Tanox (TNOX) 10-Q 2005 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

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

For the quarterly period ended September 30, 2005

OR

¨ 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: 000-30231

TANOX, INC.

(Exact Name of Registrant as Specified in Its Charter)

Delaware	76-0196733
(State or Other Jurisdiction of Incorporation or Organization)	(IRS Employer Identification No.)
10301 Stella Link Houston, Texas	77025
(Address of Principal Executive Offices)	(Zip Code)

(713) 578-4000

(Registrant’s Telephone Number, Including Area Code)

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

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

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

Number of shares of common shares outstanding at October 31, 2005: 44,849,438.

TANOX, INC.

FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2005

INDEX

	Page
Part I – Financial Information
Item 1 – Financial Statements
Condensed Consolidated Balance Sheets at September 30, 2005 and December 31, 2004	1
Condensed Consolidated Statements of Operations and Comprehensive Loss for the Three and Nine Months Ended September 30, 2005 and 2004	2
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2005 and 2004	3
Notes to Condensed Consolidated Financial Statements	4
Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations	8
Item 3 – Quantitative and Qualitative Disclosures About Market Risk	30
Item 4 – Controls and Procedures	30
Part II – Other Information
Item 1 – Legal Proceedings	31
Item 6 – Exhibits	31
Signatures	32

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PART I

FINANCIAL INFORMATION

Item 1. Financial Statements

TANOX, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In Thousands, Except Shares and Per Share Data)

	September 30, 2005			December 31, 2004
	(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	40,017		$	5,284
Restricted cash		5,000			5,000
Short-term investments		120,921			152,960
Interest receivable		896			2,149
Accounts receivable		8,521			6,049
Accounts receivable from related party		88			44
Prepaid expenses and other		3,135			2,294
Total current assets		178,578			173,780
LONG-TERM INVESTMENTS		6,000			39,267
PROPERTY, PLANT & EQUIPMENT, NET		30,691			25,506
OTHER ASSETS		1,558			—
TOTAL ASSETS	$	216,827		$	238,553
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable	$	2,851		$	2,399
Accrued liabilities		3,839			6,092
Accrued arbitration award		1,661			864
Deferred revenue		562			—
Note payable to bank		5,000			—
Total current liabilities		13,913			9,355
LONG –TERM LIABILITIES:
Note payable to bank		—			5,000
Total long-term liabilities		—			5,000
STOCKHOLDERS’ EQUITY:
Preferred stock, $.01 par value; 10,000,000 shares authorized; none outstanding		—			—
Common stock, $.01 par value; 120,000,000 shares authorized 45,399,558 and 44,531,998 shares issued, and 44,844,858 and 43,977,298 shares outstanding in 2005 and 2004, respectively		454			445
Additional paid-in capital		330,939			322,671
Treasury stock, at cost; 554,700 shares in 2005 and 2004		(6,261	)		(6,261	)
Accumulated other comprehensive income		879			1,178
Accumulated deficit		(123,097	)		(93,835	)
Total stockholders’ equity		202,914			224,198
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	216,827		$	238,553

See accompanying notes to condensed consolidated financial statements.

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TANOX, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(Unaudited)

(In Thousands, Except Per Share Data)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2005			2004			2005			2004
REVENUES:
Royalties, net of arbitration award	$	7,603		$	2,298		$	20,712		$	7,810
Royalties from related party, net of arbitration award		67			17			149			44
Development agreements, licensing fees and manufacturing rights		663			103			748			3,610
Development agreements from related party		14			48			43			3,455
Total revenues		8,347			2,466			21,652			14,919
OPERATING COSTS AND EXPENSES:
Research and development		11,402			6,622			35,156			18,698
Acquired in-process research and development		—			—			13,680			—
General and administrative		1,515			1,639			5,270			5,150
Total operating costs and expenses		12,917			8,261			54,106			23,848
LOSS FROM OPERATIONS		(4,570	)		(5,795	)		(32,454	)		(8,929	)
OTHER INCOME (EXPENSE):
Interest income		1,279			941			3,435			2,745
Interest expense		(59	)		(33	)		(155	)		(126	)
Other, net		(33	)		(26	)		(88	)		(137	)
Total other income		1,187			882			3,192			2,482
NET LOSS	$	(3,383	)	$	(4,913	)	$	(29,262	)	$	(6,447	)
BASIC LOSS PER SHARE	$	(0.08	)	$	(0.11	)	$	(0.66	)	$	(0.15	)
DILUTED LOSS PER SHARE	$	(0.08	)	$	(0.11	)	$	(0.66	)	$	(0.15	)
SHARES USED IN COMPUTING LOSS PER SHARE:
Basic		44,063			44,006			44,596			44,014
Diluted		44,063			44,006			44,596			44,014
COMPREHENSIVE LOSS:
Net loss	$	(3,383	)	$	(4,913	)	$	(29,262	)	$	(6,447	)
Foreign currency translation adjustment		3			—			3			—
Unrealized gain (loss) on available-for-sale investments		21			(221	)		(302	)		237
TOTAL COMPREHENSIVE LOSS	$	(3,359	)	$	(5,134	)	$	(29,561	)	$	(6,210	)

See accompanying notes to condensed consolidated financial statements.

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TANOX, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In Thousands)

	Nine Months Ended September 30,
	2005			2004
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(29,262	)	$	(6,447	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		2,901			1,895
Acquired in-process research and development		13,680			—
Compensation expense related to stock options		27			30
Changes in operating assets and liabilities:
Increase in receivables and other assets		(3,662	)		(19	)
Decrease in current liabilities		(442	)		(8,691	)
Net cash used in operating activities		(16,758	)		(13,232	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant and equipment		(8,086	)		(6,978	)
Cash paid for acquisition of in-process research and development		(6,000	)		—
Purchases of investments		(133,805	)		(214,435	)
Maturities and sales of investments		198,809			222,430
Decrease in restricted cash		—			5,518
Loss on disposal of PP&E		—			38
Net cash provided by investing activities		50,918			6,573
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of stock		570			492
Net cash provided by financing activities		570			492
IMPACT OF EXCHANGE RATES ON CASH		3			—
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		34,733			(6,167	)
CASH AND CASH EQUIVALENTS:
Beginning of period		5,284			21,450
End of period	$	40,017		$	15,283
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Capital contribution from forgiveness of note payable by a related party		—			10,000
Capital contribution from forgiveness of interest by a related party		—			742
Unrealized gain (loss) on available-for-sale investments		(302	)		237
Common stock issued for acquisition of in-process research and development		7,680			—

See accompanying notes to condensed consolidated financial statements.

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TANOX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2005

(UNAUDITED)

1. Basis of Consolidation

The accompanying unaudited condensed consolidated interim financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X and include the accounts of Tanox, Inc. and its wholly owned subsidiaries (collectively the Company or Tanox). Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles in the United States for complete financial statements. In the opinion of management, all adjustments considered necessary for fair presentation have been included. All such adjustments are of a normal recurring nature. These condensed consolidated interim financial statements and notes thereto should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2004. Operating results for the three and nine months ended September 30, 2005 are not necessarily indicative of the operating results that may be expected for the year ending December 31, 2005.

2. Reclassification

As of September 30, 2004, Tanox reclassified auction rate securities of $25.2 million from cash and cash equivalents to short-term investments. The accompanying consolidated statement of cash flows for the nine months ended September 30, 2004 has been adjusted to reflect these reclassifications.

3. Revenues

Development Agreements, Licensing Fees and Manufacturing Rights. Development agreement revenue includes reimbursement from Genentech, Inc. (Genentech) and Novartis Pharma AG (Novartis) of selected current quarter clinical trial costs incurred for TNX-901. Licensing fee revenue includes payments received in exchange for rights to license and sublicense Tanox’s technology or product rights. Manufacturing rights revenue represent amounts received by Tanox from Genentech and Novartis in consideration for Tanox’s relinquishment in 2004 of any rights it had to manufacture Xolair. Manufacturing rights revenue is based on the quantity of Xolair produced. Tanox received its first manufacturing rights payment of $650,000 in the third quarter of 2005, which was based on the quantity of Xolair produced in the first two quarters of 2005.

Royalties and Profit Sharing. Royalty revenues of $7.7 million and $2.3 million on the net sales of Xolair^®(omalizumab), for the quarters ended September 30, 2005 and 2004, respectively, were calculated based on net sales reported to Tanox by Genentech and Novartis. For the nine months ended September 30, 2005, $20.9 million in Xolair royalty revenue was recorded compared to $7.9 million for the same period in 2004. Royalty revenue is net of amounts which are payable by Tanox to its former attorneys (see Note 9. Commitments and Contingencies).

Under the Company’s collaboration agreements, Tanox also shares in Novartis’ net profits from sales of Xolair in the U.S. Tanox received a payment of $562,000 from Novartis in the third quarter of 2005 representing its share of U.S. net profits from Novartis’ sales of Xolair in the first two quarters of 2005. The Company disagrees with Novartis’ calculation of Tanox’s share of net profits. Accordingly, the payment received from Novartis has been recorded as deferred revenue as the parties continue to discuss the calculation.

In the United States, Tanox receives royalties on sales of Xolair and other collaboration products and

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receives a share of Novartis’ net profits on these sales. The Company also receives royalties on sales of Xolair and other collaboration products outside the U.S. Novartis profit sharing and rest-of-world royalty payments are net of certain credits, which, at September 30, 2005, approximated $1.7 million. In addition, as a result of an adverse arbitration award, 10% of all royalties received by Tanox on sales of Xolair and certain other anti-IgE products will be payable to its former attorneys, up to a maximum of $300 million. The Company expects that the net amount it will receive from Xolair sales, taking into account both the foregoing credits and the amount payable to its former attorneys, will be in the range of 8% to 12% of net sales depending on the sales level achieved and geographic distribution of the sales.

