TANOX INC - 10-K Annual Report

TABLE OF CONTENTS

	PART I	Page
ITEM 1.	Business	1
ITEM 2.	Properties	27
ITEM 3.	Legal Proceedings	27
ITEM 4.	Submission of Matters to a Vote of Security Holders	27
	PART II
ITEM 5.	Market for the Company’s Common Equity and Related Stockholder Matters	28
ITEM 6.	Selected Financial Data	29
ITEM 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	30
	Overview	30
	Critical Accounting Policies	30
	Results of Operations	31
	Liquidity and Capital Resources	33
ITEM 7A.	Quantitative and Qualitative Disclosures About Market Risk	36
ITEM 8.	Financial Statements and Supplementary Data	37
ITEM 9	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	62
ITEM 9A.	Controls and Procedures	62
	PART III
ITEM 10.	Directors and Executive Officers of the Registrant	63
ITEM 11.	Executive Compensation	63
ITEM 12.	Security Ownership of Certain Beneficial Owners and Management	63
ITEM 13.	Certain Relationships and Related Transactions	63
ITEM 14.	Principal Accounting Fees and Services	63
	PART IV
ITEM 15.	Exhibits, Financial Statement Schedules and Reports on Form 8-K	64
SIGNATURES		67

In this report, “Tanox”, the “Company”, “we”, “us” and “our” refer to Tanox, Inc. and its subsidiaries, unless the context otherwise suggests. “Common Stock” refers to Tanox’s common stock, par value $0.01 per share.

Xolair^® (omalizumab) anti-IgE antibody is a trademark of Novartis A.G.

PART I

ITEM 1. Business

Overview

Tanox discovers and develops therapeutic monoclonal antibodies to address significant unmet medical needs in the areas of immune-mediated diseases, infectious diseases, inflammation and oncology. Tanox’s products are genetically engineered antibodies that target a specific molecule or antigen. In addition, through collaborative agreements, Tanox receives royalties from the sale of Xolair^®(omalizumab), our first product.

Our first product, Xolair, was developed in collaboration with Genentech, Inc. and Novartis Pharma, A.G. Xolair received U.S. Food and Drug Administration (FDA) marketing approval on June 20, 2003, and was launched in the U.S. in July 2003. Xolair is currently labeled for treatment of adults and adolescents (12 years of age and above) with moderate-to-severe persistent asthma who have a positive skin test or in vitro reactivity to a perennial aeroallergen and whose symptoms are inadequately controlled with inhaled corticosteroids. Xolair is an anti-immunoglobulin E, or anti-IgE, antibody that has been shown to decrease the incidence of asthma exacerbations in these patients. Safety and efficacy have not been established in other allergic conditions.

On July 1, 2004, Novartis submitted an application for the European approval of Xolair as a treatment for allergic asthma. The proposed indication will focus on the prevention of asthma exacerbations and control of symptoms in adults and adolescent patients with severe persistent allergic asthma, who remain inadequately controlled despite the use of inhaled corticosteroids, long-acting beta-2 agonists, as well as other controller medications.

In May 2004, Novartis, in cooperation with Genentech, initiated a Phase 3 clinical trial for Xolair in pediatric allergic asthma patients. The pediatric trial is designed as a randomized, double-blind, placebo-controlled, global study of one-year duration, which will enroll approximately 570 patients between 6 and 12 years old. The primary objective of the study is to evaluate the efficacy and safety of Xolair in children with moderate-to-severe, persistent and inadequately controlled allergic asthma.

In July 2004, the first patient was enrolled in a Phase 2 clinical trial evaluating the safety and efficacy of Xolair in patients suffering from allergy (immediate hypersensitivity) to peanuts. The peanut allergy trial, which is being conducted by Genentech, is designed as a 38-week, multi-site study. Approximately 150 patients, between 6 and 75 years old with established peanut allergy, will be randomized 2-to-1 to receive Xolair or placebo. The primary objective of the study is to assess the efficacy of Xolair in preventing peanut-induced allergic reactions in patients with peanut allergy.

We are also assessing another product, TNX-355, as a treatment for the human immunodeficiency virus (HIV) and initiated a Phase 2 clinical trial of TNX-355 in May 2004. The Phase 2 study is a three-arm, double-blind, placebo-controlled study, which was fully enrolled as of the date of this report. All patients are anti-retroviral therapy-experienced and will be on optimized background therapy (OBT) during the study. TNX-355 is a humanized, non-immunosuppressive anti-CD4 monoclonal antibody that works by blocking the ability of HIV to enter CD4 cells. The CD4 receptor on host cell surfaces is considered to be a gateway for HIV infection. This monoclonal antibody is one of a relatively new class of drugs called viral entry inhibitors. Results from the Phase 1a study showed that TNX-355 demonstrated clinically significant viral load reductions in patients infected with HIV, lasting approximately 2 to 4 weeks with a single dose. The Phase 1b multi-dose administration study also demonstrated clinically significant viral load reductions that were maintained for 5 to 7 weeks. TNX-355 was safe and well tolerated in the single dose and multi-dose studies. TNX-355 received Fast Track Status from the FDA in 2003. The objective of the current Phase 2 study is to evaluate the safety and pharmacological activity of TNX-355 in combination with OBT as assessed by viral load reduction. TNX-355 will be administered every two weeks

during the 48-week trial duration. There is a planned interim evaluation at 24 weeks, and we expect to report those data in the fourth quarter of 2005.

