ADVANCED MAGNETICS, INC.

CONDENSED STATEMENTS OF CASH FLOWS

FOR THE SIX-MONTH PERIODS ENDED

MARCH 31, 20052006 AND 2004

2005
(Unaudited)

The accompanying notes are an integral part of the condensed financial statements.

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Our 2003 Employee Stock Purchase Plan provides for the issuance of up to 100,000 shares of our common stock to eligible employees. Under the terms of the 2003 Employee Stock Purchase Plan, eligible employees may purchase shares in five annual offerings through payroll deductions of up to a maximum of 10% of the employee’s earnings at a price equal to 85% of the fair market value of the stock on either the first or last day of the applicable annual purchase period, whichever is lower. As of March 31, 2006, 37,259 shares have been issued under the 2003 Employee Stock Purchase Plan.

On October 1, 2005, we adopted SFAS 123R and its related implementation guidance and pronouncements as promulgated by both the FASB and the SEC in SAB 107, associated with the accounting for the share-based compensation arrangements of our employees and certain of our directors, including our Employee Stock Purchase Plan program. These pronouncements require that equity-based compensation cost be measured at the grant date (based upon an estimate of the fair value of the enterprise’s equity instrumentscompensation granted), or that may be settled byin certain circumstances, the issuance of such equity instruments.service inception date, and recorded to expense or capitalized over the requisite service period, which generally is the vesting period. We adopted SFAS 123R, together with guidance included in Staff Accounting Bulletin No. 107 issued byusing the SEC on March 29, 2005, also

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known as SAB 107, eliminates the ability to account for share-based compensation transactions using APB 25 and generally requires such transactions be accounted for using a fair-value-based method.  SFAS 123R applies to awards that are granted, modified or settled in periods beginning after its applicable effective date.  In April 2005, the SEC issued a release amending the effective date of SFAS 123R for each registrant to the start of the registrant’s first fiscal year beginning after June 15, 2005.  SFAS 123R allows for three alternative transition methods.  We intend to adopt the prospective application method.  We currently intend to adopt SFAS 123R and SAB 107 either in the fourth quarter of fiscal 2005 ormethod, in the first quarter of fiscal 2006. OurAccordingly, results for interim and fiscal year periods prior to October 1, 2005 do not include, and have not been restated to reflect, amounts associated with the requirements of SFAS 123R.

In the first six months of fiscal 2006, we recorded a $2,187,747 ($0.22 per share) non-cash charge associated with the implementation of SFAS 123R for employee stock-based compensation, with a corresponding credit to additional paid-in capital. Of this amount, $1,876,652 was charged to selling, general and administrative expenses and $311,095 was charged to research and development expenses. A significant portion ofthe expense recorded in the first six months of fiscal 2006 is attributable to options granted to a related party (as discussed in Note G) and to our non-employee directors under our 2000 Stock Plan. There were no equity-based compensation costs capitalized in the first six months of fiscal 2006, as such amounts were not material. Due to the uncertainty surrounding the realization of the favorable tax attributes in future tax returns associated with operating losses we incurred in the past several years, we have recorded a full valuation allowance against our otherwise recognizable net deferred tax assets as of March 31, 2006 and September 30, 2005. Accordingly, no income tax benefits were recognized by us in the first six months of fiscal 2006 associated with the adoption of SFAS 123R, will cause usand there was no impact recorded in cash flows from financing activities nor cash flows from operating activities as reported in the accompanying Condensed Statements of Cash Flows.

Prior to recordOctober 1, 2005, we recorded stock-based compensation granted to consultants in accordance with existing pronouncements. In the first six months of fiscal 2006, we recorded a noncash accounting$322,753 ($0.03 per share) non-cash charge as anwith a corresponding credit to additional paid-in capital. Of this amount, $118,632 was charged to research and development expense each quarter in an amount approximatingand $204,121 was charged to selling, general and administrative expense. In the first six months of fiscal 2005, we recorded a non-cash charge of $3,116 (all of which was charged to research and development expense), with a corresponding credit to additional paid-in capital.

