UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

ý		Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

		For the quarterly period ended March 31, 2006.

		or

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 0-22987

VALENTIS, INC.

(Exact Name of Registrant as Specified in Its Charter)

Delaware		94-3156660
(State or Other Jurisdiction of Incorporation or Organization)		(IRS Employer Identification No.)

863A Mitten Rd., Burlingame, CA		94010
(Address of Principal Executive Offices)		(Zip Code)

650-697-1900

(Registrant’s Telephone Number Including Area Code)

Indicate by check mark whether the registrant (1) has filed all reports required 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 ý No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer o Accelerated Filer o Non-accelerated Filer ý

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

The number of outstanding shares of the registrant’s Common Stock, $0.001 par value, was 17,068,919 as of May 11, 2006.

PART I: FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

VALENTIS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

	March 31, 2006			June 30, 2005
	(unaudited)			(Note 1)
ASSETS
Current assets:
Cash and cash equivalents	$	7,134		$	8,865
Short-term investments	750			3,648
Interest and other receivables	48			357
Prepaid expenses and other current assets	429			337
Total current assets	8,361			13,207
Property and equipment, net	43			39
Goodwill	409			409
Other assets	497			497
Total assets	$	9,310		$	14,152
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	222		$	265
Accrued compensation	621			496
Accrued clinical trial costs	1,487			863
Other accrued liabilities	1,206			959
Deferred Revenue	27			—
Total current liabilities	3,563			2,583
Stockholders’ equity:
Common stock	17			15
Additional paid-in capital	243,400			236,889
Accumulated other comprehensive loss	(693		)	(698		)
Accumulated deficit	(236,977		)	(224,637		)
Total stockholders’ equity	5,747			11,569
Total liabilities and stockholders’ equity	$	9,310		$	14,152

See accompanying notes.

VALENTIS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)

	Three Months Ended March 31,						Nine Months Ended March 31,
	2006			2005			2006			2005
License and other revenue	$	114		$	324		$	587		$	1,620
Total revenue	114			324			587			1,620

Operating expenses:
Research and development	3,694			2,608			9,299			7,254
General and administrative	1,320			750			3,801			3,020
Total operating expenses	5,014			3,358			13,100			10,274
Loss from operations	(4,900		)	(3,034		)	(12,513		)	(8,654		)

Interest income	50			70			208			220
Other expenses	—			(13		)	(35		)	(58		)
Net loss	$	(4,850	)	$	(2,977	)	$	(12,340	)	$	(8,492	)

Basic and diluted net loss per share	$	(0.32	)	$	(0.23	)	$	(0.83	)	$	(0.65	)

Weighted-average shares used in computing net loss per common share	15,112			13,028			14,933			12,971

See accompanying notes.

VALENTIS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

	Nine Months Ended March 31,
	2006			2005
Cash flows from operating activities:
Net loss	$	(12,340	)	$	(8,492	)
Adjustments to reconcile loss to net cash used in operations:
Depreciation	28			43
Stock warrants granted to non-employees for services rendered	—			454
Stock-based compensation	1,435			47
401(k) stock contribution matching expense	62			55
Changes in operating assets and liabilities:
Interest and other receivables	309			(32		)
Prepaid expenses and other assets	(92		)	(32		)
Deferred revenue	27			(100		)
Accounts payable	(43		)	(170		)
Accrued liabilities	996			(1,166		)
Net cash used in operating activities	(9,618		)	(9,393		)

Cash flows from investing activities:
Purchase of property and equipment	(32		)	(8		)
Purchase of available-for-sale investments	(5,522		)	(9,579		)
Maturities of available-for-sale investments	8,425			13,488
Net cash provided by investing activities	2,871			3,901

Cash flows from financing activities:
Proceeds from issuance of common stock, net of repurchases	5,016			227
Net cash provided by financing activities	5,016			227

Net (decrease) in cash and cash equivalents	(1,731		)	(5,265		)
Cash and cash equivalents, beginning of period	8,865			9,516
Cash and cash equivalents, end of period	$	7,134		$	4,251

See accompanying notes.

VALENTIS, INC.

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Basis of Presentation

The accompanying condensed consolidated financial statements are unaudited and have been prepared by Valentis, Inc. (“Valentis,” the “Company,” “we,” “us” or “our”) in accordance with the rules and regulations of the Securities and Exchange Commission for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Certain information and footnote disclosures normally included in our annual consolidated financial statements as required by accounting principles generally accepted in the United States have been condensed or omitted. The interim condensed consolidated financial statements, in the opinion of management, reflect all adjustments (consisting of normal recurring accruals) necessary for a fair statement of financial position at March 31, 2006 and the results of operations for the interim periods ended March 31, 2006 and 2005. The balance sheet at June 30, 2005 is derived from the audited consolidated financial statements at that date but does not include all the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.

The results of operations for the three and nine months ended March 31, 2006 are not necessarily indicative of the results of operations to be expected for the fiscal year, although Valentis expects to incur a substantial loss for the year ended June 30, 2006. These interim condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the fiscal year ended June 30, 2005, which are contained in Valentis’ Annual Report on Form 10-K filed with the Securities and Exchange Commission.

The accompanying condensed consolidated financial statements include the accounts of Valentis and its wholly-owned subsidiary, PolyMASC Pharmaceuticals plc. All intercompany balances and transactions have been eliminated.

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. Our unaudited condensed consolidated financial statements have been presented on a basis that contemplates the realization of assets and satisfaction of liabilities in the normal course of business.

2. Significant Accounting Policies

Revenue Recognition

Revenue arrangements with multiple elements are divided into separate units of accounting if certain criteria are met, including whether the delivered item has value to the customer on a stand-alone basis and whether there is objective and reliable evidence of the fair value of the undelivered items. Consideration received is allocated among the separate units of accounting based on their respective fair values, and the applicable revenue recognition criteria are considered separately for each of the separate units.

Non-refundable up-front payments received in connection with research and development collaboration agreements, including technology advancement funding that is intended for the development of the Company’s core technology, are deferred and recognized on a straight-line basis over the relevant period specified in the agreement, generally the research term.

Revenue related to research with the Company’s corporate collaborators is recognized as research services are performed over the related funding periods for each contract. Under these agreements, the Company is required to perform research and development activities as specified in each respective agreement. The payments received under each respective agreement are not refundable and are generally based on a contractual cost per full-time equivalent employee working on the project. Research and development expenses under the collaborative research agreements approximate or exceed the revenue recognized under such agreements over the terms of the respective agreements. Deferred revenue may result when the Company does not incur the required level of effort during a specific period in comparison to funds received under the respective contracts. Payments received relative to substantive, at-risk incentive milestones, if any, are recognized as revenue upon achievement of the incentive milestone event because the Company has no future performance obligations related to the payment. Incentive milestone payments are triggered either by results of the Company’s research efforts or by events external to the Company, such as regulatory approval to market a product.

The Company also has licensed technology to various biotechnology, pharmaceutical and contract manufacturing companies. Under these arrangements, the Company receives nonrefundable license payments in cash. These payments are recognized as revenue when received, provided the Company has no future performance or delivery obligations under these agreements. Otherwise, revenue is deferred until performance or delivery is satisfied. Certain of these license agreements also provide the licensee an option to acquire additional licenses or technology rights for a fixed period of time. Fees received for such options are deferred and recognized at the time the option is exercised or expires unexercised. Additionally, certain of these license agreements involve technology that the Company has licensed or otherwise acquired through arrangements with third parties pursuant to which the Company is required to pay a royalty equal to a fixed percentage of amounts received by the Company as a result of licensing this technology to others. Such royalty obligations are recorded as a reduction of the related revenue. Furthermore, the Company receives royalty and profit sharing payments under a licensing agreement with a contract manufacturing company. Royalty and profit sharing payments are recognized as revenue when received. The Company also provides contract research services for research and development manufacturing of biological materials for other companies. Under these contracts, the Company generally receives payments based on a contractual cost per full-time equivalent employee working on the project. Revenue is recognized for actual research work performed during the period.

Critical Accounting Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

Valentis believes stock-based compensation and accrual for clinical trial expense represent its most significant estimates used in the preparation of its consolidated financial statements. See Note 3. for discussion of stock-based compensation. Valentis’ accruals for clinical trial expenses are based in part on estimates of services received and efforts expended pursuant to agreements established with clinical research organizations and clinical trial sites. The Company has a history of contracting with third parties that perform various clinical trial activities on behalf of Valentis in the ongoing development of its biopharmaceutical drugs. The financial terms of these contracts are subject to negotiations and may vary from contract to contract and may result in uneven payment flows. The Company determines its estimates through discussion with internal clinical personnel and outside service providers as to progress or stage of completion of trials or services and the agreed upon fee to be paid for such services. The objective of Valentis’ clinical trial accrual policy is to reflect the appropriate trial expenses in its consolidated financial statements by matching period expenses with period services and efforts expended. In the event of early termination of a clinical trial, the Company accrues expenses associated with an estimate of the remaining, non-cancelable obligations associated with the winding down of the trial.

3. Stock-Based Compensation

In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (FAS) No. 123 (revised 2004, or FAS 123R), “Share-Based Payment”. FAS 123R supersedes Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and requires companies to recognize compensation expense, using a fair-value based method, for costs related to share-based payments, including stock options and employee stock purchase plans. FAS 123R permits public companies to adopt its requirements using either the modified prospective or modified retrospective transition method.