4. Cash, Cash Equivalents, Short-term and Long-term Investments

Cash equivalents consist of highly liquid investments with original maturities of three months or less. Management determines the appropriate classification of its cash equivalents, short-term investments and long-term investments at the time of purchase, subject to reclassification (see Note 2). Investments consist of investment grade corporate bonds, commercial paper, asset-backed securities, auction-rate securities and government agency securities with maturities of less than three years from the balance sheet date. Certain investments are classified as held-to-maturity and carried at amortized cost in the accompanying financial statements. The Company’s available-for-sale investments are stated at fair value based on the quoted market price of the investment. Unrealized gains and losses on available-for-sale investments are reported as other comprehensive income (loss), which is a separate component of stockholders’ equity. For the quarter ended September 30, 2005, the fair value of Tanox’s available-for-sale investments increased by $21,000 versus a decrease in value of $221,000 for the quarter ended September 30, 2004. For the nine months ended September 30, 2005, the fair value of these available-for-sale investments decreased by $302,000 versus an increase in value of $237,000 for the same period ended September 30, 2004.

Tanox’s net carrying value of cash and cash equivalents (including restricted cash) at September 30, 2005 and December 31, 2004, was $45.0 million and $10.3 million, respectively.

Investments consist of the following (in thousands):

	September 30, 2005		December 31, 2004
Held-to-maturity investments	$	81,779	$	115,241
Available-for-sale investments		39,142		37,719
Total short-term investments		120,921		152,960
Held-to-maturity investments – long-term		6,000		39,267
	$	126,921	$	192,227

The fair value of these investments at September 30, 2005 and December 31, 2004, was $126.6 million and $191.4 million, respectively.

5. Acquisitions

Manufacturing Assets and Long-term Lease

Pursuant to a Lease Assignment and Asset Purchase Agreement dated December 9, 2004, between Biogen IDEC, Inc. and Tanox, on January 10, 2005, Tanox acquired from Biogen IDEC certain manufacturing, process development and quality control equipment, related documentation and furniture and fixtures housed in a 76,000 square foot leased facility located in San Diego, California. The Company paid Biogen IDEC approximately $5.6 million for the assets. Tanox finalized the allocation of this purchase price in the second quarter of 2005 and classified $4.6 million as property, plant and equipment and the remaining $1.0 million as

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an intangible asset for manufacturing equipment documentation, included in other assets on the balance sheet. Tanox also agreed to assume the obligations of Biogen IDEC under the triple net lease for the facility, which extends until October 2011, with two five-year extension options. The lease payments for 2005 will be approximately $3.8 million and will increase annually over the term of the lease, including extension periods, at a rate of approximately 4%. As partial consideration for Tanox’s agreement to the extension of the lease term to September 30, 2011, and assuming Tanox is not then in default under the lease agreement, Biogen IDEC agreed to make two payments to Tanox, each in the amount of approximately $2.4 million, on September 30, 2007 and November 30, 2008. We expect the total future lease obligation of Tanox for this lease assignment through 2011, net of the Biogen IDEC payments, will be approximately $24.6 million.

Anti-Tissue Factor Program

On March 31, 2005, the Company acquired a tissue factor antagonist program for the potential treatment of acute lung injury (ALI)/acute respiratory distress syndrome (ARDS) from Sunol Molecular Corporation. In addition to ALI/ARDS, Tanox believes the anti-tissue factor monoclonal antibodies acquired from Sunol have the potential to treat cancer and other diseases that result from over expression of tissue factor and related coagulation abnormalities. In consideration for the tissue factor antagonist program, the Company issued an aggregate of 800,000 shares of its common stock and paid $6.0 million in cash to Sunol. Of the shares issued, 275,000 shares will be held in escrow for up to three years after closing to secure indemnification obligations under the Asset Purchase Agreement. As part of the program, the Company received all tissue factor antagonist assets of Sunol, including anti-tissue factor monoclonal antibodies and related technologies and intellectual property, as well as non-exclusive rights to certain technologies and related intellectual property for protein and antibody expression. Based upon the closing price of the Company’s common stock on March 31, 2005, the fair value of the acquired assets was $13.7 million, including the $6 million paid in cash. As of the acquisition date, the acquired program was still in early development stage, had not reached technological feasibility and had no alternative future use. Accordingly, the Company recorded the $13.7 million purchase price as an acquired in-process research and development expense.

6. Line of Credit Note

Tanox borrowed $5.0 million in September 2002 from a bank under a $16.0 million Revolving Line of Credit Note Agreement. Under the terms of the Agreement, Tanox may secure advances up to the aggregate principal amount of $16.0 million, the proceeds of which can be used to finance the purchase of property, plant and equipment. The outstanding balance is payable in full on September 27, 2006, and advances bear interest at the lesser of the Prime Rate or LIBOR plus 1%, which at September 30, 2005 was 4.875%. The Note is collateralized with cash and investments equal to or greater than 100% of the outstanding principal balance of the Note.

7. Net Loss per Share

Financial Accounting Standards Board (FASB) No. 128, “Earnings Per Share,” requires dual presentation of basic and diluted earnings per share (EPS). Basic EPS is computed by dividing net loss by the weighted average number of shares of common stock outstanding during the year. Diluted EPS is computed in the same manner as basic EPS, except that diluted EPS reflects the potential dilution that would occur if outstanding options and warrants were exercised. Tanox incurred net losses for the three and nine month periods ended September 30, 2005 and 2004; therefore, all options outstanding for each of the periods were excluded from the computation of diluted EPS because they would have been antidilutive.

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8. Stock-Based Compensation

Tanox has adopted the disclosure requirements of SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure” (“SFAS 148”) effective December 2002. SFAS 148 amends FASB Statement No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based compensation and also amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the methods of accounting for stock-based employee compensation and the effect of the method used on reported results. As permitted by SFAS 148 and SFAS 123, the Company continues to apply the accounting provisions of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations, with regard to the measurement of compensation cost for options granted under our stock-based compensation plans. Under the intrinsic value method described in APB Option No. 25, no compensation expense is recognized if the exercise price of the employee stock option equals the market price of the underlying stock on the date of the grant. For the three months ended September 30, 2005 and 2004, no compensation expense was recorded.

Assuming the compensation cost for the stock option plans had been determined pursuant to the fair value method under SFAS No. 123, Tanox’s pro forma net loss would have been as follows (in thousands, except per share data):

	Three Months ended September 30,						Nine Months ended September 30,
	2005			2004			2005			2004
Net loss -
As reported	$	(3,383	)	$	(4,913	)	$	(29,262	)	$	(6,447	)
Stock option compensation expense if the fair value method had been applied		(1,371	)		(979	)		(4,226	)		(3,819	)
Pro forma net loss	$	(4,754	)	$	(5,892	)	$	(33,488	)	$	(10,266	)
Loss per share – Basic and Diluted
As reported	$	(0.08	)	$	(0.11	)	$	(0.66	)	$	(0.15	)
Pro forma	$	(0.11	)	$	(0.13	)	$	(0.75	)	$	(0.23	)

9. Commitments and Contingencies

Tanox had been engaged in litigation in connection with a fee dispute with the law firms that represented the Company in litigation with Genentech relating to, among other things, the intellectual property rights surrounding the development of anti-IgE technology. An arbitration panel issued an award entitling the attorneys to receive (i) approximately $3.5 million, including interest, (ii) payments ranging from 33-1/3% to 40% of the future milestone payments, in excess of the first $1 million, Tanox would receive from Genentech following product approval, and (iii) 10% of the royalties that Tanox would receive on all sales of certain anti-IgE products, including Xolair. The 10% of royalties received by Tanox is required to be paid to the attorneys within 30 days of the end of the calendar quarter in which the royalty payments are received by Tanox. At September 30, 2005, Tanox had an accrued liability of approximately $1.7 million with respect to the amounts that would be payable to the attorneys on royalties received or receivable by Tanox on net sales of Xolair.

From time to time Tanox is a defendant in lawsuits incidental to its business. Management believes the outcome of these lawsuits will not be material to Tanox’s financial statements.

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

Overview

Tanox discovers and develops therapeutic monoclonal antibodies to address significant unmet medical needs in the areas of immune-mediated diseases, infectious disease, inflammation and cancer. Our products are genetically engineered antibodies that target a specific molecule or antigen.

Xolair

Xolair was developed in collaboration with Genentech, Inc. (Genentech) and Novartis Pharma AG (Novartis). In the United States, Xolair is labeled for treatment of adults and adolescents (12 years of age and above) with moderate-to-severe persistent asthma who have a positive skin test orin vitro reactivity to a perennial aeroallergen and whose symptoms are inadequately controlled with inhaled corticosteroids. Xolair was approved for use in the U.S. by the Food and Drug Administration (FDA) in June 2003.

In the third quarter of 2005, we recorded net royalty revenue of $7.7 million from sales of Xolair and $20.9 million for the nine month period ended September 30, 2005, versus $2.3 million and $7.9 million for the same periods in 2004. Under our collaboration agreements with Genentech and Novartis, we receive royalties on the net sales of Xolair and share in Novartis’ net profits from sales of Xolair in the United States. Over the next several years, we expect our principal revenues will be royalties and profit-sharing payments related to sales of Xolair, which will be in the range of 8 percent to 12 percent of net worldwide sales.

We received a payment of $650,000 from Genentech and Novartis in the third quarter of 2005 based on the quantity of Xolair produced in the first and second quarters of 2005. Under the terms of the February 25, 2004 Tripartite Collaboration Agreement (TCA) between Tanox, Genentech and Novartis, Tanox relinquished any rights it had to manufacture Xolair and in exchange receives payments based on the quantity of Xolair produced. This is the first manufacturing rights payment Tanox has received. Over the next several years, manufacturing rights payments could be a material source of revenue for Tanox.

Under our collaboration agreements, we also share in Novartis’ net profits from sales of Xolair in the U.S. We received a payment of $562,000 from Novartis in the third quarter of 2005 representing our share of U.S. net profits from Novartis’ sales of Xolair in the first two quarters of 2005. We disagree with Novartis’ calculation of Tanox’s share of net profits. Accordingly, the payment received from Novartis has been recorded as deferred revenue as the parties continue to discuss the calculation.