We estimate the fair value of equity-based compensation utilizing the Black-Scholes option pricing model. This model requires the input of several factors such share-based compensation meetingas the criteriaexpected option term, expected volatility of our stock price over the expected option term, expected risk-free interest rate over the expected option term, expected dividend yield over the expected option term, and an expected forfeiture rate, which are subject to various assumptions. We believe this valuation methodology is appropriate for estimating the fair value of stock options we grant to employees and directors which are subject to SFAS 123R requirements. These amounts are estimates and thus may not be reflective of actual future results or amounts ultimately realized by recipients of these grants. These amounts, and the amounts applicable to future quarters, are also subject to future quarterly adjustments based upon a variety of factors, which include, but are not limited to, the issuance of new options. The following table summarizes the assumptions we utilized for grants of options to differing groups of optionees in the six months ended March 31, 2006:

Assumptions

All options granted have a contractual ten year term. Certain options granted to a related party and to directors generally vested either immediately or over a three year period. Option grants to employees generally vest over a four year period of continuous employee service. Risk free interest rates utilized are based upon published U.S. Treasury yield curves at the date of the grant for the expected option term. Expected stock price volatility is based upon the historical volatility of our

common stock price over 1 to 6.25 years. For options granted prior to September 30, 2005, we used historical exercise and forfeiture information associated with groups of employees and directors to determine expected life and forfeiture rates. For options granted after September 30, 2005, we continue to use historical forfeiture information to determine forfeiture rates. However, the simplified approach, as outlined in SAB 107, was utilized to determine expected life.

The following tables present summarized data relative to our stock option plans:

* These figures do not include warrants outstanding and/or exercisable. See Note E of Notes to Condensed Financial Statements.

The aggregate intrinsic value of options outstanding and options exercisable, measured at March 31, 2006, was approximately $30,800,000 and $16,700,000, respectively. The aggregate intrinsic value of options exercised in the provisionsquarter ended March 31, 2006, measured as of the exercise date, was approximately $4,300,000.

At March 31, 2006, the amount of unrecorded expense associated with the adoption of SFAS 123R.  As123R attributable to future periods was approximately $3.9 million, which is expected to be amortized primarily to expense on a straight line basis over a weighted average amortization period of approximately two years. This estimate is subject to change based upon a variety of future events which include, but are not limited to, changes in estimated forfeiture rates, and the issuance of new options. See also Note G.

In the second quarter of fiscal 2006, we also issued an aggregate of 24,000 restricted stock units to employees pursuant to our Amended and Restated 2000 Stock Plan, all of which were outstanding but unvested as of March 31, 2006. These grants vest ratably, on an annual basis, over a four year period. The estimated fair value of restricted stock granted was determined at the grant date based upon the quoted market price per share on the date of the grant. The estimated fair value of these restricted stock unit awards was approximately $479,000. At March 31, 2006, the amount of unrecorded expense for these restricted stock units associated with the adoption of SFAS 123R attributable to future periods was approximately $458,000, which is expected to be amortized primarily to expense on a straight line basis over a weighted average amortization period of approximately four years. This estimate is subject to change based upon a variety of future events which include, but are not limited to, changes in estimated forfeiture rates, and the issuance of new options or awards. See also Note G.

The following table presents summarized data relative to restricted stock units granted pursuant to our Amended and Restated 2000 Stock Plan:

*These figures do not include warrants outstanding and/or exercisable. See Note E of Notes to Condensed Financial Statements.

Prior to October 1, 2005, we applied Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees,” or APB 25, and related interpretations in accounting for qualifying options granted to our employees and directors under our plans and applied SFAS No. 123 “Accounting for Stock Issued to Employees,” or SFAS 123 (as amended by SFAS 148 “Accounting for Stock-Based Compensation-Transition and Disclosure-an amendment of FASB Statement No. 123,” or SFAS 148), for disclosure purposes only. The SFAS 123 and SFAS 148 disclosures for periods prior to October 1, 2005 include pro forma net loss and loss per share as if the fair value-based method of accounting had approximately 363,500 stock options outstanding whichbeen used. Stock-based compensation to certain non-employees is accounted for in accordance with SFAS 123R, utilizing the measurement guidance of EITF 96-18 “Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.”

