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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D. C. 20549
 
 FORM 10-K
  þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the fiscal year ended December 31, 2006
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from  to .
 Commission File Number 0-50632
 
 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)
    
    (Zip Code)
 Registrants telephone number, including area code: 858-530-3600
 Securities registered pursuant to Section 12(b) of the Act:
 Title of each class
    
    Name of each exchange on which registeredCommon Stock, $.001 par value
    
    Nasdaq Global Market
 Securities registered pursuant to Section 12(g) of the Act: None
 
 o þ
 o þ
 þ o
 þ
  o þ o
 o þ
   DOCUMENTS INCORPORATED BY REFERENCE




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ANADYS PHARMACEUTICALS, INC.
ANNUAL REPORT ON FORM 10-K
 Table of Contents
  
 PagePART IItem 1. Business
    
    
    3Item 1A. Risk Factors
    
    
    18Item 1B. Unresolved Staff Comments
    
    
    38Item 2. Properties
    
    
    38Item 3. Legal Proceedings
    
    
    38Item 4. Submission of Matters to a Vote of Security Holders
    
    
    38PART IIItem 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
    
    
    39Item 6. Selected Financial Data
    
    
    41Item 7. Managements Discussion and Analysis of Financial Condition and Results of
Operations
    
    
    43Item 7A. Quantitative and Qualitative Disclosure About Market Risk
    
    
    52Item 8. Financial Statements and Supplementary Data
    
    
    52Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
    
    
    52Item 9A. Controls and Procedures
    
    
    53Item 9B. Other Information
    
    
    54PART IIIItem 10. Directors and Executive Officers and Corporate Governance
    
    
    55Item 11. Executive Compensation
    
    
    55Item 12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
    
    
    55Item 13. Certain Relationships and Related Transactions, and Director Independence
    
    
    55Item 14. Principal Accounting Fees and Services
    
    
    55PART IVItem 15. Exhibits and Financial Statement Schedules
    
    
    56EXHIBIT 10.25EXHIBIT 10.45EXHIBIT 10.46EXHIBIT 23.1EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32




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INFORMATION RELATED TO FORWARD-LOOKING STATEMENTS
  
 PART I
 
 Item 1. Business
 Overview
   Toll-Like Receptors
  ANA975
    3




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ANA380
  ANA773
  AN 025-1 Series
  Industry Background
 Antivirals
   4




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Hepatitis C Virus
     Hepatitis B Virus
 th
 TLR Agonists in Cancer
  5




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Our Strategy
  
    
    Advance the Development of ANA975 in HCV.We are developing our oral TLR-7 prodrug agonist
ANA975 for the potential treatment of HCV. In particular, during 2007 we plan to:
 
    
    Clarify with the FDA whether or not we can remove the clinical hold on ANA975 and
re-initiate human testing of ANA975 in HCV patients.
 
    
    Advance the Development of a Product Candidate in Cancer.We have
selected ANA773, a compound derived from our proprietary TLR drug
discovery and delivery platform, for clinical development in
certain cancers. During 2007 we expect to:
 
    
    File an IND application for ANA773.
 
    
    Advance the Development of Another Lead Compound in HCV.We are
advancing AN 025-1, a series of non-nucleoside inhibitors of HCV
NS5B polymerase. During 2007 we plan to:
 
    
    Nominate a specific compound from a sub-series ANA59X, derived from the AN 025-1 series
and pursue its preclinical development as an orally administered direct antiviral drug for
the treatment of chronic HCV infection.
 
    
    Advance the development of ANA380 in HBV.ANA380 is our direct inhibitor of the hepatitis B
virus that we are jointly developing with LG Life Sciences of South Korea. During 2007 we
intend to:
 
    
    Finalize the global development plan with LGLS for 2007 and
2008 and pending agreement on next steps for the program, initiate a dose
selection Phase IIb clinical trial of ANA380 in HBV patients.
 
