**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

**FORM10-K**

**(Mark one)**

**x****ANNUAL REPORT UNDER SECTION 13 OR 15(d) OFTHE SECURITIESEXCHANGE ACT OF 1934**

 

**FOR THEFISCAL YEAR ENDED: DECEMBER 31, 2006**

**o****TRANSITION REPORT PURSUANT TO SECTION 13 OR15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

 

**For the transition period from                   to                   **

**Commission file number 001-32325**

**CALLISTO PHARMACEUTICALS, INC.**

(Exact Name of Registrantas Specified in its Charter)

| **Delaware**                                                    | ** ** | **13-3894575**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or Other  Jurisdiction of Incorporation or Organization) |       | (I.R.S. Employer  Identification No.) |

**420 Lexington Avenue, Suite 1609,New York, New York 10170**

(Address of PrincipalExecutive Offices) (Zip Code)

**(212) 297-0010**

(Issuer’s telephonenumber, including area code)

Securities registeredpursuant to Section 12(b) of the Act:

| Title of each class             | ** ** | **Name of each exchange on which registered** |
|---------------------------------|------------|-----------------------------------------------|
| Common Stock,  $.0001 par value |       | American Stock Exchange                       |

 

Securities registeredpursuant to section 12(g) of the Act:

Title of class:    **None**

Indicate by check mark if theregistrant is a well-known seasoned issuer, as defined in Rule 405 of theSecurities Act.  Yes  o No  x

Indicate by check mark if theregistrant is not required to file reports pursuant to Section 13 orSection 15(d) of the Act.   Yes  o    No x

Indicate by check markwhether the registrant: (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days. Yes  x No  o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
| Large accelerated filer o |   | Accelerated filer o |   | Non-accelerated filer x |
|---------------------------|--------|---------------------|--------|-------------------------|

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).  Yes  o No  x

The aggregate market value ofthe voting and non-voting common equity held by non-affiliates of theregistrant was $42,841,562 on June 30, 2006 (based on $1.20 per share, theclosing price on the American Stock Exchange that day).

As of April 16, 2007 theregistrant had a total of 39,194,996 shares of Common Stock outstanding.

 

 

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**CALLISTOPHARMACEUTICALS, INC.**

**FORM10-K**

**INDEX**
| ** ** | ** ** | ** **                                                                                                              | **PAGE** |
|------------|------------|-------------------------------------------------------------------------------------------------------------------------|----------|
| PART I     |       |                                                                                                                    |     |
|       | Item 1.    | Business                                                                                                                |     |   2 |
|       | Item 1A.   | Risk Factors                                                                                                            |     |   9 |
|       | Item 1B.   | Unresolved  Staff Comments                                                                                              |     | 19 |
|       | Item  2.   | Properties                                                                                                              |     | 19 |
|       | Item 3.    | Legal Proceedings                                                                                                       |     | 19 |
|       | Item 4.    | Submission  of Matters to a Vote of Security Holders                                                                    |     | 20 |
|       |       |                                                                                                                    |     |   |
| PART II    |       |                                                                                                                    |     |
|       | Item 5.    | Market for  the Registrant’s Common Equity, Related Stockholder Matters and Issuer  Purchases of Equity Securities |     | 21 |
|       | Item 6.    | Selected  Consolidated Financial Data                                                                                   |     | 23 |
|       | Item 7.    | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                             |     | 24 |
|       | Item 7A.   | Quantitative  and Qualitative Disclosures About Market Risk                                                             |     | 34 |
|       | Item 8.    | Financial  Statements and Supplementary Data                                                                            |     | 34 |
|       | Item 9.    | Changes in  and Disagreements with Accountants On Accounting and Financial Disclosure                                   |     | 34 |
|       | Item 9A.   | Controls and  Procedures                                                                                                |     | 35 |
|       | Item 9B.   | Other Information                                                                                                       |     | 35 |
|       |       |                                                                                                                    |     |   |
| PART III   |       |                                                                                                                    |     |
|       | Item 10.   | Directors,  Executive Officers and Corporate Governance                                                                 |     | 36 |
|       | Item 11.   | Executive  Compensation                                                                                                 |     | 40 |
|       | Item 12.   | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                        |     | 48 |
|       | Item 13.   | Certain  Relationships and Related Transactions                                                                         |     | 50 |
|       | Item 14.   | Principal  Accountant Fees and Services                                                                                 |     | 50 |
|       |       |                                                                                                                    |     |   |
| PART IV    |       |                                                                                                                    |     |
|       | Item 15.   | Exhibits and  Financial Statement Schedules                                                                             |     | 51 |
|       |       |                                                                                                                    |     |   |
|       |       | Signatures                                                                                                              |     | 55 |

 

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**PART I**

This Form 10-K contains forward-looking statementsthat involve risks and uncertainties. Such forward-looking statements arecharacterized by future or conditional verbs and include, but are not limitedto, statements regarding the results of product development efforts, clinicaltrials and applications for marketing approval of pharmaceutical products, andthe scope and success of future operations. Such statements are onlypredictions and our actual results may differ materially from those anticipatedin these forward-looking statements. Factors that may cause such differencesinclude, but are not limited to, those discussed under “Risk Factors” andelsewhere in this Form 10-K for the year ended December 31, 2006, as filed withthe Securities and Exchange Commission, including the uncertainties associatedwith product development, the risk that products that appeared promising inearly clinical trials do not demonstrate efficacy in larger-scale clinicaltrials, the risk that we will not obtain approval to market our products, therisks associated with dependence upon key personnel and the need for additionalfinancing. We do not assume any obligation to update forward-looking statementsas circumstances change.

**ITEM 1. BUSINESS.**

Callisto Pharmaceuticals, Inc. is referred tothroughout this report as “Callisto,” “we” or “us.”

We are abiopharmaceutical company focused on the development of drugs to treatneuroendocrine cancer (including advanced carcinoid cancer), acute leukemia (adisease of the white blood cells), and multiple myeloma (an incurable bloodcancer that invades and proliferates in bone marrow).  Our lead drugcandidate, Atiprimod, is an orally administered drug with antiproliferative andantiangiogenic activity.  Atiprimod is presently in three clinical trialsin neuroendocrine cancer, relapsed or refractory multiple myeloma and advancedcancer patients at a number of clinical sites in the U.S.  On November 7,2006, we announced the initiation of a multi-center, open-label Phase IIclinical trial of Atiprimod in low to intermediate grade neuroendocrinecarcinomas, including advanced carcinoid cancer patients. This trial is basedon earlier encouraging clinical results from an ongoing trial of Atiprimod inadvanced cancer patients that showed a clear response in a patient withadvanced carcinoid cancer plus additional encouraging clinical data on othercarcinoid patients. Atiprimod is also in a multi-center, dose-escalation PhaseI/IIa clinical trial in relapsed or refractory multiple myeloma patients. In 2006, we amended the protocol to continue the trial at higher dose levelsand currently have this trial underway at 4 clinical sites in the U.S.

Our second lead drug candidate, L-Annamycin, earliercompleted an initial Phase I/IIa clinical trial in relapsed or refractoryleukemia patients with a prior sponsor. L-Annamycin is a novel compound fromthe anthracycline family of proven anti-cancer drugs which has a noveltherapeutic profile, including activity against drug-resistant tumors andsignificantly reduced cardiotoxicity, or damage to the heart. L-Annamycin wasin-licensed by Callisto in October, 2004 and is presently in a Phase I/IIaclinical trial in adult relapsed or refractory acute lymphocytic leukemia (ALL)patients at three clinical sites in the U.S.  On February 22, 2007, weannounced the opening of a Phase I clinical trial of L-Annamycin in pediatricrelapsed or refractory ALL or pediatric relapsed or refractory acute myeloidleukemia (AML)****patients.

Our plan ofoperations for the next twelve months is to focus primarily on the clinicaldevelopment of our two drugs, Atiprimod to treat neuroendocrine carcinoma andmultiple myeloma and L-Annamycin to treat adult and pediatric acute leukemia.

**RECENT DEVELOPMENTS**

From October 2006until January 2007, we placed 602,350 shares of Series A Convertible PreferredStock and 8,031,333 warrants to certain investors for aggregate gross proceedsof $6,023,500. As of December 31, 2006 we had closed on 574,350 shares ofsuch Series A Convertible Preferred Stock for aggregate gross proceeds of$5,743,500. The final traunche of this financing closed January 10, 2007 whenwe placed 28,000 shares of such Series A Convertible Preferred Stock foraggregate gross proceeds of $280,000. The shares of Series A ConvertiblePreferred Stock are convertible into shares of common stock at a conversionprice of $0.75 per share.  The investors also are parties to aRegistration Rights Agreement, dated as of October 23, 2006 pursuant towhich  we agreed to file, within 60 days of closing, a registrationstatement with the Securities and Exchange Commission (the”SEC”) covering theresale of the shares of common stock underlying the Series A ConvertiblePreferred Stock and the warrants issued to the investors. The warrants are immediatelyexercisable at $0.75 per share,   will expire five years from the dateof issuance, and have certain antidilution rights for the twelve monthperiod beginning on the effective date of the registration statementregistering the shares of common stock underlying the warrants.  We paidaggregate fees and expenses of $485,308 ($448,908 prior to December 31, 2006) incash, issued an aggregate 11,775 shares of Series A Convertible Preferred Stockand 1,228,761warrants to purchase common stock to certain selling agents. Thewarrants are immediately exercisable at $0.75 per share, will expire five yearsafter issuance and have the same anti-dilutive rights as the investor warrants.On January 12, 2007 we filed a registration statement on Form S-3 covering thecommon stock issuable upon (i) the conversion of the all Series A ConvertiblePreferred Stock, (ii) the exercise of all related investor warrants and (iii)the exercise of all selling agent warrants. On February 15, 2007 Amendment No.1to this registration statement was declared effective by the SEC.

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**HISTORY**

In March 2002, Callisto Pharmaceuticals, Inc. (“OldCallisto”), a non-public company, purchased 99.7% of the outstanding commonshares of Webtronics, Inc., (“Webtronics”) a public company for $400,000.Webtronics was incorporated in Florida on February 2, 2001 and had limitedoperations at December 31, 2002.

On April 30, 2003, pursuant to an Agreement and Planof Merger dated March 10, 2003, as amended April 4, 2003, Synergy Acquisition Corp.,a wholly-owned subsidiary of Webtronics merged into Synergy PharmaceuticalsInc. (“Synergy”) and Callisto Acquisition Corp., a wholly-owned subsidiary ofWebtronics merged into Old Callisto (collectively, the “Merger”). As a resultof the Merger, Old Callisto and Synergy became wholly-owned subsidiaries ofWebtronics. In the Merger Webtronics issued 17,318,994 shares of its commonstock in exchange for outstanding Old Callisto common stock and an additional4,395,684 shares in exchange for outstanding Synergy common stock. Old Callistochanged its name to Callisto Research Labs, LLC (“Callisto Research”) andWebtronics changed its name to Callisto Pharmaceuticals, Inc. and changed itsstate of incorporation from Florida to Delaware. Subsequently, 171,818 sharesof common stock issued to former Synergy shareholders were returned to us underthe terms of certain indemnification agreements.

**ATIPRIMOD TO TREAT ADVANCED CARCINOIDCANCER PATIENTS AND MULTIPLE MYELOMA**

On August 28, 2002, our wholly-owned subsidiary,Synergy, entered into a worldwide license agreement with AnorMED Inc. (“AnorMED”),a Canadian corporation, to research, develop, sell and commercially exploit theAtiprimod (SKF 106615) patent rights.

Atiprimod is one of a class of compounds known asazaspiranes and was originally developed as a potential treatment forrheumatoid arthritis based on encouraging data from a number of animal modelsof arthritis and autoimmune indications. The development of this drugoriginated with a partnership between AnorMED and SmithKline Beecham (“SKB”)that led to the successful filing of an investigational new drug application,or IND, and completion of three Phase I clinical trials involving a total of 63patients. The drug successfully completed both single and multiple dose Phase Iclinical trials in patients with rheumatoid arthritis. Both trials evaluatedthe safety and pharmacokinetics (how the body takes up and eliminates drugs) ofAtiprimod and showed that the drug is well tolerated. In the third Phase I clinicaltrial, the drug was found to be well tolerated in an open label extension studyperformed with 43 patients from the first two studies, with patients on thedrug for as long as one year.

**PRECLINICAL STUDIES**

Atiprimod’s specific ability to lower the level of keygrowth factors, known to play an important role in the development of multiplemyeloma, is the basis for its potential use as a drug to treat this disease.Atiprimod was previously shown to inhibit the production of thepro-inflammatory mediators IL-6 and TNF(alpha) in a number of animal models ofinflammation and autoimmune disease. Atiprimod was also demonstrated using invitro models of tumor cell growth to inhibit proliferation of a number of humanmultiple myeloma cell lines. Characterization of the mechanism of Atiprimod’santiproliferative activity in a series of experiments showed that the drugworks by inducing apoptosis (programmed cell death) in myeloma cells. In asecond series of experiments performed with Atiprimod on co-cultures composedof multiple myeloma cells plus bone marrow stromal cells (used to simulate thehuman disease), the drug was found to have a profound effect on secretion ofthe angiogenic (blood vessel related) growth factor VEGF. A separate set ofexperiments also suggest an additional explanation for the disease-modifyingactivity of Atiprimod originally observed in chemically-induced arthritic-ratanimal studies, and provide a further rationale for the application of thisdrug to treat multiple myeloma. Using a bone resorption assay (bone degradationexperiment) to measure the effect of drug on osteoclast-mediated boneresorption, Atiprimod demonstrated a profound effect on osteoclast, or cellsthat break down bone, function. The drug appears to be selectively toxic foractivated osteoclasts, displaying a negligible effect on bone marrow stromalcells.

**COMPLETED CLINICAL STUDIES**

Atiprimod successfully completed single and multipledose Phase I clinical trials in patients with rheumatoid arthritis (RA). In theinitial Phase I study, 28 patients were given single escalating doses of drug(0.002 - 1.0 mg/kg), with a 4-month follow-up. Atiprimod was well tolerated,displaying no clinically relevant changes in any laboratory parameters. Inparticular, liver function tests remained in the normal range. The second PhaseI study involved a 28-day multiple-dose-rising study in 35 RA patients. Thestudy evaluated the effect of food on bioavailability, or the concentration ofdrug in the body, as well as the safety and pharmacokinetics of repeat dosing.Dosages included 0.1, 1.0, 5.0, and 10 mg/day plus a 14-day cohort at 30mg/day, with 4-month follow-up. All doses were well tolerated and clinicaltests were unremarkable. Significantly, reductions in tender and swollen joint countswere noted in a number of subjects during the course of the dosing period.Individuals from the two Phase I safety studies were also involved in a Phase Iopen-label extension trial at 5 mg/day dosage. Forty-three patients entered thestudy and remained on the drug as long as 12 months. Clinical laboratoryresults for all patients were unremarkable, in particular liver enzyme levelsremained within the normal range in all patients throughout the study period.

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**DEVELOPMENT STRATEGY**

Atiprimod commenced a Phase I/IIa clinical trial inrelapsed or refractory multiple myeloma patients on May 26, 2004. These arepatients that have a re-occurrence of active disease, and no longer respond toapproved therapies. The Phase I/IIa clinical trial is an open label study, withthe primary objective of assessing safety of drug and identifying the maximumtolerated dose. The secondary objectives are to measure the pharmacokinetics,evaluate the response in patients with refractory disease and to identifypossible surrogate responses to the drug to better determine the mechanism ofdrug action.  In December 2005, weannounced interim results from this trial performed in relapsed or refractorymultiple myeloma patients which consisted of 15 patients treated withAtiprimod, including 3 patients at the highest dose level of 180 mg/day. Twopatients exhibited stable disease, with one patient having a 34% decrease in Mprotein (measure of tumor burden) over 3 months of treatment. It was also notedthat two patients reported a subjective decrease in bone pain.  In 2006, we amended the protocol to continuethe trial at higher dose levels and currently have this trial open at 4clinical sites in the U.S.

On March 15, 2005, we announced a second Phase I/IIaclinical trial of Atiprimod in advanced cancer patients. The trial is entitled:“An Open Label Study of the Safety and Efficacy of Atiprimod Treatment forPatients with Advanced Cancer”.  Theprimary objective is to assess the safety and determine the maximum tolerateddose of Atiprimod in advanced cancer patients. The secondary objectives are tomeasure the pharmacokinetics of Atiprimod and evaluate the response in avariety of relapsed solid tumors and hematological malignancies. This study wasconducted at the University of Texas M.D. Anderson Cancer Center, and wasclosed to enrollment in November, 2006.

OnNovember 7, 2006, we announced the initiation of a multi-center, open-labelPhase II clinical trial of Atiprimod in low to intermediate gradeneuroendocrine carcinomas, including advanced carcinoid cancer patients. Thistrial is based on encouraging clinical results from the Phase I clinical trialin advanced cancer patients that showed stable disease and a reduction indisease-related symptoms in patients with advanced carcinoid cancer.  The first study site to enter the trial wasthe Hematology Oncology Services of Arkansas in Little Rock, Arkansas.  On January 31, 2007 we announced the openingof a second site for this trial  – theDana-Farber Cancer Institute in Boston, MA.  Subjects will also be seen at the followingfacilities: Brigham and Women’s Hospital, Massachusetts General Hospital andBeth Israel Deaconess Medical Center. On March 12, 2007 we announced theopening of the third site for this trial – The Physician Offices at Mount SinaiMedical Center, NY

Theprimary objective of the Phase II clinical trial is to evaluate efficacy ofAtiprimod in patients with low to intermediate grade neuroendocrine carcinomawho have metastatic or unresectable cancer and who have either symptoms,despite standard therapy (octreotide), or progression of neuroendocrine tumors.Patients, after signing an informed consent, are required to complete two weeksof a symptoms diary to establish their symptoms baseline before commencingAtiprimod dosing. A maximum of 40 evaluable patients will be enrolled in thistrial. Efficacy evaluations will include the measure of target lesions (perRECIST), and the quantization of symptom relief.

**MANUFACTURING OF ATIPRIMOD**

A practical, efficient and cost effective method forproducing Atiprimod on a commercial scale was originally developed by SKB. Inthe course of this work, a new dimaleate salt form was developed. A portion ofthe 7 kilos of Atiprimod drug substance, available from SKB, was used as the sourcefor generating the Atiprimod dimaleate drug product presently being used in thePhase I/IIa clinical study. Several lots of drug substance were re-qualified tomeet current FDA approved release specifications. The full package of fullyvalidated analytical methods developed by SKB was transferred to a contractresearch organization used by us to perform all analytical tests. Onelarge-scale GMP production run of Atiprimod dimaleate led to the successfulrelease of 10 Kg of material available for future Phase II clinical studies. Weplan to enter into a supply contract for Atiprimod with a commercial supplierby the end of 2007 or after confirming activity of the drug candidate in ourcurrent human clinical trials.

**L-ANNAMYCIN TO TREAT RELAPSED ACUTELEUKEMIA**

On August 12, 2004 we entered into a worldwideexclusive license agreement with The University of Texas M.D. Anderson CancerCenter to develop and commercially exploit the L-Annamycin patent rights.L-Annamycin, an anthracycline drug for leukemia therapy, has a noveltherapeutic profile, including activity against drug resistant tumors andsignificantly reduced toxicity.

**PRECLINICAL STUDIES**

Nonclinical studies have shown that Annamycindelivered as a liposomal preparation (L-Annamycin) is effective against severaldifferent in vivo tumor models (animal experiments), including human tumorswhich are resistant to other chemotherapy drugs, grafted into animals.Additionally, results from in vitro studies (cell culture experiments) indicatethat L-Annamycin and free Annamycin were able to partially overcome tumorresistance to chemotherapy drugs in several tumor cell lines that wereresistant to other drugs such as doxorubicin. In nonclinical toxicity studies,myelosuppression (suppression of the body’s immune response) was noted in miceat a single intravenous dose of 15.7 mg/kg L-Annamycin. With weekly intravenousdoses of 5.2 mg/kg L-Annamycin for 6 weeks, or 3.1 and 4.2 mg/kg L-Annamycin

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for 10 weeks in mice, the cardiotoxicity (toxicity toheart tissue) of L-Annamycin was substantially less than an equivalent dose ofdoxorubicin. In dogs, a single 15-minute intravenous infusion of up to 1.42mg/kg L-Annamycin was well tolerated, with no clinically significant adverseeffects, hematological or chemical changes, or pathological changes.

**COMPLETED CLINICAL STUDIES**

L-Annamycin was evaluated previously by AronexPharmaceuticals, Inc. in 3 clinical trials: 1) a Phase I clinical trial in 36patients with relapsed solid tumors, 2) a Phase II clinical trial in 13 patientswith doxorubicin-resistant breast cancer, and 3) a Phase I/IIa trial in 20patients with relapsed/refractory AML and ALL. In the initial Phase I study,L-Annamycin was administered by a single 1- to 2-h intravenous infusion at3-week intervals. Thirty-six patients with relapsed solid tumors were treatedand 109 treatment courses were administered at doses ranging from 3 to 240mg/m2. No cardiotoxicity was seen on biopsy of heart tissue of four patientsstudied. The maximum tolerated dose (MTD) for L-Annamycin in solid tumorpatients was found to be 190 mg/m2. A second Phase II study of L-Annamycin wasperformed in 13 women with doxorubicin-resistant breast cancer. The mediannumber of prior chemotherapy regimes was two, and six patients had two or moreorgan sites of involvement. L-Annamycin was administered at 190-250 mg/m2 as asingle i.v. infusion over 1-2 h every 3 weeks. Of the 13 patients, 12 had cleardeterioration and new tumor growth after one or two courses.

The potential of a less cardiotoxic drug that wasactive against multi-drug resistant tumors led to a third trial in relapsedleukemia patients (both AML and ALL). The trial involved 20 patients withrelapsed/refractory AML (n=17) or ALL (n=3). The conclusions drawn from thetrial were that L-Annamycin was safe, well tolerated and showed potentialclinical activity in patients with acute leukemias, and that further evaluationof this novel anthracycline in patients with hematopoietic, or blood borne,malignancies was clearly warranted**.**

**DEVELOPMENT STRATEGY**

We began a Phase I clinical trial at The University ofTexas M.D. Anderson Cancer Center in adult relapsed or refractory acutelymphocytic leukemia (ALL) patients on December 1, 2005.****Additionalsites enrolled in this study include the Roswell Park Cancer Institute(Buffalo, NY) and the Montefiore Medical Center (New York, NY). The single-arm,open-label L-Annamycin trial is designed to enroll patients in a doseescalation Phase I portion followed by 10 patients at a final fixed dose in thePhase II portion once the maximum tolerated dose (MTD) is determined.  Up to 34 adult patients can be treated inthis single-arm trial.

On February 22, 2007, we announced the opening of aPhase I clinical trial of L-Annamycin in pediatric relapsed or refractory ALLor AML****patients. The trial is presently openat two sites in the U.S., Phoenix Children’s Hospital, Phoenix, AZ, and theUniversity of Arizona, Tucson, AZ.

**MANUFACTURING OF ANNAMYCIN**

An improved manufacturing method for Annamycin hasbeen developed at Antibioticos S.p.A., our commercial supplier of GMP (“GoodManufacturing Practice”) drug substance. GMP material is currently beingproduced in sufficient quantity for all three anticipated trials outlined inthe development strategy section. The analytical methods developed previouslyhave been successfully transferred, and are in the process of being validatedby Quantitative Technologies, Inc., our analytical contract researchorganization, or CRO, for Annamycin development work. The final lyophilized GMPformulated drug product is being manufactured by Pharmaceutical Services, Inc.,who previously produced final product for the earlier clinical trials.Currently, Antibioticos S.p.A. is our sole supplier of Annamycin for ourclinical trials. Our agreement with Antibioticos provides that Antibioticoswill provide 400 grams of GMP drug substance (Annamycin) for our L-Annamycinclinical trials. Upon the conclusion of our Phase IIb clinical trials, theagreement provides that the parties will negotiate in good faith towards acommercial supply agreement for Annamycin.

**ORPHAN DRUG STATUS OF ATIPRIMOD ANDL-ANNAMYCIN**

On January 6, 2004, we announced that the Office ofOrphan Products Development of the FDA granted orphan drug designation toAtiprimod for the treatment of multiple myeloma.  On September 26, 2006, we announced that theOffice of Orphan Products Development of the FDA granted orphan drugdesignation to Atiprimod for the treatment of carcinoid tumors.   On June 24, 2005, we announced that theOffice of Orphan Products Development of the FDA granted orphan drugdesignation to L-Annamycin for the treatment of acute lymphoblastic leukemia.On June 28, 2005, we announced that the Office of Orphan Products Developmentof the FDA granted orphan drug designation to L-Annamycin for the treatment ofacute myeloid leukemia. The FDA grants orphan drug status for drug candidatesthat are intended to treat rare life-threatening diseases that, at the time ofapplication, affect no more than 200,000 patients in the United States. Thedrug must have the ability to provide significant patient benefit overcurrently available treatment or fill an unmet medical need. Orphan drugdesignation entitles us to seven years of market exclusivity in the UnitedStates of America, and ten years of market exclusivity in Europe, upon FDAmarketing approval, provided that we continue to meet certain conditionsestablished by the FDA. Once the FDA grants marketing approval of a new drug,the FDA will not accept or approve other applications to market the samemedicinal product for the same therapeutic indication. Other incentivesprovided by orphan status include certain tax benefits, eligibility forresearch grants and protocol assistance. Protocol assistance includes regulatoryassistance and possible exemptions or reductions of certain regulatory fees.

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**GUANYLATE CYCLASE RECEPTOR AGONISTTECHNOLOGY (Guanilib)**

Our guanylate cyclase receptor agonist (GCRA) programis based on control of cyclic guanosine monophosphate (“cyclic GMP”), animportant second messenger involved in key cellular processes, which areessential for maintenance of the balance between proliferation and cellulardeath (apoptosis). Uroguanylin, a hormone produced by and secreted byspecialized cells in the human GI tract, helps to maintain this balance byactivating synthesis of cyclic GMP through activation of guanylate cyclasereceptor. Recent findings suggest a role of cyclic GMP in gastrointestinal (GI)inflammatory diseases.

We have successfully developed a potent analog(synthetic molecule) of uroguanylin called Guanilib (formerly called SP304).Guanilib has been demonstrated to be superior to uroguanylin in its biologicalactivity, protease stability and pH characteristics. Guanilib is currentlyundergoing pre-clinical animal studies as a treatment for gastrointestinal orGI inflammation in a collaborative study involving clinical gastroenterologistDr. Scott Plevy of the University of North Carolina, Chapel Hill, NC. Recentresults from his laboratory showed that Guanilib was efficacious in treatmentof ulcerative colitis in mice. A patent allowance covering therapeuticapplications of Guanilib in colon cancer and GI inflammatory diseases hasrecently been granted by the U.S. Patent and Trademark Office.

**DEGRASYNS**

On January 10, 2006, we entered into a licenseagreement with the University of Texas M.D. Anderson Cancer Center whereby wewere granted the exclusive right to manufacture, have manufactured, use,import, offer to sell and/or sell anti-cancer compounds called tyrphostins(renamed Degrasyns). Degrasyns are a second-generation class of tyrphostinsdeveloped by scientists at the University of Texas M.D. Anderson Cancer Centerthat have a novel anti-cancer mechanism-of-action that centers on their abilityto selectively degrade key proteins that are involved in tumor cellproliferation and survival. We plan to work closely with scientists at theUniversity of Texas M.D. Anderson Cancer Center during 2007 to bring forward apre-clinical candidate for development in the clinic.

**SUPERANTIGEN-BASED BIOTERORRISMDEFENSE**

On August 20, 1996, we entered into a licenseagreement to research, develop, sell and commercially exploit certainRockefeller University (“Rockefeller”) licensed patents covering peptides andantibodies useful in treating toxic shock syndrome and septic shock. Inaddition, on July 25, 2001, we entered into a license agreement for twoadditional patents related to the regulation of exoproteins in staphylococcusaureus.

On April 1, 2005 we were awarded a two-year $885,641biodefense partnership grant from the National Institute of Allergy andInfectious Diseases (“NIAID”) to develop a monoclonal antibody and vaccineagainst bacterial superantigen toxins. The goal was to design a monoclonalantibody and vaccine that prevent the unregulated activation of T-cells (humanwhite blood cells) by bacteria from the class of staphylococcus aureus andstreptococcus pyogenes. Funding for this program will end in the spring of2007.  Because the bioterrorism programis not a core activity of Callisto, we expect to terminate further developmentwork upon the expiration of the research grant.

**GOVERNMENT REGULATION**

Regulation by governmental authorities in the UnitedStates of America and other countries will be a significant factor in theproduction and marketing of any products that may be developed by us. Thenature and the extent to which such regulation may apply will vary depending onthe nature of any such products. Virtually all of our potential products willrequire regulatory approval by governmental agencies prior tocommercialization. In particular, human therapeutic products are subject torigorous pre-clinical and clinical testing and other approval procedures by theFDA and similar health authorities in foreign countries. Various federalstatutes and regulations also govern or influence the manufacturing, safety,labeling, storage, record keeping and marketing of such products. The processof obtaining these approvals and the subsequent compliance with appropriatefederal and foreign statutes and regulations requires the expenditure ofsubstantial resources. In order to test in clinical trials, produce and marketproducts for diagnostic or therapeutic use, a company must comply withmandatory procedures and safety standards established by the FDA and comparableagencies in foreign countries. Before beginning human clinical testing of apotential new drug, a company must file an IND and receive clearance from theFDA. This application is a summary of the pre-clinical studies that wereconducted to characterize the drug, including toxicity and safety studies, aswell as an in-depth discussion of the human clinical studies that are beingproposed.

The pre-marketing program required for approval of anew drug typically involves a time-consuming and costly three-phase process. InPhase I, trials are conducted with a small number of patients to determine theearly safety profile, the pattern of drug distribution and metabolism. In PhaseII, trials are conducted with small groups of patients afflicted with a targetdisease in order to determine preliminary efficacy, optimal dosages andexpanded evidence of safety. In Phase III, large scale, multi-centercomparative trials are conducted with patients afflicted with a target diseasein order to provide enough data for statistical proof of efficacy and safetyrequired by the FDA and others.

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The FDA closely monitors the progress of each of thethree phases of clinical testing and may, in its discretion, reevaluate, alter,suspend or terminate the testing based on the data that have been accumulatedto that point and its assessment of the risk/benefit ratio to the patient.Estimates of the total time required for carrying out such clinical testingvary between two and ten years. Upon completion of such clinical testing, acompany typically submits a New Drug Application (NDA) or Product LicenseApplication (PLA) to the FDA that summarizes the results and observations ofthe drug during the clinical testing. Based on its review of the NDA or PLA,the FDA will decide whether or not to approve the drug. This review process canbe quite lengthy, and approval for the production and marketing of a newpharmaceutical or medical diagnostic product can require a number of years andsubstantial funding, and there can be no assurance that any approvals will begranted on a timely basis, if at all.

If the product is approved for sale, FDA regulationsgovern the production process and marketing activities, and a post-marketingtesting and surveillance program may be required to monitor continuously aproduct’s usage and effects. Product approvals may be withdrawn if compliancewith regulatory standards are not maintained, and other countries, in which anyproducts developed by us are marketed, may impose a similar regulatory process.

**COMPETITION**

The biopharmaceutical industry is characterized byrapidly evolving technology and intense competition. Our competitors includemajor pharmaceutical and biotechnology companies focusing on hematologicaloncology such as Bioenvision Inc., SGX Pharmaceuticals, Inc., SunesisPharmaceuticals, Inc. and Vion Pharmaceuticals, Inc. Most of our competitorshave financial, technical and marketing resources significantly greater thanour resources. Academic institutions, governmental agencies and other publicand private research organizations are also conducting research activities andseeking patent protection and may commercialize products on their own orthrough joint venture. We are aware of certain development projects forproducts to prevent or treat certain diseases targeted by us. The existence ofthese potential products or other products or treatments of which we are notaware, or products or treatments that may be developed in the future, may adverselyaffect our ability to market the products we develop.

**RESEARCH AND DEVELOPMENT EXPENSES**

Research and development expenses consist primarily ofsalaries and other personnel-related expenses, facilities costs, laboratorysupplies, license fees and patent legal costs. Research and developmentexpenses were $6,031,953 for the twelve months ended December 31, 2006,compared to $6,430,506 and $4,325,975 for the twelve months ended December 31,2005 and 2004, respectively.

On October 7, 2003 we were awarded a $265,697 SmallBusiness Technology Transfer Research grant from the National Institutes ofHealth for studies on Atiprimod. The Principal and Co-Principal Investigatorsof the grant entitled “Atiprimod to Treat Multiple Myeloma and Bone Resorption”are Dr. Gary S. Jacob, our Chief Executive Officer, and Dr. Kenneth C.Anderson, Director of the Jerome Lipper Multiple Myeloma Center of theDana-Farber Cancer Institute, respectively. The studies, which began in early2004 and were completed in November 2004, utilized unique in vitro and in vivomethods and animal models at the Dana-Farber Cancer Institute and at ourin-house laboratory facilities to explore Atiprimod’s pharmacological activityand mechanism of action. Funding for the total amount of this grant wasreceived during 2004 as expenses were incurred and $265,697 has been reportedon our Consolidated Statements of Operations as a separate line item entitled “GovernmentGrant”.

On April 1, 2005 we were awarded an $885,641biodefense partnership grant from the National Institute of Allergy andInfectious Diseases (“NIAID”) to develop a monoclonal antibody and vaccineagainst bacterial superantigen toxins over a two year period. The PrincipalInvestigator of the grant entitled: “Peptide and Antibodies as Antidotes forSuperantigens” is Dr. Kunwar Shailubhai, Senior Vice President, Drug Discoveryfor Synergy Pharmaceuticals Inc., our wholly-owned subsidiary. The grant alsofunded a collaboration with Dr. Sina Bavari of the U.S. Army Medical ResearchInstitute of Infectious Diseases, Fort Detrick, MD, to evaluate our monoclonalantibody and antagonist peptide agents in animal models. During the twelvemonths ended December 31, 2006 and 2005 we received $352,649 and $226,119,which has been reported on our Consolidated Statements of Operations as aseparate line item entitled “Government Grant”.

**PROPRIETARY RIGHTS**

We are able to protect our technology fromunauthorized use by third parties only to the extent that it is covered byvalid and enforceable patents or is effectively maintained as a trade secret.Accordingly, patents or other proprietary rights are an essential element ofour business. As of December 31, 2006, we are the assignee or exclusivelicensee of 7 pending patent applications and 15 issued patents in the UnitedStates, and currently we have approximately 150 issued or pending foreignpatent applications. We seek patent protection of inventions originating fromour ongoing research and development activities that are commercially importantto our business. Our composition-of-matter patents for L-Annamycin andAtiprimod expire in 2017 and 2016, respectively. Our formulation patents forL-Annamycin and Atiprimod dimaleate salt both expire in 2016.

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We have obtained licenses from various parties thatgive us rights to technologies that we deem to be necessary or desirable forour research and development. These licenses (both exclusive and non-exclusive)may require us to pay royalties to the parties in addition to upfront ormilestone payments, and to expend certain minimum resources to develop thesetechnologies.

Patents extend for varying periods according to thedate of patent filing or grant and the legal term of patents in the variouscountries where patent protection is obtained. The actual protection affordedby a patent, which can vary from country to country, depends on the type ofpatent, the scope of its coverage and the availability of legal remedies in thecountry.

While trade secret protection is an essential elementof our business and we have taken security measures to protect our proprietaryinformation and trade secrets, we cannot give assurance that our unpatentedproprietary technology will afford us significant commercial protection. Weseek to protect our trade secrets by entering into confidentiality agreementswith third parties, employees and consultants. Our employees and consultantsalso sign agreements requiring that they assign to us their interests inintellectual property arising from their work for us. All employees sign anagreement not to engage in any conflicting employment or activity during theiremployment with us and not to disclose or misuse our confidential information.However, it is possible that these agreements may be breached or invalidated,and if so, there may not be an adequate corrective remedy available.Accordingly, we cannot ensure that employees, consultants or third parties willnot breach the confidentiality provisions in our contracts, infringe ormisappropriate our trade secrets and other proprietary rights or that measureswe are taking to protect our proprietary rights will be adequate.

In the future, third parties may file claims assertingthat our technologies or products infringe on their intellectual property. Wecannot predict whether third parties will assert such claims against us oragainst the licensors of technology licensed to us, or whether those claimswill harm our business. If we are forced to defend ourselves against suchclaims, whether they are with or without merit and whether they are resolved infavor of, or against, our licensors or us, we may face costly litigation andthe diversion of management’s attention and resources. As a result of suchdisputes, we may have to develop costly non-infringing technology or enter intolicensing agreements. These agreements, if necessary, may be unavailable onterms acceptable to us, or at all.

**LICENSE AGREEMENTS**

On January 10, 2006, we entered into a Patent andTechnology License Agreement with The University of Texas M.D. Anderson CancerCenter. Pursuant to the license agreement, we were granted the exclusive rightto manufacture, have manufactured, use, import, offer to sell and/or sellanti-cancer compounds called tyrphostins (renamed Degrasyns). We paid anonrefundable license fee of $200,000 upon execution of this agreement and weare obligated to pay annual license maintenance fees to The University of TexasM.D. Anderson Cancer Center. We are also obligated under this agreement to payfor legal fees and expenses associated with establishing and protecting thepatent rights worldwide.

We also agreed to pay The University of Texas M.D.Anderson Cancer Center royalties based on net sales from any licensed products,plus aggregate milestone payments of up to $1,750,000 based upon achieving certainregulatory submissions and approvals. The term of the agreement is from January10, 2006 until the end of the term for which the patent rights associated withthe licensed technology have expired. If the first pending patent is issued,the agreement is projected to expire in 2025. In addition, at any time after 2years from January 10, 2006, The University of Texas M.D. Anderson CancerCenter has the right to terminate the license if we fail to provide evidencewithin 90 days of written notice that we have commercialized or are activelyand effectively attempting to commercialize the licensed technology.

On August 12, 2004, we entered into a world-widelicense agreement with The University of Texas M. D. Anderson Cancer Center toresearch, develop, sell and commercially exploit the patent rights forL-Annamycin. Consideration paid for this license amounted to $31,497 forreimbursement of out-of-pocket costs for filing, enforcing and maintaining theL-Annamycin patent rights and a $100,000 initial license fee. We also agreed topay The University of Texas M. D. Anderson Cancer Center royalties based on netsales from any licensed products, plus aggregate milestone payments of up to$750,000 based upon achieving certain regulatory submissions and approvals. Theterm of the agreement is from August 12, 2004 until November 2, 2019. Under theterms of the license agreement, we are required to make certain good faithexpenditures towards the clinical development of at least one licensed productwithin the two year period after March 2005. In addition, at any time after 5years from August 12, 2004, The University of Texas M.D. Anderson Cancer Centerhas the right to terminate the license if we fail to provide evidence within 90days of written notice that we have commercialized or we are actively andeffectively attempting to commercialize L-Annamycin.

On August 28, 2002, and as amended on May 23, 2003,Synergy entered into a worldwide license agreement with AnorMED to research,develop, sell and commercially exploit the Atiprimod patent rights. The licenseagreement provides for aggregate milestone payments of up to $14 million basedupon achieving certain regulatory submissions and approvals for an initialindication, and additional payments of up to $16 million for each additionalindication based on achieving certain regulatory submissions and approvals. Inaddition the agreement requires Synergy to pay AnorMED royalties on net sales.Commencing on January 1, 2004 and on January 1 of each subsequent year Synergyis obligated to pay AnorMED a maintenance fee of $200,000 until the firstcommercial sale of the product. The annual maintenance fee payments under thisagreement were made in January of each year since entering into the licenseagreement with AnorMED and are

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recorded as research and development expense. Pursuantto the license agreement, failure to pay the maintenance fee is a materialbreach of the license agreement. The license agreement will terminate in 2018.

On August 20, 1996, we entered into a licenseagreement to research, develop, sell and commercially exploit certainRockefeller University licensed patents covering peptides and antibodies usefulin treating toxic shock syndrome and septic shock. We agreed to work towardcommercialization of products related to these patents as evidenced by aminimum expenditure of approximately $210,000 per year, plus milestone paymentsand royalties of between 2% and 3% of annual net sales and will pay Rockefeller30% of any sublicense fee paid by sublicenses. The licensed patents under thisagreement are the subject of research being funded by the NIAID grant awardedto us on April 1, 2005 for $885,641over two years. The license agreement willterminate upon the expiration of the related patents.

**EMPLOYEES**

As of March 30, 2007, we had 9 full-time and 4part-time employees. We believe our employee relations are satisfactory.

**AVAILABLE INFORMATION**

We operate three wholly owned subsidiary companiesCallisto Research Labs, LLC, Synergy Pharmaceuticals Inc. (“Synergy”) andCallisto Pharma, GmbH (Germany); and we own one inactive subsidiary, IgX, Ltd(Ireland). We were incorporated in Delaware in May 2003 and our principaloffices are at 420 Lexington Avenue, Suite 1609, New York, NY 10170.

We maintain a site on the world wide web athttp://www.callistopharma.com; however, information found on our website is notincorporated by reference into this report. We make available free of chargethrough our website our Securities and Exchange Commission, or SEC, filings,including our annual report on Form 10-K, quarterly reports on Form 10-Q,current reports on Form 8-K and amendments to those reports filed or furnishedpursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonablypracticable after we electronically file such material with, or furnish it to,the SEC.

**ITEM 1A.  RISK FACTORS**

You should carefully consider the following riskfactors and the other information included herein (specifically, but notlimited to, Item 9A of this annual report) as well as the information includedin other reports and filings made with the SEC before investing in our commonstock. If any of the following risks actually occurs, our business, financialcondition or results of operations could be harmed. The trading price of ourcommon stock could decline due to any of these risks, and you may lose part orall of your investment.

**RISKS RELATED TO OUR BUSINESS**

**WE ARE AT AN EARLY STAGE OFDEVELOPMENT AS A COMPANY, CURRENTLY HAVE NO SOURCE OF REVENUE AND MAY NEVERBECOME PROFITABLE.**

We are a development stage biopharmaceutical company.Currently, we have no products approved for commercial sale and, to date, wehave not generated any revenue. Our ability to generate revenue depends heavilyon:

·                  demonstrationin Phase I/IIa and Phase IIb clinical trials that our two product candidates,Atiprimod for the treatment of relapsed multiple myeloma and advanced carcinoidcancer and L-Annamycin for the treatment of relapsed acute leukemia,respectively, are safe and effective;

·                  thesuccessful development of our other product candidates;

·                  ourability to seek and obtain regulatory approvals, including with respect to theindications we are seeking;

·                  thesuccessful commercialization of our product candidates; and

·                  marketacceptance of our products.

All of our existing product candidates will requireextensive additional clinical evaluation, regulatory review, significantmarketing efforts and substantial investment before they could provide us withany revenue. For example, Atiprimod for the treatment of multiple myelomaentered Phase I/IIa clinical trials in May 2004 and L-Annamycin for thetreatment of acute leukemia entered clinical trials in December 2005. Our otherproduct candidates are in preclinical development. As a result, if we do notsuccessfully develop and commercialize Atiprimod or L-Annamycin, we will beunable to generate any revenue for many years, if at all. We do not anticipatethat we will generate revenue for several years, at the earliest, or that wewill achieve profitability for at least several years after generating materialrevenue, if at all. If we are unable to generate revenue, we will not becomeprofitable, and we may be unable to continue our operations.

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**WE HAVE INCURRED SIGNIFICANT LOSSESSINCE INCEPTION AND ANTICIPATE THAT WE WILL INCUR CONTINUED LOSSES FOR THEFORESEEABLE FUTURE.**

As of December 31, 2006 and 2005, we had anaccumulated deficit of $60,444,368 and $45,140,654, respectively. We haveincurred losses in each year since our inception in 1996. We incurred a netloss of $12,919,229, $11,779,457 and $7,543,467 for the twelve months endedDecember 31, 2006, 2005 and 2004, respectively. These losses, among otherthings, have had and will continue to have an adverse effect on ourstockholders’ equity and working capital. We expect to incur significant andincreasing operating losses for the next several years as we expand ourresearch and development, continue our clinical trials of Atiprimod for the treatmentof multiple myeloma and advanced carcinoid cancer, continue and initiate ourclinical trials of L-Annamycin for the treatment of acute leukemias, acquire orlicense technologies, advance our other product candidates into clinicaldevelopment, seek regulatory approval and, if we receive FDA approval,commercialize our products. Because of the numerous risks and uncertaintiesassociated with our product development efforts, we are unable to predict theextent of any future losses or when we will become profitable, if at all. If weare unable to achieve and then maintain profitability, the market value of ourcommon stock will likely decline.