Our Strategy

Our objective is to become a profitable, fully integrated biopharmaceutical company by developing, manufacturing and marketing innovative monoclonal antibody products for the treatment of immune-mediated diseases, infectious diseases, inflammation and cancer. Key aspects of our corporate strategy include the following:

· Expand the market opportunity for Xolair. In collaboration with Genentech and Novartis, we are continuing our efforts to expand the use of Xolair beyond adolescent and adult allergic asthma. This includes both geographic and label expansion. In 2004, Xolair was approved in Brazil, Canada and New Zealand, and submitted for approval in the European Union. Clinical trials are under way to evaluate Xolair’s effectiveness in treating pediatric allergic asthma and peanut allergy.

· Advance Our Product Pipeline. Our most-advanced clinical product, TNX-355, was shown to be well tolerated in Phase 1 clinical testing, with a reduction in viral load and no depletion of CD4 cell count. We anticipate interim 24-week data from our Phase 2 clinical trial in the fourth quarter of 2005 and have begun the process of planning for a Phase 3 study and developing a commercialization strategy. We also are focused on moving additional drug candidates through our pipeline and achieved progress in this regard in 2004 with both TNX-650 and TNX-717. We anticipate filing Investigational New Drug (IND) applications for these candidates in 2005 and 2007, respectively.

· Expand Our Product Pipeline Through Acquisition and Licensing. In addition to our internal development efforts, we plan to selectively license and acquire product opportunities and businesses that complement our product pipeline and technology platform. We believe that we are well positioned to attract in-licensing and acquisition candidates as a result of our expertise in monoclonal antibody technology and our strong financial position.

· Form Strategic Collaborations to Support Development and Commercialization of Our Products. To enable us to develop products and to mitigate risk, we may deem it advantageous to partner with other pharmaceutical and biotechnology companies. These partnerships could allow us to obtain funding for our development, manufacturing and marketing activities, thereby reducing the substantial financial investment that is required to develop our products. They could provide us with domestic and international marketing and sales expertise for our partnered products. To the extent economically feasible, we expect to retain strategically important development, manufacturing or marketing rights in order to maximize the value of our drug development opportunities.

· Strengthen our Operational Capabilities. To support research and development efforts and our clinical manufacturing and commercial supply needs, we will make strategic investments in technologies and other operational, enabling infrastructure to allow us to achieve full integration. To that end, in December 2004, we executed an agreement with Biogen IDEC to assume a long-term lease of a biologics manufacturing facility in San Diego, California, and to acquire certain manufacturing assets in the facility. This transaction, which closed in January 2005, is expected to significantly expand our antibody production capacity.

Monoclonal Antibodies

Monoclonal antibodies represent an exciting area of therapeutic product development. Genetically engineered monoclonal antibodies are man-made antibodies that target a specific antigen. Most monoclonal antibodies are derived from animals such as mice. When administered to humans, monoclonal antibodies from animals are seen by the immune system as foreign, which can lead to adverse responses.

Antibody design technologies have enabled scientists to develop humanized (human-like) and fully human antibody products to address this potential problem. Advances in antibody production technologies, such as high productivity cell culture and experimental technologies such as transgenic plants and animals, have enabled manufacturers to produce antibody products more cost-effectively. Many monoclonal antibodies have been approved for marketing as therapeutics by the FDA, and a large number of monoclonal antibodies are currently under investigation in clinical trials.

Our monoclonal antibody therapeutics treat disease by altering the function of a specific disease-causing protein, called a drug target. We have designed drugs to deactivate or reduce the activity of targets in the immune system for the treatment of allergic and autoimmune disease, to block a target that prevents survival of bone-building cells for the treatment of osteoporosis, and to disable a target that is used by HIV to infect human cells. Our products and product candidates have either resulted from internal research, were in-licensed or were acquired.

Marketed Product—Xolair

Xolair, the first anti-IgE antibody to reach the market, is also Tanox’s first commercial product. Xolair was approved by the FDA on June 20, 2003. Xolair generated approximately $188.5 million of sales in the U.S. in 2004, of which Tanox earned net royalties of $13.3 million. The current approved label for Xolair is for treatment of adults and adolescents (12 years of age and above) with moderate-to-severe persistent asthma who have a positive skin test or in vitro reactivity to a perennial aeroallergen and whose symptoms are inadequately controlled with inhaled corticosteroids. Xolair has been shown to decrease the incidence of asthma exacerbations in these patients. Safety and efficacy have not been established in other allergic conditions.