    
    Expand Our Product Candidate Portfolio. We intend to expand our product candidate portfolio
in the anti-infectives and cancer markets by leveraging our expertise in TLR-based small
molecule product candidates and structure-based drug design.
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Our Development Programs
  
 HCV Programs
 ANA975
    in vitro in vivo in vitro in vivo
  7




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10
 AN 025-1/ANA59X
  HBV Programs
 ANA380
    8




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ANA975
  Cancer Program
 ANA773
  Our Drug Discovery and Development Capabilities
  Core Expertise
 TLR-Based Small-Molecule Product Candidates
   Structure-Based Drug Design & Medicinal Chemistry
   9




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Collaboration and Licensing Agreements
 Novartis International Pharmaceuticals Ltd.
      Hoffmann-La Roche Inc.
  LG Life Sciences, Ltd.
  Aphoenix, Inc.
  10




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Valeant Pharmaceuticals International (formerly known as ICN Pharmaceuticals, Inc.)
  Manufacturing and Supply
  Intellectual Property
   
    
    Obtain and maintain patent and other proprietary protection for the technology,
inventions and improvements we consider important to our business;
    
    Defend and enforce our patents;
    
    Preserve the confidentiality of our trade secrets; and
    
    Operate without infringing the patents and proprietary rights of third parties.
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Competition
   Treating HCV with Interferon-based Therapies
    12




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Direct Antivirals in Development for Treating of HCV
  Treating HBV with Direct Antivirals & Interferon
  Competitive Risks
    13




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e.g.
 Government Regulations
    
    
    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.
  Environmental and Safety Matters
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Employees
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Executive Officers of the Registrant
  Name
    
    Age
    
    PositionLawrence C. Fritz, Ph.D.
    
    
    54
    
    
    Chief Executive Officer, President and DirectorStephen T. Worland, Ph.D.
    
    
    49
    
    
    President, PharmaceuticalsJames T. Glover
    
    
    57
    
    
    Senior Vice President, Operations and Chief Financial OfficerDevron R. Averett, Ph.D.
    
    
    57
    
    
    Chief Scientific OfficerJames L. Freddo, M.D.
    
    
    51
    
    
    Chief Medical OfficerMary Yaroshevsky-Glanville
    
    
    42
    
    
    Vice President, Human CapitalCarol G. Gallagher, Pharm.D.
    
    
    42
    
    
    Vice President, Corporate Development and Commercial AffairsElizabeth E. Reed, J.D.
    
    
    36
    
    
    Vice President, Legal Affairs and Corporate Secretary
 Lawrence C. Fritz, Ph.D.
 Stephen T. Worland, Ph.D.
 James T. Glover
 Devron R. Averett, Ph.D.
 James L. Freddo, M.D ®
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Mary Yaroshevsky-Glanville
 Carol G. Gallagher, Pharm.D
 Elizabeth E. Reed, J.D. cum laude
 Company Website
 http://www.anadyspharma.com
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Item 1A. 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
 In June 2006 we suspended our 28-day clinical trial of ANA975 in HCV infected patients, and we
do not currently know when or if we will be able to resume dosing. If dosing is substantially
delayed or if clinical development of ANA975 is terminated, our stock price could decline
significantly.
  The IND covering the ANA975 development plan in the U.S. is currently on full clinical hold
and we will need to obtain agreement with the FDA and regulatory authorities in Europe prior to
resuming clinical trials.
  We currently depend on one collaboration partner, Novartis, for substantially all our revenues
and for commercialization of one of our lead product candidates, and we may depend on Novartis for
commercialization of other product candidates. If our development, license and commercialization
agreement with Novartis terminates, our business will be seriously harmed.
  The success of ANA975 depends heavily on our collaboration with Novartis. If Novartis is
unwilling to further develop or commercialize ANA975, or experiences significant delays in doing
so, our business may be materially harmed.
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We may not realize the anticipated benefits of the development and potential commercialization
of ANA380 for HBV.
  We are continuing to evaluate the animal toxicology observations that led to the suspension of
dosing in our ANA975 HCV clinical trial. To the extent that the
toxicology observations are mechanism related and if we are unable to identify levels of immune stimulation
that provide sufficient therapeutic benefit with an acceptable safety profile, our ANA773 program
for cancer and our other earlier stage TLR7 programs could be negatively impacted, causing our
stock price to decline.
  The FDA may not allow us to proceed with dosing humans with ANA773 unless and until the
outcome of our toxicology studies with ANA975 are more fully understood. Any delay to or
cancellation of our ANA773 program could adversely affect our business and cause our stock price to
decline.
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We will need 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.
  
    
    fund our research and development programs;
    
    fund our share of the further clinical development and regulatory review and approval of ANA975 and 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.
  