The third quarter of 2005 was the eighth consecutive quarter since the launch of Xolair in the third quarter of 2003 that net U.S. sales of the drug have increased. Genentech reported net U.S. sales of Xolair in the quarter of $81.6 million, an increase of 51 percent versus the third quarter of 2004. Based on information provided by Genentech, an increased number of patients have been referred for treatment with Xolair. According to Genentech, approximately 6,000 new patients were prescribed Xolair in the third quarter of 2005. In addition, the prescriber base for Xolair increased by 500 specialists in the third quarter to approximately 7,500, or 75 percent of the initial target physician population. According to Genentech, approximately 85 percent of patients referred for Xolair therapy in the United States were approved for insurance reimbursement.

On October 27, 2005, Novartis announced that the European Commission had granted marketing authorization in all 25 European Union member states for Xolair. In Europe, Xolair is licensed as add-on therapy to improve asthma control in adults and adolescents (ages 12 and above) with severe persistent allergic asthma, who have the following, despite daily high-dose inhaled corticosteroids plus a long-acting inhaled beta₂-antagonist:

• a positive skin test orin vitro reactivity to a perennial aeroallergen

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• reduced lung function (FEV₁<80%)

• frequent daytime symptoms or night-time awakenings

• multiple documented severe asthma exacerbations

Xolair treatment should only be considered for patients with convincing IgE-mediated asthma. According to Novartis, Xolair is expected to become available in the first European countries within the next few weeks.

Clinical trials are ongoing to study the long-term safety profile of Xolair and the effectiveness of Xolair in pediatric allergic asthma patients and in patients suffering from allergy (immediate hypersensitivity) to peanuts.

Clinical Development Programs

TNX-355

We currently have two other products in clinical development. Our lead clinical product is TNX-355, a potential treatment for HIV/AIDS. On October 26, we reported that the Phase 2 study met its primary endpoint with TNX-355 plus optimized background therapy (OBT) demonstrating a statistically significant reduction in viral load – the level of detectable HIV in the bloodstream – compared to placebo plus OBT at 24 weeks. Treatment with the 10 mg/kg dose of TNX-355 resulted in a viral-load reduction of 1.16 log₁₀, compared with a 0.20 log₁₀ reduction in the placebo group, representing a 0.96 log₁₀ greater reduction in viral load in the last observation carried forward analysis. Where patients without a Week 24 value had their baseline values assigned (instead of carrying forward the last observation), treatment with the 10 mg/kg dose resulted in a viral-load reduction of 1.19 log₁₀, compared with a 0.32 log₁₀ reduction in the placebo group, representing a 0.87 log₁₀greater reduction (p:0.002). TNX-355 was well tolerated, with no serious adverse events related to the drug.

The Phase 2 clinical trial was designed to compare the effects of two doses of TNX-355 – 10 mg/kg and 15 mg/kg – to that of a placebo. All study patients received OBT (a standard-of-care regimen). Patients were randomized 1:1:1 to receive 10 mg/kg, 15 mg/kg or placebo every two weeks. Patients in the 10 mg/kg dose received a loading dose of 10 mg/kg every week for eight weeks. The primary endpoint was the mean change from baseline in HIV RNA at week 24. Treatment with the 15 mg/kg of TNX-355 resulted in a viral-load reduction of 0.95 log₁₀, compared with a 0.20 log₁₀ reduction in the placebo group, representing a 0.75 log₁₀ greater reduction in viral load in the last observation carried forward analysis.

In the third quarter, an independent Data Safety Monitoring Board (DSMB) conducted a planned interim safety analysis of TNX-355. The DSMB examined all critical safety data specified in the study’s protocol, with information made available for review after the last randomized, dosed patient reached the 20-week time point of the 48-week study. Pre-specified stopping criteria, based on a group sequential test for monitoring immunosuppressive effects, were not met and no other safety concerns were cited. In addition, the DSMB board did not find cause to change the planned conduct of the trial or to alter the study’s current monitoring plan.

Additional data from this trial was submitted in an abstract to the 45^th annual Interscience Conference on Antimicrobial Agents and Chemotherapy (ICAAC), scheduled for December 16-19, 2005 in Washington, D.C.

The Phase 2 trial is ongoing with a planned continuation to 48 weeks. Following an end-of-Phase 2 meeting with the FDA, we intend to move forward with a planned Phase 3 study of the drug in 2006, and we will continue to evaluate partnership opportunities.

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TNX-832

Our other product in clinical development is an anti-tissue factor chimeric antibody, TNX-832, for the treatment of acute lung injury (ALI) and acute respiratory distress syndrome (ARDS). We are conducting a Phase 1/2 trial with TNX-832 designed to evaluate safety and pharmacokinetics of the antibody. The study is an open label, dose-escalating, placebo-controlled trial, which is expected to enroll approximately 48 patients. Two of five cohorts in the trial have been enrolled. We anticipate that the trial will be completed in the first half of 2007. In addition to ALI/ARDS, we believe our anti-tissue factor compounds have the potential to treat cancer and other diseases that result from over expression of tissue factor and related coagulation abnormalities. One of these compounds, TNX-833, is a humanized monoclonal antibody that is in pre-clinical development.

Pre-Clinical Programs

During the quarter, we continued pre-clinical development of several drug candidates including TNX-650, as a treatment for Hodgkin’s lymphoma. TNX-650 is a humanized monoclonal antibody targeting interleukin 13 (IL-13). IL-13 has been shown to be elevated in the bloodstream of patients with Hodgkin’s disease. In pre-clinical testing, our antibody inhibits the function of IL-13, blocking the proliferation of malignant cells. Approximately 25 percent of Hodgkin’s lymphoma patients do not respond to the current standard of care, which includes chemotherapy, radiation or combined modalities. Nearly 8,000 patients in the U.S. are diagnosed with Hodgkin’s disease each year. We anticipate filing an Investigational New Drug (IND) application for TNX-650 for the treatment of Hodgkin’s disease in the fourth quarter of this year and initiating a Phase 1 study in the first half of 2006. We also believe that IL-13 could play a role in other cancers and inflammatory disease, and we are conducting additional pre-clinical tests for such indications.

TNX-717 is a humanized monoclonal antibody that has the potential to treat osteoporosis. TNX-717 may promote the differentiation and survival of osteoblasts, thereby increasing the number and activity of these bone-building cells. TNX-717 works by inhibiting the function of Secreted Apoptosis-Related Protein 2 (SARP2), a naturally occurring antagonist of the Wnt-mediated osteoblast survival and differentiation pathway. SARP2 is a novel osteoporosis target with significant validation. This compound is in pre-clinical development.

TNX-234 is a humanized monoclonal antibody to complement Factor D. In pre-clinical testing, TNX-234 inhibits activation of the alternative complement pathway and has the potential to be used for the treatment of both dry and wet age-related macular degeneration (AMD). AMD is the leading cause of irreversible vision loss in the United States. Approximately 1.7 million Americans were diagnosed with advanced AMD (wet and dry) in 2004 and the number is expected to increase to nearly 3 million by 2020. We expect to initiate clinical testing of TNX-234 in 2007.

Manufacturing and Other Operations

Re-commissioning activities at our manufacturing facility in San Diego, California continue to advance. Scale up of the production process for clinical-trial material is under way for the planned Phase 3 study of TNX-355.

During the third quarter of 2005, Linda Paradiso, D.V.M., M.B.A. joined our senior management team as Vice President of Clinical and Regulatory Affairs. Dr. Paradiso brings 24 years of pharmaceutical and biotechnology industry experience to Tanox and will provide leadership for our clinical development and regulatory affairs departments. Her extensive experience in all facets of drug development and leadership capabilities will be valuable to us as we continue to move our products toward commercialization.

We did not experience any impact to our Houston facilities from Hurricane Rita in September 2005. Our manufacturing and research operation continued uninterrupted, and we did not suffer any property or other asset losses as a result of the storm.

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Critical Accounting Policies

Use of Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and footnotes thereto. Actual results may differ from those estimates.

Revenue Recognition

Revenues from development agreements include payments for milestone achievements and sponsored research and development costs. Milestone payments are received under best efforts contracts and are not refundable. They are recognized as revenue when the milestones are achieved and there are no remaining performance obligations. Revenues for sponsored research and development are recognized as revenue as we complete our obligations related to such activities. Any revenue contingent upon future performance is deferred and recognized as the performance is completed. Under our collaboration agreements with Genentech and Novartis, we receive a royalty on the net sales of Xolair worldwide and share in Novartis’ net profits from Xolair sales in the United States. Royalty revenue is recorded monthly based on contractual terms and information provided by Genentech and Novartis. Royalties are reconciled and adjusted if actual results differ from those previously reported to us and are subject to audit by Tanox. Manufacturing rights revenue represents amounts received from Genentech and Novartis in consideration of our relinquishment, under the collaboration agreements, of our rights to manufacture Xolair. The revenue is based on the quantity of Xolair produced.

Under our collaboration agreements, we also share in Novartis’ net profits from sales of Xolair in the U.S. We disagree with Novartis’ calculation of Tanox’s share of net profits. Accordingly, the payment received from Novartis in the third quarter of 2005 has been recorded as deferred revenue as the parties continue to discuss the calculation.

Revenues recognized are net of certain milestone credits and amounts due to our former attorneys under an arbitration award.

Research and Development

Research and development expenses consist of direct costs and indirect overhead costs, including facilities costs, salaries, related benefit costs and material and supply costs. Expenses may also include upfront fees and milestone payments paid to licensors and collaborative partners. Such amounts are expensed as incurred. Research and development costs also include estimates for clinical trial costs, which are based on patient enrollment and clinical trial progress. Actual costs may differ from estimates.

Recent Accounting Pronouncement

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS 123 (Revised) “Share-Based Payment.” The statement eliminates the ability to account for stock-based compensation using APB 25 and requires such transactions to be recognized as compensation expense in the statement of operations based on their fair values on the date of the grant, with the compensation expense recognized over the period in which an employee is required to provide service in exchange for the stock award. On April 14, 2005, the FASB delayed the implementation dates for this statement. Tanox will adopt this statement on January 1, 2006 using a modified prospective application. As such, the compensation expense recognition provisions will apply to new awards and to any awards modified, repurchased or cancelled after the adoption date. Additionally, for any unvested awards outstanding at the adoption date, we will recognize compensation expense over the remaining vesting period.