The Company adopted FAS 123R on July 1, 2005 using the modified prospective transition method, which requires that stock-based compensation cost is recognized for all awards granted, modified or settled after the effective date as well as for all awards granted to employees prior to the effective date that remain unvested as of the effective date. For the three months ended March 31, 2006, the Company recorded approximately $425,000 of stock-based compensation expenses, of which $185,000 was included in research and development expense and $240,000 was included in general and administrative expense. For the nine months ended March 31, 2006, the Company recorded approximately $1.4 million of stock-based compensation expenses, of which $541,000 was included in research and development expense and $894,000 was included in general and administrative expense. The adoption of FAS 123R had the impact of a loss of $0.03 and $0.10 on the Company’s net loss per share for the three and nine months ended March 31, 2006, respectively. The adoption of FAS 123R had no impact on cash flow from operations and cash flow from financing activities for the three and nine months ended March 31, 2006. As of March 31, 2006, unamortized stock-based compensation expenses of approximately $2.5 million remain to be recognized over a weighted-average period of 1.3 years. The Company amortizes stock-based compensation expenses on a straight-line basis over the vesting period.

The Company estimated the fair value of stock options granted during the three and nine months ended March 31, 2006 using the Black-Scholes-Merton option pricing model. The assumptions used under this model are as follows: 1) Due to insufficient relevant historical option exercise data, the expected term of the options was estimated to be 6.1 years using the “simplified” method suggested in the Securities and Exchange Commission’s Staff Accounting Bulletin No. 107; 2) Expected volatility was estimated to be 125% based on the Company’s historical volatility that matched the expected term; 3) Weighted average risk-free interest rate of 4.0% is based on the U.S. Treasury yield curve in effect at the time of grant for periods corresponding with the expected term of the option; 4) The Company assumed a zero percent dividend yield. In addition, under FAS 123R, fair value of stock options granted is recognized as expense over the vesting period, net of estimated forfeitures. Estimated annual forfeiture rate was based on historical data and anticipated future conditions. The estimation of forfeitures requires significant judgment, and to the extent actual results or updated estimates differ from our current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised.

Prior to the adoption of FAS 123R on July 1, 2005, Valentis accounted for its stock-based employee compensation expenses under the recognition and measurement provision of APB 25, “Accounting for Stock Issued to Employees,” and related interpretations. Under APB 25, if the exercise price of Valentis’ employee stock options equals or exceeds the market price of the underlying stock on the date of grant, no compensation expense is recognized. The following table illustrates the effect on net loss and net loss per share if the fair value method of FAS 123 had been applied to the three and nine months ended March 31, 2005.

	Three Months Ended March 31, 2005			Nine Months Ended March 31, 2005
Net loss – as reported	$	(2,977	)	$	(8,492	)

Deduct:
Stock-based employee stock compensation expense determined under FAS 123	(796		)	(2,631		)
Net loss – Pro Forma	$	(3,773	)	$	(11,123	)

Basic and diluted net loss per share -as reported	$	(0.23	)	$	(0.65	)

Basic and diluted net loss per share –pro forma	$	(0.29	)	$	(0.86	)

The weighted-average assumptions used for the valuation of options granted during the three and nine months ended March 31, 2005 were as follows: expected term of 5.00 years and 4.17 years; risk-free interest rate of 4.43% and 4.22%; expected volatility of 112% and 120%; and expected dividend yield of zero percent and zero percent, respectively.

At March 31, 2006, the Company has the following stock-based compensation plans:

The 1997 Equity Incentive Plan, as amended and restated in December 2005 (the “Incentive Plan”), provides for grants of stock options and awards to employees, directors and consultants of Valentis. The exercise price of options granted under the Incentive Plan is determined by the Board of Directors but cannot be less than 100% of the fair market value of the common stock on the date of the grant. Generally, options under the Incentive Plan vest 25% one year after the date of grant and on a pro rata basis over the following 36 months and expire upon the earlier of ten years after the date of grant or 90 days after termination of employment. Options granted under the Incentive Plan cannot be repriced without the prior approval of Valentis’ stockholders. As of March 31, 2006, an aggregate of 3.7 million shares have been authorized for issuance and options to purchase approximately 2.4 million shares of common stock had been granted under the Incentive Plan.

Pursuant to the terms of the 1998 Non-Employee Directors’ Plan, as amended and restated in December 2004 (the “Director’s Plan”), each non-employee director, other than a non-employee director who currently serves on the Board of Directors, automatically shall be granted, upon his or her initial election or appointment as a non-employee director, an option to purchase 26,000 shares of common stock, and each person who is serving as a non-employee director on the day following each Annual Meeting of Stockholders automatically shall be granted an option to purchase 10,000 shares of common stock. As of March 31, 2006, an aggregate of 575,000 shares have been authorized for issuance under the Directors’ Plan, and options to purchase approximately 319,000 shares of common stock had been granted to non-employee directors under the Directors’ Plan.

The 2001 Nonstatutory Incentive Plan, as amended and restated in May 2003 (the “NQ Plan”), provides for grants of nonstatutory stock options to employees, directors and consultants of Valentis. The exercise price of options granted under

the NQ Plan is determined by the Board of Directors but cannot be less than 100% of the fair market value of the common stock on the date of the grant. Generally, options under the NQ Plan vest 25% one year after the date of grant and on a pro rata basis over the following 36 months and expire upon the earlier of ten years after the date of grant or 90 days after termination of employment. Options granted under the NQ Plan cannot be repriced without the prior approval of Valentis’ stockholders. As of March 31, 2006, an aggregate of 690,000 shares have been authorized for issuance and options to purchase approximately 402,000 shares had been granted under the NQ Plan.

In May 2003, the Board of Directors adopted the 2003 Employee Stock Purchase Plan (the “Purchase Plan”) covering an aggregate of 600,000 shares of common stock. The Purchase Plan was approved by stockholders in May 2003 and is qualified under Section 423 of the Internal Revenue Code. The Purchase Plan is designed to allow eligible employees of Valentis to purchase shares of common stock through periodic payroll deductions. The price of common stock purchased under the Purchase Plan must be equal to at least 85% of the lower of the fair market value of the common stock on the commencement date of each offering period or the specified purchase date. 534,318 shares reserved under the Purchase Plan remain available for issuance as of March 31, 2006.

Activity under all option plans was as follows:

For the three months ended March 31, 2006:

	Number of Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life	Aggregate Intrinsic Value
						(in 000s)
Options outstanding at December 31, 2005	2,824,289		$	7.07
Options granted	75,000		$	2.22
Options exercised	—		—
Options cancelled	(17,562	)	$	6.40
Options outstanding at March 31, 2006	2,951,727		$	6.95	8.11	$	112
Options exercisable at March 31, 2006	1,497,225		$	10.08	7.62	$	16

For the nine months ended March 31, 2006:

	Number of Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life	Aggregate Intrinsic Value
						(in 000s)
Options outstanding at June 30, 2005	2,319,674		$	8.45
Options granted	734,000		$	2.67
Options exercised	—		—
Options cancelled	(101,947	)	$	10.24
Options outstanding at March 31, 2006	2,951,727		$	6.95	8.11	$	112
Options exercisable at March 31, 2006	1,497,225		$	10.08	7.62	$	16

The weighted average fair value of options granted during the three months ended March 31, 2006 and 2005 was $1.98 and $2.21, respectively. For the nine months ended March 31, 2006 and 2005, the weighted average fair value of options granted was $2.37 and $4.76, respectively.

There was no nonvested share activity under our stock option plans during the three and nine months ended March 31, 2005. Nonvested share activities under our stock option plans for the three and nine months ended March 31, 2006 are summarized as follows:

	Three Months Ended March 31, 2006				Nine Months Ended March 31, 2006
	Nonvested Number of Shares		Weighted Average Grant Date Fair Value		Nonvested Number of Shares		Weighted Average Grant Date Fair Value
Beginning nonvested balance	89,006		$	2.80	—		—
Granted	—		—		106,810		$	2.80
Vested	(13,352	)	$	2.80	(31,156	)	$	2.80
Ending nonvested balance	75,654		$	2.80	75,654		$	2.80

4. Net Loss Per Share

Basic earnings per share is computed by dividing income or loss applicable to common stockholders by the weighted-average number of shares of common stock outstanding during the period, net of certain common shares outstanding that are held in escrow or subject to Valentis’ right of repurchase or forfeiture. Diluted earnings per share include the effect of options and warrants, if dilutive. Diluted net loss per share has not been presented separately as, given our net loss position for all periods presented, the result would be antidilutive.

A reconciliation of shares used in the calculation of basic and diluted net loss per share follows (in thousands, except per share amounts):

	Three Months Ended March 31,						Nine Months Ended March 31,
	2006			2005			2006			2005
Net loss	$	(4,850	)	$	(2,977	)	$	(12,340	)	$	(8,492	)

Basic and Diluted:
Weighted average shares of common stock outstanding	15,190			13,104			15,028			13,084
Less: Weighted average shares in escrow, subject to return	(2		)	(2		)	(2		)	(2		)
Less: Weighted average shares subject to repurchase	—			(74		)	—			(111		)
Less: Weighted average shares subject to forfeiture	(76		)	—			(93		)	—
Weighted-average shares of common stock used in computing net loss per share	15,112			13,028			14,933			12,971

Basic and diluted net loss per share	$	(0.32	)	$	(0.23	)	$	(0.83	)	$	(0.65	)

The computation of basic net loss per share excludes the following shares of common stock, which are outstanding but are held in escrow or subject to Valentis’ right to repurchase or forfeiture:

• A total of 2,106 shares of common stock issued in partial consideration for a license agreement. The 2,106 shares of common stock are held in escrow and will be released when certain conditions in the license agreement are met.