    
    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 pace and timing of development activities conducted under joint development arrangements with our collaborators;
    
    the cost 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, ANA975 and additional products; and
    
    the extent to which we acquire or invest in other products technologies and businesses.
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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.
  If we fail to establish new collaborations, we may not generate sufficient revenue to attain
profitability.
  We are at an early stage of development, and we may never attain 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 and when we will become profitable, if ever.
  The technologies on which we rely are unproven and may not result in the discovery or
development of commercially viable products.
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Novartis has the right under certain circumstances to market and sell products that compete
with the product candidates and products that we license to it, and any competition by Novartis
could have a material adverse effect on our business.
  We are dependent on the commercial success of ANA975 or another oral prodrug of isatoribine or
other TLR-7 agonists and we cannot be certain that ANA975 or any other oral prodrug of isatoribine
or other TLR-7 agonists will be commercialized.
  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.
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We will need to file an additional IND application to conduct trials of ANA975 for HBV in the
U.S. and will need to continue our dialogue with the FDA as we and/or Novartis conduct additional
trials of ANA975 in the U.S. for either HCV or HBV.
  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.
   
    
    demonstrating sufficient safety and efficacy to obtain regulatory approval to commence a
clinical trial;
    
    reaching an agreement on acceptable terms with our collaborators on all aspects of the
clinical trial, including the contract research organizations and the trial sites;
    
    reaching agreement on acceptable terms with prospective contract research organizations and trial sites;
    
    manufacturing sufficient quantities or producing drug meeting our quality standards 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.
 .
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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.
  
    
    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;
    
    negative or potentially problematic results of ongoing and concurrent pre-clinical toxicology studies;
    
    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.
  The success of the clinical development program of ANA380 will depend, at least in part, on
our or our collaborators ability to maintain a positive working relationship with the FDA and
other regulatory authorities, and the failure to do so may harm or delay our ability to
commercialize ANA380 in the U.S. or other countries.
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If our efforts to discover new products or product candidates and 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.
  
    
    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.
  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.
  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.
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If we successfully develop products but those products do not achieve and maintain market
acceptance, our business will not be profitable.
  
    
    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.
   
    
    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 viral resistance, arise with respect to use of our products.
 If we fail to maintain our existing and future collaborations, we may not generate sufficient
revenue to attain profitability.
  
    
    we or our collaborators do not achieve our respective objectives under our collaboration
agreements;
    
    we or our collaborators encounter development hurdles that prevent or delay further
development of our product candidates;
    
    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;
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
    
    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.
  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.
  
    
    decide not to devote the necessary resources due to challenges or delays in pre-clinical
or clinical development;
    
    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;
    
    cannot obtain the necessary regulatory approvals; or
    
    are otherwise subject to adverse events affecting their business.
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If any conflicts arise between us and any of our collaborators, our reputation, revenues and
cash position could be significantly harmed.
  
    
    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.
   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.
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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 of our products.
  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 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.
  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.
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Our quarterly results and stock price may fluctuate significantly.
  
    
    the status of development of ANA380, ANA975 and our other product candidates, including
results of preclinical studies and clinical trials and changes in regulatory status;
    
    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 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.
  If we engage in any acquisition, we will incur a variety of costs, and we may never realize
the anticipated benefits of the acquisition.
  
    
    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;
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
    
    incurrence of substantial debt or dilutive issuances of securities to pay for acquisitions;
    
    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.
  Earthquake damage to our facilities could delay our research and development efforts and
adversely affect our business.
  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.
   
    
    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;
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
    
    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.
     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.
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
    
    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.
   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.
   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.
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Many competitors have significantly more resources and experience, which may harm our
commercial opportunity.
  
    
    research and development;
    
    preclinical testing;
    
    clinical trials;
    
    regulatory approvals;
    
    manufacturing; and
    
    sales and marketing of approved products.
  If our competitors develop treatments for HCV, HBV, cancer or in the other fields in which we
are developing products that are approved faster, marketed better or demonstrated to be more
effective than ANA975, ANA380, ANA773 or ANA59X or any other products that we may develop, our commercial opportunity
will be reduced or eliminated.
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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.
  