If stock-based compensation for employees had not yet become vested.  The amount of such charge has not been determined.determined based on SFAS 123, as amended by SFAS 148, our pro forma loss and pro forma loss per share for the quarter and six months ended March 31, 2005 would have been as follows:

The fair value of substantially all options granted during the fiscal quarter ended March 31, 2005 was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions: (1) expected life of 6.25 years; (2) expected volatility of 76.7%; (3) weighted average risk-free interest rate of 3.90% in 2005; and (4) no dividend yield. In the fiscal quarter ended March 31, 2005, the assumptions used for awards under our 2003 Employee Stock Purchase Plan were as follows: (1) expected life of 1.0 years; (2) expected volatility of 106.0%; (3) weighted average risk-free interest rate of 3.25%; and (4) no dividend yield.

I.              Concentration of Credit Risk

Our operations are located solely within the United States. We perform ongoing credit evaluations of our customers and generally do not require collateral. Three companies were responsible for approximately 87% of our revenue during the six months ended March 31, 2006. Berlex Laboratories, Inc., or Berlex, represented approximately 27% of our revenue, Tyco/Mallinckrodt represented approximately 12% of our revenue, and Guerbet represented approximately 48% of our revenue. Three companies were responsible for approximately 92% of our revenue during the six months ended March 31, 2005. Berlex represented approximately 46% of our revenue, Guerbet represented approximately 19% of our revenue, and Cytogen Corporation, or Cytogen, represented approximately 27% of our revenue in the six months ended March 31, 2005. No other company accounted for more than 10% of our total revenues for the six months ended March 31, 2006 or 2005. All of the revenue attributable to Cytogen and a significant portion of the revenue attributable to Berlex in the quarters ended March 31, 2006 and 2005 was previously deferred revenue related to up-front license fees.

Three companies were responsible for our trade receivables at March 31, 2006. Guerbet represented approximately 61%, Tyco/Mallinckrodt represented approximately 29% and Taejoon Pharmaceuticals represented approximately 10% of our trade receivables at March 31, 2006. Revenues from customers and licensees outside of the United States, principally in Europe and Japan, amounted to 55% and 21% of our total revenues for the six months ended March 31, 2006 and 2005, respectively.

J.             Recently Issued Accounting Pronouncements and Proposals

In November 2004, the FASB issued SFAS No. 151 “Inventory Costs - an amendment of ARB No. 43, Chapter 4,” or SFAS 151. This pronouncement, which becomes effective for interim or annual periods beginning after June 15, 2005, clarifies existing accounting guidance relating to accounting for certain abnormal costs of production. We believeThe adoption of SFAS 151 willdid not have a material impact on our results of operations or financial condition.

In November 2005, the FASB issued FASB Staff Position No. FAS 115-1 and FAS 124-1 “The Meaning of Other Than-Temporary Impairment and Its Application to Certain Investments”. This pronouncement addresses the determination as to when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of an impairment loss. The adoption of the provisions of this pronouncement is not expected to have a material impact on our financial position or results of operations.

In January 2006, the FASB issued proposed Statement of Financial Accounting Standards “The Fair Value Option for Financial Assets and Liabilities”. This proposed Statement would create a fair value option under which an entity may irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and financial liabilities, with changes in fair value recognized in earnings as those changes occur. An entity would be permitted to elect the fair value option at initial recognition of a financial asset or financial liability or upon an event that gives rise to new-basis accounting for that item. The election of the fair value option would be made on a contract-by-contract basis and would need to be supported by concurrent documentation or a preexisting documented policy.

In February 2006, the FASB issued FASB Staff Position No. FAS 123(R)-4 “Classification of Options and Similar Instruments Issued as Employee Compensation That Allow for Cash Settlement upon the Occurrence of a Contingent Event”.