• A weighted average total of 74,000 and 111,000 shares of common stock that were subject to a repurchase option of the Company during the three and nine months ended March 31, 2005, respectively..

• A weighted average total of 75,654 and 93,457 shares of common stock that were subject to shares vest based on continued employment during the three and nine months ended March 31, 2006.

The following potential common shares have been excluded from the calculation of diluted net loss per share because the effect of inclusion would be antidilutive.

• Options to purchase 2,951,727 shares of common stock with prices ranging from $1.97 to $465.00 and a weighted average price of $6.95 at March 31, 2006 and options to purchase 2,406,385 shares of common stock with prices ranging from $1.97 to $465.00 and a weighted average price of $8.38 per share at March 31, 2005.

• Warrants to purchase 4,749,075 shares of common stock at a weighted average price of $3.85 per share and

warrants to purchase up to 2,749,016 shares of common stock at a weighted average price of $4.29 per share at March 31, 2006 and 2005, respectively.

The options, common stock purchase warrants, shares of common stock held in escrow and shares of outstanding common stock subject to our right of repurchase or forfeiture will be included in the calculation of income or loss per share at such time as the effect is no longer antidilutive, as calculated using the treasury stock method for options and warrants.

5. Comprehensive Loss

Following are the components of comprehensive loss (in thousands):

	Three Months Ended March 31,						Nine Months Ended March 31,
	2006			2005			2006			2005
Net loss	$	(4,850	)	$	(2,977	)	$	(12,340	)	$	(8,492	)
Net unrealized gain (loss) on available-for-sale securities	2			1			5			1
Comprehensive loss	$	(4,848	)	$	(2,976	)	$	(12,335	)	$	(8,491	)

The components of accumulated other comprehensive loss are as follows (in thousands):

	March 31, 2006			June 30, 2005
Unrealized loss on available-for-sale securities	$	—		$	(5	)
Foreign currency translation adjustments	(693		)	(693		)
Accumulated other comprehensive loss	$	(693	)	$	(698	)

6. New Accounting Pronouncement

In June 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections (SFAS No. 154), a replacement of APB Opinion No. 20, Accounting Changes, and FASB No. 3, Reporting Accounting Changes in Interim Financial Statements SFAS No. 154 applies to all voluntary changes in accounting principle, and changes the requirements for accounting for and reporting of a change in accounting principle. SFAS No. 154 requires retrospective application to prior periods’ financial statements of a voluntary change in accounting principle unless it is impracticable. It is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company does not expect the adoption of SFAS No. 154 will have material impact on our consolidated results of operations and financial condition.

7. Other Accrued Liabilities

Other accrued liabilities consist of the following (in thousands):

	March 31, 2006		June 30, 2005
Accrued research and development expenses	$	258	$	208
Accrued rent	62		80
Accrued property and use taxes	354		378
Accrued legal expenses	164		121
Other	368		172
Total	$	1,206	$	959

ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The discussion in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements include, without limitation, statements containing the words “believes,” “anticipates,” “expects,” “intends,” “projects,” and other words of similar import or the negative of those terms or expressions. Forward-looking statements in this section include, but are not limited to, expectations of future levels of research and development spending, general and administrative spending, levels of capital expenditures and operating results, sufficiency of our capital resources our intention to seek revenue from the licensing of

our proprietary manufacturing technologies and from manufacturing services and the timing of the performance of any interim analysis and timing of clinical trial results. Forward-looking statements subject to certain known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Factors that could affect our actual results include the early stage of development of our products, uncertainties related to the timing of completing clinical trials and any interim analysis, the need for additional capital and whether clinical trial results will validate and support the safety and efficacy of our products. Further, there can be no assurance that the necessary regulatory approvals will be obtained, that we will be able to develop commercially viable peripheral arterial disease therapeutics or that any of our programs will be partnered with pharmaceutical partners. Actual results may differ materially from those projected in such forward-looking statements as a result of the "Other Information – Risk Factors” described in Item 1A of Part II and other risks detailed in our reports filed with the Securities and Exchange Commission. We undertake no obligation to revise or update any such forward-looking statements.

OVERVIEW

VLTS 934 PHASE IIb CLINICAL TRIAL		In March 2005, we initiated a Phase IIb clinical trial for VLTS 934, our lead product for the treatment of peripheral arterial disease, specifically intermittent claudication. The randomized, double blind, placebo-controlled trial of 148 patients is designed with an 80% chance of correctly identifying a statistically significant response between the treatment and placebo groups. Efficacy results are on schedule for July 2006.

FAVORABLE INTERIM ANALYSIS		On January 10, 2006, we announced favorable interim results in our VLTS 934 Phase IIb clinical trial in peripheral arterial disease. An interim analysis conducted by independent statisticians on a representative sample of patients receiving the placebo treatment confirmed the VLTS 934 Phase IIb placebo group assumptions. The trial remains blinded, there was no impact on the type I error rate, and no adjustments to the alpha-level for the final analysis are necessary.

PATIENT DOSING COMPLETED ON- SCHEDULE		On February 13, 2006, we announced that patient dosing was completed on-schedule in our VLTS 934 Phase IIb trial.

ABOUT VLTS 934		VLTS 934 is a nonionic block copolymer known as a poloxamer. VLTS 934 appears to have a direct effect of repairing compromised cell membranes and improving cell function, which may have a therapeutic benefit in ischemic tissue. Peripheral arterial disease (PAD) is a result of atherosclerosis in the legs of patients. Atherosclerosis is an inflammatory disorder of blood vessels that ultimately leads to the formation of atheroma or plaque in large blood vessels. This plaque impedes blood flow to tissues including the legs. We believe VLTS 934 reduces levels of specific mediators of inflammation, which drives progression of the disease. By suppressing the local inflammatory response in the blood vessels and muscle tissue, we believe it would explain the improvement in blood flow and exercise tolerance seen in the prior clinical trial that included VLTS 934.

PIPELINE		Internally, we have the following pipeline programs in various stages of development:
		• Del-1 protein for critical limb ischemia;
		• Del-1 antibody for oncology; and,
		• Polymers for other indications.

OTHER PARTNERED TECHNOLOGIES		In addition to our internal development programs, we have ten products in development by partners that incorporate our technologies. These include:
		• GeneSwitch® gene regulation technology;
		• PINC™ polymers, DNAVaxÔ and other synthetic delivery technologies; and,
		• OptiPEGÔ PEGylation technology.
		Licensing opportunities are available for these technologies, biomanufacturing and other technologies.

BIOMANUFACTURING		We conduct biomanufacturing services on a contract basis. Licensing of our

manufacturing technologies and biomanufacturing consulting services are also available. Since 1992, we have devoted substantial resources to manufacturing process development and scaleable bioprocessing. Our resources and expertise are available on a contract basis for the development of plasmid DNA-based therapeutics, microbial fermentation, protein purification, bacterial genetics and technology transfer. Our methods are distinctive and achieve the essential goal of being scaleable such that the same process can be used at small and large scales. In addition to being of direct benefit to us in our development of products, we seek revenue from manufacturing services and the licensing of our proprietary manufacturing technologies.

RESULTS OF OPERATIONS

Overview

For the quarter ended March 31, 2006, we incurred significant losses primarily due to the advancement of our research and development programs and because we generated limited revenue. This is generally consistent with our performance since inception. We expect that operating results will fluctuate from quarter to quarter and that such fluctuations may be substantial. At March 31, 2006, our accumulated deficit was approximately $237.0 million. We expect to incur substantial losses for the foreseeable future and do not expect to generate revenue from the sale of products in the foreseeable future, if at all.

There have been no significant changes in our critical accounting policies other than the adoption of SFAS 123R on July 1, 2005 (see “Stock-Based Compensation” below) during the three and nine months ended March 31, 2006 as compared to what was previously disclosed in our Annual Report on Form 10-K for the year ended June 30, 2005 filed with the Securities and Exchange Commission on September 26, 2005.

Revenue

Revenue recognized in the three and nine months ended March 31, 2006 and 2005 is as follows (in thousands):

	Three Months Ended March 31,				Nine Months Ended March 31,
	2006		2005		2006		2005
License and other revenue
GeneSwitch® gene regulation	$	74	$	124	$	356	$	811
PINC^TM gene delivery	11		—		44		550
PEGylation	—		—		120		—
Contract research	29		200		67		200
Manufacturing technology	—		—		—		59
Total revenue	$	114	$	324	$	587	$	1,620

Changes in revenue for the three and nine months ended March 31, 2006 and 2005 are explained below:

• The GeneSwitch® gene regulation revenue recognized in the three and nine months ended March 31, 2006 and 2005 resulted primarily from license fees received under several agreements for our GeneSwitch® gene regulation technology. GeneSwitch® revenue recognized in the nine months ended March 31, 2005 included approximately $550,000 of non-recurring license fee received under an agreement with Schering AG.