    
    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.
  If we cannot arrange for reimbursement policies favorable to our product candidates, their
sales will be severely hindered.
  Product liability claims may damage our reputation and, if insurance proves inadequate, the
product liability claims may harm our results of operations.
  
    
    decreased demand for our product candidates;
    
    injury to our reputation;
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
    
    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.
  Any claims relating to our improper handling, storage or disposal of biological, hazardous and
radioactive materials could be time-consuming and costly.
  Our business and operations would suffer in the event of system failures.
  Risks Related to Our Common Stock
 Future sales of our common stock may cause our stock price to decline.
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Our stock price may be volatile.
  
    
    changes in the regulatory status of our product candidates, including the status and
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;
    
    developments under our collaboration agreements with our collaborators;
    
    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 adopted effective January 1, 2006. We expect that this
accounting change 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.
 Our largest stockholders may take actions that are contrary to your interests, including
selling their stock.
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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.
  
    
    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 66 2/3% stockholder
approval; and
    
    requiring advance notice for raising matters of business or making nominations at
stockholders meetings.
  We have never paid cash dividends on our capital stock and we do not anticipate paying
dividends in the foreseeable future.
  
 Item 1B. Unresolved Staff Comments
  
 Item 2. Properties
  
 Item 3. Legal Proceedings
  
 Item 4. Submission of Matters to a Vote of Security Holders
  38




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##### Table of Contents



Part II
 
 Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchase of Equity Securities
 Market Information
  2006
    
    High
    
    LowFirst Quarter
    
    $
    16.60
    
    
    $
    8.39Second Quarter
    
    
    16.10
    
    
    
    2.92Third Quarter
    
    
    4.25
    
    
    
    2.64Fourth Quarter
    
    
    5.65
    
    
    
    2.81
 2005
    
    High
    
    LowFirst Quarter
    
    $
    9.05
    
    
    $
    6.56Second Quarter
    
    
    9.61
    
    
    
    5.92Third Quarter
    
    
    14.20
    
    
    
    9.26Fourth Quarter
    
    
    12.15
    
    
    
    7.91
 Holders
  Dividend Policy
  Securities Authorized for Issuance Under Equity Compensation Plans
   (c)Number of securitiesremaining available for(a)
    
    (b)
    
    future 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
    
    
    4,102,180
    
    
    $
    6.22
    
    
    
    888,209Equity compensation
plans not approved
by security holders
    
    
    945,000
    
    
    $
    3.82
    
    
    
    
 39




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##### Table of Contents



Performance Measurement Comparison (1)
   Comparison of Cumulative Total Return on Investment Since March 26, 2004
 
 March 26, 2004
    
    
    December 31, 2004
    
    
    December 31, 2005
    
    
    December 31, 2006Anadys Pharmaceuticals, Inc.
    
    
    $
    100.00
    
    
    
    $
    106.09
    
    
    
    $
    124.65
    
    
    
    $
    69.69NASDAQ Composite Index
    
    
    
    100.00
    
    
    
    
    110.99
    
    
    
    
    112.52
    
    
    
    
    123.23NASDAQ Biotechnology Index
    
    
    
    100.00
    
    
    
    
    102.33
    
    
    
    
    105.23
    
    
    
    
    106.31
 (1)
    
    This section is not soliciting material, is not deemed filed with the SEC and
is not to be incorporated by reference in any filing of the Company under the 1933 Act or the
1934 Act whether made before or after the date hereof and irrespective of any general
incorporation language in any such filing. 40




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##### Table of Contents



Item 6. Selected Financial Data
  For the years ended December 31,2006
    
    
    2005
    
    
    2004
    
    
    2003
    
    
    2002(In thousands, except net loss per share)Consolidated Statements of Operations Data:Revenues
    
    $
    5,420
    
    
    $
    4,887
    
    
    $
    1,762
    
    
    $
    2,286
    
    
    $
    1,282Operating expenses:Research and development(1)
    
    
    25,419
    
    
    
    20,901
    
    
    
    26,711
    
    
    
    18,819
    
    
    
    18,664General and administrative(1)
    
    
    11,308
    
    
    
    7,705
    
    
    
    8,260
    
    
    
    7,156
    
    
    
    5,864Total operating expenses(1)
    
    
    36,727
    
    
    
    28,606
    
    
    
    34,971
    
    
    
    25,975
    
    
    
    24,528Loss from operations
    
    
    (31,307
    )
    