**OUR INDEPENDENT REGISTERED PUBLICACCOUNTING FIRM HAS EXPRESSED DOUBT ABOUT OUR ABILITY TO CONTINUE AS A GOINGCONCERN, WHICH MAY HINDER OUR ABILITY TO OBTAIN FUTURE FINANCING**

Our consolidated financial statements as of December31, 2006 have been prepared under the assumption that we will continue as agoing concern for the year ending December 31, 2006. Our independent registeredpublic accounting firm has issued a report dated April 13, 2007 that includedan explanatory paragraph referring to our recurring losses from operations andnet capital deficiency and expressing substantial doubt in our ability to continueas a going concern without additional capital becoming available. Our abilityto continue as a going concern is dependent upon our ability to obtainadditional equity or debt financing, attain further operating efficiencies,reduce expenditures, and, ultimately, to generate revenue. The financialstatements do not include any adjustments that might result from the outcome ofthis uncertainty.

**WE WILL NEED TO RAISE SUBSTANTIALADDITIONAL CAPITAL TO FUND OUR OPERATIONS, AND OUR FAILURE TO OBTAIN FUNDING WHENNEEDED MAY FORCE US TO DELAY, REDUCE OR ELIMINATE OUR PRODUCT DEVELOPMENTPROGRAMS OR COLLABORATION EFFORTS.**

Our operations have consumed substantial amounts ofcash since inception. We expect to continue to spend substantial amounts to:

·                  completethe clinical development of our two lead product candidates, Atiprimod for thetreatment of multiple myeloma and advanced carcinoid cancer and L-Annamycin forthe treatment of acute leukemia;

·                  continuethe development of our other product candidates;

·                  financeour general and administrative expenses;

·                  prepareregulatory approval applications and seek approvals for Atiprimod andL-Annamycin and our other product candidates;

·                  licenseor acquire additional technologies;

·                  launchand commercialize our product candidates, if any such product candidatesreceive regulatory approval; and

·                  develop andimplement sales, marketing and distribution capabilities.

We expect that our cash used in operatingactivities will increase significantly for the next several years. For theyears ended December 31, 2006, 2005 and 2004 we used approximately $8.3million, $8.7 million and $4.7 million in operating activities, respectively.

We will be required to raise additional capital withinthe next year to complete the development and commercialization of our currentproduct candidates and to continue to fund operations at the current cashexpenditure levels. Our future funding requirements will depend on manyfactors, including, but not limited to:

·                  therate of progress and cost of our clinical trials and other developmentactivities;

·                  anyfuture decisions we may make about the scope and prioritization of the programswe pursue;

·                  thecosts of filing, prosecuting, defending and enforcing any patent claims andother intellectual property rights;

·                  thecosts and timing of regulatory approval;

·                  thecosts of establishing sales, marketing and distribution capabilities;

·                  theeffect of competing technological and market developments;

·                  theterms and timing of any collaborative, licensing and other arrangements that wemay establish; and

·                  general marketconditions for offerings from biopharmaceutical companies.

To date, our sources of cash have been primarilylimited to the sale of our equity securities. Net cash provided by financingactivities for the twelve months ended December 31, 2006, 2005 and 2004 wasapproximately $10.8 million, $4.8 million and $6.1 million, respectively. Wecannot be certain that additional funding will be available on acceptableterms, or at all. To the extent that we raise additional funds by issuingequity securities, our stockholders may experience significant dilution. Anydebt financing, if available, may involve restrictive covenants that impact ourability to conduct our business. If we are unable to raise additional capitalwhen required or on acceptable terms,

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we may have to significantly delay, scale back ordiscontinue the development and/or commercialization of one or more of ourproduct candidates. We also may be required to:

·                  seekcollaborators for our product candidates at an earlier stage than otherwisewould be desirable and on terms that are less favorable than might otherwise beavailable; and

·                  relinquishlicense or otherwise dispose of rights to technologies, product candidates orproducts that we would otherwise seek to develop or commercialize ourselves onunfavorable terms.

**IFOUR AGREEMENTS WITH ANORMED INC. OR THE UNIVERSITY OF TEXAS M.D. ANDERSONCANCER CENTER TERMINATE, OUR BUSINESS WOULD BE ADVERSELY AFFECTED.**

Our business is dependent on rights we have licensedfrom AnorMED Inc. and The University of Texas M.D. Anderson Cancer Center.Under the terms of the AnorMED license agreement, we are obligated to make amaintenance fee payment of $200,000 on January 1 of each year for the term ofthe license agreement. Pursuant to the license agreement, failure to pay themaintenance fee is a material breach of the agreement. We do not anticipatefailing to pay the maintenance fee, however in the event we cannot pay themaintenance fee, AnorMED may terminate the license agreement and we would notbe able to further develop and commercialize Atiprimod which would have anadverse effect on our business. Under the terms of The University of Texas M.D.Anderson Cancer Center license agreement for L-Annamycin, we are required tomake certain good faith expenditures towards the clinical development of atleast one licensed product within the two year period after March 2005. Inaddition, at any time after 5 years from August 12, 2004, The University of TexasM.D. Anderson Cancer Center has the right to terminate the license if we failto provide evidence within 90 days of written notice that we havecommercialized or we are actively and effectively attempting to commercializeL-Annamycin. If we fail to fulfill these obligations or other materialobligations, The University of Texas M.D. Anderson Cancer Center licenseagreement may be terminated and our business would be adversely affected.

**CLINICAL TRIALS INVOLVE A LENGTHY ANDEXPENSIVE PROCESS WITH AN UNCERTAIN OUTCOME, AND RESULTS OF EARLIER STUDIES ANDTRIALS MAY NOT BE PREDICTIVE OF FUTURE TRIAL RESULTS.**

In order to receive regulatory approval for thecommercialization of our product candidates, we must conduct, at our ownexpense, extensive clinical trials to demonstrate safety and efficacy of theseproduct candidates. Clinical testing is expensive, can take many years tocomplete and its outcome is uncertain. Failure can occur at any time during theclinical trial process.

The results of preclinical studies and early clinicaltrials of our product candidates do not necessarily predict the results oflater-stage clinical trials. Product candidates in later stages of clinicaltrials may fail to show the desired safety and efficacy traits despite having progressedthrough initial clinical testing. The data collected from clinical trials ofour product candidates may not be sufficient to support the submission of a newdrug application or to obtain regulatory approval in the United States orelsewhere. Because of the uncertainties associated with drug development andregulatory approval, we cannot determine if or when we will have an approvedproduct for commercialization or achieve sales or profits.

**DELAYS IN CLINICAL TESTING COULDRESULT IN INCREASED COSTS TO US AND DELAY OUR ABILITY TO GENERATE REVENUE.**

While to date there has been no delays in our clinicaltrials, enrollment in our Atiprimod Phase I/IIa trial in multiple myeloma wasslower than anticipated due to limited availability of relapsed multiple myelomapatients. In the future, we may experience delays in clinical testing of ourproduct candidates. We do not know whether planned clinical trials will beginon time, will need to be redesigned or will be completed on schedule, if atall. Clinical trials can be delayed for a variety of reasons, including delaysin obtaining regulatory approval to commence a trial, in reaching agreement onacceptable clinical trial terms with prospective sites, in obtaininginstitutional review board approval to conduct a trial at a prospective site,in recruiting patients to participate in a trial or in obtaining sufficientsupplies of clinical trial materials. Many factors affect patient enrollment,including the size of the patient population, the proximity of patients toclinical sites, the eligibility criteria for the trial, competing clinicaltrials and new drugs approved for the conditions we are investigating.Prescribing physicians will also have to decide to use our product candidatesover existing drugs that have established safety and efficacy profiles. Anydelays in completing our clinical trials will increase our costs, slow down ourproduct development and approval process and delay our ability to generaterevenue.

**WE MAY BE REQUIRED TO SUSPEND ORDISCONTINUE CLINICAL TRIALS DUE TO UNEXPECTED SIDE EFFECTS OR OTHER SAFETYRISKS THAT COULD PRECLUDE APPROVAL OF OUR PRODUCT CANDIDATES.**

Our clinical trials may be suspended at any time for anumber of reasons. For example, we may voluntarily suspend or terminate ourclinical trials if at any time we believe that they present an unacceptablerisk to the clinical trial patients. In addition, regulatory agencies may orderthe temporary or permanent discontinuation of our clinical trials at any timeif they believe that the clinical trials are not being conducted in accordancewith applicable regulatory requirements or that they present an unacceptablesafety risk to the clinical trial patients.

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Administering any product candidates to humans mayproduce undesirable side effects. These side effects could interrupt, delay orhalt clinical trials of our product candidates and could result in the FDA orother regulatory authorities denying further development or approval of ourproduct candidates for any or all targeted indications. Ultimately, some or allof our product candidates may prove to be unsafe for human use. Moreover, wecould be subject to significant liability if any volunteer or patient suffers,or appears to suffer, adverse health effects as a result of participating inour clinical trials.

**IF WE ARE UNABLE TO SATISFYREGULATORY REQUIREMENTS, WE MAY NOT BE ABLE TO COMMERCIALIZE OUR PRODUCTCANDIDATES.**

We need FDA approval prior to marketing our productcandidates in the United States of America. If we fail to obtain FDA approvalto market our product candidates, we will be unable to sell our productcandidates in the United States of America and we will not generate anyrevenue.

This regulatory review and approval process, whichincludes evaluation of preclinical studies and clinical trials of a productcandidate as well as the evaluation of our manufacturing process and ourcontract manufacturers’ facilities, is lengthy, expensive and uncertain. Toreceive approval, we must, among other things, demonstrate with substantialevidence from well-controlled clinical trials that the product candidate isboth safe and effective for each indication where approval is sought.Satisfaction of these requirements typically takes several years and the timeneeded to satisfy them may vary substantially, based on the type, complexityand novelty of the pharmaceutical product. We cannot predict if or when wemight submit for regulatory review any of our product candidates currentlyunder development. Any approvals we may obtain may not cover all of theclinical indications for which we are seeking approval. Also, an approval mightcontain significant limitations in the form of narrow indications, warnings,precautions, or contra-indications with respect to conditions of use.

The FDA has substantial discretion in the approvalprocess and may either refuse to file our application for substantive review ormay form the opinion after review of our data that our application isinsufficient to allow approval of our product candidates. If the FDA does notfile or approve our application, it may require that we conduct additionalclinical, preclinical or manufacturing validation studies and submit that databefore it will reconsider our application. Depending on the extent of these orany other studies, approval of any applications that we submit may be delayedby several years, or may require us to expend more resources than we haveavailable. It is also possible that additional studies, if performed andcompleted, may not be considered sufficient by the FDA to make our applicationsapprovable. If any of these outcomes occur, we may be forced to abandon ourapplications for approval, which might cause us to cease operations.

We will also be subject to a wide variety of foreignregulations governing the development, manufacture and marketing of ourproducts. Whether or not FDA approval has been obtained, approval of a productby the comparable regulatory authorities of foreign countries must still beobtained prior to manufacturing or marketing the product in those countries.The approval process varies from country to country and the time needed tosecure approval may be longer or shorter than that required for FDA approval.We cannot assure you that clinical trials conducted in one country will beaccepted by other countries or that approval in one country will result inapproval in any other country.

**IF OUR PRODUCT CANDIDATES ARE UNABLETO COMPETE EFFECTIVELY WITH MARKETED CANCER DRUGS TARGETING SIMILAR INDICATIONSAS OUR PRODUCT CANDIDATES, OUR COMMERCIAL OPPORTUNITY WILL BE REDUCED ORELIMINATED.**

We face competition from established pharmaceuticaland biotechnology companies, as well as from academic institutions, governmentagencies and private and public research institutions. Many of our competitorshave significantly greater financial resources and expertise in research anddevelopment, manufacturing, preclinical testing, conducting clinical trials,obtaining regulatory approvals and marketing approved products than we do.Smaller or early-stage companies may also prove to be significant competitors,particularly through collaborative arrangements with large, establishedcompanies. Our commercial opportunity will be reduced or eliminated if ourcompetitors develop and commercialize cancer drugs that are safer, moreeffective, have fewer side effects or are less expensive than our productcandidates. These third parties compete with us in recruiting and retainingqualified scientific and management personnel, establishing clinical trialsites and patient registration for clinical trials, as well as in acquiringtechnologies and technology licenses complementary to our programs oradvantageous to our business.

We expect that our ability to compete effectively willdepend upon our ability to:

·                  successfullyand rapidly complete clinical trials and submit for and obtain all requisiteregulatory approvals in a cost-effective manner;

·                  maintaina proprietary position for our products and manufacturing processes and otherrelated product technology;

·                  attractand retain key personnel;

·                  developrelationships with physicians prescribing these products; and

·                  build anadequate sales and marketing infrastructure for our product candidates.

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Because we will be competing against significantlylarger companies with established track records, we will have to demonstrate tophysicians that, based on experience, clinical data, side-effect profiles andother factors, our products are preferable to existing cancer drugs. If we areunable to compete effectively in the cancer drug market and differentiate ourproducts from currently marketed cancer drugs, we may never generate meaningfulrevenue.

Numerous pharmaceutical and biotechnology companieshave developed anthracycline drugs used to treat acute leukemias similar to ourcompound, L-Annamycin. These compounds include Adriamycin® and Ellence® whichare marketed by Pfizer and Cerubidine® which is marketed by BoehringerIngelheim. These drugs have been approved by the FDA and are currently beingmarketed as opposed to L-Annamycin which is in clinical development. Atiprimod,our drug candidate for relapsed multiple myeloma, works through a differentmechanism of action than Velcade which is currently marketed by MilleniumPharmaceuticals and other drugs in development, such as Celgene Corporation’sRevlimid.

**WE CURRENTLY HAVE NO SALES ANDMARKETING ORGANIZATION. IF WE ARE UNABLE TO ESTABLISH A DIRECT SALES FORCE INTHE UNITED STATES TO PROMOTE OUR PRODUCTS, THE COMMERCIAL OPPORTUNITY FOR OURPRODUCTS MAY BE DIMINISHED.**

We currently have no sales and marketing organization.If any of our product candidates are approved by the FDA, we intend to marketthat product directly to hospitals in the United States of America through ourown sales force. We will incur significant additional expenses and commitsignificant additional management resources to establish this sales force. Wemay not be able to establish these capabilities despite these additionalexpenditures. We will also have to compete with other pharmaceutical and biotechnologycompanies to recruit, hire and train sales and marketing personnel. If we electto rely on third parties to sell our product candidates in the United States,we may receive less revenue than if we sold our products directly. In addition,we may have little or no control over the sales efforts of those third parties.In the event we are unable to develop our own sales force or collaborate with athird party to sell our product candidates, we may not be able to commercializeour product candidates which would negatively impact our ability to generaterevenue.

**WE MAY NEED OTHERS TO MARKET ANDCOMMERCIALIZE OUR PRODUCT CANDIDATES IN INTERNATIONAL MARKETS.**

In the future, if appropriate regulatory approvals areobtained, we intend to commercialize our product candidates in internationalmarkets. However, we have not decided how to commercialize our productcandidates in those markets. We may decide to build our own sales force or sellour products through third parties. Currently, we do not have any plans toenter international markets. If we decide to sell our product candidates ininternational markets through a third party, we may not be able to enter intoany marketing arrangements on favorable terms or at all. In addition, thesearrangements could result in lower levels of income to us than if we marketedour product candidates entirely on our own. If we are unable to enter into amarketing arrangement for our product candidates in international markets, wemay not be able to develop an effective international sales force tosuccessfully commercialize those products in international markets. If we failto enter into marketing arrangements for our products and are unable to developan effective international sales force, our ability to generate revenue wouldbe limited.

**IF OUR RELATIONSHIP WITH OUR CONTRACTMANUFACTURER FOR L-ANNAMYCIN TERMINATES, OR THEIR FACILITIES ARE DAMAGED ORDESTROYED, WE MAY BE UNABLE TO DEVELOP OR COMMERCIALIZE L-ANNAMYCIN.**

Currently, Antibioticos S.p.A. is our sole supplier ofAnnamycin (drug substance that is the active component of the final formulatedL-Annamycin drug product). If our relationship with this contract manufacturer,or any other contract manufacturer we might use, terminates or if any of theirfacilities are damaged for any reason, including fire, flood, earthquake orother similar event, we may be unable to obtain supply of Annamycin. If any ofthese events were to occur, we may need to find alternative manufacturers ormanufacturing facilities. The number of contract manufacturers with theexpertise, required regulatory approvals and facilities to manufactureAnnamycin on a commercial scale is extremely limited, and it would take asignificant amount of time to arrange for alternative manufacturers. If we needto change to other commercial manufacturers, the FDA and comparable foreignregulators must approve these manufacturers’ facilities and processes prior toour use, which would require new testing and compliance inspections. Inaddition, we may not have the intellectual property rights, or may have toshare intellectual property rights, to any improvements in the currentmanufacturing processes or any new manufacturing processes for Annamycin. Anyof these factors could cause us to delay or suspend clinical trials, regulatorysubmissions, required approvals or commercialization of L-Annamycin, entailhigher costs, and could result in our being unable to commercialize L-Annamycinsuccessfully. Furthermore, if our contract manufacturers fail to deliver the requiredcommercial quantities of bulk drug substance or finished product on a timelybasis and at commercially reasonable prices, and we were unable to find one ormore replacement manufacturers capable of production at a substantiallyequivalent cost, in substantially equivalent volumes and quality, and on atimely basis, we would likely be unable to meet demand for L-Annamycin and wewould lose potential revenue.

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**IF THE FDA DOES NOT APPROVE OURCONTRACT MANUFACTURERS’ FACILITIES, WE MAY BE UNABLE TO DEVELOP ORCOMMERCIALIZE OUR PRODUCT CANDIDATES.**

We rely on third-party contract manufacturers tomanufacture our product candidates, and currently have no plans to develop ourown manufacturing facility. The facilities used by our contract manufacturersto manufacture our product candidates must be approved by the FDA. If the FDAdoes not approve these facilities for the manufacture of our product, we mayneed to fund additional modifications to our manufacturing process, conductadditional validation studies, or find alternative manufacturing facilities,any of which would result in significant cost to us as well as a delay of up toseveral years in obtaining approval for and manufacturing of our productcandidates. In addition, our contract manufacturers will be subject to ongoingperiodic unannounced inspection by the FDA and corresponding state agencies forcompliance with good manufacturing practices regulations, or cGMPs, and similarforeign standards. These regulations cover all aspects of the manufacturing,testing, quality control and record keeping relating to our product candidates.We do not have control over our contract manufacturers’ compliance with theseregulations and standards. Failure by our contract manufacturers to comply withapplicable regulations could result in sanctions being imposed on us, includingfines, injunctions, civil penalties, failure of the government to grant marketapproval of drugs, delays, suspension or withdrawals of approvals, operatingrestrictions and criminal prosecutions, any of which could significantly andadversely affect our business. In addition, we have no control over ourcontract manufacturers’ ability to maintain adequate quality control, qualityassurance and qualified personnel. Failure by our contract manufacturers tocomply with or maintain any of these standards could adversely affect thedevelopment of our product candidates and our business.

**IF PRODUCT LIABILITY LAWSUITS ARESUCCESSFULLY BROUGHT AGAINST US, WE MAY INCUR SUBSTANTIAL LIABILITIES AND MAYBE REQUIRED TO LIMIT COMMERCIALIZATION OF OUR PRODUCT CANDIDATES.**

We face an inherent risk of product liability lawsuitsrelated to the testing of our product candidates, and will face an even greaterrisk if we sell our product candidates commercially. Currently, we are notaware of any anticipated product liability claims with respect to our productcandidates. In the future, an individual may bring a liability claim against usif one of our product candidates causes, or merely appears to have caused, aninjury. If we cannot successfully defend ourselves against the productliability claim, we may incur substantial liabilities. Regardless of merit oreventual outcome, liability claims may result in:

·                  decreaseddemand for our product candidates;

·                  injuryto our reputation;

·                  withdrawalof clinical trial participants;

·                  costsof related litigation;

·                  substantialmonetary awards to patients;

·                  productrecalls;

·                  lossof revenue; and

·                  the inability tocommercialize our product candidates.

We have clinical trial liability insurance with a$3,000,000 annual aggregate limit for up to 40 patients participating at thesame time in our Atiprimod and L-Annamycin clinical trials. We intend to expandour insurance coverage to include the sale of commercial products if marketingapproval is obtained for our product candidates. Our current insurance coveragemay prove insufficient to cover any liability claims brought against us. Inaddition, because of the increasing costs of insurance coverage, we may not beable to maintain insurance coverage at a reasonable cost or obtain insurancecoverage that will be adequate to satisfy any liability that may arise.

**EVEN IF WE RECEIVE REGULATORYAPPROVAL FOR OUR PRODUCT CANDIDATES, WE WILL BE SUBJECT TO ONGOING SIGNIFICANTREGULATORY OBLIGATIONS AND OVERSIGHT.**

If we receive regulatory approval to sell our productcandidates, the FDA and foreign regulatory authorities may, nevertheless,impose significant restrictions on the indicated uses or marketing of suchproducts, or impose ongoing requirements for post-approval studies. Followingany regulatory approval of our product candidates, we will be subject tocontinuing regulatory obligations, such as safety reporting requirements, andadditional post-marketing obligations, including regulatory oversight of thepromotion and marketing of our products. If we become aware of previouslyunknown problems with any of our product candidates here or overseas or ourcontract manufacturers’ facilities, a regulatory agency may impose restrictionson our products, our contract manufacturers or on us, including requiring us toreformulate our products, conduct additional clinical trials, make changes inthe labeling of our products, implement changes to or obtain re-approvals ofour contract manufacturers’ facilities or withdraw the product from the market.In addition, we may experience a significant drop in the sales of the affectedproducts, our reputation in the marketplace may suffer and we may become thetarget of lawsuits, including class action suits. Moreover, if we fail tocomply with applicable regulatory requirements, we may be subject to fines,suspension or withdrawal of regulatory approvals, product recalls, seizure ofproducts, operating restrictions and criminal prosecution. Any of these eventscould harm or prevent sales of the affected products or could substantiallyincrease the costs and expenses of commercializing and marketing theseproducts.

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**WE RELY ON THIRD PARTIES TO CONDUCTOUR CLINICAL TRIALS. IF THESE THIRD PARTIES DO NOT SUCCESSFULLY CARRY OUT THEIRCONTRACTUAL DUTIES OR MEET EXPECTED DEADLINES, WE MAY NOT BE ABLE TO SEEK OROBTAIN REGULATORY APPROVAL FOR OR COMMERCIALIZE OUR PRODUCT CANDIDATES.**

We have agreements with third-party contract researchorganizations, (“CRO” or “CROs”), to provide monitors and to manage data forour clinical programs. We and our CROs are required to comply with current GoodClinical Practices, (“GCP” or “GCPs”), regulations and guidelines enforced bythe FDA for all of our products in clinical development. The FDA enforces GCPsthrough periodic inspections of trial sponsors, principal investigators andtrial sites. In the future, if we or our CROs fail to comply with applicableGCPs, the clinical data generated in our clinical trials may be deemed unreliableand the FDA may require us to perform additional clinical trials beforeapproving our marketing applications. We cannot assure you that, uponinspection, the FDA will determine that any of our clinical trials for productsin clinical development comply with GCPs. In addition, our clinical trials mustbe conducted with product produced under cGMP regulations, and will require alarge number of test subjects. Our failure to comply with these regulations mayrequire us to repeat clinical trials, which would delay the regulatory approvalprocess.

If any of our relationships with these third-partyCROs terminate, we may not be able to enter into arrangements with alternativeCROs. If CROs do not successfully carry out their contractual duties orobligations or meet expected deadlines, if they need to be replaced, or if thequality or accuracy of the clinical data they obtain is compromised due to thefailure to adhere to our clinical protocols, regulatory requirements or forother reasons, our clinical trials may be extended, delayed or terminated, andwe may not be able to obtain regulatory approval for or successfullycommercialize our product candidates. As a result, our financial results andthe commercial prospects for our product candidates would be harmed, our costscould increase, and our ability to generate revenue could be delayed.

**IF WE FAIL TO ATTRACT AND KEEP SENIORMANAGEMENT AND KEY SCIENTIFIC PERSONNEL, WE MAY BE UNABLE TO SUCCESSFULLYDEVELOP OUR PRODUCT CANDIDATES, CONDUCT OUR CLINICAL TRIALS AND COMMERCIALIZEOUR PRODUCT CANDIDATES.**

Our success depends in part on our continued abilityto attract, retain and motivate highly qualified management, clinical andscientific personnel and on our ability to develop and maintain importantrelationships with leading academic institutions, clinicians and scientists. Weare highly dependent upon our senior management and scientific staff,particularly Gary S. Jacob, Ph.D., our Chief Executive Officer. The loss ofservices of Dr. Jacob or one or more of our other members of senior managementcould delay or prevent the successful completion of our planned clinical trialsor the commercialization of our product candidates.

The competition for qualified personnel in thebiotechnology and pharmaceuticals field is intense. We will need to hireadditional personnel as we expand our clinical development and commercialactivities. We may not be able to attract and retain quality personnel onacceptable terms given the competition for such personnel among biotechnology,pharmaceutical and other companies. We do not carry “key person” insurancecovering any members of our senior management other than Dr. Jacob.

**IF WE FAIL TO ACQUIRE AND DEVELOPOTHER PRODUCTS OR PRODUCT CANDIDATES, WE MAY BE UNABLE TO GROW OUR BUSINESS.**

To date, we have in-licensed or acquired the rights toeach of our product candidates. As part of our growth strategy, in addition todeveloping our current product candidates, we intend to license or acquireadditional products and product candidates for development andcommercialization. Because we have limited internal research capabilities, weare dependent upon pharmaceutical and biotechnology companies and otherresearchers to sell or license products to us. The success of this strategydepends upon our ability to identify, select and acquire the rightpharmaceutical product candidates and products.

Any product candidate we license or acquire mayrequire additional development efforts prior to commercial sale, includingextensive clinical testing and approval by the FDA and applicable foreignregulatory authorities. All product candidates are prone to the risks offailure inherent in pharmaceutical product development, including thepossibility that the product candidate will not be shown to be sufficientlysafe and effective for approval by regulatory authorities. In addition, wecannot assure you that any products that we license or acquire that areapproved will be manufactured or produced economically, successfullycommercialized or widely accepted in the marketplace.

Proposing, negotiating and implementing aneconomically viable product acquisition or license is a lengthy and complexprocess. Other companies, including those with substantially greater financial,marketing and sales resources, may compete with us for the acquisition orlicense of product candidates and approved products. We may not be able toacquire or license the rights to additional product candidates and approvedproducts on terms that we find acceptable, or at all.

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**WE MAY UNDERTAKE ACQUISITIONS IN THEFUTURE, AND ANY DIFFICULTIES FROM INTEGRATING THESE ACQUISITIONS COULD DAMAGEOUR ABILITY TO ATTAIN OR MAINTAIN PROFITABILITY.**

We may acquire additional businesses, products orproduct candidates that complement or augment our existing business.Integrating any newly acquired business or product could be expensive andtime-consuming. We may not be able to integrate any acquired business orproduct successfully or operate any acquired business profitably. Moreover, wemany need to raise additional funds through public or private debt or equityfinancing to make acquisitions, which may result in dilution to stockholdersand the incurrence of indebtedness that may include restrictive covenants.

**WE WILL NEED TO INCREASE THE SIZE OFOUR ORGANIZATION, AND WE MAY EXPERIENCE DIFFICULTIES IN MANAGING GROWTH.**

We are a small company with 9 full-time and 3part-time employees as of March 30, 2007. To continue our clinical trials andcommercialize our product candidates, we will need to expand our employee basefor managerial, operational, financial and other resources. Future growth willimpose significant added responsibilities on members of management, includingthe need to identify, recruit, maintain and integrate additional employees.Over the next 12 months depending on the progress of our planned clinicaltrials, we plan to add additional employees to assist us with our clinicalprograms. Our future financial performance and our ability to commercialize ourproduct candidates and to compete effectively will depend, in part, on ourability to manage any future growth effectively. To that end, we must be ableto:

·                  manageour development efforts effectively;

·                  manageour clinical trials effectively;

·                  integrateadditional management, administrative, manufacturing and sales and marketingpersonnel;

·                  maintainsufficient administrative, accounting and management information systems andcontrols; and

·                  hire and trainadditional qualified personnel.

We may not be able to accomplish these tasks, and ourfailure to accomplish any of them could harm our financial results.

**REIMBURSEMENT MAY NOT BE AVAILABLEFOR OUR PRODUCT CANDIDATES, WHICH COULD DIMINISH OUR SALES.**

Market acceptance and sales of our product candidatesmay depend on reimbursement policies and health care reform measures. Thelevels at which government authorities and third-party payors, such as privatehealth insurers and health maintenance organizations, reimburse patients forthe price they pay for our products could affect whether we are able tocommercialize these products. We cannot be sure that reimbursement will beavailable for any of these products. Also, we cannot be sure that reimbursementamounts will not reduce the demand for, or the price of, our products. We havenot commenced efforts to have our product candidates reimbursed by governmentor third party payors. If reimbursement is not available or is available onlyto limited levels, we may not be able to commercialize our products.

In recent years, officials have made numerousproposals to change the health care system in the United States. Theseproposals include measures that would limit or prohibit payments for certainmedical treatments or subject the pricing of drugs to government control. Inaddition, in many foreign countries, particularly the countries of the EuropeanUnion, the pricing of prescription drugs is subject to government control. Ifour products are or become subject to government regulation that limits orprohibits payment for our products, or that subject the price of our productsto governmental control, we may not be able to generate revenue, attainprofitability or commercialize our products.

As a result of legislative proposals and the trendtowards managed health care in the United States, third-party payers areincreasingly attempting to contain health care costs by limiting both coverageand the level of reimbursement of new drugs. They may also refuse to provideany coverage of uses of approved products for medical indications other thanthose for which the FDA has granted market approvals. As a result, significantuncertainty exists as to whether and how much third-party payers will reimbursepatients for their use of newly-approved drugs, which in turn will put pressureon the pricing of drugs.

**LEGISLATIVE OR REGULATORY REFORM OFTHE HEALTHCARE SYSTEM MAY AFFECT OUR ABILITY TO SELL OUR PRODUCTS PROFITABLY.**

In both the United States and certain foreignjurisdictions, there have been a number of legislative and regulatory proposalsto change the healthcare system in ways that could impact upon our ability tosell our products profitably. In recent years, new legislation has beenproposed in the United States at the federal and state levels that would effectmajor changes in the healthcare system, either nationally or at the statelevel.

These proposals have included prescription drugbenefit proposals for Medicare beneficiaries introduced in Congress.Legislation creating a prescription drug benefit and making certain changes inMedicaid reimbursement has recently been enacted by Congress and signed by thePresident. Given this legislation’s recent enactment, it is still too early todetermine its impact on the pharmaceutical industry and our business. Furtherfederal and state proposals are likely. The potential for adoption of theseproposals affects or will affect our ability to raise

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capital, obtain additional collaborators and marketour products. We expect to experience pricing pressures in connection with thesale of our products due to the trend toward managed health care, theincreasing influence of health maintenance organizations and additionallegislative proposals. Our results of operations could be adversely affected byfuture healthcare reforms.

**RISKS RELATED TO OUR INTELLECTUALPROPERTY**

**IT IS DIFFICULT AND COSTLY TO PROTECTOUR PROPRIETARY RIGHTS, AND WE MAY NOT BE ABLE TO ENSURE THEIR PROTECTION.**

Our commercial success will depend in part onobtaining and maintaining patent protection and trade secret protection of ourproduct candidates, and the methods used to manufacture them, as well assuccessfully defending these patents against third-party challenges. We willonly be able to protect our product candidates from unauthorized making, using,selling, offering to sell or importation by third parties to the extent that wehave rights under valid and enforceable patents or trade secrets that coverthese activities.

As of December 31, 2006, we own and/or have licensedrights to 15 issued United States patents and 7 United States patent applications.We have approximately 150 issued and/or pending foreign patent applications. Wemay file additional patent applications and extensions. Our issued UnitedStates patents we own and license primarily are composition of matter andformulation patents related to Atiprimod and L-Annamycin. Our composition ofmatter patents for L-Annamycin and Atiprimod expire in 2017 and 2016,respectively. Our formulation patents for L-Annamycin and Atiprimod dimaleate(preferred salt form) both expire in 2016.

The patent positions of pharmaceutical andbiotechnology companies can be highly uncertain and involve complex legal andfactual questions for which important legal principles remain unresolved. Noconsistent policy regarding the breadth of claims allowed in biotechnologypatents has emerged to date in the United States. The biotechnology patentsituation outside the United States is even more uncertain. Changes in eitherthe patent laws or in interpretations of patent laws in the United States andother countries may diminish the value of our intellectual property.Accordingly, we cannot predict the breadth of claims that may be allowed orenforced in our licensed patents or in third-party patents.

The degree of future protection for our proprietaryrights is uncertain because legal means afford only limited protection and maynot adequately protect our rights or permit us to gain or keep our competitiveadvantage. For example:

·                  othersmay be able to make compounds that are competitive with our product candidatesbut that are not covered by the claims of our licensed patents, or for which weare not licensed under our license agreements;

·                  weor our licensors might not have been the first to make the inventions coveredby our pending patent application or the pending patent applications and issuedpatents of our licensors;

·                  weor our licensors might not have been the first to file patent applications forthese inventions;

·                  othersmay independently develop similar or alternative technologies or duplicate anyof our technologies;

·                  itis possible that our pending patent application or one or more of the pendingpatent applications of our licensors will not result in issued patents;

·                  theissued patents of our licensors may not provide us with any competitive advantages,or may be held invalid or unenforceable as a result of legal challenges bythird parties;

·                  wemay not develop additional proprietary technologies that are patentable; or

·                  the patents ofothers may have an adverse effect on our business.

We also may rely on trade secrets to protect ourtechnology, especially where we do not believe patent protection is appropriateor obtainable. However, trade secrets are difficult to protect. While we usereasonable efforts to protect our trade secrets, our employees, consultants,contractors, outside scientific collaborators and other advisors mayunintentionally or willfully disclose our information to competitors. Enforcinga claim that a third party illegally obtained and is using our trade secrets isexpensive and time consuming, and the outcome is unpredictable. In addition,courts outside the United States are sometimes less willing to protect tradesecrets. Moreover, our competitors may independently develop equivalentknowledge, methods and know-how.

**WE MAY INCUR SUBSTANTIAL COSTS AS ARESULT OF LITIGATION OR OTHER PROCEEDINGS RELATING TO PATENT AND OTHERINTELLECTUAL PROPERTY RIGHTS AND WE MAY BE UNABLE TO PROTECT OUR RIGHTS TO, ORUSE, OUR TECHNOLOGY.**

If we choose to go to court to stop someone else fromusing the inventions claimed in our licensed patents, that individual orcompany has the right to ask the court to rule that these patents are invalidand/or should not be enforced against that third party. These lawsuits areexpensive and would consume time and other resources even if we were successfulin stopping the infringement of these patents. In addition, there is a riskthat the court will decide that these patents are not valid and that we do nothave the right to stop the other party from using the inventions. There is alsothe risk that, even if the validity of these patents is upheld, the court willrefuse to stop the other party on the ground that such other party’s activitiesdo not infringe our rights to these patents.

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Furthermore, a third party may claim that we are usinginventions covered by the third party’s patent rights and may go to court tostop us from engaging in our normal operations and activities, including makingor selling our product candidates. These lawsuits are costly and could affectour results of operations and divert the attention of managerial and technicalpersonnel. There is a risk that a court would decide that we are infringing thethird party’s patents and would order us to stop the activities covered by thepatents. In addition, there is a risk that a court will order us to pay theother party damages for having violated the other party’s patents. Thebiotechnology industry has produced a proliferation of patents, and it is notalways clear to industry participants, including us, which patents covervarious types of products or methods of use. The coverage of patents is subjectto interpretation by the courts, and the interpretation is not always uniform.If we are sued for patent infringement, we would need to demonstrate that ourproducts or methods of use either do not infringe the patent claims of therelevant patent and/or that the patent claims are invalid, and we may not beable to do this. Proving invalidity, in particular, is difficult since itrequires a showing of clear and convincing evidence to overcome the presumptionof validity enjoyed by issued patents.

Because some patent applications in the United Statesof America may be maintained in secrecy until the patents are issued, becausepatent applications in the United States of America and many foreignjurisdictions are typically not published until eighteen months after filing,and because publications in the scientific literature often lag behind actualdiscoveries, we cannot be certain that others have not filed patentapplications for technology covered by our licensors’ issued patents or ourpending applications or our licensors’ pending applications or that we or ourlicensors were the first to invent the technology. Our competitors may havefiled, and may in the future file, patent applications covering technologysimilar to ours. Any such patent application may have priority over our or ourlicensors’ patent applications and could further require us to obtain rights toissued patents covering such technologies. If another party has filed a UnitedStates patent application on inventions similar to ours, we may have toparticipate in an interference proceeding declared by the United States Patentand Trademark Office to determine priority of invention in the United States.The costs of these proceedings could be substantial, and it is possible thatsuch efforts would be unsuccessful, resulting in a loss of our United Statespatent position with respect to such inventions.

Some of our competitors may be able to sustain thecosts of complex patent litigation more effectively than we can because theyhave substantially greater resources. In addition, any uncertainties resultingfrom the initiation and continuation of any litigation could have a materialadverse effect on our ability to raise the funds necessary to continue ouroperations.

**RISKS RELATED TO OUR COMMON STOCK**

**MARKET VOLATILITY MAY AFFECT OURSTOCK PRICE AND THE VALUE OF YOUR INVESTMENT.**

The market prices for securities of biopharmaceuticalcompanies in general have been highly volatile and may continue to be highlyvolatile in the future. The following factors, in addition to other riskfactors described in this section, may have a significant impact on the marketprice of our common stock:

·                  announcementsof technological innovations or new products by us or our competitors;

·                  announcementof FDA approval or non-approval of our product candidates or delays in the FDAreview process;

·                  actionstaken by regulatory agencies with respect to our product candidates, clinicaltrials, manufacturing process or sales and marketing activities;

·                  regulatorydevelopments in the United States of America and foreign countries;

·                  thesuccess of our development efforts and clinical trials;

·                  thesuccess of our efforts to acquire or in-license additional products or productcandidates;

·                  anyintellectual property infringement action, or any other litigation, involvingus;

·                  announcementsconcerning our competitors, or the biotechnology or biopharmaceuticalindustries in general;

·                  actualor anticipated fluctuations in our operating results;

·                  changesin financial estimates or recommendations by securities analysts;

·                  ourability to maintain listing requirements on the American Stock Exchange;

·                  salesof large blocks of our common stock;

·                  salesof our common stock by our executive officers, directors and significantstockholders; and

·                  the loss of anyof our key scientific or management personnel.

The occurrence of one or more of these factors maycause our stock price to decline, and investors may not be able to resell theirshares at or above the price that they paid for the shares. In addition, thestock markets in general, and the markets for biotechnology andbiopharmaceutical stocks in particular, have experienced extreme volatilitythat has often been unrelated to the operating performance of particularcompanies. These broad market fluctuations may adversely affect the tradingprice of our common stock.

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**THE LIQUIDITY OF YOUR STOCK DEPENDSIN PART ON CONTINUED LISTING OF OUR SHARES OF COMMON STOCK ON THE AMERICANSTOCK EXCHANGE.**

On October 3,2006, we received notice (the “Deficiency Letter”) from the staff of theAmerican Stock Exchange (the “Exchange”) indicating that we are not  in compliance with certain continued listingstandards, specifically, Section 1003(a)(i) of the Company Guide withshareholders’ equity of less than $2,000,000 and losses from continuingoperations and/or net losses in two of our three most recent fiscal years andSection 1003(a)(iv) of the Company Guide in that we have sustained losseswhich are so substantial in relation to our overall operations or our existingfinancial resources, or our financial condition has become so impaired that itappears questionable, in the opinion of the Exchange, as to whether we will beable to continue operations and/or meet our obligations as they mature.

On November 2,2006 we submitted a plan advising the American Stock Exchange of theactions  we have taken, or will take,that would bring us into compliance with Section 1003(a)(iv) of theCompany Guide by April 3, 2007 and with Section 1003(a)(i) of the CompanyGuide by April 3, 2008 . The plan was approved on January 24, 2007.We will continue to maintain our listing during the plan period of up to 18 months,during which time we will be subject to periodic review to determine if we aremaking progress consistent with the plan. If we are not in compliance with thecontinued listing standards at the end of the plan period, or we do not makeprogress consistent with the plan during the plan period, the American StockExchange  staff may initiate delistingproceedings. There is no guarantee that we will be able to make progressconsistent with the plan. While the plan is under periodic review by the AmericanStock Exchange, we expect that our common stock will continue to trade withoutinterruption on the American Stock Exchange. If we are delisted by the AmericanStock Exchange you may experience difficulty in trading your shares of ourcommon stock.

**WE HAVEIDENTIFIED MATERIAL WEAKNESSES IN OUR DISCLOSURE CONTROLS AND PROCEDURES. INADDITION, WE MAY EXPERIENCE ADDITIONAL MATERIAL WEAKNESSES IN THE FUTURE. ANYMATERIAL WEAKNESSES IN OUR DISCLOSURE CONTROLS AND PROCEDURES OR OUR FAILURE TOREMEDIATE SUCH MATERIAL WEAKNESSES COULD RESULT IN A MATERIAL MISSTATEMENT INOUR FINANCIAL STATEMENTS NOT BEING PREVENTED OR DETECTED AND COULD AFFECTINVESTOR CONFIDENCE IN THE ACCURACY AND COMPLETENESS OF OUR FINANCIALSTATEMENTS, AS WELL AS OUR STOCK PRICE.**

We have identifiedmaterial weaknesses in our disclosure controls and procedures relating to ourlack of sufficient internal accounting personnel and segregation of dutiesnecessary to ensure that adequate review of our financial statements and notesthereto is performed. These material weaknesses and our remediation plans aredescribed further in ITEM 9A “CONTROLS AND PROCEDURES” of this report. Materialweaknesses in our disclosure controls and procedures could result in materialmisstatements in our financial statements not being prevented or detected. Wemay experience difficulties or delays in completing remediation or may not beable to successfully remediate material weaknesses at all. Any materialweakness or unsuccessful remediation could affect investor confidence in theaccuracy and completeness of our financial statements, which in turn could harmour business and have an adverse effect on our stock price and our ability toraise additional funds.

**WE ARE AT RISK OF SECURITIES CLASSACTION LITIGATION.**

In the past, securities class action litigation hasoften been brought against a company following a decline in the market price ofits securities. This risk is especially relevant for us because biotechnologyand biopharmaceutical companies have experienced significant stock pricevolatility in recent years. If we faced such litigation, it could result insubstantial costs and a diversion of management’s attention and resources,which could harm our business.

**WE HAVE NOT PAID CASH DIVIDENDS INTHE PAST AND DO NOT EXPECT TO PAY CASH DIVIDENDS IN THE FUTURE. ANY RETURN ONINVESTMENT MAY BE LIMITED TO THE VALUE OF OUR STOCK.**

We have never paid cash dividends on our stock and donot anticipate paying cash dividends on our stock in the foreseeable future.The payment of cash dividends on our stock will depend on our earnings,financial condition and other business and economic factors affecting us atsuch time as the board of directors may consider relevant. If we do not paycash dividends, our stock may be less valuable because a return on yourinvestment will only occur if our stock price appreciates.

**ITEM 1B. UNRESOLVED STAFF COMMENTS.**

None

**ITEM 2. PROPERTIES.**

We currently lease 3,886 square feet of office spacelocated at 420 Lexington Avenue, Suite 1609, New York, New York through June30, 2011. This facility contains our executive and administrative headquarters.