• The PINC^TM gene delivery revenue recognized in the three and nine months ended March 31, 2006 resulted primarily from several license agreements related to our PINC^TM gene delivery technology. The PINC^TM gene delivery revenue recognized in the nine months ended March 31, 2005 primarily reflected a non-recurring license fee received under an agreement with Schering AG.

• The PEGylation revenue recognized in the nine months ended March 31, 2006 primarily reflected an exclusive worldwide license of our pegylated liposome technology to develop a pegylated formulation of Foscan temoporfin to treat cancer, rheumatoid arthritis and atherosclerotic plaque.

• Contract research revenue recognized in the three and nine months ended March 31, 2006 and 2005 resulted primarily from biomanufacturing contract research performed for other companies during the periods.

• Manufacturing technology revenue recognized in the nine months ended March 31, 2005 consisted of profit sharing and royalty received under an agreement related to our plasmid DNA manufacturing technology.

Revenue derived from corporate collaborations and licenses helps us partially fund our operations and may increase in the future if we are successful in establishing new collaborations, our biomanufacturing business and additional licensing of our technology. If we are unsuccessful in establishing new collaborations, our biomanufacturing business or additional licensing of our technology, our revenues will decline and we may be required to limit our research and development, clinical trial, manufacturing and marketing efforts.

Research and Development Expenses

Research and development expenses increased approximately $1.1 million to approximately $3.7 million for the three months ended March 31, 2006, compared to approximately $2.6 million for the corresponding period in 2005. The increase primarily reflected an increase of approximately $430,000 in preclinical study expenses, an increase of approximately $517,000 in clinical trial expenses and approximately $185,000 of stock-based compensation expenses recorded in the three months ended March 31, 2006. For the nine months ended March 31, 2006, research and development expenses increased approximately $2.0 million to approximately $9.3 million, compared to approximately $7.3 million for the corresponding period in 2005. The increase was primarily attributable to an increase of approximately $610,000 in preclinical study expenses, an increase of approximately $1.0 million in clinical trial expenses and approximately $541,000 of stock-based compensation expenses recorded in the nine months ended March 31, 2006. We expect research and development expenses in the future to remain at current levels. However, research and development expenses may increase or decrease depending on the outcome of the VLTS 934 Phase IIb clinical trial and if we are successful in securing additional new funding and strategic partnerships to support increased spending levels. The results of the clinical trial are expected in July 2006.

Our research and development expenses currently include costs for scientific personnel, animal studies, supplies, equipment, consultants, patent filings, overhead allocation, human trials and sponsored research at academic and research institutions. The scope and magnitude of future research and development expenses are difficult to predict at this time given the number of studies that will need to be conducted for any of our potential products. In general, biopharmaceutical development involves a series of steps—beginning with identification of a potential target and including, among others, proof of concept in animal studies and Phase I, II, and III clinical studies in humans—each of which is typically more expensive than the previous step.

General and Administrative Expenses

General and administrative expenses increased approximately $550,000 to approximately $1.3 million for the three months ended March 31, 2006, compared to approximately $750,000 for the corresponding period in 2005. For the nine months ended March 31, 2006, general and administrative expenses increased approximately $800,000 to approximately $3.8 million, compared to approximately $3.0 million for the corresponding period in 2005. The increases primarily reflected stock-based compensation expenses of approximately $240,000 and $894,000 recorded in the three and nine months ended March 31, 2006, respectively. Further, the increase in general and administrative expenses in the three months ended March 31, 2006 also reflected increased expenses related to investor relations and other professional services, as compared to the corresponding period in 2005. We expect our general and administrative expenses to increase in the future reflecting expenses associated with the requirements of the Sarbanes-Oxley Act including, as directed by Section 404 of the Sarbanes-Oxley Act, our assessment of and report on the effectiveness of our internal control over financial reporting. However, general and administrative expenses may increase or decrease depending on the outcome of the VLTS 934 Phase IIb clinical trial and if we are successful in securing additional new funding and strategic partnerships to support increased spending levels.

Interest Income and Other Expenses, net

Interest income and other expenses, net, decreased by approximately $7,000 to approximately $50,000 for the three months ended March 31, 2006, compared to approximately $57,000 in the corresponding period of 2005. The decrease in interest income and other expenses, net primarily reflected decreased interest income earned due to lower investment balances during the three months ended March 31, 2006. For the nine months ended March 31, 2006, interest income and other expenses, net, increased by approximately $11,000 to approximately $173,000, compared to approximately $162,000 in the corresponding period of 2005. The increase in interest income and other expenses, net primarily reflected lower estimated franchise tax expenses, partially offset by decreased interest income earned due to lower investment balances during the nine months ended March 31, 2006.

Stock-Based Compensation

In December 2004, the FASB issued FAS 123R, “Share-Based Payment.” FAS 123R supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and requires companies to recognize compensation expense, using a fair-value based method, for costs related to share-based payments including stock options and employee stock purchase plans. We adopted FAS 123(R) on July 1, 2005. Prior to the adoption, we disclosed such expenses on a pro forma basis in the notes to our financial statements. For the three months ended March 31, 2006, the Company recorded approximately $425,000 of stock-based compensation expenses, of which $185,000 was included in research and development expense and $240,000 was included in general and administrative expense. For the nine months ended March 31, 2006, the Company recorded approximately $1.4 million of stock-based compensation expenses, of which $541,000 was included in research and development expense and $894,000 was included in general and administrative expense.

We estimated the fair value of stock options granted during the three and nine months ended March 31, 2006 using the Black-Scholes-Merton option pricing model. The assumptions used under this model were as follows: 1) Due to insufficient relevant historical option exercise data, the expected term of the options was estimated to be 6.1 years using the “simplified” method suggested in the Securities and Exchange Commission’s Staff Accounting Bulletin No. 107; 2) Expected volatility was estimated to be 125% based on the Company’s historical volatility that matched the expected term; 3) Weighted average risk-free interest rate of 4.0% is based on the U.S. Treasury yield curve in effect at the time of grant for periods corresponding with the expected term of the option; 4) The Company assumed a zero percent dividend yield. In addition, under FAS 123R, fair value of stock options granted is recognized as expense over the vesting period, net of estimated forfeitures. Estimated annual forfeiture rate was based on historical data and anticipated future conditions. The estimation of forfeitures requires significant judgment, and to the extent actual results or updated estimates differ from our current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised (See Note 3 “Stock-Based Compensation” in our Notes to the Unaudited Condensed Consolidated Financial Statements for more information).

LIQUIDITY AND CAPITAL RESOURCES

As discussed in our Form 10-K filed with the Securities and Exchange Commission for the year ended June 30, 2005, we have received a report from our independent registered public accounting firm regarding the consolidated financial statements for the fiscal year ended June 30, 2005 that includes an explanatory paragraph stating that the financial statements have been prepared assuming Valentis will continue as a going concern. The explanatory paragraph states the following conditions which raise substantial doubt about our ability to continue as a going concern: (i) we have incurred recurring operating losses since inception, including a net loss of $11.1 million for the fiscal year ended June 30, 2005, and our accumulated deficit was $224.6 million at June 30, 2005 and (ii) we anticipate requiring additional financial resources to enable us to fund our operations at least through June 30, 2006. Management’s plans as to these matters are described below.

We are currently supporting the ongoing VLTS 934 Phase IIb clinical trial. The results of this trial are expected in July 2006. A positive outcome for the clinical trial demonstrating a statistically significant therapeutic drug effect and safety for use in the targeted population is critical to the continued development of VLTS 934. A negative trial outcome could have a material and adverse effect on the further development of VLTS 934, negatively impact our business and prospects and cause the price of our common stock to fall, negatively affect Valentis’ ability to raise additional financing on acceptable terms, if at all. Any failure to obtain a sufficient amount of additional capital in a timely manner on commercially reasonable terms may have a material adverse effect on our business and financial condition, including our viability as an enterprise. As a result of these concerns, management may pursue strategic alternatives, which may include the sale or merger of the business, the sale of certain assets or other actions. See “Other Information – Risk Factors” in Item 1A of Part II for a description of the risks related to our product development efforts, including risks with regard to the VLTS 934 PAD Phase IIb clinical trial. If results of the Phase IIb clinical trial justify proceeding to a Phase III clinical trial of VLTS 934, because of the size of the potential market for the product and the number of possible uses for the product, we expect to license VLTS 934 to a pharmaceutical company that will assume responsibility for late-stage development and commercialization.

As of March 31, 2006, we had $7.9 million in cash, cash equivalents and investments compared to $12.5 million at June 30, 2005. The decrease of $4.6 million in cash, cash equivalents and investments balances primarily reflected the funding of ongoing operations, offset by net proceeds of $5.0 million received from a private placement of our common stock completed in March 2006. Our capital expenditures were approximately $32,000 in the nine months ended March 31, 2006. We expect our capital expenditures to remain at or near current spending levels. However, capital expenditures may increase depending on the outcome of the VLTS 934 Phase IIb clinical trial and if we are successful in securing additional new funding and strategic partnerships to support increased spending levels.

Except for the quarter ended September 30, 2003, in which we reported net income of approximately $3.4 million resulting principally from the recognition of a $6.5 million non-recurring license revenue, we have experienced net losses since our inception through March 31, 2006, and reported a net loss of $4.9 million for the three months ended March 31, 2006. Our accumulated deficit was $237.0 million at March 31, 2006. We expect such losses to continue into the

foreseeable future as we proceed with the research, development and commercialization of our technologies. We anticipate that we will require additional financial resources to advance development of our VLTS 934 product, our other product candidates and continue our planned operations at least through September 30, 2006.