    
    (23,719
    )
    
    
    (33,209
    )
    
    
    (23,689
    )
    
    
    (23,246
    )Other income (expense):Interest income
    
    
    4,727
    
    
    
    2,103
    
    
    
    525
    
    
    
    229
    
    
    
    403Interest expense
    
    
    (69
    )
    
    
    (189
    )
    
    
    (228
    )
    
    
    (266
    )
    
    
    (176
    )Other, net
    
    
    (111
    )
    
    
    (118
    )
    
    
    (67
    )
    
    
    (272
    )
    
    
    (29
    )Total other income, (expenses) net
    
    
    4,547
    
    
    
    1,796
    
    
    
    230
    
    
    
    (309
    )
    
    
    198Net loss
    
    
    (26,760
    )
    
    
    (21,923
    )
    
    
    (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
    
    $
    (26,760
    )
    
    $
    (21,923
    )
    
    $
    (33,154
    )
    
    $
    (31,614
    )
    
    $
    (23,367
    )Basic and diluted net loss per share(2):
    
    $
    (0.94
    )
    
    $
    (0.89
    )
    
    $
    (1.92
    )
    
    $
    (21.58
    )
    
    $
    (25.88
    )Shares used to compute basic and diluted net loss
per share(2):
    
    
    28,512
    
    
    
    24,756
    
    
    
    17,233
    
    
    
    1,465
    
    
    
    903
 
 (1)
    
    As a result of the adoption of Statement of Accounting Standards 123R,
Share-Based Payments on January 1, 2006, there is a lack of comparability in our research
and development expense and our general and administrative expense for the periods presented
prior to January 1, 2006. Please reference Note 8 for additional information related to the
impact of SFAS 123R on our research and development expenses and our general and
administrative expenses.(2)
    
    As a result of the conversion of our preferred stock into 13,330,000 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
prior to the completion of our initial public offering. 41




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##### Table of Contents



As of December 31,2006
    
    2005
    
    2004
    
    2003
    
    2002(In thousands)Consolidated Balance Sheet Data:Cash, cash equivalents and securities available-for-sale
    
    $
    82,149
    
    
    $
    104,851
    
    
    $
    33,674
    
    
    $
    14,499
    
    
    $
    25,542Working capital
    
    
    75,054
    
    
    
    98,682
    
    
    
    28,001
    
    
    
    12,304
    
    
    
    22,239Total assets
    
    
    89,401
    
    
    
    116,976
    
    
    
    40,949
    
    
    
    20,242
    
    
    
    31,840Long-term debt, net of current portion
    
    
    
    
    
    
    682
    
    
    
    1,193
    
    
    
    1,401
    
    
    
    1,276Redeemable convertible preferred stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    45,012
    
    
    
    36,210Accumulated deficit
    
    
    (214,480
    )
    
    
    (187,720
    )
    
    
    (165,797
    )
    
    
    (132,643
    )
    
    
    (101,029
    )Total stockholders equity (deficit)
    
    
    60,325
    
    
    
    78,936
    
    
    
    31,285
    
    
    
    (30,059
    )
    
    
    (9,998
    )
 42




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##### Table of Contents



Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
 MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
   Overview
  
    
    fund our portion of the global development costs of ANA380 for the treatment of HBV;
    
    fund our portion of the global development of ANA975 for the treatment of HCV and HBV;
    
    continue the development of ANA773 for the treatment of certain cancers;
    
    continue the development of ANA59X for the treatment of HCV;
    
    continue the development of our other product candidates;
    
    advance our preclinical candidates into clinical development;
    
    develop and scale-up manufacturing of product candidates for clinical trials and potential commercialization;
    
    further our research and development programs;
    
    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.
 43




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##### Table of Contents



Research and Development
      44




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##### Table of Contents



ANA975
    
    $
    4,495ANA773
    
    
    3,944ANA380
    
    
    935Discovery stage programs
    
    
    9,369Infrastructure and support personnel
    
    
    7,464Non-cash employee and non-employee share-based compensation
    
    
    2,889Reimbursement of ANA975 costs by Novartis
    
    
    (3,677
    )Total research and development expense
    
    $
    25,419
   For the years ended December 31,2005
    
    
    2004Direct external costs:Isatoribine family of compounds, excluding ANA975
    
    $
    558
    
    
    $
    1,798ANA975
    
    
    8,613
    
    
    