This pronouncement clarifies existing accounting guidance to require that options or similar instruments be classified as liabilities if an entity can be required under any circumstance to settle the option or instrument by transferring cash or other assets. The adoption of the provisions of this pronouncement did not have a material impact on our financial position or results of operations.

G.K.            Commitments and Contingencies

Legal Proceedings

InOn January 25, 2006, Cytogen Corporation, or Cytogen, filed a lawsuit against us in Massachusetts Superior Court. The complaint includes claims of breach of contract, breach of implied covenant of good faith and fair dealing, fraudulent misrepresentation and unjust enrichment and relates to a license and marketing agreement entered into in August 2000 between us and Cytogen granting Cytogen certain rights to Combidex and to ferumoxytol for oncology imaging applications only. We filed an answer to the quarter ended March 31, 2005,complaint asserting numerous counterclaims, including breach of contract, defamation, tortious interference with advantageous business relations, tortious interference with contract, abuse of process, and violation of the Lanham Act. We believe Cytogen’s lawsuit has no merit, and we plan to conduct a vigorous defense of the claims set forth in the complaint. However, due to the fact that Cytogen is seeking unspecified damages and the case is still in its earliest stages, we cannot at this time predict the outcome of the case nor estimate the possible loss or range of loss we could incur if there were an unfavorable outcome with respect to this litigation.

Facility Lease and Related Letter of Credit and Purchase Order Committments

On February 28, 2006, we entered into a purchase commitmentlease agreement with CambridgePark 125 Realty Corporation, for certain real property located at 125 CambridgePark Drive, Cambridge, Massachusetts. The lease has a three year term, with an additional partial month at the beginning of the term and provides for one option to extend the lease for a two year period. Under the terms of the lease, we are required to pay the landlord approximately $15,600 per calendar month for the first year of the term (plus the partial month at the beginning of the term), approximately $16,300 per calendar month for the next year of the term and approximately $17,000 per calendar month for the last year of the term. In addition to rent, we are also required to pay a proportionate share of the landlord’s annual operating costs and electricity. The rent for any extension term will be determined at the time of the exercise of the option under terms set out in the lease.

We have accounted for this lease as an operating lease. In accordance with FASB Technical Bulletin No. 85-3 “Accounting for Operating Leases with Scheduled Rent Increases,” rent expense is being recognized in the financial statements on a straight-line basis over the lease term, excluding extension periods. In addition, we issued a $15,603 irrevocable letter of credit to the landlord, which expires in April 2009, in fulfillment of a security deposit requirement. This amount is classified on the accompanying balance sheet as a long-term asset and is restricted in its use.

In conjunction with this lease, we entered into several agreements for the purchase of approximately $250,000 for certain researchfurniture and development materials, of which approximately $22,000 worth had been received by us astelecommunications equipment. As of March 31, 2005.  We have no payment obligations2006, there remained approximately $150,000 to be paid pursuant to this purchase commitment until we receive supplies inthese agreements. Payment to the vendors is contingent upon satisfactory condition.

11delivery and our acceptance of all outstanding items.

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

The following information should be read in conjunction with the unaudited financial information and the notes thereto included in this Quarterly Report on Form 10-Q and the audited financial information and the notes thereto included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2004.2005.

Except for the historical information contained herein, the matters discussed in this Quarterly Report on Form 10-Q may be deemed to be forward-looking statements that involve risks and uncertainties. We make such forward-looking statements pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and other federal securities laws. In this Quarterly Report on Form 10-Q, words such as “may,” “will,” “expects,” “intends,” and similar expressions (as well as other words or expressions referencing future events, conditions or circumstances) are intended to identify forward-looking statements. Our actual results and the timing of certain events may differ materially from the results discussed, projected, anticipated or indicated in any forward-looking statements. Any forward-looking statement should be considered in light of factors discussed in this Item 1a of Part 2 below under “Certain“Risk Factors - Certain Factors That May Affect Future Results” and elsewhere in this Quarterly Report on Form 10-Q and those risks identified in our other Securities and Exchange Commission filings, including but not limited to our Annual Report on Form 10-K for the fiscal year ended September 30, 2004.2005. We caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date they are made. We disclaim any obligation, except as specifically required by law and the rules of the United States Securities and Exchange Commission, or SEC, to publicly update or revise any such statements to reflect any change in company expectations or in events, conditions or circumstances on which any such statements may be based, or that may affect the likelihood that actual results will differ from those set forth in the forward-looking statements.