We are currently seeking additional collaborative agreements and licenses with corporate partners and may seek additional funding through public or private equity or debt financing or merger of our business. We may not be able to enter into any such agreements, however, or if entered into, any such agreements may not reduce or eliminate our need to seek additional funding. Additional financing to meet our funding requirements may not be available on acceptable terms or at all. If we raise additional funds by issuing equity securities, substantial dilution to existing stockholders may result. In an effort to seek additional sources of financing, we may have to relinquish greater or all rights to products at an earlier stage of development or on less favorable terms than we would otherwise seek to obtain.

Since our inception, we have financed our operations principally through public and private issuances of our common and preferred stock and funding from collaborative arrangements. We have used the net proceeds from the sale of the common and preferred stock for general corporate purposes, which may include funding research, development and product manufacturing, increasing our working capital, reducing indebtedness, acquisitions or investments in businesses, products or technologies that are complementary to our own, and capital expenditures. We expect that proceeds received from any future issuance of stock will be used for similar purposes.

In March 2006, we completed a private placement of 2.1 million shares of our common stock and warrants to purchase up to approximately 1.1 million additional shares of our common stock at $2.50 per unit, resulting in net proceeds of approximately $5.0 million. The warrants are exercisable for a five-year period at a price of $3.00 per share.

We entered into registration rights agreements with the purchasers in the private placement. Pursuant to such registration rights agreements, we filed with the Securities and Exchange Commission a registration statement related to the shares issued to the purchasers and shares issuable upon the exercise of the warrants under the private placement. In the event (i) the registration statement is not declared effective prior to the effectiveness date as defined in the registration statement, (ii) we fail to file with the Securities and Exchange Commission a request for acceleration in accordance with Rule 461 promulgated under the Securities Act of 1933, as amended, within five trading days of the date on which we are notified (orally or in writing, whichever is earlier) by the Securities and Exchange Commission that a registration statement will not be reviewed or is not subject to further review or (iii) we must suspend the use of the registration statements for greater than 20 consecutive trading days or a total of 40 trading days in the aggregate during the time we are required to keep the registration statement effective, then we must pay to each purchaser in cash 1.0% of the purchaser’s aggregate purchase price of the shares for the first month, as well as an additional 1.5% of the purchaser’s aggregate purchase price for each additional month thereafter. We currently expect to be required to maintain availability of the registration statement for at least two years following the date it is declared effective.

In addition, under the securities purchase agreement entered into in connection with the private placement, while there is an effective registration statement and if we fail to deliver a stock certificate that is free of restrictive legends within three trading days upon delivery of such a request by a purchaser, we are required to pay to the purchaser, for each $1,000 of shares of stock or shares issuable upon exercise of warrants requested, $10 per trading day for each trading day beginning five trading days after the delivery of the request, increasing to $20 per trading day after the first five trading days for which such damages have begun to accrue, until such certificate is delivered without restrictive legends.

Net cash used in operating activities for the nine months ended March 31, 2006 was approximately $9.6 million, which primarily reflected the net loss of approximately $12.3 million, adjusted by non-cash stock-based compensation expenses of approximately $1.4 million and an increase of accrued liabilities of approximately $1.0 million. Net cash used in operating activities for the nine months ended March 31, 2005 was approximately $9.4 million, which primarily reflected the net loss of $8.5 million, decreases in accrued liabilities of $1.2 million and non-cash expenses of $486,000 related to the issuance of warrants to four individuals who are non-employees.

Net cash provided by investing activities was approximately $2.9 million and $3.9 million for the nine months ended March 31, 2006 and 2005, respectively, which primarily reflected maturities of available-for-sale investments.

Net cash provided by financing activities for the nine months ended March 31, 2006 was approximately $5.0 million, which primarily reflected the net proceeds received from the private placement of our common stock completed in March 2006. For the nine months ended March 31, 2005, net cash provided by financing activities was approximately $227,000, which was attributable to proceeds received from the issuance of common stock upon exercise of warrants.

We lease our facilities under operating leases. These leases expire between November 2006 and October 2007 with renewal options at the end of the initial terms to extend the leases for an additional six and five years, respectively.

RECENT ACCOUNTING PRONOUNCEMENT

In June 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections” (SFAS No. 154), a replacement of APB Opinion No. 20, “Accounting Changes,” and FASB No. 3, “Reporting Accounting Changes in Interim Financial Statements.” SFAS No. 154 applies to all voluntary changes in accounting principle, and changes the requirements for accounting for and reporting of a change in accounting principle. SFAS No. 154 requires retrospective application to prior periods’ financial statements of a voluntary change in accounting principle unless it is impracticable. It is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. We do not expect the adoption of SFAS No. 154 will have material impact on our consolidated results of operations and financial condition.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Valentis’ exposure to market risk for changes in interest rates relates primarily to our investment portfolio. The objective of our investment policy is to preserve our invested funds by limiting default risk, market risk and reinvestment risk. Our cash and cash equivalents consist of cash and money market accounts. Our investments consist primarily of commercial paper, medium term notes, U.S. Treasury notes and obligations of U.S. Government agencies and corporate bonds. The table below presents notional amounts and related weighted-average interest rates for our investment portfolio (in thousands, except percentages) as of March 31, 2006. All of our market risk sensitive instruments mature within a year from the balance sheet date.

	As of March 31, 2006
Cash equivalents
Fixed rate	$	6,759
Average rate	4.56		%
Short-term investments
Fixed rate	750
Average rate	4.97		%
Total cash equivalents and investment securities	$	7,509

Average rate	4.60		%

ITEM 4. CONTROLS AND PROCEDURES

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Quarterly Report on Form 10-Q is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal finance and accounting officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Our management has evaluated, with the participation of our Chief Executive Officer, who is our principal executive officer, and our Vice President of Finance and Administration, who is our principal financial officer, the effectiveness of our “disclosure controls and procedures” (as defined in Rules 13a-15(e) and 15(d)-15(e) of the Securities and Exchange Act of 1934, as amended) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, our Chief Executive Officer and our Vice President of Finance and administration concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Securities and Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commission rules and forms at the reasonable assurance level.

There have been no changes in the Company’s internal controls over financial reporting during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal controls over financial reporting.

PART II: OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Not applicable.

ITEM 1A. RISK FACTORS

The following risk factors outline certain risks and uncertainties concerning future results and should be read in conjunction with the information contained in this Quarterly Report on Form 10-Q. Any of these risk factors could materially and adversely affect our business, operating results and financial condition. Additional risks and uncertainties not presently known to us, or those we currently deem immaterial, may also materially harm our business, operating results and financial condition.

We have a history of losses and may never be profitable.

We have engaged in research and development activities since our inception. We incurred losses from operations of approximately $11.3 million, $6.5 million and $15.7 million, for our fiscal years ended June 30, 2005, 2004 and 2003, respectively. For the nine months ended March 31, 2006, we incurred a net loss of $12.3 million. As of March 31, 2006, we had an accumulated deficit totaling approximately $237.0 million. The development and sale of our products will require completion of additional clinical trials and significant research and development activities. We expect to incur net losses for the foreseeable future as we continue with the research, development and commercialization of our products. Our ability to achieve profitability depends on the successful completion of our clinical trials especially our ongoing VLTS 934 Phase IIb clinical trial, our additional research and development efforts, our ability to successfully commercially introduce our products, market acceptance of our products, the competitive position of our products and the other risk factors set forth herein. Even if we do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis.

Our ability to achieve profitability depends upon our research and development efforts and whether we can successfully develop and commercially introduce new products.

Our future success is dependent upon, among other factors, our ability to develop working products and our ability to successfully complete clinical trials. All of our potential products currently are in research, preclinical development or the early stages of clinical testing, and commercialization of those products will not occur for at least the next several years, if at all. The development of new drugs is a highly risky undertaking and there can be no assurance that our research and development efforts will be successful. In September 2004, we reported that our Deltavasc™ product did not meet its primary endpoint in its Phase IIa clinical trial in patients with the intermittent claudication form of peripheral arterial disease. Both the Deltavasc™ and the VLTS 934 groups demonstrated statistically significant improvements compared to baseline with no significant differences between treatment groups. The unforeseen results observed in both groups led to the initiation of a Phase IIb clinical trial of VLTS 934. All of our products will require extensive additional research and development prior to any commercial introduction. There can be no assurance that any of our research and development and clinical trial efforts will result in viable products. If our product and development efforts are unsuccessful, we will not achieve profitability and our business and results of operations would be adversely affected.

Our products are subject to extensive regulatory approval by the FDA and others, including with regard to completion of our clinical trials, which is expensive, time consuming and uncertain, and failure to obtain regulatory approval or successfully complete clinical trials may cause us to delay or withdraw the introduction of our products and could materially adversely affect our business and prospects.