Mechanism of Action of Xolair

Xolair is a recombinant humanized monoclonal antibody targeting IgE, one of the key inflammatory proteins implicated in allergic diseases such as asthma, allergic rhinitis and food allergy. The immune system of an allergic individual responds to an environmental protein, or allergen, by producing IgE that reacts with the allergen. IgE initially binds to the surface of mast cells and basophils through high affinity IgE receptors on the cell surface. These cells are found in tissue and also circulate in the blood, and they contain chemicals including histamine and leukotrienes, which provoke inflammation. When a mast cell or basophil armed with allergen specific IgE on its surface comes into contact with its cognate allergen, the allergen will cross-link the surface-bound IgE molecules, with resultant cross-linking of the underlying IgE receptors. This event signals the mast cell or basophil to release its powerful chemicals, causing tissue inflammation and asthma and allergy symptoms, including bronchoconstriction, wheezing, coughing, sneezing, runny nose, watery eyes and itching. Xolair works by attaching to circulating IgE and masking the binding site for the IgE receptor which prevents IgE from binding to and arming mast cells and basophils. In this manner, Xolair reduces the inflammatory response to allergens. Xolair also reduces the high-affinity IgE receptors on the surface of white blood cells, further diminishing the allergic response.

Market Opportunity—Moderate to Severe Allergic Asthma

Asthma makes breathing difficult and is potentially life threatening. Approximately 35.6 million people in the top seven global markets (France, Germany, Italy, Spain, the United Kingdom, Japan and the United States) suffer from asthma. Approximately two-thirds of these patients have allergic asthma. In the United States, there are 17 million asthmatics, of which approximately 10 million receive treatment. Of the 10 million Americans treated for asthma, approximately 8.5 million patients are age 12 and above, and 5.1 million of these 8.5 million patients have the allergic form of the disease. Of these, 4.2 million have IgE levels and body weight that fit within the dosing algorithm for Xolair, 1.9 million of these patients have

moderate-to-severe asthma, and 500,000 of them are uncontrolled by current medications. Xolair is being initially targeted to this patient population of 500,000.

Commercialization Status

Genentech and Novartis, which have commercialization rights under our collaboration, launched Xolair in the U.S. in July 2003, with a 250 person sales force (125 sales representatives from each company). This sales force is targeting sales and marketing efforts at allergists and pulmonologists who specialize in the treatment of asthma. Xolair is being distributed by a network of five specialty pharmacies: Caremark Rx, CuraScript Pharmacy, Nova Factor, Option Care and Priority Healthcare.

Xolair generated approximately $188.5 million in U.S. sales in 2004, its first full year on the market, of which Tanox earned $13.3 million in net royalties (after payments to our former attorneys and after milestone and other credits). Broad insurance coverage for Xolair has been secured. The impact of the Medicare Modernization Act on Xolair is expected to be minimal given that Xolair has a small Medicare patient population.

Xolair has also been approved for marketing in Australia, Brazil, Canada, Guatemala, New Zealand and Venezuela. The European Agency for the Evaluation of Medicinal Products (EMEA) is currently reviewing the Xolair marketing application for Europe, and we expect that the EMEA will make a decision in mid-2005.

Drugs in Development

Xolair

Two clinical trials were initiated for Xolair in 2004 by our collaborators, Genentech and Novartis. In May 2004, Novartis began a Phase 3 clinical trial of Xolair in pediatric allergic asthma patients. The pediatric trial is designed as a 12-month randomized, double-blind, placebo-controlled, global study, which will enroll approximately 570 patients who are between 6 and 12 years old. The primary objective of the study is to evaluate the efficacy and safety of Xolair in children with moderate-to-severe, persistent and inadequately controlled allergic asthma. Asthma is the most common serious chronic disease of childhood, affecting nearly 5 million children in the U.S. Characterized by coughing, chest tightness, shortness of breath and wheezing, asthma is the cause of almost 3 million physician visits and 200,000 hospitalizations each year.

In July 2004, Genentech began a 38-week, multi-site, Phase 2 clinical trial of Xolair in patients suffering from allergy (immediate hypersensitivity) to peanuts. Approximately 150 patients, between 6 and 75 years old with established peanut allergy, will be randomized 2-to-1 to receive Xolair or placebo. The primary objective of the study is to assess the efficacy of Xolair in preventing peanut-induced allergic reactions in patients with peanut allergy. Peanut allergy affects approximately 1.5 million people in the U.S., 50 to 100 of whom die each year from unintended ingestion of foods containing peanuts or peanut derived ingredients. Current treatment is avoidance of peanuts and peanut oil, which is used in preparation of many food products. Complete avoidance requires constant vigilance and is difficult because prepared food labeling does not always identify peanut-derived ingredients. Accidental exposures can result in serious allergic reactions and sometimes death. Patients with severe peanut allergy take antihistamines to prevent reactions to accidental exposure and may require administration of epinephrine for severe anaphylactic reactions.