We believe our existing facilities are wellmaintained, in good operating condition, and that our existing and plannedfacilities will be adequate to support our operations for the foreseeablefuture.

**ITEM 3. LEGAL PROCEEDINGS.**

On November 2, 2006, Trilogy Capital Partners, Inc.filed suit against us in Superior Court of the State of California, County ofLos Angeles, Central District, alleging that we breached a Letter of Engagementdated July 18, 2005 between us and Trilogy by failing to pay certain fees.  Additionally, Trilogy alleges that webreached a consulting agreement dated January 1, 2006 between us and MBAHoldings, LLC (later assigned to Trilogy) by failing to pay certain consultingfees.  Trilogy is seeking payment in theaggregate amount of $94,027.55 plus interest and attorneys fees.  On December 27, 2006, we filed an answer tothe Trilogy complaint denying the allegations in the Trilogy complaint and Onthe same date, we filed a cross-complaint against Trilogy in Superior Court ofthe State of California, County of Los Angeles, Central District, alleging,among other things, that Trilogy breached the Letter of Engagement with us byfailing to provide the agreed-upon services and fraudulently induced us toenter into the Letter of Engagement by misrepresenting its capabilities. We are asking

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for unspecified damages plus attorneys’ fees.  On January 23, 2007, Trilogy answered ourcross-complaint denying all of the allegations. The court has ordered theparties to mediation to be completed by November 20, 2007.

On December 21, 2006, we filed a complaint againstTapestry Pharmaceuticals, Inc., Leonard P. Shaykin and Kai P. Larson in theSupreme Court of the State of New York alleging that Tapestry used informationthey obtained pursuant to a confidential disclosure agreement between us andTapestry to cause Donald Picker, Ph.D., our former Executive Vice President,Research & Development, to resign and accept a position with Tapestry.  In addition, we are alleging that Tapestryfraudulently entered into the confidential disclosure agreement with us andintentionally interfered with Dr. Picker’s employment agreement with us.  We are seeking actual and punitive damages.As of April 9, 2007 the discovery process is ongoing and the defendants havefiled a motion to dismiss the complaint against Messrs. Shaykin and Larsen.

We are not a party to any other pending legalproceedings.

**ITEM 4. SUBMISSION OF MATTERS TO AVOTE OF SECURITY HOLDERS.**

On May 18, 2006, we held a Special Meeting ofStockholders and we disclosed the results of the matter voted on in ourQuarterly Report on Form 10-Q filed on August 14, 2006.  Our Annual Meeting of Stockholders was heldon October 12, 2006 and we disclosed the results of the matters voted on in ourQuarterly Report on Form 10-Q filed on November 20, 2006.  At a Special Meeting of Stockholders on March2, 2007, two matters were voted upon.  Adescription of each matter and a tabulation of the votes for each of thematters follow:

1.   Proposal toapprove the potential issuance of up to 17,448,427 shares of our common stock(issuable upon the conversion of 614,125 shares of Series A ConvertiblePreferred Stock and the exercise of 9,260,094 common stock purchasewarrants)  at a price below fair marketvalue issued in connection with a private placement conducted October2006-January 2007.

| Votes      | ** ** |
|------------|------------|
| **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** |
| 17,271,006 |       | 356,278 |   | 8,965,182 |   |

 

2.  Proposal to amend our Certificate ofIncorporation, as amended, to increase the number of authorized shares ofcommon stock, par value $.0001 per share, from 100,000,000 shares to150,000,000 shares

| Votes      | ** ** |
|------------|------------|
| **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** |
| 26,050,328 |       | 517,912 |   | 37,592 |   |

 

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# **PART II**

**ITEM 5. MARKET FOR THE REGISTRANT’SCOMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITYSECURITIES.**

**MARKET INFORMATION**

Our common stock has been quoted on the American StockExchange under the symbol “KAL” since October 25, 2004. The following tableshows the reported high and low closing prices per share for our common stockas reported on the American Stock Exchange.
| 2006           | ** ** | **HIGH** | ** ** | **LOW** | ** ** |
|----------------|------------|----------|------------|---------|------------|
|           |       |     |       |    |       |
| Fourth Quarter |       | $        | 0.97       |    | $          | 0.71 |   |
|           |       |     |       |    |       |
| Third Quarter  |       | 1.25     |       | 0.81    |       |
|           |       |     |       |    |       |
| Second Quarter |       | 1.54     |       | 1.16    |       |
|           |       |     |       |    |       |
| First Quarter  |       | 1.70     |       | 1.34    |       |
|                |            |          |            |         |            |  |  |

 
| 2005           | ** ** | **HIGH** | ** ** | **LOW** | ** ** |
|----------------|------------|----------|------------|---------|------------|
|           |       |     |       |    |       |
| Fourth Quarter |       | $        | 1.53       |    | $          | 1.01 |   |
|           |       |     |       |    |       |
| Third Quarter  |       | 1.42     |       | 0.97    |       |
|           |       |     |       |    |       |
| Second Quarter |       | 1.50     |       | 0.95    |       |
|           |       |     |       |    |       |
| First Quarter  |       | 1.98     |       | 1.30    |       |
|                |            |          |            |         |            |  |  |

 

**NUMBER OF STOCKHOLDERS**

As of March 30, 2007, we had 145 holders of record ofour common stock.

**DIVIDEND POLICY**

Historically, we have not declared paid any cashdividends to the holders of our common stock and we do not expect to pay anysuch dividends in the foreseeable future as we expect to retain our futureearnings for use in the operation and expansion of our business.

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**EQUITY COMPENSATION PLAN INFORMATION**

The following table summarizes information about ourequity compensation plans as of December 31, 2006.
|                                   | ** ** | ** **                                      | ** ** | ** **                         | ** ** | **Number of Options**             | ** ** |
|-----------------------------------|------------|-------------------------------------------------|------------|------------------------------------|------------|---------------------------------------------|------------|
| ** **                        | ** ** | **Number of**                              | ** ** | ** **                         | ** ** | **Remaining Available for**       | ** ** |
| ** **                        | ** ** | **Shares of Common**                  | ** ** | ** **                         | ** ** | **Future Issuance Under**         | ** ** |
| ** **                        | ** ** | **Stock to be Issued upon** | ** ** | **Weighted-Average Exercise** | ** ** | **Equity Compensation Plans**     | ** ** |
| ** **                        | ** ** | **Exercise of Outstanding**           | ** ** | **Price of Outstanding** | ** ** | **(excluding securities**              | ** ** |
| ** **                        | ** ** | **Options and warrants**              | ** ** | **Options and warrants** | ** ** | **reflected in column (a))** | ** ** |
| **Plan Category**            | ** ** | **(a)**                                         | ** ** | **(b)**                            | ** ** | **(c)**                                     | ** ** |
|                              |       |                                            |       |                               |       |                                        |       |
| Equity Compensation Plans         |       |                                            |       |                               |       |                                        |       |
| Approved by Stockholders          |       | 5,701,042                                       |       | $                                  | 1.76       |                                        | 5,044,000  |   |
|                              |       |                                            |       |                               |       |                                        |       |
| Equity Compensation Plans         |       |                                            |       |                               |       |                                        |       |
| Not Approved by Stockholders  (1) |       | 18,193,487                                      |       | $                                  | 1.05       |                                        | —     |   |
|                              |       |                                            |       |                               |       |                                        |       |
| Total                             |       | 23,894,529                                      |       | $                                  | 1.22       |                                        | 5,044,000  |   |

 

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| (1) | Consists of  2,352,333 stock options not subject to any of our stock option plans and  15,841,154 warrants. These non-plan stock options and warrants have been  primarily issued in conjunction with our private placements of common stock  and consulting services agreements as discussed in Notes 5, 6 and 8 to our  consolidated financial statements. |
|-----|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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**ITEM 6. SELECTED FINANCIAL DATA**

The following selected consolidated financial datashould be read in conjunction with our consolidated financial statements andrelated notes and “Management’s Discussion and Analysis of Financial Conditionand Results of Operations” included elsewhere in this Annual Report on Form10-K. The statements of operations data for the twelve months ended December31, 2006, 2005 and 2004 and the balance sheet data at December 31, 2006 and2005 are derived from our audited financial statements which are includedelsewhere in this Form 10-K. The statement of operations data for the yearsended December 31, 2003 and 2002 and the balance sheet data at December 31,2004, 2003 and 2002 are derived from our audited financial statements which arenot included in this Form 10-K. Our historical results are not necessarilyindicative of results to be expected for future periods. The followinginformation is presented in thousands, except per share data.
| ** **                                                                     | ** ** | **For the Twelve Months Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                                                     | ** ** | **2006**                                                                   | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Consolidated Statements of  Operations Data:**                               |       |                                                                       |       |   |   |   |   |   |   |   |   |
| Revenues                                                                       |       | $                                                                          | -0-        |   | $ | -0- |   | $ | -0- |   | $ | -0- |   | $ | -0- |   |
| Operating expenses:                                                            |       |                                                                       |       |   |   |   |   |   |   |   |   |
| Research and  development                                                      |       | 6,032                                                                      |       | 6,431 |   | 4,325 |   | 1,804 |   | 491 |   |
| Government grant                                                               |       | (353                                                                       | )          | (226 | ) | (266 | ) | — |   | — |   |
| Purchased in process  research and development                                 |       | —                                                                     |       | — |   | 210 |   | 6,735 |   | — |   |
| General and  administrative                                                    |       | 5,113                                                                      |       | 4,968 |   | 3,568 |   | 1,611 |   | 1,228 |   |
| Stock-based compensation  - non-employees                                      |       | 1,374                                                                      |       | 889 |   | 20 |   | 3,187 |   | — |   |
| Loss from  operations                                                     |       | (12,166                                                                    | )          | (12,062 | ) | (7,857 | ) | (13,337 | ) | (1,719 | ) |
| Other income (expense)                                                         |       | (802                                                                       | )          | 177 |   | 229 |   | 222 |   | — |   |
| Interest and investment  income                                                |       | 49                                                                         |       | 105 |   | 84 |   | 9 |   | 34 |   |
| Net loss                                                                       |       | (12,919                                                                    | )          | (11,780 | ) | (7,544 | ) | (13,106 | ) | (1,685 | ) |
| Preferred stock  beneficial conversion feature accreted as a dividend          |       | (2,385                                                                     | )          | — |   | — |   | — |   | — |   |
| Net loss available to  common stockholders                                     |       | $                                                                          | (15,304    | ) | $ | (11,780 | ) | $ | (7,544 | ) | $ | (13,106 | ) | $ | (1,685 | ) |
|                                                                           |       |                                                                       |       |   |   |   |   |   |   |   |   |
| Net loss per common  share — basic and diluted                       |       | $                                                                          | (0.40      | ) | $ | (0.37 | ) | $ | (0.26 | ) | $ | (0.61 | ) | $ | (0.10 | ) |
| Weighted average number of common shares outstanding — basic and  diluted |       | 37,941                                                                     |       | 31,527 |   | 28,485 |   | 21,358 |   | 17,319 |   |

 
| ** **                                    | ** ** | **As of December 31,** | ** ** |
|-----------------------------------------------|------------|---------------------------------------|------------|
| ** **                                    | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| Consolidated Balance  Sheet Data:             |       |                                  |       |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents                    |       | $                                     | 3,904      |   | $ | 1,421 |   | $ | 5,323 |   | $ | 3,956 |   | $ | 2,223 |   |
| Total assets                                  |       | 4,051                                 |       | 1,684 |   | 5,470 |   | 4,119 |   | 2,272 |   |
| Total current  liabilities                    |       | 3,201                                 |       | 2,017 |   | 1,220 |   | 1,264 |   | 440 |   |
| Accumulated deficit  during development stage |       | (60,444                               | )          | (45,141 | ) | (33,361 | ) | (25,818 | ) | (12,711 | ) |
| Total stockholders’ equity (deficit)     |       | $                                     | 850        |   | $ | (333 | ) | $ | 4,249 |   | $ | 2,855 |   | $ | 1,829 |   |

 

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**ITEM 7. MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

The following discussion should be read in conjunctionwith our financial statements and other financial information appearingelsewhere in this Annual Report. In addition to historical information, thefollowing discussion and other parts of this Annual Report containforward-looking information that involves risks and uncertainties.

**OVERVIEW**

We are a development stage biopharmaceutical company,whose primary focus is on biopharmaceutical product development. Sinceinception in June 1996 our efforts have been principally devoted to researchand development, securing patent protection, obtaining corporate relationshipsand raising capital. Since inception through December 31, 2006, we havesustained net losses of $58,059,883. Our losses have resulted primarily from expendituresin connection with our clinical development of licensed products, the purchaseof in-process research and development, stock based compensation expense,patent filing and maintenance, outside accounting and legal services andregulatory consulting fees.

From inception through December 31, 2006 we have notgenerated any revenue from operations. We expect to incur substantial andincreasing losses for the next several years as we develop our productcandidates, expand our clinical development team and prepare for the commerciallaunch of our product candidates. We do not currently have any commercialbiopharmaceutical products, and do not expect to have such for several years,if at all.

Our research and development expenses consistprimarily of costs associated with clinical development team salaries and staffcosts, application and filing for regulatory approval of our proposed products,regulatory and scientific consulting fees, clinical and patient costs forproduct candidates in on-going trials, sponsored pre-clinical research, royaltypayments as well as legal and professional fees associated with filing andmaintaining our patent and license rights to our proposed products. We expenseall research and development costs as they are incurred. We expect our researchand development expenses to increase significantly in the future as we developour product candidates.

Our general and administrative expenses primarilyinclude personnel and related costs, rent and professional accounting andcorporate legal fees. We expect our general and administrative expenses toincrease significantly over the next few years as we continue to build ouroperations to support our product candidates and as we incur costs associatedwith being a publicly traded company.

**HISTORY**

In March 2002, Callisto Pharmaceuticals, Inc. (“OldCallisto”), a non-public company, purchased 99.7% of the outstanding commonshares of Webtronics, Inc., a public company (“Webtronics”), for $400,000.Webtronics was incorporated in Florida on February 2, 2001 and had limitedoperations during the year ended December 31, 2002. On April 30, 2003, pursuantto an Agreement and Plan of Merger dated March 10, 2003, as amended April 4,2003, Synergy Acquisition Corp., a wholly-owned subsidiary of Webtronics mergedinto Synergy Pharmaceuticals Inc. (“Synergy”) and Callisto Acquisition Corp., awholly-owned subsidiary of Webtronics merged into Old Callisto (collectively,the “Merger”). As a result of the Merger, Old Callisto and Synergy becamewholly-owned subsidiaries of Webtronics. Old Callisto changed its name toCallisto Research Labs, LLC and Webtronics changed its name to CallistoPharmaceuticals, Inc. and changed its state of incorporation from Florida toDelaware.

**PLANOF OPERATIONS**

Our plan of operationsfor the next twelve months is to focus primarily on the clinical development ofour two drugs, Atiprimod and L-Annamycin, to treat neuroendocrine carcinomas(including advanced carcinoid cancer), adult and pediatric acute leukemia (adisease of the white blood cells) and multiple myeloma (an incurable bloodcancer that invades and proliferates in bone marrow).

Our lead drugcandidate, Atiprimod, is an orally administered drug with antiproliferative andantiangiogenic activity. We are presently enrolling patients in twoclinical trials in low to intermediate grade neuroendocrine cancer and relapsedor refractory multiple myeloma at a number of clinical sites in the U.S. On November 7, 2006, we announced the initiation of a multi-center open-label Phase IIclinical trial of Atiprimod in low- to intermediate-grade neuroendocrinecancers, including advanced carcinoid cancer patients. This trial is based onearlier encouraging clinical results from an ongoing trial of Atiprimod inadvanced cancer patients that showed stable disease and disease-related symptomrelief in patients with advanced carcinoid cancer.  Atiprimod is also in a multi-center,dose-escalation Phase I/IIa clinical trial in relapsed or refractory multiplemyeloma patients.  In December 2005, we announced interim results fromthis trial on 15 patients treated with Atiprimod, including3 patients at the highest dose level of 180 mg/day. Two patientsexhibited stable disease, with one patient having a 34% decrease in M protein(measure of tumor burden) over 3 months of treatment. In 2006, we amended theprotocol to continue the trial at higher dose levels and currently have thistrial underway at clinical sites in the U.S.

Our second leaddrug candidate, L-Annamycin, earlier completed an initial Phase I/IIa clinicaltrial in relapsed or refractory leukemia patients with a prior sponsor.L-Annamycin is a novel compound from the anthracycline family of provenanti-cancer drugs, which has a

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novel therapeuticprofile, including activity against drug resistant tumors and significantlyreduced cardiotoxicity, or damage to the heart. L-Annamycin was in-licensed byCallisto in October, 2004 and is presently in two clinical trials: 1) a PhaseI/IIa clinical trial in adult relapsed or refractory acute lymphocytic leukemia(ALL) patients at three clinical sites in the U.S.; and 2) a Phase I clinicaltrial in children and young adults with relapsed or refractory ALL or AML.

**ATIPRIMOD TO TREAT ADVANCED CARCINOIDCANCER PATIENTS AND MULTIPLE MYELOMA**

On August 28, 2002, our wholly-owned subsidiary,Synergy, entered into a worldwide license agreement with AnorMED Inc. (“AnorMED”),a Canadian corporation, to research, develop, sell and commercially exploit theAtiprimod (SKF 106615) patent rights.

Atiprimod is one of a class of compounds known asazaspiranes and was originally developed as a potential treatment forrheumatoid arthritis based on encouraging data from a number of animal modelsof arthritis and autoimmune indications. The development of this drug originatedwith a partnership between AnorMED and SmithKline Beecham (“SKB”) that led tothe successful filing of an investigational new drug application, or IND, andcompletion of three Phase I clinical trials involving a total of 63 patients.The drug successfully completed both single and multiple dose Phase I clinicaltrials in patients with rheumatoid arthritis. Both trials evaluated the safetyand pharmacokinetics (how the body takes up and eliminates drugs) of Atiprimodand showed that the drug is well tolerated. In the third Phase I clinicaltrial, the drug was found to be well tolerated in an open label extension studyperformed with 43 patients from the first two studies, with patients on thedrug for as long as one year.

**PRECLINICAL STUDIES**

Atiprimod’s specific ability to lower the level of keygrowth factors, known to play an important role in the development of multiplemyeloma, is the basis for its potential use as a drug to treat this disease.Atiprimod was previously shown to inhibit the production of thepro-inflammatory mediators IL-6 and TNF (alpha) in a number of animal models ofinflammation and autoimmune disease. Atiprimod was also demonstrated using invitro models of tumor cell growth to inhibit proliferation of a number of humanmultiple myeloma cell lines. Characterization of the mechanism of Atiprimod’santiproliferative activity in a series of experiments showed that the drugworks by inducing apoptosis (programmed cell death) in myeloma cells. In asecond series of experiments performed with Atiprimod on co-cultures composedof multiple myeloma cells plus bone marrow stromal cells (used to simulate thehuman disease), the drug was found to have a profound effect on secretion ofthe angiogenic (blood vessel related) growth factor VEGF. A separate set ofexperiments also suggest an additional explanation for the disease-modifyingactivity of Atiprimod originally observed in chemically-induced arthritic-ratanimal studies, and provide a further rationale for the application of thisdrug to treat multiple myeloma. Using a bone resorption assay (bone degradationexperiment) to measure the effect of drug on osteoclast-mediated boneresorption, Atiprimod demonstrated a profound effect on osteoclast, or whiteblood cell, function. The drug appears to be selectively toxic for activatedosteoclasts, displaying a negligible effect on bone marrow stromal cells.

**COMPLETED CLINICAL STUDIES**

Atiprimod successfully completed single and multipledose Phase I clinical trials in patients with rheumatoid arthritis (RA). In theinitial Phase I study, 28 patients were given single escalating doses of drug(0.002 - 1.0 mg/kg), with a 4-month follow-up. Atiprimod was well tolerated,displaying no clinically relevant changes in any laboratory parameters. Inparticular, liver function tests remained in the normal range. The second PhaseI study involved a 28-day multiple-dose-rising study in 35 RA patients. Thestudy evaluated the effect of food on bioavailability, or the concentration ofdrug in the body, as well as the safety and pharmacokinetics of repeat dosing.Dosages included 0.1, 1.0, 5.0, and 10 mg/day plus a 14-day cohort at 30mg/day, with 4-month follow-up. All doses were well tolerated and clinicaltests were unremarkable. Significantly, reductions in tender and swollen jointcounts were noted in a number of subjects during the course of the dosingperiod. Individuals from the two Phase I safety studies were also involved in aPhase I open-label extension trial at 5 mg/day dosage. Forty-three patients enteredthe study and remained on the drug as long as 12 months. Clinical laboratoryresults for all patients were unremarkable, in particular liver enzyme levelsremained within the normal range in all patients throughout the study period.

**DEVELOPMENT STRATEGY**

Atiprimod commenced a Phase I/IIa clinical trial inrelapsed or refractory multiple myeloma patients on May 26, 2004. These arepatients that have a re-occurrence of active disease, and no longer respond toapproved therapies. The Phase I/IIa clinical trial is an open label study, withthe primary objective of assessing safety of drug and identifying the maximumtolerated dose. The secondary objectives are to measure the pharmacokinetics,evaluate the response in patients with refractory disease and to identifypossible surrogate responses to the drug to better determine the mechanism ofdrug action.  In December 2005, weannounced interim results from this trial performed in relapsed or refractorymultiple myeloma patients which consisted of 15 patients treated withAtiprimod, including 3 patients at the highest dose level of 180 mg/day. Twopatients exhibited stable disease, with one patient having a 34% decrease in Mprotein (measure of tumor burden) over 3 months of treatment. It was also notedthat two patients reported a subjective decrease in bone pain.  In 2006, we amended the protocol to continuethe trial at higher dose levels and currently have this trial open at 4clinical sites in the U.S.

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On March 15, 2005, we announced a second Phase I/IIaclinical trial of Atiprimod in advanced cancer patients. The trial is entitled:“An Open Label Study of the Safety and Efficacy of Atiprimod Treatment forPatients with Advanced Cancer”.  Theprimary objective is to assess the safety and determine the maximum tolerateddose of Atiprimod in advanced cancer patients. The secondary objectives are tomeasure the pharmacokinetics of Atiprimod and evaluate the response in avariety of relapsed solid tumors and hematological malignancies. This study wasconducted at the University of Texas M.D. Anderson Cancer Center, and wasclosed to enrollment in November, 2006.

OnNovember 7, 2006, we announced the initiation of a multi-center, open-labelPhase II clinical trial of Atiprimod in low to intermediate grade neuroendocrinecarcinomas, including advanced carcinoid cancer patients. This trial is basedon encouraging clinical results from the Phase I clinical trial in advancedcancer patients that showed stable disease and a reduction in disease-relatedsymptoms in patients with advanced carcinoid cancer.  The first study site to enter the trial wasthe Hematology Oncology Services of Arkansas in Little Rock, Arkansas.  On January 31, 2007 we announced the openingof a second site for this trial – the Dana-Farber Cancer Institute in Boston,MA.  Subjects will also be seen at thefollowing facilities: Brigham and Women’s Hospital, Massachusetts GeneralHospital and Beth Israel Deaconess Medical Center. On March 12, 2007 weannounced the opening of the third site for this trial – The Physician Officesat Mount Sinai Medical Center, NY

Theprimary objective of the Phase II clinical trial is to evaluate efficacy ofAtiprimod in patients with low to intermediate grade neuroendocrine carcinomawho have metastatic or unresectable cancer and who have either symptoms,despite standard therapy (octreotide), or progression of neuroendocrine tumors.Patients, after signing an informed consent, are required to complete two weeksof a symptoms diary to establish their symptoms baseline before commencingAtiprimod dosing. A maximum of 40 evaluable patients will be enrolled in thistrial. Efficacy evaluations will include the measure of target lesions (perRECIST), and the quantization of symptom relief.

**MANUFACTURING OF ATIPRIMOD**

A practical, efficient and cost effective method forproducing Atiprimod on a commercial scale was originally developed by SKB. Inthe course of this work, a new dimaleate salt form was developed. A portion ofthe 7 kilos of Atiprimod drug substance, available from SKB, was used as thesource for generating the Atiprimod dimaleate drug product presently being usedin the Phase I/IIa clinical study. Several lots of drug substance werere-qualified to meet current FDA approved release specifications. The fullpackage of fully validated analytical methods developed by SKB was transferredto a contract research organization used by us to perform all analytical tests.One large-scale GMP production run of Atiprimod dimaleate led to the successfulrelease of 10 Kg of material available for future Phase II clinical studies. Weplan to enter into a supply contract for Atiprimod with a commercial supplierby the end of 2007 or after confirming activity of the drug candidate in ourcurrent human clinical trials.

**L-ANNAMYCIN TO TREAT RELAPSED ACUTELEUKEMIA**

On August 12, 2004 we entered into a worldwideexclusive license agreement with The University of Texas M.D. Anderson CancerCenter to develop and commercially exploit the L-Annamycin patent rights.L-Annamycin, an anthracycline drug for leukemia therapy, has a noveltherapeutic profile, including activity against drug resistant tumors andsignificantly reduced toxicity.

**PRECLINICAL STUDIES**

Nonclinical studies have shown that Annamycindelivered as a liposomal preparation (L-Annamycin) is effective against severaldifferent in vivo tumor models (animal experiments), including human tumorswhich are resistant to other chemotherapy drugs, grafted into animals.Additionally, results from in vitro studies (cell culture experiments) indicatethat L-Annamycin and free Annamycin were able to partially overcome tumorresistance to chemotherapy drugs in several tumor cell lines that wereresistant to other drugs such as doxorubicin. In nonclinical toxicity studies,myelosuppression (suppression of the body’s immune response) was noted in miceat a single intravenous dose of 15.7 mg/kg L-Annamycin. With weekly intravenousdoses of 5.2 mg/kg L-Annamycin for 6 weeks, or 3.1 and 4.2 mg/kg L-Annamycinfor 10 weeks in mice, the cardiotoxicity (toxicity to heart tissue) ofL-Annamycin was substantially less than an equivalent dose of doxorubicin. Indogs, a single 15-minute intravenous infusion of up to 1.42 mg/kg L-Annamycinwas well tolerated, with no clinically significant adverse effects, hematologicalor chemical changes, or pathological changes.

**COMPLETED CLINICAL STUDIES**

L-Annamycin was evaluated previously by AronexPharmaceuticals, Inc. in 3 clinical trials: 1) a Phase I clinical trial in 36patients with relapsed solid tumors, 2) a Phase II clinical trial in 13patients with doxorubicin-resistant breast cancer, and 3) a Phase I/IIa trialin 20 patients with relapsed/refractory AML and ALL. In the initial Phase Istudy, L-Annamycin was administered by a single 1- to 2-h intravenous infusion at3-week intervals. Thirty-six patients with relapsed solid tumors were treatedand 109 treatment courses were administered at doses ranging from 3 to 240mg/m2. No cardiotoxicity was seen on biopsy of heart tissue of four patientsstudied. The maximum tolerated dose (MTD) for L-Annamycin in solid tumorpatients was found to be 190 mg/m2. A second Phase II study of L-

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Annamycin was performed in 13 women withdoxorubicin-resistant breast cancer. The median number of prior chemotherapyregimes was two, and six patients had two or more organ sites of involvement.L-Annamycin was administered at 190-250 mg/m2 as a single i.v. infusion over1-2 h every 3 weeks. Of the 13 patients, 12 had clear deterioration and newtumor growth after one or two courses.

The potential of a less cardiotoxic drug that wasactive against multi-drug resistant tumors led to a third trial in relapsedleukemia patients (both AML and ALL). The trial involved 20 patients withrelapsed/refractory AML (n=17) or ALL (n=3). The conclusions drawn from thetrial were that L-Annamycin was safe, well tolerated and showed potentialclinical activity in patients with acute leukemias, and that further evaluationof this novel anthracycline in patients with hematopoietic, or blood borne,malignancies was clearly warranted**.**

**DEVELOPMENT STRATEGY**

We began a Phase I clinical trial at The University ofTexas M.D. Anderson Cancer Center in adult relapsed or refractory acutelymphocytic leukemia (ALL) patients on December 1, 2005.****Additionalsites enrolled in this study include the Roswell Park Cancer Institute(Buffalo, NY) and the Montefiore Medical Center (New York, NY). The single-arm,open-label L-Annamycin trial is designed to enroll patients in a doseescalation Phase I portion followed by 10 patients at a final fixed dose in thePhase II portion once the maximum tolerated dose (MTD) is determined.  Up to 34 adult patients can be treated inthis single-arm trial.

On February 22, 2007, we announced the opening of aPhase I clinical trial of L-Annamycin in pediatric relapsed or refractory ALLor AML****patients. The trial is presently openat two sites in the U.S., Phoenix Children’s Hospital, Phoenix, AZ, and theUniversity of Arizona, Tucson, AZ.

**MANUFACTURING OF ANNAMYCIN**

An improved manufacturing method for Annamycin hasbeen developed at Antibioticos S.p.A., our commercial supplier of GMP (“GoodManufacturing Practice”) drug substance. GMP material is currently beingproduced in sufficient quantity for all three anticipated trials outlined inthe development strategy section. The analytical methods developed previouslyhave been successfully transferred, and are in the process of being validatedby Quantitative Technologies, Inc., our analytical contract researchorganization, or CRO, for Annamycin development work. The final lyophilized GMPformulated drug product is being manufactured by Pharmaceutical Services, Inc.,who previously produced final product for the earlier clinical trials.Currently, Antibioticos S.p.A. is our sole supplier of Annamycin for ourclinical trials. Our agreement with Antibioticos provides that Antibioticoswill provide 400 grams of GMP drug substance (Annamycin) for our L-Annamycinclinical trials. Upon the conclusion of our Phase IIb clinical trials, theagreement provides that the parties will negotiate in good faith towards acommercial supply agreement for Annamycin.

**ORPHAN DRUG STATUS OF ATIPRIMOD ANDL-ANNAMYCIN**

On January 6, 2004, we announced that the Office ofOrphan Products Development of the FDA granted orphan drug designation toAtiprimod for the treatment of multiple myeloma.  On September 26, 2006, we announced that theOffice of Orphan Products Development of the FDA granted orphan drugdesignation to Atiprimod for the treatment of carcinoid tumors.   On June 24, 2005, we announced that theOffice of Orphan Products Development of the FDA granted orphan drugdesignation to L-Annamycin for the treatment of acute lymphoblastic leukemia.On June 28, 2005, we announced that the Office of Orphan Products Developmentof the FDA granted orphan drug designation to L-Annamycin for the treatment ofacute myeloid leukemia. The FDA grants orphan drug status for drug candidatesthat are intended to treat rare life-threatening diseases that, at the time ofapplication, affect no more than 200,000 patients in the United States. Thedrug must have the ability to provide significant patient benefit overcurrently available treatment or fill an unmet medical need. Orphan drugdesignation entitles us to seven years of market exclusivity in the UnitedStates of America, and ten years of market exclusivity in Europe, upon FDAmarketing approval, provided that we continue to meet certain conditionsestablished by the FDA. Once the FDA grants marketing approval of a new drug,the FDA will not accept or approve other applications to market the samemedicinal product for the same therapeutic indication. Other incentivesprovided by orphan status include certain tax benefits, eligibility forresearch grants and protocol assistance. Protocol assistance includesregulatory assistance and possible exemptions or reductions of certainregulatory fees.

**GUANYLATE CYCLASE RECEPTOR AGONISTTECHNOLOGY (Guanilib)**

Our guanylate cyclase receptor agonist (GCRA) programis based on control of cyclic guanosine monophosphate (“cyclic GMP”), animportant second messenger involved in key cellular processes, which areessential for maintenance of the balance between proliferation and cellulardeath (apoptosis). Uroguanylin, a hormone produced by and secreted by specializedcells in the human GI tract, helps to maintain this balance by activatingsynthesis of cyclic GMP through activation of guanylate cyclase receptor.Recent findings suggest a role of cyclic GMP in gastrointestinal (GI)inflammatory diseases.

We have successfully developed a potent analog(synthetic molecule) of uroguanylin called Guanilib (formerly called SP304).Guanilib has been demonstrated to be superior to uroguanylin in its biologicalactivity, protease stability and pH characteristics. Guanilib is currentlyundergoing pre-clinical animal studies as a treatment for gastrointestinal orGI inflammation in a collaborative study involving clinical

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gastroenterologist Dr. Scott Plevy of the Universityof North Carolina, Chapel Hill, NC. Recent results from his laboratory showedthat Guanilib was efficacious in treatment of ulcerative colitis in mice. Apatent allowance covering therapeutic applications of Guanilib in colon cancerand GI inflammatory diseases has recently been granted by the U.S. Patent andTrademark Office.

**DEGRASYNS**

On January 10, 2006, we entered into a licenseagreement with the University of Texas M.D. Anderson Cancer Center whereby wewere granted the exclusive right to manufacture, have manufactured, use,import, offer to sell and/or sell anti-cancer compounds called tyrphostins(renamed Degrasyns). Degrasyns are a second-generation class of tyrphostinsdeveloped by scientists at the University of Texas M.D. Anderson Cancer Centerthat have a novel anti-cancer mechanism-of-action that centers on their abilityto selectively degrade key proteins that are involved in tumor cellproliferation and survival. We plan to work closely with scientists at theUniversity of Texas M.D. Anderson Cancer Center during 2007 to bring forward apre-clinical candidate for development in the clinic.

**SUPERANTIGEN-BASED BIOTERORRISMDEFENSE**

On August 20, 1996, we entered into a licenseagreement to research, develop, sell and commercially exploit certainRockefeller University (“Rockefeller”) licensed patents covering peptides andantibodies useful in treating toxic shock syndrome and septic shock. Inaddition, on July 25, 2001, we entered into a license agreement for twoadditional patents related to the regulation of exoproteins in staphylococcusaureus.

On April 1, 2005 we were awarded a two-year $885,641biodefense partnership grant from the National Institute of Allergy andInfectious Diseases (“NIAID”) to develop a monoclonal antibody and vaccineagainst bacterial superantigen toxins. The goal was to design a monoclonalantibody and vaccine that prevent the unregulated activation of T-cells (humanwhite blood cells) by bacteria from the class of staphylococcus aureus andstreptococcus pyogenes. Funding for this program will end in the spring of2007.  Because the bioterrorism programis not a core activity of Callisto, we expect to terminate further developmentwork upon the expiration of the research grant.

**EMPLOYEES**

Our plan is to use contract research organizations (“CRO”)for most of our development efforts, including monitoring of clinical trialresults, thus minimizing the need to hire full time employees. As of March 30,2007, we had 9 full-time and 4 part-time employees.

**OFF-BALANCE SHEET ARRANGEMENTS**

We had no off-balance sheet arrangements as of December31, 2006.

**CRITICAL ACCOUNTING POLICIES**

Financial Reporting Release No. 60 requires allcompanies to include a discussion of critical accounting policies or methodsused in the preparation of financial statements. Our accounting policies aredescribed in Note 3 of the notes to our consolidated financial statementsincluded in this Annual Report on Form 10-K for the fiscal year ended December31, 2006. The financial statements are prepared in accordance with accountingprinciples generally accepted in the United States of America, which requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reporting period. Actual results could differ fromthose estimates.

We rely heavily on incentive compensation in the formof stock options to recruit, retain and motivate directors, executive officers,employees and consultants. Incentive compensation in the form of stock optionsis designed to provide long-term incentives, develop and maintain an ownershipstake and conserve cash during our development stage. Since inception throughDecember 31, 2006 stock based compensation expense has totaled $16,517,445 or27% of our total accumulated deficit of $60,444,368.

InDecember 2004, the Financial Accounting Standards Board (FASB) issuedStatement of Financial Accounting Standard (“SFAS”) No. 123 (Revised2004), *Share-Based Payments* (“SFAS123R”). SFAS 123R requires a public entity to measure the cost of employeeservices received in exchange for the award of equity instruments based on thefair value of the award at the date of grant. The expense is to be recognizedover the period during which an employee is required to provide services inexchange for the award. SFAS 123R is effective as of the beginning of the firstinterim or annual reporting period that begins after December 15, 2005 andaccordingly we adopted SFAS 123R on January 1 , 2006.

SFAS 123R providesfor two transition methods. The “modified *prospective”*method requires that share-based compensation expense be recorded for anyemployee options granted after the adoption date and for the unvested portion ofany employee options outstanding as of the adoption date. The “ *modified retrospective**“* method requires that, beginning in thefirst quarter of 2006, all prior periods presented be

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restated toreflect the impact of share-based compensation expense consistent with theproforma disclosures previously required under SFAS 123. We have elected to usethe “modified *prospective* “method in adopting this standard.

Prior toJanuary 1, 2006, we had adopted SFAS No. 123, “Accounting forStock-Based Compensation” (“SFAS 123”). As provided for by SFAS 123, we hadelected to continue to account for stock-based compensation according to theprovisions of Accounting Principles Board Opinion No. 25, “Accounting forStock Issued to Employees” (“APB 25”). Accordingly, compensation expense hadbeen recognized to the extent of employee services rendered based on theintrinsic value of stock options granted under the plan.

SFAS 123R did not change the way we account fornon-employee stock-based compensation. We continue to account for shares ofcommon stock, stock options and warrants issued to non-employees based on thefair value of the stock, stock option or warrant.

For all fair value computations required for employeeand non-employee stock-based compensation we use the Black-Scholesoption-pricing model which requires assumptions for expected stock pricevolatility, expected term of the option, risk-free interest rate and expecteddividend yield at the grant date. Our stock price fluctuated from $3.95 pershare as of December 31, 2003 to $0.86 per share as of December 29, 2006.

Research and Development: We do not currently have anycommercial biopharmaceutical products, and do not expect to have such forseveral years, if at all and therefore our research and development costs areexpensed as incurred. These include expenditures in connection with an in-houseresearch and development laboratory, salaries and staff costs, application andfiling for regulatory approval of our proposed products, purchase of in-processresearch and development, regulatory and scientific consulting fees, contractresearch and royalty payments to outside suppliers, facilities and universitiesas well as legal and professional fees associated with filing and maintainingour patent and license rights to our proposed products. While certain of ourresearch and development costs may have future benefits, our policy ofexpensing all research and development expenditures is predicated on the factthat we have no history of successful commercialization of biopharmaceuticalproducts to base any estimate of the number of future periods that would bebenefited.

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**RESULTS OF OPERATIONS**

**YEARS ENDED DECEMBER 31, 2006 ANDDECEMBER 31, 2005**

We had no revenues during the twelve months endedDecember 31, 2006 and 2005 because we do not have any commercialbiopharmaceutical products and we do not expect to have such products forseveral years, if at all.

Research and development expenses decreased $398,551,or 6%, to $6,031,953 for the twelve months ended December 31, 2006 from$6,430,504 for the twelve months ended December 31, 2005. The single mostsignificant factor contributing to this decrease in research and developmentexpense was our L-Annamycin project where our program expenses decreased toapproximately $1,300,000 during the twelve months ended December 31, 2006.Program expenses, incurred with outside contract research organizations (“CROs”),include hospital patient costs, blood testing, drug formulation, synthesis,tableting, data collection, clinical monitoring and FDA consultants. Thisdecreased level of expenditure during the twelve months ended December 31, 2006compared to approximately $2,500,000 during the twelve months ended December31, 2005 during which period we purchased and expensed a supply of drugsubstance which was used in our 2006 Annamycin clinical trials. Atiprimodclinical program expenses decreased to approximately $1,700,000 during thetwelve months ended December 31, 2006 as compared to approximately $1,900,000for the twelve months ended December 31, 2005. Partially offsetting thisdecrease in L-Annamycin and Atiprimod program expenses were higher expendituresfor two of our pre-clinical drug candidates, Degrasyns and Guanilib, increasingto approximately $1,200,000 during the twelve months ended December 31, 2006,as compared to approximately $100,000 during the twelve months ended December31, 2005. Research and development in-house overhead, not allocated to specificclinical programs,  totaled approximately$1,700,000, during the twelve months ended December 31, 2006, a decrease ofapproximately $100,000, or 5%, in line with our overall decrease in programexpenses. Partially offsetting these decreases in the above cash-basedexpenditures was higher stock-based compensation expense associated with grantsto research and development employees. During the twelve months ended December31, 2006 and 2005 stock-based compensation expense totaled $420,683 and $276,250,respectively. This increase was primarily attributable to our adoption of SFAS123R on January 1, 2006 (see Critical Accounting Policies above).

On April 1, 2005we received an $885,641 biodefense partnership grant from the NationalInstitute of Allergy and Infectious Diseases (“NIAID”) to develop a monoclonalantibody and vaccine against bacterial superantigen toxins over the next twoyears. Government grant funding under our NIAID grant for the twelve monthsended December 31, 2006 and 2005 was $352,649 and $226,119, respectively.

General andadministrative expenses for the twelve months ended December 31, 2006 were$5,112,876, an increase of $144,627 or 3%, from $4,968,249 for the twelvemonths ended December 31, 2005. This increase was entirely due to highercash-based general and administrative expenses partially offset by lowerstock-based compensation expense . Cash-based general and administrativeexpenses increased approximately $400,000, or 12%, primarily due toapproximately $300,000 of increased investor relations costs and $150,000 inhigher bonuses, partially offset by lower Sarbanes-Oxley compliance testingservices, as a result of regulatory extensions during 2006.  Stock-based compensation expense, attributableto general and administrative employees, decreased approximately $300,000, or24%, to approximately $950,000 during the twelve months ended December 31,2006.

Stock-based compensation attributable to non-employeesrecorded during the twelve months ended December 31, 2006 totaled $1,373,991 ascompared to $889,277 recorded during the twelve months ended December 31,2005.  This increase of $484,714 or 55% was primarily attributable to theexpense associated with 872,188 warrants we issued to certain investorrelations consultants. The warrants vested on the date of issuance and the fairvalue of these warrants using the Black-Scholes methodology was $411,112.

Other expense for the twelve months ended December 31,2006 of $801,690 was entirely attributable to liquidated damages incurred fornot having filed a registration statement covering our February and April 2006private placements of common stock in accordance with the terms of theregistration rights agreement we had with the investors. During the twelvemonths ended December 31, 2005 Synergy sold certain New Jersey State tax losscarry forwards under a state economic development program for cash ofapproximately $177,000. This state tax benefit was recorded as other income andas of December 31, 2005 we had no remaining New Jersey State tax loss carryforwards available for sale.

Net loss for the twelve months ended December 31, 2006was $12,919,229 compared to a net loss of $11,779,457 reported for the twelvemonths ended December 31, 2005, increased for the reasons discussed above..

The beneficial conversion dividend accreted to theSeries A preferred stockholders, upon issuance in the quarter ended December31, 2006, was $2,384,485, resulting in a net loss available to commonstockholders of $15,303,714 for the twelve months ended December 31, 2006. Thiscompared to a net loss available to common stockholders of $11,779,457 reportedfor the twelve months ended December 31, 2005, during which period we had nopreferred share transactions and thus no beneficial conversion feature thatneeded to be accreted as a dividend.

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**YEARS ENDED DECEMBER 31, 2005 ANDDECEMBER 31, 2004**

We had no revenues during the twelve months endedDecember 31, 2005 and 2004 because we do not have any commercialbiopharmaceutical products and we do not expect to have such products forseveral years, if at all.