We are subject to significant regulatory requirements, including the successful completion of clinical trials, prior to the commercialization of our products. Under the Federal Food, Drug and Cosmetic Act, the Public Health Services Act, and related regulations, the Food and Drug Administration, or FDA, regulates the development, clinical testing, manufacture, labeling, sale, distribution and promotion of drugs and biologics in the United States. Prior to market introduction in the United States, a potential drug or biological product must undergo rigorous clinical trials that meet the requirements of the FDA in order to demonstrate safety and efficacy in humans. Depending upon the type, novelty and effects of the drug and the nature of the disease or disorder to be treated, the FDA approval process can take several years, require extensive clinical testing and result in significant expenditures.

Clinical trials and the FDA approval process are long, expensive and uncertain processes, which require substantial time effort and financial and human resources. We have limited experience in conducting clinical trials, and we may encounter problems or fail to demonstrate the efficacy or safety that cause us, or the FDA, to delay, suspend or terminate the development of our products. We initiated a follow-on Phase IIb clinical trial using our VLTS 934 product compared to a saline placebo in March 2005. In addition to this Phase IIb clinical trial, VLTS 934 will require significant additional clinical testing. This process may take a number of years. We cannot assure you that our clinical testing will be completed within any specific time period, if at all. There can be no assurance that any FDA approval will be granted on a timely basis, if at all, or that any of our products will prove safe and effective in all required clinical trials or will meet all applicable regulatory requirements necessary to receive marketing approval from the FDA.

Even if we successfully obtain FDA approval for our products, we may not be able to obtain the regulatory approvals necessary to market our products outside the United States since the commercialization of our products outside the United States will be subject to separate regulations imposed by foreign government agencies. The approval procedures for marketing outside the United States vary among countries and can involve additional testing. Accordingly, we cannot predict with any certainty how long it will take or how much it will cost to obtain regulatory approvals for manufacturing and marketing our products within and outside the United States or whether we will be able to obtain those regulatory approvals at all. Our failure to successfully complete our clinical trials, obtain FDA and any applicable foreign government approvals or any delays in receipt of such approvals could have a material effect on our business, results of operations and financial condition.

We are dependent on the successful outcomes of clinical trials of our products, particularly the outcome of the Phase IIb clinical trial of VLTS 934 (which is expected in July 2006), and we cannot assure you that any clinical testing will demonstrate the safety and efficacy of our products.

In order to introduce and market our products, we must be able to, among other things, demonstrate safety and efficacy with substantial evidence from well-controlled clinical trials. In September 2004, we announced that Deltavasc™ did not meet the primary endpoint in a Phase IIa clinical trial in patients with intermittent claudication form of peripheral arterial disease. Accordingly, further Deltavasc™ clinical trials are on-hold. This had been our most advanced clinical program and represented the substantial portion of our clinical development activities. The Deltavasc™ Phase IIa clinical trial results led to the initiation of a Phase IIb clinical trial of VLTS 934.

VLTS 934 is an investigational product that is a non-ionic polyoxyethylene-polyoxypropylene block copolymer. Although, we have investigated the poloxamer’s possible mechanism of action in preclinical study, there can be no assurance that VLTS 934 improves microvascular blood flow, results in a pharmacologic effect or will demonstrate efficacy. We initiated a follow-on Phase IIb clinical trial using our VLTS 934 product compared to a saline placebo in March 2005. This clinical trial is a study performed within the FDA guidelines regarding whether patients suffering from peripheral arterial disease can achieve better cardiovascular blood flow after being treated with VLTS 934 compared to patients given a saline placebo. Clinical trials are long, expensive and uncertain processes during which we may encounter difficulties completing the trial. Problems we may encounter include the unavailability of preferred sites for conducting the trials, an insufficient number of eligible subjects, changes in the number of subjects based-on the performance of interim analyses, changes in protocol and other factors, which may delay the advancement of our clinical trials, lead to increased costs or result in the termination of the clinical trials altogether. Furthermore, the FDA may suspend clinical trials at any time if it believes the subjects participating in the trials are being exposed to unacceptable health risks or if it finds deficiencies in the clinical trial process or the conduct of the investigation.

In addition, should either our Phase IIb clinical trial of our VLTS 934 product or any other future clinical trials fail to demonstrate a statistically significant therapeutic drug effect and/or show that our product are safe for the targeted patient population, our business and prospects could be harmed, the market price of our common stock could fall, our ability to generate revenues from those products could be adversely affected, delayed or prevented entirely, and we may not be able to obtain additional financing on acceptable terms, or at all. Any failure to obtain an adequate and timely amount of additional capital on commercially reasonable terms may have a material adverse effect on our business and financial condition, including our viability as an enterprise. As a result of these concerns, management may pursue strategic alternatives, which may include the sale or merger of the business, the sale of certain assets or other actions.

The results of early Phase I and Phase II clinical trials are based on a small number of patients over a short period of time, and our success may not be indicative of results in a large number of patients or long-term efficacy.

The results in early phases of clinical testing are based upon limited numbers of patients and a limited follow-up period. Typically, our Phase I clinical trials for indications of safety enroll less than 50 patients. Our Phase IIa clinical trial of Deltavasc™ enrolled 105 patients and our Phase IIb clinical trial of VLTS 934 enrolled approximately 148 patients. Actual results with more data points may not confirm favorable results from our earlier stage trials. A number of companies in the pharmaceutical and biotechnology industries have suffered significant setbacks in late stage Phase III clinical trials even after achieving promising results in earlier stage clinical trials. In addition, we do not yet know if early results will have a lasting effect. If a sufficiently large population of patients necessary to demonstrate efficacy does not experience positive results, or if these results do not have a lasting effect, our products may not receive approval from the FDA. Failure to demonstrate the safety and effectiveness of our products in larger patient populations could have a material adverse effect on our business that would cause our stock price to decline significantly.

We have received a “going concern” opinion from our independent registered public accounting firm, which may negatively impact our business.

We have received a report from Ernst & Young LLP, our independent registered public accounting firm, regarding our consolidated financial statements for the fiscal year ended June 30, 2005, which included an explanatory paragraph stating that the financial statements were prepared assuming we will continue as a going concern. The report also stated that our recurring operating losses and need for additional financing have raised substantial doubt about our ability to continue as a going concern. Any failure to dispel any continuing doubts about our ability to continue as a going concern could adversely affect our ability to enter into collaborative relationships with business partners, to raise additional capital and to sell our products, and could have a material adverse effect on our business, financial condition and results of operations.

Our stock price has been and may continue to be volatile and an investment in our common stock could suffer a decline in value.

The trading price of the shares of our common stock has been and may continue to be highly volatile. We receive only limited attention by securities analysts and may experience an imbalance between supply and demand for our common stock resulting from low trading volumes. The market price of our common stock may fluctuate significantly in response to a variety of factors, most of which are beyond our control, including the following:

• results of our clinical trials and preclinical studies, or those of our competitors;

• our ability to attract and retain corporate partners;

• negative regulatory action or regulatory approval with respect to our products or our competitors’ products;

• developments related to our patents or other proprietary rights or those of our competitors;

• announcements by us or our competitors of new products, technological innovations, contracts, acquisitions, corporate partnerships or joint ventures;

• changes in our eligibility for continued listing of our common stock on The Nasdaq Capital Market; and

• market conditions for biopharmaceutical or biotechnology stocks in general.

The stock market has, from time to time, experienced extreme price and volume fluctuations, which have particularly affected the market prices for emerging biotechnology and biopharmaceutical companies and which have often been unrelated to their operating performance. These broad market fluctuations may adversely affect the market price of our common stock. In addition, sales of substantial amounts of our common stock in the public market could lower the market price of our common stock.

Our stock price could be adversely affected by dispositions of our shares pursuant to registration statements currently in effect.

Some of our current stockholders hold a substantial number of shares, which they are currently able to sell in the public market under certain registration statements currently in effect, or otherwise. Sales of a substantial number of our shares or the perception that these sales may occur, could cause the trading price of our common stock to fall and could impair our ability to raise capital through the sale of additional equity securities.

As of May 11, 2006, we had issued and outstanding 17,068,919 shares of our common stock. This amount does not include, as of May 11, 2006:

• approximately 3.0 million shares of our common stock issuable upon the exercise of all of our outstanding options and the release of restricted stock awards; and

• approximately 4.7 million shares of our common stock issuable upon the exercise of all of our outstanding warrants.

These shares of common stock, if and when issued, may be sold in the public market assuming the applicable registration statements continue to remain effective and subject in any case to trading restrictions to which our insiders holding such shares may be subject from time to time. If these options or warrants are exercised and sold, our stockholders may experience additional dilution and the market price of our common stock could fall.

We must be able to continue to secure additional financing in order to continue our operations, which might not be available or which, if available, may be on terms that are not favorable to us.

The continued development and clinical testing of our potential products will require substantial additional financial

resources. Our future funding requirements will depend on many factors, including:

• progress and results of our clinical trials and preclinical studies;

• time and costs involved in obtaining FDA and other regulatory approvals;

• scientific progress in our research and development programs;

• size and complexity of such programs;

• ability to establish and maintain corporate collaborations;

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

• competing technological and market developments; and

• the cost of manufacturing material for preclinical, clinical and commercial purposes.

We may have insufficient working capital to fund our cash needs unless we are able to raise additional capital in the future. We have financed our operations to date primarily through the sale of equity securities and through corporate collaborations. We do not anticipate generating revenues for the foreseeable future and may fund our operations through additional third party financing. If we raise additional funds by issuing equity securities, substantial dilution to existing stockholders may result. We may not be able to obtain additional financing on acceptable terms, or at all. Any failure to obtain an adequate and timely amount of additional capital on commercially reasonable terms will have a material adverse effect on our business, financial condition, including our viability as an enterprise. As a result of these concerns, management may pursue strategic alternatives, which may include the sale or merger of the business, the sale of certain assets or other actions.