TNX-355

TNX-355 is a humanized, non-immunosuppressive anti-CD4 monoclonal antibody that we are developing for treatment of human immunodeficiency virus (HIV). TNX-355 is a first-in-class CD4

receptor antagonist and part of a new overall class of drugs known as viral entry inhibitors. HIV enters the host cell by binding to the CD4 receptors on the cells. In laboratory studies, TNX-355 binds to the CD4 receptor on the cell surface and prevents viral entry into the cell, thereby blocking cellular infection. Because it binds to a region of the CD4 molecule that is not involved with normal immune function, laboratory studies show that TNX-355 does not suppress immune function in monkeys nor in human blood cells. Results from Phase 1 studies, completed in 2003 and 2004, showed that TNX-355 was well tolerated and can cause a transient but clinically meaningful reduction in viral load in patients infected with HIV, lasting approximately 2 to 4 weeks with single-dose administration and 5 to 7 weeks in the multi-dose administration trial. TNX-355 received Fast Track status from the FDA in October 2003.

Market Opportunity. According to the World Health Organization, HIV infects approximately 1.5 million people in North America and Western Europe. A number of drugs targeting viral replication are being used to treat the disease, often in combination with others. About 30% of the patients treated with drug combinations no longer respond to the treatment since their HIV has become drug resistant. In addition, many drug combinations produce a variety of undesirable side effects.

Development Status and Clinical Results. In May 2004, the Company initiated a Phase 2 study with TNX-355. The Phase 2 study is a three-arm, double-blind, placebo-controlled study, which was fully enrolled as of the date of this report. All patients in the study are anti-retroviral therapy-experienced and are on optimized background therapy (OBT). The objective of the 48-week study is to evaluate the safety and pharmacological activity of TNX-355 in combination with OBT as assessed by viral load reduction. The primary endpoint for the Phase 2 trial is a significant reduction in viral load levels between either of the active arms versus the control arm (OBT alone) after 24 weeks. A significant viral load reduction is defined as > 0.5 log₁₀. Secondary objectives of the study are: a change in percentage and number of CD4 cell count from baseline; the proportion (or number) of subjects who achieve a reduction of 1.0 log₁₀ HIV-1 RNA; the time to virologic failure; the extent of emergence of resistance; time to loss of virologic response; and Average Area Under the Curve Minus Baseline. We expect to report interim 24-week data from the clinical trial in the fourth quarter of 2005. We have exclusive worldwide rights to TNX-355 through a license from Biogen IDEC, Inc.

In an open-label, single-dose, dose-escalating Phase 1a safety study in 30 HIV-infected patients (J Infect Dis, 2004;189:286-291), TNX-355 demonstrated dose-responsive decreases in viral load, with greater than one log₁₀ decreases in viral load observed at the 10 and 25 mg/kg dose. The drug was well tolerated in all dose groups (0.3 - 25 mg/kg). We have also completed a multiple-dose Phase 1b trial in 22 HIV-infected patients to further evaluate the drug’s safety and effectiveness in reducing HIV-1 viral load. The results were presented at the 11^th Conference on Retroviruses and Opportunistic Infections in San Francisco on February 11, 2004. In this open-label trial, patients were on a failing HAART (highly active anti-retroviral therapy) regimen or on no other antiretroviral therapy and received one of three different regimens of TNX-355 (10 mg/kg weekly, 6 mg/kg biweekly after a 10 mg/kg loading dose, and 25 mg/kg biweekly) for 8 to 9 weeks. Transient, clinically important (³ 0.5 - 1.7 log₁₀) reductions in viral load were observed in all but one patient, and 64% of patients experienced at least a 1.0 log₁₀ (90%) decrease in viral load. This study continued to demonstrate the tolerability and anti-retroviral activity of TNX-355 observed in the Phase 1a study. As has been seen with other anti-retroviral agents when tested as monotherapies (either as a single therapy or in combination with failing drug regimens), the viral load recovered despite continued administration of TNX-355, and an assessment of therapeutic potential requires evaluation of the drug in combination with other antiretroviral agents.