    2,038ANA380
    
    
    417
    
    
    
    5,638ANA773
    
    
    110
    
    
    
    Other
    
    
    
    
    
    
    5Unallocated direct internal costs
    
    
    3,535
    
    
    
    1,843Unallocated indirect internal costs and overhead
    
    
    12,534
    
    
    
    12,851Reimbursement of ANA975 costs by Novartis
    
    
    (5,790
    )
    
    
    Deferred compensation
    
    
    924
    
    
    
    2,538Total research and development
    
    $
    20,901
    
    
    $
    26,711
 General and Administrative
  Critical Accounting Policies
  Revenue Recognition. Revenue Recognition,
 45




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##### Table of Contents



Revenue Arrangements with Multiple Deliverables.
 
    
    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 and (iii) the milestone is not refundable or creditable. If all 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.
    
    Fees that we receive for research services are generally recognized as the services are
provided, as long as the amounts received are not refundable regardless of the results of
the research project. Research services may include activities in which we deploy our
internal capabilities such as our medicinal chemistry and screening capabilities to assist
a collaborator in advancing their drug discovery effort.
 Drug Development Costs.
 Share-based Compensation.
 Adoption of Statement of Financial Accounting Standard No. 123R, Share-Based Payment
 Share-Based Payment Accounting for Stock-Based Compensation. Accounting for Stock Issued to Employees, Statement of Cash Flows
  .
 46




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##### Table of Contents



Recent Accounting Pronouncements
 Accounting for Uncertainty in Income
Taxes, an interpretation of FASB Statement No. 109,
 Fair Value Measurements
 Results of Operations
 Comparison of the Years Ended December 31, 2006, 2005 and 2004
 Revenue.
 Research and Development Expenses.
 47




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##### Table of Contents



General and Administrative Expenses.
 Interest Income.
 Interest Expense.
 Liquidity and Capital Resources
  48




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##### Table of Contents



Cash Flows from Operating Activities and Investing Activities
  For the years ended December 31,2006
    
    
    2005
    
    
    2004(In thousands)Net cash provided by (used in) operating activities
    
    $
    (20,585
    )
    
    $
    5,999
    
    
    $
    (22,574
    )Cash provided by (used in) investing activitiesPurchase of securities available-for-sale
    
    $
    (14,310
    )
    
    $
    (11,886
    )
    
    $
    (42,619
    )Proceeds from sale of securities available-for-sale
    
    
    5,750
    
    
    
    28,416
    
    
    
    17,398Purchase of property and equipment
    
    
    (1,522
    )
    
    
    (1,338
    )
    
    
    (880
    )Proceeds from disposal of property and equipment
    
    
    
    
    
    
    2
    
    
    
    35Acquisition of facility leasehold improvements from lease incentive
    
    
    
    
    
    
    
    
    
    
    (1,550
    )Net cash provided by (used in) investing activities
    
    $
    (10,082
    )
    
    $
    15,194
    
    
    $
    (27,616
    )
   49




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Cash Flows from Financing Activities
  For the years ended December 31,2006
    
    
    2005
    
    
    2004(In thousands)Cash provided by financing activitiesProceeds from exercise of stock options and employee stock purchase plan
    
    $
    954
    
    
    $
    1,057
    
    
    $
    560Proceeds from sale of common stock, net of issuance costs
    
    
    
    
    
    
    66,437
    
    
    
    43,656Proceeds from long-term debt
    
    
    
    
    
    
    393
    
    
    
    1,198Principal payments on long-term debt
    
    
    (1,559
    )
    
    
    (1,409
    )
    
    
    (1,204
    )Net cash provided by (used in) financing activities
    
    $
    (605
    )
    
    $
    66,478
    
    
    $
    44,210
   Aggregate Contractual Obligations
  Lessthan 1
    
    
    2008 to
    
    
    2010 toContractual Obligations
    
    Total
    
    
    year
    
    
    2009
    
    
    2011
    
    
    ThereafterOperating leases
    
    $
    5,491
    
    
    $
    2,062
    
    
    $
    3,429
    
    
    $
    
    
    
    $
    Milestone payments1
    
    
    1,000
    
    
    
    1,000
    
    
    
    
    