Overview

Advanced Magnetics, Inc. was incorporated in Delaware in November 1981 and is a developer of superparamagnetic iron oxide nanoparticles used in pharmaceutical products. We are dedicated to the development and commercialization of our proprietary nanoparticle technology for use in therapeutic iron compounds to treat anemia, as well as novel imaging agents to aid in the diagnosis of cancer and cardiovascular disease and cancer.disease. We have two approved products, Feridex I.V.® and GastroMARK®, and two product candidates, Combidex®ferumoxytol and ferumoxytol.  Combidex®.

Ferumoxytol, the key product in our development pipeline, is in Phase III multi-center clinical trials for use as an intravenous (IV) iron replacement therapeutic in chronic kidney disease patients, whether or not on dialysis. We expect to submit a New Drug Application, or NDA, for ferumoxytol in IV iron replacement therapy to the U.S. Food and Drug Administration, or FDA, in mid calendar year 2007.

Combidex, the other product in our development pipeline, is ouran investigational functional molecular imaging agent consisting of iron oxide nanoparticles for use in conjunction with magnetic resonance imaging, also known asor MRI, to aid in the differentiation of cancerous from normal lymph nodes. Ferumoxytol is in Phase III multi-center clinical trials for use as an iron replacement therapeutic in chronic kidney disease patients, whether or not on dialysis.  Exploratory Phase II clinical trials of ferumoxytol for use as a contrast agent in magnetic resonance angiography, also known as MRA, are currently ongoing.

In June 2000, Combidex received an approvable letter, subject to certain conditions, from the U.S. Food and Drug Administration, also known as the FDA.  In September 2004, we submitted a complete response to the approvable letter, which was accepted by the FDA and assigned a user fee goal date of March 30, 2005.  On March 3, 2005, the FDA’s Oncologic Drugs Advisory Committee, also known as ODAC, voted to not recommend approval of the proposed broad indication for Combidex.  Subsequently, in March 2005, we received an approvable letter from the FDA with respect to Combidex, subject to certain conditions.  We have formally requested a meetingDue to our limited resources and the priority we are placing on completion of the Phase III development program for ferumoxytol as an IV iron replacement therapeutic, we do not currently intend to sponsor additional clinical studies for Combidex. However, we are reviewing and evaluating existing studies, including studies sponsored by our European partner, Guerbet, to determine whether such studies will address the concerns raised by the FDA in the March 2005 approvable letter. Until we complete our evaluation of these studies and meet with the FDA to discuss next steps, in the regulatory process for Combidex. Until such next steps are determined, we cannot predict with certainty the timing or costscost of the efforts that would be necessary to satisfy the conditions specified by the FDA for approval of Combidexin the approvable letter, or our ability to complete those efforts in a timely or cost-effective manner, if at all.

Feridex I.V.®, our liver contrast agent, is currently approved and marketed in Europe, Japan, the United States and other countries. GastroMARK®GastroMARK, our oral contrast agent used for delineating the bowel in MRI, is approved and marketed in Europe, the United States and other countries.

Critical Accounting Estimates

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1996, the parties agreed to remove Canada from the territories subject to the agreement. Berlex paid us non-refundable license fees and other fees in connection with the agreements. We have determined to account for the revenue associated with this agreement on a straight-line basis over the term of the agreement due to the existence of an established contract period. Recognition of the remainder of the deferred revenue as license fee revenue is expected to occur proportionately over the remaining term of the agreement. In both fiscal quarters ended March 31, 2006 and 2005, we recorded to income $184,439 of previously deferred licensing revenue associated with our license and marketing agreement with Berlex. The agreement expires in 2010 but can be terminated earlier upon the occurrence of certain specified events.