Our Research Programs

We are committed to identifying new drugs for treating inflammatory and infectious diseases and cancer. A cornerstone of our discovery effort is our monoclonal antibody development platform which is a semi-automated, high-throughput system that gives us the capability to identify and optimize individual monoclonal antibody leads in a 12-18 month timeframe. Monoclonal antibody candidates derived from mice are generally humanized to reduce the possibility of immunogenicity, which could lead to decreased activity and tolerability in patients. Additionally, fully human monoclonal antibody candidates are generated from phage libraries using technology licensed from Dyax Corp. (Dyax), a biotechnology company. Our antibodies are also optimized for affinity, effector function and circulating half-life to enhance their therapeutic potential.

Our monoclonal antibody therapeutics treat disease by altering the function of a specific disease-causing protein, called a drug target. There can be one or more targets for each disease, and some targets may be shared by more than one indication. We select drug targets that are well-established in the scientific community, as well as novel drug targets that are proprietary to Tanox. Identification of novel targets typically involves a range of technologies including genome-wide expression profiling, proteomics, bioinformatics and transgenic mouse technologies. Once a new target has been identified and its relevance to disease has been confirmed or validated, proprietary monoclonal antibody drug candidates are generated and selected based on their ability to precisely modulate target function. We have the following product candidates in preclinical development and research:

Investigational Product	Target	Proposed Indication	Status
TNX-650	Pro-Inflammatory Cytokine	Inflammatory Diseases	Preclinical
TNX-717	Pro-Apoptotic Factor	Osteoporosis	Research
TNX-558	Complement C5a	Inflammatory Diseases	Research
TNX-668	Pro-Inflammatory Cytokine	Systemic Lupus Erythematosus	Research
TNX-336	Co-Stimulatory Molecule	Autoimmune Diseases	Research

Therapeutic monoclonal antibody candidates for certain targets have been developed for the following indications: an allergic mediator for allergic diseases, including the complement component C5a for various inflammatory indications; antagonists of two distinct pro-inflammatory cytokines for inflammatory disease and systemic lupus Erythematosus; a co-stimulatory molecule for autoimmune diseases, such as multiple sclerosis; and a proprietary cell signaling target (SARP2) for the treatment of diseases that result from reduced bone mineral density, such as osteoporosis. Initial validation of the latter target was accomplished in connection with the establishment of a cross-license agreement between Tanox and Wyeth, a US-based pharmaceutical and health care products company.

Collaboration and Licensing Agreements

Collaboration with Novartis and Genentech

Our lead product, Xolair, was the result of a three-party collaboration with Novartis and Genentech. In 1990, we established a collaboration with Novartis to jointly develop anti-IgE antibodies to treat allergic diseases. In connection with the settlement of a lawsuit in 1996, Genentech joined the collaboration for the purpose of developing certain anti-IgE antibodies. In February 2004, we finalized the detailed terms of this three-party collaboration, which provides for the following:

· Development. Novartis or Genentech are responsible for conducting clinical trials and obtaining the regulatory approval for Xolair and the other anti-IgE products developed through the collaboration in the U.S. and Europe, and they share all related development costs. We have primary development responsibility for collaboration products in China, Hong Kong, Korea,

Singapore and Taiwan (East Asia), and we and Novartis equally share these development costs. Novartis is responsible for development and associated costs in the rest of the world.

· Manufacturing. Novartis and Genentech are responsible for manufacturing Xolair and other selected anti-IgE products worldwide. In consideration for relinquishing any rights to manufacture up to 50% of the worldwide requirements of those products, we will receive quarterly payments from Novartis or Genentech based on the quantity of product manufactured.

· Marketing. Novartis and Genentech share U.S. marketing rights and have each dedicated an equal number of sales representatives to promote Xolair in the U.S. Novartis has marketing rights outside the U.S.

· Milestone Payments. We may receive up to an additional $25.0 million in Xolair-related milestone payments of which $7.2 million would be payable to our former attorneys under an adverse arbitration ruling and $2.5 million would be creditable against future royalty payments. If a second drug were to be developed under the collaboration, we could be eligible for additional milestone payments of $10.5 million.

· Royalties and Profit Sharing. In the United States, we receive royalties on sales of Xolair and other collaboration products and will receive a share of Novartis’ profits on these sales. We also receive royalties on sales of Xolair and other collaboration products outside the U.S. We share equally with Novartis the net profits and net losses from sales of Xolair and other collaboration products in East Asia. Novartis profit-sharing and rest-of-world royalty payments will be net of certain other credits, which, at December 31, 2004, approximated $2.0 million. In addition, as a result of an adverse arbitration award, 10% of all royalties received by Tanox on sales of Xolair and certain other anti-IgE products will be payable to our former attorneys, up to a maximum of $300 million. We expect that the net amount Tanox will receive from Xolair sales, taking into account both the foregoing credit and the amount payable to our former attorneys will be in the range of 8% to 12% of the net sales depending on the sales level achieved and geographic distribution of the sales. Milestone and other credits caused the net amount that Tanox received from Xolair royalties to be below 8% of net sales in 2004.

