients in our clinical trials for treatment at sub-therapeutic dose levels. We may experience similar difficulties in the future. Any delay or failure to recruit sufficient numbers of patients to satisfy the level of data required to be collected under our clinical trial protocols could prevent us from developing any products we may target.

Our potential products must undergo rigorous clinical testing and regulatory approvals, which could substantially delay or prevent us from marketing any products

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

Potential problems we may encounter in the implementation stages of our studies include the chance that we may not be able to conduct clinical trials at preferred sites, obtain sufficient test subjects or begin or successfully complete clinical trials in a timely fashion, if at all. Furthermore, the FDA may temporarily suspend clinical trials at any time if it believes the subjects participating in trials are being exposed to unacceptable health risks, if it finds deficiencies in the clinical trial process or conduct of the investigation, or to better analyze data surrounding any unexpected developments. For example, progress in our current Coagulin-B clinical trial has been interrupted twice to better analyze data from unexpected observations. These included the identification of vector fragments in the seminal fluid of two early patients beyond an expected timeframe and the development reported in December 2002 of a temporary elevation in the levels of two liver enzymes in one patient treated with a higher dose.

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

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

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

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

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

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

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

If patents can be obtained, we cannot assure you that any of these patents will provide us with any competitive advantage. For example, others may independently develop similar technologies or duplicate any technology developed by us, and patents may be invalidated in litigation.

In addition, several of our patents and patent applications are co-owned with co-inventors or institutions. To date, we have negotiated exclusive licenses for many of our co-invented technologies. However, if we cannot negotiate exclusive rights to other co-owned technology, each co-inventor may have rights to independently make, use, offer to sell or sell the patented technology. Commercialization, assignment or licensing of the technology by a co-inventor could harm our business.

We also rely on a combination of trade secret and copyright laws, employee and third-party nondisclosure agreements and other protective measures to protect intellectual property rights pertaining to our products and technologies. We cannot be certain that these measures will provide meaningful protection of our trade secrets, know-how or other proprietary information. In addition, the laws of certain foreign countries do not protect our intellectual property rights to the same extent as do the laws of the United States. We cannot assure you that we will be able to protect our intellectual property successfully.

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

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

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

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

If we do not achieve certain milestones, we may not be able to retain certain licenses to our intellectual property

We have entered into license agreements with third parties for technologies related to our gene therapy product development programs. Some of these license agreements provide for the achievement of development milestones. If we fail to achieve these milestones or to obtain extensions, the licensor may terminate these license agreements with relatively short notice to us. Termination of any of our license agreements could harm our business.

If we are able to bring our potential products to market, we continue to face a number of risks including our inexperience in marketing or selling our potential products, the acceptance of gene therapy products by physicians and insurers, our ability to price our products effectively and to obtain adequate reimbursement for sales of our products.

Even if we are able to develop our potential products and obtain necessary regulatory approvals, we have no experience in marketing or selling any of our proposed products. We intend to enter into distribution and marketing agreements with other companies for our products and do not anticipate establishing our own sales and marketing capabilities for any of our potential products in the foreseeable future. For example, we have entered into an exclusive worldwide marketing and distribution agreement with Bayer Corporation for our Coagulin-B proposed product. However, if Bayer Corporation does not perform under this agreement, we would need to market this product ourselves, and we may not be able to establish adequate marketing capabilities for this product. Similarly, we may not be able to develop adequate marketing capabilities for our other potential products, either on our own or through other third parties.

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

We expect that we will face intense competition, which may limit our ability to become profitable

Our competitors may develop more effective or more affordable products, or commercialize products earlier than we do, which would limit the prices that we could charge for the products that we are able to market, and prevent us from becoming profitable. We expect increased competition from fully integrated pharmaceutical companies and more established biotechnology companies. Most of these companies have significantly greater financial resources and expertise than we do in research and development, preclinical studies, clinical trials, obtaining regulatory approvals, manufacturing, and marketing and distribution.

Smaller companies may also prove to be significant competitors, particularly through collaborative arrangements with large pharmaceutical companies. Academic institutions, government agencies and other public and private research organizations also conduct research, seek patent protection and establish collaborative arrangements for product development and marketing. In addition, these companies and institutions compete with us in recruiting and retaining highly qualified scientific and management personnel.