Research and development expenses increased $2,104,531or 49%, to $6,430,506 for the twelve months ended December 31, 2005 from$4,325,975 for the twelve months ended December 31, 2004. The single mostsignificant factor contributing to this increase in research and developmentexpense was our L-Annamycin project where our program expenses increased toapproximately $2,500,000 during the twelve months ended December 31, 2005. Westarted our work on L-Annamycin in the latter part of 2004, and incurredapproximately $300,000 in expenses during the twelve months ended December 31,2004, primarily limited to a $100,000 initial license fee, $31,000 in patentrelated legal fees paid to The University of Texas M. D. Anderson Cancer Centerand approximately $85,000 incurred with our clinical consultant to begin theprocess of developing protocols and obtaining investigational review board(“IRB”) approvals to start our trials. Atiprimod clinical trial expenses whichinclude patient costs, drug formulation and tableting, data collection,monitoring, insurance, and FDA consultants increased approximately $500,000, or35% to approximately $1,900,000 during the twelve months ended December 31,2005 as compared to approximately $1,400,000 for the twelve months endedDecember 31, 2004. Also contributing to this increase in research anddevelopment expense in the twelve months ended December 31, 2005 were salariesand wages in the amount of $750,000 compared to $450,000 during the twelvemonths ended December 31, 2004, increasing approximately $300,000, or 67%. Theincrease was a result of hiring a chief medical officer, an in-house patentagent and several clinical trial associates to manage our clinical activities.Stock-based compensation attributable to research and development employees,recorded as research and development expense during the twelve months endedDecember 31, 2005, totaled $276,250 as compared to $1,508,588 recorded duringthe twelve months ended December 31, 2004. This decrease of approximately$1,200,000 was primarily attributable to the restructuring of Dr. Kunwar M.Shailubhai’s employment agreement during 2004, which resulted in additionalstock-based compensation expense of approximately $1,100,000 during the twelvemonths ended December 31, 2004.

Government grant funding for the twelve months endedDecember 31, 2005 was $226,119 as compared to $265,697 for the twelve monthsended December 31, 2004. Our 2005 funding was for work on a biodefensepartnership grant from the National Institute of Allergy and InfectiousDiseases to develop a monoclonal antibody and vaccine against bacterialsuperantigen toxins under our August 20, 1996 license with RockefellerUniversity. Our 2004 funding was from a grant from the National Institutes ofHealth for studies on Atiprimod. We request grant funding to reimburse researchand development expenses as incurred and this reimbursement has been reportedon our Consolidated Statements of Operations as a separate line item entitled“Government Grant”.

General and administrative expenses for the twelvemonths ended December 31, 2005 were $4,968,249, an increase of $1,401,522 or39%, from $3,566,727 for the twelve months ended December 31, 2004. Theincrease was due primarily to approximately (i) $500,000 of increased investorrelations costs, (ii) $270,000 in higher consulting fees for strategic planningand capital markets advice,(iii) $250,000 in higher personnel expensesprimarily employee group insurance, payroll taxes and recruitment feesassociated with staffing growth and (iv) $90,000 in higher costs related to ourwork on compliance with the Sarbanes-Oxley Act of 2002. Stock-basedcompensation attributable to general and administrative employees, recorded asgeneral and administrative expense during the twelve months ended December 31,2005, totaled $1,254,167 as compared to $1,203,954 recorded during the twelvemonths ended December 31, 2004.

Purchased in-process research and development was $0and $209,735 for the twelve months ended December 31, 2005 and 2004respectively. The 2004 expense was primarily in connection with the acquisitionof rights to two key patents from Houston Pharmaceuticals, Inc.

Stock-based compensation attributable to non-employeeconsultants and advisors was $889,277 during the twelve months ended December31, 2005 as compared to $20,228 for the previous year.  This increase was primarily attributable tothe expense associated with warrants we issued to Trilogy CapitalPartners to purchase 1,793,322 shares of our common stock at an exerciseprice of $1.03 per share. The fair value of the warrants using theBlack-Scholes methodology is $1,469,431 which was recorded as stock-basedcompensation expense over the twelve month term of the service agreemententered into on July 18, 2005. During the twelve months ended December 31, 2005the amortization of the Trilogy warrant stock-based compensation totaled$734,995, whereas we had no such expense during the twelve months endedDecember 31, 2004.

During December 2005 and 2004 Synergy sold certain NewJersey State tax loss carry forwards under a state economic development programfor cash of approximately $177,000 and $233,000, respectively, the proceeds ofwhich were used to support research and development activities in New Jersey.This state tax benefit was recorded as Other Income during the fourth quartersended December 31, 2005 and 2004. As of December 31, 2005 Synergy had noremaining New Jersey State tax loss carry forwards available for sale.

Net loss for the twelve months ended December 31, 2005was $11,779,457 compared to a net loss of $7,543,467 reported for the twelvemonths ended December 31, 2004. The increased net loss is primarily the resultof higher research, development, general and administrative expenses discussedabove net of lower stock based compensation and purchased in-process R&D.

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**LIQUIDITY AND CAPITAL RESOURCES**

As of December 31, 2006 we had $3,904,232 in cash andcash equivalents, compared to $1,420,510 as of December 31, 2005. This increasein cash of $2,483,722 during the twelve months ended December 31, 2006 wasprincipally the result of approximately $10.8 million of cash provided fromfund raising activities, partially offset by cash used in operating activitiesof $8.3 million during the twelve months ended December 31, 2006.

From October 2006until January 2007, we placed 602,350 shares of Series A Convertible PreferredStock and 8,031,333 warrants to certain investors for aggregate gross proceedsof $6,023,500. As of December 31, 2006 we had closed on 574,350 shares ofsuch Series A Convertible Preferred Stock for aggregate gross proceeds of$5,743,500. The final traunche of this financing closed January 10, 2007 whenwe placed 28,000 shares of such Series A Convertible Preferred Stock foraggregate gross proceeds of $280,000. The shares of Series A ConvertiblePreferred Stock are convertible into shares of common stock at a conversionprice of $0.75 per share.  The investors also are parties to aRegistration Rights Agreement, dated as of October 23, 2006 pursuant towhich  we agreed to file, within 60 days of closing, a registrationstatement with the Securities and Exchange Commission (the “SEC”) covering theresale of the shares of common stock underlying the Series A ConvertiblePreferred Stock and the warrants issued to the investors. The warrants areimmediately exercisable at $0.75 per share,   will expire five years fromthe date of issuance, and have certain antidilution rights for the twelvemonth period beginning on the effective date of the registration statementregistering the shares of common stock underlying the warrants.  We paidaggregate fees and expenses of $485,308 ($448,908 prior to December 31, 2006) incash, issued an aggregate 11,775 shares of Series A Convertible Preferred Stockand 1,228,761warrants to purchase common stock to certain selling agents. Thewarrants are immediately exercisable at $0.75 per share,will expire five yearsafter issuance and have the same anti-dilutive rights as the investor warrants.  On January 12, 2007 we filed a registrationstatement on Form S-3 registering the common stock issuable upon (i) theconversion of the all Series A Convertible Preferred Stock, (ii) the exerciseof all related investor warrants and (iii) the exercise of all selling agentwarrants. On February 15, 2007 Amendment No.1 to this registration statementwas declared effective by the SEC.

On February 3, 2006, we closed a private placement of4,283,668 shares of common stock and 1,070,917 common stock purchase warrantsto certain accredited investors at a price of $1.20 per share for aggregateproceeds of $5,140,210. We paid an aggregate $531,808 in fees and expenses; andissued an aggregate 390,284 warrants to certain selling agents. Wealso incurred $30,000 in legal fees directly associated with the closing.  On April 7, 2006 we had a second closingof the financing described above, in which we sold an additional 666,667 sharesof common stock and issued 166,667 common stock purchase warrants at the sameterms, for gross proceeds of $800,000, bringing the total gross proceeds of thefinancing to $5.94 million and net proceeds to $5.34 million. Placement agentfees of  $41,000 were paid on this second closing and three year warrantsto purchase a total of 66,667 common shares at a per share price of $1.25 wereissued to several selling agents

On August 22, 2005, we closed a private placement of1,869,203 shares of common stock to certain of our existing stockholders. Theshares were sold at a price of $0.97 per share for aggregate proceeds ofapproximately $1.8 million. We paid an aggregate $151,250 to certain sellingagents.

On July 18, 2005, we entered into a letter ofengagement with Trilogy Capital Partners, Inc. The term of the agreement is forone year beginning on July 18, 2005 and terminable thereafter by either partyupon 30 days’ prior written notice. Pursuant to the agreement, Trilogy providedmarketing and financial public relations services to us and assumed theresponsibilities of an investor relations officer for us. We were obligated topay Trilogy $12,500 per month under the agreement. Pursuant to the agreement,we also issued warrants to Trilogy to purchase 1,793,322 shares of our commonstock at an exercise price of $1.03 per share, exercisable upon issuance andexpiring on July 18, 2008. On July 5, 2006, we terminated this agreement.  This agreement is currently the subject of alawsuit and cross-complaint between the parties discussed in Item 3 of thisannual report.

On April 1, 2005 we were awarded a biodefensepartnership grant from the National Institute of Allergy and InfectiousDiseases (NIAID) to develop a monoclonal antibody and vaccine against bacterialsuperantigen toxins, in the amount of $885,641 over two years. Work on theNIAID superantigen grant started in July 2005 and funding totaled $352,649 and$226,119 during the twelve months ended December 31, 2006 and 2005,respectively.

On March 9, 2005 we sold and issued in a privateplacement an aggregate 1,985,791 shares of common stock at a per share price of$1.52, for aggregate gross proceeds of approximately $3.02 million. Becausethis transaction was completed with certain existing institutional shareholdersand certain members of our management we paid no fees to selling agents, andlegal fees were $25,000.

Our capital resources are focused primarily on theclinical development and regulatory approval of L-Annamycin for acute leukemiaand Atiprimod for multiple myeloma, advanced carcinoid cancer, and boneresorption disease, a major complication associated with multiple myeloma. Ourproduct development efforts are thus in their early stages and we cannot makeestimates of the costs or the time it will take to complete. The risk ofcompletion of any program is high because of the long duration of clinicaltesting, extended regulatory approval and review cycles and uncertainty of thecosts. Net cash inflows from any products developed may take several years toachieve. We will need additional funding to complete these activities. We couldhowever receive grants, contracts or technology licenses in the short-term. Theamount and timing of these inflows, if any, is not known.

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Our consolidated financial statements as of December31, 2006 have been prepared under the assumption that we will continue as agoing concern for the year ending December 31, 2007. Our independent registeredpublic accounting firm has issued a report dated April 13, 2007 that includedan explanatory paragraph referring to our recurring losses from operations andnet capital deficiency and expressing substantial doubt in our ability tocontinue as a going concern without additional capital becoming available. Ourability to continue as a going concern is dependent upon our ability toobtain additional equity or debt financing, attain further operatingefficiencies and, ultimately, to generate revenue. The financial statements donot include any adjustments that might result from the outcome of thisuncertainty.  We will be required to raise additional capital within thenext year to complete the development and commercialization of our currentproduct candidates and to continue to fund operations at the current cashexpenditure levels.

To date, our sources of cash have been primarilylimited to the sale of our equity securities. We cannot be certain thatadditional funding will be available on acceptable terms, or at all. To theextent that we raise additional funds by issuing equity securities, ourstockholders may experience significant dilution. Any debt financing, ifavailable, may involve restrictive covenants that impact our ability to conductour business. If we are unable to raise additional capital when required or onacceptable terms, we may have to significantly delay, scale back or discontinuethe development and/or commercialization of one or more of our productcandidates. We also may be required to:
|   | · | seek  collaborators for our product candidates at an earlier stage than otherwise  would be desirable and on terms that are less favorable than might otherwise  be available; and            |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | · | relinquish  license or otherwise dispose of rights to technologies, product candidates or  products that we would otherwise seek to develop or commercialize ourselves  on unfavorable terms. |

 

**CONTRACTUAL OBLIGATIONS ANDCOMMITMENTS**

The following is a summary of our significantcontractual cash obligations for the periods indicated that existed as ofDecember 31, 2006, and is based on information appearing in the Notes toConsolidated Financial Statements.
| ** **                                            | ** ** | **Total** | ** ** | **Less than  1 Year** | ** ** | **1-2  Years** | ** ** | **3-5  Years** | ** ** | **More than  5 Years** | ** ** |
|-------------------------------------------------------|------------|-----------|------------|---------------------------------|------------|----------------|------------|----------------|------------|----------------------------------|------------|
|                                                  |       |      |       |                            |       |           |       |           |       |                             |       |
| Operating leases  - facilities                        |       | $         | 705,988    |                            | $          | 151,524        |       | $              | 312,201    |                             | $          | 242,263 |   |   |   |
| Purchase  obligation- principally consulting services |       | 1,411,423 |       | 473,673                         |       | 805,750        |       | 132,000        |       |                             |       |
| Minimum spending  obligations (1)                     |       | 1,045,000 |       | 209,000                         |       | 418,000        |       | 418,000        |       |                             |       |
| License royalty  payments (2)                         |       | 1,145,000 |       | 210,000                         |       | 455,000        |       | 480,000        |       |                             | (3)        |
|                                                  |       |      |       |                            |       |           |       |           |       |                             |       |
| Total obligations                                     |       | $         | 4,307,411  |                            | $          | 1,044,197      |       | $              | 1,990,951  |                             | $          | 1,272,263 |   |   |   |

 

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(1) We have licensed patents from other companies andinstitutions under certain license agreements. This line item represents ourminimum obligations to spend monies for product development andcommercialization as set forth in each license.

(2) This line item represents our minimum license feepayments to (i) AnorMED, Inc. for our Atiprimod license and (ii) the Universityof Texas M.D. Anderson Cancer Center for our Degrasyns license. Our patentlicense agreements also include milestone royalty payments to be paid in cashupon the achievement of certain regulatory approval and productcommercialization goals. These milestone payments have not been estimatedbecause of the uncertainty surrounding the duration of on-going early stageclinical trials and the extent of regulatory approval and review cycles. Sinceinception we have never achieved regulatory approval of any of our proposedproducts and we do not currently have any commercial biopharmaceuticalproducts, and do not expect to have such for several years. (See Footnote 8 toour consolidated financial statements for a more detailed description of theterms of our license agreements)

(3) For purposes of this schedule we have assumed thatall patents not commercialized within 5 years will be abandoned, licenseagreements will be terminated and associated minimum license fee payments willcease.

**RECENT ACCOUNTING PRONOUNCEMENTS:**

In February 2007, the FASB issued Statement ofFinancial Accounting Standards No.159, “The Fair Value Option for FinancialAssets and Financial Liabilities, including an Amendment to SFAS 115” (“SFAS159”). The fair value option established by SFAS 159 permits all entities tomeasure all eligible items at fair value at specified election dates. Abusiness entity shall report all unrealized gains and losses on items for whichthe fair value option has been elected, in earnings at each subsequentreporting date. The provisions of SFAS 159 are effective for fiscal yearsbeginning after November 15, 2007. We are currently evaluating the impact, ifany, of the provisions of SFAS 159.

In December 2006, the Financial Accounting Standards Board (“FASB”)issued a FASB Staff Position (“FSP”) Emerging Issues Task Force (“EITF”) IssueNo. 00-19-2”Accounting for Registration Payment Arrangements” (“FSP 00-19-2”)which addresses an issuer’s accounting for registration payment arrangements.FSP 00-19-2 specifies that the contingent obligation to make future payments orotherwise transfer consideration under a registration payment arrangement,whether issued as a separate agreement or included as a provision of a financialinstrument or other agreement, should be separately recognized and measured inaccordance with FASB Statement No.5 “Accounting for Contingencies”. Theguidance in FSP 00-19-2 amends FASB Statements No. 133, “Accounting forDerivative Instruments and Hedging

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Activities”, and No.150, “Accountingfor Certain Financial Instruments with Characteristics of both Liabilities andEquity”, and FASB Interpretation No.45, “Guarantor’s Accounting and DisclosureRequirements for Guarantees, Including Indirect Guarantees of Indebtedness ofOthers” to include scope exceptions for registration payment arrangements. FSP00-19-2 is effective immediately for registration payment arrangements and thefinancial instruments subject to those arrangements that are entered into ormodified subsequent to the date of issue of FSP 00-19-2. For registrationpayment arrangements and financial instruments subject to those arrangementsthat were entered into prior to the issuance of FSP 00-19-2, this is effectivefor financial statements issued for fiscal years beginning after December 15,2006, and interim periods within those fiscal years. We have analyzed theprovisions of FSP 00-19-2 and determined that it is not likely have a materialeffect on Callisto’s consolidated financial statements.

In September 2006, theFASB issued Statement of Financial Accounting Standards No.157, “Fair ValueMeasurements” (“SFAS 157”). SFAS 157 defines fair value, establishes aframework for measuring fair value in accordance with generally accepted accountingprinciples and expands disclosures about fair value measurements. Theprovisions of SFAS 157 are effective for fiscal years beginning after November15, 2007. We are currently evaluating the impact, if any, of the provisions ofSFAS 157.

In July 2006, the FASB issued FASB Interpretation No.48 (“FIN 48”) “Accounting for Uncertainty in Income Taxes (an interpretation ofFASB Statement No. 109”) which is effective for fiscal years beginning afterDecember 15, 2006. This interpretation was issued to clarify the accounting foruncertainty in the amount of income taxes recognized in the financialstatements by prescribing a recognition threshold and measurement attribute forthe financial statement recognition and measurement of a tax position taken orexpected to be taken in a tax return. The provisions of FIN 48 are effectiveJanuary 1, 2007, with the cumulative effect of the change in accountingprinciple recorded as an adjustment to retained earnings. The Company does notexpect the adoption of FIN 48 to have a material impact on its consolidatedfinancial position, results of operations or cash flows.

In May 2005, the FASB issued SFAS No. 154, “AccountingChanges and Error Corrections,” which changes the requirements for accountingfor and reporting of a change in accounting principle. SFAS No. 154 requiresretrospective application to prior periods’ financial statements of a voluntarychange in accounting principle unless it is impracticable. SFAS No. 154 alsorequires that a change in method of depreciation, amortization, or depletionfor long-lived, nonfinancial assets be accounted for as a change in accountingestimate that is affected by a change in accounting principle. SFAS No. 154 iseffective for accounting changes and a correction of errors made in fiscalyears beginning after December 15, 2005, but does not change the transitionprovisions of any existing accounting pronouncements, including those that arein a transition phase as of the effective date of SFAS No. 154. The adoption ofSFAS No. 154 did not have a material effect on our results of operations or ourfinancial position.

**ITEM 7A. QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK.**

At December 31, 2006 and 2005, a substantialportion of our cash and cash equivalents consists of short term, highly liquidinvestments in a money market fund managed by a large money center bank(JPMorganChase). Original maturities of fund investments are all less thanthree months.

**ITEM 8. FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA.**

The full text of our audited consolidated financialstatements as of December 31, 2006 and 2005 and for the fiscal years endedDecember 31, 2006, 2005 and 2004 and for the period from June 5, 1996(inception) to December 31, 2006, begins on page F-1 of this Annual Report onForm 10-K.

**ITEM 9. CHANGES IN AND DISAGREEMENTSWITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

None

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**ITEM 9A. CONTROLS AND PROCEDURES.**

Based on an evaluation of our disclosure controls andprocedures (as defined in Rules 13a-15(e) and 15d-15(e) of the SecuritiesExchange Act of 1934, as amended) required by paragraph (b) of Rule 13a-15 orRule 15d-15, as of December 31, 2006, our Chief Executive Officer and PrincipalFinancial Officer have concluded that, due to the material weakness in theinternal control over financial reporting noted below, our disclosure controlsand procedures were not effective in ensuring that information required to bedisclosed by us in the reports that we file or submit under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the Commission’s rules and forms. Our Chief Executive Officer and PrincipalFinancial Officer also concluded that, as of December 31, 2006, our disclosurecontrols and procedures were not effective in ensuring that informationrequired to be disclosed by us in the reports that we file or submit under theExchange Act is accumulated and communicated to our management, including ourChief Executive Officer and Principal Financial Officer, to allow timelydecisions regarding required disclosures.

In connection with the audit of our financialstatements, our independent registered public accountants noted various errorsin the calculations in the accounting of the issuance of preferred stock in thefourth quarter of 2006 which led to the recording of material adjustments toour financial statements. Our independent registered public accountants alsoadvised us of various omissions in our financial statement disclosures. Theweakness identified is as a result of the fact that we lack sufficient internalaccounting personnel and segregation of duties necessary to ensure that anadequate review of the financial statements and notes thereto is performed.

In order to ensure the effectiveness of our disclosurecontrols in the future we plan to add financial staff resources to ouraccounting and finance department. In designing and evaluating our disclosure controls andprocedures, management recognizes that any controls and procedures, no matterhow well designed and operated, can provide only reasonable assurance ofachieving the desired control objectives, and management necessarily isrequired to apply its judgment in evaluating the relationship between thebenefit of desired controls and procedures and the cost of implementing newcontrols and procedures.

The consolidated financial statements include alladjustments identified as a result of the evaluation performed.**.**

Except for the above there were no changes in ourinternal controls over financial reporting that could significantly affectinternal controls over financial reporting during the quarter ended December31, 2006.

**ITEM 9B. OTHER INFORMATION**

None.

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**PARTIII**

**ITEM 10. DIRECTORS, EXECUTIVEOFFICERS AND CORPORATE GOVERNANCE.**

The following table sets forth certain informationregarding the directors and executive officers of Callisto Pharmaceuticals,Inc. as of March 30, 2007:
| **Name**                  | ** ** | **Age** | ** ** | **Positions**                                                                                              |
|---------------------------|------------|---------|------------|------------------------------------------------------------------------------------------------------------|
| Gabriele M. Cerrone       |       | 35      |       | Chairman of the Board                                                                                      |
| Gary S. Jacob             |       | 60      |       | Chief Executive Officer, Chief Scientific Officer  and Director;  Chairman of Synergy Pharmaceuticals Inc. |
| Bernard F. Denoyer        |       | 59      |       | Vice President, Finance and Secretary                                                                      |
| Daniel S. D’Agostino |       | 40      |       | Chief Business Officer                                                                                     |
| John P. Brancaccio        |       | 59      |       | Director                                                                                                   |
| Christoph Bruening        |       | 39      |       | Director                                                                                                   |
| Riccardo Dalla-Favera     |       | 54      |       | Director                                                                                                   |
| Stephen K. Carter         |       | 68      |       | Director                                                                                                   |
| Randall Johnson           |       | 60      |       | Director                                                                                                   |

 

Gabriele M. Cerrone has served as our Chairman of theBoard of Directors since May 2003 and as a consultant since January 2005. FromMarch 1999 to January 2005 Mr. Cerrone served as a Senior Vice President ofInvestments of Oppenheimer & Co. Inc., a financial services firm. Prior tosuch affiliation, Mr. Cerrone held the position of Managing Director ofInvestments at Barrington Capital, L.P., a merchant bank, between March 1998and March 1999. Between May 2001 and May 2003, Mr. Cerrone served on the boardof directors of SIGA Technologies, Inc. Mr. Cerrone currently serves asChairman of the Board and a consultant to FermaVir Pharmaceuticals, Inc., abiotechnology company. Mr. Cerrone is the managing partner of Panetta PartnersLtd., a Colorado limited partnership, that is a private investor in real estateand public and private companies engaged in biotechnology and other areas.

Gary S. Jacob, Ph.D. has served as our Chief ExecutiveOfficer as well as Chief Scientific Officer since May 2003 and a Director sinceOctober, 2004. Dr. Jacob has also served as Chairman of Synergy PharmaceuticalsInc. since October 2003. Dr. Jacob served as Chief Scientific Officer ofSynergy Pharmaceuticals Inc. from 1999 to 2003. From 1990 to 1998, Dr. Jacobserved as a Monsanto Science Fellow, specializing in the field of Glycobiology.From 1997 to 1998, Dr. Jacob was Director of Functional Genomics, CorporateScience & Technology, Monsanto, where he played a pivotal role in the rapiddevelopment of Monsanto’s plant genomics strategy and the buildup of thein-house advanced genomics program. From 1990 to 1997, Dr. Jacob was Directorof Glycobiology, G.D. Searle Pharmaceuticals Inc. From 1986 to 1990, Dr. Jacobwas Manager of the G.D. Searle Glycobiology Group located at Oxford University,England.

Bernard F. Denoyer, CPA has served as our VicePresident, Finance since January 2004. From July 2003 to December 2003, Mr.Denoyer served as an independent consultant to our company providing interimCFO services. From January 2005 to February 2006 Mr. Denoyer also served asVice President Controller for Xenomics, Inc. In addition to our company, Mr.Denoyer provided interim CFO and other services to emerging technologycompanies, principally portfolio companies of Marsh & McLennan Capital,LLC, from October 2000 to December 2003. From October 1994 until September2000, Mr. Denoyer served as Chief Financial Officer and Senior Vice Presidentat META Group, Inc., a public information technology research company. From1990 to 1993 he was Vice President Finance of Environetics, Inc., apharmaceutical water diagnostic business.

Daniel S. D’Agostino has served as our Chief BusinessOfficer since October 2005 and as a consultant since October 2004. From July2001 to July 2004 Mr. D’Agostino served as a Managing Director of HealthcareInvestment Banking of Punk, Ziegel & Company LLP, a boutique healthcareinvestment bank. Prior to such affiliation, Mr. D’Agostino held the position ofhead of biotechnology investment banking at Gerard Klauer Mattison & Co., afull service investment bank, between June 1999 and July 2001.  Prior tothat Mr. D’Agostino was employed by BT Alex.Brown, Dillon Read & Co., andWasserstein Perella & Co. all as a member of the investment banking group. Mr. D’Agostino has been a Limited Partner of Punk, Ziegel & CompanyLLP since February 2002.

John P. Brancaccio, a retired CPA, has served as aDirector of our company since April 2004. Since April 2004, Mr. Brancaccio hasbeen the Chief Financial Officer of Accelerated Technologies, Inc., anincubator for medical device companies. From May 2002 until March 2004, Mr.Brancaccio was the Chief Financial Officer of Memory Pharmaceuticals Corp., abiotechnology company. From 2000 to 2002, Mr. Brancaccio was the ChiefFinancial Officer/Chief Operating Officer of Eline Group, an entertainment andmedia company. Mr. Brancaccio is currently a director of Alfacell Corporationas well as a director of each of Xenomics, Inc. and FermaVir Pharmaceuticals,Inc.

Christoph Bruening has served as a Director of ourcompany since May 2003. Mr. Bruening organized Value Relations GmbH, a fullservice investor relations firm operating in Frankfurt, Germany in 1999 andcurrently serves as its Managing Partner. From 1998 to 1999, Mr. Brueningserved as a funds manager and Director of Asset Management for Value Managementand Research AG, a private investment fund

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and funds manager in Germany. From 1997 to 1998, Mr.Bruening was a financial analyst and Head of Research for Value Research GmbH.Mr. Bruening is currently a member of the advisory board of Clarity AG.

Riccardo Dalla-Favera, M.D has served as a Director ofour company since June 2005. Dr. Dalla-Favera has been Director of the HerbertIrving Comprehensive Cancer Center at Columbia University since early 2005,Director for the Institute for Cancer Genetics at Columbia University since1999 and Professor in the Department of Genetics & Development at ColumbiaUniversity since 1992. Dr. Dalla-Favera was formerly Deputy Director ofColumbia-Presbyterian Cancer Center from 1992 to 1998.

Stephen K. Carter, M.D. has served as a Director ofour company since August 2004. Since 2000, Dr. Carter has been employed as anindependent consultant. From 1998 to 2000, Dr. Carter was senior vicepresident, clinical and regulatory affairs of SUGEN, Inc. (subsequentlyacquired by Pharmacia & Upjohn, Inc.). From 1995 to 1996, Dr. Carter wassenior vice president, research and development with Boehringer IngelheimPharmaceuticals, Inc. and from 1982 to 1995 held various positions withBristol-Myers Squibb Company, including senior vice president, worldwideclinical research and development. Dr. Carter is a director of VionPharmaceuticals, Inc., Cytogen Corp., Emisphere Technologies Inc., AlfacellCorp. and Tapestry Pharmaceuticals Inc. (each a biotechnology company).

Randall Johnson, Ph.D. has served as a Director of ourcompany since February 2005. Since February 2002, Dr. Johnson has been servingas a consultant to various venture capital, biotechnology and pharmaceuticalcompanies focusing on oncology. From October 1982 to February 2002, Dr. Johnsonserved in a number of capacities at GlaxoSmithKline PLC/SmithKline BeechamPharmaceuticals, most recently as a Group Director in the Department ofOncology Research.

**COMPENSATION OF DIRECTORS**

Under the 2005 Directors’ Stock Option Plan, uponelection to the Board, each non-employee and non-consultant director receives agrant of 45,000 stock options vesting over three years and having an exerciseprice equal to the fair market value of the common stock on the date of grant.Upon re-election to the Board, each of our non-employee and non-consultantdirectors receive an annual grant of 6,000 options vesting over three yearshaving an exercise price equal to the fair market value of the common stock onthe date of grant. In addition, non-employee and non-consultant directors willreceive an annual grant of options with an exercise price equal to the fairmarket value of the common stock on the date of grant for serving on Boardcommittees which will vest in one year. Chairpersons of each of the AuditCommittee, Compensation Committee and Corporate Governance/Nominating Committeereceive 5,000, 3,500 and 2,000 stock options, respectively, and members of suchcommittees receive 3,000, 2,000 and 1,000 stock options, respectively.

Non-employee and non-consultant directors also receivean annual cash fee of $15,000 as well as cash compensation for serving on boardcommittees. Chairpersons of each of the Audit Committee, Compensation Committeeand Corporate Governance/Nominating Committee receive $10,000, $7,000 and$4,000, respectively, and members of such committees receive $6,000, $4,000 and$2,500, respectively.

**AUDIT COMMITTEE**

The Audit Committee’s responsibilities include: (i)reviewing the independence, qualifications, services, fees, and performance ofthe independent registered public accountants, (ii) appointing, replacing anddischarging the independent auditors, (iii) pre-approving the professionalservices provided by the independent auditors, (iv) reviewing the scope of theannual audit and reports and recommendations submitted by the independentauditors, and (v) reviewing our financial reporting and accounting policies,including any significant changes, with management and the independentauditors. The Audit Committee also prepares the Audit Committee report that isrequired pursuant to the rules of the SEC.

The Audit Committee currently consists of JohnBrancaccio, chairman of the Audit Committee, Christoph Bruening and RandallJohnson. Our board of directors has determined that each of Mr. Bruening andMr. Brancaccio is “independent” as that term is defined under applicable SECrules and under the current listing standards of the American Stock Exchange.Mr. Brancaccio is our audit committee financial expert.  The Board of Directors has adopted a writtencharter setting forth the authority and responsibilities of the AuditCommittee. A copy of this charter is available at our web sitewww.callistopharma.com.

**COMPENSATION COMMITTEE**

The Compensation Committee has responsibility forassisting the Board of Directors in, among other things, evaluating and makingrecommendations regarding the compensation of the executive officers and directorsof our company; assuring that the executive officers are compensatedeffectively in a manner consistent with our stated compensation strategy;producing an annual report on executive compensation in accordance with therules and regulations promulgated by the SEC; periodically evaluating the termsand administration of ours incentive plans and benefit programs and monitoringof compliance with the legal prohibition on loans to our directors andexecutive officers.

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The Compensation Committee currently consists ofChristoph Bruening, chairman of the Compensation Committee, John Brancaccio andStephen Carter. The Board of Directors has determined that all of the membersare “independent” under the current listing standards of the American StockExchange.  The Board of Directors hasadopted a written charter setting forth the authority and responsibilities ofthe Compensation Committee. A copy of this charter is available at our web sitewww.callistopharma.com.

*CompensationCommittee Interlocks and Insider Participation*

None of themembers of our compensation committee is an officer or employee of our company.None of our executive officers currently serves, or in the past year hasserved, as a member of the board of directors or compensation committee of anyentity that has one or more executive officers serving on our board ofdirectors or compensation committee.

**CORPORATE GOVERNANCE/NOMINATINGCOMMITTEE**

The Corporate Governance/Nominating Committee hasresponsibility for assisting the Board in, among other things, effecting Boardorganization, membership and function including identifying qualified Boardnominees; effecting the organization, membership and function of Boardcommittees including composition and recommendation of qualified candidates;establishment of and subsequent periodic evaluation of successor planning forthe chief executive officer and other executive officers; development andevaluation of criteria for Board membership such as overall qualifications,term limits, age limits and independence; and oversight of compliance with theCorporate Governance Guidelines. The Corporate Governance/Nominating Committeeshall identify and evaluate the qualifications of all candidates for nominationfor election as directors.

The Corporate Governance/Nominating Committeecurrently consists of Stephen Carter, chairman of the CorporateGovernance/Nominating Committee, John Brancaccio and Christoph Bruening. TheBoard of Directors has determined that all of the members are “independent”under the current listing standards of the American Stock Exchange.  The Board of Directors has adopted a writtencharter setting forth the authority and responsibilities of the CorporateGovernance/Nominating Committee. A copy of this charter is available at our website www.callistopharma.com.

**SCIENTIFIC ADVISORY BOARD**

Our scientific advisory board assists us inidentifying research and development opportunities, in reviewing withmanagement the progress of our projects and in recruiting and evaluatingscientific staff. Although we expect to receive guidance from the members ofour scientific advisory board, all of its members are employed on a full-timebasis by others and, accordingly, are able to devote only a small portion oftheir time to us. Management expects to meet with its scientific advisory boardmembers individually from time to time on an informal basis. We have enteredinto a consulting agreement with each member of the scientific advisory board.The scientific advisory board consists of the following scientists:

Moshe Talpaz, M.D. Dr. Talpaz is the chairman of ourScientific Advisory Board and currently is associated with the University ofMichigan Comprehensive Cancer Center where he holds the titles of Professor,Internal Medicine, Associate Director, Translational Research and AssociateChief of Hematologic Malignancies. Dr. Talpaz was formerly the Professor ofMedicine, David Burton, Jr. Endowed Chair at the M.D. Anderson Cancer Center,Houston, Texas. Dr. Talpaz was formerly Chairman of the Department of Bioimmunotherapyof the M.D. Anderson Cancer Center. Dr. Talpaz has been and continues to beinvolved in the clinical development of numerous cancer drugs and has been apioneer in developing currently accepted treatment protocols especially in theleukemia area. Dr. Talpaz is a member of many committees such as the NationalComprehensive Cancer Network Guidelines Panel and sits on several editorial andadvisory boards, such as Hematology Digest, Bone Marrow Transplantation andClinical Cancer Research. In 2003, Dr. Talpaz received the prestigious “Leukemiaand Lymphoma Society Service to Mankind Award” for his pioneering work in thiscancer field. Dr. Talpaz discovered the use of interferon-a for treatingchronic myeloid leukemia (CML) and he was the principal investigator until FDAapproval. In addition, Dr. Talpaz has acted as a consultant to Hoffman LaRochewith regards to the FDA approval process for interferon.

Kenneth C. Anderson, M.D. Dr. Anderson is the KraftFamily Professor of Medicine at Harvard Medical School; and serves as Chief ofthe Division of Hematologic Neoplasia, Director of the Jerome Lipper MultipleMyeloma Center and Vice Chair of the Joint Program in Transfusion Medicine atDana-Farber Cancer Institute. His translational research focuses on developmentof novel therapeutics targeting the myeloma cell in its microenvironment. Hehosted the VI International Myeloma Workshop on Multiple Myeloma, serves on theBoard of Directors and as Chairman of the Scientific Advisors of the MultipleMyeloma Research Foundation, and is a Doris Duke Distinguished ClinicalResearch Scientist.

Roman Perez-Soler, M.D. Dr. Perez-Soler is currentlyGutman Professor of Oncology and Chairman of the Department of Oncology atMontefiore Medical Center as well as Associate Director of Clinical Research atthe Albert Einstein Cancer Center and Chief of the Division of Medical Oncologyat the Albert Einstein College of Medicine. Dr. Perez-Soler was formerlyProfessor of Medicine and Deputy Chairman of the Department of Thoracic/Headand Neck Medical Oncology at The University of Texas M.D. Anderson CancerCenter and Associate Director for Clinical and Translational Research at theKaplan Cancer Center at New York University. Dr. Perez-Soler is a nationallyand

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internationally renowned clinical translationalresearcher in the areas of new anticancer drug development, with a strongemphasis in liposome delivery and thoracic malignancies.

**COMPLIANCE WITH SECTION 16(a) OF THEEXCHANGE ACT**.

Section 16(a) of the Securities Exchange Act of 1934requires our officers and directors, and persons who own more than ten percentof a registered class of our equity securities, to file reports of ownershipand changes in ownership with the Securities and Exchange Commission andAmerican Stock Exchange. Officers, directors and greater than ten percentstockholders are required by SEC regulation to furnish us with copies of allSection 16(a) forms they file.

Based on a review of the copies of such formsreceived, we believe that during 2006, all filing requirements applicable toour officers, directors and greater than ten percent beneficial owners werecomplied with, except that a Form 4 with respect to each of Randall Johnson,Stephen Carter, John Brancaccio, Christoph Bruening and Riccardo Dalla-Faverawas filed late.

**CODE OF BUSINESS CONDUCT AND ETHICS**

We have adopted a formal Code of Business Conduct andEthics applicable to all Board members, executive officers and employees. Acopy of this Code of Business Conduct and Ethics is posted on our website atwww.callistopharma.com.

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**ITEM 11. EXECUTIVE COMPENSATION.**

****CompensationCommittee Report****

**Underthe rules of the SEC, this Compensation Committee Report is not deemed to beincorporated by reference by any general statement incorporating this AnnualReport by reference into any filings with the SEC.**

The CompensationCommittee has reviewed and discussed the following Compensation Discussion andAnalysis with management. Based on this review and these discussions, theCompensation Committee recommended to the Board of Directors that the followingCompensation Discussion and Analysis be included in this Annual Report on Form10-K.

**Submitted by theCompensation Committee**

Christoph Bruening, Chairman

John Brancaccio

Stephen Carter

**Compensation Discussion and Analysis**

*Overview*

We compete with many other biotechnology companies inseeking to attract and retain a skilled work force. To meet this challenge, wehave developed our compensation structure to enable our management to makedecisions regarding our compensation programs, to manage these programs, and toeffectively communicate the goals of these programs to our employees andstockholders.

Our compensation philosophy is to offer our employeescompensation and benefits that are competitive and that meet our goals ofattracting, retaining and motivating highly skilled employees so that we canachieve our financial and strategic objectives.

Utilizing this philosophy, our compensation programsare designed to:

·                  be“market-based” and reflect the competitive environment for personnel; 

·                  stress our “payfor performance” approach to managing pay levels; 

·                  share risks andrewards with employees at all levels; 

·                  be affordable,within the context of our operating expense model; 

·                  align theinterests of our employees with those of our stockholders; 

·                  reflect ourvalues; and 

·                  be fairly andequitably administered. 

In addition, as we administer our compensationprograms, we plan to:

·                  evolve andmodify our programs to reflect the competitive environment and our changingbusiness needs; 

·                  focus onsimplicity, flexibility and choice wherever possible; 

·                  openlycommunicate the details of our programs with our employees and managers toensure that our programs and their goals are understood; and

·                  provide ourmanagers and employees with the tools they need to administer our compensationprograms.

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*Elements of Our Compensation Program*

As a total rewards package, we design our compensationprogram to enable us to attract and retain talented personnel. The individualelements of our compensation program serve to satisfy this larger goal inspecific ways as described below.

We design base pay to provide the essential reward foran employee’s work, and is required to be competitive in attracting talent.Once base pay levels are initially determined, increases in base pay areprovided to recognize an employee’s specific performance achievements.Consistent with our compensation philosophy, we implement a “pay forperformance” approach that provides higher levels of compensation to individualemployees whose results merit greater rewards. Our managers typically makeperformance assessments throughout the year, and provide ongoing feedback toemployees, provide resources and maximize individual and team performancelevels.

We design equity-based compensation, including stockoptions, to ensure that we have the ability to retain talent over a longerperiod of time, and to provide optionees with a form of reward that alignstheir interests with those of our stockholders. Employees whose skills andresults we deem to be critical to our long-term success are eligible to receivehigher levels of equity-based compensation.

We also utilize various forms of variablecompensation, including cash bonuses that allow us to remain competitive withother companies while providing upside potential to those employees who achieveoutstanding results.

Core benefits, such as our basic health benefits, aredesigned to provide a stable array of support to employees and their familiesthroughout various stages of their careers, and are provided to all employeesregardless of their individual performance levels.

The four key elements of our compensation structureare:

·                  base pay; 

·                  variable pay; 

·                  equity-basedpay; and 

·                  benefits. 

Consistent with our compensation philosophy, we have structuredeach element of our rewards package as follows:

***Base Pay***

We create a set of base pay structures that are bothaffordable and competitive in relation to the market. We continuously monitorbase pay levels within the market and make adjustments to our structures asneeded. In general, an employee’s base pay level should reflect the employee’soverall sustained performance level and contribution to our company over time.We seek to structure the base pay for our top performers to be aggressive in relationto the market.

***Variable Pay***

We design our variable pay programs to be bothaffordable and competitive in relation to the market. We monitor the market andadjust our variable pay programs as needed. Our variable pay programs, such asour bonus program, are designed to motivate employees to achieve overall goals.Our programs are designed to avoid entitlements, to align actual payouts withthe actual results achieved and to be easy to understand and administer.

***Equity-Based Rewards***

We design our equity programs to be both affordableand competitive in relation to the market. We monitor the market and applicableaccounting, corporate, securities and tax laws and regulations and adjust ourequity programs as needed. Stock options and other forms of equity compensationare designed to reflect and reward a high level of sustained individualperformance over time. We design our equity programs to align employees’interests with those of our stockholders.

***Benefits Programs***

We design our benefits programs to be both affordableand competitive in relation to the market while conforming with local laws andpractices. We monitor the market, local laws and practices and adjust ourbenefits programs as needed. We design our benefits programs to provide anelement of core benefits, and to the extent possible, offer options foradditional benefits, be tax-effective for employees in each country and balancecosts and cost sharing between us and our employees.

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*Determining the Amount of Each Element of Compensation*

*Base Pay*.    Weprovide our executive officers and other employees with base salary tocompensate them for services rendered during the fiscal year. The CompensationCommittee intends to compensate our executive officers competitively within theindustry. The Compensation Committee considered the scope of and accountabilityassociated with each executive officer’s position and such factors as theperformance and experience of each executive officer when setting base salarylevels for fiscal year 2006. With respect to executive officers other thanDr. Jacob, who is discussed below, the Compensation Committee targetedbase salaries to be competitive with our peers within the biotechnologyindustry. In some circumstances it is necessary to provide compensation abovethese levels; these circumstances include the need to retain key individuals,to recognize roles that were larger in scope or accountability than standardmarket positions and/or to reward individual performance.

Salary levels aretypically reviewed annually as part of our performance review process as wellas upon a promotion or other change in job responsibility.

*Variable Pay*.    TheCompensation Committee and the executive officer work together to establishtargets and goals for the executive officer. Upon completion of the fiscal year, the Compensation Committee assessesthe executive officer’s performance and with input from management determinesthe amount of variable pay to be awarded within the parameters of the executiveofficer’s agreement with us..

*Equity-Based Pay*.The Compensation Committee may provide our executive officers with long-termincentive awards through grants of stock options. The Compensation Committee isresponsible for determining who will receive awards, when awards will be granted,the exercise price of each stock option grant, and the number of shares of ourcommon stock subject to each option. The Compensation Committee considersgrants of long-term incentive awards to executive officers each fiscal year.   Stock options enhance the link between thecreation of stockholder value and long-term executive incentive compensation.Stock options provide our executive officers with the opportunity to purchaseand maintain an equity interest in our company and to share in the appreciationof the value of our common stock. Additionally, stock options maintain acompetitive level of total compensation. The Compensation Committee believesthat stock options are inherently performance-based and are a form of at-riskcompensation, as the optionee does not receive any benefit unless our stockprice rises after the date that the option is granted, thus providing directincentive for future performance. Stock option award levels are determinedbased on prevailing market practice and market data and vary among participantsbased on their positions within our company.

Our stock optionstypically have annual vesting over a three-year period and a term of ten years,in order to encourage a long-term perspective and to encourage key employees toremain with us. We also use performance based vesting in our optiongrants.  Generally, vesting and exerciserights cease upon termination of employment. Prior to the exercise of anoption, the holder has no rights as a stockholder with respect to the shares subjectto such option, including voting rights and the right to receive dividends ordividend equivalents.

*Timing of Equity Awards*

Only the Compensation Committee may approve stock option grants to our executiveofficers.  Stock options are generallygranted at predetermined meetings of the Compensation Committee.  On limited occasions, grants may occur uponunanimous written consent of the Compensation Committee, which occurs primarilyfor the purpose of approving a compensation package for newly hired or promotedexecutive.  The exercise price of a newlygranted option is the closing price of our common stock on the American StockExchange on the date of grant.