Either Novartis or Genentech may withdraw from the collaboration, and, in such case, rights to Xolair and any other products developed by the collaboration revert to us and the remaining collaborator (or, if Genentech is the withdrawing party, to F. Hoffman-La Roche Ltd., if Roche exercises its option to do so), depending on which party shares rights with the withdrawing collaborator in a particular territory.

In addition to the collaboration described above, we and Genentech are parties to a cross-license agreement under which each has an option to license the other party’s patents that are necessary for the manufacture, use or sale of certain anti-IgE antibodies. This option may be exercised at any time if either party chooses to independently develop a product that does not fall within the collaboration, if our collaboration with Novartis and Genentech terminates, or if we and Genentech mutually agree.

We are also party to an Amended and Restated Development and Licensing Agreement with Novartis under which we have agreed to collaborate on anti-IgE antibodies that do not fall within the three-party collaboration and, in general, are either (i) invented and synthesized by Tanox or (ii) invented and synthesized by Novartis and derived from a Tanox antibody or would infringe certain Tanox patent rights.

Other License Agreements

Biogen IDEC. In 1998, we entered into an agreement to license from Biogen, Inc. (now Biogen IDEC, Inc.) its anti-CD4 monoclonal antibody and intellectual property on an exclusive worldwide basis with limited sublicensing rights. Biogen IDEC owns issued U.S., European, Canadian, Hong Kong and

Australian patents and has pending applications in Japan, which cover our TNX-355 product. We agreed to make royalty payments to Biogen IDEC based on annual net sales levels. In addition to royalty payments, we may make up to an aggregate of $1.4 million (which could be increased to an aggregate of $10.4 million in the event we merge or affiliate with a company of similar size to Biogen IDEC) in product license fees and development milestone payments under this agreement, of which we have paid $200,000. The license terminates on a country-by-country basis on the later of the expiration of 12 years following the first commercial product sale or the expiration or invalidity of applicable patents. The licensed patents expire in Europe in 2011 and in the United States in 2016, subject to extensions.

Wyeth. In November 2003, we entered into cross license agreements with Wyeth Pharmaceuticals Division, a division of Wyeth, with respect to patent rights covering a new class of drugs for the treatment of osteoporosis. Under the agreements, Wyeth received a license under Tanox patents to develop a small molecule-based drug, and Tanox received a license under Wyeth’s patent applications to develop an antibody-based drug. The research is based on a proprietary target gene on which Tanox holds a patent. Under the cross-licensing agreements, Tanox may receive milestone and royalty payments with respect to Wyeth-developed products and may pay Wyeth milestones and royalties with respect to Tanox-developed products. In 2003, we received an upfront license payment of $1.0 million from Wyeth.

Dyax. In November 2004, we entered into an agreement with Dyax Corp. (Dyax) to obtain a non-exclusive license to its proprietary antibody phage display libraries. We intend to utilize the Dyax libraries to identify fully human monoclonal antibodies that bind with high specificity and affinity to a number of our targets. Under the terms of the agreement, Dyax received an up front license fee of $900,000. Dyax is also entitled to annual technology license fees, clinical milestone payments, and royalties upon successful commercialization by Tanox of products based on antibodies identified from the Dyax libraries.

Patents and Proprietary Rights

Proprietary protection for our products, processes and know-how is important to our business. Our policy is to file patent applications to protect technology, inventions, and improvements that we consider important to the development of our business. We continually strive for technological innovations to develop and maintain our competitive position. We aggressively prosecute our patents and protect our proprietary technology to maintain our proprietary position. Our success depends in large part on our ability to obtain, protect and enforce commercially valuable patents.

We hold or have in-licensed a number of U.S. and foreign patents covering certain proprietary technology and products, with over 65 U.S. patents granted to date, as well as numerous patents granted in Europe, Canada, Japan, Australia, Singapore, Hong Kong, Korea and several other Asian countries. One of the key families of patents we hold relates to anti-IgE antibodies and their use in the treatment of allergy-related disease. These patents cover Xolair and are licensed to Genentech and Novartis under our three-party collaboration and to Novartis under the Amended and Restated Development and Licensing Agreement. The patents expire between 2009 and 2013, subject to potential patent term extension. In addition, we co-own other anti-IgE related patents with Novartis. We also have additional pending applications related to the treatment of IgE mediated disease.

Our portfolio also includes a family of patents that was in-licensed from Biogen IDEC related to anti-CD4 antibodies. These patents cover TNX-355, and the U.S. patent expires in 2016, subject to potential patent term extension as it applies to TNX-355. Foreign patents, including those in Europe, Canada, and Australia, will expire in 2011, subject to potential patent term extension. The application in Japan is still pending. We also have patents related to complement pathway inhibitors and apoptosis-regulating proteins, including Bak and SARP.