We may also take actions to conserve our cash resources through reductions in our personnel, delaying or scaling back our development programs or relinquishing greater or all rights to products at an earlier stage of development or on less favorable terms than we otherwise would. Any or all of these actions could have a material adverse affect on our business.

The future success of our business depends on our ability to attract and retain corporate partners to develop, introduce and market our peripheral arterial disease product candidate and other product candidates.

Our business strategy is to attract business partners to fund or conduct research and development, clinical trials, manufacturing, marketing and sales of our peripheral arterial disease product candidate and other product candidates. We face intense competition from many other companies in the pharmaceutical and biotechnology industry for corporate collaborations, as well as for establishing relationships with academic and research institutions and for obtaining licenses to proprietary technology. If we are unable to attract and retain corporate partners to develop, introduce and market our products, our business may be materially and adversely affected.

Our strategy and any reliance on corporate partners, if we are able to establish such collaborative relationships, are subject to additional risks. Our partners may not devote sufficient resources to the development, introduction and marketing of our products or may not pursue further development and commercialization of products resulting from collaborations with us. If a corporate partner elects to terminate its relationship with us, our ability to develop, introduce and market our products may be significantly impaired and we may be forced to discontinue the product altogether. We may not be able to negotiate alternative corporate partnership agreements on acceptable terms, if at all. The failure of any future collaboration efforts could have a material adverse effect on our ability to develop, introduce and market our products and, consequently, could have a material adverse effect on our business, results of operations and financial condition.

We face strong competition in our market and competition from alternative treatments in the biopharmaceuticals market.

The pharmaceutical and biotechnology industries are highly competitive. We are aware of several pharmaceutical and biotechnology companies that are pursuing peripheral arterial disease therapeutics. For example, we are aware that AnGes MG, Centelion/Gencell SAS, NicOx, Sigma Tau, Inc., Nissan Chemical, Mitsubishi Pharmaceuticals, Kos Pharmaceuticals, Endovasc, Sangamo BioSciences, Inc. and Otsuka Pharmaceutical Co., Ltd. have engaged or are engaged in developing biotechnology or pharmaceutical therapies. Many of these companies are addressing diseases that have been targeted by us directly or through our corporate partners, and many of them may have more experience in these areas. Our competitive position depends on a number of factors, including safety, efficacy, reliability, marketing and sales efforts, and existence of competing products, and treatments and general economic conditions. Many of our competitors have substantially greater financial, research, product development, manufacturing, marketing and technical resources than we do.

Some companies also have greater name recognition than us and long-standing collaborative relationships.

We also face competition from biotechnology and pharmaceutical companies using more traditional approaches to treating human diseases and existing treatments. Our competitors, academic and research institutions or others may develop safer, more effective or less costly cardiovascular therapies, biologic delivery systems, gene-based therapeutics or chemical-based therapies. In addition, competitors may achieve superior patent protection or obtain regulatory approval or product commercialization earlier than we do. Any such developments could seriously harm our business, financial condition and results of operations.

Adverse events in the field of cardiovascular therapies may negatively impact regulatory approval or public perception of our potential products.

The FDA may become more restrictive regarding the conduct of clinical trials including cardiovascular therapies. This approach by the FDA can lead to delays in the timelines for regulatory review, as well as potential delays in the conduct of our clinical trials. In addition, negative publicity may affect patients’ willingness to participate in our clinical trials. If fewer patients are willing to participate in our clinical trials, the timelines for recruiting patients and conducting the trials will be delayed. The commercial success of our potential products will depend in part on public acceptance of the use of our therapies for the prevention or treatment of human diseases. Negative public reaction to our therapies in general could result in stricter labeling requirements of products, including any of our products, and could cause a decrease in the demand for products we may develop.

If we are unable to obtain rights to required technologies including poloxamer, proprietary gene sequences, proteins or other technologies, we will be unable to operate our business.

Our VLTS 934 product and other therapies involve multiple component technologies, many of which may be patented by others. For example, our products can use poloxamers, proprietary gene sequences, proteins or other technologies some of which have been, or may be, patented by others. As a result, we may be required to obtain licenses or acquire rights to those poloxamers, gene sequences, proteins or other technologies. We may not be able to obtain a license or acquire rights to those technologies on reasonable terms, if at all. As a consequence, we might be prohibited from developing potential products or we might have to make cumulative royalty payments to several companies. These cumulative royalties would reduce amounts paid to us or could make our products too expensive to develop or market. From time to time, we may engage in preliminary discussions with third parties concerning potential acquisitions of technologies or products. Even if we are successful in acquiring technologies or products, we may experience difficulties in and costs associated with the assimilation of technologies, products, operations and personnel acquired, diversion of management’s attention from other business concerns, inability to maintain uniform standards, controls, procedures and policies and the subsequent loss of key personnel. If we are unable to acquire or obtain rights to technologies or products necessary for our business, our business would be harmed.

We rely on patents and other proprietary rights to protect our intellectual property and any inability to protect our intellectual property rights would adversely impact our business.

We rely on a combination of patents, trade secrets, trademarks, proprietary know-how, and nondisclosure and other contractual agreements and technical measures to protect our intellectual property rights. We file patent applications to protect processes, practices and techniques related to our products that are significant to the development of our business. We own or have exclusive rights to 44 issued United States patents and 58 granted foreign patents on the technologies related to our products and processes. We own or have exclusive rights to approximately 17 pending patent applications in the United States and 38 foreign pending patent applications. Our patent applications may not be approved. Any patents granted now or in the future may be invalidated or offer only limited protection against potential infringement and development by our competitors of competing products. Moreover, our competitors, many of which have substantial resources and have made substantial investments in competing technologies, may seek to apply for and obtain patents that will prevent, limit or interfere with our ability to make, use or sell our products either in the United States or in international markets. In addition to patents, we rely on trade secrets and proprietary know-how, which we seek to protect, in part, through proprietary information agreements with employees, consultants and other parties. Our proprietary information agreements with our employees and consultants contain industry standard provisions requiring such individuals to assign to us, without additional consideration, any intellectual property conceived or reduced to practice by them while employed or retained by us, subject to customary exceptions. Proprietary information agreements with employees, consultants and others may be breached, and we may not have adequate remedies for any breach. Also, our trade secrets may become known to, or independently developed by, competitors. Any failure to protect our intellectual property would significantly impair our competitive position and adversely affect our results of operations and business.

We could become subject to litigation regarding our intellectual property rights, which could seriously harm our business.

In previous years, there has been significant litigation in the United States involving patents and other intellectual property rights. Competitors in the biotechnology industry may use intellectual property litigation against us to gain advantage. In the future, we may be a party to litigation to protect our intellectual property or as a result of an alleged infringement of others’ intellectual property. These claims and any resulting lawsuit, if successful, could subject us to significant liability for damages and invalidation of our proprietary rights. Any potential intellectual property litigation, if successful, also could force us to stop selling, incorporating or using our products that use the challenged intellectual property; obtain from the owner of the infringed intellectual property right a license to sell or use the relevant technology, which license may not be available on reasonable terms, or at all; or redesign our products that use the technology. We may also be required in the future to initiate claims or litigation against third parties for infringement of our intellectual property rights to protect these rights or determine the scope or validity of our intellectual property or the rights of our competitors. The pursuit of these claims could result in significant expenditures and the diversion of our technical and management personnel. If we are forced to take any of these actions, our business may be seriously harmed.

Any claims, with or without merit, and regardless of whether we prevail in the dispute, would be time-consuming, could result in costly litigation and the diversion of technical and management personnel and could require us to develop non-infringing technology or to enter into royalty or licensing agreements. An adverse determination in a judicial or administrative proceeding and failure to obtain necessary licenses or develop alternate technologies could prevent us from developing and selling our products, which would have a material adverse effect on our business, results of operations and financial condition.

We may experience delays in the commercial introduction, manufacture or regulatory approval of our products as a result of failure to comply with FDA manufacturing practices and requirements.

Drug-manufacturing facilities regulated by the FDA must comply with the FDA’s current good manufacturing practice (cGMP) regulations, which include quality control and quality assurance requirements, as well as maintenance of records and documentation. Manufacturers of biologics also must comply with the FDA’s general biological product standards and may be subject to state regulation as well. Such manufacturing facilities are subject to ongoing periodic inspections by the FDA and corresponding state agencies, including unannounced inspections, and must be licensed as part of the product approval process before being utilized for commercial manufacturing. Noncompliance with the applicable requirements can result in, among other things, fines, injunctions, civil penalties, recall or seizure of products, total or partial suspension of production, withdrawal of marketing approvals, and criminal prosecution. Any of these actions by the FDA would materially and adversely affect our ability to continue clinical trials, commercialize our products and adversely affect our business. We cannot assure you that we or our contract manufacturers will attain or maintain compliance with current or future good manufacturing practice requirements and the FDA could suspend or further delay our clinical trials, the commercial introduction and manufacture of our products or place restrictions on our ability to conduct clinical trials or commercialize our products, including the mandatory withdrawal of the product from the clinical trials.