*Executive Equity Ownership*

We encourage our executives to hold a significantequity interest in our company. However, we do not have specific shareretention and ownership guidelines for our executives.

*Performance-Based Compensation and Financial Restatement*

We have not considered or implemented a policyregarding retroactive adjustments to any cash or equity-based incentivecompensation paid to our executives and other employees where such paymentswere predicated upon the achievement of certain financial results that weresubsequently the subject of a financial restatement.

*Severance and Change in Control Arrangements*

Several of our executives have employment and otheragreements which provide for severance payment arrangements and/or accelerationof stock option vesting that would be triggered by an acquisition or otherchange in control of our company. See “—Employment Agreements and Change ofControl Arrangements” below for a description of the severance and change incontrol arrangements for our named executive officers.

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*Effect of Accounting and Tax Treatment on CompensationDecisions*

In the review and establishment of our compensationprograms, we consider the anticipated accounting and tax implications to us andour executives.

Section 162(m) of the Internal Revenue Codeimposes a limit on the amount of compensation that we may deduct in any oneyear with respect to our chief executive officer and each of our next four mosthighly compensated executive officers, unless certain specific and detailedcriteria are satisfied. Performance-based compensation, as defined in theInternal Revenue Code, is fully deductible if the programs are approved bystockholders and meet other requirements. We believe that grants of equityawards under our existing stock plans qualify as performance-based for purposesof satisfying the conditions of Section 162(m), thereby permitting us toreceive a federal income tax deduction in connection with such awards. Ingeneral, we have determined that we will not seek to limit executivecompensation so that it is deductible under Section 162(m). However, fromtime to time, we monitor whether it might be in our interests to structure ourcompensation programs to satisfy the requirements of Section 162(m). Weseek to maintain flexibility in compensating our executives in a mannerdesigned to promote our corporate goals and therefore our compensationcommittee has not adopted a policy requiring all compensation to be deductible.Our compensation committee will continue to assess the impact ofSection 162(m) on our compensation practices and determine what furtheraction, if any, is appropriate.

Beginning onJanuary 1, 2006, we began accounting for stock-based payments includingour stock options in accordance with the requirements of FASB Statement 123(R).

*Role of Executives in Executive Compensation Decisions*

Our board of directors and our Compensation Committeegenerally seek input from our Chief Executive Officer, Gary S. Jacob, whendiscussing the performance of, and compensation levels for executives otherthan himself. The Compensation Committee also works with Dr. Jacob and our VicePresident, Finance evaluating the financial, accounting, tax and retentionimplications of our various compensation programs. Neither Dr. Jacob nor any ofour other executives participates in deliberations relating to his or her owncompensation.

**ChiefExecutive Officer Compensation for Fiscal Year 2006**

On February 16, 2007, Dr. Jacob entered into anExtension and Amendment Agreement with us as approved by the CompensationCommittee which extended the term under his employment agreement to June 30, 2009.  In addition, pursuant to the agreement, Dr.Jacob was granted 225,000 ten year incentive stock options exercisable at $0.81per share of which 75,000 vest on each of December 31, 2007, 2008 and 2009. TheCompensation Committee believes the grant of options to Dr. Jacob is a keycomponent of his compensation and an important means of ensuring that as ChiefExecutive Officer he continues to share significantly in the success of ourbusiness with the other stockholders.  The Compensation Committee determinedthat it was appropriate to grant these options for these reasons and due to Dr.Jacob’s performance. Dr. Jacob received a salary of $287,500 for 2006.  Dr. Jacob also earned a bonus of $48,125 for2006.  Dr. Jacob’s bonus was earnedpursuant to this employment agreement and is based on achieving key performanceobjectives for our company as approved and measured by the CompensationCommittee.

## **SUMMARY COMPENSATION TABLE**

The followingtable provides certain summary information concerning compensation awarded to,earned by or paid to our Chief Executive Officer, Principal Financial Officerand three other highest paid executive officers whose total annual salary and bonus exceeded $100,000 (collectively, the“named executive officers”) for fiscal year 2006.
| Name & Principal Position | ** ** | **Year** | ** ** | **Salary ($)** | ** ** | **Bonus  ($)** | ** ** | **Option  Awards ($)  (1)** | ** ** | **Total ($)** | ** ** |
|----------------------------------------------|------------|----------|------------|---------------------|------------|----------------|------------|--------------------------------------------|------------|--------------------|------------|
| **Gary S. Jacob**                            |       | 2006     |       | 287,500             |       | 48,125         |       | 82,147                                     |       | 417,772            |       |
| Chief  Executive Officer                     |       | 2005     |       | 225,000             |       | 33,750         |       | —                                     |       | 258,750            |       |
| and  Chief Scientific Officer                |       | 2004     |       | 225,000             |       | 33,750         |       | —                                     |       | 258,750            |       |
|                                         |       |     |       |                |       |           |       |                                       |       |               |       |
| **Bernard F. Denoyer**                       |       | 2006     |       | 111,576             |       | 10,461         |       | —                                     |       | 122,037            |       |
| Vice  President, Finance                     |       | 2005     |       | 79,167              |       | 6,563          |       | —                                     |       | 85,730             |       |
| and  Secretary                               |       | 2004     |       | 86,250              |       | 9,000          |       | —                                     |       | 95,250             |       |
|                                         |       |     |       |                |       |           |       |                                       |       |               |       |
| **Gabriele M. Cerrone (2)**                  |       | 2006     |       | 213,542             |       | 125,855        |       | —                                     |       | 339,397            |       |
| Chairman  of the Board                       |       | 2005     |       | 191,498             |       | 30,750         |       | —                                     |       | 222,248            |       |
|                                         |       |     |       |                |       |           |       |                                       |       |               |       |
| **Daniel S. D’Agostino (3)**            |       | 2006     |       | 175,000             |       | 32,814         |       | —                                     |       | 207,814            |       |
| Chief  Business Officer                      |       | 2005     |       | 138,614             |       | —         |       | —                                     |       | 138,614            |       |
|                                         |       |     |       |                |       |           |       |                                       |       |               |       |
| **Donald Picker (4)**                        |       | 2006     |       | 210,417             |       | —         |       | —                                     |       | 210,417            |       |
| Executive  Vice President,                   |       | 2005     |       | 200,000             |       | 20,000         |       | —                                     |       | 220,000            |       |
| R&D                                      |       | 2004     |       | 191,875             |       | 37,500         |       | —                                     |       | 229,375            |       |

 

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(1)          Amounts representstock-based compensation expense for fiscal year 2006 for stock options grantedin 2006 under SFAS 123R as discussed in Note 3 Summary of SignificantAccounting Policies subheading “Share-based payments,” of the Notes to ourConsolidated Financial Statements included elsewhere in this report.

(2)          Mr. Cerrone is beingpaid pursuant to a consulting agreement with us.

(3)          Mr. D’Agostino wasappointed Chief Business Officer in October 2005.  From October 2004 to October 2005, Mr. D’Agostinoserved as a consultant to us.

(4)          Mr.Picker resigned as Executive Vice President, R&D on December 19, 2006.

**GRANTSOF PLAN-BASED AWARDS**

The following table setsforth information regarding stock option awards to our named executive officersunder our stock option plans during the fiscal year ended December 31, 2006:
| Name          | ** ** | **Grant Date** | ** ** | **Number of Securities  Underlying Options(#)** | ** ** | **Exercise or Base  Price of Option  Awards ($/Share)** | ** ** | **Fair Value at  Grant Date  of Option Awards** | ** ** |
|---------------|------------|---------------------|------------|----------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|
| Gary S. Jacob |       | March 17, 2006      |       | 150,000                                                        | (1)        | $                                                                                | 1.64       |                                                                     | $          | 183,386 | (2) |
|               |            |                     |            |                                                                |            |                                                                                  |            |                                                                          |            |  |  |

 

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(1) 50,000 options vest on each of March 17, 2007,2008 and 2009.

(2) Amount represents stock-based compensation expensefor stock options granted in 2006 under SFAS 123R as discussed in Note 3 Summaryof Accounting Policies subheading “Share-based payments,” of the Notes to our ConsolidatedFinancial Statements included elsewhere in this annual report.

**OUTSTANDINGEQUITY AWARDS AT FISCAL YEAR-END**

The following table setsforth information for the named executive officers regarding the number ofshares subject to both exercisable and unexercisable stock options, as well asthe exercise prices and expiration dates thereof, as of December 31, 2006.

| Name                      | ** ** | **Number  of  Securities  Underlying  Unexercised  Options  (#)  Exercisable** | ** ** | **Number  of  Securities  Underlying  Unexercised  Options  (#)  Unexercisable** | ** ** | **Option  Exercise  Price  ($)** | ** ** | **Option  Expiration  Date** | ** ** |
|---------------------------|------------|--------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|----------------------------------|------------|------------------------------|------------|
| Gary S. Jacob             |       | 500,000                                                                        |       | —                                                                           |       | 1.50                             |       | June  13, 2013               |       |
|                           |       | 62,500                                                                         |       | 212,500                                                                          | (1)        | 3.00                             |       | June  29, 2014               |       |
|                           |       | 100,000                                                                        |       | 250,000                                                                          | (2)        | 1.01                             |       | July  6, 2015                |       |
|                           |       | 50,000                                                                         |       | 100,000                                                                          | (3)        | 1.64                             |       | March  17, 2016              |       |
|                      |       |                                                                           |       |                                                                             |       |                             |       |                         |       |
| Bernard F. Denoyer        |       | 100,000                                                                        |       | —                                                                           |       | 3.60                             |       | January  15, 2014            |       |
|                           |       | 25,000                                                                         |       | 50,000                                                                           | (4)        | 1.38                             |       | July  29, 2015               |       |
|                      |       |                                                                           |       |                                                                             |       |                             |       |                         |       |
| Gabriele M. Cerrone       |       | 189,167                                                                        |       | —                                                                           |       | 0.75                             |       | May  3, 2008                 |       |
|                           |       | 27,778                                                                         |       | —                                                                           |       | 0.75                             |       | October  1, 2009             |       |
|                           |       | 200,000                                                                        |       | —                                                                           |       | 1.25                             |       | January  18, 2011            |       |
|                           |       | 333,055                                                                        |       | —                                                                           |       | 1.30                             |       | April  22, 2013              |       |
|                           |       | 75,000                                                                         |       | —                                                                           |       | 1.50                             |       | June  13, 2013               |       |
|                           |       | 100,000                                                                        |       | —                                                                           |       | 3.20                             |       | April  26, 2014              |       |
|                           |       | 375,000                                                                        |       | —                                                                           |       | 1.70                             |       | January  10, 2015            |       |
|                      |       |                                                                           |       |                                                                             |       |                             |       |                         |       |
| Daniel S. D’Agostino |       | 100,000                                                                        |       | 300,000                                                                          | (5)        | 1.53                             |       | October  10, 2015            |       |

 

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(1)50,000 options vest on June 1, 2007 and 12,500 options will vest on June 1,2007 since we have established a second disease target for Atiprimod.  The remaining 150,000 options vest uponcertain drug development or licensing benchmarks.

(2)100,000 options vest on July 6, 2007 and 150,000 options vest on July 6, 2008.

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(3)50,000 options vest on each of March 17, 2008 and 2009.

(4)25,000 options vest on each of July 29, 2007 and 2008.

(5)100,000 options vest on each of October 10, 2007 and 2008.  The remaining 100,000 options vest upon thesuccessful in-licensing or acquisition of a drug candidate.

**DIRECTORCOMPENSATION**

The following table setsforth summary information concerning the total compensation paid to ournon-employee directors in 2006 for services to our company.

 
| Name                       | ** ** | **Fees Earned or  Paid in Cash  ($)** | ** ** | **Option   Awards ($) (1)** | ** ** | **Total ($)** | ** ** |
|----------------------------|------------|-----------------------------------------------------------|------------|--------------------------------------------|------------|--------------------|------------|
| Christoph  Bruening (2)    |       | 30,500                                                    |       | 519                                        |       | 31,019             |       |
| Riccardo  Dalla-Favera (3) |       | 15,000                                                    |       | 165                                        |       | 15,165             |       |
| John P.  Brancaccio (4)    |       | 31,500                                                    |       | 546                                        |       | 32,046             |       |
| Stephen K.  Carter (5)     |       | 23,000                                                    |       | 328                                        |       | 23,328             |       |
| Randall Johnson (6)        |       | 21,000                                                    |       | 274                                        |       | 21,274             |       |

 

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(1)****Amounts represent the expensed fairvalue for fiscal year 2006 of stock options granted in 2006 under SFAS 123R asdiscussed in Note 3 Summary of Significant Accounting Policies subheading “Share-basedpayments,” of the Notes to Consolidated Financial Statements included in thisreport.

(2) Stock options for thepurchase of an aggregate of 227,000 shares were outstanding as of December 31,2006, with a grant date fair value of $434,697.

(3) Stock options for thepurchase of an aggregate of 88,000 shares were outstanding as of December 31,2006, with a grant date fair value of $63,729.

(4) Stock options for thepurchase of an aggregate of 120,123 shares were outstanding as of December 31,2006, with a grant date fair value of $224,488.

(5) Stock options for thepurchase of an aggregate of 104,861 shares were outstanding as of December 31,2006, with a grant date fair value of $119,025.

(6) Stock options for thepurchase of an aggregate of 103,000 shares were outstanding as of December 31,2006, with a grant date fair value of $93,097.

**EMPLOYMENT AGREEMENTS AND CHANGE INCONTROL ARRANGEMENTS**

We are party to anemployment agreement with Gary S. Jacob, Ph.D. dated June 13, 2003, pursuant towhich Dr. Jacob serves as our Chief Executive Officer and Chief ScientificOfficer. Dr. Jacob’s employment agreement, as amended, is in effect untilDecember 31, 2009.  Dr. Jacob’s salaryis $300,000 per year and he is eligible to receive a cash bonus of up to$60,000 per year based on meeting performance objectives and bonus criteria tobe mutually identified by Dr. Jacob and the Board of Directors.   During 2006, Dr. Jacob earned a bonus of$48,125.  On February 16, 2007, Dr. Jacobwas granted 225,000 ten year incentive stock options exercisable at $0.81 pershare of which 75,000 vest on each of December 31, 2007, 2008 and 2009.  Dr. Jacob is a party to an Extension andSeverance Agreement with us dated June 9, 2005 as amended February 16, 2007which provides that in the event there is a change of control of our companyand the executive’s employment shall have been terminated within two yearsafter a change in control by him for good reason or by our company and suchtermination did not occur as a result of (i) the executive’s death, (ii) theexecutive’s disability, (iii) the executive’s retirement or (iv) the executive’stermination for cause, the executive shall be entitled to an amount equal tothe compensation due to the executive for the term of his employment under hisemployment agreement for the time remaining of such employment term. Inaddition, all of the executive’s unvested stock options shall immediately andirrevocably vest and the exercise period of such options will be extended tothe later of the longest period permitted by our stock option plans or tenyears following termination.  A “Changein Control” shall be deemed to have occurred if (i) there shall be consummated(A) any consolidation or merger of our company in which we are not thecontinuing or surviving corporation or pursuant to which shares of our commonstock would be converted into cash, securities or other property, other than amerger of our company in which the holders of our common stock immediatelyprior to the****merger have substantially thesame proportionate ownership of common stock of the surviving corporationimmediately after the merger, or (B) any sale, lease, exchange or othertransfer (in

45

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one transaction ora series of related transactions) of all or substantially all the assets of ourcompany; or (ii) the stockholders of our company shall approve any plan orproposal for the liquidation or dissolution of our company, (ii) any person (assuch term is used in Sections 13(d) and 14(d)(2) of the Securities Exchange Actof 1934 (the “Exchange Act”)), other than us or any employee benefit plansponsored by us, shall become the beneficial owner (within the meaning of Rule13d-3 under the Exchange Act) of our securities representing 20% or moreof the combined voting power of our then outstanding securities ordinarily (andapart from rights accruing in special circumstances) having the right to votein the election of directors, as a result of a tender or exchange offer, openmarket purchases, privately negotiated purchases or otherwise, or (iv) at anytime during a period of two consecutive years, individuals who at the beginningof such period constituted the Board of Directors of our company shall ceasefor any reason to constitute at least a majority thereof, unless the electionor the nomination for election by our stockholders of each new director duringsuch two-year period was approved by a vote of at least two-thirdsof the directors then still in office who were directors at the beginning ofsuch two-year period (or in the case that Dr. Jacob is our CEO, inaddition if the Board appoints a new CEO during the term of the agreement orsubstantially reduces the title and authority of Dr. Jacob without his priorconsent). Had a “Change of Control” occurred on December 31, 2006 and theexecutive had been terminated on that date, Dr. Jacob would have been eligiblefor total compensation (salary and bonus) for the term of his employment underhis employment agreement for the time remaining of such employment term, of$1,080,000.

We are party to an employment agreement with BernardDenoyer dated January 15, 2004, pursuant to which Mr. Denoyer serves as ourVice President, Finance and Secretary. Mr. Denoyer’s employment agreement isfor a term of 12 months beginning January 15, 2004 and is automaticallyrenewable for successive one year periods at the end of the term. On January15, 2004 Mr. Denoyer received a grant of 100,000 stock options which vest overa three year period and are exercisable at $3.60 per share. On July 29, 2005Mr. Denoyer was granted an additional 75,000 stock options which vest overthree years and are exercisable at $1.38 per share. On September 1, 2006 Mr.Denoyer’s salary was increased to $120,000 per year and he became eligible forto receive a cash bonus of up to 10% of his salary per year.

On October 10,2005 we entered into an employment agreement with Dan D’Agostino to serve asour Chief Business Officer. Pursuant to the employment agreement, we willemploy Mr. D’Agostino for a period of one year commencing October 10, 2005which term will be automatically renewed for successive one year periods untilwritten notice not to renew is delivered by either us or Mr. D’Agostino. Mr. D’Agostinowill be paid an annual base salary of $175,000. In addition, Mr. D’Agostinowill be eligible to earn an annual cash bonus up to 15% of his annual basesalary, plus up to $25,000 based on meeting performance objectives and bonuscriteria, specifically surrounding our corporate development plans to expandour technology and product portfolio.  Inaddition, Mr. D’Agostino’s employment agreement provides that in the eventthere is a change of control of our company and Mr. D’Agostino’s employmentshall have been terminated within two years after a change in control by himfor good reason or by our company and such termination did not occur as aresult of (i) death, (ii) disability, (iii) retirement or (iv) termination forcause, Mr. D’Agostino shall only be entitled to all of his unvested stockoptions immediately and irrevocably vesting and the exercise period of suchoptions will be extended to the later of the longest period permitted by ourstock option plans or ten years following termination. On October 10, 2005 Mr.D’Agostino was granted an aggregate 400,000 incentive stock options pursuant toour stock option plan with an exercise price of $1.53 per share. 300,000 ofsuch options will vest pursuant to the following schedule: 100,000 optionsvested on October 10, 2006; 100,000 options will vest on October 10, 2007; and100,000 options will vest on October 10, 2008. The remaining 100,000 optionswill vest upon the successful in-licensing of certain drug candidates. The fairvalue of Mr. D’Agostino’s unvested options as of December 31, 2006, which wouldhave vested had a “Change of Control” occurred as of December 31, 2006, was $342,172.

**CONSULTING AGREEMENTS**

On February 26, 2006 we entered into a consultingagreement with Dr. Arthur Sytkowski to be our medical monitor for clinical trials.Under the agreement Dr. Sytkowski is paid $250 per hour and reimbursed forexpenses. The term of the agreement is twelve months and can be terminated byhim or us with 90 days advanced notice.

On January 31, 2006 we entered into a consultingagreement with Dr. Moshe Talpaz, whereby Dr. Talpaz will provide consultingservices for our Degrasyns program. Under the agreement Dr. Talpaz will be paid$10,000 per year and was granted 575,000 10-year options to purchase our commonstock at $1.60 per share. Such options vest based on milestones related to theDegrasyns compounds being developed towards FDA approval. In addition, pursuantto the agreement we agreed to issue 75,000 restricted shares of common stock toDr. Talpaz subject to stockholder approval. The term of the agreement is forthe length of time we are developing the Degrasyns platform of compounds in allindications.

OnDecember 27, 2004, we entered into a consulting agreement with Gabriele M.Cerrone, our Chairman of the Board and a principal stockholder.  On January 25, 2007, we entered into anExtension and Amendment Agreement with Mr. Cerrone.  The agreement extendsthe term of the consulting agreement between us and Mr. Cerrone dated as ofDecember 27, 2004 to December 31, 2009. Among other things, the agreement increases Mr. Cerrone’s compensationfrom $205,000 to $275,000 per year.  In addition, Mr. Cerrone was granted225,000 ten year non-qualified stock options at an exercise price of $0.96 pershare of which 75,000 vest on each of December 31, 2007, 2008 and 2009. Additionally, pursuant to the agreement, in recognition of the servicesbeyond that required of Mr. Cerrone during the period from July 1, 2006 toJanuary 25, 2007, we will accrue a bonus to Mr. Cerrone of $75,000, payable onMarch 31, 2007.  Mr. Cerrone shall be eligible to earn a cash bonus of upto 22.5% of his base compensation for each twelve month period during the termof the agreement based

46

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onmeeting performance objectives and bonus criteria to be mutually identified byMr. Cerrone and our Board.  Underthe original agreement, Mr. Cerrone received a grant of 375,000 stock options,all of which have vested.

In the event the agreement is terminated without causeor for good reason, Mr. Cerrone will receive a cash payment equal to theaggregate amount of his annual fee for the then remaining term of the Agreementand all unvested stock options will immediately vest and the exercise period ofsuch options will be extended to the later of the longest period permitted by ourstock option plans or ten years following termination. In the event a change ofcontrol of the Company occurs, Mr. Cerrone shall be entitled to suchcompensation upon the subsequent termination of the agreement within two yearsof the change in control unless such termination is the result of Mr. Cerrone’sdeath, disability or retirement or his termination for cause.

On August 12, 2004, in connection with our L-Annamycinlicense, we entered into a consulting agreement with Roman Perez-Soler, M.D.,for a term concurrent with the L-Annamycin license agreement. In connectiontherewith Dr. Perez-Soler agreed to be appointed to our Scientific AdvisoryBoard. As consideration for consulting and advisory services Dr. Perez-Solershall receive a $30,000 per year consulting fee and 44,000 shares of restrictedcommon stock. In addition, we granted to Dr. Perez-Soler an option to purchase468,500 shares of common stock at an exercise price of $3.00 per share.

**STOCK OPTION PLANS**

We rely on incentive compensation in the form of stockoptions to retain and motivate directors, executive officers, employees andconsultants. Incentive compensation in the form of stock options is designed toprovide long-term incentives to directors, executive officers, employees andconsultants, to encourage them to remain with us and to enable them to developand maintain an ownership position in our common stock.

In 1996, we adopted the 1996 Incentive andNon-Qualified Stock Option Plan (the “Plan”) for employees, consultants andoutside directors to purchase up to 2,000,000 shares of common stock. This Planwas amended in December 2002 to increase the number of shares authorized underthe Plan to 10,000,000. The option term for 4,745,042 options outstanding todate under the Plan is ten years from date of grant. The Plan terminated onJanuary 1, 2006 under its original terms and no further options will be grantedunder the Plan.

On October 20, 2005, our stockholders approved the2005 Equity Compensation Incentive Plan. The maximum number of shares of commonstock with respect to which awards may be granted under the 2005 Equity Plan is5,000,000. The option term for options granted under the 2005 Equity Plan isten years from date of grant and there were 4,150,000 options available forfuture grants as of December 31, 2006.

On October 20, 2005, our stockholders approved our2005 Directors’ Stock Option Plan. The maximum number of shares of common stockwith respect to which awards may be granted under the 2005 Directors’ Plan is1,000,000. The option term for options granted under the 2005 Directors’ Planis ten years from date of grant and there are 894,000 option shares availablefor future grants as of December 31, 2006.

Our 2005 Equity Compensation Incentive Plan authorizesthe grant of stock options to directors (excluding outside directors), eligibleemployees, including executive officers and consultants. The value realizablefrom exercisable options is dependent upon the extent to which our performanceis reflected in the value of our common stock at any particular point in time.Equity compensation in the form of stock options is designed to providelong-term incentives to directors, executive officers and other employees. Weapprove the granting of options in order to motivate these employees tomaximize stockholder value. Generally, vesting for options granted under thestock option plan is determined at the time of grant, and options expire aftera 10-year period. Options are generally granted at an exercise price not lessthan the fair market value at the date of grant. As a result of this policy,directors, executives, employees and consultants are rewarded economically onlyto the extent that the stockholders also benefit through appreciation in themarket. Options granted to employees are based on such factors as individualinitiative, achievement and performance. In administering grants to executives,the Compensation Committee of the Board of Directors evaluates each executive’stotal equity compensation package. The compensation committee generally reviewsthe option holdings of each of the executive officers, including vesting andexercise price and the then current value of such unvested options. We considerequity compensation to be an integral part of a competitive executive compensationpackage and an important mechanism to align the interests of management withthose of our stockholders.

The options we grant under the 2005 Equity Plan may beeither “incentive stock options” within the meaning of Section 422 of theInternal Revenue Code of 1986, as amended (the “Code”), or non-statutory stockoptions at the discretion of the Board of Directors and as reflected in theterms of the written option agreement. None of our stock option plans arequalified deferred compensation plans under Section 401(a) of the Code, and arenot subject to the provisions of the Employee Retirement Income Security Act of1974, as amended (ERISA). As of December 31, 2006, we have 2,352,333 stockoptions outstanding not subject to our stock option plans.

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**ITEM 12. SECURITY OWNERSHIP OFCERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS**

The following table sets forth certain informationregarding beneficial ownership of shares of our common stock as of March 30,2007 by (i) each person know to beneficially own more than 5% of theoutstanding common stock, (ii) each of our directors, (iii) the Named ExecutiveOfficers and (iv) all directors and executive officers as a group. Except asotherwise indicated, the persons named in the table have sole voting andinvestment power with respect to all shares beneficially owned, subject tocommunity property laws, where applicable. Unless otherwise indicated, theaddress of each beneficial owner listed below is c/o Callisto Pharmaceuticals,Inc., 420 Lexington Avenue, Suite 1609, New York, N.Y. 10170.
|                                                                   | ** ** | **Shares of Common Stock** | ** ** |
|-------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                        | ** ** | **Beneficially Owned (1)**      | ** ** |
| **Name and Address of Beneficial Owner** | ** ** | **Number of Shares**            | ** ** | **Percentage of Class** | ** ** |
| ** **                                                        | ** ** | ** **                                | ** ** | ** ** | ** ** |
| Gabriele M. Cerrone                                               |       | 3,486,737                                 | (2)        | 8.6 | % |
| Chairman of the Board                                             |       |                                      |       |   |   |
|                                                              |       |                                      |       |   |   |
| Gary S. Jacob                                                     |       | 834,745                                   | (3)        | 2.1 | % |
| Chief Executive Officer,  Chief Scientific Officer                |       |                                      |       |   |   |
| and Director                                                      |       |                                      |       |   |   |
|                                                              |       |                                      |       |   |   |
| Bernard Denoyer                                                   |       | 125,000                                   | (4)        | * |   |
| Vice President, Finance and  Secretary                            |       |                                      |       |   |   |
|                                                              |       |                                      |       |   |   |
| Daniel S. D’Agostino                                         |       | 116,448                                   | (5)        | * |   |
| Chief Business Officer                                            |       |                                      |       |   |   |
|                                                              |       |                                      |       |   |   |
| Riccardo Dalla-Favera                                             |       | 27,000                                    | (6)        | * |   |
| Director                                                          |       |                                      |       |   |   |
|                                                              |       |                                      |       |   |   |
| Stephen Carter                                                    |       | 62,574                                    | (7)        | * |   |
| Director                                                          |       |                                      |       |   |   |
|                                                              |       |                                      |       |   |   |
| Christoph Bruening                                                |       | 576,865                                   | (8)        | 1.5 | % |
| Director                                                          |       |                                      |       |   |   |
|                                                              |       |                                      |       |   |   |
| John Brancaccio                                                   |       | 71,415                                    | (9)        | * |   |
| Director                                                          |       |                                      |       |   |   |
|                                                              |       |                                      |       |   |   |
| Randall K. Johnson                                                |       | 65,000                                    | (10)       | * |   |
| Director                                                          |       |                                      |       |   |   |
|                                                              |       |                                      |       |   |   |
| All Directors and Executive  Officers as a group (9 persons)      |       | 5,365,784                                 | (11)       | 12.8 | % |
|                                                              |       |                                      |       |   |   |
| Panetta Partners Ltd.                                             |       | 2,186,737                                 |       | 5.6 | % |

 

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* lessthan 1%

48

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(1)                   Applicablepercentage ownership as of March 30, 2007 is based upon 39,194,996 shares ofcommon stock outstanding.

(2)                   Consists of1,300,000 shares of common stock issuable upon exercise of stock options heldby Mr. Cerrone and 2,126,737 shares of common stock, 30,000 shares of commonstock issuable upon conversion of 2,250 shares of Series A ConvertiblePreferred Stock and 30,000 shares of common stock issuable upon exercise of thewarrants, each held by Panetta Partners, Ltd.   Mr. Cerrone is thesole managing partner of Panetta and in such capacity only exercises voting anddispositive control over securities owned by Panetta, despite him having only asmall pecuniary interest in such securities.

(3)                   Includes700,000 shares of common stock issuable upon exercise of stock options.

(4)                   Consists of125,000 shares of common stock issuable upon exercise of stock options.

(5)                   Includes 100,000shares of common stock issuable upon exercise of stock options.

(6)                   Consists of27,000 shares of common stock issuable upon exercise of stock options.

(7)                   Consists of62,574 shares of common stock issuable upon exercise of stock options.

(8)                   Includes of101,166 shares of common stock issuable upon exercise of stock options.

(9)                   Consists of71,415 shares of common stock issuable upon exercise of stock options.

(10)             Consists of 65,000shares of common stock issuable upon exercise of stock options.

(11)             Includes 2,552,155shares of common stock issuable upon exercise of stock options, 30,000 sharesof common stock issuable upon conversion of 2,250 shares of Series AConvertible Preferred Stock and 30,000 shares of common stock issuable uponexercise of the warrants.

Beneficial ownership is determined in accordance withthe rules of the Securities and Exchange Commission and generally includesvoting and investment power with respect to securities. Beneficial ownershipdetermined in this manner may not constitute ownership of such securities forother purposes or indicate that such person has an economic interest in suchsecurities.

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**ITEM 13. CERTAIN RELATIONSHIPS ANDRELATED TRANSACTIONS.**

OnDecember 27, 2004 we entered into a consulting agreement with Gabriele M.Cerrone, our Chairman of the Board and a principal shareholder.  On January 25, 2007, we enteredinto an Extension and Amendment Agreement with Mr. Cerrone.  The agreementextends the term of the consulting agreement between us and Mr. Cerrone datedas of December 27, 2004 to December 31, 2009. Among other things, the agreement increases Mr. Cerrone’s compensationfrom $205,000 to $275,000 per year.  In addition, Mr. Cerrone was granted225,000 ten year non-qualified stock options at an exercise price of $0.96 pershare of which 75,000 vest on each of December 31, 2007, 2008 and 2009. Additionally pursuant to the agreement, in recognition of the services beyondthat required of Mr. Cerrone during the period from July 1, 2006 to January 25,2007, we will accrue a bonus to Mr. Cerrone of $75,000, payable on March 31,2007.  Mr. Cerrone shall be eligible to earn a cash bonus of up to 22.5%of his base compensation for each twelve month period during the term of theagreement based on meeting performance objectives and bonus criteria to bemutually identified by Mr. Cerrone and our Board.

The agreement, the amendment and their respectiveterms were approved by our Compensation Committee, which consists solely ofindependent members of the Board. Additional information concerning the termsof the consulting agreement are set forth in Item 9 of this annual report.

**CONFLICTS OF INTEREST**

Gabriele Cerrone and his affiliates are subject tocertain potential conflicts of interests. His consulting agreement expresslyrecognizes that he may provide consulting services to others. In addition, fromtime to time, he or his affiliates may be presented with business opportunitieswhich could be suitable for our business and Mr. Cerrone is not subject to anyrestrictions with respect to other business activities, except to the extentsuch activities are in violation of our Code of Conduct and Ethics or violategeneral confidentiality provisions of his consulting agreement. In instanceswhere there is potential conflict of interest or business opportunity, withrespect to any officer or director, including Mr. Cerrone, our Audit Committeehas both the authority and responsibility to review such matters and takeappropriate actions.

Any future transactions with officers, directors or 5%stockholders will be on terms no less favorable to us than could be obtainedfrom independent parties. Any affiliated transactions must be approved by amajority of our independent and disinterested directors who have access to ourcounsel or independent legal counsel at our expense.

**ITEM 14. PRINCIPAL ACCOUNTANT FEESAND SERVICES**

**AUDIT FEES.**

The aggregate fees billed and unbilled for the fiscalyear ended December 31, 2006 for professional services rendered by ourprincipal accountants for the audits of our annual financial statements, thereview of our financial statements included in our quarterly reports on Form10-Q and consultations and consents were approximately $138,750. The aggregatefees billed and unbilled for the fiscal year ended December 31, 2005 forprofessional services rendered by our principal accountants for the audits ofour annual financial statements, the review of our financial statementsincluded in our quarterly reports on Form 10-Q and consultations andconsents were approximately $155,000.

**AUDIT-RELATED FEES.**

The aggregate fees billed for the fiscal year endedDecember 31, 2006 and 2005 for assurance and related services rendered by ourprincipal accountants related to the performance of the audit or review of ourfinancial statements, specifically accounting research, were approximately $0and $6,000, respectively.

**TAX AND OTHER FEES.**

There were no aggregate fees billed for the fiscalyears ended December 31, 2006 and 2005 as there were no tax related or otherservices rendered by our principal accountants in connection with thepreparation of our federal and state tax returns.

Consistent with SEC policies and guidelines regardingaudit independence, the Audit Committee is responsible for the pre-approval ofall audit and permissible non-audit services provided by our principalaccountants on a case-by-case basis. Our Audit Committee has established apolicy regarding approval of all audit and permissible non-audit servicesprovided by our principal accountants. Our Audit Committee pre-approves theseservices by category and service. Our Audit Committee has pre-approved all ofthe services provided by our principal accountants.

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**ITEM 15. EXHIBITS AND FINANCIALSTATEMENT SCHEDULES.**

(a)        *List of Documents Filed as a Part of This Report:*
| (1)     | *Index  to Consolidated Financial Statements:*                                                                                                                                             | F-1    |
|-----------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                        |                                                                                                                                                                                       |   |
|                        | Report of Independent Registered  Public Accounting Firm                                                                                                                                   | F-2    |
|                        | Consolidated  Balance Sheets as of December 31, 2006 and 2005                                                                                                                         | F-3    |
|                        | Consolidated  Statements of Operations for each of the three years in the period ended  December 31, 2006 and for the period from June 5, 1996 (inception) to  December 31, 2006      | F-4    |
|                        | Consolidated  Statements of Changes in Stockholders’ Equity (Deficit) for the period from  June 5, 1996 (inception) to December 31, 2006                                         | F-5    |
|                        | Consolidated  Statements of Cash Flows for each of the three years in the period ended  December 31, 2006 and for the period from June 5, 1996 (inception) to  December 31, 2006 | F-11   |
|                        | Notes to  Consolidated Financial Statements                                                                                                                                                | F-12   |

 

(2)        *Indexto Financial Statement Schedules:*

All schedules have been omitted because the requiredinformation is included in the consolidated financial statements or the notesthereto, or is not applicable or required.

(3)        *Indexto Exhibits*

Index to Exhibits
| Exhibit  Number | ** ** | **Description**                                                                                                                                                                                                                                                                                                     |
|-----------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |       |                                                                                                                                                                                                                                                                                                                |
| 3.1             |       | Certificate of Incorporation, as amended                                                                                                                                                                                                                                                                            |
|            |       |                                                                                                                                                                                                                                                                                                                |
| 3.2             |       | Certificate of Designations, Number, Voting Powers,  Preferences and Rights of Series A Convertible Preferred Stock of Callisto  Pharmaceuticals, Inc. (Incorporated by reference to Exhibit 3.1 filed with  the Company’s Current Report on Form 8-K filed on October 27, 2006)                               |
|            |       |                                                                                                                                                                                                                                                                                                                |
| 3.3             |       | Certificate of Amendment to Certificate of  Designations, Number, Voting Powers, Preferences and Rights of Series A  Convertible Preferred Stock of Callisto Pharmaceuticals, Inc. (Incorporated  by reference to Exhibit 3.2 filed with the Company’s Current Report on Form  8-K filed on December 27, 2006) |
|            |       |                                                                                                                                                                                                                                                                                                                |
| 3.4             |       | Bylaws (Incorporated by reference to Exhibit 99.2  filed with the Company’s Current Report on Form 8-K filed on May 28, 2003)                                                                                                                                                                        |
|            |       |                                                                                                                                                                                                                                                                                                                |
| 4.1             |       | 1996 Incentive and Non-Qualified Stock Option Plan  (Incorporated by reference to Exhibit 4.1 filed with the Company’s Current  Report on Form 8-K filed on May 15, 2003)                                                                                                                                      |
|            |       |                                                                                                                                                                                                                                                                                                                |
| 4.2             |       | Form of Warrant to purchase shares of common stock  issued in connection with the sale of common stock (Incorporated by reference  to Exhibit 4.1 filed with the Company’s Current Report on Form 8-K filed on  January 28, 2004)                                                                              |
|            |       |                                                                                                                                                                                                                                                                                                                |
| 4.3             |       | Form of Warrant issued to Trilogy Partners, Inc.  (Incorporated by reference to Exhibit 4.1 filed with the Company’s Current Report  on Form 8-K filed on July 22, 2005)                                                                                                                                       |
|            |       |                                                                                                                                                                                                                                                                                                                |
| 4.4             |       | 2005 Equity Compensation Incentive Plan  (Incorporated by reference to Appendix B filed with the Company’s Definitive  Proxy Statement on Schedule 14A filed on August 31, 2005)                                                                                                                               |
|            |       |                                                                                                                                                                                                                                                                                                                |
| 4.5             |       | 2005 Directors’ Stock Option Plan (Incorporated by  reference to Appendix C filed with the Company’s Definitive Proxy Statement  on Schedule 14A filed on August 31, 2005)                                                                                                                                |
|            |       |                                                                                                                                                                                                                                                                                                                |
| 4.6             |       | Form of Warrant to purchase Common Stock issued in  connection with the sale of Common Stock (Incorporated by reference to  Exhibit 4.1 filed with the Company’s Current Report on Form 8-K filed on  February 9, 2006)                                                                                        |

 

51

----

 
| 4.7    |   | Form of Warrant to purchase Common Stock issued to  certain selling agents in connection with the sale of Common Stock  (Incorporated by reference to Exhibit 4.2 filed with the Company’s Current  Report on Form 8-K filed on February 9, 2006)                                                                                                                           |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 4.8    |   | Form of Warrant issued pursuant to the Letter  Agreement dated September 8, 2006 between Callisto Pharmaceuticals, Inc. and  certain investors (Incorporated by reference to Exhibit 4.1 filed with the  Company’s Current Report on Form 8-K filed on September 14, 2006)                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 4.9    |   | Form of Warrant to purchase shares of Common Stock  issued in connection with the sale of the Series A Convertible Preferred  Stock (Incorporated by reference to Exhibit 4.1 filed with the Company’s  Current Report on Form 8-K filed on October 27, 2006)                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 10.1   |   | Employment Agreement dated June 13, 2003 by and  between Callisto Pharmaceuticals, Inc. and Gary S. Jacob (Incorporated by  reference to Exhibit 10.1 filed with the Company’s Quarterly Report on Form  10-QSB filed on August 20, 2003)*                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 10.2   |   | Employment Agreement dated April 6, 2004 by and  between Synergy Pharmaceuticals Inc. and Kunwar Shailubhai (Incorporated by  reference to Exhibit 10.2 filed with the Company’s Annual Report on Form  10-KSB on April 14, 2004)*                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 10.3   |   | License Agreement dated as of August 28, 2002 by and  between Synergy Pharmaceuticals Inc. and AnorMED Inc.(Incorporated by  reference to Exhibit 10.4 filed with the Company’s Current Report on Form  10-QSB filed on November 14, 2003)**                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 10.4   |   | Employment Agreement dated January 15, 2004 by and  between Callisto Pharmaceuticals, Inc and Bernard Denoyer (Incorporated by  reference to Exhibit 10.6 filed with the Company’s Annual Report on Form  10-KSB on April 14, 2004)*                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 10.5   |   | Patent and Technology License Agreement dated August  12, 2004 by and between The Board of Regents of the University of Texas  System, on behalf of The University of Texas M. D. Anderson Cancer Center and  Callisto Pharmaceuticals, Inc. (Incorporated by reference to Exhibit 10.1  filed with the Company’s Current Report on Form 8-K filed on September 7,  2004)** |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 10.6   |   | License Agreement between Callisto Pharmaceuticals,  Inc. and The Rockefeller University effective as of July 25, 2001  (Incorporated by reference to Exhibit 10.12 filed with the Company’s Annual  Report on Form 10-K filed on June 6, 2005)                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 10.7   |   | Extension and Severance Compensation Agreement dated  June 9, 2005 between Callisto Pharmaceuticals, Inc. and Gary S. Jacob  (Incorporated by reference to Exhibit 10.1 filed with the Company’s Current  Report on Form 8-K filed on June 15, 2005)*                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 10.8   |   | Letter of Engagement between Trilogy Capital Partners,  Inc. and Callisto Pharmaceuticals, Inc. dated July 18, 2005 (Incorporated by  reference to Exhibit 10.1 filed with the Company’s Current Report on Form 8-K  filed on July 22, 2005)                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 10.9   |   | Common Stock Purchase Agreement dated as of August  22, 2005 between Callisto Pharmaceuticals, Inc. and the investors listed on  Exhibit A thereto (Incorporated by reference to Exhibit 10.1 filed with the  Company’s Current Report on Form 8-K filed on August 26, 2005)                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 10.10  |   | Amendment dated October 19, 2005 to the Employment  Agreement dated as of June 13, 2003 by and between Callisto Pharmaceuticals,  Inc. and Gary S. Jacob (Incorporated by reference to Exhibit 10.1 filed with  the Company’s Current Report on Form 8-K filed on October 21, 2005)*                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 10.11  |   | Amendment dated October 19, 2005 to the Employment  Agreement dated as of January 15, 2004 by and between Callisto  Pharmaceuticals, Inc. and Bernard Denoyer (Incorporated by reference to  Exhibit 10.4 filed with the Company’s Current Report on Form 8-K filed on October  21, 2005)*                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 10.12  |   | Amendment dated October 19, 2005 to the Employment  Agreement dated as of April 6, 2004 by and between Synergy Pharmaceuticals  Inc. and Kunwar Shailubhai (Incorporated by reference to Exhibit 10.5 filed  with the Company’s Current Report on Form 8-K filed on October 21, 2005)*                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |

 

52

----

 
| 10.13  |   | Patent and Technology License Agreement dated  January 10, 2006 between The University of Texas M.D. Anderson Cancer Center  and Callisto Pharmaceuticals, Inc. **                                                                                                                                       |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                     |
| 10.14  |   | Securities Purchase Agreement dated February 3, 2006  between Callisto Pharmaceuticals, Inc. and the investors listed on Schedule A  thereto (Incorporated by reference to Exhibit 10.1 filed with the Company’s  Current Report on Form 8-K filed on February 9, 2006)                             |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 10.15  |   | Form of Letter Agreement dated September 8, 2006  between Callisto Pharmaceuticals, Inc. and certain investors (Incorporated by  reference to Exhibit 10.1 filed with the Company’s Current Report on Form 8-K  filed on September 14, 2006)                                                        |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 10.16  |   | Form of Amendment Agreement dated as of September 8,  2006 between Callisto Pharmaceuticals, Inc. and certain investors  (Incorporated by reference to Exhibit 10.2 filed with the Company’s Current  Report on Form 8-K filed on September 14, 2006)                                               |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 10.17  |   | Form of Lock-up Agreement dated as of September 8,  2006 between Callisto Pharmaceuticals, Inc. and certain investors  (Incorporated by reference to Exhibit 10.3 filed with the Company’s Current  Report on Form 8-K filed on September 14, 2006)                                                 |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 10.18  |   | Form of Securities Purchase Agreement dated October  23, 2006 by and among Callisto Pharmaceuticals, Inc. and the purchasers set  forth on the signature page thereto (Incorporated by reference to Exhibit  10.1 filed with the Company’s Current Report on Form 8-K filed on October 27,  2006)   |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 10.19  |   | Form of Registration Rights Agreement dated October  23, 2006 by and among Callisto Pharmaceuticals, Inc. and the purchaser’s  signatory thereto (Incorporated by reference to Exhibit 10.2 filed with the  Company’s Current Report on Form 8-K filed on October 27, 2006)                    |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 10.20  |   | Form of Securities Purchase Agreement dated December  20, 2006 by and among Callisto Pharmaceuticals, Inc. and the purchasers set  forth on the signature page thereto (Incorporated by reference to Exhibit  10.1 filed with the Company’s Current Report on Form 8-K filed on December  27, 2006) |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 10.21  |   | Form of Securities Purchase Agreement dated January  10, 2007 by and among Callisto Pharmaceuticals, Inc. and the purchasers set  forth on the signature page thereto (Incorporated by reference to Exhibit  10.1 filed with the Company’s Current Report on Form 8-K filed on January 17,  2007)   |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 10.22  |   | Extension and Amendment Agreement dated January 25,  2007 between Callisto Pharmaceuticals, Inc. and Gabriele M. Cerrone*                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 10.23  |   | Extension and Amendment Agreement dated February 16,  2007 between Callisto Pharmaceuticals, Inc. and Gary S. Jacob*                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 14     |   | Code of Business Conduct and Ethics (Incorporated by  reference to Exhibit 14 filed with the Company’s Annual Report on Form 10-KSB  filed on April 14, 2004)                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 21     |   | List of Subsidiaries                                                                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 23     |   | Consent of BDO Seidman, LLP                                                                                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 31.1   |   | Certification of Chief Executive Officer required  under Rule 13a-14(a)/15d-14(a) under the Exchange Act                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 31.2   |   | Certification of Principal Financial Officer  required under Rule 13a-14(a)/15d-14(a) under the Exchange Act                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 32.1   |   | Certification of Chief Executive Officer pursuant to  18 U.S.C Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 32.2   |   | Certification of Principal Financial Officer  pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002                                                                                                                                                   |

 

----

*      Management contract or compensatory planor arrangement required to be filed as an Exhibit to this form pursuant to Item601 of Regulation S-K.