Our commercial success depends on our ability to operate without infringing the patents and other proprietary rights of third parties. In the event that our technologies may infringe patents or violate

proprietary rights of third parties, we may be prevented from pursuing product development, manufacturing or commercialization in that field. Such a result may materially harm our business, financial condition and results of operations. If our antibody products or their commercial use or production meet all of the requirements of any of the claims of third-party patents, or patents that may issue from third-party patent applications, then we may need a license to one or more of these patents. We expect to seek to obtain licenses to such patents when, in our judgment, such licenses are needed. However, we cannot assure you that we will be able to obtain any such license on commercially favorable terms, if at all. If these licenses are not obtained, we might be prevented from using certain of our technologies for the generation of our recombinant antibody products.

The scope, enforceability and validity of third party patents, the extent to which we must obtain licenses under such patents or under other proprietary rights and the cost and availability of licenses are unknown, but these factors may limit our ability to market our products. Moreover, even if a license were available, the payments that would be required could render our efforts to market certain of our products uneconomic. If we elect to manufacture or market these products without either a license or a favorable result in litigation, damages could be assessed that could be materially adverse to us. Further, failure to obtain a license could result in an injunction prohibiting us from manufacturing or selling the affected lines of products.

In addition to patents, we rely on trade secrets and proprietary know-how. We seek protection in part through confidentially agreements. Our policy is to require all employees, consultants, advisors, outside scientific collaborations, sponsored researchers, and other advisors to execute confidentially agreements upon commencing a relationship with Tanox.

Government Regulation

The manufacture and marketing of our products and our research and development activities are subject to regulations relating to product safety and efficacy by numerous governmental authorities in the United States and other countries. In the United States, drugs are subject to rigorous FDA regulation. The Federal Food, Drug and Cosmetic Act and other federal and state statutes and regulations govern, among other things, the testing, manufacture, safety, effectiveness, labeling, storage, record keeping, approval, advertising and promotion of our products. The lengthy process of seeking drug approvals, and the subsequent compliance with applicable statutes and regulations, require the expenditure of substantial resources. Failure to comply with applicable regulations can result in refusal by the FDA to approve product license applications. The FDA also has the authority to revoke previously granted product approvals.

Before we may market a pharmaceutical product in the United States, the FDA requires us to complete a series of preclinical and human clinical tests. Other countries have similar regulations. Preclinical tests include laboratory evaluations of product chemistry and animal studies to assess the potential safety and efficacy of the product and its formulations. The results of these studies must be submitted to the FDA as part of the investigational new drug application (IND). Human clinical trials cannot begin until the FDA approves the IND application. Clinical testing involves a three-phase process. In Phase 1, a small number of patients or healthy volunteers are tested with the drug to assess its safety profile (adverse effects), dosage tolerance, metabolism, distribution, excretion and clinical pharmacology. In Phase 2, clinical trials are conducted with groups of patients afflicted with a specified disease in order to provide enough data to evaluate the preliminary efficacy, optimal dosage regimen and expanded evidence of safety. In Phase 3, the drug is tested in a large number of patients with a target disease to provide enough data to statistically evaluate the efficacy and safety of the product. We cannot assure you that we will successfully complete clinical testing of our products within any specified time period, if at all. The results of the preclinical and clinical testing of the product are then submitted to the FDA in the form of a biological license application (BLA) or new drug application (NDA), for marketing approval. In

responding to a BLA or NDA, the FDA may grant marketing approval, request additional testing or information (either before or after approval) or deny the application if it determines that the application does not provide sufficient evidence of safety and efficacy for approval. We cannot assure you that FDA approval will be obtained on a timely basis, if at all, for any of our products.

In addition, the FDA requires the registration of each drug and approval of each manufacturing establishment. Since any approval granted by the FDA is both site and process specific, any material change in the manufacturing process, equipment or location necessitates additional FDA review and approval. For our monoclonal antibody products, we are subject to the procedures for biological products. Domestic manufacturing establishments are subject to FDA inspection and must comply with current good manufacturing practices (cGMP) for pharmaceutical products. To supply products for use in the United States, foreign manufacturing establishments must comply with cGMP and are subject to periodic FDA or other regulatory authority inspection under reciprocal agreements with the FDA.

For marketing outside the United States, we also are subject to foreign regulatory requirements governing human clinical trials and marketing approval for pharmaceutical products. The requirements governing the conduct of clinical trials, product licensing, pricing and reimbursement vary widely from country to country. Whether or not we obtain FDA approval, we must obtain approval of a product by the comparable regulatory authorities of foreign countries before manufacturing or marketing the product in those countries. The approval process varies from country to country and the time required for these approvals may differ substantially from that required for FDA approval. We cannot assure you that clinical trials conducted in one country will be accepted by other countries or that approval in one country will result in approval in any other country.