    
    
    
    
    
    
    Minimum royalty commitment
    
    
    975
    
    
    
    75
    
    
    
    200
    
    
    
    200
    
    
    
    500$
    7,466
    
    
    $
    3,137
    
    
    $
    3,629
    
    
    $
    200
    
    
    $
    500
 
 1
    
    We are in the process of finalizing our joint global development plan for
ANA380 with LGLS. Assuming that we jointly decide to initiate a Phase IIb dose
selection clinical trial, we may be required to pay $1 million to LGLS at the
initiation of the Phase IIb dose selection clinical trial. We may also be required to
pay an additional $24.5 million to LGLS, subject to the attainment of product
development and commercialization objectives. These additional milestone payments have
not been included in this contractual obligations table as we are unable to estimate
when, if ever, these payments will be made as they are contingent upon the results of
our future clinical trials including our Phase IIb dose selection clinical trial.  50




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##### Table of Contents



Future Cash Requirements
   
    
    the progress of our clinical trials;
    
    the progress of our preclinical development activities;
    
    the progress of our research activities;
    
    the number and scope of our research programs;
    
    our ability to establish and maintain strategic collaborations;
    
    the costs involved in enforcing or defending patent claims and other intellectual property rights;
    
    the pace and timing of development activities conducted under joint development agreements with our collaborators;
    
    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, ANA975, ANA773 or any other product
candidates we may develop; and
    
    the extent to which we acquire or invest in other products, technologies and businesses.
     51




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##### Table of Contents



Off-Balance Sheet Arrangements
  
 Item 7A. Quantitative and Qualitative Disclosure About Market Risk
  
 Item 8. Financial Statements and Supplementary Data
  
 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
  52




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##### Table of Contents



Item 9A. Controls and Procedures
 Managements Report on Internal Control over Financial Reporting
 Evaluation of Disclosure Controls and Procedures:
 Managements Annual Report on Internal Control over Financial Reporting
 Internal Control  Integrated Framework Internal
Control  Integrated Framework
  Changes in Internal Control Over Financial Reporting:
 Report of Independent Registered Public Accounting Fir m
     53




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##### Table of Contents



.
   
 
 Item 9B. Other Information
  54




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##### Table of Contents



Part III
  
 Item 10. Directors, Executive Officers and Corporate Governance
     http://www.anadyspharma.com
 
 Item 11. Executive Compensation
  
 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
  
 Item 13. Certain Relationships and Related Transactions, and Director Independence
  
 Item 14. Principal Accounting Fees and Services
  55




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##### Table of Contents



Part IV
 
 Item15. Exhibits and Financial Statement Schedules
  (1)
    
    Financial Statements. See index to consolidated financial statements on page F-1.(2)
    
    Financial Statement Schedules. All 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 Registrant4.1(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 therein10.3(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.10.21(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#
    
    Severance Agreement dated November 14, 2003 by and between the Registrant and Steve Worland, Ph.D.10.27(3)#
    
    Terms of Employment dated February 1, 2001 by and between the Registrant and Steve Worland, Ph.D.10.29(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.10.33(2)
    
    Sub-lease agreement dated February 23, 2004 by and between the Registrant and Torrey Mesa Research Institute.10.34(4)*
    
    Joint Development and License Agreement between LG Life Sciences and Anadys Pharmaceuticals, Inc.
 56




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##### Table of Contents



ExhibitNumber
    
    Exhibit Description10.35(5)*
    
    Agreement dated July 28, 2004 by and between Hoffmann-La Roche, Inc. and Anadys Pharmaceuticals, Inc.10.36(5)*
    
    Collaboration Agreement dated September 3, 2004 by and between Aphoenix, Inc. and Anadys Pharmaceuticals,
Inc.10.37(6)#
    
    Consulting Agreement dated May 25, 2005 by and between Marios Fotiadis and Anadys Pharmaceuticals, Inc.10.38(6)*
    
    License and Co-Development Agreement dated June 1, 2005 by and between Novartis International Pharmaceutical
Ltd. and Anadys Pharmaceuticals, Inc.10.40(7)#
    
    Terms of Employment dated January 26, 2005 by and between the Registrant and Jennifer K. Crittenden10.41(8)#
    
    Change in Control Agreement dated April 17, 2006 by and between the Registrant and Jennifer K. Crittenden10.42(9)#
    