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We have begun evaluating the impact of adopting SFAS 123 (Revised) on our results of operations. We currently determine the fair value of stock-based compensation using a Black-Scholes option pricing model. In connection with evaluating the impact of adopting SFAS 123 (Revised), we are also considering the potential implementation of a different valuation model to determine the fair value of stock-based compensation, although no decision has yet been made. We believe the adoption of SFAS 123 (Revised) will have a material impact on our results of operations, regardless of the valuation technique used.

Results of Operations

Three Months Ended September 30, 2005 and 2004

Total Revenues. Revenues consist of the following for the three months ended September 30, 2005 and 2004:

(in thousands)	Three months ended September 30,
	2005		2004
Royalties, net of arbitration award	$	7,603	$	2,298
Royalties from related party, net of arbitration award		67		17
Development agreements, license fees and manufacturing rights		663		103
Development agreements from related party		14		48
Total revenues	$	8,347	$	2,466

Royalty revenue increased $5.4 million for the three months ended September 30, 2005 compared to the same period in 2004 due to an increase in sales of Xolair. Development agreements, license fees and manufacturing rights in 2005 includes $650,000 in manufacturing rights revenue from the production of Xolair in the first two quarters of 2005.

Research and Development Expenses. Research and development expense consists of costs incurred for product development and discovery research programs. Research and development expenses consist of direct costs and indirect overhead costs, including facilities costs, salaries, related benefit costs and material and supply costs. At September 30, 2005, our research and development clinical stage programs include TNX-355 and TNX-832. Research and preclinical stage programs include TNX-650 for Hodgkin’s lymphoma, TNX-717 for the treatment of osteoporosis and bone fracture, TNX-234 for the treatment of AMD and other discovery and exploratory research projects. For the three months ended September 30, 2005 and 2004, costs associated with research and development programs, including overhead allocation, were:

(in thousands)	Three months ended September 30,
	2005		2004
Clinical stage programs	$	8,685	$	4,794
Research and preclinical stage programs		2,717		1,828
Total research and development expenses	$	11,402	$	6,622

Research and development expenses increased $4.8 million in the third quarter of 2005 compared to the third quarter of 2004. Approximately $4.2 million of this increase was attributable to the additional costs

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associated with the start-up of our San Diego manufacturing facility in 2005. The remainder of the 2005 increase relates to increased clinical trial costs associated with the TNX-832 Phase 1/2 study and increased personnel costs.

General and Administrative Expenses.For the three months ended September 30, 2005 and 2004, the costs associated with general and administrative activities were $1.5 million and $1.6 million, respectively.

Other Income. Other income was $1.2 million and $882,000 for the three months ended September 30, 2005 and 2004, respectively. This increase was principally due to a rise in interest income in 2005 compared to 2004 resulting from higher average interest rates, which was partially offset by lower amounts available for investment.

Income Taxes.We have not recorded an income tax provision because of a projected net loss for the year 2005.

Net Loss. For the three months ended September 30, 2005, we recorded a net loss of $3.4 million, as compared to a net loss for the three months ended September 30, 2004 of $4.9 million.

Nine Months Ended September 30, 2005 and 2004

Total Revenues. Revenues consist of the following for the nine months ended September 30, 2005 and 2004:

(in thousands)	Nine months ended September 30,
	2005		2004
Royalties, net of arbitration award	$	20,712	$	7,810
Royalties from related party, net of arbitration award		149		44
Development agreements, license fees and manufacturing rights		748		3,610
Development agreements from related party		43		3,455
Total revenues	$	21,652	$	14,919

Royalty revenue increased $13.0 million for the nine months ended September 30, 2005 compared to the same period in 2004 due to an increase in sales of Xolair. Development agreements, license fees and manufacturing rights in 2005 includes $650,000 in manufacturing rights revenue from the production of Xolair in the first two quarters of 2005. Development agreement revenue for 2004 includes a one-time reimbursement of $6.6 million received under the terms of the TCA among Novartis, Genentech and Tanox dated February 25, 2004, representing reimbursement by Genentech and Novartis of a portion of the TNX-901 development costs incurred by Tanox in previous years.

Research and Development Expenses. Research and development expense consists of costs incurred for product development and discovery research programs. Research and development expenses consist of direct costs and indirect overhead costs, including facilities costs, salaries, related benefit costs and material and supply costs. At September 30, 2005, our research and development clinical stage programs include TNX-355 and TNX-832. Research and preclinical stage programs include TNX-650 for Hodgkin’s lymphoma, TNX-717 for the treatment of osteoporosis and bone fracture, TNX-234 for the treatment of AMD and other discovery and exploratory research projects. For the nine months ended September 30, 2005 and 2004, costs associated with research and development programs, including overhead allocation, were:

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(in thousands)	Nine months ended September 30,
	2005		2004
Clinical stage programs	$	27,443	$	13,175
Research and preclinical stage programs		7,713		5,523
Total research and development expenses	$	35,156	$	18,698

Research and development expenses increased $16.5 million in the nine months ended September 30, 2005 compared to the nine months ended September 30, 2004. Approximately $11.7 million of this increase was attributable to the costs associated with the start-up of our San Diego manufacturing facility in 2005. The remainder of the 2005 increase relates to increased clinical trial costs associated with the TNX-355 Phase 2 study and the TNX-832 Phase 1/2 study and increased personnel costs.

Acquired in-process research and development.On March 31, 2005, we acquired a tissue factor antagonist program for the potential treatment of ALI/ARDS from Sunol. In addition to ALI/ARDS, the anti-tissue factor monoclonal antibodies acquired from Sunol have the potential to treat cancer and other diseases that result from over expression of tissue factor and related coagulation abnormalities. We issued an aggregate of 800,000 shares of our common stock and paid $6.0 million in cash for the program, resulting in a fair value of $13.7 million. Of the shares issued, 275,000 shares will be held in escrow for up to three years after the closing of the transaction to secure indemnification obligations under the Asset Purchase Agreement. As of the acquisition date, the acquired program was still in early stage development and had not reached technological feasibility. We determined that no alternative future use existed for this program, and, accordingly, the acquisition was recorded as acquired in-process research and development expense.

General and Administrative Expenses.For the nine months ended September 30, 2005 and 2004, the costs associated with general and administrative activities were $5.3 million and $5.2 million, respectively.

Other Income. Other income was $3.2 million and $2.5 million for the nine months ended September 30, 2005 and 2004, respectively. This increase was principally due to a rise in interest income in 2005 resulting from higher average interest rates, which was partially offset by lower amounts available for investment.

Income Taxes.We have not recorded an income tax provision because of a projected net loss for the year 2005.

Net Loss. For the nine months ended September 30, 2005, we recorded a net loss of $29.3 million, compared to a net loss of $6.4 million for the nine months ended September 30, 2004. The higher net loss in 2005 was due primarily to the acquired in-process research and development expense for the purchase of the tissue factor antagonist program, start-up costs associated with our San Diego manufacturing facility and the increase in other research and development expenses. In addition, our 2004 operating results benefited from the one-time reimbursement of $6.6 million received under the three-party collaboration agreement with Genentech and Novartis to reimburse us for a portion of our TNX-901 development costs.

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Liquidity and Capital Resources

We have financed our operations since inception primarily through sales of equity securities, development and licensing fee revenues, interest income and equipment financing agreements and, beginning in 2003, royalty revenue from sales of Xolair. During the year ended December 31, 2000, we sold approximately 8.6 million shares of common stock in an initial public offering for net proceeds of $225.8 million. As of September 30, 2005, we had $171.9 million in cash, cash equivalents and investments, of which $165.9 million were classified as current assets. At September 30, 2005, $5.0 million of cash was pledged to secure our obligations under our line of credit.

Cash, cash equivalents and investments decreased by $30.6 million for the nine months ended September 30, 2005 to $171.9 million from $202.5 million at December 31, 2004. The net decrease in funds was primarily due to the acquisition of the manufacturing assets from Biogen IDEC, the acquisition from Sunol of acquired in-process research and development materials and intellectual property rights and the funding of operating activities.

Net cash used in operating activities was $16.8 million for the nine months ended September 30, 2005 compared to $13.2 million for the same period in 2004. The 2005 use of cash was comprised mainly of a net loss of $29.3 million, an increase in receivables and other assets of $3.7 million, adjusted for acquired in-process research and development of $13.7 million. The 2004 net cash used was mainly due to the release from escrow of $9.7 million to our former attorneys in connection with an accrued arbitration award.

Net cash provided by investing activities was $50.9 million for the nine months ended September 30, 2005 compared to $6.6 million for the nine months ended September 30, 2004. In 2005, investments, net of purchases and maturities, decreased by $65.0 million compared to a decrease of $8.0 million for the same period in 2004. In 2004, restricted cash decreased by $5.5 million due to the release from escrow of $9.7 million to our former attorneys offset by the maturity of a restricted investment. Additions to property and equipment were $8.1 million for the nine months ended September 30, 2005 versus $7.0 million for the same period in 2004. In 2005, $6.0 million of cash was paid for acquired in-process research and development.

Net cash provided by financing activities was $570,000 for the nine months ended September 30, 2005 compared to $492,000 for the nine months ended September 30, 2004. These inflows of cash resulted from stock option exercises.

Tanox entered into a manufacturing and supply agreement in July 2004 to have a third party manufacture and supply TNX-355 for Phase 3 clinical trials and potential product launch. Payments due to the third party under this agreement are based on the achievement of manufacturing deliverables and quantities to be manufactured based on the size of clinical trials. Under the terms of the agreement, if Tanox were to terminate the agreement before or upon completion of the technology transfer deliverable (Research Stage), it would be required to pay a cancellation fee equal to twenty-five percent of the un-invoiced portion of the remaining process development program balance, as defined in the agreement.