In recent years, there have been numerous proposals to change the healthcare system in the United States. Some of these proposals have included measures that would limit or eliminate payments for medical procedures and treatments or subject pharmaceutical product pricing to government control. In addition, as a result of marketplace pressures, third-party payors are increasingly attempting to contain healthcare costs by limiting both coverage and the level of reimbursement of new drug products. Consequently, significant uncertainty exists as to the reimbursement status of newly-approved healthcare products. If we or any of our collaborators succeed in bringing one or more of our products to market, we cannot assure you that third-party payors will consider them cost effective or allow reimbursement to the consumer at price levels sufficient for us to realize an appropriate return on our investment in product development or to even realize a profit. Significant changes in the healthcare system in the United States or elsewhere, including changes resulting from adverse trends in third-party reimbursement programs, could materially reduce our profitability. Such changes could also significantly harm our ability to raise the capital we would need to continue our operations. Furthermore, if these proposals affect our collaborators, the proposals may harm our ability to commercialize the products we develop jointly with them.

In addition to FDA regulations, we are subject to regulation under the Occupational Safety and Health Act, the Environmental Protection Act, the Toxic Substances Control Act, the Resource Conservation and Recovery Act and other present and future federal, state or local regulations.

Competition

The pharmaceutical and biotechnology industries are characterized by rapidly evolving technology and intense competition. Many companies, including major pharmaceutical and chemical companies, as well as specialized biotechnology companies, perform activities similar to Tanox’s. Many of these companies have substantially greater financial and other resources, larger intellectual property estates, larger research and development staffs, and greater capabilities and experience in preclinical testing, human clinical trials, regulatory affairs, manufacturing and marketing. We chose to enter into the collaboration agreements with Novartis and Genentech, in part, to secure the benefit of their experience in these areas, as well as the

contribution of their greater financial resources. In addition, colleges, universities, governmental agencies and other public and private research organizations conduct research and may market commercial products on their own or through joint ventures. These institutions are becoming more active in seeking patent protection and licensing arrangements to collect royalties for using technology that they have developed. We also compete with these institutions in recruiting and retaining highly qualified scientific personnel.

The diseases that we have targeted, including asthma, allergy, inflammation, other diseases affecting the human immune system, infectious diseases and cancer are intensely competitive areas targeted by both pharmaceutical companies and other biotechnology companies, including Novartis and Genentech. All of these companies may have competitive products on the market, may be testing their products in clinical trials or may be focusing on product approaches that could prove to be superior to our approaches. For instance, we are aware that some of these companies, which may be our competitors, have filed applications for or have been issued patents and may obtain additional patent and proprietary rights relating to products or processes used in, necessary to, competitive with or otherwise related to, our products or processes. These patents include, among other items, patents relating to humanized monoclonal antibodies.

Our competition will be determined in part by the potential indications for which our antibodies are developed and ultimately approved by regulatory authorities. For some of our potential products, an important factor in competition may be the timing of market introduction of our products or competitive products. Accordingly, we expect the relative speed with which we develop our products, complete the necessary approval processes and are able to generate and market commercial quantities of the products to be important competitive factors. We expect that competition among products approved for sale will be based, among other factors, on product efficacy and safety, timing and scope of regulatory approval, product availability, advantages over alternative treatment methods, price and cost-effectiveness, development, distribution and marketing capabilities, third-party reimbursement and patent position.

We are aware that several companies, including Novartis, have existing products that compete with Xolair, including corticosteriods, beta-agonists, antihistamines, leukotriene inhibitors, PDE4 inhibitors and allergen immunotherapy. In addition, several other companies have products in development that may compete with Xolair. These companies include, but are not limited to, Biogen IDEC (Anti-CD23), CellTech/Schering-Plough (Anti-IL5), GlaxoSmithKline (Anti-IL5), Protein Design Labs (Anti-IL2) and Genaera/MedImmune (Anti-IL9).

Our TNX-355 program will face competition from existing HIV therapies and particularly new viral entry inhibitors that target CCR5, CXCR4 and gp120 receptors, such as Fuzeon (Roche/Trimeris), PRO-542 and PRO-140 (Progenics), SCH-C and SCH-D (Schering-Plough), UK-427857 (Pfizer/Millenium), TAK-220 (Takeda), AMD070 (AnorMed) and 873140/ONO4128 (GlaxoSmithKline).

Our competitive position also depends upon our ability to:

· discover or acquire and successfully develop new therapeutic products that successfully treat human diseases;

· develop proprietary products or processes for which we can obtain patent protection and secure necessary licenses under third party patents;

· secure sufficient capital resources to complete product development and regulatory processes;

· build or secure manufacturing capacity and manufacture efficiently;

· enter into collaboration and licensing agreements on acceptable terms;

(Mark one)
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Delaware		76-0196733
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