Our research and development processes involve the controlled use of hazardous materials, chemicals and radioactive materials and produce waste products that could subject us to unanticipated environmental liability and would adversely affect our results of operations. We are subject to federal, state and local environmental laws and regulations governing the use, manufacture, storage, handling and disposal of such materials and waste products. Although we believe that our safety procedures for handling and disposing of such materials comply with the standards prescribed by such laws and regulations, the risk of accidental contamination or injury from these materials cannot be eliminated completely. In the event of such an accident, we could be held liable for any damages that result, and any such liability could exceed our resources. Although we believe that we are in compliance in all material respects with applicable environmental laws and regulations, there can be no assurance that we will not be required to incur significant costs to comply with environmental laws and regulations in the future or that any of our operations, business or assets will not be materially adversely affected by current or future environmental laws or regulations.

We depend on key personnel to develop our potential products and, if we are unable to hire additional personnel due to the intense competition in the Bay Area and other obstacles in recruiting qualified personnel for key management, scientific and technical positions, our business may suffer.

Our ability to attract and retain management, scientific and technical staff to develop our potential products and formulate our research and development strategy is a critical factor in determining whether we will be successful in the future. The San Francisco Bay Area, where our corporate headquarters and clinical development center is located, is home to a large number of biotechnology and pharmaceutical companies, and there is a limited number of qualified individuals to fill key scientific and technical positions. Competition for highly skilled personnel is intense and we may not be successful in attracting and hiring qualified personnel to fulfill our current or future needs.

Although we have programs in place to retain personnel, including programs to create a positive work environment

and competitive compensation packages, none of our officers or key employees is bound by an employment agreement for any specific term and these individuals may terminate their employment at any time. Our future success depends upon the continued services of our executive officers and other key scientific, marketing, manufacturing and support personnel. As of March 31, 2006, we had a total of 19 full-time employees, including 13 employees supporting our research and development efforts. We do not have “key person” life insurance policies covering any of our employees and the loss of services of any of our key employees would adversely affect our business. If we do not attract and retain qualified personnel, our research and development programs could be delayed, which could materially and adversely affect the development of our products and our business.

If we fail to manage growth effectively, our business could be disrupted, which could harm our operating results.

If any of our products successfully complete clinical trials and receive FDA approval, we may experience growth in our business. We must be prepared to expand our workforce and to train, motivate and manage additional employees as the need for additional personnel arises. Failure to attract and retain sufficient numbers of additional employees could impede our growth. In addition, our ability to manage our growth effectively could require us to make significant investments and expenditures to enhance our operational, management and financial infrastructure, information systems and procedures. Any failure to effectively manage future growth could have a material adverse effect on our business, results of operations and financial condition.

There are no assurances that we can maintain our listing on The Nasdaq Capital Market and the failure to maintain listing could adversely affect the liquidity and price of our common stock.

On January 31, 2003, our common stock began trading on The Nasdaq Capital Market pursuant to an exception from delisting. In the event we fail to demonstrate compliance, as well as an ability to sustain compliance, with all requirements for continued listing on The Nasdaq Capital Market, including Nasdaq’s corporate governance criteria, our securities will be delisted from The Nasdaq Capital Market. If our securities are delisted from The Nasdaq Capital Market, the trading of our common stock is likely to be conducted on the OTC Bulletin Board. The delisting of our common stock from The Nasdaq Capital Market will result in decreased liquidity of our outstanding shares of common stock and a resulting inability of our stockholders to sell our common stock or obtain accurate quotations as to their market value, which would reduce the price at which our shares trade. The delisting of our common stock could also deter broker-dealers from making a market in or otherwise generating interest in our common stock and would adversely affect our ability to attract investors in our common stock. Furthermore, our ability to raise additional capital would be severely impaired. As a result of these factors, the value of the common stock would decline significantly, and our stockholders could lose some or all of their investment.

If we are unable to complete our assessment as to the adequacy of our internal control over financial reporting within the required time periods as required by Section 404 of the Sarbanes-Oxley Act of 2002, or in the course of such assessments identify and report material weaknesses in our controls, investors could lose confidence in the reliability of our financial statements, which could result in a decrease in the value of our common stock.

As directed by Section 404 of the Sarbanes-Oxley Act of 2002, the Securities and Exchange Commission adopted rules requiring public companies to include a report of management on the company’s internal control over financial reporting in their Annual Reports on Form 10-K. This report is required to contain an assessment by management of the effectiveness of a company’s internal control over financial reporting. In addition, the independent registered public accounting firm auditing a public company’s financial statements must attest to and report on management’s assessment of the effectiveness of the company’s internal control over financial reporting. Our current non-affiliated market capitalization qualifies us as a non-accelerated filer. As such, we are required to comply with the Section 404 requirements beginning with the fiscal year that ends June 30, 2008. However, if we achieve a non-affiliated market capitalization of $75 million or more by December 31, 2006, we would be classified as an accelerated filer. As such, we would be required to comply with the Section 404 requirements beginning with the fiscal year that ends June 30, 2007.We intend to diligently and vigorously assess (and enhance as may be appropriate) our internal control over financial reporting in order to ensure compliance with the Section 404 requirements. We anticipate expending significant resources in developing the necessary documentation and testing procedures required by Section 404, however, there is a risk that we will not comply with all of the requirements imposed by Section 404. In addition, the very limited size of our organization could lead to conditions that could be considered material weaknesses, such as those related to segregation of duties that is possible in larger organizations but significantly more difficult in smaller organizations. Also, controls related to our general information technology infrastructure may not be as comprehensive as in the case of a larger organization with more sophisticated capabilities and more extensive resources. It is not clear how such circumstances should be interpreted in the context of an assessment of internal control over financial reporting. If we fail to implement required new or improved controls, we may be unable to comply with the requirements of Section 404 in a timely manner, and may result in our independent registered public accounting firm issuing a qualified or adverse report on our internal control and/or management’s assessment thereof. This

could result in an adverse reaction in the financial markets due to a loss of confidence in the reliability of our financial statements, which could cause the market price of our common stock to decline.

Our certificate of incorporation and by-laws include anti-takeover provisions that may enable our management to resist an unwelcome takeover attempt by a third party.

Our basic corporate documents and Delaware law contain provisions that enable our management to attempt to resist a takeover unless it is deemed by management and our Board of Directors to be in the best interests of our stockholders. Those provisions might discourage, delay or prevent a change in the control of our company or a change in our management. Our Board of Directors may also choose to adopt further anti-takeover measures without stockholder approval. The existence and adoption of these provisions could adversely affect the voting power of holders of common stock and limit the price that investors might be willing to pay in the future for shares of our common stock.

The concentration of ownership among our executive officers, directors and their affiliates may delay or prevent a change in our corporate control.

Our executive officers, directors and their affiliates beneficially own or control in excess of approximately 15% of outstanding common shares, warrants or options to purchase common stock, with approximately 10% of outstanding common shares, warrants and options to purchase common stock held by Perseus-Soros BioPharmaceutical Fund, L.P. As a result, our executive officers, directors and their affiliates will be able to exercise significant control over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions, which could delay or prevent an outside party from acquiring or merging with us, which could in turn reduce our stock price.

If our facilities were to experience an earthquake or other catastrophic loss, our operations would be seriously harmed.

Our facilities could be subject to a catastrophic loss such as fire, flood or earthquake. All of our research and development activities, our corporate headquarters and other critical business operations are located near major earthquake faults in Burlingame, California. Any such loss at any of our facilities could disrupt our operations, delay development of our products and result in large expense to repair and replace our facilities. We currently do not maintain insurance policies protecting against catastrophic loss, except for fire insurance with coverage amounts normally obtained in our industry.

ITEM 2. UNREGISTERED SALES AND USE OF PROCEEDS

Not applicable.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

ITEM 5. OTHER INFORMATION

Not applicable.

ITEM 6. EXHIBITS

a.	Exhibits

	31.1	Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act.
	31.2	Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act.
	32.1	Certification of Principal Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act.
	32.2	Certification of Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act.

	VALENTIS, INC.


Date: May 12, 2006	/s/ BENJAMIN F. MCGRAW III
	Benjamin F. McGraw III Chairman of the Board of Directors, President and Chief Executive Officer (Principal Executive Officer)


Date: May 12, 2006	/s/ JOSEPH A. MARKEY
	Joseph A. Markey Vice President of Finance and Administration (Principal Financial and Accounting Officer)

PART I: FINANCIAL INFORMATION
ITEM 1:	FINANCIAL STATEMENTS (Unaudited)		3
	Condensed Consolidated Balance Sheets		3
	Condensed Consolidated Statements of Operations		4
	Condensed Consolidated Statements of Cash Flows		5
	Notes to the Condensed Consolidated Financial Statements		6
ITEM 2:	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS		11
	Overview		12
	Results of Operations		13
	Liquidity and Capital Resources		15
ITEM 3:	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		17
ITEM 4:	CONTROLS AND PROCEDURES		17
PART II: OTHER INFORMATION			17
ITEM 1:	LEGAL PROCEEDINGS		17
ITEM 1A:	RISK FACTORS		18
ITEM 2:	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS		25
ITEM 3:	DEFAULTS UPON SENIOR SECURITIES		25
ITEM 4:	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS		25
ITEM 5:	OTHER INFORMATION		25
ITEM 6:	EXHIBITS		25
SIGNATURES		26