53

----

**   Confidential treatment has been requestedwith respect to deleted portions of this agreement.

54

----

**SIGNATURES**

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized.

 
|                            |   | Callisto Pharmaceuticals, Inc. |
|----------------------------|--------|--------------------------------|
|                       |   |                           |
| Date: April  17, 2007 |   | By:                            | /s/ Gary S. Jacob |
|                       |   |                           | Gary S. Jacob,  Chief Executive Officer |

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, this report has been signed below by the followingpersons on behalf of the registrant and in the capacities and on the datesindicated.
| SIGNATURE                  | ** ** | **TITLE**                                    | ** ** | **DATE**       |
|----------------------------|------------|----------------------------------------------|------------|----------------|
|                       |       |                                         |       |           |
| /s/ Gary S.  Jacob         |       | Chief Executive Officer and Director         |       | April 17, 2007 |
| Gary S. Jacob              |       | (Principal Executive Officer)                |       |           |
|                       |       |                                         |       |           |
| /s/ Bernard F.  Denoyer    |       | Vice President, Finance                      |       | April 17, 2007 |
| Bernard F.  Denoyer        |       | (Principal Financial and Accounting Officer) |       |           |
|                       |       |                                         |       |           |
| /s/ Gabriele M.  Cerrone   |       | Chairman of the Board                        |       | April 17, 2007 |
| Gabriele M.  Cerrone       |       |                                         |       |           |
|                       |       |                                         |       |           |
| /s/ Riccardo  Dalla-Favera |       | Director                                     |       | April 17, 2007 |
| Riccardo  Dalla-Favera     |       |                                         |       |           |
|                       |       |                                         |       |           |
| /s/ John P.  Brancaccio    |       | Director                                     |       | April 17, 2007 |
| John P.  Brancaccio        |       |                                         |       |           |
|                       |       |                                         |       |           |
| /s/ Stephen K.  Carter     |       | Director                                     |       | April 17, 2007 |
| Stephen K.  Carter         |       |                                         |       |           |
|                       |       |                                         |       |           |
| /s/ Christoph  Bruening    |       | Director                                     |       | April 17, 2007 |
| Christoph  Bruening        |       |                                         |       |           |
|                       |       |                                         |       |           |
| /s/ Randall K.  Johnson    |       | Director                                     |       | April 17, 2007 |
| Randall K.  Johnson        |       |                                         |       |           |

 

55

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**CALLISTOPHARMACEUTICALS, INC.**(A Development Stage Company)

**Index toConsolidated Financial Statements**
| Report of Independent  Registered Public Accounting Firm                                 |   | F-2    |
|------------------------------------------------------------------------------------------|--------|--------|
|                                                                                     |   |   |
| Consolidated  Balance Sheets as of December 31, 2006 and 2005                            |   | F-3    |
|                                                                                     |   |   |
| Consolidated  Statements of Operations for the three years                               |   |   |
| in the period ended December  31, 2006 and for the period                                |   |   |
| from June 5, 1996  (inception) to December 31, 2006                                      |   | F-4    |
|                                                                                     |   |   |
| Consolidated  Statement of Changes in Stockholders’ Equity (Deficit)                |   |   |
| for the period from June 5,  1996 (inception) to December 31, 2006                       |   | F-5    |
|                                                                                     |   |   |
| Consolidated  Statements of Cash Flows for the three years in the period ended           |   |   |
| December 31, 2006 and for  the period from June 5, 1996 (inception) to December 31, 2006 |   | F-11   |
|                                                                                     |   |   |
| Notes  to Consolidated Financial Statements                                              |   | F-12   |

 

F-1

----

Report ofIndependent Registered Public Accounting Firm

Board of Directors and StockholdersCallisto Pharmaceuticals, Inc.New York, New York

We have audited the accompanying consolidated balancesheets of Callisto Pharmaceuticals, Inc. and Subsidiaries (a development stagecompany) (the “Company”) as of December 31, 2006 and 2005, the relatedconsolidated statements of operations and cash flows for each of the threeyears in the period ended December 31, 2006 and for the period from June 5,1996 (inception) to December 31, 2006 and the related consolidated statement ofstockholders’ equity (deficit) for the period from June 5, 1996 (inception) toDecember 31, 2006. These financial statements are the responsibility of theCompany’s management. Our responsibility is to express an opinion on thesefinancial statements based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. The Company is not required to have, nor were we engaged toperform, an audit of its internal control over financial reporting. Our auditsincluded consideration of internal control over financial reporting as a basisfor designing audit procedures that are appropriate in the circumstances, butnot for the purpose of expressing an opinion on the effectiveness of theCompany’s internal control over financial reporting. Accordingly, we express nosuch opinion. An audit also includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements, assessingthe accounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the financialposition of Callisto Pharmaceuticals, Inc. and Subsidiaries as of December 31,2006 and 2005, and the results of their operations and their cash flows foreach of the three years in the period ended December 31, 2006 and for theperiod from June 5, 1996 (inception) to December 31, 2006, in conformity withaccounting principles generally accepted in the United States of America.

The accompanying financial statements have beenprepared assuming that the Company will continue as a going concern. Asdiscussed in Note 2 to the financial statements, the Company has sufferedrecurring losses from operations and has a net capital deficiency that raisesubstantial doubt about its ability to continue as a going concern. Management’splans in regard to these matters are also described in Note 2. The financialstatements do not include any adjustments that might result from the outcome ofthis uncertainty.

As described in Note 3, in 2006 the Company adoptedprovisions of Statement of Financial Accounting Standard No. 123(R) “ShareBased Payments” utilizing the modified prospective transition method.
| /s/ BDO Seidman, LLP |   |
|----------------------|--------|
|                 |
| New York, New York   |
| April 13, 2007       |

F-2

----

**CALLISTOPHARMACEUTICALS, INC.**(A Development Stage Company)**CONSOLIDATED BALANCE SHEETS**
| ** **                                                                                                                                                                         | ** ** | **AS OF DECEMBER 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                                                                                                         | ** ** | **2006**                              | ** ** | **2005** | ** ** |
| **ASSETS**                                                                                                                                                                         |       |                                  |       |   |   |
| Current assets:                                                                                                                                                                    |       |                                  |       |   |   |
| Cash and cash  equivalents                                                                                                                                                         |       | $                                     | 3,904,232  |   | $ | 1,420,510 |   |
| Prepaid expenses and  other                                                                                                                                                        |       | 66,741                                |       | 181,284 |   |
|                                                                                                                                                                               |       |                                  |       |   |   |
|                                                                                                                                                                               |       | 3,970,973                             |       | 1,601,794 |   |
|                                                                                                                                                                               |       |                                  |       |   |   |
| Property and equipment  - net                                                                                                                                                      |       | 6,451                                 |       | — |   |
| Security deposits                                                                                                                                                                  |       | 73,716                                |       | 82,196 |   |
|                                                                                                                                                                               |       |                                  |       |   |   |
|                                                                                                                                                                               |       | $                                     | 4,051,140  |   | $ | 1,683,990 |   |
|                                                                                                                                                                               |       |                                  |       |   |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)**                                                                                                                            |       |                                  |       |   |   |
| Current liabilities:                                                                                                                                                               |       |                                  |       |   |   |
| Accounts payable                                                                                                                                                                   |       | $                                     | 1,843,422  |   | $ | 1,424,612 |   |
| Accrued expenses                                                                                                                                                                   |       | 1,357,600                             |       | 592,297 |   |
|                                                                                                                                                                               |       |                                  |       |   |   |
|                                                                                                                                                                               |       | 3,201,022                             |       | 2,016,909 |   |
| Stockholders’ equity  (deficit):                                                                                                                                              |       |                                  |       |   |   |
| Series A convertible  preferred stock, par value $0.0001, 700,000 shares authorized, 586,125 shares  outstanding at December 31, 2006 with a liquidation preference of $5,861,250. |       | 58                                    |       | — |   |
| Common stock, par value  $.0001, 100,000,000 shares authorized, 39,194,996 and 33,233,096 shares  outstanding at December 31, 2006 and 2005, respectively.                         |       | 3,919                                 |       | 3,323 |   |
| Additional paid-in  capital                                                                                                                                                        |       | 61,290,509                            |       | 46,387,875 |   |
| Unamortized deferred  stock based compensation                                                                                                                                     |       | —                                |       | (1,583,463 | ) |
| Deficit accumulated during  development stage                                                                                                                                      |       | (60,444,368                           | )          | (45,140,654 | ) |
|                                                                                                                                                                               |       | 850,118                               |       | (332,919 | ) |
|                                                                                                                                                                               |       |                                  |       |   |   |
|                                                                                                                                                                               |       | $                                     | 4,051,140  |   | $ | 1,683,990 |   |

 

The accompanying notesare an integral part of these consolidated financial statements

F-3

----

**CALLISTO PHARMACEUTICALS, INC.**

(A Development Stage Company)

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**
| ** **                                                                     | ** ** | ** **                                                    | ** **  | ** **            | ** ** | ** **  | ** ** | **For the**           | ** ** |
|--------------------------------------------------------------------------------|------------|---------------------------------------------------------------|-------------|-----------------------|------------|-------------|------------|----------------------------|------------|
| ** **                                                                     | ** ** | ** **                                                    | ** **  | ** **            | ** ** | ** **  | ** ** | **period From**       | ** ** |
| ** **                                                                     | ** ** | ** **                                                    | ** **  | ** **            | ** ** | ** **  | ** ** | **June 5, 1996** | ** ** |
| ** **                                                                     | ** ** | ** **                                                    | ** **  | ** **            | ** ** | ** **  | ** ** | **(Inception) to**    | ** ** |
| ** **                                                                     | ** ** | **For the years ended December 31,** | ** **  | **December 31,** | ** ** |
| ** **                                                                     | ** ** | **2006**                                                      | ** **  | **2005**              | ** ** | **2004**    | ** ** | **2006**                   | ** ** |
| Revenues                                                                       |       | $                                                             | —      |                  | $          | —      |       | $                          | —     |   | $ | — |   |
|                                                                           |       |                                                          |        |                  |       |        |       |                       |       |
| Costs and expenses:                                                            |       |                                                          |        |                  |       |        |       |                       |       |
|                                                                           |       |                                                          |        |                  |       |        |       |                       |       |
| Research and  development                                                      |       | 6,031,953                                                     |        | 6,430,504             |       | 4,325,975   |       | 22,037,815                 |       |
|                                                                           |       |                                                          |        |                  |       |        |       |                       |       |
| Government grant                                                               |       | (352,649                                                      | )           | (226,119              | )          | (265,697    |       | (844,465                   | )          |
|                                                                           |       |                                                          |        |                  |       |        |       |                       |       |
| Purchased in process  research and development                                 |       | —                                                        |        | —                |       | 209,735     |       | 6,944,553                  |       |
|                                                                           |       |                                                          |        |                  |       |        |       |                       |       |
| General and  administrative                                                    |       | 5,112,876                                                     |        | 4,968,249             |       | 3,566,727   |       | 20,753,740                 |       |
|                                                                           |       |                                                          |        |                  |       |        |       |                       |       |
| Stock-based  compensation – non-employees                                 |       | 1,373,991                                                     |        | 889,277               |       | 20,228      |       | 9,698,561                  |       |
|                                                                           |       |                                                          |        |                  |       |        |       |                       |       |
| Loss from operations                                                           |       | (12,166,171                                                   | )           | (12,061,911           | )          | (7,856,968  | )          | (58,590,204                | )          |
|                                                                           |       |                                                          |        |                  |       |        |       |                       |       |
| Interest and investment  income                                                |       | 48,632                                                        |        | 105,303               |       | 84,081      |       | 703,616                    |       |
| Other income (expense)                                                         |       | (801,690                                                      | )           | 177,151               |       | 229,420     |       | (173,295                   | )          |
|                                                                           |       |                                                          |        |                  |       |        |       |                       |       |
| Net loss                                                                       |       | (12,919,229                                                   | )           | (11,779,457           | )          | (7,543,467  | )          | (58,059,883                | )          |
|                                                                           |       |                                                          |        |                  |       |        |       |                       |       |
| Series A Preferred  stock beneficial conversion feature accreted as a dividend |       | (2,384,485                                                    | )           | —                |       | —      |       | (2,384,485                 | )          |
| Net loss available to  common stockholders                                     |       | $                                                             | (15,303,714 | )                     | $          | (11,779,457 | )          | $                          | (7,543,467 | ) | $ | (60,444,368 | ) |
|                                                                           |       |                                                          |        |                  |       |        |       |                       |       |
| Weighted average shares  outstanding:                                          |       |                                                          |        |                  |       |        |       |                       |       |
| basic and diluted                                                              |       | 37,941,267                                                    |        | 31,527,060            |       | 28,485,227  |       |                       |       |
|                                                                           |       |                                                          |        |                  |       |        |       |                       |       |
| Net loss per common  share:                                                    |       |                                                          |        |                  |       |        |       |                       |       |
| basic and diluted                                                              |       | $                                                             | (0.40       | )                     | $          | (0.37       | )          | $                          | (0.26      | ) |   |   |

 

The accompanying notesare an integral part of these consolidated financial statements

F-4

----

**CALLISTO PHARMACEUTICALS, INC.**

(A Development Stage Company)

**CONSOLIDATEDSTATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (DEFICIT)**
| ** **                                 | ** ** | **Preferred  Shares** | ** ** | **Preferred  Stock,  Par Value** | ** ** | **Common  Shares** | ** ** | **Common  Stock,  Par Value** | ** ** | **Additional  Paid in Capital** | ** ** |
|--------------------------------------------|------------|-----------------------|------------|---------------------------------------|------------|--------------------|------------|------------------------------------|------------|-------------------------------------------|------------|
| Balance at inception,  June 5, 1996        |       | —                |       | —                                |       | —             |       | —                             |       | —                                    |       |
| Net loss for the period                    |       |                  |       |                                  |       |               |       |                               |       |                                      |       |
| Issuance of founder  shares                |       | —                |       | —                                |       | 2,642,500          |       | 264                                |       | 528                                       |       |
| Common stock issued                        |       | —                |       | —                                |       | 1,356,194          |       | 136                                |       | 272                                       |       |
| Common stock issued via  private placement |       | —                |       | —                                |       | 1,366,667          |       | 137                                |       | 1,024,863                                 |       |
| Balance, December 31,  1996                |       | —                |       | —                                |       | 5,365,361          |       | 537                                |       | 1,025,663                                 |       |
| Net loss for the year                      |       | —                |       | —                                |       | —             |       | —                             |       | —                                    |       |
| Common stock issued via  private placement |       | —                |       | —                                |       | 1,442,666          |       | 144                                |       | 1,081,855                                 |       |
|                                       |       |                  |       |                                  |       |               |       |                               |       |                                      |       |
| Balance, December 31,  1997                |       | —                |       | —                                |       | 6,808,027          |       | 681                                |       | 2,107,518                                 |       |
| Net loss for the year                      |       | —                |       | —                                |       | —             |       | —                             |       | —                                    |       |
| Amortization of Stock  based Compensation  |       | —                |       | —                                |       | —             |       | —                             |       | 52,778                                    |       |
| Common stock issued via  private placement |       | —                |       | —                                |       | 1,416,667          |       | 142                                |       | 1,062,358                                 |       |
| Common stock issued for  services          |       | —                |       | —                                |       | 788,889            |       | 79                                 |       | 591,588                                   |       |
| Common stock  repurchased and cancelled    |       | —                |       | —                                |       | (836,792           | )          | (84                                | )          | (96,916                                   | )          |
|                                       |       |                  |       |                                  |       |               |       |                               |       |                                      |       |
| Balance, December 31,  1998                |       | —                |       | —                                |       | 8,176,791          |       | 818                                |       | 3,717,326                                 |       |
| Net loss for the year                      |       | —                |       | —                                |       | —             |       | —                             |       | —                                    |       |
| Deferred Compensation -  stock options     |       | —                |       | —                                |       | —             |       | —                             |       | 9,946                                     |       |
| Amortization of Stock  based Compensation  |       | —                |       | —                                |       | —             |       | —                             |       | —                                    |       |
| Common stock issued for  services          |       | —                |       | —                                |       | —             |       | —                             |       | 3,168,832                                 |       |
| Common stock issued via  private placement |       | —                |       | —                                |       | 346,667            |       | 34                                 |       | 259,966                                   |       |
|                                       |       |                  |       |                                  |       |               |       |                               |       |                                      |       |
| Balance, December 31,  1999                |       | —                |       | —                                |       | 8,523,458          |       | 852                                |       | 7,156,070                                 |       |
| Net loss for the year                      |       | —                |       | —                                |       | —             |       | —                             |       | —                                    |       |
| Amortization of Stock  based Compensation  |       | —                |       | —                                |       | —             |       | —                             |       | —                                    |       |
| Common stock issued                        |       | —                |       | —                                |       | 4,560,237          |       | 455                                |       | 250,889                                   |       |
| Other                                      |       | —                |       | —                                |       | —             |       | —                             |       | 432                                       |       |
| Preferred shares issued                    |       | 3,485,299             |       | 348                                   |       | —             |       | —                             |       | 5,986,302                                 |       |
| Preferred stock issued  for services       |       | 750,000               |       | 75                                    |       | —             |       | —                             |       | 1,124,925                                 |       |
| Balance, December 31,  2000                |       | 4,235,299             |       | 423                                   |       | 13,083,695         |       | 1,307                              |       | 14,518,618                                |       |
| Net loss for the year                      |       | —                |       | —                                |       | —             |       | —                             |       | —                                    |       |
| Deferred Compensation -  stock Options     |       | —                |       | —                                |       | —             |       | —                             |       | 20,000                                    |       |
| Amortization of Stock  based Compensation  |       | —                |       | —                                |       | —             |       | —                             |       | —                                    |       |
| Balance, December 31,  2001                |       | 4,235,299             |       | 423                                   |       | 13,083,695         |       | 1,307                              |       | 14,538,618                                |       |
| Net loss for the year                      |       | —                |       | —                                |       | —             |       | —                             |       | —                                    |       |
| Amortization of Stock  based Compensation  |       | —                |       | —                                |       | —             |       | —                             |       | —                                    |       |
|                                       |       |                  |       |                                  |       |               |       |                               |       |                                      |       |
| Balance, December 31, 2002                 |       | 4,235,299             |       | 423                                   |       | 13,083,695         |       | 1,307                              |       | 14,538,618                                |       |

 

The accompanying notesare an integral part of these consolidated financial statements

F-5

----

 
| ** **                                 | ** ** | **Unamortized  Deferred  Stock Based  Compensation** | ** ** | **Deficit  Accumulated  during the  Development  Stage** | ** ** | **Total  Stockholders’  Equity** | ** ** |
|--------------------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------|------------|
| Balance at inception,  June 5, 1996        |       | —                                                    |       | —                                                        |       | —                                |       |
| Net loss for the year                      |       |                                                      |       | (404,005                                                      | )          | (404,005                              | )          |
| Issuance of founder  shares                |       | —                                                    |       | —                                                        |       | 792                                   |       |
| Common stock issued                        |       | —                                                    |       | —                                                        |       | 408                                   |       |
| Common stock issued via  private placement |       | —                                                    |       | —                                                        |       | 1,025,000                             |       |
| Balance, December 31,  1996                |       | —                                                    |       | (404,005                                                      | )          | 622,195                               |       |
| Net loss for the year                      |       | —                                                    |       | (894,505                                                      | )          | (894,505                              | )          |
| Common stock issued via  private placement |       | —                                                    |       | —                                                        |       | 1,081,999                             |       |
|                                       |       |                                                      |       |                                                          |       |                                  |       |
| Balance, December 31,  1997                |       | —                                                    |       | (1,298,510                                                    | )          | 809,689                               |       |
| Net loss for the year                      |       | —                                                    |       | (1,484,438                                                    | )          | (1,484,438                            | )          |
| Amortization of Stock  based Compensation  |       | —                                                    |       | —                                                        |       | 52,778                                |       |
| Common stock issued                        |       |                                                      |       |                                                          |       | 1,062,500                             |       |
| Common stock issued for  services          |       | —                                                    |       | —                                                        |       | 591,667                               |       |
| Common Stock  repurchased and cancelled    |       | —                                                    |       | —                                                        |       | (97,000                               | )          |
|                                       |       |                                                      |       |                                                          |       |                                  |       |
| Balance, December 31,  1998                |       | —                                                    |       | (2,782,948                                                    | )          | 935,196                               |       |
| Net loss for the year                      |       | —                                                    |       | (4,195,263                                                    | )          | (4,195,263                            | )          |
| Deferred Compensation -  stock options     |       | (9,946                                                    | )          | —                                                        |       | —                                |       |
| Amortization of Stock  based Compensation  |       | 3,262                                                     |       | —                                                        |       | 3,262                                 |       |
| Common stock issued for  services          |       | —                                                    |       | —                                                        |       | 3,168,832                             |       |
| Common stock issued via  private placement |       | —                                                    |       | —                                                        |       | 260,000                               |       |
|                                       |       |                                                      |       |                                                          |       |                                  |       |
| Balance, December 31,  1999                |       | (6,684                                                    | )          | (6,978,211                                                    | )          | 172,027                               |       |
| Net loss for the year                      |       |                                                      |       | (2,616,261                                                    | )          | (2,616,261                            | )          |
| Amortization of Stock  based Compensation  |       | 4,197                                                     |       |                                                          |       | 4,197                                 |       |
| Common stock issue                         |       | —                                                    |       | —                                                        |       | 251,344                               |       |
| Other                                      |       | —                                                    |       | —                                                        |       | 432                                   |       |
| Preferred shares issued                    |       | —                                                    |       | —                                                        |       | 5,986,650                             |       |
| Preferred stock issued  for services       |       | —                                                    |       | —                                                        |       | 1,125,000                             |       |
| Balance, December 31,  2000                |       | (2,487                                                    | )          | (9,594,472                                                    | )          | 4,923,389                             |       |
| Net loss for the year                      |       | —                                                    |       | (1,432,046                                                    | )          | (1,432,046                            | )          |
| Deferred Compensation -  stock options     |       | (20,000                                                   | )          | —                                                        |       | —                                |       |
| Amortization of Stock  based Compensation  |       | 22,155                                                    |       | —                                                        |       | 22,155                                |       |
| Balance, December 31,  2001                |       | (332                                                      | )          | (11,026,518                                                   | )          | 3,513,498                             |       |
| Net loss for the year                      |       | —                                                    |       | (1,684,965                                                    | )          | (1,684,965                            | )          |
| Amortization of Stock  based Compensation  |       | 332                                                       |       | —                                                        |       | 332                                   |       |
|                                       |       |                                                      |       |                                                          |       |                                  |       |
| Balance, December 31, 2002                 |       | —                                                    |       | (12,711,483                                                   | )          | 1,828,865                             |       |

 

The accompanying notesare an integral part of these consolidated financial statements

F-6

----

 
| ** **                                                   | ** ** | **Preferred  Stock** | ** ** | **Preferred  Stock  Par  Value** | ** ** | **Common  Stock** | ** ** | **Common  Stock  Par  Value** | ** ** | **Additional  Paid in  Capital** | ** ** | **Unamortized  Deferred  Stock Based  Compensation** | ** ** | **Deficit  Accumulated  during the  Development  Stage** | ** **  | **Total  Stockholders’  Equity** | ** ** |
|--------------------------------------------------------------|------------|----------------------|------------|----------------------------------|------------|-------------------|------------|-------------------------------|------------|---------------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------------------------------|-------------|---------------------------------------|------------|
| Balance December 31, 2002                                    |       | 4,235,299            |       | 423                              |       | 13,083,695        |       | 1,307                         |       | 14,538,618                            |       | —                                                    |       | $                                                             | (12,711,483 | )                                     | 1,828,865  |   |
|                                                         |       |                 |       |                             |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |        |                                  |       |
| Net loss for the year                                        |       | —               |       | —                           |       | —            |       | —                        |       | —                                |       | —                                                    |       | (13,106,247                                                   | )           | (13,106,247                           | )          |
|                                                         |       |                 |       |                             |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |        |                                  |       |
| Conversion of preferred  stock in connection with the Merger |       | (4,235,299           | )          | (423                             | )          | 4,235,299         |       | 423                           |       | —                                |       | —                                                    |       | —                                                        |        | —                                |       |
|                                                         |       |                 |       |                             |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |        |                                  |       |
| Common stock issued to former  Synergy stockholders          |       | —               |       |                             |       | 4,329,927         |       | 432                           |       | 6,494,458                             |       | —                                                    |       | —                                                        |        | 6,494,890                             |       |
|                                                         |       |                 |       |                             |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |        |                                  |       |
| Common stock issued  in exchange for Webtronics common stock |       | —               |       |                             |       | 1,503,173         |       | 150                           |       | (150                                  | )          | —                                                    |       | —                                                        |        | —                                |       |
|                                                         |       |                 |       |                             |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |        |                                  |       |
| Deferred Compensation -  stock options                       |       | —               |       |                             |       | —            |       | —                        |       | 9,313,953                             |       | (9,313,953                                                | )          | —                                                        |        | —                                |       |
|                                                         |       |                 |       |                             |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |        |                                  |       |
| Amortization of  deferred Stock based Compensation           |       | —               |       |                             |       | —            |       | —                        |       | —                                |       | 3,833,946                                                 |       | —                                                        |        | 3,833,946                             |       |
|                                                         |       |                 |       |                             |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |        |                                  |       |
| Private placement of  common stock, net                      |       | —               |       | —                           |       | 2,776,666         |       | 278                           |       | 3,803,096                             |       | —                                                    |       | —                                                        |        | 3,803,374                             |       |
| Balance, December 31, 2003                                   |       | —               |       | —                           |       | 25,928,760        |       | 2,590                         |       | 34,149,975                            |       | (5,480,007                                                | )          | (25,817,730                                                   | )           | 2,854,828                             |       |
|                                                              |            |                      |            |                                  |            |                   |            |                               |            |                                       |            |                                                           |            |                                                               |             |                                       |            |  |

 

The accompanying notesare an integral part of these consolidated financial statements

F-7

----

 
| ** **                                                                       | ** ** | **Preferred  Stock** | ** ** | **Preferred  Stock  Par  Value** | ** ** | **Common  Stock** | ** ** | **Common  Stock  Par  Value** | ** ** | **Additional  Paid in  Capital** | ** ** | **Unamortized  Deferred  Stock Based  Compensation** | ** ** | **Deficit  Accumulated  during the  Development  Stage** | ** ** | **Total  Stockholders’  Equity** | ** ** |
|----------------------------------------------------------------------------------|------------|----------------------|------------|----------------------------------|------------|-------------------|------------|-------------------------------|------------|---------------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------|------------|
| Balance, December31, 2003                                                        |       | —               |       | —                           |       | 25,928,760        |       | 2,590                         |       | 34,149,975                            |       | (5,480,007                                                | )          | (25,817,730                                                   | )          | 2,854,828                             |       |
|                                                                             |       |                 |       |                             |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| Net loss for the period                                                          |       | —               |       | —                           |       | —            |       | —                        |       | —                                |       | —                                                    |       | (7,543,467                                                    | )          | (7,543,467                            | )          |
|                                                                             |       |                 |       |                             |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| Amortization of deferred  Stock-based compensation expense                       |       | —               |       | —                           |       | —            |       | —                        |       | —                                |       | 3,084,473                                                 |       | —                                                        |       | 3,084,473                             |       |
|                                                                             |       |                 |       |                             |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| Variable accounting for  stock options                                           |       | —               |       | —                           |       | —            |       | —                        |       | (816,865                              | )          | —                                                    |       | —                                                        |       | (816,865                              | )          |
|                                                                             |       |                 |       |                             |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| Stock-based compensation  net of forfeitures                                     |       | —               |       | —                           |       | —            |       | —                        |       | 240,572                               |       | 93,000                                                    |       | —                                                        |       | 333,572                               |       |
|                                                                             |       |                 |       |                             |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| Common stock issued via  private placements, net                                 |       | —               |       | —                           |       | 3,311,342         |       | 331                           |       | 6,098,681                             |       | —                                                    |       | —                                                        |       | 6,099,012                             |       |
|                                                                             |       |                 |       |                             |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| Warrant and stock-based  compensation for services in connection with the Merger |       | —               |       | —                           |       | —            |       | —                        |       | 269,826                               |       | —                                                    |       | —                                                        |       | 269,826                               |       |
|                                                                             |       |                 |       |                             |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| Common stock returned  from former Synergy stockholders                          |       | —               |       | —                           |       | (90,000           | )          | (9                            | )          | (159,083                              | )          | —                                                    |       | —                                                        |       | (159,092                              | )          |
|                                                                             |       |                 |       |                             |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| Stock issued for patent  rights                                                  |       | —               |       | —                           |       | 25,000            |       | 3                             |       | 56,247                                |       | —                                                    |       | —                                                        |       | 56,250                                |       |
|                                                                             |       |                 |       |                             |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| Common stock issued for  services                                                |       | —               |       | —                           |       | 44,000            |       | 7                             |       | 70,833                                |       | —                                                    |       | —                                                        |       | 70,840                                |       |
|                                                                             |       |                 |       |                             |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| Balance, December 31, 2004                                                       |       | —               |       | —                           |       | 29,219,102        |       | 2,922                         |       | 39,910,187                            |       | (2,302,534                                                | )          | (33,361,197                                                   | )          | 4,249,378                             |       |

 

The accompanying notesare an integral part of these consolidated financial statements

F-8

----

 
| ** **                                                | ** ** | **Common  Stock** | ** ** | **Common  Stock  Par  Value** | ** ** | **Additional  Paid in  Capital** | ** ** | **Unamortized  Deferred  Stock Based  Compensation** | ** ** | **Deficit  Accumulated  during the  Development  Stage** | ** ** | **Total  Stockholders’  Equity(Deficit)** | ** ** |
|-----------------------------------------------------------|------------|-------------------|------------|-------------------------------|------------|---------------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------------------------------|------------|------------------------------------------------|------------|
| Balance, December 31, 2004                                |       | 29,219,102        |       | $                             | 2,922      |                                  | $          | 39,910,187                                                |       | $                                                             | (2,302,534 | )                                              | $          | (33,361,197 | ) | $ | 4,249,378 |   |
|                                                      |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                           |       |
| Net loss for the year                                     |       | —            |       | —                        |       | —                                |       | —                                                    |       | (11,779,457                                                   | )          | (11,779,457                                    | )          |
|                                                      |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                           |       |
| Deferred stock- based compensation  - new grants          |       | —            |       | —                        |       | 1,571,772                             |       | (1,571,772                                                | )          | —                                                        |       | —                                         |       |
|                                                      |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                           |       |
| Amortization of deferred  stock-  based compensation |       | —            |       | —                        |       | —                                |       | 2,290,843                                                 |       | —                                                        |       | 2,290,843                                      |       |
|                                                      |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                           |       |
| Variable accounting for  stock options                    |       | —            |       | —                        |       | 75,109                                |       | —                                                    |       | —                                                        |       | 75,109                                         |       |
|                                                      |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                           |       |
| Common stock issued via  private placement:               |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                           |       |
| March 2005                                                |       | 1,985,791         |       | 198                           |       | 3,018,203                             |       | —                                                    |       | —                                                        |       | 3,018,401                                      |       |
| August 2005                                               |       | 1,869,203         |       | 187                           |       | 1,812,940                             |       | —                                                    |       | —                                                        |       | 1,813,127                                      |       |
| Finders fees and  expenses                                |       | —            |       | —                        |       | (176,250                              | )          | —                                                    |       | —                                                        |       | (176,250                                       | )          |
|                                                      |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                           |       |
| Exercise of common  stock warrant                         |       | 125,000           |       | 13                            |       | 128,737                               |       | —                                                    |       | —                                                        |       | 128,750                                        |       |
|                                                      |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                           |       |
| Common stock issued for  services                         |       | 34,000            |       | 3                             |       | 47,177                                |       | —                                                    |       | —                                                        |       | 47,180                                         |       |
|                                                      |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                           |       |
| Balance, December 31, 2005                                |       | 33,233,096        |       | $                             | 3,323      |                                  | $          | 46,387,875                                                |       | $                                                             | (1,583,463 | )                                              | $          | (45,140,654 | ) | $ | (332,919 | ) |

 

The accompanying notesare an integral part of these consolidated financial statements

F-9

----

 
| ** **                                                                                   | ** ** | **Series A  Convertible  Preferred  Shares** | ** ** | **Convertible  Preferred  Stock** | ** ** | **Common  Stock** | ** ** | **Common  Stock  Par  Value** | ** ** | **Additional  Paid in  Capital** | ** ** | **Unamortized  Deferred  Stock Based  Compensation** | ** ** | **Deficit  Accumulated  during the  Development  Stage** | ** ** | **Total  Stockholders’  Equity** | ** ** |
|----------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|-------------------------------|------------|---------------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------|------------|
| Balance, December 31,  2005                                                                  |       | —                                            |       | —                            |       | 33,233,096        |       | $                             | 3,323      |                                  | $          | 46,387,875                                                |       | $                                                             | (1,583,463 | )                                     | $          | (45,140,654 | ) | $ | (332,919 | ) |
|                                                                                         |       |                                              |       |                              |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| Net loss for the period                                                                      |       | —                                            |       | —                            |       | —            |       | —                        |       | —                                |       | —                                                    |       | (12,919,229                                                   | )          | (12,919,229                           | )          |
|                                                                                         |       |                                              |       |                              |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| Reclassification of  deferred unamortized stock-based compensation upon adoption of FAS 123R |       |                                              |       |                              |       |              |       |                          |       | (1,583,463                            | )          | 1,583,463                                                 |       |                                                          |       | —                                |       |
|                                                                                         |       |                                              |       |                              |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| Stock based  compensation expense                                                            |       |                                              |       |                              |       |              |       |                          |       | 2,579,431                             |       |                                                      |       |                                                          |       | 2,579,431                             |       |
|                                                                                         |       |                                              |       |                              |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| Common stock issued via  private placement:                                                  |       |                                              |       |                              |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| February 2006                                                                                |       |                                              |       |                              |       | 4,283,668         |       | 428                           |       | 5,139,782                             |       |                                                      |       |                                                          |       | 5,140,210                             |       |
| Finders fees and  expenses                                                                   |       |                                              |       |                              |       |              |       |                          |       | (561,808                              | )          |                                                      |       |                                                          |       | (561,808                              | )          |
| April 2006                                                                                   |       |                                              |       |                              |       | 666,667           |       | 67                            |       | 799,933                               |       |                                                      |       |                                                          |       | 800,000                               |       |
| Finders fees and  expenses                                                                   |       |                                              |       |                              |       |              |       |                          |       | (41,000                               | )          |                                                      |       |                                                          |       | (41,000                               | )          |
| Waiver and  Lock-up Agreement                                                                |       |                                              |       |                              |       | 740,065           |       | 74                            |       | 579,622                               |       |                                                      |       |                                                          |       | 579,696                               |       |
|                                                                                         |       |                                              |       |                              |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| Common stock issued for  services                                                            |       |                                              |       |                              |       | 87,000            |       | 9                             |       | 121,101                               |       |                                                      |       |                                                          |       | 121,110                               |       |
|                                                                                         |       |                                              |       |                              |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| Exercise of common  stock warrants                                                           |       |                                              |       |                              |       | 184,500           |       | 18                            |       | 190,017                               |       |                                                      |       |                                                          |       | 190,035                               |       |
|                                                                                         |       |                                              |       |                              |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| Series A convertible  preferred stock issued via private placement:                          |       | 574,350                                           |       | 57                                |       |              |       |                          |       | 5,743,443                             |       |                                                      |       |                                                          |       | 5,743,500                             |       |
| Finders fees and  expenses                                                                   |       | 11,775                                            |       | 1                                 |       |              |       |                          |       | (448,909                              | )          |                                                      |       |                                                          |       | (448,908                              | )          |
| Detachable  warrants                                                                         |       |                                              |       |                              |       |              |       |                          |       | 2,384,485                             |       |                                                      |       |                                                          |       | —                                |       |
| Beneficial  conversion feature accreted as a dividend                                        |       | —                                            |       |                              |       | —            |       | —                        |       | —                                |       | —                                                    |       | (2,384,485                                                    | )          | —                                |       |
| Balance, December 31, 2006                                                                   |       | 586,125                                           |       | $                                 | 58         |              | 39,194,996 |                          | $          | 3,919                                 |       | $                                                         | 61,290,509 |                                                          | $          | —                                |       | $ | (60,444,368 | ) | $ | 850,118 |   |
|                                                                                              |            |                                                   |            |                                   |            |                   |            |                               |            |                                       |            |                                                           |            |                                                               |            |                                       |            |  |  |  |  |  |  |

 

The accompanying notesare an integral part of these consolidated financial statements

F-10

----

**CALLISTO PHARMACEUTICALS, INC.**

(A Development Stage Company)

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**
| ** **                                                                                                  | ** ** | **For the years ended December 31,** | ** **  | **Period from  June 5, 1996  (inception) to  December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|-------------|--------------------------------------------------------------------------------------|------------|
| ** **                                                                                                  | ** ** | **2006**                                                      | ** **  | **2005**                                                                             | ** ** | **2004** | ** ** | **2006** | ** ** |
| Cash flows from  operating activities:                                                                      |       |                                                          |        |                                                                                 |       |   |   |   |   |
| Net loss                                                                                                    |       | $                                                             | (12,919,229 | )                                                                                    | $          | (11,779,457 | ) | $ | (7,543,467 | ) | $ | (58,059,883 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities:                                |       |                                                          |        |                                                                                 |       |   |   |   |   |
| Depreciation                                                                                                |       | 2,151                                                         |        | 18,856                                                                               |       | 27,632 |   | 86,788 |   |
| Stock-based  compensation expense                                                                           |       | 2,746,478                                                     |        | 2,419,694                                                                            |       | 2,732,770 |   | 16,517,445 |   |
| Purchased in-process  research and development (non-cash portion)                                           |       | —                                                        |        | —                                                                               |       | 106,235 |   | 6,841,053 |   |
| Stock-based liquidated  damages                                                                             |       | 579,696                                                       |        | —                                                                               |       | — |   | 579,696 |   |
| Changes in operating  assets and liabilities:                                                               |       |                                                          |        |                                                                                 |       |   |   |   |   |
| Prepaid expenses                                                                                            |       | 114,543                                                       |        | (136,053                                                                             | )          | 7,413 |   | (66,741 | ) |
| Security deposit                                                                                            |       | 8,480                                                         |        | —                                                                               |       | (19,216 | ) | (73,716 | ) |
| Accounts payable and  accrued expenses                                                                      |       | 1,138,176                                                     |        | 790,058                                                                              |       | (43,481 | ) | 2,908,594 |   |
| Total adjustments                                                                                           |       | 4,589,524                                                     |        | 3,092,555                                                                            |       | 2,811,353 |   | 26,793,119 |   |
|                                                                                                        |       |                                                          |        |                                                                                 |       |   |   |   |   |
| Net cash used in  operating activities                                                                      |       | (8,329,705                                                    | )           | (8,686,902                                                                           | )          | (4,732,114 | ) | (31,266,764 | ) |
| Cash flows from  investing activities:                                                                      |       |                                                          |        |                                                                                 |       |   |   |   |   |
| Acquisition of  equipment                                                                                   |       | (8,602                                                        | )           | —                                                                               |       | — |   | (93,239 | ) |
| Net cash used in  investing activities                                                                      |       | (8,602                                                        | )           | —                                                                               |       | — |   | (93,239 | ) |
|                                                                                                        |       |                                                          |        |                                                                                 |       |   |   |   |   |
| Cash flows from  financing activities:                                                                      |       |                                                          |        |                                                                                 |       |   |   |   |   |
| Issuance of common and  preferred stock                                                                     |       | 11,683,710                                                    |        | 4,831,528                                                                            |       | 6,533,144 |   | 36,969,173 |   |
| Finders fees and  expenses                                                                                  |       | (1,051,716                                                    | )           | (176,250                                                                             | )          | (434,132 | ) | (2,023,723 | ) |
| Exercise of common  stock warrants                                                                          |       | 190,035                                                       |        | 128,750                                                                              |       | — |   | 318,785 |   |
| Net cash provided by  financing activities                                                                  |       | 10,822,029                                                    |        | 4,784,028                                                                            |       | 6,099,012 |   | 35,264,235 |   |
|                                                                                                        |       |                                                          |        |                                                                                 |       |   |   |   |   |
| Net  increase (decrease) in cash and cash equivalents                                                       |       | 2,483,722                                                     |        | (3,902,874                                                                           | )          | 1,366,898 |   | 3,904,232 |   |
|                                                                                                        |       |                                                          |        |                                                                                 |       |   |   |   |   |
| Cash and cash  equivalents at beginning of period                                                           |       | 1,420,510                                                     |        | 5,323,384                                                                            |       | 3,956,486 |   | — |   |
|                                                                                                        |       |                                                          |        |                                                                                 |       |   |   |   |   |
| Cash and cash  equivalents at end of period                                                                 |       | $                                                             | 3,904,232   |                                                                                 | $          | 1,420,510 |   | $ | 5,323,384 |   | $ | 3,904,232 |   |
| Supplementary  disclosure of cash flow information:                                                         |       |                                                          |        |                                                                                 |       |   |   |   |   |
| Cash paid for  taxes                                                                                        |       | $                                                             | 13,880      |                                                                                 | $          | 46,643 |   | $ | 2,921 |   | $ | 123,487 |   |
| Cash paid for  interest                                                                                     |       | $                                                             | —      |                                                                                 | $          | — |   | $ | — |   | $ | — |   |
|                                                                                                        |       |                                                          |        |                                                                                 |       |   |   |   |   |
| Supplemental disclosure  of non-cash investing and financing activities:                                    |       |                                                          |        |                                                                                 |       |   |   |   |   |
| Accretion of  fair value of beneficial conversion feature as a dividend to Series A  Preferred stockholders |       | $                                                             | 2,384,485   |                                                                                 | $          | — |   | $ | — |   | $ | 2,384,485 |   |
| Stock options,  warrants and common stock issued for services                                               |       | $                                                             | 2,746,478   |                                                                                 | $          | 2,419,694 |   | $ | 2,732,770 |   | $ | 16,517,445 |   |
| Stock-based  liquidated damages                                                                             |       | $                                                             | 579,676     |                                                                                 | $          | — |   | $ | — |   | $ | 579,676 |   |

 

 The accompanyingnotes are an integral part of these consolidated financial statements

F-11

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**CALLISTO PHARMACEUTICALS, INC.**

(A Development StageCompany)

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

**1. Business overview:**

Callisto Pharmaceuticals, Inc. (“Callisto”) is adevelopment stage biopharmaceutical company, whose primary focus is onbiopharmaceutical product development. See footnote 4 for a completedescription of Merger and consolidation. Since inception in June of 1996Callisto’s efforts have been principally devoted to research and development,securing and protecting patents and raising capital. From inception throughDecember 31, 2006, Callisto has sustained cumulative net losses of $58,059,883.Callisto’s losses have resulted primarily from expenditures incurred inconnection with research and development activities, application and filing forregulatory approval of proposed products, stock based compensation expense,patent filing and maintenance expenses, purchase of in-process research anddevelopment, outside accounting and legal services and regulatory, scientificand financial consulting fees. From inception through December 31, 2006,Callisto has not generated any revenue from operations, expects to incuradditional losses to perform further research and development activities anddoes not currently have any commercial biopharmaceutical products, and does notexpect to have such for several years, if at all.