We are aware that other companies are conducting preclinical studies and clinical trials for viral and non-viral gene therapy products that could compete with products we are developing.

We have limited experience in manufacturing our potential products at a commercial scale, which raises uncertainty about our ability to manufacture our potential products cost-effectively

Even if we are able to develop our potential products and obtain necessary regulatory approvals, we have limited experience in manufacturing any of our proposed products on a commercial basis. If we are unable to manufacture our products in a cost-effective manner, we are not likely to become profitable. We have not yet received a license from the FDA for our manufacturing facilities, and cannot apply for one until we submit our product for commercial approval. Even if we do receive a manufacturing license, we may fail to maintain adequate compliance with the FDA’s regulations concerning current good manufacturing practices (cGMP), in which case the license, and our authorization to manufacture product, could be revoked.

We may lose access to critical materials from single source suppliers, which is not within our control and could delay us from manufacturing vector needed to support our clinical trials or future commercialization

We obtain materials used in the manufacture of our clinical vector products from a number of suppliers, some of whom are our sole qualified source of these materials. We qualify the suppliers of our clinical materials according to cGMP regulations. If we were to lose access to critical materials from any of these sole-source suppliers, we would be required to obtain a new source of the materials. It could take us several months to qualify new suppliers before we could use their materials in the manufacture of our clinical vector products.

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

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

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

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

We anticipate that our existing capital resources as of March 31, 2004, will be adequate to fund our needs for at least the next three years. However, we may require additional funding to complete the research and development activities currently contemplated and to commercialize our products. Our future capital requirements will depend on many factors, including:

	•	continued scientific progress in research and development programs;

	•	the scope and results of preclinical studies and clinical trials;

	•	the time and costs involved in obtaining regulatory approvals;

	•	the costs involved in filing, prosecuting and enforcing patent claims;

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

	•	the cost of manufacturing scale-up;

	•	the cost of commercialization activities; and

	•	other factors which may not be within our control.

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

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

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

We use radioactive materials and other hazardous substances in our research and development and manufacturing operations. As a result, we are potentially subject to substantial liabilities related to personal injuries or property damages they may cause. In addition, clean up costs associated with radioactivity or other hazardous substances, and related damages or liabilities could be significant and could harm our business. We are required to comply with increasingly stringent laws and regulations governing environmental protection and workplace safety which could impose substantial fines and criminal sanctions for violations. Maintaining compliance with these laws and regulations could require substantial additional capital.

Risks Related to Our Stock

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

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

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

From March 31, 2002 to April 30, 2004, our stock price has fluctuated between a range of $11.20 and $2.75 per share. In addition, in recent years, the stock market in general, and the shares of biotechnology and health care companies in particular, have experienced extreme price fluctuations. We believe that in addition to broad market and industry fluctuations that may cause the market price of our common stock to decline dramatically, various other factors may cause the market price of our common stock to continue to fluctuate, perhaps substantially, including announcements of:

	•	technological innovations or regulatory approvals;

	•	results of clinical trials;

	•	new products by us or our competitors;

	•	developments or disputes concerning patents or proprietary rights;

	•	achieving or failing to achieve certain developmental milestones;

	•	public concern as to the safety of gene therapy, recombinant biotech or traditional pharmaceutical products;

	•	health care or reimbursement policy changes by governments or insurance companies;

	•	developments in relationships with corporate partners; or

	•	a change in financial estimates or securities analysts’ recommendations.

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

Item 3. Quantitative and Qualitative Disclosure About Market Risk

Our market risk disclosures set forth in Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2003, have not changed significantly.

Item 4. Controls and Procedures

Evaluation of disclosure controls and procedures. Our management, with the participation of our chief executive officer and chief financial officer, has evaluated our disclosure controls and procedures (as defined in Securities Exchange Act Rules 13a-15(e) and 15d-15(e)) as of March 31, 2004 and concluded that they were effective to provide a reasonable assurance that the information required to be disclosed by us in this Quarterly Report on Form 10-Q was recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and Form 10-Q.

Changes in internal control over financial reporting. There were no changes in our internal control over financial reporting during the quarter ended March 31, 2004 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

As of April 30, 2004, we were not involved in any material legal proceedings.

Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

On March 30, 2004, Avigen issued a total of 18,000 shares of its common stock at an aggregate purchase price of $108,900 upon the exercise of warrants previously sold in a private placement. These shares were issued to Iwaki and Associates, an entity controlled by Yuichi Iwaki, one of Avigen’s directors, in reliance on Section 4(2) under the Securities Act, in that they were issued to the original purchaser of the warrants. The purchaser represented, in connection with the original purchase of the warrants, that it was an accredited investor as defined in the Regulation D under the Securities Act.

Item 3. Defaults Upon Senior Securities

None.

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

None.

Item 5. Other Information

Consistent with Section 10A(i)(2) of the Securities Exchange Act of 1934, as added by Section 202 of the Sarbanes-Oxley Act of 2002, we are responsible for listing the non-audit services approved by our Audit Committee to be performed by Ernst & Young LLP, our external auditor. Non-audit services are defined as services other than those provided in connection with an audit or a review of our financial statements. The Audit Committee has approved our recurring engagements of Ernst & Young LLP for the following non-audit services: (1) preparation of tax returns, and tax advice in preparing for and in connection with such filings; (2) all work required to be performed by Ernst & Young LLP in connection with preparing and giving consents required to be given in connection with our filings with the Securities and Exchange Commission; (3) all work required to be performed by Ernst & Young LLP in connection with preparing and giving consents required to be given in connection with our planned filing with the Securities and Exchange Commission of a Form S-8 to register 250,000 shares of the Company’s common stock pursuant to the amendment to the Company’s 1996 Non-Employee Director’s Stock Option Plan to be approved at the Company’s upcoming annual meeting of stockholders; and (4) advice in preparing for the internal control documentation requirements of Section 404 of the Sarbanes-Oxley Act of 2002.

Item 6. Exhibits and Reports on Form 8-K

(a) The following exhibits are included herein:

Exhibit No.		Description

3.1*		Amended and Restated Certificate of Incorporation
3.1.1**		Certificate of Amendment to Certificate of Incorporation
3.2*		Restated Bylaws of the Registrant
4.1*		Specimen Common Stock Certificate
10.52		Separation Agreement dated March 8, 2004 between Avigen and John Monahan
31.1		Certification required by Rule 13a-14(a) or Rule 15d-14(a)
31.2		Certification required by Rule 13a-14(a) or Rule 15d-14(a)
32.1		Certification required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. §1350)

*	Filed as an exhibit to Avigen’s Registration Statement on Form S-1 (No. 333-3220) and incorporated herein by reference.
**	Incorporated by reference from such document filed with the SEC as an exhibit to Avigen’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2000 (Commission file number 0-28272), as filed with the SEC on February 13, 2001.

(b) Reports on Form 8-K

On February 11, 2004, we filed a current report on Form 8-K to furnish under Item 12 the announcement of our financial results for the quarter and year ended December 31, 2003, which announcement included our consolidated statements of operations and consolidated balance sheets for the periods presented.

SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	AVIGEN, INC.

Date: May 7, 2004	By:	/s/ KENNETH G. CHAHINE

		Kenneth G. Chahine Chief Executive Officer and President

Date: May 7, 2004	By:	/s/ THOMAS J. PAULSON

		Thomas J. Paulson Vice President Finance, Chief Financial and Accounting Officer, and Secretary

EXHIBIT INDEX

Exhibit No.		Description

3.1*		Amended and Restated Certificate of Incorporation
3.1.1**		Certificate of Amendment to Certificate of Incorporation
3.2*		Restated Bylaws of the Registrant
4.1*		Specimen Common Stock Certificate
10.52		Separation Agreement dated March 8, 2004 between Avigen and John Monahan
31.1		Certification required by Rule 13a-14(a) or Rule 15d-14(a)
31.2		Certification required by Rule 13a-14(a) or Rule 15d-14(a)
32.1		Certification required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. §1350)

*	Filed as an exhibit to Avigen’s Registration Statement on Form S-1 (No. 333-3220) and incorporated herein by reference.
**	Incorporated by reference from such document filed with the SEC as an exhibit to Avigen’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2000 (Commission file number 0-28272), as filed with the SEC on February 13, 2001.