Tanox and the third party manufacturer began discussions in the fourth quarter of 2004 related to revisions to the agreement because we determined that we would produce TNX-355 for Phase 3 clinical trials in the newly-leased San Diego manufacturing facility. In February 2005, a letter agreement with the third party manufacturer was reached to suspend all provisions of the manufacturing and supply agreement for a period to be determined by us, but not to exceed 30 months. Under the terms of the letter agreement, Tanox will pay a total of $1.7 million, of which $340,000 represents a cancellation fee and the remaining $1,360,000 may be credited against future work performed by the third party manufacturer, subject to certain limitations. We also paid $250,000 for work performed by the third party manufacturer as of December 31, 2004. We plan to resume production of TNX-355 under the manufacturing and supply agreement on or before August 30, 2007.

We were engaged in litigation in connection with a fee dispute with the law firms that represented us in

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litigation with Genentech relating to, among other things, the intellectual property rights surrounding the development of anti-IgE technology. In 1999, an arbitration panel issued an award entitling the attorneys to receive (1) approximately $3.5 million, including interest, (2) payments ranging from 33-1/3% to 40% of the future milestone payments, in excess of the first $1 million, we would receive from Genentech following product approval, and (3) 10% of the royalties that we would receive on all sales of certain anti-IgE products, including Xolair. During the appeals process, we were required to place amounts in escrow to secure payment of the award, and had escrowed $9.7 million with the Harris County District Court as of December 31, 2003. These funds were released to the former attorneys in February 2004. The payment due to the attorneys in the amount of 10% of the royalties we receive on Xolair sales is required to be paid within 30 days of the end of each calendar quarter in which the royalty payments are received by Tanox.

On February 25, 2004, Tanox, Genentech and Novartis entered into a Tripartite Collaboration Agreement to settle all then outstanding litigation and arbitrations among the parties and to finalize the detailed terms of the three-party collaboration, begun in 1996, to develop and commercialize certain anti-IgE antibodies, including Xolair and TNX-901. Under the terms of the three-party collaboration agreement, Genentech and Novartis each reimbursed Tanox $3.3 million for a portion of its TNX-901 development costs, and Tanox relinquished any rights to manufacture Xolair in exchange for the right to receive payments tied to the quantity of Xolair produced. The first manufacturing rights payment was received in the third quarter of 2005.

In September 2002, we entered into a $16.0 million Revolving Line of Credit Note Agreement with a bank. Under the terms of the agreement, we may secure advances up to the aggregate principal amount of $16.0 million, the proceeds of which can be used to finance the purchase of property, plant and equipment. The outstanding principal balance is payable in full on September 27, 2006, and advances bear interest at the lesser of the Prime Rate or LIBOR, the London Interbank Offered Rate, plus 1%. Accrued interest is payable on the last day of each month. As of September 30, 2005, we had borrowed $5.0 million under the Agreement.

Pursuant to a Lease Assignment and Asset Purchase Agreement dated December 9, 2004, between Biogen IDEC and Tanox, on January 10, 2005, we acquired from Biogen IDEC certain manufacturing, process development and QC equipment, related documentation and furniture and fixtures housed in a 76,000 square foot leased facility located in San Diego, California. We also agreed to assume the obligations of Biogen IDEC under the triple net lease for the facility, which extends until October 2011, with two five-year extension options. The lease payments for 2005 will be approximately $3.8 million and will increase annually over the term of the lease, including extension periods, at a rate of approximately 4%. We paid Biogen IDEC approximately $5.6 million for the assets. As partial consideration for our agreement to the extension of the lease term to September 30, 2011, and assuming we are not then in default under the lease agreement, Biogen IDEC agreed to make two payments to us, each in the amount of approximately $2.4 million, on September 30, 2007 and November 30, 2008. We expect the total future lease obligation of Tanox for this lease assignment through 2011, net of the Biogen IDEC payments, will be approximately $24.6 million.

On March 31, 2005, we acquired a tissue factor antagonist program for the potential treatment of ALI/ARDS from Sunol. In addition to ALI/ARDS, we believe the anti-tissue factor monoclonal antibodies acquired from Sunol have the potential to treat cancer and other diseases that result from over expression of tissue factor and related coagulation abnormalities. In consideration for the tissue factor antagonist program, we issued an aggregate of 800,000 shares of our Common Stock and paid $6.0 million in cash to Sunol. Of the shares issued, 275,000 shares will be held in escrow for up to three years after the closing of the transaction to secure indemnification obligations under the Asset Purchase Agreement. As part of the program, we received all tissue factor antagonist assets of Sunol, including anti-tissue factor monoclonal antibodies and related technologies and intellectual property, as well as non-exclusive rights to certain technologies and related intellectual property for protein and antibody expression. Based upon the closing price of our Common Stock on March 31, 2005, the fair value of the acquired assets was $13.7 million, including the $6 million paid in cash. As of the acquisition date, the acquired program was still in early development stage, had not reached technological feasibility and had no alternative future use. Accordingly, we recorded the $13.7 million acquisition price as an acquired in-process research and development expense.

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In the second quarter of 2005, Tanox Biotech (Shanghai), Ltd (Tanox Shanghai), a wholly owned subsidiary of Tanox Pharma International, was established to carry out research projects and collaborate with academic research institutes in China. In May 2005, Tanox Shanghai entered into an agreement with the Institute of Health Science in Shanghai, China, to establish a joint research laboratory.

Our current and anticipated development projects require substantial additional capital to complete. We do not expect to generate positive cash flow from operations until at least 2007 because we anticipate that the amount of cash we need to fund operations, including research and development, manufacturing and other costs, and for capital expenditures, will increase in the future as our projects move from research to clinical development to commercialization. We may make additional acquisitions of businesses or intellectual property assets and also expect that we will need to expand our clinical development, manufacturing capacity, facilities, business development and marketing activities to support the future development of our programs. Based on cash projections, we expect that cash on hand and revenue from operations will be sufficient to fund our existing operations for at least the next four years. However, our future capital needs will depend on many factors, including the continued successful commercialization of Xolair, progress in our research and development activities, the size and design of our clinical trials, commercialization activities, the costs and magnitude of product or technology acquisitions, the cost of preparing, filing, prosecuting, maintaining and enforcing patent claims and other intellectual property rights, competing technological and market developments, changes in or terminations of existing collaboration and licensing arrangements, establishing additional collaboration and licensing arrangements, potential merger and acquisition activities, potential litigation surrounding any of the foregoing, and manufacturing scale-up costs and marketing activities, if we undertake those activities. Consequently, we may need to raise additional funds and we may issue additional shares of common stock or other equity securities.

We filed a universal shelf Registration Statement with the Securities and Exchange Commission (SEC), which would permit us to sell up to $100 million of equity or debt securities in one or more offerings. We expect to use the net proceeds from sales of securities under this shelf registration statement to provide additional funding for development of products in our drug development pipeline, potential product acquisition or licensing opportunities and general corporate purposes. The terms of any offering of securities will be made public in a subsequent filing with the SEC at the time of any such sale.

Pursuant to the terms of a registration rights agreement entered into with Sunol in connection with the acquisition of the tissue factor antagonist program, we filed a Registration Statement with the SEC covering the resale, from time to time, of up to 525,000 shares of common stock by Sunol and its shareholders to whom a portion of those shares have been distributed. The registration statement was declared effective on July 20, 2005.

Forward-Looking Information and Risk Factors that May Affect Future Results

All statements in this Form 10-Q other than statements of historical facts are “forward-looking statements” for purposes of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended. Forward-looking statements can generally be identified by the use of terminology such as “believes,” “may,” “will,” “expects,” “intends,” “plans,” “anticipates,” “estimates,” “potential,” or “continue” or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements contained in this report are reasonable, we cannot assure you that they will prove to be correct. Our future financial condition and results of operations, as well as any forward-looking statements, are subject to inherent risks and uncertainties, including but not limited to the risk factors set forth below, and actual results could differ materially from those projected or assumed in the forward-looking statements due to a number of factors, including:

• our ability to develop safe and effective drugs;

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• failure to achieve positive results in preclinical and toxicology studies in animals and clinical trials in humans;

• failure to economically and timely manufacture sufficient amounts of our products for clinical trials and commercialization activities;

• failure to receive, or delay in receiving, marketing approval for our products;

• failure to successfully finance and commercialize our products, including gaining market acceptance;

• our ability to manage relationships with collaboration partners;

• our ability to obtain, maintain and successfully enforce patent and other proprietary rights protection of our products;

• variability of royalty, license and other revenues, and potential adjustments and changes in amounts paid to us and amounts we may be required to pay to third parties;

• our ability to use our manufacturing capacity and facilities costs effectively and in accordance with regulatory requirements;

• our ability to enter into future collaboration agreements to support our research and development activities;

• drug withdrawal from the market due to rare adverse reactions caused by the marketed drug;

• our ability to secure licenses from third parties holding patents that may affect the manufacture or marketing of our products;

• competition and technological change;

• existing and future regulations affecting our business, including the content, timing of submissions and decisions made by the FDA and other regulatory agencies;

• governmental changes affecting Medicare and the healthcare and pharmaceutical industries including policies that affect coverage and levels of reimbursement for sales of our products; and

• our ability to hire and retain experienced managers and scientists.

The following section discusses important risks and uncertainties that could materially and adversely affect our business, results of operations and financial condition, which in turn could materially and adversely affect the trading price of our common stock.

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Regulatory Risks

Developing therapeutic monoclonal antibodies is expensive and highly uncertain. If our preclinical and/or clinical trial results are negative, we may be forced to stop developing products important to our future.

Successful development of therapeutic monoclonal antibodies is highly uncertain. First, we must discover or otherwise acquire drug candidates. Then we must demonstrate through preclinical studies and clinical trials that our products are safe and effective for use in a particular target indication before we can obtain regulatory approvals to sell our products commercially to that patient group. These studies and trials tend to be very costly and time consuming. Furthermore, the results of preclinical studies and initial clinical trials of our products do not necessarily predict the results from later-stage clinical trials, which must demonstrate the desired safety and efficacy traits.

Products that appear promising in research or early phases of development may not reach later stages of development or be submitted for marketing approval for a number of reasons, including:

• The product is found to be less effective than required or cause serious adverse reactions or side effects in patients participating in the trials; often these reactions may not be detectable in small, early stage trials and can only be identified when the product is administered to a larger patient base, as in Phase 3 trials or following market approval;

• The commercial introduction of competitive drugs that have greater efficacy or safety than our product or otherwise adversely impact the risk/benefit profile of our product;

• Inability to develop manufacturing methods that are efficient, cost-effective and capable of meeting stringent regulatory standards; and

• Proprietary rights of third parties, which cover our products and for which we are not able to secure licenses on reasonable terms.