Callisto’s product development efforts are thus intheir early stages and Callisto cannot make estimates of the costs or the timethey will take to complete. The risk of completion of any program is highbecause of the many uncertainties involved in bringing new drugs to marketincluding the long duration of clinical testing, the specific performance ofproposed products under stringent clinical trial protocols, the extendedregulatory approval and review cycles, the nature and timing of costs andcompeting technologies being developed by organizations with significantlygreater resources.

**2. Basis of presentation and going concern:**

The accompanying consolidated financial statements ofCallisto which include its wholly owned subsidiaries: (1) Callisto ResearchLabs, LLC (including its wholly owned but inactive subsidiary, Callisto Pharma,GmbH (Germany)) and (2) Synergy Pharmaceuticals Inc. (“Synergy”, including itswholly owned but inactive subsidiary IgX, Ltd (Ireland)), have been prepared inaccordance with accounting principles generally accepted in the United States ofAmerica (“GAAP”). The results of operations of Synergy are included in theconsolidated financial statements from May 1, 2003 to December 31, 2006. Allintercompany balances and transactions have been eliminated (see footnote 4).

The consolidated financial statements as of December31, 2006 have been prepared under the assumption that Callisto will continue asa going concern for the twelve months ending December 31, 2007. Callisto’sability to continue as a going concern is dependent upon its ability to obtainadditional equity or debt financing, attain further operating efficiencies and,ultimately, to generate revenue. The financial statements do not include anyadjustments that might result from the outcome of this uncertainty. Callisto will be required to raise additional capital within the next twelvemonths to complete the development and commercialization of current productcandidates and to continue to fund operations at its current cash expenditurelevels.

Cash used in operating activities was $8.3 million,$8.7 million and $4.7 million for the twelve months ended December 31, 2006,2005 and 2004 respectively. During the year ended December 31, 2006, 2005 and2004 Callisto incurred net losses of approximately $12.9 million, $11.8 millionand $7.5 million, respectively.

To date, Callisto’s sources of cash have beenprimarily limited to the sale of equity securities. Net cash provided byfinancing activities for the twelve months ended December 31, 2006, 2005 and2004 was approximately $10.8 million, $4.8 million and $6.1 millionrespectively. Callisto cannot be certain that additional funding will beavailable on acceptable terms, or at all. To the extent that Callisto can raiseadditional funds by issuing equity securities, Callisto’s stockholders mayexperience significant dilution. Any debt financing, if available, may involverestrictive covenants that impact Callisto’s ability to conduct its business.If Callisto is unable to raise additional capital when required or onacceptable terms, it may have to significantly delay, scale back or discontinuethe development and/or commercialization of one or more of Callisto’s productcandidates. Callisto also may be required to:

·             seek collaborators for product candidatesat an earlier stage than otherwise would be desirable and on terms that areless favorable than might otherwise be available; and

·             relinquish licensesor otherwise dispose of rights to technologies, product candidates or productsthat Callisto would otherwise seek to develop or commercialize ourselves, onunfavorable terms.

 

F-12

----

**3. Summary of significant accounting policies**

Use of Estimates - The preparationof financial statements in conformity with GAAP requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reporting period. Actual results could differ from those estimates.

Cash and cash equivalents - Cash andcash equivalents consist of short term, highly liquid investments, withoriginal maturities of less than three months when purchased and are stated atcost.

Fair value of financial instruments- Callisto’s financial instruments consist of cash and accounts payable. Thesefinancial instruments are stated at their respective carrying values which areequivalent to fair value due to their short term nature.

Business concentrations and credit risks- All of Callisto’s cash and cash equivalents as of December 31, 2006 and 2005are on deposit with a major money center financial institution. Deposits at anypoint in time may exceed federally insured limits.

Share-basedpayments - In December 2004, the Financial AccountingStandards Board (FASB) issued Statement of Financial Accounting Standard (“SFAS”)No. 123 (Revised 2004), *Share-BasedPayments* (“SFAS 123R”). SFAS 123R requires a public entity tomeasure the cost of employee services received in exchange for the award ofequity instruments based on the fair value of the award at the date of grant.The expense is to be recognized over the period during which an employee isrequired to provide services in exchange for the award. SFAS 123R is effectiveas of the beginning of the first interim or annual reporting period that beginsafter December 15, 2005 and accordingly Callisto adopted SFAS 123R onJanuary 1 , 2006.

SFAS 123R providesfor two transition methods. The “modified *prospective”*method requires that share-based compensation expense be recorded for anyemployee options granted after the adoption date and for the unvested portionof any employee options outstanding as of the adoption date. The “ *modified retrospective**“* method requires that, beginning in thefirst quarter of 2006, all prior periods presented be restated to reflect theimpact of share-based compensation expense consistent with the proformadisclosures previously required under SFAS 123. Callisto has elected to use the“modified *prospective*” method inadopting this standard.

Prior toJanuary 1, 2006, Callisto had adopted SFAS No. 123, “Accounting forStock-Based Compensation” (“SFAS 123”). As provided for by SFAS 123, Callistohad elected to continue to account for stock-based compensation according tothe provisions of Accounting Principles Board Opinion No. 25, “Accountingfor Stock Issued to Employees” (“APB 25”). Accordingly, compensation expensehad been recognized to the extent of employee or director services renderedbased on the intrinsic value of stock options granted under the plan. Callistoaccounts for common stock, stock options, and warrants granted to non-employeesbased on the fair market value of the instrument, using the Black-Scholesoption pricing model based on assumptions for expected stock price volatility,term of the option, risk-free interest rate and expected dividend yield at thegrant date.

For all awardsgranted prior to January 1, 2006, the unearned deferred fair value ofstock based compensation is being recognized as an expense on a straight linebasis over the remaining requisite service period, which ranged from ninemonths to three years at the date of adoption. Our financial results for priorperiods have not been restated. The adoption of SFAS 123R increased net lossfor the twelve months ended December 31, 2006 by $1,372,487, or $0.03 pershare, for stock based compensation cost related to employee stock options. Theunrecognized compensation cost related to non-vested share-based compensationarrangements for all employee stock options outstanding at December 31, 2006,as measured at the date of grant, was $621,853 and will be recognized over aweighted average vesting period of 1.37 years.

Effective with theadoption of SFAS 123R stock-based compensation expense related to Callisto’sshare-based compensation arrangements attributable to employees is beingrecorded as a component of general and administrative expense and research anddevelopment expense in accordance with the guidance of Staff AccountingBulletin 107 **,** Topic 14, paragraphF *. Classification of Compensation ExpenseAssociated with Share-Based Payment Arrangements* (“SAB 107”). Priorperiod financial statement accounts have been reclassified to conform tothis presentation.

F-13

----

Stock basedcompensation expense related to employee and non-employee stock options recognizedin operating results for the twelve months ended December 31, 2006, 2005 and2004 and for the period from June 6, 1996 (inception), through December 31,2006 was as follow:
| ** **                                               | ** ** | **Twelve Months Ended ,** | ** ** | **December 31,** | ** ** | **June 5, 1996  (Inception) to  December 31** | ** ** |
|----------------------------------------------------------|------------|------------------------------------------|------------|-----------------------|------------|-------------------------------------------------------------------|------------|
| **Stock based compensation expense**      | ** ** | **2006**                                 | ** ** | **2005**              | ** ** | **2004**                                                          | ** ** | **2006** | ** ** |
| ** **                                               | ** ** | ** **                               | ** ** | ** **            | ** ** | ** **                                                        | ** ** | ** ** | ** ** |
| Employees —  included in research and development   |       | $                                        | 420,683    |                  | $          | 276,250                                                           |       | $ | 1,508,588 |   | $ | 2,552,542 |   |
| Employees —  included in general and administrative |       | 951,804                                  |       | 1,254,167             |       | 1,203,954                                                         |       | 4,266,342 |   |
| Subtotal  employee stock option grants                   |       | 1,372,487                                |       | 1,530,417             |       | 2,712,542                                                         |       | 6,818,884 |   |
|                                                     |       |                                     |       |                  |       |                                                              |       |   |   |
| Non-employee —  research and development            |       | 102,750                                  |       | —                |       | —                                                            |       | 102,750 |   |
| Non-employee —  general and administrative          |       | 1,271,241                                |       | 889,277               |       | 20,228                                                            |       | 9,595,811 |   |
| Subtotal  non-employee stock option grants               |       | 1,373,991                                |       | 889,277               |       | 20,228                                                            |       | 9,698,561 |   |
| Total stock based  compensation expense                  |       | $                                        | 2,746,478  |                  | $          | 2,419,694                                                         |       | $ | 2,732,770 |   | $ | 16,517,445 |   |

 

The estimated fair valueof employee options granted was determined in accordance with SFAS 123R on thedate of grant using the Black-Scholes option valuation model with the followingweighted-average assumptions for options granted during the twelve months endedDecember 31, 2006: risk free interest of 4.25% to 4.57%, dividend yield 0% andexpected option term of 3 to 7 years. The risk-free interest rate assumption isbased upon observed interest rates appropriate for the expected term ofCallisto’s employee stock options. Callisto has not paid any dividends oncommon stock since its inception and does not anticipate paying dividends onits common stock in the foreseeable future. The computation of the expectedoption term is based on expectations regarding future exercises of optionswhich generally vest over 3 years and have a 10 year life. Theexpected volatility is based on the historical volatility of Callisto’s stockand was 79% for all options granted during the 3 months ended March 31, 2006and then 60% for option grants since April 1, 2006.

SFAS 123R requiresforfeitures to be estimated at the time of grant and revised, if necessary, insubsequent periods if actual forfeitures differ from those estimates.  Callisto estimated future unvested optionforfeitures based on historical Company experience and has incorporated this ratein determining the fair value of employee option grants.

Callisto’s determination of fair value is affected byCallisto’s stock price as well as the assumptions discussed above that requirejudgment. The weighted-average fair value of all options granted during thetwelve months ended December 31, 2006, estimated as of the grant date using theBlack-Scholes option valuation model, was $0.091 per share. See footnotes 6. *Stock option plans and 8. Commitments and contingencies*, foradditional information about Callisto’s stock option plans and option grants.

A summary of stock option activity as of December 31,2006 and of changes in options outstanding under Callisto’s plans during thetwelve months ended December 31, 2006 is presented below:
| ** **                           | ** ** | **Number**          | ** ** | **Exercise  Price** | ** **       | **Weighted  Average  Exercise  Price** | ** ** |
|--------------------------------------|------------|---------------------|------------|---------------------|------------------|----------------------------------------|------------|
| ** **                           | ** ** | **of options** | ** ** | **Per Share**  | ** **       | **Per Share**                     | ** ** |
|                                 |       |                |       |                |             |                                   |       |
| Balance,  December 31, 2005          |       | 8,008,210           |       | $                   | 0.75 - 6.75      |                                   | $          | 1.79 |   |
| 2006: Granted                        |       | 978,500             |       | $                   | 0.77 - 1.64      |                                   | $          | 1.48 |   |
| Forfeitures                          |       | (933,335            | )          | $                   | 0.75 – 3.00 |                                   | $          | 1.78 |   |
| Balance, December 31,  2006          |       | 8,053,375           |       | $                   | 0.75 – 6.75 |                                   | $          | 1.75 |   |
| Exercisable as of  December 31, 2006 |       | 5,424,046           |       | $                   | 0.75 – 6.75 |                                   | $          | 1.62 |   |

 

SFAS 123R requiresthat cash flows resulting from tax deductions in excess of the cumulativecompensation cost recognized for options exercised (excess tax benefits) beclassified as cash inflows from financing activities and cash outflows fromoperating activities. Due to Callisto’s accumulated deficit position, no taxbenefits have been recognized in the cash flow statement.

F-14

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Had compensationcost for stock options granted to employees and directors prior toJanuary 1, 2006 been determined based upon the fair value at the grantdate for awards, consistent with the methodology prescribed under SFAS 123,Callisto’s net loss for the twelve months ended December 31, 2005 and 2004would have been as follows:
| ** **                                                                                                  | ** ** | **2005**               | ** **  | **2004**      | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|------------------------|-------------|---------------|------------|
| Net loss  applicable to common stockholders, as reported                                                    |       | $                      | (11,779,457 | )             | $          | (7,543,467 | ) |
|                                                                                                        |       |                   |        |          |       |
| Add: Stock-based  employee compensation expense recorded under APB No. 25 intrinsic method                  |       | 1,530,417              |        | 2,712,542     |       |
| Deduct:  Stock-based employee compensation expense determined under Fair Value based  method for all awards |       | (2,526,419             | )           | (2,916,720    | )          |
|                                                                                                        |       |                   |        |          |       |
| Pro forma net  loss applicable to common stockholders                                                       |       | $                      | (12,775,459 | )             | $          | (7,747,645 | ) |
|                                                                                                        |       |                   |        |          |       |
| Net loss per  share:                                                                                        |       |                   |        |          |       |
| Basic and  diluted - as reported                                                                            |       | $                      | (0.37       | )             | $          | (0.26 | ) |
|                                                                                                        |       |                   |        |          |       |
| Basic and  diluted -pro forma                                                                               |       | $                      | (0.41       | )             | $          | (0.27 | ) |
|                                                                                                        |       |                   |        |          |       |
| Weighted average  fair value per share for options granted                                                  |       | $                      | 0.93        |          | $          | 1.81 |   |
|                                                                                                        |       |                   |        |          |       |
| Black-Scholes  Methodology Assumptions:                                                                     |       |                   |        |          |       |
|                                                                                                        |       |                   |        |          |       |
| Expected stock  volatility                                                                                  |       | 79                     | %           | 100           | %          |
| Dividend yield                                                                                              |       | 0                      | %           | 0             | %          |
| Risk free  interest rate                                                                                    |       | 4.25                   | %           | 2.87% to 4.5  | %          |
| Expected lives of  options                                                                                  |       | 3 to 7 years |        | 7 to 10 years |       |

 

Research and development - Callistodoes not currently have any commercial biopharmaceutical products, and does notexpect to have such for several years, if at all and therefore, because thebenefits are uncertain, and occur only when research leads to a commercialproduct, research and development costs are expensed as incurred as prescribedby SFAS No. 2. These include expenditures in connection with an in-houseresearch and development laboratory, salaries and staff costs, application andfiling for regulatory approval of proposed products, patent filing andmaintenance expenses, purchase of in-process research and development,regulatory and scientific consulting fees as well as contract research androyalty payments to licensors, patient costs, drug formulation and tableting,data collection, monitoring, insurance, and FDA consultants.

Income taxes - Income taxes areaccounted for under the asset and liability method prescribed by SFAS No. 109, “Accountingfor Income Taxes.” Deferred income taxes are recorded for temporary differencesbetween financial statement carrying amounts and the tax basis of assets andliabilities. Deferred tax assets and liabilities reflect the tax rates expectedto be in effect for the years in which the differences are expected to reverse.A valuation allowance is provided if it is more likely than not that some orthe entire deferred tax asset will not be realized.

Net Loss per Share- Basic and diluted net loss per share is presented in conformity with SFASNo. 128, “Earnings per Share,” for all periods presented. In accordancewith SFAS No. 128, basic and diluted net loss per common share wasdetermined by dividing net loss applicable to common stockholders by theweighted-average common shares outstanding during the period. Diluted weighted-averageshares are the same as basic weighted-average shares since the inclusion ofissuable shares pursuant to the exercise of stock options and warrants, wouldhave been antidilutive. As of December 31, 2006 there were 15,841,154 warrantsand 8,053,375 stock options outstanding, and at December 31, 2005 there were2,567,317 warrants and 8,008,210 stock options outstanding. In additionCallisto had 7,658,000 common shares issuable upon conversion of its Series Aconvertible preferred stock as of December 31, 2006 (See Note 5 below) and nopreferred stock was outstanding as of December 31, 2005 and 2004.

Government Grants- On October 7, 2003 Callisto was awarded a $265,697 Small Business TechnologyTransfer Research grant from the National Institutes of Health for studies onAtiprimod. The Principal and Co-Principal Investigators of the grant entitled “Atiprimodto Treat Multiple Myeloma and Bone Resorption” are Dr. Gary S. Jacob, ChiefExecutive Officer of Callisto, and Dr. Kenneth C. Anderson, Director of the JeromeLipper Multiple Myeloma Center of the Dana-Farber Cancer Institute,respectively. Funding for the total amount of this grant was received duringthe twelve months ended December 31, 2004 and $265,697 has been reported on ourConsolidated Statements of Operations as a separate line item entitled “GovernmentGrant”.

F-15

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On April 1, 2005Callisto was awarded an $885,641 biodefense partnership grant from the NationalInstitute of Allergy and Infectious Diseases (“NIAID”) to develop a monoclonalantibody and vaccine against bacterial superantigen toxins over a two yearperiod.  Callisto receives cash fundingunder approved grants and records the receipt as an offset to research anddevelopment expense only when the expense is incurred. Funds received as an offsetto research and development expenses incurred totaled $352,649 and $226,119during the twelve months ended December 31, 2006 and 2005, respectively andhave been reported on our Condensed Consolidated Statements of Operations as aseparate line item entitled “Government Grant”. In addition as of December 31, 2006 Callisto has received approximately$294,000 of cash advances under the NIAID grant for which it had not yetincurred any expenses and this amount is included in a segregated cash accountand in current liabilities.  During October 2006 Callisto usedapproximately $75,000 of this cash, to pay operating expenses not specificallyrelated to the work on the biodefense program, until the proceeds from the saleof Series A Convertible Preferred Stock were received during the quarter endedDecember 31, 2006.

RECENT ACCOUNTING PRONOUNCEMENTS:

In February 2007, the FASB issued Statement ofFinancial Accounting Standards No.159, “The Fair Value Option for FinancialAssets and Financial Liabilities, including an Amendment to SFAS 115” (“SFAS159”). The fair value option established by SFAS 159 permits all entities tomeasure all eligible items at fair value at specified election dates. Abusiness entity shall report all unrealized gains and losses on items for whichthe fair value option has been elected in earnings at each subsequent reportingdate. The provisions of SFAS 159 are effective for fiscal years beginning afterNovember 15, 2007. Callisto is currently evaluating the impact, if any, of theprovisions of SFAS 159.

In December 2006, theFinancial Accounting Standards Board (“FASB”) issued a FASB Staff Position (“FSP”)Emerging Issues Task Force (“EITF”) Issue No. 00-19-2”Accounting forRegistration Payment Arrangements” (“FSP 00-19-2”) which addresses an issuer’saccounting for registration payment arrangements. FSP 00-19-2 specifies thatthe contingent obligation to make future payments or otherwise transferconsideration under a registration payment arrangement, whether issued as aseparate agreement or included as a provision of a financial instrument orother agreement, should be separately recognized and measured in accordancewith FASB Statement No.5 “Accounting for Contingencies”. The guidance in FSP00-19-2 amends FASB Statements No. 133, “Accounting for Derivative Instrumentsand Hedging Activities”, and No.150, “Accounting for Certain FinancialInstruments with Characteristics of both Liabilities and Equity”, and FASBInterpretation No.45, “Guarantor’s Accounting and Disclosure Requirements forGuarantees, Including Indirect Guarantees of Indebtedness of Others” to includescope exceptions for registration payment arrangements. FSP 00-19-2 iseffective immediately for registration payment arrangements and the financialinstruments subject to those arrangements that are entered into or modifiedsubsequent to the date of issue of FSP 00-19-2. For registration paymentarrangements and financial instruments subject to those arrangements that wereentered into prior to the issuance of FSP 00-19-2, this is effective forfinancial statements issued for fiscal years beginning after December 15, 2006,and interim periods within those fiscal years. Callisto has analyzed theprovisions of FSP 00-19-2 and determined that it is not likely have a material effecton Callisto’s consolidated financial statements.

In September 2006, theFASB issued Statement of Financial Accounting Standards No.157, “Fair ValueMeasurements” (“SFAS 157”). SFAS 157 defines fair value, establishes aframework for measuring fair value in accordance with generally acceptedaccounting principles and expands disclosures about fair value measurements.The provisions of SFAS 157 are effective for fiscal years beginning afterNovember 15, 2007. Callisto is currently evaluating the impact, if any, of theprovisions of SFAS 157.

In July 2006, the FASB issued FASB Interpretation No.48 (“FIN 48”) “Accounting for Uncertainty in Income Taxes (an interpretation ofFASB Statement No. 109”) which is effective for fiscal years beginning afterDecember 15, 2006. This interpretation was issued to clarify the accounting foruncertainty in the amount of income taxes recognized in the financialstatements by prescribing a recognition threshold and measurement attribute forthe financial statement recognition and measurement of a tax position taken orexpected to be taken in a tax return. The provisions of FIN 48 are effective January1, 2007, with the cumulative effect of the change in accounting principlerecorded as an adjustment to retained earnings. The Company does not expect theadoption of FIN 48 to have a material impact on its consolidated financialposition, results of operations or cash flows.

In May 2005, the FASB issued SFAS No. 154, “AccountingChanges and Error Corrections,” which changes the requirements for accountingfor and reporting of a change in accounting principle. SFAS No. 154 requiresretrospective application to prior periods’ financial statements of a voluntarychange in accounting principle unless it is impracticable. SFAS No. 154 alsorequires that a change in method of depreciation, amortization, or depletionfor long-lived, nonfinancial assets be accounted for as a change in accountingestimate that is affected by a change in accounting principle. SFAS No. 154 is effectivefor accounting changes and a correction of errors made in fiscal yearsbeginning after December 15, 2005, but does not change the transitionprovisions of any existing accounting pronouncements, including those that arein a transition phase as of the effective date of SFAS No. 154. The adoption ofSFAS No. 154 did not have a material effect on Callisto’s results of operationsor financial position.

**4. Merger and consolidation:**

In March 2002, Callisto Pharmaceuticals, Inc. (“OldCallisto”), a non-public company, purchased 99.7% of the outstanding commonshares of Webtronics, Inc., (“Webtronics”) a public company for $400,000.Webtronics was incorporated in Florida on February 2, 2001 and had limitedoperations during the twelve months ended December 31, 2002. The purchase priceof Webtronics was treated as a cost of becoming

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a public company, however because there was no capitalraised at the time, the amount was charged to general and administrativeexpense during the twelve months ended December 31, 2002.

On April 30, 2003, pursuant to an Agreement and Planof Merger dated March 10, 2003, as amended April 4, 2003, Synergy AcquisitionCorp., a wholly-owned subsidiary of Webtronics merged into SynergyPharmaceuticals Inc. (“Synergy”) and Callisto Acquisition Corp., a wholly-ownedsubsidiary of Webtronics merged into Old Callisto (collectively, the “Merger”).As a result of the Merger, Old Callisto and Synergy became wholly-ownedsubsidiaries of Webtronics. In connection with the Merger Webtronics issued17,318,994 shares of its common stock in exchange for outstanding Old Callistocommon stock and an additional 4,395,684 shares in exchange for outstandingSynergy common stock. Subsequently, 171,818 shares of common stock issued toformer Synergy shareholders were returned to Callisto under the terms ofcertain indemnification agreements. The Merger was accounted for as arecapitalization of Old Callisto by an exchange of Webtronics common stock forthe net assets of Old Callisto consisting primarily of cash and fixed assets.Old Callisto then changed its name to Callisto Research Labs, LLC andWebtronics changed its name to Callisto Pharmaceuticals, Inc. and changed itsstate of incorporation from Florida to Delaware. Callisto remains thecontinuing legal entity and registrant for Securities and Exchange Commissionreporting purposes.

The merged companies are considered to be in thedevelopment stage. No revenues have been realized since inception and allactivities have been concentrated in research and development ofbiopharmaceutical products not yet approved by the Food and DrugAdministration. The fair value of the net shares issued to former Synergyshareholders in the Merger totaled $6,335,799 through December 31, 2005. Thefair value per share of $1.50, used to determine this amount, was the value pershare Callisto sold common stock in a private placement. The totalconsideration was allocated in full to the Synergy research and developmentprojects which had not yet reached technological feasibility and having noalternative use was charged to purchased in-process research and developmentexpense during the year ended December 31, 2003.

**5. Stockholders’ equity (deficit):**

From October 2006 until January 2007, Callisto placed602,350 shares of Series A Convertible Preferred Stock and 8,031,333 warrantsto certain investors for aggregate gross proceeds of $6,023,500. As ofDecember 31, 2006 Callisto had closed on 574,350 shares of such Series AConvertible Preferred Stock for aggregate gross proceeds of $5,743,500. Thefinal traunche of this financing closed January 10, 2007 when Callisto placed28,000 shares of such Series A Convertible Preferred Stock for aggregate grossproceeds of $280,000. The shares of Series A Convertible Preferred Stock are convertibleinto shares of common stock at a conversion price of $0.75 per share.  Theinvestors also are parties to a Registration Rights Agreement, dated as ofOctober 23, 2006 pursuant to which Callisto agreed to file, within 60 daysof closing, a registration statement with the Securities and ExchangeCommission (the “SEC”) covering the resale of the shares of common stockunderlying the Series A Convertible Preferred Stock and the warrants issued tothe investors. The warrants are immediately exercisable at $0.75 per share,  will expire five years from the date of issuance, and have certainantidilution rights for the twelve month period beginning on the effective dateof the registration statement registering the shares of common stock underlyingthe warrants.  Callisto (i) paid aggregate fees and expenses of $485,308($448,908 prior to December 31, 2006) in cash, (ii) issued an aggregate 11,775shares of Series A Convertible Preferred Stock and (iii) issued1,228,761warrants to purchase common stock, to certain selling agents. Thewarrants are immediately exercisable at $0.75 per share, will expire five yearsafter issuance and have the same anti-dilutive rights as the investor warrants.On January 12, 2007 Callisto filed a registration statement on Form S-3registering the common stock issuable upon (i) the conversion of the all SeriesA Convertible Preferred Stock, (ii) the exercise of all related investorwarrants and (iii) the exercise of all selling agent warrants. On February 15,2007 Amendment No.1 to this registration statement was declared effective bythe SEC.

The material termsof the Series A Preferred Stock consist of:

*Dividends* .Holders of the Series A Convertible Preferred Stock shall not be entitledto receive dividends except as and if declared at Callisto’s sole election.

*Voting Rights*.. Shares of the Series A Convertible Preferred Stock shall have novoting rights. However, so long as any shares of Series A ConvertiblePreferred Stock are outstanding, Callisto shall not, without the affirmativevote of a majority in interest of the shares of Series A ConvertiblePreferred Stock then outstanding, (a) alter or change adversely thepowers, preferences or rights given to the Series A Convertible PreferredStock, (b) authorize or create any class of stock senior or equal to theSeries A Convertible Preferred Stock, (c) amend its articles ofincorporation or other charter documents, so as to affect adversely any rightsof the holders of Series A Convertible Preferred Stock or (d) increasethe authorized number of shares of Series A Convertible Preferred Stock.

*Liquidation.* Upon any liquidation,dissolution or winding-up of Callisto, the holders of the Series AConvertible Preferred Stock shall be entitled to receive an amount equal to theStated Value per share, which is $10 per share plus any accrued and unpaiddividends.

*Conversion Rights*.Each share of Series A Convertible Preferred Stock shall be convertibleinto that number of shares of common stock determined by dividing the StatedValue, currently $10 per share, by the conversion price, currently $0.75 pershare. The conversion price is subject to adjustment for dilutive issuances.

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*Automatic conversion*. BeginningOctober 24, 2007, if the price of the common stock equals $1.50 per share for 20consecutive trading days, and an average of 50,000 shares of common stock perday shall have been traded during the 20 trading days, Callisto shall have theright to deliver a notice to the holders of the Series A ConvertiblePreferred Stock, to convert any portion of the shares of Series AConvertible Preferred Stock into shares of Common Stock at the conversionprice.

As per EmergingIssues Task Force (“EITF”) Issue 00-19, *“Accounting for DerivativeFinancial Instruments Indexed to, and Potentially Settled in, Company Stock”*,**Callisto has determined that the warrants should be treatedas “permanent equity”.

As per EITF 00-27,“*Application of Issue 98-5 to Certain ConvertibleInstruments*” Callisto evaluated the preferred stock transaction andaccordingly found that there was an embedded beneficial conversionfeature.  The fair value of thedetachable warrants on the date of grant was $3,390,506 using Black Scholesassumptions of 60% volatility, a risk free interest rate of 4.57% to 4.84%, nodividend, an expected life of 5 years and a stock price on that dates of grantranging from $0.88 to $ 0.75 per share. The conversion rights of the preferred stock contained a beneficialconversion feature totaling $2,384,485, using the “effective conversion price”method based on relative fair value of the preferred stock and the warrants.This beneficial conversion feature was immediately accreted to the preferredstock as a dividend because the preferred stock could be converted immediatelyupon issuance.  The beneficial conversionfeature associated with final traunche of 28,000 shares of Series A ConvertiblePreferred Stock placed in January 2007 amounted to $119,683 and will berecorded as a beneficial conversion feature accreted as a dividend in thequarter ended March 31, 2007.

On October 3,2006, Callisto received notice (the “Deficiency Letter”) from the staff of theAmerican Stock Exchange (“AMEX”) indicating that it is not in compliance withcertain continued listing standards, specifically, Section 1003(a)(i) ofthe Company Guide with shareholders’ equity of less than $2,000,000 and lossesfrom continuing operations and/or net losses in two of its three most recentfiscal years and Section 1003(a)(iv) of the Company Guide in that it hassustained losses which are so substantial in relation to its overall operationsor its existing financial resources, or its financial condition has become soimpaired that it appears questionable, in the opinion of the Exchange, as towhether it will be able to continue operations and/or meet its obligations asthey mature.

On November 2,2006 Callisto submitted a plan advising AMEX of the actions it has taken, orwill take, that would bring it into compliance with Section 1003(a) (iv)of the Company Guide by April 3, 2007 and with Section 1003(a) (i) of theCompany Guide by April 3, 2008. The plan was approved January 24,2007 and Callisto may maintain its listing during the plan period of up to 18months, during which time Callisto will be subject to periodic review todetermine if it is making progress consistent with the plan. If it is not incompliance with the continued listing standards at the end of the plan period,or it does not make progress consistent with the plan during the plan period,AMEX staff may initiate delisting proceedings. There is no guarantee thatCallisto will be able to make progress consistent with the plan. While the planis under periodic review by AMEX, Callisto expects that its common stock willcontinue to trade without interruption on AMEX.

On September 8,2006 Callisto entered into a Letter Agreement with certain investors (the “Investors”)who participated in a private placement of our common stock and warrants inFebruary and April 2006 (the “Prior Placement” see below).  Pursuant tothis Letter Agreement, the Investors agreed to amend (the “Amendment”) thesecurities purchase agreement (the “Securities Purchase Agreement”), enteredinto in connection with the Prior Placement, to (i) delete the mandatoryregistration rights set forth in the Securities Purchase Agreement and addpiggyback registration rights and (ii) waive any unpaid penalties pursuant tothe liquidated damages provisions contained in the Securities PurchaseAgreement. In addition, the Investors agreed to enter into a lock-up agreement(the “Lock-up Agreement”) pursuant to which they agreed not to sell or transferthe shares of common stock and warrants acquired in the Prior Placement for aperiod of nine months beginning September 1, 2006. In exchange for theInvestors entering into the Amendment and the Lock-Up Agreement, Callistoagreed to issue to each Investor one share of common stock and 2.35 five yearwarrants exercisable at $1.00 per share (the “New Warrants”) for every fiveshares of common stock they purchased in the Prior Placement.  Inaddition, Callisto agreed in the Letter Agreement to amend the warrants (the “OldWarrants”) issued in the Prior Placement to the Investors to (i) extend theexpiration date of the Old Warrants by 42 months thereby making them 5 yearwarrants and (ii) eliminate the provision in the Old Warrants by which Callistocan force exercise of the unexercised warrants.  During October andNovember 2006 Callisto entered into the Amendment and Lock-up Agreements witheach Investor pursuant to which Callisto issued 740,065 shares of common stockand 2,086,988 New Warrants.  $153,797 incash liquidated damages, payable to these Investors as of September 30, 2006,was concurrently waived.

The fair value ofthe shares issued to the Investors was $643,858 using the stock price onSeptember 8, 2006 of $0.87 per share. The fair value of the New Warrants was $934,928 using Black Scholesassumptions of 60% volatility, a risk free interest rate of 4.25%, no dividend,an expected life of 5 years and a stock price on that date of $0.87 per share,resulting in a total consideration associated with this transaction of $1,578,786.$425,899 of this fair value was allocated to additional stock-based liquidateddamages expense during the quarter ended December 31, 2006 which, when combinedwith $153,797 of accrued liquidated damages waived as of September 30, 2006,resulted in total non-cash share based liquidated damages of $579,696 for thetwelve months ended December 31, 2006. The balance of the total consideration,$999,090, was charged to additional paid in capital as a cost of placing theSeries A Convertible Preferred Stock discussed above.

On February 3,2006, Callisto closed a private placement of 4,283,668 shares of common stockand 1,070,917 common stock purchase warrants to certain accredited investors.The warrants are exercisable for 18 months from closing at an exercise price of$1.60 per share. The securities were sold at a price of $1.20 per share foraggregate proceeds of $5,140,210 and Callisto paid an aggregate transactionrelated fees

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and expenses of$561,808, yielding net proceeds of $4,578,402. In addition Callisto issued anaggregate 390,284 warrants to certain selling agents, which areexercisable at $1.25 per share and will expire three years after closing.

On April 7,2006 Callisto had a second closing of the financing described above, in whichCallisto sold an additional 666,667 shares of common stock and issued 166,667common stock purchase warrants at the same terms, for gross proceeds of $800,000,bringing the total gross proceeds of the financing to $5.94 million and netproceeds to $5.34 million. Transaction related fees and expenses of $41,000 were paid on this second closing and three year warrants to purchase atotal of 66,667 common shares at a per share price of $1.25 were issued tocertain selling agents.

Callisto agreed to file, within 60 days after theclosing, a registration statement covering the resale of the shares of commonstock and the shares underlying the warrants or pay financial liquidateddamages to the investors up to a maximum of 8% of the gross proceeds.  Asof December 31, 2006 Callisto had incurred $801,690 in liquidated damagesrelated to the registration rights agreement which have been classified asother expense on our condensed consolidated statement of operations. On January12, 2007 Callisto filed a registration statement on Form S-3 registering thecommon stock issued (i) on February 3, 2006, (ii) on April 7, 2006 and (iii)the common stock underlying the selling agent warrants. On February 15, 2007Amendment No.1 to this registration statement was declared effective by theSEC.

As provided for by EITF Issue 00-19, “*Accounting for Derivative Financial InstrumentsIndexed to, and Potentially Settled in, a Company’s Own Stock*” the warrantswere classified as permanent equity. The fair value of the investorwarrants on the dates of grant was $1,269,978 using Black Scholes assumptionsof 79% volatility, a risk free interest rate of 4.25%, no dividend, an expectedlife of 5 years and a stock price on that date of $1.59 per share. This fairvalue allocated to the investor warrants was recorded as additional paid incapital during the year ended December 31, 2006.

On October 20, 2005, at the Annual Meeting ofStockholders, Callisto stockholders voted to amend Callisto’s certificate ofincorporation to increase the authorized number of shares of common stock from75,000,000 shares to 100,000,000 shares. In addition the stockholders voted toadopt the Callisto 2005 Equity Compensation Incentive Plan and the Callisto2005 Directors’ Stock Option Plan. (Note 6) The details of these stockholderresolutions are included in Callisto’s Proxy Statement (Schedule 14AInformation) filed September 1, 2005 with the Securities and ExchangeCommission.

On October 5, 2005, Trilogy Capital Partners, Inc.exercised 125,000 common stock warrants at an exercise price of $1.03 per sharefor aggregate proceeds of $128,750. (Note 8)

On August 22, 2005, Callisto sold and issued in aprivate placement an aggregate 1,869,203 shares of common stock at a price of$0.97 per share for aggregate proceeds of $1,813,127 and paid an aggregate$151,250 to certain selling agents.

On March 9, 2005, Callisto sold and issued in aprivate placement 1,985,791 shares of common stock at a per share price of$1.52, for aggregate gross proceeds of $3,018,401 and net proceeds of$2,993,401. Because this transaction was completed with certain existinginstitutional shareholders and certain members of management, Callisto paid noselling agent fees and legal fees were $25,000.

On April 19, 2004, Callisto sold and issued in aprivate placement to accredited investors an aggregate 2,151,109 shares ofcommon stock at an issue price of $2.25 per share for aggregate gross proceedsof $4,839,995. Callisto incurred fees and expenses aggregating $294,241 tovarious selling agents. In addition, Callisto issued an aggregate 124,711warrants to purchase common stock to such selling agents. The warrants areimmediately exercisable at $2.48 per share and will expire five years afterissuance.

In January 2004 Callisto recorded $209,076 ofpurchased in process research and development as a result of the issuance of263,741 warrants to two Callisto shareholders, which warrants are immediatelyexercisable at $1.50 per share and will expire ten years after issuance; and$60,750 of stock-based compensation expense associated with shares of commonstock issued to a shareholder for services performed.

From November 2003 through January 2004, Callisto soldand issued 3,905,432 shares of common stock at an issue price of $1.50 foraggregate gross proceeds of $5,858,148. Callisto incurred an aggregate of$501,516 in fees to various selling agents. In addition Callisto issued 31,467shares of common stock and 370,543 warrants to purchase common stock to suchselling agents. The warrants are immediately exercisable at $1.90 per share andwill expire five years after issuance.

As of December 31, 2003 Callisto had closed on aportion of this transaction, specifically 2,776,666 shares of common stock at aprice of $1.50 per share for aggregate gross proceeds of $4,164,999, less$361,625 incurred in fees to various selling agents. During January 2004,Callisto completed this private placement begun in late 2003 and issued1,128,766 shares of common stock at an issue price of $1.50 for aggregateproceeds of $1,693,149, less $139,891 in fees to various selling agents.

During 2000, the Board of Directors approved anincrease in the authorized common shares from 35,000,000 shares to 60,000,000shares and a one-for-three reverse split of the common stock. All share and pershare information has been adjusted to reflect the stock split as if it

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had occurred at the beginning of the earliest periodpresented. In May 2003, as part of the Merger, the authorized common shareswere increased to 75,000,000 shares.

During 2000, Callisto sold 2,252,441 shares of SeriesA convertible preferred stock at $1.70 per share and 1,232,858 shares of SeriesB convertible preferred stock at $1.75 per share. In addition, the Board ofDirectors authorized the issuance of 750,000 shares of Series C convertiblepreferred stock at $0.10 per share to an executive officer of Callisto. The netproceeds from the sale of these 4,235,299 shares of convertible preferred stocktotaled $6,061,650. The holders of the convertible preferred stock had equalvoting rights with the common stockholders, had certain liquidation preferencesand were convertible at any time into shares of common stock at a ratio of oneshare of common stock for each share of convertible preferred stock at theelection of the holder. Callisto recorded compensation expenses ofapproximately $1,050,000 related to the shares sold to the executive officer.During the second quarter of 2003, all of the convertible preferredstockholders converted their shares of preferred stock to common stock inconnection with the Merger.

During 2000, Callisto also sold 4,526,903 shares ofcommon stock at a purchase price of $0.05 per share to certain officers anddirectors for services performed in the year 1999. Based on the most recentprivate placement of common stock during the fourth quarter of 1999, the valueof these shares was determined to be $0.70 per share and Callisto recorded$3,168,832 as stock based compensation expense.

During 1998, as part of a settlement agreement betweenthe founding partners of CSO Ventures, Inc. and Callisto, one of the foundersof CSO sold 836,792 shares of common stock back to Callisto at a price ofapproximately $0.12 per share, for $97,000. Concurrently, Callisto entered intoa stock purchase agreement with a private investor to sell him 766,667 sharesof common stock at a price of $92,000 or $0.12 per share. The fair value of thecommon stock issued was determined to be $0.75 per share and Callisto recorded$483,000 of stock based compensation expense.

During the period from December 1996 to December 1999,Callisto completed the following private placements of its common stock:
| ** **    | ** ** | **Shares** | ** ** | **Price Per Share** | ** ** | **Gross Proceeds** | ** ** |
|---------------|------------|------------|------------|-------------------------------|------------|-------------------------|------------|
| December 1996 |       | 1,366,667  |       | $                             | 0.75       |                    | $          | 1,025,000 |   |
| December 1997 |       | 1,442,667  |       | $                             | 0.75       |                    | 1,081,999  |   |
| October 1998  |       | 1,416,667  |       | $                             | 0.75       |                    | 1,062,500  |   |
| January 1999  |       | 146,667    |       | $                             | 0.75       |                    | 110,000    |   |
| December 1999 |       | 200,000    |       | $                             | 0.75       |                    | 150,000    |   |
|          |       |       |       |                          |       |                    |       |
| Total         |       | 4,572,668  |       |                          |       | $                       | 3,429,499  |   |

 

As of December 31, 2006 Callisto had 15,841,154warrants outstanding to investors, selling agents and advisors with a weightedaverage exercise price of $0.95 per share.

**6. Stock option plans:**

In 1996, Callisto adopted an incentive and non-qualifiedstock option plan (the “Plan”) for employees, consultants and outside directorsto purchase up to 2,000,000 shares of common stock. The Plan was amended inDecember 2002 to increase the number of shares authorized under the Plan to10,000,000. The option term for the 4,745,042 options outstanding underthe Plan is ten years from date of grant. The Plan terminated on January 1,2006 under its original terms and no further options will be granted under thePlan.

On October 20, 2005, Callisto adopted 2005 EquityCompensation Incentive Plan (“2005 Equity Plan”). The maximum number of sharesof common stock with respect to which awards may be granted under the 2005Equity Plan is 5,000,000. The option term for options granted under the2005 Equity Plan is ten years from date of grant, there were 850,000 optionsoutstanding and there were 4,150,000 options available for future grants as ofDecember 31, 2006.

On October 20, 2005, Callisto also adopted theCallisto 2005 Directors’ Stock Option Plan (“2005 Director’s Plan”). Themaximum number of shares of common stock with respect to which awards may begranted under the 2005 Director’s Plan is 1,000,000. The option term foroptions granted under the 2005 Director’s Plan is ten years from date of grant,there were 106,000 options outstanding, and there were 894,000 optionsavailable for future grants as of December 31, 2006.

The following represent options outstanding for theyears since June 5, 1996 (inception) through December 31, 2006.