Total license fee revenue for the three months ended March 31, 2006 and 2005 was recognized as follows:

During the fiscal quarter ended March 31, 2005, we increased our projection of future research and development expenses associated with the Cytogen agreement based upon our current estimate of the cost of future efforts that might be required to obtain approval of Combidex.  As a result, our revenue associated with this agreement decreased as compared with the fiscal quarter ended March 31, 2004.  This decrease was partially offset by an increase in expenses related to the Cytogen agreement incurred in the fiscal quarter ended March 31, 2005 as compared to expenses incurred in the fiscal quarter ended March 31, 2004.  This increase in expenses was primarily the result of a higher level of both internal and external costs associated with our preparation for and participation in the March 2005 ODAC meeting.

Royalty Revenue

Royalties decreased $20,423,increased $29,190 or 29%59%, to $49,577$78,767 for the fiscal quarter ended March 31, 2005,2006, compared with royalties of $70,000$49,577 for the fiscal quarter ended March 31, 2004.2005. Royalty payments can fluctuate from quarter to quarter based on uneven demand by end users for our marketed products, Feridex I.V. and GastroMARK. Royalty payments from our marketing partners have been at lower levels in recent years, andHowever, we expect royalties to continuegenerally remain at lowcurrent levels overall due to the current competitive landscape for our marketed products.

Product Sale Revenue

Product sale revenue for the three months ended March 31, 2006 and 2005 consisted of the following:

The increase in product sale revenue in the fiscalquarter ended March 31, 2006 as compared to the quarter ended March 31, 2005 as compared to the fiscal quarter ended March 31, 2004 was primarily the result of the fluctuationan increase in sales ofGastroMARK to our marketing partners. Product sales may fluctuate from quarter to quarter. Fluctuations in our product sales are largely attributable to our marketing partners from period to period based on uneven purchasing patterns of our marketing partnersunpredictable annual product demand by end users and the batch size in which our products are manufactured and shipped.  Other product sales in the fiscal quarter ended March 31, 2005 included the sale of bulk Combidex to one ofshipped, which creates uneven purchasing patterns by our foreign marketing partners for research and development purposes.partners. We expect revenue from product sales will continue to fluctuate from quarter to quarter as a result of these factors. Product sales in the variable naturethree months ended March 31, 2005 included the sale of bulk Combidex to one of our product sales to ourforeign marketing partners as well as the batch size in which our products are manufactured.for research and development purposes.

Costs and Expenses

Cost of Product Sales

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We incurred costs of $51,156 associated with product sales during the quarter ended March 31, 2006 compared to costs of $54,194 associated with product sales during the fiscal quarter ended March 31, 2005, compared toa decrease of $3,038 or 6%. These costs of $32,806 associated with product sales during the fiscal quarter ended March 31, 2004.  This constituted approximately 29%13% and 37%29% of product sales during the fiscal quarters ended March 31, 20052006 and 2004, 2005,

respectively. Our gross margins are dependent on the mix of customers, prices we charge for our products, product mix, changes in unit volume and production efficiencies.

The percentage decrease in cost of sales in the quarter ended March 31, 2006 is attributable to the sale of higher margin products as compared to the same quarter in the prior fiscal year.

Research and Development Expenses

Research and development expenses include external expenses, such as costs of clinical trials, contract research and development expenses, consulting fees and expenses and professional fees, and internal expenses, such as compensation of employees engaged in research and development activities, the manufacture of limited quantities of product needed to support research and development efforts, related costs of facilities, and other general costs related to research and development.

At the end of fiscal 2000, we adopted the guidance under SEC Staff Accounting Bulletin No. 101, also known as SAB 101, “Revenue Recognition in Financial Statements” (later revised as Staff Accounting Bulletin No. 104).  As a result of this change of accounting method, we have tracked our internal research and development expenses since this time in relation to our license and marketing agreement with Cytogen and not by specific research and development project and therefore we can only provide external research and development costs and not total costs by project since the end of fiscal 2000.

Research and development expenses for the three months ended March 31, 2006 and 2005 consisted of the following: