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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549
   FORM 10-K (MARK ONE) þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the fiscal year ended December 31, 2004 OR o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from  to Commission File Number _______   ANADYS PHARMACEUTICALS, INC. (Exact name of registrant as specified in its charter)
 DELAWARE
    
    22-3193172(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)
 3115 Merryfield Row
San Diego, California 92121
(Address of principal executive offices) Companys telephone number, including area code: 858-530-3600 Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value per share   Indicate by check mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No  ̈ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. þ Indicate by check mark whether registrant is an accelerated filer (as defined in Rule 12b-2 of
the Exchange Act). Yes  ̈ No þ The aggregate market value of the common stock held by non-affiliates of the registrant
computed by reference to the closing price of the registrants common stock reported on the Nasdaq
National Market as of the last business day of the registrants most recently completed second
fiscal quarter was approximately $125,605,000 as of such date. As of March 15, 2005, the Registrant had outstanding 22,360,691 shares of common stock. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Companys Proxy Statement to be filed with the Securities and Exchange
Commission in connection with the 2005 Annual Meeting of Stockholders are incorporated herein by
reference into Part III.




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ANADYS PHARMACEUTICALS, INC.
ANNUAL REPORT ON FORM 10-K Table of Contents  
 PagePART IItem 1. Business
    
    
    3Item 2. Properties
    
    
    25Item 3. Legal Proceedings
    
    
    25Item 4. Submission of Matters to a Vote of Security Holders
    
    
    25PART IIItem 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
    
    
    26Item 6. Selected Financial Data
    
    
    28Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operation
    
    
    29Item 7A. Quantitative and Qualitative Disclosure About Market Risk
    
    
    34Item 8. Financial Statements and Supplementary Data
    
    
    34Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
    
    
    34Item 9A. Controls and Procedures
    
    
    34Item 9B. Other Information
    
    
    34PART IIIItem 10. Directors and Executive Officers of the Registrant
    
    
    35Item 11. Executive Compensation
    
    
    35Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
    
    
    35Item 13. Certain Relationships and Related Transactions
    
    
    35Item 14. Principal Accounting Fees and Services
    
    
    35PART IVItem 15. Exhibits and Financial Statement Schedules
    
    
    35EXHIBIT 23.1EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32




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PART I 
 Item 1. Business BUSINESS Overview Anadys Pharmaceuticals, Inc. is a biopharmaceutical company committed to the discovery,
development and commercialization of novel small molecule medicines for the treatment of serious
viral and bacterial infections. Our clinical development programs include ANA975, an oral prodrug
of isatoribine for the treatment of hepatitis C virus (HCV) and hepatitis B virus (HBV), and ANA380
for the treatment of HBV. In addition, our anti-infective therapeutic platform, which includes
core capabilities in Toll-Like Receptor (TLR)-based small molecules and structure-based drug
design, is designed to advance a pipeline of drug candidates into the clinic. Our most advanced HCV product candidate is known as ANA975, which is one of several oral
prodrugs based on our proprietary small molecule compound isatoribine. We believe isatoribine
regulates the bodys innate immunity and triggers a specific cellular response to viral infections,
including localized production of natural interferons. Isatoribine interacts with a specific
receptor, or protein, named Toll-Like Receptor 7, or TLR7, which represents a new mechanism of
action for the treatment of infectious disease. Results from our Phase IB trial showed that isatoribine caused a viral load reduction over
seven days similar to levels reported for currently commercialized primary HCV therapies
(interferon products plus ribavirin) over a comparable time period. Specifically, results from
clinical trials of isatoribine administered by intravenous infusion have demonstrated a
statistically significant viral load reduction of mean 0.76
log10 units, or 82 percent, in HCV
patients. This was a relatively small study conducted over the course of seven days and as such may
not be predictive of results from later stage clinical trials or the ability of isatoribine to
achieve sustained viral response, or SVR. However, we believe these results provide proof of
concept that a compound interacting with TLR7 can reduce viral load in HCV infected patients, and
that the data from this trial provide the first evidence that a selective agonist of TLR7 can
reduce circulating levels of HCV at least in part by activating innate immunity. As of December 31,
2004, isatoribine had been administered to 64 subjects, of which 44 were patients chronically
infected with HCV. In these clinical trials, isatoribine demonstrated favorable safety and
tolerability, although definitive conclusions regarding product safety cannot be made until the
results of additional preclinical tests and future studies of longer duration in more patients are
known. In the course of evaluating isatoribine in the context of the current HCV market, we
identified three key drivers for developing an effective frontline HCV therapy: First, comparable
efficacy compared to current standard of care; second, an improved safety and tolerability profile;
and third, ease of use. Isatoribine has demonstrated the potential to satisfy the first two
requirements, but is limited with regard to the third due to its intravenous administration. As
such, we have coalesced our clinical development efforts of TLR7 agonists for HCV around an oral
prodrug of isatoribine, and have initiated clinical studies with ANA975. ANA975 is an oral prodrug, a distinct proprietary chemical entity that is administered orally
and then is converted into the active compound, resulting in isatoribine in the bloodstream. We
believe that ANA975 has the potential to provide the same combination of antiviral effect and
tolerability as observed with isatoribine, but with the added advantage of oral administration. In
January 2005, we initiated Phase I clinical trials of ANA975 in healthy volunteers at a clinical
center in the U.K. to assess safety, tolerability and pharmacokinetics of ANA975. The Phase I
clinical trial is an open-label, ascending single-dose evaluation of ANA975 with three planned dose
levels of 400 mg, 800 mg and 1200 mg. The first two of the three planned cohorts have received
doses. Interim data from the 400 and 800 mg cohorts indicated that the bioavailability of the
ANA975 oral solution and conversion to isatoribine in plasma was rapid and effective, in excess of
90 percent. The data also indicated that ANA975 was safe and well tolerated in the healthy
volunteers, although definitive conclusions regarding product safety cannot be made until the
results of additional pre-clinical testing and future clinical trials of longer duration in more
patients are known. In order to support the filing of an Investigational New Drug, or IND, application with the
U.S. Food and Drug Administration, anticipated in mid-2005, we continue to conduct additional
preclinical testing of ANA975. In one of the recently completed preclinical studies we evaluated
cardiovascular safety pharmacology in monkeys. No prolongations of QT or QTc intervals were
observed. Isolated instances of sporadic dysrhythmic activity of no hemodynamic consequence were
observed at the highest doses in the study. Notably, no serious adverse events have been reported
in any of our isatoribine or ANA975 clinical trials to date, and no cardiac irregularities were
noted in the ECG data collected periodically during these clinical trials. Accordingly, we expect
to escalate to the third planned dose cohort with additional cardiac monitoring in test subjects
once our protocol amendment is accepted. Based on our internal analysis of all of our preclinical
and clinical data and the advice of external cardiovascular experts, we maintain our previously
forecasted clinical development milestones for ANA975, and expect to file our IND in mid-2005 and
to proceed into studies in HCV patients in the second half of 2005. We expect that the mechanism of action of ANA975 may also provide utility in HBV infected
patients in a similar manner as in HCV infected patients. This notion is further supported by the
recent approval of Pegasys (pegylated interferon-alpha-2a marketed by Roche) for the treatment of
HBV in Europe. We therefore plan to explore the use of ANA975 for the treatment of HBV. In addition to ANA975 for HBV, we are developing ANA380, a compound currently in Phase II
clinical trials. We have an exclusive license from LG Life Sciences, or LGLS, for the development
and commercialization of ANA380 for the treatment of chronic HBV in North America, Europe, Japan
and most other countries in the world other than China, Korea, India and countries in Southeast
Asia. We are jointly conducting and equally funding the global clinical development of ANA380.
Previously reported results from a completed Phase I/II trial demonstrated that oral administration
of ANA380 reduced viral load by an average of 3.4 log10 units in the chronic HBV infected patients
in the trial who received doses of 60 mg or more for four weeks. In December 2004, we reported interim data from an ongoing Phase II clinical trial of ANA380
in patients with lamivudine-resistant, or lamR, hepatitis B virus. The ongoing clinical trial is an
open label, multi-center, sequential group dose escalation study designed to assess the safety and
antiviral activity of ANA380 in chronically infected HBV patients who are resistant to lamivudine.
Eligible patients have been treated with lamivudine therapy but failed, as shown by rebounding
viral load levels and detection of lamivudine resistant mutations. Patients were enrolled
sequentially into three cohorts totaling 41 patients and are receiving once-daily doses of 30 mg,
60 mg and 90 mg. After 12 weeks of treatment, patients receiving 30 mg and 60 mg doses of ANA380
showed an average DNA viral load reduction of 2.8 and 3.2
log10 units, respectively. Furthermore,
interim data from the 90 mg cohort showed an average viral load
reduction of 2.7 log10 units after
four weeks. We believe that the interim results from this trial provide clinical evidence
confirming the promising activity of ANA380 against lamR hepatitis B strains. Anadys and LGLS are
evaluating the market opportunity for ANA380. In addition, Anadys and LGLS are evaluating various
cost-effective development alternatives for the advancement of ANA380. These alternatives include
collaborative research in pursuit of additional back-up compounds or combination products and/or
licensing and commercialization relationships with established pharmaceutical and biotechnology
companies. We also are developing a novel class of molecules that act against certain bacterial
infections, including serious hospital-based infections, by inhibiting ribosomal function, which is
the ability to synthesize new proteins. This effort has yielded a class of proprietary compounds
that exhibit in vitroantibacterial activity on various infectious agents, or 3




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pathogens, that are resistant to current antibiotic drugs. Members of this class of compounds
also exhibit potency and bactericidal activity, or the ability to cause the death of bacterial
cells, equal to or better than the potency and bactericidal activity reported for many
commercialized antibiotics. These efforts are currently in the discovery stage. In addition to the compounds described above, we have used our core capabilities to identify
additional lead anti-infective compounds. These include additional oral prodrugs of several
classes of TLR-7 agonists for other viral indications. We have entered into several collaborative
and validating relationships with pharmaceutical and biotechnology companies, including Amgen,
Aphoenix, Daiichi, Gilead and Roche that utilize our proprietary drug discovery technologies and
capabilities. We have received research funding and milestone payments from several of these
collaborations, some of which also include the potential for additional downstream milestones and
royalties. Industry Background Anti-infective medicines are designed to treat infectious diseases, including those caused by
bacteria and viruses that invade the body and overcome its natural defenses. Some infections affect
the entire body while others may be localized to one organ or system within the body, such as the
liver. The severity of infectious diseases varies significantly depending on the nature of the
infectious agent as well as the hosts immune system. According to a World Health Organization
report, infectious diseases, including HCV, HBV and drug resistant bacterial infections, cause
life-threatening illnesses and represent one of the most significant causes of mortality worldwide. Based on industry analyst reports and available market data, we estimate that worldwide annual
sales of drugs to treat infectious diseases are approximately $40 billion and that they will grow
to $45 billion by 2008. In 2002, based on industry analyst reports and available market data, we
estimate that nine of the 55 drugs exceeding $1 billion in annual sales were anti-infective drugs.
However, current treatment alternatives for a number of infectious diseases remain limited.
Pharmaceutical companies continue to focus on addressing unmet medical needs including greater
efficacy, fewer side effects, fewer drug interactions and improved convenience such as oral dosing.
A number of infectious diseases continue to develop increased resistance to existing therapies,
creating a continuous need for new therapies. Anti-infective compounds often have a favorable clinical path when compared to compounds in
other therapeutic areas. Although early-stage clinical results in the drug development process are
often not very predictive of results in later-stage, large-scale trials, preclinical and early
clinical data of anti-infective compounds have been demonstrated to be more predictive of a
products clinical success than many other classes of drugs. In addition, clinical trials of
anti-infective compounds generally have endpoints that can be achieved and measured in shorter time
frames, thereby lowering the development risk profile and resulting in less expensive and shorter
clinical development cycles. As a result, the success rate of clinical trials in the anti-infective
area is higher than many other therapeutic areas, including oncology, cardiovascular and central
nervous system disorders. Hepatitis C Virus Hepatitis C virus causes inflammation of the liver and degradation of liver function.
According to a Center for Disease Control, or CDC, report, approximately 70 percent of individuals
infected with HCV progress to chronic hepatitis. The most common symptoms of chronic hepatitis,
which may show no symptoms for many years, include an enlarged liver and spleen, jaundice, muscle
wasting, excoriations (the result of scratching), ascites (swelling of the abdomen) and swelling of
the ankles. Chronic HCV infection may also progress to further, more serious complications such as
cirrhosis of the liver, liver cancer and death. Of those patients who progress to chronic
hepatitis, the World Health Organization, or WHO, reports that 10 to 20 percent develop cirrhosis
over a period of 20 years, with approximately 1 to 5 percent of these patients progressing to
end-stage liver disease or liver cancer in their lifetime. In total, the National Institutes of
Health reports that HCV causes 10,000 to 12,000 deaths a year in the U.S., and the CDC estimates
the annual mortality rate could increase to 38,000 by the year 2010, surpassing the number of
deaths attributed annually to HIV/AIDS. The CDC reports, as of its most recent study issued at the end of 2002, that approximately 2.7
million Americans were chronically infected with HCV and at risk of disease progression. There is
no vaccine available to prevent the spread of HCV. The current standard of care for chronic HCV is
a combination of pegylated interferon-alpha and ribavirin. According to 2003 IMS Health
prescription data, only 80,000 patients in the U.S. receive treatment for HCV. In spite of the
current low penetration rate of existing drugs, based on industry analyst reports and available
market data, we estimate that annual U.S. sales of drugs for the treatment of HCV, including
pegylated interferon-alpha and ribavirin, are approximately $3.5 billion. Sales of HCV drugs are
expected to grow due to improved market penetration through improvements in therapies such as
replacing injectable interferon with oral drugs, increased awareness and improved diagnosis rates. Interferon-alpha is administrated by injection and results in abnormally high levels of this
cytokine circulating systemically throughout the body. Therapy with interferon-alpha causes a
number of side effects in many patients, including depression and flu-like symptoms, often
experienced during the entire standard year-long primary course of therapy used for treatment of
HCV. These side effects may make patients feel worse than foregoing treatment, which reduces their
motivation to continue HCV therapy. Many patients take additional drugs to treat these side
effects, further increasing the cost and the risk of additional side effects to the patient. As a
result, poor compliance with the HCV course of therapy may decrease the patient response rate. In addition to the side effects, current therapies do not provide sustained elimination of the
virus, or sustained virologic response, for 47 to 54 percent of the treated patients when measured
six months after the end of treatment. Due to the lack of alternative treatments, patients without
a sustained virologic response have no other treatment option but to undergo a second 48-week
course of interferon-alpha based therapy with a different brand of interferon-alpha. This second
course of therapy subjects the relapse patient to a similar risk of side effects as the previous
course of therapy. Hepatitis B Virus Hepatitis B virus, or HBV, infection is a growing global health problem that can cause both
acute and chronic viral infections. According to the WHO, more than 2 billion people alive today
have been infected with HBV at some time in their lives, and approximately 350 to 400 million
people remain chronically infected and become carriers of HBV. Of these chronic carriers, WHO
further estimates 15 to 40 percent will develop serious consequences of infection during their
lifetime, including loss of liver function, cirrhosis, and liver cancer. According to WHO,
approximately 1.2 million people die each year from chronic HBV or related conditions, including
cirrhosis and liver cancer. Based on industry analyst reports and available market data, we
estimate that the current annual market for HBV therapy is approximately $300 million and that it
will grow to over $1 billion by 2009. The anticipated market growth is expected to be due to the
continued need for improved drugs to fight the development of resistance and to improve efficacy
rates. Current small molecule treatments for HBV include lamivudine (Zeffix/Epivir HBV) from
GlaxoSmithKline, and adefovir dipivoxil (Hepsera) from Gilead. Recently, interferon-alpha therapy
(Intron-A) from Schering-Plough, Pegasys (pegylated interferon-alpha-2a) from Roche have been
endorsed by various regulators for the treatment of HBV. Also, entecavir (Baraclude) from
Bristol-Myers Squibb Co. has recently received FDA advisory committee approval for the treatment of
HBV in the U.S. In addition, tenofovir (Viread) an approved HIV compound from Gilead is expected to
pursue trials to gain a label claim for HBV. Finally, several other compounds are being studied in
Phase III clinical trials. The development of virus resistant to direct antiviral therapies is a growing problem in HBV
infected patients due to the virus ability to rapidly mutate. Genetically altered HBV that is
resistant to lamivudine can be detected in 14 to 32 percent of patients after one year of
lamivudine treatment. The proportion of patients with genetically resistant HBV 4




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increases with the duration of treatment, such that after four years of treatment with
lamivudine about two thirds of patients carry resistant virus. Adefovir is an additional direct
antiviral therapy approved in the U.S. and Europe for the treatment of HBV. Adefovir is indicated
for the treatment of HBV, primarily for patients who failed frontline lamivudine treatment.
Lamivudine and adefovir have significant limitations as long-term therapies, including the
potential for renal toxicity associated with adefovir, and the emergence of HBV variants resistant
to lamivudine. Antibacterials Bacterial infections become clinically apparent when microorganisms release toxins and/or
excessively provoke the immune system, harming otherwise healthy cells. Antibacterials work to
counter these infections by either killing the organism (bactericidal) or preventing it from
multiplying (bacteriostatic), thereby allowing the patients immune system to clear the remaining
bacteria. Pharmaceutical companies continue to focus on addressing a number of unmet medical needs for
antibacterials, including greater efficacy with improved resistance profiles, fewer side effects,
fewer drug interactions and improved convenience. While resistance to antibiotics has developed in
all settings, resistance among pathogens associated with bacterial infections acquired in the
hospital setting, or nosocomial infections, has emerged at especially high rates. According to one
industry source, each year, more than two million nosocomial infections occur in the U.S. with 50
to 60 percent of them caused by bacteria resistant to one or more previously effective
antibacterial compounds. The same industry source estimates that these infections contribute to
more than 77,000 deaths each year in the U.S. Our translation inhibitors offer the possibility to
treat infections resistant to currently available antibiotics. Another unmet medical need is a drug that more effectively treats Pseudomonas aeruginosa, a
serious pathogen in hospital-based infections and a leading contributor to mortality in cystic
fibrosis, or CF, patients. The novel class of bacterial translation inhibitors that we have focused
on display in vitroactivity against Pseudomonas aeruginosa, offering the possibility for more
effective antibiotic control in nosocomial pseudomonas patients and CF patients. Based on industry analyst reports and available market data, we estimate that global annual
antibiotic sales are approximately $27 billion and that they will to grow to $30 billion by 2008.
According to industry sources total worldwide annual hospital-based antibacterial sales are
approximately $8 billion. Sales for tobramycin, the most common antibiotic treatment for CF
patients, were $172 million in 2003. Our Strategy Our objective is to become one of the key companies in the discovery, development and
commercialization of small molecule therapeutics for the treatment of infectious diseases,
including HCV and HBV. Main aspects of our corporate strategy to achieve this objective include the
following:  
    Advance the Development of Our Lead HCV and HBV Compounds.We are developing our two
most advanced clinical compounds for the potential treatment of HCV and HBV and supporting
preclinical activities that include backups. In particular, during 2005 we expect to:  
    Complete the Phase I clinical trial of ANA975 that we initiated in January 2005.
    File an investigational new drug, or IND, application for ANA975, supporting subsequent studies in HCV and HBV.
    Initiate 28-day studies of ANA975 in HCV patients.
    Initiate 28-day studies of ANA975 in HBV patients.
    Complete 28-day studies in HCV patients and advance ANA975 into further clinical trials.
    Complete the Phase II clinical trial of ANA380 in lamR patients.  
    Expand Our Product Candidate Portfolio.We intend to continue to focus our drug
discovery and development efforts on the anti-infectives market. We believe the infectious
diseases market is attractive due to its large market opportunity, continual demand for
newer drugs to treat emerging resistance, well-characterized endpoints, high predictive
value of preclinical and early clinical results, and potential for expedited regulatory
review. We intend to leverage our expertise in TLR-based small molecule therapeutics and
structure-based drug design to expand our product candidate portfolio. In particular, we
intend to:  
    Exploit and expand our internal drug discovery capabilities to rapidly identify and
develop promising product candidates for the anti-infective markets, including HCV and
HBV. Our integrated drug discovery and development capabilities are designed to identify
and prioritize targets and provide proprietary high-throughput screening. We believe
successful integration of our drug discovery and development capabilities will allow us
to more rapidly identify and develop promising product candidates. Our intent is to
build a pipeline of novel drug candidates.
    Establish additional strategic collaborations to optimize our product candidate
portfolio, exploit additional TLR-based therapeutic opportunities and broaden our
discovery technology. In addition to our internal development efforts, we plan to
continue to pursue strategic activities, including collaborations, in-licensing and
out-licensing products and programs and acquisitions. We intend to focus on strategic
relationships and/or acquisitions of complementary businesses, technologies, services or
products that we believe can provide us access to, or facilitate our discovery of, new
compounds that have demonstrated potential in preclinical or clinical studies and are
synergistic with our existing product candidate portfolio.
    Continue our focus on TLR-based biology and chemistry, which offer new opportunities
for the development of small molecule immune-based antiviral medicines.
    Extend our leadership in structure-based drug design targeting both proteins and RNA. We continue
to identify and prioritize small molecules directed at key viral protein and bacterial RNA-related
targets for combating infectious diseases.  
    Commercialize Our Product Candidates.We intend to commercialize those compounds for
which we receive regulatory approval. To further our commercialization efforts, we expect
to: 5




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
    Directly market and commercialize in North America our lead hepatitis compounds and
other potential product candidates that are of strategic interest to us, although we may
enter into an agreement to co-promote one or more of our product candidates in the U.S.
    Establish strategic collaborations to market potential product candidates in Europe,
Asia and elsewhere. We may also explore the possibility of using TLR-7 agonists such as
isatoribine or other related compounds as a therapy for diseases other than HCV and HBV,
and may enter into strategic partnerships for the development and commercialization of
such therapies. With respect to product candidates we may discover that are not of
strategic interest to us, we may license development and/or commercialization rights to
collaborators in exchange for up-front payments, research funding, milestone payments
and/or royalties. Our Development Programs The following table illustrates our most advanced product candidates for the treatment of HCV,
HBV and bacterial infections and indicates their current stage of development. (BAR CHART) HCV Programs ANA975 Our most advanced HCV product candidate is known as ANA975, which is based on our proprietary
small molecule compound isatoribine. ANA975 is a distinct chemical entity that is administered
orally and then is converted into the active compound, resulting in isatoribine in the bloodstream.
We believe isatoribine activates the bodys innate immunity and triggers a specific cellular
response to viral infections, including localized production of multiple cytokines, including
natural interferons. Isatoribine interacts with a specific receptor, or protein, named Toll-Like
Receptor 7, or TLR7, which represents a new mechanism of action for the treatment of HCV that we
believe may offer improved therapeutic benefits over existing therapies. Because the underlying
mechanism of action for ANA975 is the same as for isatoribine, we expect that the knowledge we
derived from our clinical development of isatoribine will help to accelerate the development of
ANA975. ANA975 has been tested for a variety of biopharmaceutical properties in several preclinical
animal models and has shown significant oral bioavailability at levels that support further
development as a potential primary HCV therapy. Based on these animal data and the results from our
isatoribine clinical trials, we believe that ANA975 has the potential to be an orally administered
drug that could potentially replace interferon alpha as a component of a primary HCV therapy.
Interferon products are injectable therapies that cause a number of side effects in many patients,
including depression and flu-like symptoms. Prior to human dosing we conducted a series of preclinical toxicology studies, including in
vitroand in vivosafety pharmacology studies, in vitrogenetic toxicology studies and in vivo
repeat dose toxicology studies. Based on favorable outcomes of these studies in December 2004 we
filed an Investigational Medical Product Dossier with the U.K. health authorities MHRA requesting
permission to commence human dosing, which permission was granted in January 2005. We initiated
Phase I clinical trials of ANA975 in healthy volunteers at a clinical center in the U.K. to assess
safety, tolerability and pharmacokinetics of ANA975 in January 2005. The Phase I clinical trial is
an open-label, ascending single-dose evaluation of ANA975 with three planned dose levels of 400 mg,
800 mg and 1200 mg. The first two of the three planned cohorts have received doses. The plasma
concentrations of isatoribine after single-dose administration of an oral solution of ANA975 400 mg
or 800 mg were similar to concentrations found in previous clinical studies in which intravenous
isatoribine was administered at similar dose levels, indicating that the bioavailability of the
ANA975 oral solution in terms of isatoribine plasma exposure is in excess of 90 percent. The plasma
concentration of isatoribine over time at 800 mg was approximately twice the concentration at 400
mg, indicating little or no saturation of absorption or conversion of ANA975 to isatoribine. The
data also indicated that ANA975 was safe and well tolerated in the healthy volunteers, although
definitive conclusions regarding product safety cannot be made until the results of additional
pre-clinical testing and future clinical trials of longer duration in more patients are known. 6




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In order to support the upcoming filing of an Investigational New Drug, or IND, application
with the U.S. Food and Drug Administration, we continue to conduct additional preclinical testing
of ANA975. In one of the recently completed preclinical studies we evaluated cardiovascular safety
pharmacology in monkeys in which we continuously collected hemodynamic and ECG data over an
approximately 25-hour period commencing one-half hour prior to dosing. No prolongations of QT or
QTc intervals were observed. Isolated instances of sporadic dysrhythmic activity of no hemodynamic
consequence were observed at the highest doses in the study. Notably, no serious adverse events
have been reported in any of our isatoribine or ANA975 clinical trials to date, and no cardiac
irregularities were noted in the ECG data collected periodically during these clinical trials. We
are assessing the data from our recent preclinical study with the assistance of external clinicians
and cardiovascular experts in order to determine whether these events are related to ANA975 (or its
metabolites) or unrelated causes. Also, we intend to implement additional cardiac monitoring in
subsequent dose cohorts receiving ANA975 in our ongoing Phase I clinical trial until the origin of
these animal findings and their relevance for human safety are better understood. Accordingly, we
expect to escalate to the third planned dose cohort with additional cardiac monitoring in test
subjects once our protocol amendment is accepted. Based on our internal analysis of all of our
preclinical and clinical data and the advice of external cardiovascular experts, we maintain our
previously forecasted clinical development milestones for ANA975, and expect to file our IND in
mid-2005 and to proceed into studies in HCV patients in the second half of 2005. Isatoribine Isatoribine is a proprietary nucleoside analog that we have evaluated in ongoing clinical
trials for the treatment of HCV infections. Nucleoside analogs are chemically modified versions of
nucleosides, which are small molecules that occur naturally and are used by biological organisms to
store and read genetic information. As of December 31, 2004, isatoribine had been administered to
64 subjects, of which 44 were patients chronically infected with HCV. We are nearing completion of
an ongoing Phase I/II clinical trial to evaluate the safety and tolerability of isatoribine in
combination with increasing doses of interferon, and have enrolled 15 out of 16 patients in the
study. In our Phase IB clinical trial of isatoribine we measured certain markers of biologic
activity that change in scientifically known ways for HCV therapies that have demonstrated
efficacy. This is generally regarded as successfully achieving a sustained virologic response,
specifically the absence of HCV in the patients body when measured six months after the end of
treatment. One of the biologic markers we measured is viral load reduction. Results from our Phase
IB trial showed that isatoribine caused a viral load reduction over seven days similar to levels
reported for currently commercialized primary HCV therapies (interferon products plus ribavirin)
over a similar time period. This was a relatively small study conducted over the course of seven
days and as such may not be predictive of the ability of isatoribine to achieve a sustained
virologic response. For current standard of care, the likelihood of a sustained viral response can
be predicted on the basis of the characteristics of the early viral response in the blood of
patients during the first few weeks of treatment. The Phase IB clinical trial was designed to test the safety and tolerability of isatoribine in
patients chronically infected with HCV. The study was a dose-escalating, open-label evaluation of
isatoribine administered intravenously over a period of seven days to 32 adult patients at 200 mg,
400 mg, 600 mg and 800 mg daily doses. The trial was conducted at two clinical centers in Western
Europe. Patients participating in the study were either HCV-treatment naïve or relapsed from
interferon-alpha, a component of the current standard of treatment. Of the 32 patients in the
study, 23 were infected with HCV genotype 1, which accounts for more than two-thirds of the
infections in the United States yet is the most difficult to treat with current therapies. Study results showed that isatoribine was biologically active, as evidenced by statistically
significant changes in 2-, 5-oligoadenylate synthetase (OAS), a biological marker for the
activity of interferon-alpha that is believed to mediate antiviral effects, in patients who
received either 600 mg or 800 mg daily for seven days. Viral load was most significantly reduced in
patients receiving 800 mg daily doses. After seven days, the average decrease in plasma viral load
was 0.76 log10 units, or 82 percent, in these patients. Of the 12 patients in this 800 mg dose
group, 10 were infected with HCV genotype 1. After completing the dosing phase, OAS expression and
plasma viral load returned to pre-treatment levels in all patients within seven days. Isatoribine treatment was safe and well tolerated in the study, with no serious adverse events
and a low frequency of mild to moderate side effects compared to interferon treatment, although
definitive conclusions regarding product safety cannot be made until the results of additional
preclinical testing and future clinical trials of longer duration in more patients are known. No
patient altered treatment or withdrew from the study due to adverse events or clinical laboratory
abnormalities. The results from this completed clinical trial corroborate and extend previously
disclosed safety, tolerability, and pharmacokinetic data derived from single doses of isatoribine
in healthy volunteers. Mechanism of Action Isatoribines interaction with TLR7 represents a new mechanism of action for the treatment of
infectious disease. The human immune system has two primary arms, the innate arm and the adaptive
arm. Within each arm of the immune system, there are two primary classes of agents, proteins and
cells, responsible for executing immunological function. The proteins and cells of the innate arm
and the adaptive arm act in a network of interplay and feedback to create the most complete
immunological response to infection. The innate arm is responsible for mounting a generalized early response to infection caused by
numerous pathogens (the microscopic organisms that cause infection). This innate response includes
production of proteins that activate cells of the immune system, as well as direct activation of
certain cell types, including dendritic cells. One protein produced upon activation of the innate
arm is interferon-alpha. Direct administration of an interferon-alpha product is a mainstay of
current treatments for HCV. It is believed that interferon-alpha acts to stimulate an immunological
response to the HCV infection, ultimately leading to control of the infection. The adaptive arm of the immune system is responsible for mounting a response that is tailored
to the specific pathogen causing the infection. The adaptive arm is alerted to the presence of
infection by the early response of the innate arm. Furthermore, the adaptive arm is stimulated to
augment its response by the proteins and activated cells produced by the innate arm. We believe we
can produce a therapeutic effect in HCV and other chronic infections, such as HBV, by using
isatoribine to activate the innate arm of the immune system, thereby also activating components of
the adaptive arm. Activation of both arms should augment immunological response to the viral
infection, and may lead to a sustained response as is seen with direct administration of
interferon-alpha without the adverse effects associated with interferon-alpha treatment. We believe that isatoribine acts at least in part by interacting with a specific type of
protein molecule contained on the surface of immune system cells. This type of protein is called a
receptor because it recognizes and binds specific molecules, acting to receive the information that
such molecules are present. By binding specific molecules, receptors can act to recognize and react
to changes outside or inside a cell. Receptor-mediated responses are central to the bodys ability
to maintain health and fight infection. We believe that isatoribine binds to a specific receptor
named Toll-like receptor 7, or TLR7, which is present in immune system cells. The TLR7
receptor is one of many Toll-like receptors present in immune system cells that
act to alert the immune system to molecules whose presence serves to signal that an infection is
occurring. We believe our preclinical and clinical data are consistent with the proposal that by
binding to the TLR7 receptor, isatoribine activates the immune system and leads to increased
control of the HCV infection. 7




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The interaction of isatoribine with TLR7 results in two complementary events: (i) localized
production of multiple cytokines (proteins that function to activate cells of the immune system),
including natural interferon and (ii) maturation of certain immune cells which ultimately migrate
to the lymph and mediate certain cellular antiviral effects. The specific mechanism of action
offers the potential to induce efficacious immune responses through acceleration and/or
amplification of normal immune signaling mechanisms, which generally are relatively localized in
nature and mediated by multiple proteins and cellular interactions. We believe that the results of
our clinical trials of isatoribine provide proof of concept that a compound interacting with TLR7
can reduce viral load. We expect the localized nature of this induction will minimize exposure of
the body to non-physiologic, undesirable concentrations of circulating immune cytokines, thereby
reducing side effects. Reduction of the adverse effects of current therapy could increase the
number of patients successfully completing therapy, with a consequential improvement in outcome. We maintain worldwide rights to develop and commercialize isatoribine and ANA975. We acquired
the exclusive worldwide rights to isatoribine in March 2000 as part of a licensing agreement with
Valeant Pharmaceuticals International (formerly known as ICN Pharmaceuticals, Inc.) and Devron
Averett, Ph.D. that included six compounds. We expect to commercialize ANA975 and other potential
HCV product candidates in the U.S. Other HCV Programs We have investigated additional mechanisms that may confer therapeutic potential for HCV. For
example, we are taking advantage of our core capabilities in structure based drug design and
medicinal chemistry in the selection of our AN 025-1 program for intensified focus aimed at
identifying a preclinical candidate. This program contains a class of compounds we have identified
as having preferential potential for leading to drug candidates. When tested in cell based assays,
which are laboratory tests designed to predict the potency of compounds against cells infected with
a virus, this class of compounds were shown to possess characteristics consistent with high quality
leads for HCV. Furthermore, we have begun to investigate the in vitrometabolism of the lead series
with favorable results. In parallel, we also continue to investigate additional mechanisms in
earlier discovery programs. These efforts rely on various aspects of our drug discovery and
development capabilities, including our expertise in medicinal chemistry and structure based drug
design. Each of these mechanisms is being explored to understand both the biological and chemical
potential for providing new HCV therapeutics. HBV Programs We are also pursuing the development of one or more product candidates for the treatment of
HBV. In particular, we expect ANA975 to have activity against chronic infections caused by HBV. We
have also in-licensed ANA380 from LGLS, a compound currently in Phase II clinical trials for the
treatment of chronic HBV. We have an exclusive license for the development and commercialization of
ANA380 for the treatment of chronic HBV in North America, Europe, Japan and most other countries in
the world other than China, Korea, India and countries in Southeast Asia. ANA975 Because interferon alpha is used in the treatment of both HCV and HBV, we expect that the
mechanism of action of isatoribine may provide utility in HBV infected patients in a similar manner
as in HCV infected patients. As a result we are exploring the use of ANA975 for the treatment of
HBV, both as a single agent and in combination with nucleoside or nucleotide analogs. ANA380 ANA380 is a nucleotide analog that has exhibited activity in vitroagainst both HBV typically
found in untreated patients and also HBV variants that demonstrate resistance to treatment with the
nucleoside analog lamivudine, which is a currently commercialized therapy for HBV. We continue to
explore this activity in our ongoing Phase II clinical trial. Nucleotide analogs are chemically
modified versions of nucleotides, which are small molecules that occur naturally and are used by
biological organisms to store and read genetic information. Results from a completed Phase I/II
trial demonstrated that oral administration of ANA380 reduced viral
load by an average of 3.4 log10 units in the chronic HBV infected patients in the trial who received doses of 60 mg or more for
four weeks. In December 2004, we reported positive interim data from a Phase II clinical trial of ANA380
in patients with lamR hepatitis B virus . The ongoing clinical trial is an open label,
multi-center, sequential group dose escalation study designed to assess the safety and antiviral
activity of ANA380 in chronically infected hepatitis B patients who are resistant to lamivudine.
Eligible patients have been treated with lamivudine therapy but failed, as shown by rebounding
viral load levels and detection of lamivudine resistant mutations. Patients were enrolled
sequentially into three cohorts totaling 41 patients and are receiving once-daily doses of 30 mg,
60 mg and 90 mg. After 12 weeks of treatment, patients receiving 30 mg and 60 mg doses of ANA380 showed an
average DNA viral load reduction of 2.8 and 3.2 log10 units, respectively. Furthermore, interim data
from the 90 mg cohort showed an average viral load reduction of 2.7 log10 units after four weeks.
We believe that the interim results from this trial provide clinical evidence confirming the
promising activity of ANA380 against lamR hepatitis B strains. Current small molecule treatments for HBV include lamivudine (Zeffix/Epivir HBV) from
GlaxoSmithKline, and adefovir (Hepsera) from Gilead. Recently, interferon-alpha therapy (Intron-A)
from Schering-Plough, Pegasys (pegylated interferon-alpha-2a) from Roche have been endorsed by
various regulators for the treatment of HBV. Also, entecavir (Baraclude) from Bristol-Myers Squibb
Co. has recently received FDA advisory committee approval for the treatment of HBV in the U.S. In
addition, tenofovir (Viread) an approved HIV compound from Gilead is expected to pursue trials to
gain a label claim for HBV. Finally, several other compounds are being studied in Phase III
clinical trials. Given the increased number of currently available treatments for HBV as well as those in
development, Anadys and LGLS are regularly evaluating the competitive landscape as well as various
development alternatives for the advancement of ANA380. These include collaborative research in
pursuit of additional back-up compounds or combination products and/or outlicensing and
commercialization opportunities. As part of our analysis, we are also assessing the potential
market opportunity for ANA380 and its merits as a competitive product candidate for HBV in our
territories. As a result of this assessment, Anadys may decide to license all or substantially all
of our rights to ANA380 to a third party or, if we are unable to obtain license terms acceptable to
us and/or LGLS, we may decide to substantially limit our development of ANA380. In addition, we are pursuing
ANA975 for HBV. This unique mechanism may offer the opportunity to be used in combination with
ANA380 or as a replacement to current therapies. Bacterial Ribosomal Translation Inhibitors Representative members of this class have shown in vitroactivity against several pathogens
resistant to existing antibiotics. Furthermore, members of this class of compounds have
demonstrated activity against both Gram-positive pathogens, including drug-resistant pathogens such
as methicillin-resistant Staphylococcus aureus(MRSA), as well as Gram-negative pathogens,
including Pseudomonas aeruginosa, which is a leading contributor to mortality in cystic fibrosis,
or CF, patients. MRSA and Pseudomonas aeruginosaare two of the main causative agents of many
serious hospital-based infections. Representative members of this class have been tested in animal
models of bacterial infections and have shown promising in vivoefficacy. In September 2004 we were
awarded a Phase II Small Business Innovation Research (SBIR) grant from the National Institutes of
Health (NIH) of up to $1.2 million over two years to fund this program. 8




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Additional Therapeutic Applications Additional Oral Prodrugs of TLR-7 Agonists We are also exploring the development of oral prodrugs of other TLR-7 agonists, which could
have utility in a number of viral and non-viral therapeutic applications. We are utilizing our
know-how and expertise around oral prodrugs to maximize this strategy. Isatoribine We have coalesced our clinical development efforts of TLR7 agonists for HCV around our oral
prodrug ANA975 based upon its favorable oral bioavailability and pharmaceutical properties. Even
though we will no longer actively develop isatoribine for the treatment of hepatitis C, we may
consider its potential as an agonist of TLR7 for other therapeutic indications that can benefit
from regulation of innate immunity, including other infectious diseases, cancer, asthma, allergies
and vaccine adjuvants. We will consider pursuing these opportunities with appropriate partners. ANA971 Likewise, we have decided not to pursue ANA971 for the treatment of hepatitis C. ANA971 is our
first generation oral prodrug of isatoribine that we discovered through the interaction of our
medicinal chemistry and internal development capabilities. Results of the Phase I clinical trial of
ANA971 in healthy volunteers indicated that the compound was safe and well tolerated, however
systemic delivery of isatoribine from oral ANA971 was significantly less than we anticipate for
ANA975. Based on a number of other attractive characteristics, including solubility, we are
considering the potential of ANA971 for its use in other therapeutic indications, potentially as an
intravenous formulation. Our Drug Discovery and Development Capabilities We intend to expand our product candidate portfolio by exploiting and enhancing our internal
drug discovery and development capabilities. Our drug discovery efforts have a particular focus on
both TLR-based small molecule therapeutics and structure-based drug design. This enables us to
engage in the efficient discovery and development of new product candidates. We have developed
expertise in identifying and prioritizing targets, high-throughput screening, and high output drug
discovery. We apply our capabilities and technologies to our internal discovery and development
efforts as well as to collaborations with biotechnology and pharmaceutical companies. The following
chart illustrates the various stages of the drug discovery and development process to which our
capabilities and technologies are being applied. (CHART) Core Expertise TLR-Based Small Molecule Therapeutics We are using the clinical proof-of-concept established with isatoribine together with our
expertise in TLR-based biology and chemistry to build a portfolio of product candidates. Our effort
focuses on small molecules targeting Toll-Like Receptors specifically associated with viral
infections. There are 10 known TLRs that have been identified in humans by researchers in recent
years. Toll-like receptors are present in certain immune system cells and serve to
activate the bodys immune system. We believe that certain Toll-Like Receptors offer new opportunities for the development of
small molecule immune-based antiviral medicines. These same Toll-Like Receptors also have the
potential to address other therapeutic applications such as cancer, asthma, allergies and vaccine
adjuvants. We will consider pursuing these opportunities with appropriate partners. 9




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Structure-Based Drug Design; Medicinal Chemistry The targets of drugs are most often macromolecules that carry out essential biological
functions. Such macromolecules adopt one or more specific conformations in three-dimensional space.
These conformations are referred to as the structure of the target. While the structure of a target
is critical for its biological function, the structure also determines the chemical nature of
compounds that can bind to and modulate the function of the target. Because of this determinacy,
knowledge of the three-dimensional structure of a target can offer important guidance in the search
for compounds that bind the target and offer potential as drug candidates. Structural information on a given target can be useful during the initial stages of a drug
discovery program where we seek to increase the binding affinity, or during later stages where we
seek the optimal balance of many parameters that ultimately control the pharmacology of drug
candidates. For example, our efforts to develop proprietary RNA-directed chemistries have been
greatly enhanced by obtaining the three-dimensional structures of prototype leads bound to their
respective RNA targets. We have established capability to crystallize both protein and RNA targets,
collect X-ray diffraction data and solve three-dimensional structures of lead-target complexes that
include both proteins and RNA. Collaboration and Licensing Agreements Hoffmann-La Roche Inc. In August 2002, we entered into a collaboration agreement with Roche pursuant
to which we are advancing a key oncology program for Roche using our medicinal chemistry
capabilities. We are deploying our capabilities to advance lead compounds identified by Roche
against an oncology target by engaging our high-output medicinal chemistry platform that includes
structure assisted drug design, cheminformatics, parallel synthesis and purification, and rapid
retesting of compounds. Roche will retain ownership of all molecules designed pursuant to the
project that are based on Roches lead compound. We received and recognized revenue from research
funding of approximately $1.8 million over the initial one-year term and, if certain milestones are
achieved, are entitled to certain milestone payments which may total up to $10.0 million for each
product candidate and royalties on net sales of any new drug resulting from the collaboration that
is commercialized by Roche. There is no guarantee that we will receive any milestone or royalty
payments under this agreement. In conjunction with the collaboration, Roche purchased 364,119
shares of our Series C preferred stock for a cash payment of approximately $2.5 million. In October
2003, we executed an extension of the agreement for another six months. Under the terms of the
extension, we have received and recognized as revenue additional funding of $910,000 to deploy our
discovery capabilities to advance Roches lead compounds against the oncology target. We have
completed performance under this agreement in March 2004. On July 28, 2004, we entered into a new drug discovery collaboration with Roche. Under the
terms of the agreement, we will receive research and development funding from Roche and in exchange
we will engage our drug discovery capabilities, including medicinal chemistry, structure-based drug
design, cheminformatics and biology to advance lead compounds against an undisclosed Roche program.
Under the terms of the agreement, we may receive up to $3.5 million in research funding and, if
certain milestones are achieved, are entitled to certain milestone payments which may total up to
$10.0 million for each product candidate and royalties on net sales of any new drug resulting from
the collaboration that is commercialized by Roche. There is no guarantee that we will receive any
milestone or royalty payments under this agreement. As of December 31, 2004, we have received
$876,000 in research and development funding from Roche of which approximately $745,000 was
recorded as revenue during the year ended December 31, 2004. The agreement includes potential
milestone payments if certain research and commercial milestones are achieved and royalties on net
sales of any new drug resulting from the collaboration that may be commercialized by Roche. There
is no guarantee the Company will receive any royalty payments or milestone payments under the
agreement. Amgen Inc. In February 2003, we entered into a collaboration agreement with Amgen to
discover novel compounds against a therapeutic target of Amgen. We designed, configured, and ran an
ATLASTM assay to screen compound collections against the target provided by
Amgen. Amgen has exclusive rights to develop and commercialize any products resulting from
compounds discovered in the collaboration. Under the terms of the agreement, we have received
$400,000 from Amgen through research funding payments, a technology access fee and a research
milestone payment. If certain clinical and commercial milestones are achieved, we are entitled to
milestone payments, which may total up to $10.75 million. We are also entitled to royalty payments
based on sales of any new drug that originates from our compound library and that results from the
collaboration. There is no guarantee we will receive any royalty payments or further milestone
payments under this agreement. We have completed performance under this agreement in April 2004. Daiichi Pharmaceutical Co. Ltd. In December 2003, we entered into a collaboration agreement with Daiichi to
discover novel compounds against therapeutic targets of Daiichi. We are designed, configuring and
running ATLAS TM assays to screen the Daiichi targets against a compound
collection provided by Daiichi. Under the terms of the agreement, we have received and recognized
as revenue a $400,000 collaboration fee, and may receive additional payments, which may total up to
$100,000, provided that certain success criteria are met under the collaboration. We completed
performance under this agreement in June 2004. LG Life Sciences, Ltd. In February 2004, we obtained an exclusive option from LG Life Sciences, Ltd.
(LGLS) to enter into a joint development and license agreement for the development and potential
commercialization of a compound currently in Phase II clinical trials for the treatment of chronic
HBV infection. We paid LGLS $500,000 for this option. On April 18, 2004, we exercised our option
and entered into a joint development and license agreement with LGLS for the clinical development
and commercialization of ANA380 for the treatment of chronic HBV infection in North America,
Europe, Japan and the rest of the world other than China, Korea, India and countries in Southeast
Asia. Under the terms of the agreement, we will share the costs for the global clinical development
of ANA380 with LGLS. In connection with the execution of the agreement, we paid a licensing fee of
$4 million during May 2004 to LGLS. In addition, we may be required to make additional milestone
payments totaling up to $25.5 million, subject to the attainment of product development and
commercialization objectives. We will pay royalties on any product sales in its sales territory to
LGLS and will receive royalties on any product sales in China from LGLS. Aphoenix, Inc. On September 3, 2004, the Company entered into a drug discovery collaboration agreement with
Aphoenix, Inc. to discover and advance lead compounds against Aphoenix targets for multiple
therapeutic indications. Under the terms of the agreement, the Company will receive research
funding of $1.25 million over the three-year term of the agreement. As of December 31, 2004, the
Company have received $500,000 in research funding from Aphoenix of which approximately $31,000 was
recorded as revenue for the year ended December 31, 2004. The Company may receive additional
payments in the form of milestone and royalty payments provided that certain success criteria are
met under the collaboration. There is no guarantee the Company will receive any royalty payments or
milestone payments under the agreement. 10




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Valeant Pharmaceuticals International (formerly known as ICN Pharmaceuticals, Inc.) In December 2002, we entered into an agreement with Valeant and Ribapharm,
Inc., which replaced and superceded prior documentation from 1999 and early 2000 relating to our
exclusive license from these licensors of six compounds (including isatoribine and ANA246). Under
the current agreement, we have an exclusive worldwide license to six antiviral compounds (including
isatoribine and ANA246), their prodrugs, metabolites, and the methods of using such compounds,
prodrugs and metabolites. We also have the right to receive assignment of the issued patents
covering the licensed matter at the time the patents are issued. Under the agreement, we are
entitled to receive milestone payments, which may total up to $425,000 for each product candidate
if certain clinical milestones are achieved. In connection with this agreement we have a minimum
royalty commitment of $50,000 and $75,000 for the years ended December 31, 2006 and 2007,
respectively, and $100,000 for each of the nine years thereafter. Manufacturing and Supply All of our manufacturing is out-sourced to third parties, with control by our internal
managers. We believe there are alternate sources of supply that can satisfy our clinical trial
requirements without significant delay or material additional costs. We rely on third-party
manufacturers to produce sufficient quantities of isatoribine and ANA975 for use in clinical studies. We
intend to continue this practice for any future clinical trials and large-scale commercialization
of ANA975 and for any other potential products for which we retain significant development and
commercialization rights. All of our current product candidates are small molecule drugs.
Historically, these drugs have been simpler and less expensive to manufacture than biologic drugs. Intellectual Property and Patents Our policy is to pursue patents and to otherwise endeavor to protect our technology,
inventions and improvements that are commercially important to the development of our business. We
also rely upon trade secrets that may be important to the development of our business. Our success will depend in large part on our ability to:  
    obtain and maintain patent and other proprietary protection for the technology, inventions and improvements we consider important to our business;
    defend our patents;
    preserve the confidentiality of our trade secrets; and
    operate without infringing the patents and proprietary rights of third parties. As of December 31, 2004, we had 19 patents issued in the U.S. and 53 foreign patents. Of
these, two of the U.S. patents and approximately 25 of the foreign patents relate to isatoribine
and expire in 2007 or 2008. We obtained rights to these patents through our agreement with
Valeant Pharmaceuticals International. One of the pending U.S. patents and one of the
pending foreign patents relate to ANA971. Two of the U.S. patents and approximately 25 of the
foreign patents relate to ATLASTM and expire in 2013 through 2016. In addition, as of
December 31, 2004, we had over 50 pending patent applications, both foreign and domestic. The
patents and patent applications include coverage of our drug discovery technologies, composition of
matter claims as well as method of use claims. We intend to continue using our scientific expertise
to pursue and file patent applications on new developments with respect to uses, methods and
compositions of matter in order to enhance our intellectual property position in the field of
anti-infectives. After the patents related to isatoribine expire, we will have no direct means to prevent third
parties from making, selling, using or importing isatoribine in the U.S., Europe or Japan. Instead,
we would need to rely upon the U.S. Drug Price Competition and Patent Term Restoration Act of 1984,
commonly known as the Hatch-Waxman Act, and applicable foreign legislation, to achieve market
exclusivity for isatoribine. For NDAs for new chemical entities not previously approved, the
Hatch-Waxman Act provides for marketing exclusivity to the first applicant to gain approval for a
particular drug by prohibiting acceptance or approval of an abbreviated new drug application, or
ANDA, from a generic competitor for up to five years after approval of the original NDA. Although
statutory market exclusivity in the U.S., Europe and Japan may apply even when the composition of
matter patent has already expired, we cannot guarantee that isatoribine will quality for such
market exclusivity. We intend to aggressively prosecute our patent applications and enforce and defend our patents
and otherwise enforce and defend our proprietary technology. Although we believe our rights under
patents and patent applications provide a competitive advantage, the patent positions of
pharmaceutical and biotechnology companies are highly uncertain and involve complex legal and
factual questions. We may not be able to develop patentable products or processes, and may not be
able to obtain patents from pending applications. Even if patent claims are allowed, the claims may
not issue, or in the event of issuance, may not be sufficient to protect the technology owned by or
licensed to us. Any patents or patent rights that we obtain may be circumvented, challenged or
invalidated by our competitors. We also rely on trade secrets and proprietary know-how, especially when we do not believe that
patent protection is appropriate or can be obtained. Our practice is to require our employees,
consultants, outside scientific collaborators, sponsored researchers and other advisors to execute
confidentiality agreements upon the commencement of employment or other relationships with us.
These agreements generally provide that all confidential information developed by or made known to
the individual during the course of the individuals relationship with us is to be kept
confidential and not disclosed to third parties. In the case of employees, the agreements generally
provide that all discoveries, developments, inventions and other intellectual property conceived or
reduced to practice by the individual while employed by us will be our exclusive property. In the
case of advisors and consultants, the agreements generally provide that all discoveries,
developments, inventions, and other intellectual property conceived or reduced to practice by the
individual as a result of performance of services for us and not resulting from research related to
work supported by another entity with which the individual is party to a confidentiality agreement,
shall be our exclusive property. These agreements may not effectively prevent disclosure of
confidential information nor result in the effective assignment to us of intellectual property, and
may not provide an adequate remedy to us in the event of unauthorized disclosure of confidential
information or other breaches of the agreements. Competition The biotechnology and pharmaceutical industries are very competitive and subject to rapid and
significant technological change. Many of the drugs that we are attempting to discover or develop
will be competing with existing therapies. In addition, a number of companies are pursuing the
development of pharmaceuticals that target the same diseases and conditions that we are targeting.
We believe that a significant number of drugs are currently under development and may become
available in the future for the treatment of HCV and HBV. Due to the level of focus on developing
treatments for HCV, HBV and for drugs that treat other viral and bacterial infections, ongoing
research efforts are intense and new treatments are being sought out and developed by our
competitors. Various companies are developing or commercializing products that are used for the
treatment of HCV, HBV, and other diseases that we have targeted for product development. Some of
these products use therapeutic approaches that may compete directly with ANA975 or ANA380. ANA975
also is subject to competition in the treatment of HCV from a number of products already approved
and on the market, including the following: Peg-Intron 11




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(pegylated interferon-alpha-2b), Rebetol (ribavirin), and Intron-A (interferon-alpha-2a),
which are marketed by Schering-Plough, and Pegasys (pegylated interferon-alpha-2a), Copegus
(ribavirin USP), and Roferon-A (interferon-alpha-2a), which are marketed by Roche. One industry
source has estimated that sales of Schering Ploughs HCV products were approximately $850 million
in 2004 while Roches HCV franchise sales were approximately $1.38 billion in 2004. We also face
competition from a number of companies working in the field of antibacterials and many antibiotics
and other approved products. Interferon has been the standard treatment for HCV since the late 1980s. Although interferons
show antiviral effects, they have a short half-life requiring frequent dosing and cause numerous
side effects. Pegylated interferons were developed to provide an improved dosing regimen with both
Pegasys and Peg-Intron approved as once-per-week products. Both products are delivered by injection
with Peg-Intron requiring reconstitution before administration. Ribavirin, which is administered
orally, is used in combination with interferon products to provide an improved sustained viral
response rate over interferon therapy alone. Total sales of ribavirin in 2003 is estimated to have
been approximately $838 million. Psychiatric reactions, including depression, irritability and anxiety, and flu-like symptoms
such as fatigue, pyrexia, myalgia, cough, headache, and rigors as well as neutropenia and thyroid
dysfunction are some of the side effects that patients experience when receiving interferon-based
therapies. However, due to the nature of HCV infection, patients may not show any symptoms from the
HCV itself when they initiate therapy. As a result, experiencing the side effects of
interferon-based therapies often makes patients feel sicker than the disease. According to the
National Institutes of Health, these side effects have caused discontinuation of treatment in
approximately 10 to 14 percent of patients. These side effects also require additional drug
therapies, which increase the cost to the patient. Further, the optimal dose, treatment length and
response rates to interferon and ribavirin therapy vary considerably based on HCV genotype as well
as the use of monotherapy versus combination therapy. Our internal market research analysis leads us to believe that an oral formulation of
isatoribine would be well received by patients and physicians and could replace pegylated
interferon in certain populations, especially where patient compliance is a concern. Currently
available pegylated interferons are presented in a once-a-week injection for 48 weeks, an
inconvenient but necessary treatment due to the lack of alternative oral formulations. Once side
effects and the inconvenience of once-a-week injections are managed, patients should expect no more
than a 50 percent chance of suppressing the virus, or achieving a SVR, six-months after the end of
treatment. In addition to an improved route of administration, product candidates such as ANA975,
with expected fewer side effects and an improved SVR, would offer significant clinical benefit to
HCV patients. Current small molecule treatments for HBV include lamivudine (Zeffix/Epivir HBV) from
GlaxoSmithKline, and adefovir (Hepsera) from Gilead. Recently, interferon-alpha therapy (Intron-A)
from Schering-Plough, Pegasys (pegylated interferon-alpha-2a) from Roche have been endorsed by
various regulators for the treatment of HBV. Also, entecavir (Baraclude) from Bristol-Myers Squibb
Co. has recently received FDA advisory committee approval for the treatment of HBV in the U.S. In
addition, tenofovir (Viread) an approved HIV compound from Gilead is expected to pursue trials to
gain a label claim for HBV. Finally, several other compounds are being studied in Phase III
clinical trials. Due to multiple side effects and inconvenient route of administration
(injection), interferon-based therapies continue to lose market share to direct antiviral drugs
such as Zeffix and Hepsera. Direct antiviral therapies offer an improved treatment alternative due
to their improved side effect profile and more convenient oral formulation. However, currently
marketed antiviral therapies have significant long term limitations, including the potential for
renal toxicity associated with adefovir, and the emergence of HBV variants resistant to lamivudine. Because we have only completed Phase IB clinical trials of isatoribine, and ANA380 is
currently only in Phase II clinical trials, it is difficult to predict the efficacy that will be
seen of these product candidates in larger, more diverse patient populations. It is also difficult
to predict whether these product candidates will be used as single agents or in combination
therapies or if these product candidates will cause any toxicity issues, potential side effects or
other negative indications associated with their long-term use. During the course of future
clinical trials, we may discover that these product candidates are less effective, require
unacceptable dosing regimens, or have a similar side effects profile as the profile associated with
current therapies. This may result in our product candidates being less advantageous or less
desirable from a patient prospective as compared to current therapies for HCV or HBV. We face competition from pharmaceutical and biotechnology companies both in the U.S. and
abroad. Our competitors may utilize discovery technologies and techniques or partner with
collaborators in order to develop products more rapidly or successfully than we or our
collaborators are able to do. Many of our competitors, particularly large pharmaceutical companies,
have substantially greater financial, technical and human resources than we do and far more
experience in the discovery and development of product candidates and the commercialization of
potential products. In addition, academic institutions, government agencies, and other public and
private organizations conducting research may seek patent protection with respect to potentially
competitive products or technologies. These organizations may also establish exclusive
collaborative or licensing relationships with our competitors. We believe that our ability to compete depends, in part, upon our ability to create, maintain
and license scientifically advanced technology. Further, we need to attract and retain qualified
personnel, obtain patent protection or otherwise develop proprietary technology or processes and
secure sufficient capital resources for the substantial time period between technological
conception and commercial sales of products based upon our technology. We expect that competition among HCV, HBV and antibacterial products approved for sale will be
based on various factors, including product efficacy, such as improved SVR, safety, such as
reducing negative side effects, reliability, ease of administration (e.g., oral vs. intravenous
administration), availability, price, reimbursement status and patent position. Potential
competitors may develop treatments for HCV or HBV or other technologies and products that are more
effective and/or safer than our product candidates or that would make our technology and product
candidates obsolete or non-competitive. Government Regulations We are subject to regulation by the U.S. Food and Drug Administration, or FDA, and comparable
regulatory agencies in foreign countries with respect to the development and commercialization of
products and services resulting from our drug discovery activities. These agencies and other
federal, state and local entities regulate research and development activities and the testing,
manufacture, quality control, safety, efficacy, labeling, storage, record keeping, advertising and
promotion of these products and services. As an initial step in the drug approval process of pharmaceuticals an applicant typically
conducts preclinical laboratory and animal studies of the product candidate. Following these
studies, the applicant will submit an Investigational New Drug, or IND, application to the FDA.
Once the IND becomes effective, the applicant can commence clinical studies in the U.S. of the
product candidate in humans to determine safety and efficacy. Following clinical studies, the
marketing of a new drug requires the filing of a New Drug Application, or NDA, with the FDA and its
subsequent approval (similar requirements exist within foreign agencies). The process required by
the FDA and comparable agencies before a pharmaceutical or biologic device may be marketed in the
U.S. or in any other country generally requires many years and substantial effort and financial
resources and approval from the FDA may not be granted in a timely manner, if at all. The time
required to satisfy FDA requirements or similar requirements of foreign regulatory agencies may
vary substantially based upon the type, complexity and novelty of the product or the targeted
disease. Even if a product receives regulatory approval, later discovery of previously unknown
problems with a product may result in restrictions on the product or even complete withdrawal of
the product from the market. 12




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Under the FDAs regulations, the clinical testing program required for marketing approval of a
new drug typically involves three sequential phases, which may overlap.  
    Phase I: Studies are conducted on normal, healthy human volunteers to determine safety,
dosage tolerance, absorption, metabolism, distribution and excretion. If possible, Phase I
studies may also be designed to gain early evidence of effectiveness.
    Phase II: Studies are conducted on small groups of patients afflicted with a specific
disease to gain preliminary evidence of efficacy, to determine the common short-term side
effects and risks associated with the substance being tested and to determine dosage
tolerance and optimal dosage.
    Phase III: Involves large-scale studies conducted on disease-afflicted patients to
provide statistical evidence of efficacy and safety and to provide an adequate basis for
physician labeling. Frequent reports are required in each phase and, if unwarranted hazards to subjects are found,
the FDA may request modification or discontinuance of clinical testing until further preclinical
testing is conducted. Additional testing (Phase IV) may be conducted after FDA approval for
marketing is granted and would be designed to evaluate alternative utilizations of drug products
prior to their being marketed for such additional utilizations as well as to test for complications
resulting from long term exposure not revealed in earlier clinical testing. Phase IV testing is
often similar to Phase II evaluation of efficacy testing using a carefully selected clinical
population. We are currently conducting Phase I clinical trials of ANA975 in Europe. To date, we have not
filed an IND application, or any other applications, with the FDA to conduct clinical trials in the
U.S. for any of our product candidates. Any IND application that we submit to the FDA for ANA975
will likely incorporate the results of our European clinical trials. The FDA may reject these
clinical trial results based on a determination that the foreign clinical trials were not conducted
in accordance with requisite U.S. regulatory standards and procedures. Moreover, the FDA may
subject the foreign trial data that we submit to a greater level of scrutiny and we may incur
additional costs and delays responding to FDA requests for supplemental information or
clarification. If we are unable to obtain FDA approval for any IND, we will not be permitted to
conduct clinical trials for ANA975 or any of our other product candidate in the U.S. and ultimately
seek or obtain U.S. regulatory approval for commercialization. Environmental and Safety Matters Our research and development involves the controlled use of biological, hazardous and
radioactive materials and waste. We are also subject to numerous federal, state and local
environmental and safety laws and regulations, including those governing the use, manufacture,
storage, handling and disposal of hazardous materials and waste products. The cost of compliance
with and any violation of these regulations could have a material adverse effect on our business
and results of operations. Although we believe that our safety procedures for handling and
disposing of these materials comply with the standards prescribed by state and federal regulations,
we cannot assure investors that accidental contamination or injury from these materials will not
occur. To date, compliance with laws and regulations relating to the protection of the environment
has not had a material effect on our capital expenditures or our competitive position. However, we
are not able to predict the extent of government regulation, and the cost and effect thereof on our
results of operations, which might result from any legislative or administrative action pertaining
to environmental or safety matters. In the event of contamination or injury, we could be held
liable for substantial damages or penalized with fines in an amount exceeding our resources, and
our clinical trials could be suspended. In addition, we may have to incur significant costs to
comply with future environmental laws and regulations. Employees As of December 31, 2004, we had 83 full-time employees, including 67 in
research and development, and the balance in general and administrative positions, with 33 of our
employees holding Ph.D. degrees. None of our employees are represented by a labor union, and we
consider our employee relations to be good. Executive Officers The
following table sets forth information regarding our executive
officers as of Decembr 31, 2004: Name
    
    Age
    
    PositionKleanthis G. Xanthopoulos, Ph.D.
    
    
    46
    
    
    Chief Executive Officer, President and DirectorStephen T. Worland, Ph.D.
    
    
    46
    
    
    Executive Vice President, Research and DevelopmentMichael J. Kamdar
    
    
    38
    
    
    Senior Vice President, Corporate Development and FinanceDevron R. Averett, Ph.D.
    
    
    55
    
    
    Chief Scientific OfficerElizabeth E. Reed, J.D.
    
    
    33
    
    
    Senior Director, Legal Affairs and Corporate SecretaryMary Yaroshevsky-Glanville
    
    
    40
    
    
    Senior Director, Human Capital
 Kleanthis G. Xanthopoulos, Ph.D.has served as our President and Chief Executive Officer and
as a Director since May 2000. From 1997 to 2000 he held a variety of positions at Aurora
Biosciences Corporation, including Vice President, Genomics & Molecular Biology. Dr. Xanthopoulos
was a Section Head of the National Human Genome Research Institute at The National Institutes of
Health and is an Onassis Scholar. Dr. Xanthopoulos was a Postdoctoral Research Fellow at the
Rockefeller University from 1987 to 1990 and an Associate Professor of Molecular Biology at the
Karolinska Nobel Medical Institute, Sweden from 1991 to 1995. Dr. Xanthopoulos is also a member of
the board of directors of Odyssey Thera, Inc. and BIOCOM, San Diegos life science industry
association. Dr. Xanthopoulos received his B.Sc. in Biology with honors from Aristotle University
of Thessaloniki, Greece, and received both his M.Sc. in Microbiology and Ph.D. in Molecular Biology
from the University of Stockholm, Sweden. Steve Worland, Ph.D.joined the company as our Chief Scientific Officer in 2001, and was
promoted to Executive Vice President, Head of Research and Development in October 2004. From 1999
to 2001 he was Vice President, Head of Antiviral Research, at Agouron Pharmaceuticals, a Pfizer
Company. Dr. Worland was at Agouron from 1988 through the acquisition of Agouron by Warner-Lambert
in 1999, where he held various positions and responsibilities that culminated with his assumption
of global responsibility for anti-infective strategy as Vice President for Warner-Lambert. At
Agouron, Warner-Lambert and Pfizer, Dr. Worland led teams responsible for discovery and clinical
development in the areas of HIV, HCV and Rhinovirus. Dr. Worland was a National Institutes of
Health Postdoctoral Fellow in Molecular Biology at Harvard University from 1985 to 1988. Dr.
Worland received his B.S. in Biological Chemistry from the University of Michigan and his Ph.D. in
Chemistry from the University of California, Berkeley. 13




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Michael J. Kamdarhas served as our Senior Vice President, Corporate Development and Finance
since February 2004. Previously, Mr. Kamdar served as our Vice President, Corporate Development
and Strategy with responsibility for business development, investor relations, global market
planning and corporate communications since August 2001. From 2000 to 2001, Mr. Kamdar was Senior
Director, Business Development at Agouron Pharmaceuticals, a Pfizer Company. Mr. Kamdar was at
Agouron from 1994 through 2001, including through the acquisition of Agouron by Warner-Lambert in
1999. Mr. Kamdar held various business development positions and responsibilities at Agouron that
culminated with his assumption of global responsibility for corporate partnering, in-licensing,
technology acquisition and strategic alliance efforts in the anti-infective, oncology and
opthalmology therapeutic areas. Prior to Agouron, Mr. Kamdar held various product management and
new product planning positions for Hybritech, Inc., an Eli Lilly Company, and Centocor Inc. Mr.
Kamdar received his B.S. in Biology from St. Josephs University and his M.B.A. from Villanova
University. Devron R. Averett, Ph.D.joined the company as Senior Vice President, Research, Development
and Medical in 2000 and later served as Senior Vice President, Drug Development before he was
promoted to Chief Scientific Officer in October 2004. From 1996 to 1999, Dr. Averett was Senior
Vice President, Research and Development for Valeant Pharmaceuticals International (formerly known
as ICN Pharmaceuticals, Inc.). Prior to this, Dr. Averett held a variety of positions of increasing
responsibility at Glaxo Wellcome and Burroughs Wellcome Co., culminating in global leadership roles
in discovery and clinical virology. Dr. Averett received his B.S. in Chemistry and M.S. in
Microbiology from the University of Georgia and his Ph.D. in Microbiology and Immunology from the
University of North Carolina. Elizabeth E. Reed, J.D.has served as our Senior Director, Legal Affairs since December 2002,
and as our Corporate Secretary since January 2002. Ms. Reed joined the Company as our Director of
Legal Affairs in October 2001. Prior to joining us, Ms. Reed was associated with the law firm of
Cooley Godward LLP from 1998 to 2001. Prior to Cooley Godward, Ms. Reed was associated with the law
firm of Brobeck, Phleger & Harrison LLP. Ms. Reed is a member of the State Bar of California and
received her B.S. in Business Administration from the University of California, Berkeley and holds
a J.D. from Harvard Law School. Mary Yaroshevsky-Glanvillehas served as our Senior Director, Human Capital since August 2002
and as our Director of Human Capital from April 2001 to August 2002. From 2000 to 2001, Ms.
Yaroshevsky-Glanville served as Director of Human Resources at Inflazyme Inc. Previously, Ms.
Yaroshevsky-Glanville served as Director of Human Resources at Inex Pharmaceuticals Corp. from 1995
to 2000 and as Manager, Human Resources and Office Administration from 1994 through 1995. Prior to
joining Inex, Ms. Yaroshevsky-Glanville held personnel and human resources positions at HBC, Inc.
Ms. Yaroshevsky-Glanville has a Human Resources Management Certificate from the British Columbia
Institute of Technology, has received a Certified Human Resources Professional designation from the
Human Resources Management Association, and holds a B.Sc. in Computer Information System Management
from the DeVry Institute of Technology. Company Website The Companys primary website can be found at www.anadyspharma.com. The Company makes
available free of charge at this website (under the Investors
 Financial Information - SEC
Filings caption) all of its reports filed or furnished pursuant to Section 13(a) or 15(d) of the
Securities Exchange Act of 1934, including its Annual Report on Form 10-K, its Quarterly Reports on
Form 10-Q and its Current Reports on Form 8-K and amendments to those reports. These reports are
made available on the website as soon as reasonably practicable after their filing with, or
furnishing to, the Securities and Exchange Commission. Furthermore, we also make available on our
website, and in print to any shareholder who requests it, the Committee Charters for Audit,
Compensation, and Nominating and Governance Committees, as well as the Code of Ethics that applies
to all directors, officers and employees of the Company. Amendments to these documents or waivers
related to the Code of Ethics will be made available on the Companys website as soon as reasonably
practicable after their execution. Risk Factors You should consider carefully the following information about the risks described below,
together with the other information contained in this Annual Report and in our other public filings
before making any investment decisions regarding our stock. If any of the following risks actually
occurs, our business, financial condition, results of operations and future growth prospects would
likely be materially and adversely affected. In these circumstances, the market price of our common
stock would likely decline, and you may lose all or part of the money you paid to buy our common
stock. Risks Related to Our Business We are at an early stage of development, and we may never attain product sales. Our existing organizational structure was formed in May 2000. Since then, most of our
resources have been dedicated to the development of our proprietary drug discovery technologies,
research and development and preclinical and early stage clinical testing of compounds. Any
compounds discovered by us will require extensive and costly development, preclinical testing and
clinical trials prior to seeking regulatory approval for commercial sales. Our most advanced
product candidates, ANA380 and ANA975 and any other compounds we
discover or in-license, may never
be approved for commercial sales. The time required to attain product sales and profitability is
lengthy and highly uncertain and we cannot assure you that we will be able to achieve or maintain
product sales. We expect our net operating losses to continue for at least several years and we are unable to
predict the extent of future losses or when we will become profitable, if ever. We have incurred net operating losses since our incorporation in 1992 and through December 31,
2004 we have an accumulated deficit of $165.8 million. Our operating losses are due in large part
to the significant research and development costs required to identify and validate potential
product candidates and conduct preclinical studies and clinical trials of isatoribine, ANA971 and
ANA975. To date, we have generated limited revenues, consisting of one-time or limited payments
associated with our collaborations or grants, and we do not anticipate generating significant
continuing revenues for at least several years, if ever. We expect to increase our operating
expenses over at least the next several years as we plan to expand the clinical trial program for
ANA975, fund our share of the development costs of ANA380, further our research and development
activities and potentially acquire or license new technologies and product candidates. As a result,
we expect to continue to incur significant and increasing operating losses for the foreseeable
future. Because of the numerous risks and uncertainties associated with our research and product
development efforts, we are unable to predict the extent of any future losses or when we will
become profitable, if ever. Even if we do achieve profitability, we may not be able to sustain or
increase profitability on an ongoing basis. The technologies on which we rely are unproven, and may not result in the discovery or
development of commercially viable products. Our proprietary technologies and methods of identifying, prioritizing and screening molecular
targets represent unproven approaches to the identification of drug leads that may possess
therapeutic potential. Much of our research focuses on the biology of a specific receptor, or
protein, named Toll-like receptor 7, or TLR7, and on the interactions between small molecules and
RNA (ribonucleic acid). However, RNA biology and chemistry are difficult, time-consuming and
expensive, and studying small molecule-RNA interactions may not result in the discovery of any
viable therapeutic product candidates. Additionally, the interaction between isatoribine and TLR7
represents a new mechanism of action for the treatment of HCV and there is no guarantee that an
acceptable balance between therapeutic benefit and risk will be achieved with ANA975 in HCV
infected patients. Furthermore, there is no guarantee that TLR biology will result in an acceptable
balance between therapeutic benefit and risk in any other therapeutic area, such as cancer, asthma,
allergies or vaccine adjuvants. There are no drugs on the market that have been discovered or
developed using our proprietary technologies. The process of successfully 14




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discovering product candidates is expensive, time-consuming and unpredictable, and the historical
rate of failure for drug candidates is extremely high. Research programs to identify product
candidates require a substantial amount of our technical, financial and human resources even if no
product candidates are identified. If we are unable to identify new product candidates using our
proprietary drug discovery technologies or capabilities, we may not be able to establish or
maintain a clinical development pipeline or generate product revenue. We are dependent on the commercial success of ANA975 or another oral prodrug of isatoribine or
other TLR7 agonists and we cannot be certain that ANA975 or any other oral prodrug of
isatoribine or other TLR7 agonists will be commercialized. Our work with ANA975 to date has been limited to pre-clinical studies and early stage clinical
trials in a small number of healthy volunteers. However, we have expended significant time, money
and effort in the clinical trials of isatoribine and ANA971. Because the underlying mechanism of
action for ANA975 is the same as for isatoribine and ANA971, we expect that the knowledge derived
from our clinical development of isatoribine and ANA971 will help to accelerate the development of
ANA975. Nonetheless, we will have to spend considerable additional time, money and effort before
seeking regulatory approval to market any product candidates, including ANA975. Our business
prospects depend primarily on our ability to successfully complete clinical trials, obtain required
regulatory approvals and successfully commercialize ANA975 or another oral prodrug of isatoribine
or another TLR7 agonist. If we fail to commercialize ANA975 or another oral prodrug of
isatoribine, or another TLR7 agonist we may be unable to generate sufficient revenues to attain
profitability and our reputation in the industry and in the investment community would likely be
significantly damaged, each of which would cause our stock price to decrease. Because the results of preclinical studies and initial clinical trials of isatoribine, ANA975
and ANA380 are not necessarily predictive of future results, we can provide no assurances that
ANA975 or ANA380 will have favorable results in later clinical trials, or receive regulatory
approval. Positive results from preclinical studies or early clinical trials should not be relied upon
as evidence that later or larger-scale clinical trials will succeed. Initial clinical trials of
isatoribine, ANA975 and ANA380 have been conducted only in small numbers of patients that may not fully
represent the diversity present in larger populations infected with HCV or HBV, and thus the
limited results we have obtained may not predict results from studies in larger numbers of patients
drawn from more diverse populations, and also may not predict the ability of isatoribine to achieve
a sustained virologic response or the ability of ANA380 to provide a long-term therapeutic benefit.
These initial trials have not been designed to assess the long-term therapeutic utility of
isatoribine, ANA975 or ANA380. We will be required to demonstrate through larger-scale clinical
trials that ANA975 and ANA380 are safe and effective for use in a diverse population before we can
seek regulatory approvals for their commercial sale. There is typically an extremely high rate of
attrition from the failure of drug candidates proceeding through clinical trials. If ANA975,
ANA380, or any other product candidate, fails to demonstrate sufficient safety and efficacy in any
clinical trial, we would experience potentially significant delays in, or be required to abandon,
development of that product candidate. If we delay or abandon our development efforts related
ANA975 or ANA380, we may not be able to generate sufficient revenues to become profitable, and our
reputation in the industry and in the investment community would likely be significantly damaged,
each of which would cause our stock price to decrease significantly. We have not filed an IND to conduct clinical trials of isatoribine or ANA975 in the U.S. and we
may not be able to obtain FDA approval of an IND to permit us to conduct clinical trials of
isatoribine or ANA975 in the U.S. We are currently conducting clinical trials of ANA975 in the U.K., in accordance with
applicable European Union national regulations. Prior to commencing any clinical trials of ANA975
or any other oral prodrug of isatoribine in the U.S., we will need to submit an Investigational New
Drug, or IND, application to the U.S. Food and Drug Administration, or FDA. Any IND application
that we submit to the FDA for ANA975 or any other oral prodrug of isatoribine will likely
incorporate the results of our European clinical trials of these product candidates. Although we
view it as unlikely, the FDA could reject these clinical trial results based on a determination
that the clinical trials were not conducted in accordance with requisite U.S. regulatory standards
and procedures. Moreover, the FDA may subject the trial data that we submit to additional scrutiny
and we may incur additional costs and delays responding to FDA requests for supplemental
information or clarification. In addition, the FDA will need to approve the adequacy of our
pre-clinical studies of ANA975. In order to support the filing of an IND with the United States
Food and Drug Administration, we continue to conduct additional pre-clinical testing on ANA975 in
parallel with our clinical testing. If we are unable to obtain FDA approval for any IND for ANA975
or any other product candidate based on isatoribine, we will not be permitted to conduct clinical
trials for ANA975, or any other product candidates based on isatoribine in the U.S. and ultimately
seek or obtain U.S. regulatory approval for commercialization. As a result, any delay in an IND
becoming effective for one of these product candidates could delay the further development of our
lead HCV product candidate and potential commercialization and delay our ability to generate
product sales. We may not realize the anticipated benefits of the development and potential commercialization
of ANA380. In April 2004, we entered into an agreement with LGLS for the joint development and potential
commercialization of ANA380. Under the terms of the agreement, we and LGLS are equally conducting
and funding the global clinical development of ANA380 and LGLS has granted to us an exclusive
license to commercialize ANA380 as a therapy for chronic HBV in North America, Europe, Japan and
all other countries in the world other than China, Korea, India and countries in Southeast Asia. As
a result of the joint development aspect of our agreement with LGLS, the future success of our HBV
programs will depend in part on our ability to maintain our relationship with LGLS with respect to
ANA380. We cannot guarantee that LGLS will not reduce or curtail its efforts to develop ANA380 with
us because of changes in its research and development budget or other factors affecting its
business or operations. If we are not able to maintain a positive relationship with LGLS with
respect to ANA380, we may not be able to effectively develop or commercialize products based on
ANA380, in which case our HBV development and potential commercialization efforts could be
significantly impaired and our ability to generate anticipated product revenues may suffer. In
addition, given the increased number of currently available treatments for HBV as well as those in
development, Anadys and LGLS are evaluating the market opportunity for ANA380. Anadys and LGLS also
are evaluating various cost-effective development alternatives for the advancement of ANA380. As
part of this evaluation, we are assessing the overall projected costs of our ANA380 program and the
potential market opportunity for ANA380 if it is ultimately commercialized as a treatment for HBV.
As a result of this assessment, Anadys may decide to license all or substantially all of our rights
to ANA380 to a third party or, if we are unable to obtain license
terms acceptable to us and/or LGLS, we may
decide to substantially limit our development of ANA380. We have only recently become involved with the clinical development of ANA380 and may face
challenges with the implementation, coordination and management of the global joint development
program. Clinical trials of ANA380 are currently being conducted in Korea and Hong Kong, and we are in
the process of coordinating with LGLS the design of a joint development plan for this program.
Because laws and regulatory requirements for conducting clinical trials differ across countries, we
may face challenges regarding certain legal and regulatory matters as we work with LGLS to
implement a coordinated global development plan for ANA380. If we are unable to implement a
coordinated plan that satisfies the regulatory requirements in all of the countries where we intend
to conduct clinical trials and ultimately obtain regulatory approval, the clinical development or
regulatory approval of ANA380 may be delayed and our ability to generate revenues may be harmed. In
addition, because we have not yet finalized the global joint development budget with LGLS, we
cannot predict the precise amount of our share of the development costs for the program. 15




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Delays in the commencement of clinical testing of our current and potential product candidates
could result in increased costs to us and delay our ability to generate revenues. Our potential drug products and our collaborators potential drug products will require
preclinical testing and extensive clinical trials prior to submission of any regulatory application
for commercial sales. We commenced clinical trials of isatoribine in late 2002 and in February 2004
we commenced clinical trials of ANA971 and our joint development program with LGLS for ANA380. We
recently commenced clinical trials of ANA975 in early 2005. As a result, we have very limited
experience conducting clinical trials. In part because of this limited experience, we cannot be
certain that planned clinical trials will begin or be completed on time, if at all. Delays in the
commencement of clinical testing could significantly increase our product development costs and
delay product commercialization. In addition, many of the factors that may cause, or lead to, a
delay in the commencement of clinical trials may also ultimately lead to denial of regulatory
approval of a product candidate. The commencement of clinical trials can be delayed for a variety of reasons, including delays
in:  
    Demonstrating sufficient safety and efficacy to obtain regulatory approval to commence a clinical trial;
    reaching agreement on acceptable terms with prospective contract research organizations and trial sites;
    Manufacturing sufficient quantities of a product candidate;
    obtaining approval of an IND application or proposed trial design from the FDA; and
    obtaining institutional review board approval to conduct a clinical trial at a prospective site. In addition, the commencement of clinical trials may be delayed due to insufficient patient
enrollment, which is a function of many factors, including the size of the patient population, the
nature of the protocol, the proximity of patients to clinical sites, the availability of effective
treatments for the relevant disease, and the eligibility criteria for the clinical trial. Delays in the completion of, or the termination of, clinical testing of our current and
potential product candidates could result in increased costs to us and delay or prevent us from
generating revenues. Once a clinical trial has begun, it may be delayed, suspended or terminated by us or the FDA,
or other regulatory authorities due to a number of factors, including:  
    ongoing discussions with the FDA or other regulatory authorities regarding the scope or design of our clinical trials;
    failure to conduct clinical trials in accordance with regulatory requirements;
    lower than anticipated enrollment or retention rate of patients in clinical trials;
    inspection of the clinical trial operations or trial sites by the FDA or other regulatory authorities resulting in the imposition
of a clinical hold;
    lack of adequate funding to continue clinical trials;
    negative results of clinical trials;
    requests by the FDA for supplemental information on, or clarification of, the results of clinical trials conducted in other
countries;
    insufficient supply or deficient quality of drug candidates or other materials necessary for the conduct of our clinical trials; or
    serious adverse events or other undesirable drug-related side effects experienced by participants. Many
of the factors that may lead to a delay, suspension or termination of clinical testing of a current
or potential product candidate may also ultimately lead to denial of regulatory approval of a
current or potential product candidate. If we experience delays in the completion of, or
termination of, clinical testing, our financial results and the commercial prospects for our
product candidates may be harmed, and our ability to generate product revenues will be delayed. The success of the clinical development program of ANA380 will depend, at least in part, on our
ability to initiate and maintain a positive working relationship with the FDA and other
regulatory authorities, and our failure to do so may harm or delay our ability to commercialize
ANA380 in the U.S. or other countries. Although a U.S. IND covering ANA380 has been filed with the FDA, to date no clinical trials of
ANA380 have been conducted in the U.S. As a result, the FDA may subject the clinical trial design
for ANA380 to additional scrutiny and we may incur additional costs and delays responding to
potential future FDA requests for supplemental information or clarification. Any delay imposed by
the FDA regarding conducting clinical trials of ANA380 in the U.S. could delay the further
development of our lead HBV product candidate and its potential commercialization and delay our
ability to generate product sales. In addition, due to the structure of our joint development
program with LGLS for the clinical development of ANA380, we do not have complete control over the
design of the clinical trials of ANA380 and will be affected, at least in part, by decisions
previously made by LGLS with respect to clinical trial structure and communications with regulatory
authorities. As part of conducting the global joint development plan, it is our intention to build
and maintain open communication channels with regulatory authorities, including the FDA. If we are
unable to do so within our desired timeframe, our clinical development plan in the U.S. and other
countries may be delayed and our ability to generate revenues may suffer. If our efforts to obtain rights to new products or product candidates from third parties do not
yield product candidates for clinical development or are not otherwise successful, we may not
generate product revenues or achieve profitability. Our long term ability to earn product revenue depends on our ability to identify, through
internal research programs, potential product candidates that may be developed into new
pharmaceutical products and/or obtain new products or product candidates through licenses from
third parties. If our internal research programs to discover and develop small
molecule therapeutics for the treatment of infectious diseases do not generate sufficient product
candidates, we will need to obtain rights to new products or product candidates from third parties.
We may be unable to obtain suitable product candidates or products from third parties for a number
of reasons, including:  
    we may be unable to purchase or license products or product candidates on terms that would
allow us to make an appropriate return from resulting products;
    competitors may be unwilling to assign or license product or product candidate rights to us; or
    we may be unable to identify suitable products or product candidates within, or complementary
to, our areas of interest relating to small molecule anti-infective medicines and the
treatment of HCV, HBV and bacterial infections. If we are unable to obtain rights to new products or product candidates from third parties, our
ability to generate product revenues and achieve profitability may suffer. 16




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Because we acquired isatoribine from Valeant Pharmaceuticals International (formerly known as
ICN Pharmaceuticals, Inc.) any dispute with Valeant Pharmaceuticals International may adversely
affect our ability to commercialize isatoribine or prodrugs of isatoribine. In March 2000, we acquired the exclusive worldwide rights to isatoribine and five other
compounds from Valeant Pharmaceuticals International (formerly known as ICN Pharmaceuticals, Inc.),
or Valeant, as part of an agreement with Valeant and Devron R. Averett, Ph.D. If there is any
dispute between Valeant and us regarding our rights under the agreement, our ability to develop and
market isatoribine or any other compound licensed from Valeant may be adversely affected. In the
past we have been involved in disputes with Valeant regarding patent prosecution matters related to
the licensed compounds and entered into a new agreement with Valeant in December 2002 that
superseded the original license agreement and resolved these disputes. Valeant may develop
technologies and products similar to the drugs we may derive from these compounds, which do not
infringe the patents acquired by us. If we are not able to resolve any future license disputes that
may arise or obtain adequate patent protection, our ability to develop isatoribine or the other
relevant compounds may be compromised and we may not be able to prevent competitors, including
Valeant, from making, using and selling competing products, which could have a material adverse
effect on our financial condition and results of operation. Even if we successfully complete clinical trials of ANA975, ANA380 or any future product
candidate, there are no assurances that we will be able to submit, or obtain FDA approval of, a
new drug application. There can be no assurance that if our clinical trials of ANA975, ANA380 or any other potential
product candidate are successfully completed, we will be able to submit a new drug application, or
NDA, to the FDA or that any NDA we submit will be approved by the FDA in a timely manner, if at
all. If we are unable to submit a NDA with respect to ANA975, ANA380 or any future product
candidate, or if any NDA we submit is not approved by the FDA, we will be unable to commercialize
that product in the U.S. The FDA can and does reject NDAs and may require additional clinical
trials, even when drug candidates performed well or achieved favorable results in large-scale Phase
III clinical trials. If we fail to commercialize ANA975, ANA380 or any future product candidate in
clinical trials, we may be unable to generate sufficient revenues to attain profitability and our
reputation in the industry and in the investment community would likely be damaged, each of which
would cause our stock price to decrease. If we successfully develop products but those products do not achieve and maintain market
acceptance, our business will not be profitable. Even if ANA975, ANA971, isatoribine, ANA380 or any future product candidates are approved for
commercial sale by the FDA or other regulatory authorities, the degree of market acceptance of any
approved product candidate by physicians, healthcare professionals and third-party payors and our
profitability and growth will depend on a number of factors, including:  
    our ability to provide acceptable evidence of safety and efficacy;
    relative convenience and ease of administration;
    the prevalence and severity of any adverse side effects;
    availability of alternative treatments;
    pricing and cost effectiveness;
    effectiveness of our or our collaborators sales and marketing strategy; and
    our ability to obtain sufficient third-party insurance coverage or reimbursement. The current standard of care for the treatment of chronic HCV is the combination of pegylated
interferon-alpha and ribavirin. If ANA975 or any future product candidate that we discover and
develop for the treatment of HCV does not provide a treatment regimen that is more beneficial than
the current standard of care or otherwise provides patient benefit, that product likely will not be
accepted favorably by the market. Similarly, if ANA380 does not provide a treatment regime that is
more beneficial than any current or proposed therapy for the treatment of HBV, that product will
likewise not be accepted favorably by the market. If any products we may develop do not achieve
market acceptance, then we will not generate sufficient revenue to achieve or maintain
profitability. In addition, even if our products achieve market acceptance, we may not be able to maintain
that market acceptance over time if:  
    new products or technologies are introduced that are more favorably received than our products,
are more cost effective or render our products obsolete; or
    complications, such as antibiotic or viral resistance, arise with respect to use of our products. If we are unable to obtain statutory marketing exclusivity after our patents covering
isatoribine or other product candidates expire, we will face increased competition, which may
result in reduced potential revenues. The primary composition of matter patents covering isatoribine will expire in 2007 and 2008.
We have filed for patent protection on ANA971 and ANA975, although there can be no assurance that
we will be able to secure adequate patent protection. After the patent expirations of isatoribine
itself, however, we will have no direct means to prevent third parties from making, selling, using
or importing isatoribine in the U.S., Europe or Japan. Instead, if we pursue commercialization of
isatoribine, we expect to rely upon the U.S. Drug Price Competition and Patent Term Restoration Act
of 1984, commonly known as the Hatch-Waxman Act, and applicable foreign legislation, to achieve
market exclusivity for isatoribine. For NDAs for new chemical entities not previously approved, the
Hatch-Waxman Act provides for marketing exclusivity to the first applicant to gain approval for a
particular drug by prohibiting acceptance or approval of an abbreviated new drug application, or
ANDA, from a generic competitor for up to five years after approval of the original NDA. This
exclusivity only applies to submissions of an ANDA and would not prevent a third party from
conducting pivotal clinical trials and thereafter filing a complete NDA regulatory submission for
isatoribine after the patent expirations. Our competitors will be free during any period of
statutory exclusivity to develop the data necessary either to file an ANDA at the end of the
exclusivity period or to conduct studies in support of a complete NDA filing during the period of
market exclusivity. Japanese law may provide us with marketing exclusivity in Japan for a period up
to six years following Japanese marketing approval. Although statutory market exclusivity in
Europe, the U.S. and Japan may apply even when the composition of matter patent has already
expired, it is possible that isatoribine will not qualify for such exclusivity, or alternatively,
the terms of the Hatch-Waxman Act, or similar foreign statutes, could be amended or interpreted to
our disadvantage. If we do not qualify for marketing exclusivity for isatoribine, the competition
we face would increase, reducing our potential revenues and adversely affecting our ability to
attain or maintain profitability. We will need substantial additional funding and may be unable to raise capital when needed,
which would force us to delay, reduce or eliminate our research and development programs or
commercialization efforts. We will need to raise substantial additional capital at least within the next several years
to, among other things:  
    fund our research and development programs;
    advance our HCV product candidate into and through clinical trials and the regulatory review and approval process; 17




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
    fund our share of the further clinical development and regulatory review and approval of ANA380;
    establish and maintain manufacturing, sales and marketing operations;
    commercialize our product candidates, if any, that receive regulatory approval; and
    acquire rights to products or product candidates, technologies or businesses. Our future funding requirements will depend on, and could increase significantly as a result
of, many factors, including:  
    the rate of progress and cost of our research and development activities;
    the scope, prioritization and number of preclinical studies and clinical trials we pursue;
    the costs and timing of regulatory approval;
    the costs of establishing or contracting for manufacturing, sales and marketing capabilities;
    the effects of competing technological and market developments;
    the terms and timing of any collaborative, licensing and other arrangements that we may establish; and
    the extent to which we acquire or license new technologies, products or product candidates. We do not anticipate that we will generate significant continuing revenues for at least
several years, if ever. Until we can generate significant continuing revenues, we expect to satisfy
our future cash needs through public or private equity offerings, debt financings, corporate
collaboration and licensing arrangements and grant funding, as well as through interest income
earned on cash balances. We cannot be certain that additional funding will be available to us on
acceptable terms, or at all. If funds are not available, we may be required to delay, reduce the
scope of or eliminate one or more of our research or development programs or our commercialization
efforts. Raising additional funds by issuing securities or through collaboration and licensing
arrangements may cause dilution to existing stockholders, restrict our operations or require us
to relinquish proprietary rights. We may raise additional funds through public or private equity offerings, debt financings or
corporate collaborations and licensing arrangements. We cannot be certain that additional funding
will be available on acceptable terms, or at all. To the extent that we raise additional capital by
issuing equity securities, our stockholders ownership will be diluted. Any debt financing we enter
into may involve covenants that restrict our operations. These restrictive covenants may include
limitations on borrowing, specific restrictions on the use of our assets as well as prohibitions on
our ability to create liens, pay dividends, redeem capital stocks or make investments. In addition,
if we raise additional funds through collaboration and licensing arrangements, it may be necessary
to relinquish potentially valuable rights to our potential products or proprietary technologies, or
grant licenses on terms that are not favorable to us. For example, we might be forced to relinquish
all or a portion of our sales and marketing rights with respect to potential products or license
intellectual property that enables licensees to develop competing products. If we fail to establish new collaborations, we may not generate sufficient revenue to attain
profitability. Our near and long-term viability will depend in part on our ability to successfully establish
new strategic collaborations with pharmaceutical and biotechnology companies. Since we do not
currently possess the resources necessary to independently fully develop and commercialize ANA975
or another prodrug of isatoribine, or isatoribine itself, and other potential products that may be
based upon our technologies, we will either need to develop or acquire these resources on our own,
which will require substantial funding, time and effort, or will need to enter into additional
collaborative agreements to assist in the development and commercialization of some of these
potential products. Establishing strategic collaborations is difficult and time-consuming.
Potential collaborators may reject collaborations based upon their assessment of our financial,
regulatory or intellectual property position. If we fail to establish a sufficient number of
additional collaborations on acceptable terms, we may not generate sufficient revenue. Even if we
successfully establish new collaborations, these relationships may never result in the successful
development or commercialization of any product candidates or the generation of sales or royalty
revenue. If we fail to maintain our existing and future collaborations, we may not generate sufficient
revenue to attain profitability. Our future success will also depend in part on our ability to maintain our existing
collaborations and any future collaborations we may establish. Our existing collaborators and
future collaborators may decide to reduce or curtail their collaborations with us because of
changes in their research and development budgets or other factors affecting their business or
operations. Our present collaborative arrangements and any future collaboration opportunities could
be harmed if:  
    we or our collaborators do not achieve our respective objectives under our collaboration agreements;
    we are unable to obtain patent protection for the product candidates or proprietary technologies we discover in our
collaborations;
    we are unable to properly manage multiple simultaneous product discovery and development collaborations;
    our present or potential collaborators are less willing to expend their resources on our programs due to their focus on other;
    programs or as a result of general market conditions;
    our collaborators become competitors of ours or enter into agreements with our competitors;
    we or our collaborators encounter regulatory hurdles that prevent commercialization of our product candidates;
    we develop products and processes or enter into additional collaborations that conflict with the business objectives of our
other collaborators;
    consolidation in our target markets or the pharmaceutical or biotechnology industry limits the number of potential
collaborators;
    the rights granted under our collaboration agreements prove insufficient to adequately develop and commercialize our products
and product candidates;
    a collaborator breaches, terminates or fails to renew a collaboration with us; or
    we are unable to negotiate additional collaboration agreements on terms satisfactory to us. If any of these events occur, we may not be able to develop or commercialize products or
generate sufficient revenue to support our operations and attain and maintain profitability. To the
extent that we enter into co-promotion or other collaborative arrangements, our product revenues
are likely to be lower than if we directly marketed and sold any products that we may develop. 18




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We are dependent on collaborators allocating adequate resources to our collaborations, and
actions taken by collaborators could prevent us from commercializing products and earning
milestone and other contingent payments, royalties or other revenue. Much of the potential revenue from our existing and future collaborations will consist of
contingent payments, such as payments for achieving development milestones and royalties payable on
sales of drugs developed using our technologies or capabilities. The milestone and royalty revenues
that we may receive under these collaborations will depend upon our collaborators ability to
successfully develop, introduce, market and sell new products. In addition, our existing
collaborators may decide to enter into arrangements with third parties to commercialize products
developed under our existing or future collaborations using our technologies or capabilities, which
could reduce the milestone and royalty revenue that we may receive, if any. In many cases we will
not be involved in these processes and accordingly will depend entirely on our collaborators. Our
collaboration partners may fail to develop or effectively commercialize products using our products
or technologies because they:  
    decide not to devote the necessary resources due to internal constraints, such as limited
personnel with the requisite scientific expertise, limited cash resources or specialized
equipment limitations, or other drug development priorities that our collaboration
partners believe may have a higher likelihood of obtaining regulatory approval or may
potentially generate a greater return on investment;
    do not have sufficient resources necessary to carry the product candidate through clinical
development, regulatory approval and commercialization;
    are unable to allocate sufficient resources due to factors affecting their businesses or
operations or as a result of general market conditions;
    decide to pursue a competitive potential product developed outside of the collaboration; or
    cannot obtain the necessary regulatory approvals. If our collaboration partners fail to develop or effectively commercialize product candidates
or products for any of these reasons, we may not be able to replace the collaboration partner with
another partner to develop and commercialize a product candidate or product under the terms of the
collaboration or because we are unable to obtain a license from such collaboration partner on terms
acceptable to us. The majority of our current collaboration agreements are directed toward the discovery and
development of drug candidates. Under our existing collaboration agreements, we generally would not
earn significant milestone payments unless and until our collaborators have advanced product
candidates into clinical testing, which may not occur for many years, if ever. In addition, a
collaborator may disagree as to whether a particular milestone has been achieved. Consequently, we
cannot guarantee that milestone payments will be received or that commercialized drugs will be
developed on which royalties will be payable to us. If we are unable to generate significant
milestone and royalty revenues from our collaborations, we may never attain profitability. If any conflicts arise between us and any of our collaborators, our reputation, revenues and
cash position could be significantly harmed. Conflicts may arise between our collaborators and us, such as conflicts concerning the conduct
of research, the achievement of milestones or the ownership or protection of intellectual property
developed during the collaboration. In addition, in the past we have been involved in disputes with
Valeant Pharmaceuticals International (formerly ICN Pharmaceuticals, Inc.) regarding the license of
certain compounds, which resulted in us entering into a new agreement with Valeant in December 2002
that superseded the original March 2000 license agreement between us and Valeant and resolved the
disputes. Any such disagreement between us and a collaborator could result in one or more of the
following, each of which could harm our reputation, result in a loss of revenues and a reduction in
our cash position, and cause a decline in our stock price:  
    unwillingness on the part of a collaborator to pay us research funding, milestone payments or royalties we
believe are due to us under our collaboration agreement;
    uncertainty regarding ownership of intellectual property rights arising from our collaborative activities, which
could result in litigation and prevent us from entering into additional collaborations;
    unwillingness on the part of a collaborator to keep us informed regarding the progress of its development and
commercialization activities, or to permit public disclosure of the results of those activities;
    slowing or cessation of a collaborators development or commercialization efforts with respect to our products; or
    termination or non-renewal of the collaboration. In addition, certain of our current or future collaborators may have the right to terminate
the collaboration agreement on short notice. Accordingly, in the event of any conflict between the
parties, our collaborators may elect to terminate the collaboration prior to completion of its
original term. If a collaboration is terminated prematurely, we would not realize the anticipated
benefits of the collaboration, our reputation in the industry and in the investment community may
be harmed and our stock price may decline. We depend on outside parties to conduct our clinical trials, which may result in costs and
delays that prevent us from obtaining regulatory approval or successfully commercializing
product candidates. Although we have designed and managed our preclinical studies and clinical trials relating to
isatoribine, ANA971 and ANA975 to date, we engaged clinical investigators and medical institutions
to enroll patients in these clinical trials and contract research organizations to perform data
collection and analysis and other aspects of our preclinical studies and clinical trials. As a
result, we depend on these clinical investigators, medical institutions and contract research
organizations to properly perform the studies and trials. If these parties do not successfully
carry out their contractual duties or obligations or meet expected deadlines, or if the quality or
accuracy of the clinical data they obtain is compromised due to the failure to adhere to our
clinical protocols or for other reasons, our clinical trials may be extended, delayed or
terminated. We may not be able to enter into replacement arrangements without undue delays or
excessive expenditures. If there are delays in testing or regulatory approvals as a result of the
failure to perform by third-parties, our drug discovery and development costs will increase and we
may not be able to obtain regulatory approval for or successfully commercialize our product
candidates. In addition, we may not be able to maintain any of these existing relationships, or
establish new ones on acceptable terms, if at all. We do not have internal manufacturing capabilities, and if we fail to develop and maintain
supply relationships with collaborators or other outside manufacturers, we may be unable to
develop or commercialize any products. Our ability to develop and commercialize any products we may develop will depend in part on
our ability to manufacture, or arrange for collaborators or other parties to manufacture, our
products at a competitive cost, in accordance with regulatory requirements and in sufficient
quantities for clinical testing and eventual commercialization. We currently do not have any
significant manufacturing arrangements or agreements, as our current product candidates will not
require commercial-scale manufacturing for at least several years, if ever. Our inability to enter
into or maintain manufacturing agreements with collaborators or capable contract manufacturers on
acceptable terms could delay or prevent the development and commercialization of our products,
which would adversely affect our ability to generate revenues and would increase our expenses. 19




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If we are unable to establish sales and marketing capabilities or enter into agreements with
third parties to sell and market any products we may develop, we may not be able to generate
product revenue. We do not currently have the capabilities for the sales, marketing and distribution of
pharmaceutical products. In order to commercialize any products, we must build our sales,
marketing, distribution, managerial and other non-technical capabilities or make arrangements with
third parties to perform these services. Although we currently expect to commercialize in North
America our HCV product candidate and other potential product candidates that are of strategic
interest to us, because the most advanced of these product candidates are in early stage clinical
development, we have not definitively determined whether we will attempt to establish internal
sales and marketing capabilities or enter into agreements with third parties to sell and market any
products we may develop. The establishment and development of our own sales force to market any
products we may develop in North America will be expensive and time consuming and could delay any
product launch, and we cannot be certain that we would be able to successfully develop this
capacity. If we are unable to establish our sales and marketing capability or any other
non-technical capabilities necessary to commercialize any product we may develop, we will need to
contract with third parties to market and sell any products we may develop in North America. We
will also need to develop a plan to market and sell any products we may develop outside North
America. If we are unable to establish adequate sales, marketing and distribution capabilities,
whether independently or with third parties, we may not be able to generate product revenue and may
not become profitable. We will need to increase the size of our organization, and we may encounter difficulties
managing our growth, which could adversely affect our results of operations. We will need to expand and effectively manage our managerial, operational, financial and other
resources in order to successfully pursue our research, development and commercialization efforts
and secure collaborations to market and distribute our products. We increased the number of our
full-time employees from 21 as of December 31, 2000 to 83 as of December 31, 2004, which has placed
a strain on our managerial, operational and financial resources. If we continue to grow, it is
possible that our management, accounting and scientific personnel, systems and facilities currently
in place may not be adequate to support this future growth. To manage any growth, we will be
required to continue to improve our operational, financial and management controls, reporting
systems and procedures and to attract and retain sufficient numbers of talented employees. We may
be unable to successfully manage the expansion of our operations or operate on a larger scale and,
accordingly, may not achieve our research, development and commercialization goals. If we are unable to attract and retain key management and scientific staff, we may be unable to
successfully develop or commercialize our product candidates. We are a small company, with under 100 employees, and our success depends on our continued ability
to attract, retain and motivate highly qualified management and scientific personnel. In
particular, our research and drug discovery programs depend on our ability to attract and retain
highly skilled chemists, biologists, and preclinical and clinical personnel, especially in the
fields of HCV and RNA biology and chemistry. We may not be able to attract or retain qualified
management and scientific personnel in the future due to the intense competition for qualified
personnel among biotechnology and pharmaceutical businesses, particularly in the San Diego,
California area. If we are not able to attract and retain the necessary personnel to accomplish our
business objectives, we may experience constraints that will impede significantly the achievement
of our research and development objectives and our ability to meet the demands of our collaborators
in a timely fashion. In addition, all of our employees are at will employees, which means that
any employee may quit at any time and we may terminate any employee at any time. Currently we do
not have employment agreements with any employees or members of senior management that provide any
guarantee of continued employment by us. We do not carry key person insurance covering members of
senior management other than Kleanthis G. Xanthopoulos, Ph.D., our President, Chief Executive
Officer and a director. The insurance covering Dr. Xanthopoulos is in the amount of $1 million. In
particular, if we lose Dr. Xanthopoulos, Stephen T. Worland, Ph.D., our Executive Vice President,
Research and Development, Michael J. Kamdar, Senior Vice President, Corporate Development and
Finance, or other members of our senior management team, we may not be able to find suitable
replacements and our business may be harmed as a result. Our quarterly results and stock price may fluctuate significantly. We expect our results of operations to be subject to quarterly fluctuations. The level of our
revenues, if any, and results of operations at any given time, will be based primarily on the
following factors:  
    the status of development of ANA380, ANA975 and our other product
candidates, including results of preclinical studies and clinical
trials;
    our recommendation of additional compounds for preclinical development;
    our execution of collaborative, licensing or other arrangements, and
the timing and accounting treatment of payments we make or receive
under these arrangements;
    whether or not we achieve specified research or commercialization
milestones under any agreement that we enter into or have entered into
with collaborators and the timely payment by commercial collaborators
of any amounts payable to us;
    our or our collaborators termination of any of our collaborative,
licensing or other arrangements, or any disputes regarding such
arrangements;
    our addition or termination of research programs or funding support;
    variations in the level of expenses related to our product candidates
or potential product candidates during any given period; and
    the effect of competing technological and market developments. These factors, some of which are not within our control, may cause the price of our stock to
fluctuate substantially. In particular, if our quarterly operating results fail to meet or exceed
the expectations of securities analysts or investors, our stock price could drop suddenly and
significantly. In addition, fluctuations in the stock prices of other companies in the
biotechnology and pharmaceuticals industries and in the financial markets generally may affect our
stock price. We believe that quarterly comparisons of our financial results are not necessarily
meaningful and should not be relied upon as an indication of our future performance. If we engage in any acquisition, we will incur a variety of costs, and we may never realize the
anticipated benefits of the acquisition. We may attempt to acquire businesses, technologies, services or products or in-license
technologies that we believe are a strategic fit with our business, at the appropriate time and as
resources permit. We believe that strategic acquisitions of complementary businesses, technologies,
services or products are a material component of our business strategy to provide us with access to
new compounds that are potentially synergistic with our existing product candidate portfolio. If we
undertake any acquisition in addition to our recent in-license of ANA380 from LGLS, the process of
integrating the acquired business, technology, service or product may result in unforeseen
operating difficulties and expenditures and may divert significant management attention from our
ongoing business operations. These operational and financial risks include:  
    exposure to unknown liabilities;
    disruption of our business and diversion of our managements time and attention to
acquiring and developing acquired products or technologies;
    incurrence of substantial debt or dilutive issuances of securities to pay for acquisitions; 20




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
    higher than expected acquisition and integration costs;
    increased amortization expenses;
    negative effect on our earnings (or loss) per share;
    difficulty and cost in combining and integrating the operations and personnel of any
acquired businesses with our operations and personnel;
    impairment of relationships with key suppliers, contractors or customers of any acquired
businesses due to changes in management and ownership; and
    inability to retain key employees of any acquired businesses. Although we acquired the exclusive worldwide rights to isatoribine as part of a licensing
agreement with Valeant Pharmaceuticals International (formerly known as ICN Pharmaceuticals, Inc.)
and have obtained from LGLS development and commercialization rights to ANA380 in certain
territories, we have limited experience in identifying acquisition targets, successfully completing
potential acquisition targets and integrating any acquired businesses, technologies, services or
products into our current infrastructure. Moreover, we may fail to realize the anticipated benefits
of any acquisition or devote resources to potential acquisitions that are never completed. If we
fail to successfully identify strategic opportunities, complete strategic transactions or integrate
acquired businesses, technologies, services or products, we may not be able to successfully expand
our product candidate portfolio to provide adequate revenue to attain and maintain profitability. Earthquake damage to our facilities could delay our research and development efforts and
adversely affect our business. Our headquarters and research and development facilities in San Diego, California, are located in a
seismic zone, and there is the possibility of an earthquake, which could be disruptive to our
operations and result in delays in our research and development efforts. In the event of an
earthquake, if our facilities or the equipment in our facilities are significantly damaged or
destroyed for any reason, we may not be able to rebuild or relocate our facility or replace any
damaged equipment in a timely manner and our business, financial condition and results of
operations could be materially and adversely affected. Risks Related to Our Industry Because our product candidates and development and collaboration efforts depend on our
intellectual property rights, adverse events affecting our intellectual property rights will
harm our ability to commercialize products. Our commercial success depends on obtaining and maintaining patent protection and trade secret
protection of our product candidates, proprietary technologies and their uses, as well as
successfully defending these patents against third-party challenges. We will only be able to
protect our product candidates, proprietary technologies and their uses from unauthorized use by
third parties to the extent that valid and enforceable patents or effectively-protected trade
secrets cover them. Due to evolving legal standards relating to the patentability, validity and enforceability of
patents covering pharmaceutical inventions and the scope of claims made under these patents, our
ability to obtain and enforce patents is uncertain and involves complex legal and factual
questions. Accordingly, rights under any issued patents may not provide us with sufficient
protection for isatoribine or our other drug candidates or provide sufficient protection to afford
us a commercial advantage against competitive products or processes. In addition, we cannot
guarantee that any patents will issue from any pending or future patent applications owned by or
licensed to us. Even with respect to patents that have issued or will issue, we cannot guarantee
that the claims of these patents are, or will be valid, enforceable or will provide us with any
significant protection against competitive products or otherwise be commercially valuable to us.
For example:  
    we might not have been the first to make, conceive, or reduce to practice the inventions covered by all
or any of our pending patent applications and issued patents;
    we might not have been the first to file patent applications for these inventions;
    others may independently develop similar or alternative technologies or duplicate any of our technologies;
    it is possible that none of our pending patent applications will result in issued patents;
    our issued or acquired patents may not provide a basis for commercially viable products, may not provide
us with any competitive advantages, or may be challenged by third parties;
    our issued patents may not be valid or enforceable;
    we may not develop additional proprietary technologies that are patentable; or
    the patents of others may have an adverse effect on our business. Patent applications in the U.S. are maintained in confidence for up to 18 months after their
filing. Consequently, we cannot be certain that we or our collaborators were the first to invent,
or the first to file patent applications on our product candidates. In the event that a third party
has also filed a U.S. patent application relating to our product candidates or a similar invention,
we may have to participate in interference proceedings declared by the U.S. Patent Office to
determine priority of invention in the U.S. The costs of these proceedings could be substantial and
it is possible that our efforts would be unsuccessful, resulting in a material adverse effect on
our U.S. patent position. Furthermore, we may not have identified all U.S. and foreign patents or
published applications that affect our business either by blocking our ability to commercialize our
drugs or by covering similar technologies that affect our drug market. In addition, some countries, including many in Europe, do not grant patent claims directed to
methods of treating humans, and in these countries patent protection may not be available at all to
protect our drug candidates. Even if patents issue, we cannot guarantee that the claims of those
patents will be valid and enforceable or provide us with any significant protection against
competitive products, or otherwise be commercially valuable to us. We may be particularly affected
by this because we expect that ANA975 and ANA380, if approved, will be marketed in foreign
countries with high incidences of HCV and HBV infection. Other companies may obtain patents and/or regulatory approvals to use the same drugs to treat
diseases other than HCV or HBV. As a result, we may not be able to enforce our patents effectively
because we may not be able to prevent healthcare providers from prescribing, administering or using
another companys product that contains the same active substance as our products when treating
patients infected with HCV or HBV. If we fail to obtain and maintain patent protection and trade secret protection of ANA380, ANA975,
isatoribine or other oral prodrugs of isatoribine or our other product candidates, proprietary
technologies and their uses, the competition we face would increase, reducing our potential
revenues and adversely affecting our ability to attain or maintain profitability. 21




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If we are sued for infringing intellectual property rights of others, it will be costly and time
consuming, and an unfavorable outcome in that litigation would have a material adverse effect on
our business. Our commercial success also depends upon our ability to develop, manufacture, market and sell our
product candidates and use our proprietary technologies without infringing the proprietary rights
of third parties. We may be exposed to future litigation by third parties based on claims that our
product candidates, technologies or activities infringe the intellectual property rights of others.
Numerous U.S. and foreign issued patents and pending patent applications owned by others exist in
HCV, HBV and the other fields in which we are developing products. These could materially affect
our ability to develop our drug candidates or sell our products. Because patent applications can
take many years to issue, there may be currently pending applications, unknown to us, which may
later result in issued patents that our product candidates or technologies may infringe. There also
may be existing patents, of which we are not aware, that our product candidates or technologies may
inadvertently infringe. Further, there may be issued patents and pending patent applications in
fields relevant to our business, of which we may become aware from time to time, that we believe we
do not infringe or that we believe are invalid or relate to immaterial portions of our overall drug
discovery and development efforts. We cannot assure you that third parties holding any of these
patents or patent applications will not assert infringement claims against us for damages or
seeking to enjoin our activities. We also cannot assure you that, in the event of litigation, we
will be able to successfully assert any belief we may have as to non-infringement, invalidity or
immateriality, or that any infringement claims will be resolved in our favor. There is a substantial amount of litigation involving patent and other intellectual property rights
in the biotechnology and biopharmaceutical industries generally. Any litigation or claims against
us, with or without merit, may cause us to incur substantial costs, could place a significant
strain on our financial resources, divert the attention of management from our core business and
harm our reputation. In addition, intellectual property litigation or claims could result in
substantial damages and force us to do one or more of the following if a court decides that we
infringe on another partys patent or other intellectual property rights:  
    cease selling, incorporating or using any of our product candidates or
technologies that incorporate the challenged intellectual property;
    obtain a license from the holder of the infringed intellectual
property right, which license may be costly or may not be available on
reasonable terms, it at all; or
    redesign our processes or technologies so that they do not infringe,
which could be costly and time-consuming and may not be possible. If we find during clinical evaluation that our drug candidates for the treatment of HCV or HBV
should be used in combination with a product covered by a patent held by another company or
institution, and that a labeling instruction is required in product packaging recommending that
combination, we could be accused of, or held liable for, infringement of the third-party patents
covering the product recommended for co-administration with our product. In that case, we may be
required to obtain a license from the other company or institution to use the required or desired
package labeling, which may not be available on reasonable terms, or at all. If we fail to obtain any required licenses or make any necessary changes to our technologies, we
may be unable to develop or commercialize some or all of our product candidates. We may be involved in lawsuits or proceedings to protect or enforce our patent rights, trade
secrets or know-how, which could be expensive and time consuming. The defense and prosecution of intellectual property suits and related legal and administrative
proceedings can be both costly and time consuming. Litigation and interference proceedings could
result in substantial expense to us and significant diversion of effort by our technical and
management personnel. Further, the outcome of patent litigation is subject to uncertainties that
cannot be adequately quantified in advance, including the demeanor and credibility of witnesses and
the identity of the adverse party. This is especially true in biotechnology related patent cases
that may turn on the testimony of experts as to technical facts upon which experts may reasonably
disagree and which may be difficult to comprehend by a judge or jury. An adverse determination in
an interference proceeding or litigation, particularly with respect to ANA975, isatoribine or any
other oral prodrug of isatoribine or to ANA380, to which we may become a party could subject us to
significant liabilities to third parties or require us to seek licenses from third parties. If
required, the necessary licenses may not be available on acceptable terms, or at all. Adverse
determinations in a judicial or administrative proceeding or failure to obtain necessary licenses
could prevent us from commercializing ANA975, ANA380 or our other product candidates, which could
have a material and adverse effect on our results of operations. Furthermore, because of the substantial amount of pre-trial document and witness discovery
required in connection with intellectual property litigation, there is risk that some of our
confidential information could be compromised by disclosure during this type of litigation. In
addition, during the course of this kind of litigation, there could be public announcements of the
results of hearings, motions or other interim proceedings or developments. If securities analysts
or investors perceive these results to be negative, it could have a substantial adverse effect on
the trading price of our common stock. Confidentiality agreements with employees and others may not adequately prevent disclosure of
trade secrets and other proprietary information and may not adequately protect our intellectual
property. We also rely on trade secrets to protect our technology, especially where we do not believe
patent protection is appropriate or obtainable. However, trade secrets are difficult to protect. In
order to protect our proprietary technology and processes, we also rely in part on confidentiality
and intellectual property assignment agreements with our corporate partners, employees,
consultants, outside scientific collaborators and sponsored researchers and other advisors. These
agreements may not effectively prevent disclosure of confidential information nor result in the
effective assignment to us of intellectual property, and may not provide an adequate remedy in the
event of unauthorized disclosure of confidential information or other breaches of the agreements.
In addition, others may independently discover our trade secrets and proprietary information, and
in such case we could not assert any trade secret rights against such party. Enforcing a claim that
a party illegally obtained and is using our trade secrets is difficult, expensive and time
consuming, and the outcome is unpredictable. In addition, courts outside the U.S. may be less
willing to protect trade secrets. Costly and time-consuming litigation could be necessary to seek
to enforce and determine the scope of our proprietary rights, and failure to obtain or maintain
trade secret protection could adversely affect our competitive business position. Many competitors have significantly more resources and experience, which may harm our commercial
opportunity. The biotechnology and pharmaceutical industries are subject to intense competition and rapid and
significant technological change. We have many potential competitors, including major drug and
chemical companies, specialized biotechnology firms, academic institutions, government agencies and
private and public research institutions. Many of our competitors have significantly greater
financial resources, experience and expertise in:  
    research and development;
    preclinical testing;
    clinical trials;
    regulatory approvals;
    manufacturing; and
    sales and marketing of approved products. 22




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Smaller or early-stage companies and research institutions may also prove to be significant
competitors, particularly through collaborative arrangements with large and established
pharmaceutical or other companies. We will also face competition from these parties in recruiting
and retaining qualified scientific and management personnel, establishing clinical trial sites and
patient registration for clinical trials, and acquiring and in-licensing technologies and products
complementary to our programs or potentially advantageous to our business. If any of our
competitors succeed in obtaining approval from the FDA or other regulatory authorities for their
products sooner that we do or for products that are more effective or less costly than ours, our
commercial opportunity could be significantly reduced. If our competitors develop treatments for HCV, HBV or bacterial infections that are approved
faster, marketed better or demonstrated to be more effective than ANA975, ANA380 or any other
products that we may develop, our commercial opportunity will be reduced or eliminated. We believe that a significant number of drugs are currently under development and may become
available in the future for the treatment of HCV, HBV, and bacterial infection. Potential
competitors may develop treatments for HCV, HBV, bacterial infection or other technologies and
products that are more effective or less costly than our product candidates or that would make our
technology and product candidates obsolete or non-competitive. Some of these products may use
therapeutic approaches that compete directly with ANA975 or with ANA380. In addition, less
expensive generic forms of currently marketed drugs could lead to additional competition upon
patent expiration or invalidations. ANA975 is also subject to competition in the treatment of HCV from a number of products
already approved and on the market, including the following: Peg-Intron (pegylated
interferon-alpha-2b), Rebetol (ribavirin), and Intron-A (interferon-alpha-2a), which are marketed
by Schering-Plough, and Pegasys (pegylated interferon-alpha-2a), Copegus (ribavirin USP), and
Roferon-A (interferon-alpha-2a), which are marketed by Roche. We expect new products for the
treatment of HCV will be introduced that may lead to further competition for ANA975. Additional
compounds in late stage clinical trials include, but are not limited to, Viramidine, in development
by Valeant Pharmaceuticals, Zadaxin, in development by SciClone Pharmaceuticals, Merimepodib, in
development by Vertex Pharmaceuticals, and NM283, in development by Idenix Pharmaceuticals and
Novartis. Similarly, ANA380 is also subject to competition in the treatment of HBV from other products
already approved and on the market. Current small molecule treatments for HBV include lamivudine
(Zeffix/Epivir HBV) from GlaxoSmithKline, and adefovir (Hepsera) from Gilead. Recently,
interferon-alpha therapy (Intron-A) from Schering-Plough, Pegasys (pegylated interferon-alpha-2a)
from Roche have been endorsed by various regulators for the treatment of HBV. Also, entecavir
(Baraclude) from Bristol-Myers Squibb Co. has recently received FDA advisory committee approval for
the treatment of HBV in the U.S. In addition, tenofovir (Viread) an approved HIV compound from
Gilead is expected to pursue trials to gain a label claim for HBV. Finally, several other compounds
are being studied in Phase III clinical trials. We also face competition from a number of
companies working in the field of antibacterials. Many other competitors are developing products
for the treatment of our target diseases. If successful, we will compete with these products and
others in varying stages of the drug development process. If we cannot establish pricing of our product candidates acceptable to the government, insurance
companies, managed care organizations and other payors, any product sales will be severely
hindered. The continuing efforts of the government, insurance companies, managed care organizations and other
payors of health care costs to contain or reduce costs of health care may adversely affect:  
    our ability to set a price we believe is fair for any products we or our collaborators may develop;
    our ability to generate adequate revenues and gross margins; and
    the availability of capital. In certain foreign markets, the pricing of prescription pharmaceuticals is subject to
government control. In the U.S., given recent federal and state government initiatives directed at
lowering the total cost of health care, the U.S. Congress and state legislatures will likely
continue to focus on health care reform, the cost of prescription pharmaceuticals and on the reform
of the Medicare and Medicaid systems. The trend toward managed health care in the U.S., which could
significantly influence the purchase of health care services and products, as well as legislative
proposals to reform health care, control pharmaceutical prices or reduce government insurance
programs, may result in lower prices for our product candidates. While we cannot predict whether
any legislative or regulatory proposals affecting our business will be adopted, the announcement or
adoption of these proposals could have a material and adverse effect on our potential revenues and
gross margins. If we cannot arrange for reimbursement policies favorable to our product candidates, their sales
will be severely hindered. Our ability to commercialize ANA975, ANA380 or any other product candidates successfully will
depend in part on the extent to which governmental authorities, private health insurers and other
organizations establish appropriate reimbursement levels for the cost of ANA975, ANA380 or any
other products and related treatments. Third-party payors are increasingly challenging the prices
charged for medical products and services, including treatments for HCV and HBV. Also, the trend
toward managed health care in the U.S. as well as legislative proposals to reform health care,
control pharmaceutical prices or reduce government insurance programs, may also result in exclusion
of our product candidates from reimbursement programs. The cost containment measures that health
care payors and providers are instituting and the effect of any health care reform could materially
and adversely affect our ability to earn product revenue. Product liability claims may damage our reputation and, if insurance proves inadequate, the
product liability claims may harm our results of operations. We face an inherent risk of product liability exposure for claimed injuries related to the testing
of our product candidates in human clinical trials, and will face an even greater risk if we or our
collaborators sell our product candidates commercially. If we cannot successfully defend ourselves
against product liability claims, we will incur substantial liabilities. Regardless of merit or
eventual outcome, product liability claims may result in:  
    decreased demand for our product candidates;
    injury to our reputation;
    withdrawal of clinical trial participants;
    the inability to establish new collaborations with potential collaborators;
    substantial costs of related litigation;
    substantial monetary awards to patients; and
    the inability to commercialize our product candidates. We currently have product liability insurance that covers our clinical trials in Europe and
plan to increase and expand this coverage as we commence larger scale trials. In addition, we will
need to increase and expand coverage prior to commencing any clinical trials in the U.S. We also
intend to expand our insurance coverage to include the sale of commercial products if marketing
approval is obtained for any of our product candidates. However, insurance coverage is increasingly
expensive. We may not be able to maintain insurance coverage at a reasonable cost and we may not be
able to obtain insurance coverage that will be adequate to satisfy any liability that may arise. 23




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Any claims relating to our improper handling, storage or disposal of biological, hazardous and
radioactive materials could be time-consuming and costly. Our research and development involves the controlled use of hazardous materials, including
chemicals that cause cancer, volatile solvents, including ethylacetate and acetonitrile,
radioactive materials and biological materials including plasma from patients infected with HCV or
HBV that have the potential to transmit disease. Our operations also produce hazardous waste
products. We are subject to federal, state and local laws and regulations governing the use,
manufacture, storage, handling and disposal of these materials and waste products. If we fail to
comply with these laws and regulations or with the conditions attached to our operating licenses,
the licenses could be revoked, and we could be subjected to criminal sanctions and substantial
liability or required to suspend or modify our operations. Although we believe that our safety
procedures for handling and disposing of these materials comply with legally prescribed standards,
we cannot completely eliminate the risk of accidental contamination or injury from these materials.
In the event of contamination or injury, we could be held liable for damages or penalized with
fines in an amount exceeding our resources, and our clinical trials could be suspended. In
addition, we may have to incur significant costs to comply with future environmental laws and
regulations. We do not currently have a pollution and remediation insurance policy. Our business and operations would suffer in the event of system failures. Despite the implementation of security measures, our internal computer systems are vulnerable to
damage from computer viruses, unauthorized access, natural disasters, terrorism, war and
telecommunication and electrical failures. Any system failure, accident or security breach that
causes interruptions in our operations could result in a material disruption of our drug discovery
programs. To the extent that any disruption or security breach results in a loss or damage to our
data or applications, or inappropriate disclosure of confidential or proprietary information, we
may incur liability as a result, our drug discovery programs may be adversely affected and the
further development of our product candidates may be delayed. In addition, we may incur additional
costs to remedy the damages caused by these disruptions or security breaches. Risks Related to Our Common Stock Future sales of our common stock may cause our stock price to decline. Our current stockholders hold a substantial number of shares of our common stock that they are able
to sell in the public market. Significant portions of these shares are held by a small number of
stockholders. Sales by our current stockholders of a substantial number of shares or the
expectation that such sale may occur, could significantly reduce the market price of our common
stock. Moreover, the holders of up to approximately 13,501,676 shares of common stock, including
shares issued upon the exercise of certain of our warrants, have rights, subject to some
conditions, to require us to file registration statements to permit the resale of their shares in
the public market or to include their shares in registration statements that we may file for
ourselves or other stockholders. Our stock price may be volatile. The market price for our common stock is likely to be volatile, in part because our shares have
only recently begun to be traded publicly. In addition, the market price of our common stock may
fluctuate significantly in response to a number of factors, most of which we cannot control,
including:  
    changes in the regulatory status of our product candidates, including results of our clinical trials for ANA975 and ANA380;
    significant contracts, new technologies, acquisitions, commercial relationships, joint ventures or capital commitments;
    disputes or other developments relating to proprietary rights, including patents, trade secrets, litigation matters, and
our ability to patent or otherwise protect our product candidates and technologies;
    conditions or trends in the pharmaceutical and biotechnology industries;
    fluctuations in stock market prices and trading volumes of similar companies or of the markets generally;
    variations in our quarterly operating results;
    changes in securities analysts estimates of our financial performance;
    failure to meet or exceed securities analysts or investors expectations of our quarterly financial results, clinical
results or our achievement of milestones;
    changes in accounting principles including the implementation of SFAS No. 123R, Share-Based Payment,which we are planning
to adopt effective July 1, 2005. Upon adoption of this standard we expect that it will have a negative impact on our
operating losses and potential earnings in future periods;
    sales of large blocks of our common stock, or the expectation that such sales may occur, including sales by our executive
officers, directors and significant stockholders;
    additions or departures of key personnel;
    discussion of our business, products, financial performance, prospects or our stock price by the financial and scientific
press and online investor communities such as chat rooms;
    regulatory developments in the U.S. and foreign countries;
    economic and political factors, including wars, terrorism and political unrest; and
    technological advances by our competitors. 24




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Anti-takeover provisions in our organizational documents and Delaware law may discourage or
prevent a change in control, even if an acquisition would be beneficial to our stockholders,
which could affect our stock price adversely and prevent attempts by our stockholders to replace
or remove our current management. Our amended and restated certificate of incorporation and amended and restated bylaws contain
provisions that may delay or prevent a change in control, discourage bids at a premium over the
market price of our common stock and adversely affect the market price of our common stock and the
voting and other rights of the holders of our common stock. These provisions include:  
    dividing our board of directors into three classes serving staggered three-year terms;
    prohibiting our stockholders from calling a special meeting of stockholders;
    permitting the issuance of additional shares of our common stock or preferred stock without stockholder approval;
    prohibiting our stockholders from making certain changes to our amended and restated certificate of
incorporation or amended and restated bylaws except with 662/3% stockholder approval; and
    requiring advance notice for raising matters of business or making nominations at stockholders meetings. We are also subject to provisions of the Delaware corporation law that, in general, prohibit
any business combination with a beneficial owner of 15% or more of our common stock for five years
unless the holders acquisition of our stock was approved in advance by our board of directors.
Although we believe these provisions collectively provide for an opportunity to receive higher bids
by requiring potential acquirors to negotiate with our board of directors, they would apply even if
the offer may be considered beneficial by some stockholders. In addition, these provisions may
frustrate or prevent any attempts by our stockholders to replace or remove our current management
by making it more difficult for stockholders to replace members of our board of directors, which is
responsible for appointing the members of our management. We may incur increased costs as a result of recently enacted and proposed changes in laws and
regulations relating to corporate governance matters. Recently enacted and proposed changes in the laws and regulations affecting public companies,
including the provisions of the Sarbanes-Oxley Act of 2002 and rules adopted or proposed by the
Securities and Exchange Commission and by the Nasdaq Stock Market, will result in increased costs
to us as we evaluate the implications of any new rules and respond to their requirements. The new
rules could make it more difficult or more costly for us to obtain certain types of insurance,
including director and officer liability insurance, and we may be forced to accept reduced policy
limits and coverage or incur substantially higher costs to obtain the same or similar coverage. The
impact of these events could also make it more difficult for us to attract and retain qualified
persons to serve on our board of directors, our board committees or as executive officers. We are
presently evaluating and monitoring developments with respect to new and proposed rules and cannot
predict or estimate the amount of the additional costs we may incur or the timing of such costs. We have never paid cash dividends on our capital stock and we do not anticipate paying dividends
in the foreseeable future. We have paid no cash dividends on any of our classes of capital stock to date, and we currently
intend to retain our future earnings, if any, to fund the development and growth of our business.
In addition, the terms of any future debt or credit facility may preclude us from paying any
dividends. As a result, capital appreciation, if any, of our common stock will be your sole source
of potential gain for the foreseeable future. If our independent registered public accounting firm is unable to provide us with the
attestation of the adequacy of our internal control over financial reporting as required by
Section 404 of the Sarbanes-Oxley Act of 2002, investors could lose confidence in the
reliability of our financial statements, which could result in a decrease in the value of your
shares. As directed by Section 404 of the Act, the SEC adopted rules requiring public companies to
include a report of management on the companys internal control over financial reporting in their
annual reports on Form 10-K that contains an assessment by management of the effectiveness of the
companys internal control over financial reporting. We expect that we will be required to include
such a report in our annual reports on Form 10-K beginning with the year ending December 31, 2005.
In addition, the registered public accounting firm auditing our financial statements must attest to
and report on managements assessment of the effectiveness of our internal control over financial
reporting beginning with the year ending December 31, 2005. While we intend to conduct a rigorous
review of our internal control over financial reporting in order to assure compliance with the
Section 404 requirements, if our independent registered public accounting firm interprets the
Section 404 requirements and the related rules and regulations differently from us or if our
independent registered public accounting firm is not satisfied with our internal control over
financial reporting or with the level at which it is documented, operated or reviewed, they may
decline to attest to managements assessment or issue a qualified report. This could result in an
adverse reaction in the financial markets due to a loss of confidence in the reliability of our
financial statements, which could cause the market price of our shares to decline. 
 Item 2. Properties Our headquarters and research and development facility is located in
approximately 50,000 square feet of office and laboratory space in San Diego, California. We occupy
this facility under a lease, which expires on August 1, 2009. We believe that our current facility
is adequate to meet our needs for the foreseeable future. We believe that suitable additional or
alternative space will be available in the future on commercially reasonable terms as needed. 
 Item 3. Legal Proceedings We are currently not party to any material legal proceedings. 
 Item 4. Submission of Matters to a Vote of Security Holders No matters were submitted to a vote of security holders during the fourth quarter ended
December 31, 2004. 25




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Part II 
 Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchase of
Equity Securities Market Information Our common stock is traded on the Nasdaq National Market under the symbol ANDS since March 26,
2004. Prior to such time, there was no public market for our common stock. The following table
sets forth the high and low sales prices for our common stock for the periods indicated, as
reported on the Nasdaq National Market. Such quotations represent inter-dealer prices without
retail markup, markdown or commission and may not necessarily represent actual transactions. 2004
    
    High
    
    
    LowFirst Quarter
    
    $
    7.23
    
    
    $
    7.00Second Quarter
    
    
    8.69
    
    
    
    6.80Third Quarter
    
    
    7.55
    
    
    
    4.53Fourth Quarter
    
    
    7.50
    
    
    
    5.25
 As of February 28, 2005, there were approximately 748 holders of record of our common stock.
On February 28, 2005, the last sale price reported on the Nasdaq National Market for our common
stock was $7.61 per share. Dividend Policy We have never declared or paid any cash dividends on our capital stock. We currently intend
to retain future earnings, if any, for development of our business and, therefore, do not
anticipate that we will declare or pay cash dividends on our capital stock in the foreseeable
future. Securities Authorized for Issuance Under Equity Compensation Plans The following table summarizes the equity compensation plans, including 2002 Equity Incentive
Plan, 2004 Equity Incentive Plan, 2004 Non-Employee Directors Stock Option Plan and 2004 Employee
Stock Purchase Plan, under which Company Common Stock may be issued as of December 31, 2004.
Stockholders of the Company approved all plans. (c)Number of securitiesremaining for future(a)
    
    
    (b)
    
    
    issuance under equityNumber of securities to
    
    
    Weighted-average
    
    
    compensation plansbe issued upon exercise
    
    
    exercise price of
    
    
    (excluding securitiesof outstanding options
    
    
    outstanding options
    
    
    reflected in column (a))Equity compensation plans approved by security holders
    
    
    2,365,154
    
    
    $
    4.12
    
    
    
    941,506
 Use of Proceeds from Registered Securities Our initial public offering of common stock (the Offering) was effected through a
Registration Statement on Form S-1 (File number 333-110528) that was declared effective by the
Securities and Exchange Commission on March 25, 2004. The Offering commenced on March 26, 2004 and
did not terminate before any securities were sold. On March 31, 2004, 6,250,000 shares of common
stock were sold on our behalf at an initial public offering price of $7.00 per share, resulting in
aggregate proceeds of approximately $39.0 million, net of underwriting discounts and commissions
and offering expenses, through a syndicate of underwriters managed by SG Cowen, Piper Jaffray, Legg
Mason Wood Walker, and Needham & Company, Inc. In addition during March and April 2004, we closed
the sale of an additional 743,950 shares of our common stock pursuant to the exercise by the
underwriters of an over-allotment option that resulted in additional net proceeds to us of $4.7
million, net of underwriting discounts and commissions and offering expenses. The Registration
Statement initially registered up to $86,250,000 of Common Stock to be sold by us. As of December 31, 2004, we paid to the underwriters underwriting discounts and commissions
totaling approximately $3.4 million in connection with the Offering. In addition, we incurred
additional expenses of approximately $1.9 million in connection with the Offering, which when added
to the underwriting discounts and commissions paid by us, amounts to total Offering expenses of
approximately $5.3 million. The net Offering proceeds to us including the underwriters exercise of
an over-allotment option and purchase of 743,950 shares after deducting underwriting discounts and
commissions and offering expenses, were approximately $43.7 million. No offering expenses were paid
directly or indirectly to any of our directors or officers (or their associates) or persons owning
ten percent or more of any class of our equity securities or to any other affiliates. The net proceeds from the offering have been invested into short and long-term investment
securities and are being used for general corporate purposes. 26




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Purchases of Equity Securities by the Issuer and Affiliated Purchasers Total Number ofShares Purchased
    
    
    Maximum Number ofas Part of Publicly
    
    
    Shares that May YetTotal Number of
    
    
    Average Price
    
    
    Announced Plans
    
    
    Be Purchased UnderPeriod
    
    Shares Purchased
    
    
    Paid per Share
    
    
    or Programs
    
    
    the Plans or ProgramsOctober 1  October 31, 2004
    
    
    13,508
    
    
    $
    0.051
    
    
    
    
    
    
 During the month ended October 31, 2004, we repurchased 13,508 shares of unvested common stock
from a consultant for $0.051 per share in conjunction with the termination of his consulting
contract with the Company. The repurchase price per share paid by the Company was equal to the
original purchase price per share paid by the consultant. This repurchase was not part of a
publicly announced plan or program and the Company does not currently have any publicly announced
plans or programs for the repurchase of our outstanding common stock as of December 31, 2004. No other shares were repurchased by the Company during the year ended December 31, 2004. 27




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Item 6. Selected Financial Data The selected financial data set forth below with respect to our consolidated statements of
operations for the years ended December 31, 2004, 2003 and 2002, and with respect to our
consolidated balance sheets at December 31, 2004 and 2003 are derived from our consolidated
financial statements that have been audited by Ernst & Young LLP, which are included elsewhere in
this report, and are qualified by reference to such financial statements. The consolidated
statement of operations data for the years ended December 31, 2001 and 2000 and the consolidated
balance sheet data as of December 31, 2002, 2001 and 2000 are derived from our audited financial
statements that are not included in this report. The selected financial information set forth below
should be read in conjunction with Managements Discussion and Analysis of Financial Condition and
Results of Operations and our financial statements and related notes appearing elsewhere in this
report. Years Ended December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(In thousands, except per share amounts)Consolidated Statements of Operations Data:Revenues
    
    $
    1,762
    
    
    $
    2,286
    
    
    $
    1,282
    
    
    $
    287
    
    
    $
    9,215Operating expenses:Research and development
    
    
    24,173
    
    
    
    16,554
    
    
    
    18,054
    
    
    
    8,799
    
    
    
    14,936General and administrative
    
    
    5,666
    
    
    
    4,716
    
    
    
    5,434
    
    
    
    4,027
    
    
    
    4,391Restructuring costs
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,381Stock-based compensation:Research and development
    
    
    2,538
    
    
    
    2,265
    
    
    
    610
    
    
    
    859
    
    
    
    989General and administrative
    
    
    2,594
    
    
    
    2,440
    
    
    
    430
    
    
    
    989
    
    
    
    1,240Total operating expenses
    
    
    34,971
    
    
    
    25,975
    
    
    
    24,528
    
    
    
    14,674
    
    
    
    23,937Loss from operations
    
    
    (33,209
    )
    
    
    (23,689
    )
    
    
    (23,246
    )
    
    
    (14,387
    )
    
    
    (14,722
    )Other income (expense):Interest income
    
    
    525
    
    
    
    229
    
    
    
    403
    
    
    
    899
    
    
    
    599Interest expense
    
    
    (228
    )
    
    
    (266
    )
    
    
    (176
    )
    
    
    (287
    )
    
    
    (505
    )Other, net
    
    
    (67
    )
    
    
    (272
    )
    
    
    (29
    )
    
    
    (253
    )
    
    
    1,033Total other income, (expenses) net
    
    
    230
    
    
    
    (309
    )
    
    
    198
    
    
    
    359
    
    
    
    1,127Net loss
    
    
    (32,979
    )
    
    
    (23,998
    )
    
    
    (23,048
    )
    
    
    (14,028
    )
    
    
    (13,595
    )Accretion to redemption value of redeemable convertible preferred
stock
    
    
    (175
    )
    
    
    (674
    )
    
    
    (319
    )
    
    
    
    
    
    
    Deemed
dividend-beneficial conversion feature for Series C preferred stock
    
    
    
    
    
    
    (6,942
    )
    
    
    
    
    
    
    
    
    
    
    Net loss applicable to common stockholders
    
    $
    (33,154
    )
    
    $
    (31,614
    )
    
    $
    (23,367
    )
    
    $
    (14,028
    )
    
    $
    (13,595
    )Basic and diluted net loss per share(1):
    
    $
    (1.92
    )
    
    $
    (21.58
    )
    
    $
    ($25.88
    )
    
    $
    (25.18
    )
    
    $
    (52.90
    )Shares used to compute basic and diluted net loss per share(1):
    
    
    17,233
    
    
    
    1,465
    
    
    
    903
    
    
    
    557
    
    
    
    257
   (1)
    As a result of the conversion of our preferred stock into 13,330
shares of our common stock upon completion of our initial public
offering on March 31, 2004, there is a lack of comparability in the
basic and diluted net loss per share amounts for the periods
presented above. Please reference Note 1 for the basic and diluted
net loss per share calculation for the periods presented. As of December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(In thousands)Consolidated Balance Sheet Data:Cash, cash equivalents and securities available-for-sale
    
    $
    33,674
    
    
    $
    14,499
    
    
    $
    25,542
    
    
    $
    10,985
    
    
    $
    22,221Working capital
    
    
    28,001
    
    
    
    12,304
    
    
    
    22,239
    
    
    
    8,812
    
    
    
    19,460Total assets
    
    
    40,949
    
    
    
    20,242
    
    
    
    31,840
    
    
    
    16,604
    
    
    
    27,707Long-term debt, net of current portion
    
    
    1,193
    
    
    
    1,401
    
    
    
    1,276
    
    
    
    967
    
    
    
    2,197Redeemable convertible preferred stock
    
    
    
    
    
    
    45,012
    
    
    
    36,210
    
    
    
    
    
    
    
    Accumulated deficit
    
    
    (165,797
    )
    
    
    (132,643
    )
    
    
    (101,029
    )
    
    
    (77,662
    )
    
    
    (63,609
    )Total stockholders equity (deficit)
    
    
    31,285
    
    
    
    (30,059
    )
    
    
    (9,998
    )
    
    
    12,211
    
    
    
    20,683
 28




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##### Table of Contents



Item 7. Managements Discussion and Analysis of Financial Condition and Result of Operations MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS This discussion and analysis should be read in conjunction with our financial statements and
notes thereto included in this annual report on Form 10-K (this Annual Report). Operating
results are not necessarily indicative of results that may occur in future periods. This Annual Report contains forward-looking statements. These forward-looking statements
involve a number of risks and uncertainties. Such forward-looking statements include statements
about our strategies, objectives, discoveries, collaborations, clinical trials, internal programs,
and other statements that are not historical facts, including statements which may be preceded by
the words intend, will, plan, expect, anticipate, estimate, aim, believe, hope or
similar words. For such statements, we claim the protection of the Private Securities Litigation
Reform Act of 1995. Readers of this Annual Report are cautioned not to place undue reliance on
these forward-looking statements, which speak only as of the date on which they are made. We
undertake no obligation to update publicly or revise any forward-looking statements. Actual events
or results may differ materially from our expectations. Important factors that could cause actual
results to differ materially from those stated or implied by our forward-looking statements
include, but are not limited to, the risk factors identified in our SEC reports, including this
Annual Report. Overview We are a biopharmaceutical company committed to advancing patient care by discovering,
developing and commercializing novel small molecule, anti-infective medicines for the treatment of
hepatitis C virus, hepatitis B virus and certain bacterial infections. To date we have devoted
substantially all of our resources to the development of our proprietary drug discovery
technologies, general research and development and preclinical and clinical testing of isatoribine,
ANA975, which is an oral prodrug of isatoribine, and our other product candidates. We have incurred
significant operating losses since our inception in 1992 and our commencement of operations in 1994
and, as of December 31, 2004 our accumulated deficit was $165.8 million. We expect to incur
substantial and increasing losses for at least the next several years as we:  
    Continue the development of ANA975 for the treatment of HCV and HBV;  
    Fund our portion of the global development costs of ANA380;  
    Continue the development of our other HCV, HBV and antibacterial product candidates;  
    Further our research and development programs;  
    Advance our preclinical candidates into clinical development;  
    Establish a commercial infrastructure;  
    Commercialize any product candidates that receive regulatory approval; and  
    Potentially in-license technology and acquire or invest in businesses, products or technologies that are synergistic with our own. During 2004, we completed an initial public offering of 6,993,950 shares of common stock for
proceeds to us of $43.7 million, net of underwriting discounts and commissions and offering
expenses. In conjunction with our initial public offering, each share of Series C redeemable
preferred stock and each share of convertible preferred stock was automatically converted into
common stock. Research and Development Our research and development expenses consist primarily of costs associated with the discovery
and preclinical and clinical development of our lead product candidates, ANA975, ANA380 and our
other product candidates. In addition, research and development expenses include external costs
such as fees paid to consultants, joint development collaboration costs and related contract
research, and internal costs of compensation and other expenses for research and development
personnel, supplies and materials, facility costs, amortization of purchased technology and
depreciation. To the extent that costs are not tracked to a specific project, they are included in
the captions unallocated direct internal costs and unallocated indirect internal costs and overhead
in the table below. We charge all research and development expenses to operations as incurred. The following summarizes our research and development expenses for the years
ended December 31, 2004, 2003 and 2002: Years Ended December 31,2004
    
    
    2003
    
    
    2002(In thousands)Direct external costs:Isatoribine family of compounds, excluding ANA975
    
    $
    1,798
    
    
    $
    1,846
    
    
    $
    3,892ANA975
    
    
    2,038
    
    
    
    
    
    
    
    ANA380
    
    
    5,638
    
    
    
    
    
    
    
    Other
    
    
    5
    
    
    
    25
    
    
    
    74Unallocated direct internal costs
    
    
    1,843
    
    
    
    1,037
    
    
    
    669Unallocated indirect internal costs and overhead
    
    
    12,851
    
    
    
    13,646
    
    
    
    13,419Total research and development
    
    $
    24,173
    
    
    $
    16,554
    
    
    $
    18,054
 At this time, due to the risks inherent in the clinical trial process and given
the early-stage of development of our lead compounds, we are unable to estimate with any certainty
the costs we will incur in the continued development of our product candidates for
commercialization. However, we expect our research and development costs to be substantial and to
increase as we move other product candidates into preclinical and clinical trials. 29




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##### Table of Contents



Clinical development timelines, likelihood of success and total costs vary widely. We are
currently focused primarily on advancing the development of ANA975 as a potential frontline therapy
for HCV and HBV and ANA380 for the treatment of HBV. General and Administrative General and administrative expenses consist primarily of salaries and benefits
for administrative, finance, business development, human resources, legal and internal systems
support personnel. In addition, general and administrative expenses include insurance costs,
professional services and an allocated portion of facilities costs. Critical Accounting Policies Our discussion and analysis of our financial condition and results of
operations are based on our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the U.S., or GAAP. The preparation of
these financial statements requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities and expenses and related disclosure of contingent assets and
liabilities. We review our estimates on an on-going basis. We base our estimates on historical
experience and on various other assumptions that we believe to be reasonable under the
circumstances, the results of which form the basis for making judgments about the carrying values
of assets and liabilities. Actual results may differ from these estimates under different
assumptions or conditions. While our significant accounting policies are described in more detail
in Note 1 to our consolidated financial statements included in this Annual Report, we believe the
following accounting policies to be critical to the judgments and estimates used in the preparation
of our consolidated financial statements: Revenue Recognition. Our revenue recognition policies are in accordance with the
Securities and Exchange Commission, or SEC, Staff Accounting Bulletin, or SAB, No. 104, Revenue
Recognition,which provides guidance on revenue recognition in financial statements, and is based
on the interpretations and practices developed by the SEC. Many of our collaboration agreements
contain multiple elements, including technology access fees, research funding, milestones and
royalty obligations. As of December 31, 2004, we do not have any revenue from royalties or
significant milestone payments. Revenue from milestones is recognized when earned, as evidenced by written
acknowledgment from the collaborator or other persuasive evidence that the milestone has been
achieved, provided that (i) the milestone event is substantive and its achievability was not
reasonably assured at the inception of the agreement, (ii) our performance obligations after the
milestone achievement will continue to be funded by the collaborator at the comparable level to
before the milestone achievement and (iii) the milestone is not refundable or creditable. If both
of these criteria are not met, the milestone payment is recognized over the remaining minimum
period of our performance obligations under the agreement. Upfront fees under our collaborations,
such as technology access fees, are recognized over the period the related services are provided.
Non-refundable upfront fees not associated with our future performance are recognized when
received. Amounts received for research funding are recognized as revenues as the services are
performed. Amounts received for research funding for a specific number of full time researchers are
recognized as revenue as the services are provided, as long as the amounts received are not
refundable regardless of the results of the research project. In November 2002, the Emerging Issues Task Force, or EITF, finalized its
tentative consensus on EITF Issue 00-21, Revenue Arrangements with Multiple Deliverables,which
provides guidance on the timing and method of revenue recognition for sales arrangements that
include the delivery of more than one product or service. EITF 00-21 is effective prospectively for
arrangements entered into in fiscal periods beginning after June 15, 2003. Drug Development Costs.We account for certain compound manufacturing costs, clinical trial
site costs, joint development costs and drug development costs by estimating the services incurred
but not reported. We review and accrue drug development costs based on work performed, which
relies on estimates of total costs incurred based on patient enrollment, completion of studies and
other events. These costs and estimates vary based on the type of clinical trial, the site of the
clinical trial and the length of treatment period for each patient as well as other factors. Drug
development costs are subject to revisions as trials and studies progress to completion. Revisions
are charged to expense in the period in which the facts that give rise to the revision become
known. Stock-based compensation.As permitted by the Statement of Financial Accounting
Standards, or SFAS, No. 123, Accounting for Stock-Based Compensation,we account for stock options
granted to employees using the intrinsic value method in accordance with Accounting Principles
Board, or APB, Opinion No. 25, Accounting for Stock Issued to Employees,and the Financial
Accounting Standards Board, or FASB, Interpretation No. 44, Accounting for Certain Transactions
Involving Stock Compensation  An Interpretation of APB 25.Pursuant to these guidelines, we
measure the intrinsic value of the option or restricted stock award on its grant date as the
difference between the purchase price of the restricted stock or the exercise price of employee
stock options and the fair market value of our stock on the date of issuance or grant, and expense
the difference if any, over the vesting period of the option or restricted stock award. SFAS No. 123 requires stock-based compensation to be accounted for under the
fair value method. If we adopted SFAS No. 123 to account for options granted to employees under our
stock-based compensation plans, our loss would have been materially impacted. Options or stock awards issued to non-employees are recorded at their fair
value in accordance with SFAS No. 123, and periodically remeasured in accordance with EITF No.
96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring or
in Conjunction with Selling Goods or Services,and recognized over the related service period. The above listing is not intended to be a comprehensive list of all of our
accounting policies. In many cases, the accounting treatment of a particular transaction is
specifically dictated by GAAP. There are also areas in which our managements judgment in selecting
any available alternative would not produce a materially different result. See our audited
consolidated financial statements and notes thereto included elsewhere in this Annual Report, which
contains accounting policies and other disclosures required by GAAP. Recent Accounting Pronouncements In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment,that addresses the
accounting for share-based payment transactions in which a Company receives employee services in
exchange for either equity instruments of the Company or liabilities that are based on the fair
value of the Companys equity instruments or that may be settled by the issuance of such equity
instruments. The statement eliminates the ability to account for share-based compensation
transactions using the intrinsic method that we currently use and requires that such transactions
be accounted for using a fair-value-based method and recognized as expense in our consolidated
statement of operations. The effective date of the standard is for periods beginning after June 15,
2005. Upon adoption of this standard we expect that it will have a significant impact on our
consolidated statement of operations as we will be required to expense the fair value of our stock
option grants and stock purchases under our employee stock purchase plan. 30




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Results of Operations Comparison of the Years Ended December 31, 2004, 2003 and 2002 Revenue.We recorded revenues of $1.8 million, $2.3 million and $1.3 million for
the years ended December 31, 2004, 2003 and 2002, respectively. The $500,000 decrease from 2003 to
2004 was primarily attributable to revenues derived from our collaborations with Roche and Amgen in
2003 compared to 2004. The $1.0 million increase from 2002 to 2003 was primarily attributable to
revenues derived from our collaborations with Roche and Amgen. Fluctuations in our
collaboration-related revenue from period to period are expected, as amounts recognized are
dependent upon a number of factors including but not limited to the timing of agreements, the
timing of the workflow under the agreements and our collaborators abilities to provide us with the
materials and information necessary for us to conduct our portion of the collaboration effort. We
expect our revenues to continue to fluctuate in future periods as we continue to enter into new
agreements and perform activities under existing agreements. Research and Development Expenses.Research and development expenses were $24.2
million, $16.6 million and $18.1 million for the years ended December 31, 2004, 2003 and 2002,
respectively. The $7.6 million increase from 2003 to 2004 was primarily a result of the following:
(i) the $500,000 option payment and the $4,000,000 licensing fee paid to LG Life Sciences in
conjunction with the execution of our joint development and license agreement and (ii) an increase
in drug development expenses of $2.9 million related to drug development costs associated with the
continued development of our isatoribine family of compounds and joint drug development costs
associated with ANA380. The $1.5 million decrease from 2002 to 2003 was primarily a result of a
decreases of $1.9 million in external drug development expenses and $1.1 million in lab supplies
and outside lab services, partially offset by increases of $773,000 in personnel expenses as a
result of hiring additional research and development personnel and an increase of $708,000 in
facilities expenses related to the leasing of a second facility. General and Administrative Expenses.General and administrative expenses were
$5.7 million, $4.7 million and $5.4 million for the years ended December 31, 2004, 2003 and 2002,
respectively. The $1.0 million increase from 2003 to 2004 was primarily the result of the
following: (i) moving expenses associated with our relocation of our corporate headquarters in
June 2004, (ii) increases in legal expenses associated with the filing of patent applications and
other legal costs associated with the on-going operations of the Company and (iii) increases in
costs as a result of being a public company including director and officer insurance premiums,
accounting fees and investor and public relations expenses. The $700,000 decrease from 2002 to
2003 was primarily related to (i) lower legal fees of $305,000 and (ii) lower depreciation of
$198,000. Stock-based Compensation.Deferred compensation for stock options and stock
awards granted have been determined as the difference between the exercise price and the fair value
of our common stock on the date of grant. Option or awards issued to non-employees are recorded at
their fair value in accordance with SFAS No. 123 and periodically remeasured in accordance with
EITF 96-18 and recognized over the service period. In conjunction with the Companys initial public
offering, we reviewed our historical exercise prices through March 25, 2004 and, as a result,
revised the estimate of fair value for all stock options granted subsequent to July 1, 2002. With
respect to these options granted, we recorded deferred stock-based compensation of $6.0 million,
$5.1 million, and $263,000 for the years ended December 31, 2004, 2003 and 2002, respectively, for
the difference between the original exercise price per share determined by the Board of Directors
and the revised estimate of fair value per shares at the respective grant dates. We recorded these
amounts as a component of stockholders equity and will amortize the amount, on an accelerated
basis, as a non-cash charge to operations over the vesting period of the options. We recorded
stock-based compensation expense related to the amortization of employee stock options grants and
the issuance of non-employee stock option grants of $5.1 million, $4.7 million, and $1.0 million
for the years ended December 31, 2004, 2003 and 2002, respectively. Interest Income.Interest income was $525,000, $229,000 and $403,000 for the years ended
December 31, 2004, 2003 and 2002, respectively. The $296,000 increase from 2003 to 2004 was
primarily attributable to an increase in interest income due to our higher average cash, cash
equivalents and securities available-for-sale balances as a result of the receipt of the proceeds
from our initial public offering during April and May 2004. The $174,000 decrease in interest
income from 2002 to 2003 was primarily attributable to lower prevailing interest rates associated
with our lower average cash, cash equivalents and securities available-for-sale balances during
2002 and 2003. Interest Expense.Interest expense was $228,000, $266,000 and $176,000 for the
years ended December 31, 2004, 2003 and 2002, respectively. Interest expense for the year ended
December 31, 2004 was relatively consistent with the interest expense for the year ended December
31, 2003. The $90,000 increase from 2002 to 2003 was the result of a higher average balance
outstanding under our long-term debt during 2003 compared to 2002 as we received $1.8 million of
funding in late 2002 and an additional $1.6 million of funding throughout 2003. Other, net.Other, net was an expense of $67,000, $272,000 and $29,000 for the
years ended December 31, 2004, 2003 and 2002, respectively. The fluctuation in other, net for the
years ended December 31, 2004, 2003 and 2002 was primarily the result of the loss on the disposal
of assets related to the substantial dissolution of our German subsidiary in 2003. Liquidity and Capital Resources As of December 31, 2004, we had cash, cash equivalents, and securities available-for-sale of
$33.7 million. To date, we have funded our operations primarily through the sale of equity
securities as well as through equipment financing. Through December 31, 2004, we had received
approximately $171.2 million from the sale of equity securities. In addition, as of December 31,
2004, we had financed through loans the purchase of equipment totaling approximately $9.7 million,
of which $2.6 million in loans was outstanding at that date. These obligations are secured by the
purchased equipment and leasehold improvements, bear interest at rates ranging from approximately
8.6% to 10.0% and are due in monthly installments through October 2008. 31




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Cash Flows from Operating Activities and Investing Activities: Our consolidated statements of cash flows are summarized as follows: Years Ended December 31,2004
    
    
    2003
    
    
    2002(in thousands)Net cash used in operating activities
    
    $
    (22,574
    )
    
    $
    (18,333
    )
    
    $
    (19,101
    )Cash provided by (used in) investing activitiesPurchase of securities available-for-sale
    
    $
    (42,619
    )
    
    $
    (7,820
    )
    
    $
    (18,953
    )Proceeds from sale of securities available-for-sale
    
    
    17,398
    
    
    
    23,960
    
    
    
    7,977Purchase of property and equipment
    
    
    (880
    )
    
    
    (674
    )
    
    
    (2,787
    )Proceeds from disposal of property and equipment
    
    
    35
    
    
    
    25
    
    
    
    Acquisition of facility leasehold improvements from lease incentive
    
    
    (1,550
    )
    
    
    
    
    
    
    Net cash provided by (used in) investing activities
    
    $
    (27,616
    )
    
    $
    15,491
    
    
    $
    (13,763
    )
 Cash flows used in operating activities increased by $4.2 million from 2003 to 2004. The key
component was our increased net loss from 2003 to 2004 of $9.0 million. The following items also
significantly impacted our cash flows used in operating activities:  
    Amortization of deferred compensation from employee stock options increased $1.4 million
from $4.9 million during 2004 compared to $3.5 million during 2003.
    During 2004, we received $1.6 million in lease incentives as a result of entering into a
lease for our new corporate headquarters and research and development facility. In
addition, we paid $1.3 million for a refundable security deposit on this facility. Cash flows used in operating activities decreased by $768,000 from 2002 to 2003. The key
component was our decreased costs associated with external drug development related to the
development of our lead compounds from 2002 to 2003. Cash flows provided by (used in) investing activities decreased by $43.1 million from 2003 to
2004. The key component was the use of our excess proceeds from our initial public offering during
2004 for the purchase of marketable securities whereas during 2003 the Company used proceeds from
the sale of marketable securities to fund operations. The following items also significantly
impacted our cash flows from investing activities:  
    The Company purchased property, equipment, and facility leasehold improvements in the
amount of $880,000, which related primarily to research and development equipment.
    During 2004, the Company utilized $1.6 million of lease incentives to fund the
construction of certain tenant improvements to prepare our new corporate headquarters and
research and development facility for occupancy. Cash flows provided by (used in) investing activities increased by $29.3 million from 2002 to
2003. The key component was the result of the Company utilizing the proceeds from the sale of
marketable securities to fund the operations of the Company in 2003 compared to 2002 where the
Company used the excess proceeds from our redeemable preferred stock financing in 2002 to purchase
marketable securities. The following item also significantly impacted our cash flows from investing
activities:  
    During 2002, the Company purchased property and equipment in the amount of $2.8 million
compared to $674,000 in 2003. 2002 purchases were primarily related to research and
development equipment. Cash Flows from Financing Activities: Our consolidated statements of cash flows are summarized as follows: Years Ended December 31,2004
    
    
    2003
    
    
    2002(in thousands)Cash provided by financing activitiesProceeds from exercise of stock options and employee stock
purchase plan
    
    $
    560
    
    
    $
    27
    
    
    $
    8Proceeds from sale of common stock, net of issuance costs
    
    
    43,656
    
    
    
    7
    
    
    
    14Proceeds from sale of preferred stock, net of issuance costs
    
    
    
    
    
    
    8,078
    
    
    
    35,776Proceeds from long-term debt
    
    
    1,198
    
    
    
    1,585
    
    
    
    1,818Principal payments on long-term debt
    
    
    (1,204
    )
    
    
    (1,753
    )
    
    
    (1,267
    )Net cash provided by financing activities
    
    $
    44,210
    
    
    $
    7,944
    
    
    $
    36,349
 Cash flows provided by financing activities increased by $36.3 million from 2003 to 2004. The
key component was the proceeds from our initial public offing of $43.7 million during 2004. The
following items also significantly impacted our cash flows provided by financing activities: 32




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##### Table of Contents




    During 2004, the Company received proceeds from the exercise of employee stock options and
employee stock purchase plan of $560,000.  
    During 2004, the Company modified its existing loan and security agreement and as a result
increased the maximum amount available under the agreement to $3 million, provided for a
revolving credit facility and extended the availability of the credit facility to December
31, 2005. During 2004, the Company executed promissory notes under the loan and security
agreement in the amount of $1.2 million for eligible equipment and tenant improvements. Cash flows provided by financing activities decreased by $28.4 million from 2002 to 2003. The
key component was the proceeds from our redeemable preferred stock issuance of $35.8 million during
2002. The following items also significantly impacted our cash flows provided by financing
activities:  
    During 2003, the Company received proceeds of $8.1 million from a follow-on offering of
our redeemable preferred stock.
    The Company executed promissory notes under our loan and security agreements in the
amount of $1.8 million during 2002 compared to $1.6 million during 2003 to finance eligible
equipment and tenant improvements. Aggregate Contractual Obligations The following summarizes our long-term contractual obligations as of December
31, 2004 (in thousands): Less than
    
    
    2006 to
    
    
    2009 toContractual Obligations
    
    Total
    
    
    1 year
    
    
    2008
    
    
    2010
    
    
    ThereafterOperating leases
    
    $
    7,980
    
    
    $
    1,376
    
    
    $
    5,486
    
    
    $
    1,118
    
    
    $
    Equipment financing
    
    
    2,576
    
    
    
    1,360
    
    
    
    1,216
    
    
    
    
    
    
    
    Minimum royalty commitment
    
    
    1,025
    
    
    
    
    
    
    
    125
    
    
    
    100
    
    
    
    800$
    11,581
    
    
    $
    2,736
    
    
    $
    6,827
    
    
    $
    1,218
    
    
    $
    800
 We also enter into agreements with clinical sites that conduct our clinical
trials. We make payments to sites based upon the number of patients enrolled and the length of
their participation in the trials. For the years ended December 31, 2004 and 2003, we had made
aggregate payments of $664,000 and $673,000 respectively, to clinical sites in connection with our
Phase I clinical trials for isatoribine and Phase I clinical trials for ANA971. The majority of our
clinical costs are related to the accrual and on-going costs of patients entering our clinical
trials as well as the manufacturing of compounds to be used in our clinical trials. Costs
associated with clinical trials will continue to vary as the trials go through their natural phases
of enrollment and follow-up. Overview of Financial Position and Future Cash Requirements Our consolidated balance sheet as of December 31, 2004, compared to our consolidated balance
sheet as of December 31, 2003, was impacted by the following:  
    The increase in cash, cash equivalents and securities available-for-sale of $19.2
million was primarily the result of our initial public offering which was declared
effective on March 25, 2004 through which we raised net proceeds of $43.7 million. The net
proceeds from our initial public offering were reduced by cash requirements for operations
of the Company.
    The increase in accrued expenses of $1.9 million was primarily the result of an increase
in our costs associated on-going drug development associated with both ANA975 and ANA380.
In addition, we expect to continue to record costs associated with our joint development of
ANA380 with LG Life Sciences, Ltd. (LGLS). In February 2004, we obtained an exclusive
option from LGLS to enter into a joint development and license agreement for the
development and commercialization of ANA380 for the treatment of chronic HBV infection. We
paid $500,000 to LGLS for this option. On April 19, 2004, we announced that we exercised
our option and had entered into a joint development and license agreement with LGLS for the
clinical development and commercialization of ANA380 for the treatment of chronic HBV
infection in North America, Europe, Japan and the rest of the world other than China,
Korea, India and countries in Southeast Asia. Under the terms of the agreement, we will
share the costs for the global clinical development of ANA380 with LGLS. During May 2004,
we paid a licensing fee of $4 million to LGLS. In addition, we could be required to make
additional milestone payments totaling up to $25.5 million, subject to the attainment of
product development and commercialization objectives. We will pay royalties on any product
sales in our sales territory to LGLS and will receive royalties on any product sales in
China from LGLS. For the year ended December 31, 2004, we have recorded $750,000 as a
component of research and development expense, which represents our share of expenses
incurred by LGLS related to the clinical development of ANA380. We have estimated these
costs based on information provided to the Company by LGLS and based upon our understanding
of the global clinical development plan for ANA380.
    The increase in property and equipment of $933,000 was primarily the result of tenant
improvements funded through lease incentives for our new corporate headquarters and
research and development facility. In addition, we paid $1.3 million for a refundable
security deposit on this facility, which is included as a component of other assets. 33




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##### Table of Contents



Our future capital uses and requirements depend on numerous forward-looking factors. These
factors include but are not limited to the following:  
    the progress of our clinical trials;
    the progress of our research activities;
    the number and scope of our research programs;
    the progress of our preclinical development activities;
    our ability to establish and maintain strategic collaborations;
    the costs involved in enforcing or defending patent claims and other intellectual property rights;
    the costs and timing of regulatory approvals;
    the costs of establishing or expanding manufacturing, sales and distribution capabilities;
    the costs related to development and manufacture of pre-clinical, clinical and validation lots for regulatory and commercialization of drug supply;
    the success of the commercialization of ANA380 or ANA975; and
    the extent to which we acquire or invest in other products, technologies and businesses. We believe that the net proceeds from our initial public offering, together with interest
thereon, our existing cash, cash equivalents, and securities available-for-sale and revenues we may
generate from our collaborations, will be sufficient to meet our projected operating requirements
through at least the beginning of 2006. However, our forecast of the period of time through which
our financial resources will be adequate to support our operations is a forward-looking statement
that involves risks and uncertainties, and actual results could vary materially. Until we can generate significant cash from our operations, we expect to
continue to fund our operations with existing cash resources that were primarily generated from the
proceeds of offerings of our equity securities and from equipment and leasehold improvement
financing. In addition, we may finance future cash needs through the sale of other equity
securities, strategic collaboration agreements and debt financing. However, we may not be
successful in obtaining collaboration agreements, or in receiving milestone or royalty payments
under those agreements. In addition, we cannot be sure that our existing cash and marketable
securities resources will be adequate or that additional financing will be available when needed or
that, if available, financing will be obtained on terms favorable to us or our stockholders. Having
insufficient funds may require us to delay, scale back or eliminate some or all of our research or
development programs or to relinquish greater or all rights to product candidates at an earlier
stage of development or on less favorable terms than we would otherwise choose. Failure to obtain
adequate financing also may adversely affect our ability to operate as a going concern. If we raise
additional funds by issuing equity securities, substantial dilution to existing stockholders would
likely result. If we raise additional funds by incurring debt financing, the terms of the debt may
involve significant cash payment obligations as well as covenants and specific financial ratios
that may restrict our ability to operate our business. Off-Balance Sheet Arrangements As of December 31, 2004, 2003 and 2002, we did not have any relationships with unconsolidated
entities or financial partnerships, such as entities often referred to as structured finance or
special purpose entities, which would have been established for the purpose of facilitating
off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we
do not engage in trading activities involving non-exchange traded contracts. As such, we are not
materially exposed to any financing, liquidity, market or credit risk that could arise if we had
engaged in these relationships. We do not have relationships or transactions with persons or
entities that derive benefits from their non-independent relationship with us or our related
parties other than what is disclosed in Note 6 to the consolidated financial statements included
elsewhere in this annual report. 
 Item 7A. Quantitative and Qualitative Disclosure About Market Risk Our primary exposure to market risk is interest income sensitivity, which is affected by
changes in the general level of U.S. interest rates, particularly because the majority of our
investments are in short-term marketable securities. Due to the nature of our short-term
investments, we believe that we are not subject to any material market risk exposure. We do not
have any foreign currency or other derivative financial instruments. 
 Item 8. Financial Statements and Supplementary Data The consolidated financial statements and related financial required to be filed are indexed on
page F-1 and are incorporated herein. 
 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Not Applicable. 
 Item 9A. Controls and Procedures Our Chief Executive
Officer and Senior Vice President, Corporate Development and Finance performed an evaluation
of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-l5(e)
and l5d-15(e) of the Securities Exchange Act of 1934) as of the end of the period covered by
this annual report. Based on that evaluation, our Chief Executive Officer and Senior Vice
President of Corporate Development and Finance concluded that as of the date of such evaluation,
our disclosure controls and procedures were effective to provide reasonable assurance that
information required to be disclosed by us in our periodic reports under the Exchange Act
is recorded, processed, summarized and reported within the time periods specified in
Securities and Exchange Commission rules and forms, and that such information is accumulated
and communicated to our management, including our Chief Executive Officer and Senior Vice
President, Corporate Development and Finance, as appropriate, to allow timely decisions
regarding required disclosure. It should be noted that the design of any system of controls
is based in part upon certain assumptions about the likelihood of future events, and can
therefore only provide reasonable, not absolute, assurance that the design will succeed in
achieving its stated goals. There was no change in our internal control over financial reporting that occurred during our
most recent fiscal quarter that has materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting. 
 Item 9B. Other Information Not Applicable. 34




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##### Table of Contents



Part III Certain information required by Part III is omitted from this report because the Registrant
expects to file a definitive proxy statement for its 2005 Annual Meeting of Stockholders (the
Proxy Statement) within 120 days after the end of its fiscal year pursuant to Regulation 14A
promulgated under the Securities Exchange Act of 1934, as amended, and the information included
therein is incorporated herein by reference to the extent provided below. 
 Item 10. Directors and Executive Officers of the Registrant The information required by Item 10 of Form 10-K is incorporated by reference to the
information under the heading Election of Directors and Section 16(a) Beneficial Ownership
Reporting Compliance in our Proxy Statement to be filed with the Commission pursuant to Regulation
14A within 120 days after December 31, 2004 and to be used in connection with our 2005 Annual
Meeting of Stockholders. Information regarding executive officers is set forth in Item 1 of Part I of this report under
the caption Executive Officers. The information required by Item 10 of Form 10-K is also incorporated by reference to the
information under the heading Audit Committee, relating to the members of the Companys Audit
Committee and the Audit Committee financial expert in our Proxy Statement. The information required by Item 10 of Form 10-K is also incorporated by reference to the
information under the heading Shareholder Communications with the Board of Directors, relating to
the procedures by which stockholders may recommend candidates for director to the Nominating and
Governance Committee of the Board of Directors, in our Proxy Statement. The Company has adopted a Code of Ethics, which applies to all Anadys Pharmaceuticals Inc.
directors, officers and employees, including the Chief Executive Officer and Senior Vice President,
Corporate Development and Finance and all of the financial team. The Code of Ethics is posted on
the Companys website, (under the Investors  Corporate Governance caption.) The Company intends
to satisfy the disclosure requirement regarding any amendment to, or waiver of, a provision of the
Code of Ethics for the Chief Executive Officer and Senior Vice President, Corporate Development and
Finance or persons performing similar functions, by posting such information on its website. 
 Item 11. Executive Compensation The information required by Item 11 of Form 10-K is incorporated by reference to the
information under the heading Compensation of Executive Officers in our Proxy Statement to be
filed with the Commission pursuant to Regulation 14A within 120 days after December 31, 2004 and to
be used in connection with our 2005 Annual Meeting of Stockholders. 
 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters The information required by Item 12 of Form 10-K is incorporated by reference to the
information under the heading Security Ownership of Certain Beneficial Owners and Management in
the Proxy Statement to be filed with the Commission pursuant to Regulation 14A within 120 days
after December 31, 2004 and to be used in connection with our 2005 Annual Meeting of. Information
regarding equity compensation plans under which Company common stock may be issued as of December
31, 2004 is set forth in Item 5 of this Report. 
 Item 13. Certain Relationships and Related Transactions The information required by Item 13 of Form 10-K is incorporated by reference to the
information under the heading Certain Transactions in the Proxy Statement. 
 Item 14. Principal Accounting Fees and Services The information required by Item 14 of Form 10-K is incorporated by reference to the
information under the heading Independent Registered Public Accounting Firm  Fees in the Proxy
Statement. 
 Part IV 
 Item15. Exhibits and Financial Statement Schedules (a) The following financial statements, financial statements schedules and exhibits are filed
as part of this report or incorporated herein by reference:  (1)
    Financial StatementsSee index to consolidated financial statements on page F-1.(2)
    Financial Statement SchedulesAll financial statements schedules for which provision is made in Regulation S-X are
omitted because they are not required under the related instructions, are inapplicable, or
the required information is given in the financial statements, including the notes
thereto.(3)
    Exhibits. ExhibitNumber
    
    Exhibit Description3.1(1)
    
    Form of Amended and Restated Certificate of Incorporation of the Registrant3.2(1)
    
    Form of Amended and Restated Bylaws of the Registrant
 35




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##### Table of Contents



4.1(2)
    
    Form of Specimen Common Stock Certificate4.2(3)
    
    Amended and Restated Registration
Rights Agreement dated as of June 20, 2002 by and among the Registrant and Stockholders named therein10.1(3)
    
    Standard Industrial/ Commercial Single-Tenant Lease dated November 3, 2000 by and between the Registrant and Campson Corporation10.2(3)
    
    Standard Industrial/ Commercial Single-Tenant Lease dated April 23, 2002 by and between the Registrant and 6777 Nancy Ridge LLC10.3(3)#
    
    2002 Equity Incentive Plan10.4(3)#
    
    Form of Stock Option Agreement under 2002 Equity Incentive Plan10.5(2)#
    
    2004 Equity Incentive Plan10.6(2)#
    
    Form of Stock Option Agreement under 2004 Equity Incentive Plan10.7(2)#
    
    2004 Employee Stock Purchase Plan10.8(2)#
    
    Form of Offering Document under the 2004 Employee Stock Purchase Plan10.9(2)#
    
    2004 Non-Employee Directors Stock Option Plan10.10(2)#
    
    Form of Stock Option Agreement Under 2004 Non-Employee Directors Stock Option Plan10.11(3)
    
    Form of Indemnification Agreement by and between the Registrant and each of its directors and officers10.12(2)#
    
    Severance Agreement dated June 9, 2000 by and between the Registrant and Kleanthis G. Xanthopoulos, Ph.D.10.13(2)#
    
    Severance Agreement dated June 9, 2000 by and between the Registrant and Devron R. Averett, Ph.D.10.14(2)*
    
    Research Collaboration Agreement dated February 21, 2003 by and between the Registrant and Amgen Inc.10.15(2)*
    
    Screening Agreement dated June 6, 2002 by and between the Registrant and Cerylid Pty Ltd.10.16(2)*
    
    Agreement dated August 7, 2002 by and between the Registrant and Hoffmann-La Roche Inc.10.17(2)*
    
    Amendment No. 1 to the August 7, 2002 Agreement between Hoffman-La Roche Inc. and the Registrant dated October 1, 200310.18(2)*
    
    Research Collaboration Agreement dated June 7, 2002 by and between the Registrant and Gilead Sciences, Inc., as amended.10.19(2)*
    
    Research and License Agreement dated October 10, 2002 by and between the Registrant and Sequoia Sciences, Inc.10.20(2)*
    
    Technology License Agreement dated January 9, 2001 by and between the Registrant and EMBL Enterprise Management Technology
Transfer GmbH, as amended.10.21(2)*
    
    Agreement dated December 20, 2002 by and between the Registrant and Valeant Pharmaceuticals International (formerly known as
ICN Pharmaceuticals, Inc.)10.22(3)#
    
    Terms of Compensation dated June 9, 2000 by and between the Registrant and Devron R. Averett10.23(3)
    
    Equipment Loan and Security Agreement dated as of December 20, 2002 by and between the Registrant and GATX Ventures, Inc.10.24(3)
    
    Master Security Agreement dated as of June 17, 2003 by and between the Registrant and General Electric Capital Corporation10.25(2)#
    
    Severance Agreement dated November 14, 2003 by and between the Registrant and Steve Worland, Ph.D.10.26(2)#
    
    Severance Agreement dated November 14, 2003 by and between the Registrant and Michael Kamdar10.27(3)#
    
    Terms of Employment dated February 1, 2001 by and between the Registrant and Steve Worland, Ph.D.10.28(3)#
    
    Terms of Employment dated March 5, 2001 by and between the Registrant and Michael Kamdar10.29(2)#
    
    Severance Agreement dated November 14, 2003 by and between the Registrant and Elizabeth E. Reed10.30(2)#
    
    Terms of Employment dated October 2, 2001 by and between the Registrant and Elizabeth E. Reed10.31(2)*
    
    Agreement dated December 8, 2003 by and between the Registrant and Daiichi Pharmaceutical Co. Ltd.10.32(4)*
    
    Amended and Restated Exclusive Option Agreement dated as of February 24, 2004 by and between the Registrant and LG Life
Sciences, Ltd., as amended10.33(2)
    
    Sub-lease agreement dated February 23, 2004 by and between the Registrant and Torrey Mesa Research Institute.10.34(5)*
    
    Joint Development and License Agreement between LG Life Sciences and Anadys Pharmaceuticals Inc.10.35(6)*
    
    Agreement dated July 28, 2004 by and between Hoffmann-La Roche, Inc. and Anadys Pharmaceuticals, Inc.10.36(6)*
    
    Collaboration Agreement dated September 3, 2004 by and between Aphoenix, Inc. and Anadys Pharmaceuticals, Inc.21.1(3)
    
    List of Subsidiaries of the Registrant23.1
    
    Consent of Independent Registered Public Accounting Firm31.1
    
    Section 302 Certification by Anadys President and Chief Executive Officer31.2
    
    Section 302 Certification by Anadys Senior Vice President, Corporate Development and Finance32
    
    Section 906 Certification by Anadys Chief Executive Officer and Senior Vice President, Corporate Development and Finance
   (1)
    
    Incorporated by reference to the Registrants Quarterly Report on Form 10-Q filed on May 14, 2004(2)
    
    Incorporated by reference to the Registrants Registration Statement on Form S-1 (SEC File No. 333-110528) filed on March 19, 2004(3)
    
    Incorporated by reference to the Registrants Registration Statement on Form S-1 (SEC File No. 333-110528) filed on November 14, 2003(4)
    
    Incorporated by reference to the Registrants Registration Statement on Form S-1 (SEC File No. 333-110528) filed on March 24, 2004(5)
    
    Incorporated by reference to the Registrants Quarterly Report on Form 10-Q filed on August 16, 2004(6)
    
    Incorporated by reference to the Registrants Quarterly Report on Form 10-Q filed on November 12, 2004 36




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##### Table of Contents



#
    
    Indicates management contract or compensatory plan.*
    
    Confidential treatment has been requested with respect to certain portions of this exhibit. Omitted portions have been filed separately with the
Securities and Exchange Commission. 37




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##### Table of Contents



SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934 as amended,
the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized, in the City of San Diego, State of California, on the 30th day of March, 2005. ANADYS PHARMACEUTICALS, INC.By: /s/ KLEANTHIS G. XANTHOPOULOS, PH.D.Kleanthis G. Xanthopoulos, Ph.D.Chief Executive Officer and President
 Pursuant to the requirements of the Securities Act of 1934 as amended, this report has been signed
by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Signature
    
    Title
    
    Date/s/ KLEANTHIS G. XANTHOPOULOS, PH.D.

Kleanthis G. Xanthopoulos, Ph.D.
    
    Chief Executive Officer,
President and Director(Principal Executive Officer)
    
    March 30, 2005/s/ MICHAEL J. KAMDAR

Michael J. Kamdar
    
    Senior Vice President, Corporate
Development and Finance(Principal Financial Officer
and Principal Accounting
Officer)
    
    March 30, 2005/s/ JASON FISHERMAN, M.D.

Jason Fisherman, M.D.
    
    Chairman of the Board
    
    March 30, 2005/s/ CHARLES COHEN, PH.D.

Charles Cohen, Ph.D.
    
    Director
    
    March 30, 2005/s/ MARIOS FOTIADIS

Marios Fotiadis
    
    Director
    
    March 30, 2005/s/ ARGERIS N. KARABELAS, PH.D.

Argeris N. Karabelas, Ph.D.
    
    Director
    
    March 30, 2005/s/ STEVEN H. HOLTZMAN

Steven H. Holtzman
    
    Director
    
    March 30, 2005/s/ STELIOS PAPADOPOULOS, PH.D.

Stelios Papadopoulos, Ph.D.
    
    Director
    
    March 30, 2005/s/ GEORGE A. SCANGOS, PH.D.

George A. Scangos, Ph.D.
    
    Director
    
    March 30, 2005/s/ DOUGLAS E. WILLIAMS, PH.D.

Douglas E. Williams, Ph.D.
    
    Director
    
    March 30, 2005
 38




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##### Table of Contents



ANADYS PHARMACEUTICALS, INC. INDEX TO FINANCIAL STATEMENTS PageReport of Independent Registered Public Accounting Firm
    
    F-2Consolidated Balance Sheets as of December 31, 2004 and 2003
    
    F-3Consolidated Statements of Operations for the years ended December 31, 2004, 2003 and 2002
    
    F-4Consolidated Statements of Stockholders Equity (Deficit) for the years ended December 31, 2004, 2003 and 2002
    
    F-5Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003 and 2002
    
    F-7Notes to Consolidated Financial Statements
    
    F-8
 F - 1




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##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Anadys Pharmaceuticals, Inc. We have audited the accompanying consolidated balance sheets of Anadys
Pharmaceuticals, Inc. as of December 31, 2004 and 2003, and the related consolidated statements of
operations, stockholders equity (deficit) and cash flows for each of the three years in the period
ended December 31, 2004. These financial statements are the responsibility of the Companys
management. Our responsibility is to express an opinion on these financial statements based on our
audits. We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are free of material
misstatement. We were not engaged to perform an audit of the Companys internal controls over
financial reporting. Our audit included consideration of internal control over financial reporting
as a basis for designing audit procedures that are appropriate in the circumstances, but not for
the purpose of expressing an option of the effectiveness of the Companys internal control over
financial reporting. Accordingly we express no such option. An audit also includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Anadys Pharmaceuticals, Inc. at
December 31, 2004 and 2003 and the consolidated results of its operations and its cash flows for
each of the three years in the period ended December, 31, 2004, in conformity with U. S. generally
accepted accounting principals. /s/ Ernst & Young LLP
 San Diego, California
February 9, 2005 F - 2




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ANADYS PHARMACEUTICALS, INC. 
 CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share data)
 December 31,2004
    
    
    2003AssetsCurrent assets:Cash and cash equivalents
    
    $
    5,988
    
    
    $
    11,968Securities available-for-sale
    
    
    27,686
    
    
    
    2,531Accounts receivable
    
    
    186
    
    
    
    525Prepaid expenses and other current assets
    
    
    1,138
    
    
    
    1,168Total current assets
    
    
    34,998
    
    
    
    16,192Property and equipment, net
    
    
    4,030
    
    
    
    3,097Other assets, net
    
    
    1,921
    
    
    
    953Total assets
    
    $
    40,949
    
    
    $
    20,242Liabilities and stockholders equity (deficit)Current liabilities:Accounts payable
    
    $
    1,120
    
    
    $
    765Accrued expenses
    
    
    3,607
    
    
    
    1,664Current portion of long-term debt
    
    
    1,310
    
    
    
    1,059Current portion of deferred rent
    
    
    360
    
    
    
    Deferred revenue
    
    
    600
    
    
    
    400Total current liabilities
    
    
    6,997
    
    
    
    3,888Long-term debt, net of current portion
    
    
    1,193
    
    
    
    1,401Long-term portion of deferred rent
    
    
    1,474
    
    
    
    Commitments and contingenciesRedeemable convertible preferred stock, $0.01 par value:Authorized shares  no shares and 40,287,030 shares
at December 31, 2004 and 2003, respectivelyIssued and outstanding shares  no shares and
34,484,669 at December 31, 2004 and 2003,
respectively; liquidation preference of $46,425 at
December 31, 2003
    
    
    
    
    
    
    45,012Stockholders equity (deficit):Convertible preferred stock, $0.01 par value:Authorized shares  no
shares and 33,766,599
shares at December 31,
2004 and 2003,
respectivelyIssued and outstanding
shares  no shares and
33,513,599 shares at
December 31, 2004 and
2003; liquidation
preference of $80,773
at December 31, 2003
    
    
    
    
    
    
    80,779Preferred stock, $0.001 par value:Authorized shares 
10,000,000 shares and
no shares at December
31, 2004 and 2003,
respectivelyIssued and outstanding
shares  no shares at
December 31, 2004 and
2003
    
    
    
    
    
    
    Common stock, $0.001 par value:Authorized shares 
90,000,000 shares and
130,000,000 shares at
December 31, 2004 and
2003, respectivelyIssued and outstanding
shares  22,334,521
shares and 1,905,708
shares at December 31,
2004 and 2003,
respectively
    
    
    22
    
    
    
    2Additional paid-in capital
    
    
    199,990
    
    
    
    24,011Deferred compensation
    
    
    (2,862
    )
    
    
    (2,206
    )Accumulated other comprehensive loss
    
    
    (68
    )
    
    
    (2
    )Accumulated deficit
    
    
    (165,797
    )
    
    
    (132,643
    )Total stockholders equity (deficit)
    
    
    31,285
    
    
    
    (30,059
    )Total liabilities and stockholders equity (deficit)
    
    $
    40,949
    
    
    $
    20,242
 See accompanying notes to consolidated financial statements. F - 3




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ANADYS PHARMACEUTICALS, INC. 
 CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data)
 Years Ended December 31,2004
    
    
    2003
    
    
    2002Revenues:Collaborative agreements
    
    $
    1,672
    
    
    $
    2,155
    
    
    $
    903Grants
    
    
    90
    
    
    
    131
    
    
    
    379Total revenues
    
    
    1,762
    
    
    
    2,286
    
    
    
    1,282Operating expenses:Research and development
    
    
    24,173
    
    
    
    16,554
    
    
    
    18,054General and administrative
    
    
    5,666
    
    
    
    4,716
    
    
    
    5,434Stock-based compensation:Research and development
    
    
    2,538
    
    
    
    2,265
    
    
    
    610General and administrative
    
    
    2,594
    
    
    
    2,440
    
    
    
    430Total operating expenses
    
    
    34,971
    
    
    
    25,975
    
    
    
    24,528Loss from operations
    
    
    (33,209
    )
    
    
    (23,689
    )
    
    
    (23,246
    )Other income (expense):Interest income
    
    
    525
    
    
    
    229
    
    
    
    403Interest expense
    
    
    (228
    )
    
    
    (266
    )
    
    
    (176
    )Other, net
    
    
    (67
    )
    
    
    (272
    )
    
    
    (29
    )Total other income (expense)
    
    
    230
    
    
    
    (309
    )
    
    
    198Net loss
    
    
    (32,979
    )
    
    
    (23,998
    )
    
    
    (23,048
    )Accretion to redemption value of redeemable convertible preferred stock
    
    
    (175
    )
    
    
    (674
    )
    
    
    (319
    )Deemed dividend-beneficial conversion feature for Series C preferred stock
    
    
    
    
    
    
    (6,942
    )
    
    
    Net loss applicable to common stockholders
    
    $
    (33,154
    )
    
    $
    (31,614
    )
    
    $
    (23,367
    )Basic and diluted net loss per share (1)
    
    $
    (1.92
    )
    
    $
    (21.58
    )
    
    $
    (25.88
    )Shares used to compute basic and diluted net loss per share (1)
    
    
    17,233
    
    
    
    1,465
    
    
    
    903
   (1)
    As a result of the conversion of the Companys preferred stock into 13,330
shares of our common stock upon completion of our initial public offering on March
31, 2004, there is a lack of comparability in the basic and diluted net loss per
share amounts for the periods presented above. Please reference Note 1 for the pro
forma basic and diluted net loss per share calculation for the periods presented. See accompanying notes to consolidated financial statements. F - 4




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ANADYS PHARMACEUTICALS, INC. 
 CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT)
(In thousands, except share data) AccumulatedOtherConvertible
    
    
    
    
    
    Additional
    
    
    
    
    
    
    Comprehensive
    
    
    
    
    

    TotalPreferred Stock
    
    
    Common Stock
    
    
    Paid-in
    
    
    Deferred
    
    
    Income
    
    
    Accumulated
    
    
    StockholdersShares
    
    
    Amount
    
    
    Shares
    
    
    Amount
    
    
    Capital
    
    
    Compensation
    
    
    (Loss)
    
    
    Deficit
    
    
    Equity (Deficit)Balance at December 31, 2001
    
    
    33,513,599
    
    
    $
    80,779
    
    
    
    1,485,159
    
    
    $
    2
    
    
    $
    9,649
    
    
    $
    (587
    )
    
    $
    30
    
    
    $
    (77,662
    )
    
    $
    12,211Issuance of common
stock pursuant to
exercise of stock
options
    
    
    
    
    
    
    
    
    
    
    2,680
    
    
    
    
    
    
    
    8
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8Compensation
related to stock
options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    38
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    38Compensation
related to
restricted stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    508
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    508Issuance of
restricted stock
for acquired
technology
    
    
    
    
    
    
    
    
    
    
    114,954
    
    
    
    
    
    
    
    6
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6Issuance of
restricted stock
for consulting
services
    
    
    
    
    
    
    
    
    
    
    169,936
    
    
    
    
    
    
    
    8
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8Accretion to
redemption value of
redeemable
convertible
preferred stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (319
    )
    
    
    (319
    )Deferred
compensation
related to issuance
of stock options to
employees
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    263
    
    
    
    (263
    )
    
    
    
    
    
    
    
    
    
    
    Amortization of
deferred
compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    494
    
    
    
    
    
    
    
    
    
    
    
    494Comprehensive loss:Unrealized loss on
short-term
investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (32
    )
    
    
    
    
    
    
    (32
    )Foreign currency
translation
adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    128
    
    
    
    
    
    
    
    128Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (23,048
    )
    
    
    (23,048
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (22,952
    )Balance at December 31, 2002
    
    
    33,513,599
    
    
    
    80,779
    
    
    
    1,772,729
    
    
    
    2
    
    
    
    10,480
    
    
    
    (356
    )
    
    
    126
    
    
    
    (101,029
    )
    
    
    (9,998
    )Issuance of common
stock pursuant to
exercise of stock
options
    
    
    
    
    
    
    
    
    
    
    8,984
    
    
    
    
    
    
    
    27
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    27Compensation
related to stock
options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    366
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    366Compensation
related to
restricted stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    814
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    814Issuance of
restricted stock
for cash
    
    
    
    
    
    
    
    
    
    
    26,993
    
    
    
    
    
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2Issuance of
restricted stock
for consulting
services
    
    
    
    
    
    
    
    
    
    
    82,008
    
    
    
    
    
    
    
    4
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4Issuance of
restricted stock
for acquired
technology
    
    
    
    
    
    
    
    
    
    
    14,994
    
    
    
    
    
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1Accretion to
redemption value of
redeemable
convertible
preferred stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (674
    )
    
    
    (674
    )Deemed dividend-
beneficial
conversion feature
for Series C
preferred stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,942
    
    
    
    
    
    
    
    
    
    
    
    (6,942
    )
    
    
    Deferred
compensation
related to issuance
of stock options to
employees
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,096
    
    
    
    (5,096
    )
    
    
    
    
    
    
    
    
    
    
    Deferred
compensation
related to issuance
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    279
    
    
    
    (279
    )
    
    
    
    
    
    
    
    
    
    
    of restricted stock
Amortization of
deferred
compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,525
    
    
    
    
    
    
    
    
    
    
    
    3,525Comprehensive loss:Unrealized loss on
short-term
investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5
    )
    
    
    
    
    
    
    (5
    )Substantial
dissolution of
foreign operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (123
    )
    
    
    
    
    
    
    (123
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (23,998
    )
    
    
    (23,998
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (24,126
    )
 F - 5




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##### Table of Contents



ANADYS PHARMACEUTICALS, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT)  (Continued)
(In thousands, except share data) AccumulatedOtherConvertible
    
    
    
    
    
    Additional
    
    
    
    
    
    
    Comprehensive
    
    
    
    
    
    
    TotalPreferred Stock
    
    
    Common Stock
    
    
    Paid-in
    
    
    Deferred
    
    
    Income
    
    
    Accumulated
    
    
    StockholdersShares
    
    
    Amount
    
    
    Shares
    
    
    Amount
    
    
    Capital
    
    
    Compensation
    
    
    (Loss)
    
    
    Deficit
    
    
    Equity (Deficit)Balance at December 31, 2003
    
    
    33,513,599
    
    
    $
    80,779
    
    
    
    1,905,708
    
    
    $
    2
    
    
    $
    24,011
    
    
    $
    (2,206
    )
    
    $
    (2
    )
    
    $
    (132,643
    )
    
    $
    (30,059
    )Conversion of
convertible
preferred stock
into common stock
    
    
    (33,513,599
    )
    
    
    (80,779
    )
    
    
    6,519,467
    
    
    
    6
    
    
    
    80,773
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Conversion of
redeemable
preferred stock
into common stock
    
    
    
    
    
    
    
    
    
    
    6,761,679
    
    
    
    7
    
    
    
    45,005
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    45,012Issuance of common
stock in initial
public offering,
net of underwriters
costs and issuance
costs
    
    
    
    
    
    
    
    
    
    
    6,993,950
    
    
    
    7
    
    
    
    43,649
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    43,656Issuance of common
stock pursuant to
the exercise of
employee stock
options
    
    
    
    
    
    
    
    
    
    
    145,156
    
    
    
    
    
    
    
    430
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    430Issuance of common
stock pursuant to
the Employee Stock
Purchase Plan
    
    
    
    
    
    
    
    
    
    
    22,069
    
    
    
    
    
    
    
    130
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    130Compensation
related to stock
options and
warrants issued to
non-employees
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    75
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    75Compensation
related to
restricted stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    172
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    172Repurchase and
retirement of
unvested restricted
stock
    
    
    
    
    
    
    
    
    
    
    (13,508
    )
    
    
    
    
    
    
    (1
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1
    )Accretion of
issuance costs on
redeemable
convertible
preferred stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    175
    
    
    
    
    
    
    
    
    
    
    
    (175
    )
    
    
    Deferred
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,968
    
    
    
    (5,968
    )
    
    
    
    
    
    
    
    
    
    
    compensation
related to issuance
of stock options to
employeesAmortization of
deferred
compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,915
    
    
    
    
    
    
    
    
    
    
    
    4,915Reversal of
deferred
compensation
associated with
cancelled stock
options to
employees
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (397
    )
    
    
    397
    
    
    
    
    
    
    
    
    
    
    
    Comprehensive loss:Unrealized loss on
short-term
investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (66
    )
    
    
    
    
    
    
    (66
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (32,979
    )
    
    
    (32,979
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (33,045
    )Balance at December 31, 2004
    
    
    
    
    
    $
    
    
    
    
    22,334,521
    
    
    $
    22
    
    
    $
    199,990
    
    
    $
    (2,862
    )
    
    $
    (68
    )
    
    $
    (165,797
    )
    
    $
    31,285
 See accompanying notes to consolidated financial statements. F - 6




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##### Table of Contents



ANADYS PHARMACEUTICALS, INC. 
 CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
 Years Ended December 31,2004
    
    
    2003
    
    
    2002Operating activitiesNet loss
    
    $
    (32,979
    )
    
    $
    (23,998
    )
    
    $
    (23,048
    )Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization
    
    
    1,465
    
    
    
    1,756
    
    
    
    1,828Amortization of deferred compensation
    
    
    4,915
    
    
    
    3,525
    
    
    
    494Compensation related to restricted stock
    
    
    172
    
    
    
    814
    
    
    
    508Compensation related to stock option issuances to non-employees
    
    
    45
    
    
    
    366
    
    
    
    38Interest expense related to warrants issued in conjunction with debt
    
    
    48
    
    
    
    42
    
    
    
    Rent expense related to warrants issued in conjunction with lease
    
    
    30
    
    
    
    
    
    
    
    Substantial dissolution of foreign operations
    
    
    
    
    
    
    (135
    )
    
    
    Loss from disposals of property and equipment and related deposits
    
    
    28
    
    
    
    235
    
    
    
    Accrued interest income on amounts due from related party, net of amount forgiven
    
    
    
    
    
    
    169
    
    
    
    (3
    )Cash received from lease incentive
    
    
    1,550
    
    
    
    
    
    
    
    Changes in operating assets and liabilities:Accounts receivable
    
    
    339
    
    
    
    (183
    )
    
    
    (55
    )Prepaid expenses and other current assets
    
    
    30
    
    
    
    (630
    )
    
    
    195Other assets, net
    
    
    (999
    )
    
    
    (131
    )
    
    
    (21
    )Accounts payable
    
    
    355
    
    
    
    (467
    )
    
    
    (58
    )Accrued expenses
    
    
    1,943
    
    
    
    (60
    )
    
    
    1,052Deferred rent
    
    
    284
    
    
    
    (36
    )
    
    
    (31
    )Deferred revenue
    
    
    200
    
    
    
    400
    
    
    
    Net cash used in operating activities
    
    
    (22,574
    )
    
    
    (18,333
    )
    
    
    (19,101
    )Investing activitiesPurchase of securities available-for-sale
    
    
    (42,619
    )
    
    
    (7,820
    )
    
    
    (18,953
    )Proceeds from sale of securities available-for-sale
    
    
    17,398
    
    
    
    23,960
    
    
    
    7,977Purchase of property and equipment
    
    
    (880
    )
    
    
    (674
    )
    
    
    (2,787
    )Proceeds from disposal of property and equipment
    
    
    35
    
    
    
    25
    
    
    
    Acquisition of leasehold improvements from lease incentive
    
    
    (1,550
    )
    
    
    
    
    
    
    Net cash provided by (used in) investing activities
    
    
    (27,616
    )
    
    
    15,491
    
    
    
    (13,763
    )Financing activitiesProceeds from exercise of stock options and employee stock purchase plan
    
    
    560
    
    
    
    27
    
    
    
    8Proceeds from sale of common stock, net of issuance costs
    
    
    43,656
    
    
    
    7
    
    
    
    14Proceeds from sale of preferred stock, net of issuance costs
    
    
    
    
    
    
    8,078
    
    
    
    35,776Proceeds from long-term debt
    
    
    1,198
    
    
    
    1,585
    
    
    
    1,818Principal payments on long-term debt
    
    
    (1,204
    )
    
    
    (1,753
    )
    
    
    (1,267
    )Net cash provided by financing activities
    
    
    44,210
    
    
    
    7,944
    
    
    
    36,349Effect of exchange rates on cash
    
    
    
    
    
    
    
    
    
    
    128Net increase (decrease) in cash and cash equivalents
    
    
    (5,980
    )
    
    
    5,102
    
    
    
    3,613Cash and cash equivalents at beginning of year
    
    
    11,968
    
    
    
    6,866
    
    
    
    3,253Cash and cash equivalents at end of year
    
    $
    5,988
    
    
    $
    11,968
    
    
    $
    6,866Supplemental disclosure of cash flow informationCash paid during the year for interest
    
    $
    288
    
    
    $
    266
    
    
    $
    176Schedule of non-cash investing and financing activitiesAccretion of costs on redeemable convertible preferred stock
    
    $
    175
    
    
    $
    674
    
    
    $
    319Forgiveness of note due from related party
    
    $
    
    
    
    $
    169
    
    
    $
    Deemed dividend-beneficial conversion feature for Series C preferred stock
    
    $
    
    
    
    $
    6,942
    
    
    $
    Conversion of redeemable convertible preferred stock to common stock upon initial public offering
    
    $
    45,012
    
    
    $
    
    
    
    $
    Conversion of convertible preferred stock to common stock upon initial public offering
    
    $
    80,779
    
    
    $
    
    
    
    $
    
 See accompanying notes to consolidated financial statements. F - 7




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##### Table of Contents



ANADYS PHARMACEUTICALS, INC. 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, expect share and per share amounts)
 1.Organization and Summary of Significant Accounting Policies Organization and Business Anadys Pharmaceuticals, Inc., (Anadys or the Company) was incorporated in
Delaware in September 1992 as ScripTech Pharmaceuticals, Inc. and in 1994 changed its name to
Scriptgen Pharmaceuticals, Inc. In May 2000, following the addition of a substantially new
management team and the infusion of new capital, product candidates and technologies, the Company
changed its name to Anadys Pharmaceuticals, Inc. Anadys is a biopharmaceutical company committed to
advancing patient care by discovering, developing and commercializing novel small molecule
medicines for the treatment of hepatitis C virus, or HCV, hepatitis B virus, or HBV, and certain
bacterial infections. The Companys clinical development programs include ANA975, an oral prodrug
of isatoribine for the treatment of HCV and HBV, and ANA380 for the treatment of HBV. In addition,
the Companys anti-infective therapeutic platform, including core capabilities in Toll-Like
Receptor-based small molecules and structure-based drug design, is designed to advance a strong and
continual pipeline of drug candidates into the clinic. Accordingly, the Company has discovery
programs exploring the use of additional oral prodrugs of TLR-7 agonists and direct antiviral
discovery efforts focused on structural-based drug design. Basis of Presentation Anadys has incurred operating losses since inception, has generated only modest
operating revenues and has an accumulated deficit of $165,797 as of December 31, 2004. The Company
anticipates that it has sufficient capital to maintain its operations through at least the
beginning of 2006; however, successful completion of the Companys development program and its
transition, ultimately, to attaining profitable operations is dependent upon obtaining additional
financing adequate to fulfill its research and development activities and achieving a level of
revenue adequate to support the Companys cost structure. There can be no assurance that the
Company will be successful in these areas. To supplement its existing resources, the Company likely
will need to raise additional capital through the sale of equity securities, strategic
collaborations and debt financings. There can be no assurance that such capital will be available
on favorable terms, or at all. Principles of Consolidation The accompanying consolidated financial statements include the accounts of the
Company and its wholly owned subsidiary, Anadys Pharmaceuticals Europe GmbH. All significant
intercompany accounts and transactions have been eliminated. In August 2003 the Company
substantially dissolved its subsidiary operations. The consolidation of foreign subsidiaries requires financial statement
translation in accordance with Statement of Financial Accounting Standards (SFAS) No. 52. Assets
and liabilities are translated into U.S. dollars at year-end exchange rates. Statements of
operations and cash flows are translated at the average exchange rates for each year. Use of Estimates The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and accompanying notes.
Actual amounts could differ from those estimates. Cash and Cash Equivalents Cash and cash equivalents are comprised of highly liquid investments with an
original maturity of less than three months when purchased. Securities Available-for-Sale Investments with an original maturity of more than three months have been
classified by management as securities available-for-sale. Such investments are carried at fair
value, with unrealized gains and losses included as a component of accumulated other comprehensive
income (loss) in stockholders equity (deficit). Fair Value of Financial Instruments The carrying amount of cash, cash equivalents, securities available-for-sale,
accounts receivable, accounts payable and accrued expenses are considered to be representative of
their respective fair value because of the short-term nature of those items. Based on the borrowing
rates currently available to the Company for loans with similar terms, management believes the fair
value of the long-term debt approximates its carrying value. Concentration of Credit Risk Financial instruments that potentially subject the Company to a significant
concentration of credit risk consist primarily of cash, cash equivalents, securities
available-for-sale and accounts receivable. The Company maintains deposits in federally insured
financial institutions in excess of federally insured limits. Management, however, believes the
Company is not exposed to significant credit risk due to the financial position of the depository
institutions in which those deposits are held. Additionally, the Company has established guidelines
regarding diversification of its investments and their maturities, which are designed to maintain
safety and liquidity. The Company derives its revenues from a relatively small number of customers.
For the year ended December 31, 2002, revenues from four customers accounted for 48%, 22%, 18% and
12%, respectively, of total revenues; related accounts receivable were 48%, 28%, 6% and 0%,
respectively. For the year ended December 31, 2003, revenues from two customers accounted for 72%
and 17%, respectively, of total revenues; related accounts receivable were 87% and 0%,
respectively. For the year ended December 31, 2004, revenues from two customers accounted for 68%
and 23%, respectively, of total revenues; there were no related accounts receivable as of December
31, 2004. F - 8




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##### Table of Contents



Property and Equipment Property and equipment are stated at cost and depreciated over the estimated
useful lives of the assets (ranging from three to five years) using the straight-line method.
Leasehold improvements are amortized over the estimated useful life of the asset or the lease term,
whichever is shorter. Intangibles The Company amortizes intangible assets over their estimated useful lives,
which range from three to four years. The Companys intangible assets are recorded as a component
of other assets, net on the consolidated balance sheet. Impairment of Long-Lived Assets In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets, if indicators of impairment exist, the Company assesses the recoverability of the affected
long-lived assets by determining whether the carrying value of such assets can be recovered through
undiscounted future operating cash flows. If impairment is indicated, the Company measures the
amount of such impairment by comparing the fair value of the asset to the carrying value of the
asset and records the impairment as a reduction in the carrying value of the related asset and
charge to operating results. Although the Companys current and historical operating and cash flow
losses are indicators of impairment, the Company believes expected undiscounted future operating
cash flows will exceed the carrying value of the long-lived assets, and accordingly the Company has
not recognized an impairment loss through December 31, 2004. Research and Development Research and development expenses consist primarily of costs associated with
the clinical trials of the Companys product candidates, compensation and other expenses for
research and development personnel, supplies and development materials, costs for consultants and
related contract research, facility costs, amortization of purchased technology and depreciation.
Expenditures relating to research and development are expensed as incurred. Accumulated Other Comprehensive Income (Loss) In accordance with SFAS No. 130, Reporting Comprehensive Income, all components
of comprehensive income (loss), including net income (loss), are reported in the financial
statements in the period in which they are recognized. Comprehensive income (loss) is defined as
the change in equity during a period from transactions and other events and circumstances from
non-owner sources. Net income (loss) and other comprehensive income (loss), including unrealized
gains and losses on investments and foreign currency translation adjustments, are reported, net of
their related tax effect, to arrive at comprehensive income (loss). Deferred Rent Rent expense is recorded on a straight-line basis over the term of the lease.
The difference between rent expense recorded and amounts paid under the lease agreement is recorded
as deferred rent in the accompanying consolidated balance sheet. During 2004, the Company entered
into a sub-lease agreement to lease the Companys corporate headquarters and research and
development facility located in San Diego, California. In accordance with the sub-lease agreement,
the Company was allocated a $1,550 tenant improvement allowance as an incentive to moving into the
facility. The Company recorded this incentive as an increase to both property and equipment and
deferred rent and these amounts will be amortized on a straight-line basis over the life of the
lease of 62 months. As of December 31, 2004, the Company has $1,400 of unamortized deferred rent
associated with the lease incentive. Stock-Based Compensation As permitted by SFAS No. 123, Accounting for Stock-Based Compensation, the
Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees(APB 25), and related interpretations in accounting for its employee stock
options. Under APB 25, when the purchase price of restricted stock or the exercise price of the
Companys employee stock options equals or exceeds the fair value of the underlying stock on the
date of issuance or grant, no compensation expense is recognized. In conjunction with the Companys
initial public offering, the Company reviewed its historical exercise prices through March 25, 2004
and, as a result, revised the estimate of fair value for all stock options granted subsequent to
July 1, 2002. With respect to these options granted, the Company has recorded deferred stock
compensation of $5,968, $5,096, and $263 during the years ended December 31, 2004, 2003 and 2002,
respectively, for the difference between the original exercise price per share determined by the
Board of Directors and the revised estimate of fair value per share at the respective grant dates.
The Company recorded deferred stock compensation related to the issuance of restricted stock of
$279 during the year ended December 31, 2003. No deferred stock compensation related to the
issuance of restricted stock was recorded during 2004 or 2002. Deferred stock compensation related
to employee stock options issued between July 1, 2002 and March 25, 2004 is recognized and
amortized on an accelerated basis in accordance with Financial Accounting Standards Board
Interpretation (FIN) No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock
Option or Award Plans, over the vesting period of the related options, generally four years. Options or stock awards issued to non-employees are recorded at their fair
value in accordance with SFAS No. 123,,and Emerging Issues Task Force No. 96-18, Accounting for
Equity Instruments That Are Issued to Other Than Employees for Acquiring or in Conjunction with
Selling Goods or Services, and are periodically revalued as the options vest and are recognized as
expense over the related service period. The Company granted stock options and stock awards to
non-employees as follows: 71,480 and 17,168 for the years ended December 31, 2004 and 2003,
respectively. There were no options granted to non-employees during 2002. Compensation expense
related to non-employee stock option grants was $46, $1,150 and $546 for the years ended December
31, 2004, 2003 and 2002, respectively. The options were valued using the following weighted-average
assumptions for the years ended December 31, 2004, 2003 and 2002: risk free interest rates of
4.24%, 2.97% and 3.83%, respectively; dividend yield of 0% for all periods; expected volatility of
70% for all periods and contractual term of 5.00, 7.55, and 8.55 years, respectively. F - 9




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As required under SFAS No. 123, the pro forma effects of stock-based compensation on net
loss are estimated at the date of grant using the Black-Scholes option-pricing model. The
Black-Scholes option valuation model was developed for use in estimating the fair value of traded
options that have no vesting restrictions and are fully transferable. Because the Companys
employee stock options have characteristics significantly different from those of traded options,
and because changes in the subjective input assumptions can materially affect the fair value
estimate, in managements opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options. The fair value of options issued to employees was estimated at the date of
grant using the Black-Scholes option valuation model with the following weighted average
assumptions for the years ended December 31, 2004, 2003 and 2002: risk-free interest rates of
3.25%, 3.04% and 3.82%, respectively; a dividend yield of 0% for all periods; expected volatility
of 70% for all periods; and weighted-average expected lives of the options of five years for all
periods. The estimated weighted average fair value of stock options granted during 2004, 2003 and
2002 was $7.02, $9.18 and $2.70 , respectively. For purposes of pro forma disclosures, the estimated fair value of the options
is amortized on a straight-line basis to expense over the vesting period of the related options.
The Companys pro forma information for employee stock options and stock purchase plan follows: Years Ended December 31,2004
    
    
    2003
    
    
    2002Net loss applicable to common shareholders, as reported
    
    $
    (33,154
    )
    
    $
    (31,614
    )
    
    $
    (23,367
    )Add: Stock-based employee
compensation included in
reported net loss
    
    
    4,903
    
    
    
    3,165
    
    
    
    81Deduct: Total stock-based
employee compensation
determined under fair value
based method for all awards
    
    
    (3,620
    )
    
    
    (3,065
    )
    
    
    (209
    )Adjusted pro forma net loss
    
    $
    (31,871
    )
    
    $
    (31,514
    )
    
    $
    (23,495
    )Adjusted pro forma basic and diluted net loss per share
    
    $
    (1.85
    )
    
    $
    (21.51
    )
    
    $
    (26.02
    )
 Net Loss Per Share The Company calculated net loss per share in accordance with SFAS No. 128,
Earnings Per Share. Basic earnings per share (EPS) is calculated by dividing the net income or
loss by the weighted average number of common shares outstanding for the period, without
consideration for common stock equivalents. Diluted EPS is computed by dividing the net income or
loss by the weighted average number of common shares equivalents outstanding for the period
determined using the treasury-stock method. For purposes of this calculation, common stock subject
to repurchase by the Company, preferred stock, options, and warrants are considered to be common
stock equivalents and are only included in the calculation of diluted earnings per share when their
effect is dilutive. F - 10




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The unaudited pro forma shares used to compute basic and diluted net loss per
share represent the weighted average common shares outstanding, reduced by the weighted average
unvested common shares subject to repurchase, and include the assumed conversion of all outstanding
shares of preferred stock into shares of common stock using the as-if converted method as of
January 1, 2002 or the date of issuance, if later. Year Ended December 31,2004
    
    
    2003
    
    
    2002Historical:Numerator:Net loss
    
    $
    (32,979
    )
    
    $
    (23,998
    )
    
    $
    (23,048
    )Accretion to redemption value of redeemable convertible preferred stock
    
    
    (175
    )
    
    
    (674
    )
    
    
    (319
    )Deemed dividend-beneficial conversion feature for Series C preferred stock
    
    
    
    
    
    
    (6,942
    )
    
    
    Net loss applicable to common stockholders
    
    $
    (33,154
    )
    
    $
    (31,614
    )
    
    $
    (23,367
    )Denominator:Weighted average common shares
    
    
    17,287
    
    
    
    1,847
    
    
    
    1,505Weighted average unvested common shares subject to repurchase
    
    
    (54
    )
    
    
    (382
    )
    
    
    (602
    )Denominator for basic and diluted earnings per share
    
    
    17,233
    
    
    
    1,465
    
    
    
    903Basic and diluted net loss per share
    
    $
    (1.92
    )
    
    $
    (21.58
    )
    
    $
    (25.88
    )Pro forma:Net loss
    
    $
    (32,979
    )
    
    $
    (23,998
    )
    
    $
    (23,048
    )Deemed dividend resulting from beneficial conversion feature on Series C
preferred stock
    
    
    
    
    
    
    (6,942
    )
    
    
    Pro forma net loss applicable to common shareholders
    
    $
    (32,979
    )
    
    $
    (30,940
    )
    
    $
    (23,048
    )Pro forma basic and diluted net loss per share
    
    $
    (1.61
    )
    
    $
    (2.26
    )
    
    $
    (2.24
    )Shares used above
    
    
    17,233
    
    
    
    1,465
    
    
    
    903Pro forma adjustments to reflect assumed weighted average affect of
conversion of preferred stock
    
    
    3,238
    
    
    
    12,249
    
    
    
    9,404Pro forma shares used to compute basic and diluted net loss per share
    
    
    20,471
    
    
    
    13,714
    
    
    
    10,307
 Year Ended December 31,2004
    
    
    2003
    
    
    2002Historical outstanding
antidilutive securities not
included in diluted net loss per
share calculationPreferred stock
    
    
    
    
    
    
    13,281
    
    
    
    12,101Common stock subject to repurchase
    
    
    
    
    
    
    194
    
    
    
    541Options to purchase common stock
    
    
    2,365
    
    
    
    1,157
    
    
    
    707Warrants
    
    
    376
    
    
    
    346
    
    
    
    3412,741
    
    
    
    14,978
    
    
    
    13,690
 Revenue Recognition In accordance with Staff Accounting Bulletin (SAB) No. 104, Revenue
Recognition, revenue is recognized when persuasive evidence of an arrangement exists, delivery has
occurred or services have been rendered, the price is fixed and determinable and collectibility is
reasonably assured. Revenue is deferred for fees received before earned. Some of the Companys
agreements contain multiple elements, including milestone and royalty obligations. As of December
31, 2004, the Company did not have any revenue from royalties. F - 11




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Revenue from milestones is recognized when earned, as evidenced by written acknowledgment
from the collaborator or other persuasive evidence that the milestone has been achieved, provided
that (i) the milestone event is substantive and its achievability was not reasonably assured at the
inception of the agreement, and (ii) the Companys performance obligations after the milestone
achievement will continue to be funded by the collaborator at a level comparable to before the
milestone achievement. If both of these criteria are not met, the milestone payment is recognized
over the remaining minimum period of the Companys performance obligations under the agreement.
Upfront fees under the Companys collaborations, such as technology access fees, are recognized
over the period the related services are provided. Non-refundable upfront fees not associated with
future Company performance are recognized when received. Amounts received for research funding are
recognized as revenues as the services are performed. Amounts received for research funding for a
specific number of full time researchers are recognized as revenue as the services are provided, as
long as the amounts received are not refundable regardless of the results of the research project.
As of December 31, 2004, the Company recorded $600 in deferred revenue for cash received prior to
the research being performed. Recent Accounting Pronouncements In December 2004, the Financial Accounting Standards Board issued Statement No. 123 (revised
2004), Share Based Payment(SFAS No. 123R), which is a revision of Statement No. 123, Accounting
for Stock-Based Compensation(SFAS No. 123). This statement supercedes APB Opinion 25, Accounting
for Stock Issued to Employees(APB 25), and amends Statement No. 95, Statement of Cash Flows.
Generally, the approach in SFAS No. 123R is similar to the approach described in SFAS No. 123;
however, SFAS No. 123R requires all share-based payments to employees, including grants of employee
stock options, to be recognized in the income statement based on their fair values. Pro forma
disclosure is no longer an alternative. SFAS No. 123R permits companies to adopt its requirements using either a modified
prospective method or a modified retrospective method. Under the modified prospective method,
compensation cost is recognized in the financial statements beginning with the effective date,
based on the requirements of SFAS No. 123R for all share-based payments granted after that date,
and based on the requirements for SFAS No. 123 for all unvested awards granted prior to the
effective date of SFAS No. 123R. Under the modified retrospective method, the requirements are
the same as under the modified prospective method, but also permits companies to restate
financial statements of previous periods based on pro forma disclosures made in accordance with
SFAS No. 123. The Company currently utilizes the Black-Scholes model to measure the fair value of
stock options granted to employees under the pro forma disclosure requirements of SFAS No. 123.
While SFAS No. 123R permits companies to continue to use such model, it also permits the use of a
lattice model. The Company has not yet determined which method or model it will use to measure
the fair value of employee stock options under the adoption for SFAS No. 123R. The new standard is
effective for periods beginning after June 15, 2005, and the Company expects to adopt SFAS No. 123R
on July 1, 2005. The Company currently accounts for share-based payments to employees using APB 25s intrinsic
value method and, as such, recognizes no compensation cost for employee stock options granted with
exercise prices equal to or greater than the fair value of our common stock on the date of the
grant. Accordingly, the adoption of SFAS No. 123Rs fair value method is expected to result in
significant non-cash charges which will increase the Companys reported cost of revenues and
operating expenses, however, it will have no impact on our cash flows. The impact of adoption of
SFAS No. 123R cannot be predicted at this time because it will depend on the level of share-based
payments granted in the future and the model the Company chooses to use. However, had the Company
adopted SFAS No. 123R in prior periods, the impact of that standard would have approximated the
impact of SFAS No. 123 as described in the disclosure of pro forma net loss above. 2. Balance Sheet Details Securities Available-For-Sale Securities available-for-sale consisted of the following: December 31, 2004UnrealizedAmortizedCost
    
    
    Gain
    
    
    Loss
    
    
    Market ValueCorporate bonds
    
    $
    27,754
    
    
    $
    6
    
    
    $
    (74
    )
    
    $
    27,686
 December 31, 2003UnrealizedAmortizedCost
    
    
    Gain
    
    
    Loss
    
    
    Market ValueCorporate bonds
    
    $
    2,531
    
    
    $
    
    
    
    $
    
    
    
    $
    2,531
 Gross realized gains and losses for each of these security types were not
material for the years ended December 31, 2004 and 2003. As of December 31, 2004, securities available-for-sale with a maturity date of less than
one year had an aggregate market value of $25,654 and securities available-for-sale with a maturity
date of more than one year, but less than five years had an aggregate market value of $2,032. F - 12




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Property and Equipment Property and equipment consist of the following: December 31,2004
    
    
    2003Furniture and fixtures
    
    $
    105
    
    
    $
    542Equipment
    
    
    7,521
    
    
    
    7,275Computers and software
    
    
    1,728
    
    
    
    1,514Leasehold improvements
    
    
    1,917
    
    
    
    44311,271
    
    
    
    9,774Less accumulated depreciation and amortization
    
    
    (7,241
    )
    
    
    (6,677
    )$
    4,030
    
    
    $
    3,097
 Depreciation and amortization expense relating to property and equipment for
the years ended December 31, 2004, 2003 and 2002 was $1,434, $1,662, and $1,734 respectively. Amortization expense is included in research and development expense in the
accompanying consolidated statements of operations. Amortization expense was $31, $94, and $94,
for the years ended December 31, 2004, 2003 and 2002, respectively. Other Balance Sheet Captions December 31,2004
    
    
    2003Prepaid expenses and other current assets consisted of the following:Prepaid expenses
    
    $
    244
    
    
    $
    232Prepaid initial public offering costs
    
    
    
    
    
    
    419Prepaid rent
    
    
    70
    
    
    
    140Prepaid insurance
    
    
    216
    
    
    
    31Other receivables
    
    
    551
    
    
    
    193Deposits
    
    
    57
    
    
    
    153$
    1,138
    
    
    $
    1,168Other assets consisted of the following:Intangible assets, net
    
    $
    
    
    
    $
    31Lab compounds, net
    
    
    641
    
    
    
    901Deposits
    
    
    1,280
    
    
    
    21$
    1,921
    
    
    $
    953Accrued expenses consisted of the following:Accrued employee benefits
    
    $
    361
    
    
    $
    344Accrued employee bonus
    
    
    669
    
    
    
    555Accrued drug development
    
    
    1,702
    
    
    
    356Accrued legal and patent costs
    
    
    221
    
    
    
    212Accrued audit and tax costs
    
    
    124
    
    
    
    62Accrued annual report costs
    
    
    100
    
    
    
    Accrued facility costs
    
    
    95
    
    
    
    70Other accrued expenses
    
    
    335
    
    
    
    65$
    3,607
    
    
    $
    1,664
 F - 13




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3. Debt During 1999, the Company entered into a $5,100 loan and security agreement with
a financing institution pursuant to which the Company drew down the entire line of $5,100 to make
certain capital expenditures. As the credit facility was utilized, separate promissory notes were
executed. Each promissory note had 48 monthly payments with the interest rate being fixed at the
funding date of each promissory note (10.19% to 11.39%). Principal amounts outstanding under this
loan agreement and security agreement were paid in full during 2004. In 2002, the Company entered into a $2,600 loan and security agreement with
GATX Ventures (GATX) pursuant to which during the years ended December 31, 2003 and 2002, the
Company drew down the entire line of $2,600 to make certain capital expenditures. As the credit
facility was utilized, separate promissory notes were executed. Each promissory note has monthly
payments ranging from 36 to 43 months with the interest rate being fixed at the funding date of
each promissory note (9.55% to 9.95%). Each promissory note is collateralized by the related
equipment acquired with the loan. In conjunction with these promissory notes, the Company issued
warrants to purchase 96,564 shares of common stock, with an exercise price of $6.87 per share (Note
5). During 2003, the Company entered into a $1,900 loan and security agreement with General
Electric Capital Corporation (GE) to finance eligible equipment and tenant improvements. On
September 8, 2004, the Company modified this agreement to include increasing the maximum amount
available under the agreement to $3,000, providing for a revolving credit facility, and extending
the term to December 31, 2005. During 2004, the Company executed promissory notes under the
equipment financing agreement in the amount of $1,198 to finance eligible equipment and tenant
improvements. As the credit facility is utilized, separate promissory notes are executed. Each
promissory note has 42 to 48 monthly payments with the interest rate being fixed at the funding
date of each promissory note (8.56% to 9.00%). Each promissory note is collateralized by the
related equipment acquired with the loan. In conjunction with these promissory notes, the Company
issued warrants to purchase 28,227 shares of common stock, with an exercise price of $6.87 per
share (Note 5). As of December 31, 2004, a total of $1,500 was outstanding under the equipment
financing agreement and $1,500 was available under the loan and security agreement. Annual principal payments due on the notes payable are as follows at December
31, 2004: 2005
    
    $
    1,3602006
    
    
    7712007
    
    
    3722008
    
    
    73Total
    
    
    2,576Less: net debt discount
    
    
    (73
    )Current portion
    
    
    (1,310
    )$
    1,193
 4. Commitments and Contingencies As of December 31, 2004, the Company leases its corporate headquarters and
research and development facility under a non-cancelable lease, which expires on August 1, 2009.
The lease requires the Company to pay a share of real estate taxes and building operating expenses
if such expenses exceed a base level stipulated in the lease. Gross rent expense for the years
ended December 31, 2004, 2003 and 2002 was approximately $1,309, $1,614 and $1,484, respectively. Future minimum lease payments under equipment and facility leases are as
follows at December 31, 2004: 2005
    
    $
    1,3762006
    
    
    1,7752007
    
    
    1,8292008
    
    
    1,8822009
    
    
    1,118Total
    
    $
    7,980
 Collaboration Agreements Under certain licensing and other agreements, the Company is required to make
payments upon the achievement of certain milestones, to pay royalties on certain drug sales, if
any, and to pay other amounts in connection with sublicenses, if any (collectively Contingent
Payments). To date, the Company has not become obligated to make any Contingent Payments under
such agreements. Costs of the research and development resources performing collaborative
activities are included in research and development expenses in the accompanying statement of
operations. In June 2002, the Company entered into a collaboration agreement with Gilead
Sciences, Inc. (Gilead) to discover novel antiviral compounds. The agreement required Gilead to
pay an initial technology access fee and make research funding payments totaling $371, make certain
milestone payments and to pay royalties on sales of any new drug resulting from the collaboration.
The term of the collaboration agreement expired in February 2003. In August 2002, the Company entered into a collaboration agreement with
Hoffman-La Roche Inc. (Roche) to deploy the Companys discovery capabilities to advance lead
compounds identified by Roche against an oncology target. The agreement required Roche to make
research funding payments of $1,820 over the one year research term of the agreement, make certain
milestone payments and to pay royalties on sales of any new drug resulting from the collaboration.
In conjunction with the collaboration Roche purchased 364,119 shares of the Companys Series C
redeemable preferred stock at $6.89 per share. In October 2003, the Company executed an extension
of the agreement for an additional six months. Under the terms of the extension, the Company
received additional funding of $910 to deploy the Companys discovery capabilities to advance
Roches lead compounds against the oncology target. The Company recorded revenue of $455, $1,656
and $619 during the year ended December 31, 2004, 2003 and 2002, respectively, related to this
collaboration. F - 14




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In February 2003, the Company entered into a collaboration with Amgen Inc.
(Amgen) to discover novel compounds against a therapeutic target of Amgen. Under the terms of the
agreement, the Company has received $400 from Amgen through research funding payments, a technology
access fee and a research milestone payment. The agreement requires Amgen to pay royalties on sales
of any new drug resulting from the collaboration. The term of the collaboration agreement expired
in September 2003. In December 2003, the Company entered into a collaboration agreement with
Daiichi Pharmaceutical Co. Ltd. (Daiichi) to discover novel compounds against therapeutic targets
of Daiichi. The Company is designing, configuring and running ATLAS TM assays
to screen the Daiichi targets against a compound collection provided by Daiichi. Under the terms of
the agreement, the Company has received a $400 collaboration fee, which was recognized as revenue
during the year ended December 31, 2004. The Company may receive additional milestone payments
provided that certain success criteria are met under the collaboration. On July 28, 2004, the Company entered into a new drug discovery collaboration with Roche.
Under the terms of the agreement, the Company will receive research and development funding from
Roche and in exchange the Company will engage its drug discovery capabilities, including medicinal
chemistry, structure-based drug design, cheminformatics and biology to advance lead compounds
against an undisclosed Roche program. As of December 31, 2004, the Company has received $876 in
research and development funding from Roche of which $745 was recorded as revenue for the year
ended December 31, 2004. The agreement includes potential milestone payments if certain research
and commercial milestones are achieved and royalties on net sales of any new drug resulting from
the collaboration that may be commercialized by Roche. There is no guarantee the Company will
receive any royalty payments or milestone payments under the agreement. On September 3, 2004, the Company entered into a drug discovery collaboration agreement with
Aphoenix, Inc. to discover and advance lead compounds against Aphoenix targets for multiple
therapeutic indications. Under the terms of the agreement, the Company may receive research funding
of $1,250 over a three-year term of the agreement. As of December 31, 2004, the Company has
received $500 in research funding from Aphoenix of which approximately $31 was recorded as revenue
for the year ended December 31, 2004. The Company may receive additional payments in the form of
milestone and royalty payments provided that certain success criteria are met under the
collaboration. There is no guarantee the Company will receive any royalty payments or milestone
payments under the agreement. Grants During September 2004, the Company was awarded a Phase II Small Business Innovation Research
grant from the National Institute of Health (NIH). Funding for the first and second year of the
grant is expected to be $536 and $669, respectively, for a total expected funding of $1,200, over
the life of the grant. The second year funding under the grant is contingent upon the Company
showing satisfactory progress on the grant and the availability of funds at the NIH. As of December
31, 2004, the Company has recorded revenue of $105 under the grant. License Agreements In January 2001, the Company executed a technology license agreement (the
License Agreement) with EMBL Enterprise Management Technology Transfer GmbH (EMBLEM), whereby
the Company obtained an exclusive royalty-free worldwide license to certain technology and the
rights to make, use, sell and offer to sell products, methods and processes claimed in the licensed
patents with the right to sublicense. In addition, the Company cross-licensed certain technology
under a non-exclusive royalty-free sublicense. The licenses expire upon expiration of the last of
the licensed patents or any earlier date as the parties mutually agree upon. The License Agreement
provided that in consideration for the license, the Company would issue an aggregate of 129,948
shares of restricted common stock to EMBL or EMBLEM (the EMBLEM Shares). The Company ascribed an
aggregate value of approximately $378, which represented the difference between the purchase price
of the EMBLEM Shares, and the deemed fair value of the shares. The acquired technology was
amortized to research and development expense over a four-year period ending in May 2004. The
Companys right to repurchase the EMBLEM Shares lapsed monthly over four years from the effective
date ending in May 2004 In December 2002, the Company entered into an agreement with Valeant Pharmaceuticals
International (formerly known as ICN Pharmaceuticals, Inc.) and Ribapharm, Inc. for an exclusive
worldwide license to six antiviral compounds. Under the terms of the agreement, the Company is
entitled to clinical milestone payments, which may total up $425 for each product candidate. As of
December 31, 2004, the Company has not received any milestone payments. In connection with this
agreement, the Company has a minimum royalty commitment of $50 and $75 for the years ended December
31, 2006 and 2007, respectively, and $100 for each of the nine years thereafter. In February 2004, the Company obtained an exclusive option from LG Life Sciences, Ltd.
(LGLS) to enter into a joint development and license agreement for the development and potential
commercialization of a compound currently in Phase II clinical trials for the treatment of chronic
HBV infection. The Company paid LGLS $500 for this option. On April 18, 2004, the Company exercised
its option and entered into a joint development and license agreement with LGLS for the clinical
development and commercialization of ANA380 for the treatment of chronic HBV infection in North
America, Europe, Japan and the rest of the world other than China, Korea, India and countries in
Southeast Asia. Under the terms of the agreement, the Company will share the costs for the global
clinical development of ANA380 with LGLS. In connection with the execution of the agreement, the
Company paid a licensing fee of $4,000 during May 2004 to LGLS. This payment is included as a
component of research and development expenses for the year ended December 31, 2004. In addition,
the Company may be required to make additional milestone payments totaling up to $25,500, subject
to the attainment of product development and commercialization objectives. The Company will pay
royalties on any product sales in its sales territory to LGLS and will receive royalties on any
product sales in China from LGLS. As of December 31, 2004, the Company has recorded $750 of drug
development costs, which are recorded as a component of research and development expense associated
with the Companys share of joint development costs of ANA380 incurred by LGLS. The drug
development costs recorded by the Company at December 31, 2004 are based upon our understanding of
the on-going development activities related to ANA380 being performed by LGLS and information
provided to the Company by LGLS related to the costs that they have incurred related to the
development of ANA380. Our share of the joint development costs of ANA380 may fluctuate based upon
the following factors: on-going negotiations with LGLS related to the collaboration, changes to
the world-wide development plan of ANA380 and the composition of costs incurred by LGLS related to
the development of ANA380. 5. Redeemable Convertible Preferred Stock and Stockholders Equity Redeemable Convertible Preferred Stock The Company completed an equity financing in which an aggregate of $38,325 was
raised through the sale of Series C redeemable convertible preferred stock on June 20, 2002 and
July 12, 2002. In November 2003, the Company sold 1,179,749 shares of Series C redeemable
convertible preferred stock at a purchase price of $6.89 per share for total proceeds of $8,100,
net of $22 of offering costs. The Series C redeemable preferred stock was sold at a price per share
below the anticipated initial public offering price of the Companys common stock. Accordingly,
pursuant to EITF 98-5, Accounting for Convertible Securities with Beneficial Conversion Features,
the Company has recorded a deemed dividend on the Series C redeemable preferred stock of $6,942
during the year ended December 31, 2003, which is equal to the number of shares of Series C
redeemable preferred stock sold times the difference between the anticipated initial public
offering price and the Series C redeemable preferred stock price per share. F - 15




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In connection with the Companys initial public offering, each share of Series C redeemable
convertible preferred stock outstanding as of March 31, 2004 was automatically converted into
common stock at a ratio of one share of common stock for 5.10 shares of Series C redeemable
convertible preferred stock. This conversion resulted in the Company issuing 6,761,679 shares of
common stock upon conversion. Convertible Preferred Stock In connection with the Companys initial public offering, each share of Series A-1,
A-2, A-3, A-4, A-5 and B of convertible preferred stock outstanding as of March 31, 2004 was
automatically converted into common stock at a ratio of one share of common stock for approximately
11.92, 11.92, 10.62, 7.38, 3.36 and 2.35 shares of preferred stock, respectively. This conversion
resulted in the Company issuing 6,519,467 shares of common stock upon conversion. Common Stock A portion of the outstanding shares of common stock has been issued to the Companys founders,
directors, employees and consultants of the Company. In connection with certain stock purchase
agreements, the Company has the option to repurchase the unvested shares in the event of
termination of employment or engagement. Shares issued under these agreements generally vest over
four years. During 2004, the Company repurchased 13,508 shares of unvested common stock. No
shares remain unvested as of December 31, 2004. In 2000 and 2001, the Company entered into restricted stock purchase agreements
with certain individuals who joined the Company at the time as members of the Companys management,
Board of Directors or Scientific Advisory Board. These individuals were allowed to purchase a total
of 44,160 shares in 2003 of restricted common stock at $0.05 per share. No restricted stock shares
were issued during 2004 and 2002. The restricted stock vests based upon continued service to the
Company, at 1/48th per month, with the unvested shares subject to repurchase by the Company,
generally at the original purchase price. The Company has recorded the deferred compensation using
the intrinsic value method for members of the Companys management and board of directors and uses
the Black-Scholes method for Scientific Advisory Board members, which is being amortized over the
vesting period. At December 31, 2004, no shares of common stock were unvested and subject to
repurchase by the Company. Changes in Capitalization On October 25, 2003, conditioned upon the effectiveness of the Companys
initial public offering, the Companys Board of Directors approved the filing of an amended and
restated certificate of incorporation to provide for authorized capital stock of 90,000,000 shares
of common stock and 10,000,000 shares of undesignated preferred stock. On March 18, 2004, the Company effected a 1 for 5.1 reverse stock split of its outstanding
common stock. The consolidated financial statements give retroactive effect to the reverse stock
split for all share information for all periods presented. In conjunction with the closing of the Companys initial public offering and subsequent to
effecting its reverse stock split, the Company has restated its par value of its common stock from
$0.01 to $0.001. The consolidated financial statements give retroactive effect to the restatement
of the common stock par value for all periods presented. Warrants In 2002, in connection with the Companys Series C redeemable preferred stock financing,
the Company issued warrants to the placement agents of the financing as a component of the
placement agents fee. Based on the fee arrangement, the Company issued a warrant to purchase
319,331 shares of Series C redeemable preferred stock to SG Cowen Securities Corporation and a
warrant to purchase 79,832 shares of Series C redeemable preferred stock to Bear, Stearns & Co.
Inc., each at an initial exercise price of $1.35 per share. The warrants expire on July 12, 2007.
The Company ascribed an aggregate value of approximately $327 to such warrants, which was recorded
as a reduction of the face value of the Series C redeemable preferred stock with periodic accretion
up to its full value on the redemption date. In conjunction with the Companys initial public
offering, the warrants to purchase 319,381 and 79,832 shares of Series C redeemable preferred stock
was converted into a warrant to purchase 62,624 and 15,653 shares of common stock, respectively,
with an exercise price of $6.87. In 2002, in connection with the Companys establishment of a line of credit
with GATX, the Company issued a warrant to GATX to purchase 96,564 shares of Series C redeemable
preferred stock at an initial exercise price of $1.35 per share. The warrant expires on December
17, 2012. In conjunction with the Companys initial public offering, the warrant to purchase
96,554 shares of Series C redeemable preferred stock was converted into a warrant to purchase
18,934 shares of common stock with an exercise price of $6.87. The Company ascribed an aggregate
value of approximately $115 to such warrant, which is being amortized to interest expense over the
life of the lease financing. In 2003, in connection with the Companys establishment of a line of credit
with GE, the Company issued a warrant to GE to purchase 28,227 shares of Series C redeemable
preferred stock at an initial exercise price of $1.35 per share. The warrant expires on March 26,
2006. In conjunction with the Companys initial public offering, the warrant to purchase 28,227
shares of Series C redeemable preferred stock was converted into a warrant to purchase 5,535 shares
of common stock with an exercise price of 6.87. The Company ascribed an aggregate value of
approximately $50 to such warrant, which is being amortized to interest expense over the life of
the lease financing. In 2004, in connection with the Companys lease of its corporate headquarters
and research and development facility, the Company issued a warrant to purchase 150,000 shares of
Series C redeemable preferred stock at an initial exercise price of $1.35 per share. The warrant
expires on February 23, 2009 In conjunction with the Companys initial public offering, the
warrant to purchase 150,000 shares of Series C redeemable preferred stock was converted into a
warrant to purchase 29,412 shares of common stock with an exercise price of $6.87. The Company
ascribed an aggregate value of approximately $272 to such warrant, which is being amortized to rent
expense over the life of the lease. As of December 31, 2004, the Company had 375,697 warrants to purchase common stock outstanding
with exercise prices ranging from $6.87 to $28.22. These warrants expire at various times between
March 25, 2006 through December 17, 2012. Stock Options In 2002, the Company adopted the 2002 Equity Incentive Plan (the 2002 Plan).
In connection with the adoption of the 2002 Plan, the Companys 1994 Stock Option Plan and 1998
Equity Incentive Plan (collectively, the Prior Plans) were amended and restated into the 2002
Plan. All options that were previously granted under the Prior Plans were governed by the 2002 Plan
and the Prior Plans no longer existed as individual plans. The 2002 Plan provided for the issuance
of incentive stock options to officers and other employees of the Company and non-qualified stock
options, awards of stock and direct stock purchase opportunities to directors, officers, employees
and consultants of the Company. F - 16




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Upon the effectiveness of the initial public offering, the 2004 Equity Incentive Plan (the
2004 Plan) was adopted. The initial share reserve under the 2004 Plan was equal to the number
shares of common stock reserved under the 2002 Plan that remained available for future stock awards
upon the effectiveness of the IPO. Options granted under the 2002 Plan continue to be governed by
the provisions of the 2002 Plan. The total number of shares, which remain issuable under the 2004 Plan, is
283,242 at December 31, 2004. The options are exercisable at various dates and will expire no more
than ten years from their date of grant, or in the case of certain non-qualified options, fifteen
years from the date of grant. The exercise price of each option shall be determined by the Board of
Directors although generally options have an exercise price equal to the fair market value of the
Companys stock on the date of the option grant. In the case of incentive stock options, the
exercise price shall not be less than 100% of the fair market value of the Companys common stock
at the time the option is granted. For holders of more than 10% of the Companys total combined
voting power of all classes of stock, incentive stock options may not be granted at less than 110%
of the fair market value of the Companys common stock at the date of grant and for a term not to
exceed five years. Unvested incentive stock options are not subject to repurchase. Upon the effectiveness of the initial public offering, the 2004 Non-Employee Directors Stock
Option Plan (the NEDSOP Plan) was adopted with a reserve of 125,000 shares of common stock. The
number of shares in reserve for issuance under the Purchase Plan was increased by 125,000 shares of
common stock on November 19, 2004. The total number of shares, which remain issuable under the
NEDSOP Plan, is 196,333 at December 31, 2004. The options are exercisable at various dates and
will expire no more than ten years from their date of grant. The exercise price of each option
shall be determined by the Board of Directors although generally options have an exercise price
equal to the fair market value of the Companys stock on the date of the option grant. The following table summarizes information about stock options outstanding
under the 2004 Plan and the NEDSOP Plan at December 31, 2004: Options Outstanding
    
    
    Options ExercisableWeighted
    
    
    Weighted
    
    
    
    
    
    
    WeightedRange of
    
    
    
    
    
    Average
    
    
    Average
    
    
    
    
    
    
    AverageExercise
    
    Number
    
    
    Remaining
    
    
    Exercise
    
    
    Number
    
    
    ExercisePrice
    
    Outstanding
    
    
    Contractual Life
    
    
    Price
    
    
    Exercisable
    
    
    Price$2.95-$4.99
    
    
    1,493,498
    
    
    
    8.2
    
    
    $
    2.95
    
    
    
    613,344
    
    
    $
    2.95$5.00-$7.00
    
    
    823,756
    
    
    
    9.4
    
    
    $
    6.03
    
    
    
    84,084
    
    
    $
    6.78$7.01-$8.20
    
    
    47,900
    
    
    
    9.5
    
    
    $
    7.48
    
    
    
    
    
    
    $
    2,365,154
    
    
    
    
    
    
    
    
    
    
    
    697,428
 A summary of the Companys stock option activity and related information is as follows: WeightedOptions
    
    
    AverageOutstanding
    
    
    Exercise PriceBalance at December 31, 2001
    
    
    647,968
    
    
    $
    3.58Granted
    
    
    142,449
    
    
    
    2.95Exercised
    
    
    (2,680
    )
    
    
    2.95Cancelled
    
    
    (80,514
    )
    
    
    3.22Balance at December 31, 2002
    
    
    707,223
    
    
    
    3.50Granted
    
    
    581,527
    
    
    
    2.95Exercised
    
    
    (8,984
    )
    
    
    2.95Cancelled
    
    
    (122,319
    )
    
    
    3.00Balance at December 31, 2003
    
    
    1,157,447
    
    
    
    3.28Granted
    
    
    1,451,947
    
    
    
    4.66Exercised
    
    
    (145,156
    )
    
    
    2.95Cancelled
    
    
    (99,084
    )
    
    
    3.20Balance at December 31, 2004
    
    
    2,365,154
    
    
    $
    4.12
 Common stock reserved for future issuance at December 31, 2004 are as follows: December 31, 2004Warrants
    
    
    375,697Stock options under the Companys Plans:Granted and outstanding
    
    
    2,365,154Reserved for future grant
    
    
    479,5753,220,426
 F - 17




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Employee Stock Purchase Plan Upon the effectiveness of the Companys initial public offering, the 2004 Employee Stock
Purchase Plan (the Purchase Plan) was adopted with an initial reserve of 150,000 shares of common
stock. The number of shares in reserve for issuance under the Purchase Plan was increased by
334,000 shares of common stock on November 19, 2004. Employees may purchase common stock under the
Purchase Plan every six months (up to but not exceeding 12% of each employees earnings) over the
offering period at 85% of the fair market value of the common stock at certain specified dates. The
offering period may not exceed 24 months with the exception of the first offering period, which
began on April 1, 2004 and will end on May 15, 2006, which is approximately 26 months. For the year
ended December 31, 2004, 22,069 shares of common stock were issued under the Purchase Plan. As of
December 31, 2004, 461,931 shares of common stock are available for issuance under the Purchase
Plan. The weighted-average fair value of employee stock Purchase Plan
purchases was $5.91 per
share. 6. Related Party Transactions In December 1997, the Company issued 773,623 shares of Series A-4 preferred
stock for $20,000 to BioChem Pharma, Inc. (BioChem). The Company also entered into a
collaboration agreement with BioChem pursuant to which the Company was using BioChems technologies
to identify drug candidates. The Company was responsible for all aspects of drug discovery and
BioChem was responsible for preclinical and clinical development, and will retain worldwide
commercialization rights. Any profits on any commercialized products emanating from these programs
will be shared in accordance with the terms of the agreement. The Company also issued a warrant to
purchase 91,085 shares of the Companys common stock in connection with the transaction. During 2000, the Company made two advances of $148 each, with interest rates of
prime (4.25% at December 31, 2002) plus 1.0%, to the Companys President. One advance was due June
11, 2002, and the other was to mature December 14, 2001; the latter was forgiven in January 2001 by
the Companys Board of Directors and recorded as compensation expense. During 2002, the Companys
Board of Directors extended the maturity date of the remaining note to September 30, 2003. In
January 2003, the second advance to the Companys President was forgiven by the Companys Board of
Directors and recorded as compensation expense. 7. Income Taxes Significant components of the Companys deferred tax assets are shown below. A
valuation allowance of $59,396 and $45,103 has been established to offset the deferred tax assets,
as realization of such assets is uncertain at December 31, 2004 and 2003, respectively. December 31,2004
    
    
    2003Deferred tax assets:Net operating loss carryforwards
    
    $
    26,620
    
    
    $
    40,329Research and development credits
    
    
    5,946
    
    
    
    5,141Depreciation and amortization
    
    
    
    
    
    
    1,248Non-qualified stock options
    
    
    1,326
    
    
    
    497Capitalized research and development expense
    
    
    24,059
    
    
    
    Accruals
    
    
    1,643
    
    
    
    Other
    
    
    245
    
    
    
    125Total deferred tax assets
    
    
    59,839
    
    
    
    47,340Deferred tax liabilities:Capital lease obligation, net
    
    
    (443
    )
    
    
    (2,237
    )Total deferred tax liabilities
    
    
    (443
    )
    
    
    (2,237
    )Net deferred tax assets
    
    
    59,396
    
    
    
    45,103Valuation allowance for deferred tax assets
    
    
    (59,396
    )
    
    
    (45,103
    )Net deferred taxes
    
    $
    
    
    
    $
    
 At December 31, 2004, the Company had federal and state tax net operating loss
carryforwards of approximately $71,615 and $27,037, respectively. The federal and state loss
carryforwards will begin expiring in 2007 and 2012, respectively, unless previously utilized. The
difference between the federal and state loss carryforwards is primarily attributable to the
capitalization of research and development expenses for state income tax purposes and the 50% and
60% limitation of state loss carryforwards. During the year ended December 31, 2004, the Company
elected to capitalize prior years research and development expenses, which resulted in a
corresponding reduction in its net operating losses. The Company also has federal and
state research and development tax credit carryforwards of approximately $4,551 and $2,147,
respectively. The federal and state research and development credits will begin expiring in 2007
unless previously utilized. Pursuant to Internal Revenue Code Sections 382 and 383, use of the Companys
net operating loss and credit carryforwards may be limited because of cumulative changes in
ownership of more than 50%, which occur within a three-year period. 8. Savings Plan The Company has a retirement savings plan for all employees, subject to certain
age requirements, pursuant to Section 401(k) of the Internal Revenue Code. Employees may contribute
up to 15% of their salary, subject to a maximum annual statutory limit. The Company may make
discretionary contributions and has made no contributions to date. F - 18




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9. Unaudited Quarterly Results of Operations The
following quarterly financial data, in the opinion of management,
reflects all adjustments, consisting of normal recurring adjustments,
necessary for a fair presentation of results for the periods
presented. First
    
    
    Second
    
    
    Third
    
    
    FourthFiscal year 2004
    
    Quarter
    
    
    Quarter
    
    
    Quarter
    
    
    QuarterRevenues
    
    $
    683
    
    
    $
    214
    
    
    $
    356
    
    
    $
    509Net loss
    
    
    (7,442
    )
    
    
    (10,948
    )
    
    
    (7,041
    )
    
    
    (7,548
    )Net loss attributable to common shareholders
    
    
    (7,617
    )
    
    
    (10,948
    )
    
    
    (7,041
    )
    
    
    (7,548
    )Basic and diluted net loss per share
    
    
    (3.77
    )
    
    
    (0.50
    )
    
    
    (0.32
    )
    
    
    (0.34
    )
 First
    
    
    Second
    
    
    Third
    
    
    FourthFiscal year 2003
    
    Quarter
    
    
    Quarter
    
    
    Quarter
    
    
    QuarterRevenues
    
    $
    562
    
    
    $
    643
    
    
    $
    527
    
    
    $
    554Net loss
    
    
    (7,548
    )
    
    
    (5,331
    )
    
    
    (5,216
    )
    
    
    (5,903
    )Net loss attributable to common shareholders
    
    
    (7,713
    )
    
    
    (5,498
    )
    
    
    (5,385
    )
    
    
    (13,018
    )Basic and diluted net loss per share
    
    
    (6.00
    )
    
    
    (3.92
    )
    
    
    (3.54
    )
    
    
    (9.24
    )
 F - 19