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| ** **                         | ** ** | ** **                  | ** ** | ** **              | ** **       | **Weighted  Average** | ** ** |
|------------------------------------|------------|-----------------------------|------------|-------------------------|------------------|-----------------------|------------|
| ** **                         | ** ** | **Number  of options** | ** ** | **Exercise Price** | ** **       | **Exercise  Price**   | ** ** |
| ** **                         | ** ** | **outstanding**             | ** ** | **Per Share**      | ** **       | **Per Share**    | ** ** |
| Balance, June 5,  1996 (inception) |       | 0                           |       | $                       | 0.00             |                  | $          | 0.00 |   |
| 1996: Granted                      |       | 66,668                      |       | $                       | 0.75             |                  | $          | 0.75 |   |
|                               |       |                        |       |                    |             |                  |       |
| Balance,  December 31, 1996        |       | 66,668                      |       | $                       | 0.75             |                  | $          | 0.75 |   |
| 1997: Granted                      |       | 166,668                     |       | $                       | 0.75             |                  | $          | 0.75 |   |
|                               |       |                        |       |                    |             |                  |       |
| Balance,  December 31, 1997        |       | 233,336                     |       | $                       | 0.75             |                  | $          | 0.75 |   |
| 1998: Granted                      |       | 264,169                     |       | $                       | 0.75             |                  | $          | 0.75 |   |
|                               |       |                        |       |                    |             |                  |       |
| Balance,  December 31, 1998        |       | 497,505                     |       | $                       | 0.75             |                  | $          | 0.75 |   |
| 1999: Granted                      |       | 633,334                     |       | $                       | 0.75 - 4.90      |                  | $          | 1.92 |   |
|                               |       |                        |       |                    |             |                  |       |
| Balance,  December 31, 1999        |       | 1,130,839                   |       | $                       | 0.75 - 4.90      |                  | $          | 1.41 |   |
| 2000: Granted                      |       | 815,666                     |       | $                       | 2.85 - 6.75      |                  | $          | 3.83 |   |
| Forfeitures                        |       | (15,000                     | )          | $                       | 0.75             |                  | $          | 0.75 |   |
|                               |       |                        |       |                    |             |                  |       |
| Balance,  December 31, 2000        |       | 1,931,505                   |       | $                       | 0.75 - 6.75      |                  | $          | 2.44 |   |
| 2001: Granted                      |       | 730,000                     |       | $                       | 1.25 - 6.50      |                  | $          | 2.77 |   |
|                               |       |                        |       |                    |             |                  |       |
| Balance,  December 31, 2001        |       | 2,661,505                   |       | $                       | 0.75 - 6.75      |                  | $          | 2.53 |   |
| 2002: Granted                      |       | 330,000                     |       | $                       | 4.50 - 6.50      |                  | $          | 5.50 |   |
|                               |       |                        |       |                    |             |                  |       |
| Balance,  December 31, 2002        |       | 2,991,505                   |       | $                       | 0.75 - 6.75      |                  | $          | 2.86 |   |
| 2003: Granted                      |       | 3,013,555                   |       | $                       | 1.10 - 2.50      |                  | $          | 1.48 |   |
| Forfeitures                        |       | (1,151,500                  | )          | $                       | 2.85 - 6.75      |                  | $          | 4.51 |   |
|                               |       |                        |       |                    |             |                  |       |
| Balance,  December 31, 2003        |       | 4,853,560                   |       | $                       | 0.75 - 6.75      |                  | $          | 1.61 |   |
| 2004: Granted                      |       | 2,853,500                   |       | $                       | 1.50 - 3.60      |                  | $          | 3.11 |   |
| Forfeitures                        |       | (385,000                    | )          | $                       | 1.50 - 2.50      |                  | $          | 1.66 |   |
|                               |       |                        |       |                    |             |                  |       |
| Balance, December  31, 2004        |       | 7,322,060                   |       | $                       | 0.75 - 6.75      |                  | $          | 2.19 |   |
| 2005: Granted                      |       | 2,174,484                   |       | $                       | 0.97 - 1.70      |                  | $          | 1.34 |   |
| Forfeitures                        |       | (1,488,334                  | )          | $                       | 1.50 - 3.50      |                  | $          | 3.12 |   |
| Balance,  December 31, 2005        |       | 8,008,210                   |       | $                       | 0.75 - 6.75      |                  | $          | 1.79 |   |
| 2006: Granted                      |       | 978,500                     |       | $                       | 0.77 - 1.64      |                  | $          | 1.48 |   |
| Forfeitures                        |       | (933,335                    | )          | $                       | 0.75 – 3.00 |                  | $          | 1.78 |   |
| Balance, December 31,  2006        |       | 8,053,375                   |       | $                       | 0.75 – 6.75 |                  | $          | 1.75 |   |

 

Includedin the balance at December 31, 2006 were 2,353,333 Non-Plan options, of which1,883,833 were exercisable at a weighted average exercise price of $1.72 pershare.

Theweighted average remaining term of all options outstanding decreased from 7.4years at December 31, 2005 to 6.6 years at December 31, 2006.

On April 26, 2004, Callisto’s Board of Directorsgranted 100,000 stock options to Gabriele M. Cerrone, Chairman of the Board, inrecognition of his efforts during the past year on behalf of Callisto. Thestock options are immediately exercisable at $3.20 per share and stock-basedcompensation expense of $286,918 was recorded in connection with the grant,based on a Black-Scholes fair value of $2.87 per share.

On June 29, 2004, Callisto’s Compensation Committeerecommended and the Board of Directors approved the grant of 275,000 stockoptions to Gary Jacob, Chief Executive Officer, as additional compensation. Thestock options are exercisable at $3.00 per share. 25,000 options vest on eachof June 1, 2005 and June 1, 2006 and 50,000 options vest on June 1, 2007. Theremaining 175,000 options vest upon the achievement of performance milestonesassociated with the successful in-licensing, advancement and development ofcertain drug candidates. If the milestones are achieved Callisto will recordstock-based compensation expense based on the intrinsic value of the options atthat time. At this date, the milestones have not yet been achieved. OnJuly 6, 2005, Callisto’s Compensation Committee recommended and the Board ofDirectors approved the grant of 350,000 stock options to Mr. Jacob asadditional compensation. The stock options are exercisable at $1.01 pershare. 100,000 options vest on each of July 6, 2006 and 2007 and 150,000options vest on July 6, 2008.

F-21

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**7. Income taxes**:

At December 31, 2006 and 2005, Callisto had availableFederal net operating tax loss carry forwards of approximately $31,000,000 and$22,000,000, respectively, expiring through 2026 to offset future taxableincome. The net deferred tax asset has been fully offset by a valuationallowance due to uncertainties regarding realization of benefits from thesefuture tax deductions. As a result of the change in control provisions ofInternal Revenue Code Section 382, a significant portion of these net operatingloss carry forwards may be subject to limitation on future utilization.

During the twelve months ended December 31, 2005 and2004 Synergy sold certain New Jersey State tax loss carry forwards under astate economic development program for cash of approximately $177,000 and$233,000, respectively. The proceeds of economic development funds have beenused to support research and development activities in New Jersey. This statetax benefit was recorded as Other Income during the fourth quarter endedDecember 31, 2005 and 2004.  As ofDecember 31, 2005 Callisto had no remaining New Jersey State tax loss carryforwards available for sale and no such benefits were realized during thetwelve months ended December 31, 2006.

F-22

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**8. Commitments and contingencies**:

**License agreements:**

On January 10, 2006, Callisto entered into a Patentand Technology License Agreement with The University of Texas M.D. AndersonCancer Center. Pursuant to the license agreement, Callisto was granted theexclusive right to manufacture, have manufactured, use, import, offer to selland/or sell anti-cancer compounds called tyrphostins (renamed Degrasyns).Callisto paid a nonrefundable fee of $200,000 upon execution of this agreement,expensed as research and development and is obligated to pay annual licensemaintenance fees to The University of Texas M.D. Anderson Cancer Center.Callisto is also obligated under this agreement to pay for the legal fees andexpenses associated with establishing and protecting the patent rightsworldwide. Callisto also agreed to pay The University of Texas M.D. AndersonCancer Center royalties based on net sales from any licensed products, plusaggregate milestone payments of up to $1,750,000 based upon achieving certainregulatory submissions and approvals. The term of the agreement is from January10, 2006 until the end of the term for which the patent rights associated withthe licensed technology have expired. If the first pending patent is issued,the agreement is projected to expire in 2025. In addition, at any time aftertwo years from January 10, 2006, The University of Texas M.D. Anderson CancerCenter has the right to terminate the license if Callisto fails to provideevidence within 90 days of written notice that it has commercialized or isactively and effectively attempting to commercialize the licensed technology.

On March 23,2006, Callisto entered into a 2-year sponsored laboratory study agreement withthe University of Texas M. D. Anderson Cancer Center whereby Dr. NicholasDonato, as principal investigator, will analyze the anti-tumor activity andmechanism of action of Callisto’s WP1130 Degrasyn compound and analogs. Theagreement calls for payment of $145,900 to M.D. Anderson in two installments of$72,950 with the first payment due within 30 days of the effective date of theagreement, and the second payment due within six months of execution. Theseresearch expenditures were expensed as incurred during the twelve months endedDecember 31, 2006 consistent with Callisto’s application of SFAS No.2.

On March 27,2006, Callisto entered into a 2-year sponsored laboratory study agreement withthe University of Texas M. D. Anderson Cancer Center whereby Dr. WilliamBornmann, as principal investigator, will perform molecular modeling andsynthesize a library of compounds based on Callisto’s Degrasynplatform technology. The agreement calls for payment of $127,145 to M.D.Anderson in two installments of $63,572 with the first payment due within 30days of the effective date of the agreement, and the second payment duewithin six months of execution. These research expenditures were expensed asincurred during the twelve months ended December 31, 2006 consistent withCallisto’s application of SFAS No.2.

On August 12, 2004, Callisto entered into a world-widelicense agreement with The University of Texas M. D. Anderson Cancer Center toresearch, develop, sell and commercially exploit the patent rights forL-Annamycin, an anthracycline cancer drug for leukemia therapy. Considerationpaid for this license amounted to $31,497 for reimbursement of out-of-pocketcosts for filing, enforcing and maintaining the L-Annamycin patent rights and a$100,000 initial license fee. L-Annamycin has not reached commercialization andtherefore these costs were recorded as research and development expense.Callisto also agreed to pay The University of Texas M. D. Anderson CancerCenter royalties based on net sales from any licensed products, plus aggregatemilestone payments of up to $750,000 based upon achieving certain regulatorysubmissions and approvals. The term of the agreement is from August 12, 2004until November 2, 2019. Under the terms of the license agreement, Callisto isrequired to make certain good faith expenditures towards the clinicaldevelopment of at least one licensed product within the two year period afterMarch 2005. In addition, at any time after 5 years from August 12, 2004, TheUniversity of Texas M.D. Anderson Cancer Center has the right to terminate thelicense if Callisto fails to provide evidence within 90 days of written noticethat it has commercialized or it is actively and effectively attempting tocommercialize L-Annamycin.

On February 24, 2004, Callisto entered into anagreement with Houston Pharmaceuticals, Inc. (“HPI”) to sublicense the rightsto a key patent covering a technology platform for site-directed DNAintercalation and Callisto acquired the rights to a patent covering newanthracycline analogs. Callisto issued to HPI 25,000 shares of common stock ata fair value of $56,250 and reimbursed HPI approximately $103,500 for variouscosts and expenses. The total consideration of $159,750 was allocated in fullto the HPI patent rights, which have not yet reached technological feasibility,and having no alternative use, was accounted for as purchased in-processresearch and development expense during the quarter ended March 31, 2004. Thefair value of the common stock issued to HPI was $2.25, based on the price pershare paid in the April 2004 private placement, which closed on April 19, 2004.In addition, Callisto granted to HPI 1,170,000 performance based stock options,exercisable at $3.50 per share, which vest upon the achievement of certainmilestones. Callisto also agreed to pay HPI royalties of 2% on net sales fromany products resulting from commercializing the site-directed DNAintercalation. Pursuant to the sublicense agreement, in the event Callisto’sBoard of Directors determined to abandon its development and commercializationof the site-directed DNA intercalation, HPI had the right to terminate thesublicense agreement. On September 19, 2005, because data from in vivopre-clinical studies did not meet Callisto’s standards for clinicaldevelopment, Callisto notified HPI of its decision to terminate the sublicenseagreement. On September 28, 2005 Callisto agreed with HPI that HPI wouldrepurchase certain patent rights in exchange for forfeiting the 1,170,000performance based stock options. Accordingly the 1,170,000 options granted toHPI were cancelled.

On August 28, 2002, and as amended on May 23, 2003,Synergy entered into a worldwide license agreement with AnorMED, Inc. (“AnorMED”)to research, develop, sell and commercially exploit the Atiprimod patentrights. The license agreement provides for aggregate milestone payments of upto $14 million based upon achieving certain regulatory submissions andapprovals for an initial indication, and 

F-23

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additional payments of up to $16 million for eachadditional indication based on achieving certain regulatory submissions andapprovals. In addition the agreement requires Synergy to pay AnorMED royaltieson net sales. Commencing on January 1, 2004 and on January 1 of each subsequentyear Synergy is obligated to pay AnorMED a maintenance fee of $200,000 untilthe first commercial sale of the product. The first two annual maintenance feepayments under this agreement were made in January 2004, 2005 and 2006 andthese were recorded as research and development expense. The license agreementwill terminate in 2018.

On August 20, 1996, Callisto entered into a licenseagreement to research, develop, sell and commercially exploit certainRockefeller University licensed patents covering peptides and antibodies usefulin treating toxic shock syndrome and septic shock. Callisto agreed to worktoward commercialization of products related to these patents as evidenced by aminimum expenditure per year of approximately $210,000, plus milestone paymentsand royalties of between 2% and 3% of annual net sales and will pay Rockefeller30% of any sublicense fee paid by sublicensees. The licensed patents under thisagreement are the subject of research being funded by the NIAID grant awardedto Callisto on April 1, 2005 for $885,641over two years. The license agreementwill terminate upon the expiration of the related patents.

**Employment and Consulting Agreements:**

OnJanuary 31, 2006, Callisto entered into a consulting agreement with Dr. MosheTalpaz, whereby Dr. Talpaz will provide consulting services for Callisto’sDegrasyns program. Under the agreement Dr. Talpaz will be paid $10,000 per yearand was granted 575,000 10-year options to purchase Callisto common stock at$1.60 per share. Such options vest based on milestones related to the Degrasynscompounds being developed towards FDA approval. The term of the agreement isfor the length of time Callisto is developing the Degrasyns platform ofcompounds in all indications

On October 10, 2005 Callisto entered into anemployment agreement with Dan D’Agostino to serve as Callisto’s Chief BusinessOfficer. Pursuant to the employment agreement, Callisto will employ Mr. D’Agostinofor a period of one year commencing October 10, 2005 which term will beautomatically renewed for successive one year periods until written notice notto renew is delivered by either Callisto or Mr. D’Agostino. Mr. D’Agostino willbe paid an annual base salary of $175,000 (“Base Salary”). In addition, Mr. D’Agostinowill be eligible to earn an annual cash bonus up to 15% of his annual BaseSalary annually, plus up to $25,000 based on meeting performance objectives andbonus criteria, specifically surrounding Callisto’s corporate development plansto expand its technology and product portfolio.

Mr. D’Agostino was granted an aggregate 400,000incentive stock options pursuant to Callisto’s stock option plan with anexercise price of $1.53 per share. 300,000 of such options will vest pursuantto the following schedule: 100,000 options will vest on October 10, 2006;100,000 options will vest on October 10, 2007; and 100,000 options will vest onOctober 10, 2008. The remaining 100,000 options will vest upon the successfulin-licensing of certain drug candidates.

On July 18, 2005, Callisto entered into a letter ofengagement (the “Agreement”) with Trilogy Capital Partners, Inc. (“Trilogy”).The term of the Agreement is for one year beginning on July 18, 2005 andterminable thereafter by either party upon 30 days’ prior written notice.Pursuant to the Agreement, Trilogy will provide marketing and financial publicrelations services to Callisto and will assume the responsibilities of aninvestor relations officer for Callisto. Callisto will pay Trilogy $12,500 permonth under the Agreement.

Pursuant to the Agreement, Callisto issued warrants toTrilogy to purchase 1,793,322 shares of Common Stock of Callisto at an exerciseprice of $1.03 per share (the “Warrants”). The Warrants issued to Trilogy areexercisable upon issuance and expire on July 18, 2008. The fair value of theWarrants using the Black-Scholes methodology was $1,469,931 on the date ofgrant and is being amortized to stock-based compensation expense over the termof the Agreement. Stockbased compensation expense associated with these warrants was $735,236 and$734,695 during the twelve months ended December 31, 2006 and 2005,respectively. During the twelve months ended December 31, 2006 Trilogyexercised 185,500 common stock warrants for cash totaling $190,035 and duringthe twelve months ended December 31, 2005 Trilogy exercised 125,000 commonstock warrants for cash totaling $128,750.

On November 2, 2006, Trilogy Capital Partners, Inc.filed suit against Callisto in Superior Court of the State of California,County of Los Angeles, Central District, alleging that Callisto breached aLetter of Engagement dated July 18, 2005 between Callisto and Trilogy byfailing to pay certain fees. Additionally, Trilogy alleges that Callisto breached a consultingagreement dated January 1, 2006 between Callisto and MBA Holdings, LLC (laterassigned to Trilogy) by failing to pay certain consulting fees.  Trilogy is seeking payment in the aggregateamount of $94,027.55 plus interest and attorneys fees.  On December 27, 2006, Callisto filed ananswer to the Trilogy complaint denying the allegations in the Trilogycomplaint and on the same date, Callisto filed a cross-complaint againstTrilogy in Superior Court of the State of California, County of Los Angeles,Central District, alleging, among other things, that Trilogy breached theLetter of Engagement with Callisto by failing to provide the agreed-uponservices and fraudulently induced Callisto to enter into the Letter ofEngagement by  misrepresenting itscapabilities.  Callisto is asking forunspecified damages plus attorneys’ fees. On January 23, 2007, Trilogy answered Callisto’s cross-complaint denyingall of the allegations. The court has ordered the parties to mediation to becompleted by November 20, 2007.

On December 27, 2004, Callisto entered into aconsulting agreement (the “Agreement”) with Gabriele M. Cerrone, Callisto’sChairman of the Board (the “Consultant”). The duties of the Consultant and theobligations of Callisto to pay compensation commenced on January 10, 

F-24

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2005 (the “Start Date”). The duties of the Consultantpursuant to the Agreement will consist of strategic planning and capitalmarkets consulting advice. The term of the Agreement will commence upon theStart Date and continue until December 31, 2006 with automatic renewal forsuccessive one year periods unless either party gives notice to the other notto renew the Agreement. Callisto will pay Consultant the annual sum of $205,000(the “Base Compensation”) at the rate of $17,083.33 per month commencing on theStart Date. In addition, per the Agreement Consultant was granted 375,000 tenyear non-qualified stock options at an exercise price of $1.70 per share, whichwas the stock price on December 27, 2004 (date of execution of the Agreement),one half of such options vest on each of the first two anniversaries of thedate of the Agreement. The stock-based compensation expense associated withthese option grants during the year ended December 31, 2005 was $212,619. Thisexpense was based on an initial Black-Scholes fair value of $1.52 per share onthe date of grant and subsequently marked to market quarterly as required by FinancialAccounting Standards Board Interpretation No. 44 (“FIN 44”). Accordingly themeasurement date will be the earlier of the second anniversary of the agreement(fully vested) or the accelerated vesting date if Mr. Cerrone is terminatedwithout cause or good reason. In the event the Agreement is terminated withoutcause or for good reason, the Consultant will receive a cash payment equal tothe aggregate amount of Base Compensation for the then remaining term of theAgreement and all unvested stock options will immediately vest and the exerciseperiod of such options will be extended to the later of the longest periodpermitted by Callisto’s stock option plans or ten years following termination.In the event a change of control of Callisto occurs, Consultant shall beentitled to such compensation upon the subsequent termination of the Agreementwithin two years of the change in control unless such termination is the resultof the Consultant’s death, disability or retirement or the Consultant’stermination for cause. During the twelve months ended December 31, 2006and 2005. Mr. Cerrone earned bonuses totaling $125,855 and $30,750,respectively.

On January 25, 2007, Callisto entered into anExtension and Amendment Agreement with Mr. Cerrone.  The agreement extendsthe term of the consulting agreement between us and Mr. Cerrone, dated as ofDecember 27, 2004, to December 31, 2009. Among other things, the agreement increases Mr. Cerrone’s compensationfrom $205,000 to $275,000 per year.  In addition, Mr. Cerrone was granted225,000 ten year non-qualified stock options at an exercise price of $0.96 pershare of which 75,000 vest on each of December 31, 2007, 2008 and 2009. Additionally, pursuant to the agreement, in recognition of the servicesbeyond that required of Mr. Cerrone during the period from July 1, 2006 toJanuary 25, 2007, Callisto accrued a bonus to Mr. Cerrone of $75,000, payableon March 31, 2007.  Mr. Cerrone shall be eligible to earn a cash bonus ofup to 22.5% of his base compensation for each twelve month period during theterm of the agreement based on meeting performance objectives and bonuscriteria to be mutually identified by Mr. Cerrone and Callisto’s Board.

On December 22, 2004, the Board of Directors ofCallisto, acting upon advice of its Compensation Committee, awarded Mr. Cerronea cash bonus of $200,000 in recognition of his contributions to Callistoincluding negotiation and acquisition of certain intellectual property licensesduring 2004. Accordingly this bonus was charged to research and developmentexpense during 2004. Mr. Cerrone’s cash bonus for the year ended December 31,2005 was $30,750 per his Agreement and based on his role in strategic planningand capital markets consulting for Callisto during 2005 this bonus was chargedto general and administrative expense.

On August 12, 2004, in connection with the L-Annamycinlicense, Callisto entered into a consulting agreement with Roman Perez-Soler,M.D., for a term concurrent with the L-Annamycin license agreement. Inconnection therewith Dr. Perez-Soler agreed to be appointed to Callisto’sScientific Advisory Board. As consideration for consulting and advisoryservices Dr. Perez-Soler shall receive a $30,000 per year consulting fee and44,000 shares of restricted common stock. These shares were recorded as stockbased compensation expense during the 12 months ended December 31, 2004 for atotal of $70,840 based on the closing stock price of $1.61 on August 23, 2004.In addition, Callisto granted to Dr. Perez-Soler an option to purchase 468,500shares of common stock at an exercise price of $3.00 per share. The optionshares vest upon achievement of specific milestones related to futuredevelopment of L-Annamycin, at which time stock-based compensation expense willbe recorded based upon the fair value of the options at that time.

On April 6, 2004, Kunwar Shailubhai, Ph.D. enteredinto an employment agreement with Synergy in which he agreed to serve as SeniorVice President, Drug Discovery. Dr. Shailubhai’s employment agreement is for aterm of 12 months beginning April 6, 2004 and is automatically renewable forsuccessive one year periods at the end of the term. Dr. Shailubhai’s salary is$150,000 per year and he is eligible to receive a cash bonus of up to 15% ofhis salary per year. Dr. Shailubhai received a grant of 100,000 stock optionswhich are exercisable at $1.50 per share. 50,000 of such stock options vestedin June 2004 and 50,000 options vested in December 2004.

Callisto previously had an employment agreement datedJune 13, 2003 with Kunwar Shailubhai, Ph.D. to serve as Executive VicePresident and Head of Research and Development for a term of 18 monthsbeginning June 13, 2003. Dr. Shailubhai’s salary was $170,000 per year and hewas eligible to receive a cash bonus of up to 15% of his salary per year. Inconnection with his employment agreement, Dr. Shailubhai received a grant of25,000 stock options which were fully vested and have an exercise price of$1.50 per share. Dr. Shailubhai also received a grant of 325,000 stock optionswhich were to have vested over a three year period and were exercisable at$1.50 per share. This employment agreement was terminated on April 6, 2004 andunvested options were forfeited.

The new grant of 100,000 options was not subject tovariable accounting under FIN 44 because it was deemed that****Dr.Shailubhai continued as an employee within a consolidated group and there wereno change in the exercise price. The unamortized deferred compensation costassociated with the 225,000 cancelled options of $706,813 as of the date ofcancellation, was charged to stock-based compensation expense during thequarter ended June 30, 2004. The remaining deferred balance, based on theoriginal intrinsic value, associated with the remaining 100,000 options of $314,139,was expensed over the vesting period of the new grant (e.g. April 7, 2004through December 31, 2004).

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On January 15, 2004, Callisto entered into anemployment agreement with Bernard Denoyer, its Vice President, Finance. Mr.Denoyer’s employment agreement is for a term of 12 months beginning January 15,2004 and is automatically renewable for successive one year periods at the endof the term. Mr. Denoyer’s salary is $90,000 per year and he is eligible toreceive a cash bonus of up to 10% of his salary per year. Mr. Denoyer receiveda grant of 100,000 stock options which vest over a three year period and areexercisable at $3.60 per share. On July 29, 2005 Mr. Denoyer was granted anadditional 75,000 stock options which vest over three years and are exercisableat $1.38 per share. On September 1, 2006 Mr. Denoyer’s salary was increased to$120,000 per year and he became eligible for to receive a cash bonus of up to15% of his salary per year. During the years ended December 31, 2006, 2005 and2004, Mr. Denoyer earned a bonus of $10,461, $6,563 and $9,000, respectively.

On June13, 2003, Callisto entered into an employment agreement with Gary S. Jacob,Ph.D., to serve as Chief Executive Officer and Chief Scientific Officer. Dr.Jacob’s employment agreement is for a term of 18 months beginning June 13, 2003and is automatically renewable for successive one year periods at the end ofthe term. In connection with his employment agreement, Dr. Jacob received agrant of 500,000 stock options which vested over a three year period throughJune 13, 2006 and are exercisable at $1.50 per share.  On March 17, 2006, pursuant to CompensationCommittee approval, Dr. Jacob’s salary was increased to $300,000 peryear; he became eligible to receive a cash bonus of up to 15% of his salary peryear and received a grant of 150,000 stock options which vest over a three yearperiod which are exercisable at $1.64 per share. During the years endedDecember 31, 2006, 2005 and 2004, Dr. Jacob earned a bonus of $48,125, $33,750and $33,750, respectively. On February 16, 2007, Dr. Jacob entered into anExtension and Amendment Agreement with Callisto as approved by the CompensationCommittee which extended the term under his employment agreement to June 30,2009.  In addition, pursuant to theagreement, Dr. Jacob was granted 225,000 ten year incentive stock optionsexercisable at $0.81 per share of which 75,000 vest on each of December 31,2007, 2008 and 2009.

OnSeptember 23, 2003, Callisto entered into an employment agreement with DonaldH. Picker, Ph.D., to serve as Vice President, Drug Development. The employmentagreement was for a term of 18 months beginning September 23, 2003 and wasautomatically renewable for successive one year periods at the end of the term.Dr. Picker’s salary was initially $175,000 per year and he was eligible toreceive a cash bonus of up to $45,000 per year upon the achievement of certainperformance milestones. In connection with his employment agreement, Dr. Pickerreceived a grant of 325,000 stock options which vest over a three year periodand are exercisable at $1.50 per share. On April 6, 2004 the employmentagreement of Donald H. Picker, Callisto’s Executive Vice President, R&D wasamended. Dr. Picker’s salary was increased from $175,000 to $200,000 per yearand certain milestones were added upon which cash bonuses of up to $92,500 overa 12 month period may be paid. During the years ended December 31, 2006, 2005, and2004, Dr. Picker earned a bonus of $0, $20,000, and $37,500, respectively,based on achievement of certain milestones. Dr. Picker resigned his position onDecember 19, 2006.

OnDecember 21, 2006, Callisto filed a complaint against Tapestry Pharmaceuticals,Inc., Leonard P. Shaykin and Kai P. Larson in the Supreme Court of the State ofNew York alleging that Tapestry used information they obtained pursuant to aconfidential disclosure agreement between Callisto and Tapestry to cause DonaldPicker, Ph.D., Callisto’s former Executive Vice President, Research &Development, to resign and accept a position with Tapestry. In addition,Callisto is alleging that Tapestry fraudulently entered into the confidentialdisclosure agreement with Callisto and intentionally interfered with Dr. Picker’semployment agreement with Callisto. Callisto is seeking actual and punitivedamages. As of April 9, 2007 the discovery process is ongoing and thedefendants have filed a motion to dismiss the complaint against Messrs. Shaykinand Larsen.

Callisto has various consulting agreements withmembers of its scientific advisory board to provide services. Fees are basedand paid on services provided.

**Lease agreements:**

On August 20, 2003, Callisto entered into a five yearlease for its corporate headquarters in New York City with an approximate rentof $100,000 annually through August 2008. On June 7, 2004 Callisto extended itslease for its corporate headquarters in New York City three additional yearsthrough June 30, 2011, and increased its space to 3,886 rentable square feet.This increased average annual rent to approximately $150,000. On November 4,2003, Synergy entered a two year lease for laboratory space in New Jersey,principally to support combined Callisto and Synergy research efforts, with anapproximate rent of $50,000 annually through November 2005, at which timeCallisto did not renew its lease, because its research group moved tolaboratory and office space in Doylestown PA, funded in full by the NIAIDbiodefense grant. During the twelve months ended December 31, 2006, 2005 and2004 total rent expense was $181,036, $244,531and $217,297, respectively. Totalannual commitments under the remaining New York City lease for each of theyears ended December 31, are as follows:
| 2007   |   | $       | 151,524 |   |
|--------|--------|---------|---------|--------|
| 2008   |   | 154,555 |    |
| 2009   |   | 157,646 |    |
| 2010   |   | 160,799 |    |
| 2011   |   | 81,464  |    |
|   |   |    |    |
| Total  |   | $       | 705,988 |   |

 

9. Property and equipment:

Equipment consists of laboratory, testing and computerequipment and furniture and fixtures consists of office furniture, both statedat cost, with useful lives ranging from 2-4 years, depreciated on a straightline basis. Depreciation expense for the years ended December 31, 2006, 2005,2004 and from June 5, 1996 (inception) to December 31, 2006 was $2,151,$18,856, $27,632 and $86,788, respectively.
| ** **                       | ** ** | **December 31,** | ** ** |
|----------------------------------|------------|-----------------------|------------|
| ** **                       | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Equipment                        |       | $                     | 54,896     |   | $ | 46,294 |   |
| Furniture and  fixtures          |       | 38,343                |       | 38,343 |   |
| Less -  Accumulated depreciation |       | (86,788               | )          | (84,637 | ) |
|                             |       |                  |       |   |   |
| Property and equipment,  net     |       | $                     | 6,451      |   | $ | 0 |   |

 

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10. Selected Quarterly Financial Data (Unaudited):
| ** **                                  | ** ** | **(Amounts in dollars)** | ** ** |
|---------------------------------------------|------------|------------------------------------|------------|
| ** **                                  | ** ** | **First**                          | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** | ** ** | ** ** |
| ** **                                  | ** ** | **Quarter**                        | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Total** | ** ** |
|                                        |       |                               |       |   |   |   |   |   |   |   |   |
| Year Ended  December 31, 2005          |       |                               |       |   |   |   |   |   |   |   |   |
| Net loss  applicable to common stockholders |       | $                                  | (2,594,131 | ) | $ | (2,610,677 | ) | $ | (3,320,569 | ) | $ | (3,254,080 | ) | $ | (11,779,457 | ) |
| Net loss per  share:                        |       |                               |       |   |   |   |   |   |   |   |   |
| Basic and  diluted                          |       | $                                  | (0.09      | ) | $ | (0.08 | ) | $ | (0.10 | ) | $ | (0.10 | ) | $ | (0.37 | ) |
|                                        |       |                               |       |   |   |   |   |   |   |   |   |
| Year Ended  December 31, 2006          |       |                               |       |   |   |   |   |   |   |   |   |
| Net loss  applicable to common stockholders |       | $                                  | (4,374,628 | ) | $ | (3,416,171 | ) | $ | (1,930,146 | ) | $ | (5,582,769 | ) | $ | (15,303,714 | ) |
| Net loss per  share:                        |       |                               |       |   |   |   |   |   |   |   |   |
| Basic and diluted                           |       | $                                  | (0.12      | ) | $ | (0.09 | ) | $ | (0.05 | ) | $ | (0.14 | ) | $ | (0.40 | ) |

 

**11. Subsequent events**:

On March 2, 2007, at aSpecial Meeting of Stockholders, Callisto’s stockholders approved (i) thepotential issuance of up to 17,448,427 shares of our common stock (issuableupon the conversion of 614,125 shares of Series A Convertible Preferred Stockand the exercise of 9,260,094 common stock purchase warrants at a price belowfair market value issued in connection with a private placement conductedOctober 2006-January 2007 and (ii) an amendment to Callisto’s  Certificate of Incorporation, as amended, toincrease the number of authorized shares of common stock, par value $.0001 pershare, from 100,000,000 shares to 150,000,000 shares.

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Index to Exhibits
| Exhibit    | ** ** | ** **                                                                                                                                                                                                                                                                                                          |
|------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                     |
|       |       |                                                                                                                                                                                                                                                                                                                |
| 3.1        |       | Certificate of Incorporation, as amended                                                                                                                                                                                                                                                                            |
|       |       |                                                                                                                                                                                                                                                                                                                |
| 3.2        |       | Certificate of Designations, Number, Voting Powers,  Preferences and Rights of Series A Convertible Preferred Stock of Callisto  Pharmaceuticals, Inc. (Incorporated by reference to Exhibit 3.1 filed with  the Company’s Current Report on Form 8-K filed on October 27, 2006)                               |
|       |       |                                                                                                                                                                                                                                                                                                                |
| 3.3        |       | Certificate of Amendment to Certificate of  Designations, Number, Voting Powers, Preferences and Rights of Series A  Convertible Preferred Stock of Callisto Pharmaceuticals, Inc. (Incorporated  by reference to Exhibit 3.2 filed with the Company’s Current Report on Form  8-K filed on December 27, 2006) |
|       |       |                                                                                                                                                                                                                                                                                                                |
| 3.4        |       | Bylaws (Incorporated by reference to Exhibit 99.2  filed with the Company’s Current Report on Form 8-K filed on May 28, 2003)                                                                                                                                                                                  |
|       |       |                                                                                                                                                                                                                                                                                                                |
| 4.1        |       | 1996 Incentive and Non-Qualified Stock Option Plan  (Incorporated by reference to Exhibit 4.1 filed with the Company’s Current  Report on Form 8-K filed on May 15, 2003)                                                                                                                                      |
|       |       |                                                                                                                                                                                                                                                                                                                |
| 4.2        |       | Form of Warrant to purchase shares of common stock  issued in connection with the sale of common stock (Incorporated by reference  to Exhibit 4.1 filed with the Company’s Current Report on Form 8-K filed on  January 28, 2004)                                                                              |
|       |       |                                                                                                                                                                                                                                                                                                                |
| 4.3        |       | Form of Warrant issued to Trilogy Partners, Inc.  (Incorporated by reference to Exhibit 4.1 filed with the Company’s Current  Report on Form 8-K filed on July 22, 2005)                                                                                                                                       |
|       |       |                                                                                                                                                                                                                                                                                                                |
| 4.4        |       | 2005 Equity Compensation Incentive Plan  (Incorporated by reference to Appendix B filed with the Company’s Definitive  Proxy Statement on Schedule 14A filed on August 31, 2005)                                                                                                                               |
|       |       |                                                                                                                                                                                                                                                                                                                |
| 4.5        |       | 2005 Directors’ Stock Option Plan (Incorporated by  reference to Appendix C filed with the Company’s Definitive Proxy Statement  on Schedule 14A filed on August 31, 2005)                                                                                                                                |
|       |       |                                                                                                                                                                                                                                                                                                                |
| 4.6        |       | Form of Warrant to purchase Common Stock issued in  connection with the sale of Common Stock (Incorporated by reference to  Exhibit 4.1 filed with the Company’s Current Report on Form 8-K filed on  February 9, 2006)                                                                                        |
|       |       |                                                                                                                                                                                                                                                                                                                |
| 4.7        |       | Form of Warrant to purchase Common Stock issued to  certain selling agents in connection with the sale of Common Stock  (Incorporated by reference to Exhibit 4.2 filed with the Company’s Current  Report on Form 8-K filed on February 9, 2006)                                                              |
|       |       |                                                                                                                                                                                                                                                                                                                |
| 4.8        |       | Form of Warrant issued pursuant to the Letter  Agreement dated September 8, 2006 between Callisto Pharmaceuticals, Inc. and  certain investors (Incorporated by reference to Exhibit 4.1 filed with the  Company’s Current Report on Form 8-K filed on September 14, 2006)                                     |
|       |       |                                                                                                                                                                                                                                                                                                                |
| 4.9        |       | Form of Warrant to purchase shares of Common Stock  issued in connection with the sale of the Series A Convertible Preferred  Stock (Incorporated by reference to Exhibit 4.1 filed with the Company’s  Current Report on Form 8-K filed on October 27, 2006)                                                  |
|       |       |                                                                                                                                                                                                                                                                                                                |
| 10.1       |       | Employment Agreement dated June 13, 2003 by and  between Callisto Pharmaceuticals, Inc. and Gary S. Jacob (Incorporated by  reference to Exhibit 10.1 filed with the Company’s Quarterly Report on Form  10-QSB filed on August 20, 2003)*                                                                     |
|       |       |                                                                                                                                                                                                                                                                                                                |
| 10.2       |       | Employment Agreement dated April 6, 2004 by and  between Synergy Pharmaceuticals Inc. and Kunwar Shailubhai (Incorporated by  reference to Exhibit 10.2 filed with the Company’s Annual Report on Form  10-KSB on April 14, 2004)*                                                                             |
|       |       |                                                                                                                                                                                                                                                                                                                |
| 10.3       |       | License Agreement dated as of August 28, 2002 by and  between Synergy Pharmaceuticals Inc. and AnorMED Inc.(Incorporated by  reference to Exhibit 10.4 filed with the Company’s Current Report on Form  10-QSB filed on November 14, 2003)**                                                                   |

 

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| 10.4   |   | Employment Agreement dated January 15, 2004 by and  between Callisto Pharmaceuticals, Inc and Bernard Denoyer (Incorporated by  reference to Exhibit 10.6 filed with the Company’s Annual Report on Form  10-KSB on April 14, 2004)*                                                                                                                                        |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 10.5   |   | Patent and Technology License Agreement dated August  12, 2004 by and between The Board of Regents of the University of Texas  System, on behalf of The University of Texas M. D. Anderson Cancer Center and  Callisto Pharmaceuticals, Inc. (Incorporated by reference to Exhibit 10.1  filed with the Company’s Current Report on Form 8-K filed on September 7,  2004)** |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 10.6   |   | License Agreement between Callisto Pharmaceuticals,  Inc. and The Rockefeller University effective as of July 25, 2001  (Incorporated by reference to Exhibit 10.12 filed with the Company’s Annual  Report on Form 10-K filed on June 6, 2005)                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 10.7   |   | Extension and Severance Compensation Agreement dated  June 9, 2005 between Callisto Pharmaceuticals, Inc. and Gary S. Jacob  (Incorporated by reference to Exhibit 10.1 filed with the Company’s Current  Report on Form 8-K filed on June 15, 2005)*                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 10.8   |   | Letter of Engagement between Trilogy Capital  Partners, Inc. and Callisto Pharmaceuticals, Inc. dated July 18, 2005  (Incorporated by reference to Exhibit 10.1 filed with the Company’s Current  Report on Form 8-K filed on July 22, 2005)                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 10.9   |   | Common Stock Purchase Agreement dated as of August  22, 2005 between Callisto Pharmaceuticals, Inc. and the investors listed on  Exhibit A thereto (Incorporated by reference to Exhibit 10.1 filed with the  Company’s Current Report on Form 8-K filed on August 26, 2005)                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 10.10  |   | Amendment dated October 19, 2005 to the Employment  Agreement dated as of June 13, 2003 by and between Callisto Pharmaceuticals,  Inc. and Gary S. Jacob (Incorporated by reference to Exhibit 10.1 filed with  the Company’s Current Report on Form 8-K filed on October 21, 2005)*                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 10.11  |   | Amendment dated October 19, 2005 to the Employment  Agreement dated as of January 15, 2004 by and between Callisto  Pharmaceuticals, Inc. and Bernard Denoyer (Incorporated by reference to  Exhibit 10.4 filed with the Company’s Current Report on Form 8-K filed on  October 21, 2005)*                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 10.12  |   | Amendment dated October 19, 2005 to the Employment  Agreement dated as of April 6, 2004 by and between Synergy Pharmaceuticals  Inc. and Kunwar Shailubhai (Incorporated by reference to Exhibit 10.5 filed  with the Company’s Current Report on Form 8-K filed on October 21, 2005)*                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 10.13  |   | Patent and Technology License Agreement dated  January 10, 2006 between The University of Texas M.D. Anderson Cancer Center  and Callisto Pharmaceuticals, Inc. **                                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 10.14  |   | Securities Purchase Agreement dated February 3, 2006  between Callisto Pharmaceuticals, Inc. and the investors listed on Schedule A  thereto (Incorporated by reference to Exhibit 10.1 filed with the Company’s  Current Report on Form 8-K filed on February 9, 2006)                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 10.15  |   | Form of Letter Agreement dated September 8, 2006  between Callisto Pharmaceuticals, Inc. and certain investors (Incorporated by  reference to Exhibit 10.1 filed with the Company’s Current Report on Form 8-K  filed on September 14, 2006)                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 10.16  |   | Form of Amendment Agreement dated as of September 8,  2006 between Callisto Pharmaceuticals, Inc. and certain investors  (Incorporated by reference to Exhibit 10.2 filed with the Company’s Current  Report on Form 8-K filed on September 14, 2006)                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 10.17  |   | Form of Lock-up Agreement dated as of September 8,  2006 between Callisto Pharmaceuticals, Inc. and certain investors  (Incorporated by reference to Exhibit 10.3 filed with the Company’s Current  Report on Form 8-K filed on September 14, 2006)                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                             |
| 10.18  |   | Form of Securities Purchase Agreement dated October  23, 2006 by and among Callisto Pharmaceuticals, Inc. and the purchasers set  forth on the signature page thereto (Incorporated by reference to Exhibit  10.1 filed with the Company’s Current Report on Form 8-K filed on October 27,  2006)                                                                           |

 

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| 10.19  |   | Form of Registration Rights Agreement dated October  23, 2006 by and among Callisto Pharmaceuticals, Inc. and the purchaser’s  signatory thereto (Incorporated by reference to Exhibit 10.2 filed with the  Company’s Current Report on Form 8-K filed on October 27, 2006)                    |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                     |
| 10.20  |   | Form of Securities Purchase Agreement dated December  20, 2006 by and among Callisto Pharmaceuticals, Inc. and the purchasers set  forth on the signature page thereto (Incorporated by reference to Exhibit  10.1 filed with the Company’s Current Report on Form 8-K filed on December  27, 2006) |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 10.21  |   | Form of Securities Purchase Agreement dated January  10, 2007 by and among Callisto Pharmaceuticals, Inc. and the purchasers set  forth on the signature page thereto (Incorporated by reference to Exhibit  10.1 filed with the Company’s Current Report on Form 8-K filed on January 17,  2007)   |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 10.22  |   | Extension and Amendment Agreement dated January 25,  2007 between Callisto Pharmaceuticals, Inc. and Gabriele M. Cerrone*                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 10.23  |   | Extension and Amendment Agreement dated February 16,  2007 between Callisto Pharmaceuticals, Inc. and Gary S. Jacob*                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 14     |   | Code of Business Conduct and Ethics (Incorporated by  reference to Exhibit 14 filed with the Company’s Annual Report on Form 10-KSB  filed on April 14, 2004)                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 21     |   | List of Subsidiaries                                                                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 23     |   | Consent of BDO Seidman, LLP                                                                                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 31.1   |   | Certification of Chief Executive Officer required  under Rule 13a-14(a)/15d-14(a) under the Exchange Act                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 31.2   |   | Certification of Principal Financial Officer  required under Rule 13a-14(a)/15d-14(a) under the Exchange Act                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 32.1   |   | Certification of Chief Executive Officer pursuant to  18 U.S.C Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                     |
| 32.2   |   | Certification of Principal Financial Officer  pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002                                                                                                                                                   |

 

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*    Management contract or compensatory plan orarrangement required to be filed as an Exhibit to this form pursuant to Item601 of Regulation S-K.

**   Confidential treatment has been requestedwith respect to deleted portions of this agreement.

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