Our products other than Xolair require significant additional laboratory development or clinical trials before they can be submitted for marketing approval. We have limited capacity to conduct and manage clinical trials, and we rely on third parties, potentially including collaborative partners and contract research organizations, to assist us in these efforts. Our reliance on third parties may result in delays in completing, or failing to complete, clinical trials if our collaborators or contractors fail to perform under our agreements with them.

We may be unable to enroll sufficient patients in a timely manner in order to complete our clinical trials.

The speed with which we are able to enroll patients in clinical trials is an important factor in determining how quickly we may complete clinical trials and the cost of running those trials. Many factors affect patient enrollment, including the size of the patient population, the proximity of patients to clinical sites, the eligibility criteria for the study, perceived risks and benefits of the drug under study, whether the drug will continue to be made available to the patient following completion of the trial, and other ongoing trials directed at the same indication. Any of these factors may make it difficult for us to enroll enough patients to complete the trials.

Delays in patient enrollment will result in increased costs and program delays, which could slow down our product development and approval process. Even if the trials are ultimately completed and the product is approved for sale, a program delay could compromise the commercial viability of our drug relative to competitive therapies, which could materially harm our business and results of operations.

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If we do not receive and maintain regulatory approvals, we will not be able to market our products.

The biotechnology and pharmaceutical industries are subject to stringent regulation with respect to product safety and efficacy by various international, federal, state and local authorities. Of particular significance are the FDA’s requirements covering R&D, testing, manufacturing, quality control, labeling and promotion of drugs for human use. A biotherapeutic cannot be marketed in the United States until it has been approved by the FDA, and then can only be marketed for the indications approved by the FDA. As a result of these requirements, the length of time, the level of expenditures and the laboratory and clinical information required for approval of a Biologics License Application, are substantial and can require a number of years.

Our collaboration partners have secured approval to market Xolair in the United States, the European Union, Australia, Brazil, Canada, Dominican Republic, Guatemala, Israel, New Zealand and Venezuela. There can be no assurance that Xolair will be approved for sale in any new market.

As a company, Tanox has not prepared or submitted any marketing approval applications to the FDA or any other regulatory agency for any of its products. The FDA can delay, limit or not grant marketing approval for our products for many reasons, including:

• their belief that a product candidate is not safe and effective;

• their interpretation of data from preclinical testing and clinical trials may be different than our interpretation;

• failure of our manufacturing processes or facilities to meet cGMP standards; and

• changes in its approval policies and guidelines or adoption of new regulations.

The process of obtaining approvals to manufacture and market our products in foreign countries is subject to delay and failure for the same reasons.

Even if we or our collaboration partners secure marketing approval for a product, such as Xolair, the approval may be conditioned on our successful completion of post-marketing clinical studies. In addition, each marketed product and its manufacturer continue to be subject to strict conditions and regulation after approval. Any unforeseen problems with an approved product or any violation of regulations could result in restrictions on the product, including, for example, changes in its labeling, written notices to physicians or a product recall.

Delays in receiving or failing to receive regulatory approvals, or losing previously received approvals to market Xolair, would delay or preclude product commercialization, which would adversely affect our business, financial condition and results of operations.

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We are subject to the uncertainty related to reimbursement policies and healthcare reform measures.

In recent years, there has been legislation and numerous proposals to change the healthcare system in the United States. Some of these measures limit or eliminate payments for medical procedures and treatments or subject pharmaceutical product pricing to government control. In addition, as a result of marketplace pressures, third-party payors are increasingly attempting to contain healthcare costs by limiting both coverage and the level of reimbursement of new drug products. Consequently, significant uncertainty exists as to the reimbursement status of newly-approved healthcare products. If we succeed in bringing one or more of our products to market, we cannot assure you that third-party payors will consider them cost effective or allow reimbursement to the consumer at price levels sufficient for us to realize an appropriate return on our investment in product development or to even realize a profit.

Significant changes in the healthcare system in the United States or elsewhere, including changes resulting from adverse trends in third-party reimbursement programs, could materially reduce our potential profitability and harm our ability to raise the capital we would need to continue our operations. Furthermore, even though initial insurance and Medicare/Medicaid coverage of Xolair is encouraging, reimbursement proposals may negatively affect our collaborators’ commercialization of Xolair, which could also adversely affect our business, financial condition and results of operations.

New accounting pronouncements or regulatory rulings may impact our future financial position or results of operations.

There may be new accounting pronouncements or regulatory rulings which may have an impact on our future financial position or results of operations. In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS 123 (Revised) “Share-Based Payment.” The statement eliminates the ability to account for stock-based compensation using APB 25 and requires such transactions to be recognized as compensation expense in the statement of operations based on their fair values on the date of the grant, with the compensation expense recognized over the period in which an employee is required to provide service in exchange for the stock award. On April 14, 2005, the FASB delayed the implementation dates for this statement. Tanox will adopt this statement on January 1, 2006 using a modified prospective application. As such, the compensation expense recognition provisions will apply to new awards and to any awards modified, repurchased or cancelled after the adoption date. Additionally, for any unvested awards outstanding at the adoption date, we will recognize compensation expense over the remaining vesting period.

We have begun evaluating the impact of adopting SFAS 123 (Revised) on our results of operations. We currently determine the fair value of stock-based compensation using a Black-Scholes option pricing model. In connection with evaluating the impact of adopting SFAS 123 (Revised), we are also considering the potential implementation of a different valuation model to determine the fair value of stock-based compensation, although no decision has yet been made. We believe the adoption of SFAS 123 (Revised) will have a material impact on our results of operations, regardless of the valuation technique used.

Risks Relating to our Industry, Business and Strategy

Our ability to become a profitable fully integrated biopharmaceutical company will depend on the continued commercial success of Xolair and on the success of TNX-355, which is still in development, or our success in securing, developing and commercializing new clinical candidates. If we are unable to commercialize TNX-355 or experience significant delays in doing so, and if we are unable to secure new development candidates, our business may be harmed.

We anticipate that, in the near term, our ability to become profitable will depend on the success of our collaboration partners in generating significant levels of sales of Xolair. In the longer term, an important part of our strategy is to become a fully integrated biopharmaceutical company. Our ability to do so will depend on the successful development, approval and commercialization of TNX-355, our most advanced product candidate, of TNX-832, or of potential new clinical stage drug candidates that we may develop or otherwise in-license or acquire.

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All of our product candidates, other than TNX-355 and TNX-832, are in preclinical development or in research, and we do not expect to seek regulatory approval of these candidates for many years, if ever. A significant portion of the research that we are conducting involves new and unproven technologies. Research programs to identify new disease targets and product candidates require substantial technical, financial and human resources whether or not we ultimately identify any candidates. Our research programs may show promise initially in identifying potential product candidates, yet fail to yield product candidates for clinical development.

In addition, if we do not achieve the clinical endpoints in our clinical studies of TNX-355 or TNX-832, we may decide to terminate development of those products. Even if we reach our endpoints, the results of the trials may indicate that further development or, assuming marketing approval, commercialization of TNX-355 or TNX-832 would not be economically viable. In that event, we would need to in-license or acquire suitable product candidates or products from third parties, and we may not be able to so for a number of reasons. The licensing and acquisition of pharmaceutical products is highly competitive. A number of more established companies, including large pharmaceutical companies, are aggressively pursuing strategies to license or acquire products in the fields in which we are interested. These established companies have a competitive advantage over us due to their size, cash and other resources, and greater clinical development and commercialization capabilities and experience. Other factors that may prevent us from licensing or otherwise acquiring suitable product candidates include the following:

• we may be unable to license or acquire the relevant technology on terms that would allow us to make an appropriate return from the product;

• companies that perceive us to be their competitors may be unwilling to assign or license their product rights to us; or

• we may be unable to identify suitable products or product candidates within our areas of expertise.

Even if we are successful in developing and securing marketing approval of TNX-355, TNX-832 or other in-licensed or acquired product candidates, we may be unable to successfully launch, market or otherwise commercialize the product.

If we are unable to secure suitable potential product candidates through internal research programs or by acquiring drugs or drug candidates from third parties, or if we are unable to successfully develop, launch, market or commercialize the product(s) (assuming approval for marketing), our goal of becoming a fully integrated biopharmaceutical company will not materialize, and our profit potential will be harmed.

Failure to secure future collaboration partners for our products or failure by those partners to develop, manufacture, market or distribute those products ,or pay the royalties and other payments we expect, may delay or significantly impair our ability to generate revenues or profit.

We intend to rely on future collaboration partners to develop, manufacture, commercialize, market or distribute certain of our product candidates. Many of our competitors are similarly seeking to develop or expand their collaboration and license arrangements with pharmaceutical companies. The success of these efforts by our competitors could have an adverse impact on our ability to form future collaboration arrangements. Also, the pharmaceutical companies that we may target for one or more of our product candidates might require a profit return that is greater than what our product may be able to deliver. The process of establishing collaborative relationships is difficult and time consuming and involves significant uncertainty. We cannot assure you that we will be able to negotiate acceptable collaboration agreements in the future. To the extent that we are unable to enter into future collaboration agreements, we would encounter increased capital requirements to undertake research, development and marketing at our own expense, and, in some cases, may have to discontinue development of one or more products. Assuming we are able to continue to develop certain products on our own, we may experience significant delays in introducing our product candidates or find that the absence of these collaboration agreements adversely affects our ability to manufacture or sell our product candidates, particularly outside the United States.

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Even if we enter into future collaborative agreements, we cannot assure you that efforts under these agreements will succeed because:

• the contracts may fail to provide significant protection or may become unenforceable if the partners fail to perform;

• our partners may not commit enough capital or other resources to successfully develop, market or distribute our products;

• our partners may not continue to develop and commercialize products resulting from our collaborations; and

• disputes with our partners may arise that could delay or terminate our product candidates’ research, development or commercialization or result in significant litigation or arbitration.

If any of these risks occur, our revenues, product development, productivity and business may suffer.

We face intense competition and rapid technological change that could result in products superior to the products we are developing.

The biotechnology and pharmaceutical industries are subject to rapid and significant technological change. We have numerous competitors in the United States and abroad, including, among others, major pharmaceutical and chemical companies, specialized biotechnology firms, universities and other research institutions. These competitors may develop technologies and products that are more effective or less costly than, or otherwise preferable to, any of our current or future products, and that could render our technologies and products obsolete or noncompetitive. Many of these competitors have substantially more resources and product development, production and marketing capabilities than we do. We cannot be certain that one or more companies will not receive patent protection that dominates, blocks or otherwise adversely affects our product development or business. In addition, many of our competitors have significantly greater experience than we do in undertaking preclinical testing and clinical trials of pharmaceutical products and obtaining FDA and other regulatory approvals of products. If we succeed in achieving commercial sales of our products, we also will be competing in commercial manufacturing efficiency and marketing capability, areas in which we have no experience. Our competitors may obtain FDA approval for products sooner or be more successful in manufacturing and marketing their products than are we or our collaborators.

Products currently exist in the market that will compete directly with the products that we seek to develop. Any product candidate that we develop and that obtains regulatory approval must then compete for market acceptance among physicians, patients, healthcare payors and the medical community, as well as for market share. Significant factors in determining whether we will be able to compete successfully include:

• relative efficacy and safety of our products;

• timing and scope of regulatory approval;

• product availability;

• potential advantages over alternative treatment methods;

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• development, marketing, distribution and manufacturing capabilities and support of our collaborators, if any;

• reimbursement coverage from Medicare/Medicaid, insurance companies and others;

• price and cost-effectiveness of our products;

• ability to produce drug candidates in commercial quantities at a reasonable cost;

• scope of patent protection for our products; and

• availability of licenses under third party technology and patent rights.

If our products are not competitive based on these or other factors, our business, financial condition and results of operations will be materially harmed.

Failure to attract and retain key personnel and principal members of our scientific and management staff could materially harm our business.

Our success depends greatly on our ability to attract and retain qualified scientific, manufacturing, clinical and other technical personnel, as well as to retain the services of our existing technical management staff. To pursue our research and development programs and product development plans, we will be required to hire additional qualified clinical, scientific, manufacturing and other technical personnel. There is intense competition for qualified staff, and we cannot assure you that we will be able to attract and retain the necessary qualified staff to develop our business. The failure to attract and retain these key personnel and management staff, or the loss of any of our current management team and our inability to replace him or her on a timely basis, could materially harm our business and financial condition.

We may be subject to product liability claims, and our insurance coverage may not be adequate to cover these claims.

Our business exposes us to potential product liability risks, which are inherent in testing, manufacturing, marketing and selling pharmaceutical products. We may be held liable if any product we develop, or any product that uses or incorporates any of our technologies, causes side effects, injury or is found otherwise unsuitable during clinical testing, manufacturing, marketing or sale. We cannot assure you that we will be able to avoid product liability exposure.

Product liability insurance for the biopharmaceutical industry is generally expensive. Although we currently maintain product liability insurance covering our products in amounts we believe to be commercially reasonable, we cannot assure you that our coverage is adequate or that continued coverage will be available at acceptable costs. In addition, some of our license and collaboration agreements require us to obtain product liability insurance. Future license and collaboration agreements may also include such a requirement. Our inability to obtain sufficient insurance coverage at an acceptable cost or otherwise to protect against potential product liability claims could prevent or inhibit us or our collaborators from commercializing our products. A successful claim in excess of our insurance coverage could materially harm our business, financial condition and results of operations. In addition, any such claim could materially reduce our revenues from sales of our products.

We deal with hazardous materials and must comply with environmental laws and regulations, which can be expensive and restrict how we do business.

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Our research and development work and manufacturing processes involve the controlled use of hazardous materials, including chemical, radioactive and biological materials. Our operations also produce hazardous waste products. We are subject to federal, state and local laws and regulations governing how we use, manufacture, store, handle and dispose of these materials. Although we believe that we comply in all material respects with applicable environmental laws and regulations, we cannot assure you that we will not incur significant costs to comply with environmental laws and regulations in the future. In addition, current or future environmental laws and regulations may impair our research, development or production efforts.

We could be liable for damages, penalties or other forms of censure if we are involved in a hazardous waste spill or other accident.

Despite precautionary procedures that we implement for handling and disposing of hazardous materials, we cannot eliminate the risk of accidental contamination or discharge or any resultant injury from these materials. If a hazardous waste spill or other accident occurs, and we are held liable for damages, the liability could exceed our financial resources.

Risks Associated with Manufacturing and Marketing

Our revenues are dependent on sales of Xolair. Failure to continue to receive market acceptance for and successfully commercialize Xolair would have a significant adverse effect on us.

Our results of operations and future prospects are highly dependent on increasing the sales of our only commercial product, Xolair. Our revenues in 2004 and thus far in 2005 consisted largely of revenue from product sales of Xolair, and we expect that revenues from sales of Xolair and from payments based on the quantity of Xolair manufactured will constitute a larger percentage of our revenue in the next several years. Even though the FDA approved Xolair and initial insurance and Medicare/Medicaid coverage is encouraging, we cannot be certain that physicians, patients and payors will continue to widely accept Xolair as a treatment for its approved indication in the United States or in any foreign markets. A number of factors may affect the rate and level of Xolair’s ultimate market acceptance, including:

• the effectiveness of Novartis’ and Genentech’s sales and marketing efforts;

• the perception by physicians and other members of the healthcare community of Xolair’s safety, efficacy and benefits compared to those of competing products or therapies;

• the willingness of additional physicians to adopt a new asthma treatment regimen;

• Xolair’s price relative to other products or competing treatments;

• the availability of third-party reimbursement;

• the ability to conduct the Phase 4 commitment studies and the impact of the study results on the labeling of Xolair;

• the ability to secure marketing approval for Xolair in other major markets, including Europe and Asia;

• regulatory developments related to manufacturing or using Xolair;

• the results of clinical development efforts for new indications of Xolair, and the scope and timing of additional marketing approvals and favorable reimbursement programs for any such expanded use;

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• availability of sufficient quantities of Xolair for commercial and clinical purposes;

• increased competition for Xolair from new or existing products, which may demonstrate better safety, efficacy, cost-effectiveness or ease of administration than Xolair; and

• adverse side effects or unfavorable publicity concerning Xolair.

If the level of Xolair sales declines or fails to increase, our financial condition, results of operations and future potential would be significantly harmed.

We have limited experience in manufacturing and may encounter manufacturing problems or delays that could result in delayed clinical trials. Our own ability to manufacture products on a commercial scale is uncertain.

We own a pilot manufacturing facility in Houston, Texas, and recently assumed the lease on a manufacturing facility in San Diego, California, which we intend to use to manufacture clinical trial materials and potentially initial commercial products. Our facilities are subject to risks from severe weather, manufacturing hazards, damage and accidents.

To develop products, we require sufficient quantity and quality of manufactured product for clinical trials. Regulatory or technical manufacturing issues that we may encounter could delay clinical development of our products. Any failure to produce these clinical requirements, either as a result of our inability to produce in accordance with cGMP or due to inadequate manufacturing capacity, can delay the commencement or continuation of our clinical trials.

To commercialize our products successfully, we must manufacture our products in commercial quantities in compliance with regulatory requirements and at an acceptable cost. If the manufacturing facilities used to produce our products cannot pass pre-approval or periodic plant inspections, the FDA and other regulatory agencies may not approve our products for sale or may delay or bar their further sale. In order to obtain regulatory approvals and to create capacity to produce our products in sufficient quantities for commercial sale at an acceptable cost, we will have to develop or acquire additional technology for commercial scale manufacturing and build or otherwise obtain access to adequate facilities, which will require substantial additional funds. We will also be required to demonstrate to the FDA and corresponding foreign authorities our ability to manufacture our products using controlled, reproducible processes. We cannot assure you that we, operating alone or with the assistance of others, can develop the necessary manufacturing technology or that we will be able to fund or build an adequate commercial manufacturing facility necessary to obtain regulatory approvals and to produce adequate commercial supplies of our potential products on a timely basis.

Manufacturing changes may result in delays in obtaining regulatory approval or marketing for our products.

If we make changes in the manufacturing process of our products and product candidates once we begin clinical development, we may be required to demonstrate to the FDA and corresponding foreign authorities that the changes have not caused the resulting drug material to differ significantly from the drug material previously produced. Changing the manufacturing site is considered to be a change in the manufacturing process; therefore, moving production to our San Diego manufacturing facility from our Houston pilot plant will entail manufacturing changes. Any significant manufacturing changes for the production of our product candidates could result in delays in development or regulatory approval. Our inability to maintain our manufacturing operations in compliance with applicable regulations within our planned time and cost parameters could materially harm our business, financial condition and results of operations.

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With respect to our TNX-355 antibody product, we will need to show that the drug material we produce in the San Diego manufacturing facility for the Phase 3 studies will be sufficiently similar to the product that was used for the Phase 2 study in order to avoid delays in development or regulatory approval for this antibody product. Additionally, showing comparability between the material we produce before and after manufacturing changes is particularly important if we want to rely on results of prior preclinical studies and clinical trials performed using the previously produced drug material. Depending upon the type and degree of differences between the newer and older drug material, we may be required to conduct additional animal studies or human clinical trials to demonstrate that the newly produced drug material is sufficiently similar to the previously produced drug material.

We have made manufacturing changes and are likely to make additional manufacturing changes for the production of our products currently in clinical development. An inability to show comparability between the older material and the newer material after making manufacturing changes could result in delays in development or regulatory approvals or in reduction or interruption of commercial sales of our products and product candidates.

We lack sales and marketing experience, which makes us depend on third parties for their expertise in this area.

Under the terms of our collaboration agreements, Novartis and Genentech have exclusive marketing rights to Xolair and other collaboration anti-IgE products, and the revenues we receive from Xolair will depend primarily on the marketing and sales efforts of our collaboration partners. However, commercialization rights may revert back to us if our collaborators terminate our relationship. Furthermore, we intend to retain marketing rights, particularly in the United States and selected Asian countries, for other potential products that we can develop and sell effectively with a small, targeted sales force. We currently have no sales, marketing or distribution capabilities. If Xolair marketing rights revert to us or if we elect to market other products directly, we would require significant additional management expertise and have to make significant additional expenditures to develop an internal marketing function and a sales force. We cannot assure you that we would be able to establish a successful marketing and sales force should we choose to do so.

Risks Related to Financial Results and Need for Financing

We have a history of net losses; we expect to continue to incur net losses and we may never achieve or maintain profitability.

We have incurred net losses since our inception. As of September 30, 2005, we had an accumulated deficit of approximately $123.1 million, including a net loss of approximately $29.3 million for the nine months ended September 30, 2005. Our losses have primarily been the result of costs incurred in our research and development programs and from our general and administrative costs.

We have funded our operations principally from licensing fees, royalty revenue and milestone payments under our current or former collaborations, as well as with proceeds from private placements and an initial public offering of our common stock. We expect to continue to incur substantial operating losses until such time, if ever, that we are able to generate sufficient revenue from milestone and manufacturing payments, royalties and profit-sharing payments on Xolair sales and, potentially, revenues from an additional product or products to cover our expenses. Our revenues may be reduced by adjustments and changes in amounts paid to us and amounts we may be required to pay to third parties.

Our ability to achieve and maintain long term profitability depends to a significant extent on the continued successful commercialization of Xolair. It will also depend on our successfully completing preclinical and clinical trials, obtaining required regulatory approvals and successfully manufacturing and marketing our other current and future product candidates. We cannot assure you that we will be able to achieve any of the foregoing or that we will be profitable even if we successfully commercialize our products.

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The market price of our common stock has been volatile.

Like other stocks of biopharmaceutical companies, the market price for our common stock has been and may continue to be volatile. Since January 1, 2003, our stock price ranged from $8.03 to $22.74. Factors that may have contributed to the volatility of our stock during this period included:

• FDA approval of Xolair;

• Reported sales volume of Xolair;

• Results of clinical trials; and

• General market conditions, including particularly the biotechnology company segment.

Failure by Novartis or Genentech to develop, manufacture, market or distribute Xolair would impair our ability to generate revenues.

Under the terms of our collaboration agreements, Novartis and Genentech are generally responsible for conducting clinical trials on, obtaining regulatory approval for, and manufacturing, marketing and distributing Xolair. As a result, our ability to profit from Xolair and any other anti-IgE products covered by our collaboration agreements with Genentech and Novartis depends in large part on their performance. We cannot control the amount and timing of resources Novartis and Genentech will devote to any of our products. If Novartis or Genentech experiences manufacturing or distribution difficulties, does not actively market Xolair or other partnered anti-IgE products or does not otherwise perform under our collaboration agreements, our potential for revenue from these products will be dramatically reduced. Novartis and Genentech may terminate our collaboration agreements, and, in that event, we would experience increased capital requirements to undertake development and marketing at our expense. We cannot assure you that we would be able to manufacture, market and distribute Xolair or our other anti-IgE products on our own.

We may need additional financing, but our access to capital funding is uncertain, and issuance of additional common stock could dilute existing stockholders.

Our current and anticipated development projects require substantial additional capital. While we expect that our cash on hand, together with our revenue from Xolair, will fund our existing operations for the next four years, our future capital needs will depend on many factors, including the commercial success of Xolair, receiving royalty, profit sharing, milestone and manufacturing payments from our collaboration partners, making progress in our clinical development of TNX-355 and TNX-832, other research and development activities and entering into additional collaboration agreements. Our capital requirements may also depend on the progress and level of costs associated with preclinical studies and clinical trials, the costs associated with acquisitions of new product candidates by licensing or otherwise, the costs of preparing, filing, prosecuting, maintaining and enforcing patent claims and other intellectual property rights, competing technological and market developments, changes in or terminations of existing collaboration and licensing arrangements and the cost of manufacturing scale-up and development of marketing activities, if undertaken by us. We do not have committed external sources of funding and we cannot assure you that we will be able to obtain additional funds on acceptable terms, if at all. If adequate funds are not available, we may be required to:

• delay, reduce the scope of or eliminate one or more of our development programs;

• obtain funds through arrangements with collaboration partners or others that may require us to relinquish rights to technologies, product candidates or products that we would otherwise seek to develop or commercialize ourselves; or

• license rights to technologies, product candidates or products on terms that are less favorable to us than might otherwise be available.

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We may raise additional funds by issuing additional stock, which would cause further dilution to our stockholders, and new investors could have rights superior to existing stockholders. If funding is insufficient at any time in the future, we may be unable to develop or commercialize our products, take advantage of business opportunities or respond to competitive pressures, and our business and financial condition may be harmed.

Risks Relating to Intellectual Property

The patentability, validity, enforceability and commercial value of our patents are highly uncertain. If our intellectual property positions are challenged, invalidated or circumvented and we fail to prevail in resulting intellectual property litigation, our business could be adversely affected.

Our success depends in part on obtaining, maintaining and enforcing patents and maintaining trade secrets. While we file and prosecute patent applications to protect our inventions, our pending patent applications may not result in the issuance of valid patents and our issued patents may not provide competitive advantages. Also, our patents may not prevent others from developing competitive products using related or the same technology. We cannot assure you that pending patent applications developed by or licensed to us will result in patents being issued or that, if issued, the patents will give us an advantage over competitors with similar technology.

We own or have licenses to certain issued patents. The patents we own that are most material to our business are five U.S. patents and six foreign patents relating to anti-IgE antibodies. However, the patent position of biotechnology and pharmaceutical firms is highly uncertain and involves many complex legal and technical issues. There is no clear policy involving the breadth of claims allowed or the degree of protection afforded under such patents. Issued patents can be challenged in litigation in the courts and in proceedings in the United States Patent and Trademark Office and in courts and patent offices in foreign countries. Issuance of a patent is not conclusive as to its validity, enforceability or the scope of its claim. We cannot assure you that our patents will not be successfully challenged as to enforceability, invalidated or limited in the scope of their coverage. Moreover, litigation to uphold the validity of patents and to prevent infringement can be very costly and can result in diverting technical and management personnel’s time and attention, which may materially harm our business, financial condition and results of operations. If the outcome of litigation is adverse to us, third parties may be able to use our patented technology without paying us. Moreover, we cannot assure you that our patents will not be infringed or successfully avoided through design innovation. Any of these events may materially and adversely affect our business.

In addition to the intellectual property rights described above, we also rely on unpatented technology, trade secrets and confidential information. We cannot assure you that others will not independently develop substantially equivalent information and techniques or otherwise gain access to our technology or disclose such technology, or that we can effectively protect our rights in unpatented technology, trade secrets and confidential information. We require each of our employees, consultants and advisors to execute a confidentiality agreement at the commencement of an employment or consulting relationship with us. We cannot assure you, however, that these agreements will provide effective protection if an unauthorized use or disclosure of this confidential information occurs.

If we fail to obtain any required patent license from third parties, our product development efforts could be limited.

Our commercial success depends on our ability to operate without infringing the patents and other proprietary rights of third parties. Other companies, some of which may be our competitors, have filed applications for or have been issued patents, and may obtain additional patents and proprietary rights, relating to products or processes used in, necessary to, or otherwise related to our products and product candidates.

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For example, we are aware of broad patents owned by others relating to the manufacture, use and sale of recombinant humanized antibodies. Many of our product candidates are genetically engineered recombinant humanized antibodies. If our antibody products or their commercial use or production meet all of the requirements of any of the claims of the aforementioned patents, or other third party patents or patent applications, then we may need a license to one or more of these patents. We expect to seek to obtain patent licenses when, in our judgment, such licenses are needed. Even if we determine that a license is not necessary, a patent holder could disagree and sue us for damages and seek to prevent us from manufacturing, selling or developing our products. Legal disputes can be costly and time consuming to defend. If any patent holder successfully challenges our judgment that our products do not infringe their patents or that their patents are invalid, we could be required to pay costly damages or to obtain a license to sell or develop our drugs. If we determine that a license is required, there can be no assurance that we will be able to obtain the license on commercially reasonable terms, if at all. If we are unable to secure a required license, we might be prevented from using certain of our technologies for the generation and manufacture of our recombinant antibody products or from pursuing product development, manufacturing or commercialization in a particular field, and this may materially harm our business and financial prospects.

In addition to patents, we rely on trade secrets and proprietary know-how. We seek protection in part through confidentiality agreements. We cannot assure you, however, that these agreements will provide meaningful protection of our proprietary information or trade secrets in the event of an unauthorized use or disclosure or that our valuable trade secrets will not become known to, or independently developed, by our competitors.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Our primary market risks are exposure to changes in interest rates and foreign currency exchange fluctuations. In the normal course of business, we have established policies and procedures to manage these risks.

Item 4. Controls and Procedures

Our Chief Executive Officer and Vice President of Finance have concluded that Tanox’s disclosure controls and procedures (as defined in Securities Exchange Act of 1934 (the “Exchange Act”) Rules 13a-15(e) and 15d-15(e) are effective, based on an evaluation of such controls and procedures conducted as of the end of the period covered by this report.

There were no change in our internal control over financial reporting that occurred during the quarter ended September 30, 2005 that has materially affected, or is reasonably likely to materially affect, Tanox’s internal control over financial reporting.

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PART II

OTHER INFORMATION

Item 1. Legal Proceedings

From time to time Tanox is a defendant in lawsuits incidental to its business. Management believes that the outcome of these lawsuits will not be material to Tanox’s financial statements.

Item 6. Exhibits

(a) Exhibits.

31.1 Certification of CEO Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2 Certification of Vice President of Finance Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1 Certification of CEO and Vice President of Finance Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

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

		TANOX, INC.
Date: November 3, 2005	By:	/s/ Nancy T. Chang
		Nancy T. Chang
		President and Chief Executive Officer

Date: November 3, 2005	By:	/s/ Gregory P. Guidroz
		Gregory P. Guidroz
		Vice President of Finance

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