    Form of Inducement Stock Option Agreement10.43(9)#
    
    Offer Letter between the Company and James T. Glover, CPA, dated September 11, 200610.44(10)#
    
    Offer Letter between the Company and Lawrence C. Fritz, Ph.D., dated November 6, 200610.45#
    
    Severance and Change in Control Agreement dated November 20, 2006 by and between the Registrant and Lawrence C. Fritz, Ph.D.10.46#
    
    Severance and Change in Control Agreement dated November 13, 2006 by and between the Registrant and James T. Glover, CPA.21.1(3)
    
    List of Subsidiaries of the Registrant23.1
    
    Consent of Independent Registered Public Accounting Firm31.1
    
    Section 302 Certification by the Registrants President and Chief Executive Officer31.2
    
    Section 302 Certification by the Registrants Senior Vice President, Operations and Chief Financial Officer32
    
    Section 906 Certification by the Registrants Chief Executive Officer and Senior Vice President, Operations
and Chief Financial Officer
 
 (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 Quarterly Report on Form 10-Q filed on August
16, 2004(5)
    
    Incorporated by reference to the Registrants Quarterly Report on Form 10-Q filed on November
12, 2004(6)
    
    Incorporated by reference to the Registrants Quarterly Report on Form 10-Q filed on August
12, 2005(7)
    
    Incorporated by reference to the Registrants Annual Report on Form 10-K filed on March 15,
2006(8)
    
    Incorporated by reference to the Registrants Quarterly Report on Firm 10-Q filed on May 10,
2006(9)
    
    Incorporated by reference to the Registrants Current Report on Form 8-K filed on September
25, 2006(10)
    
    Incorporated by reference to the Registrants Current Report on Form 8-K filed on November
20, 2006#
    
    Indicates management contract or compensatory plan.*
    
    Confidential treatment has been granted with respect to certain portions of this exhibit.
Omitted portions have been filed separately with the Securities and Exchange Commission. 57




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SIGNATURES
  ANADYS PHARMACEUTICALS, INC.By:
    
    /s/ LAWRENCE C. FRITZ, PH.D.Lawrence C. Fritz, Ph.D.President and Chief Executive Officer
  Signature
    
    Title
    
    Date/s/ LAWRENCE C. FRITZ, PH.D.

Lawrence C. Fritz, Ph.D.
    
    President, Chief Executive
Officer and Director(Principal
Executive Officer)
    
    March 15, 2007/s/ JAMES T. GLOVER.
    
    Senior Vice President, Operations and Chief
    
    March 15, 2007James T. Glover.
    
    Financial
Officer (Principal Financial and
Accounting Officer)/s/ GEORGE A. SCANGOS, PH.D.

George A. Scangos, Ph.D.
    
    Chairman of the Board
    
    March 15, 2007/s/ MARK G. FOLETTA

Mark G. Foletta
    
    Director
    
    March 15, 2007/s/ MARIOS FOTIADIS

Marios Fotiadis
    
    Director
    
    March 15, 2007/s/ STEVEN H. HOLTZMAN

Steven H. Holtzman
    
    Director
    
    March 15, 2007/s/ STELIOS PAPADOPOULOS, PH.D.

Stelios Papadopoulos, Ph.D.
    
    Director
    
    March 15, 2007/s/ DOUGLAS E. WILLIAMS, PH.D.

Douglas E. Williams, Ph.D.
    
    Director
    
    March 15, 2007/s/ KLEANTHIS G. XANTHOPOULOS, PH.D.

Kleanthis G. Xanthopoulos, Ph.D.
    
    Director
    
    March 15, 2007
 58




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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, 2006 and 2005
    
    
    F-3Consolidated Statements of Operations for the years ended December 31, 2006, 2005 and 2004
    
    
    F-4Consolidated Statements of Stockholders Equity for the years ended December 31, 2006, 2005 and 2004
    
    
    F-5Consolidated Statements of Cash Flows for the years ended December 31, 2006, 2005 and 2004
    
    
    F-7Notes to Consolidated Financial Statements
    
    
    F-8
 F-1




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##### Table of Contents



Report of Independent Registered Public Accounting Firm
        
 F-2




---



##### Table of Contents



ANADYS PHARMACEUTICALS, INC.
 
 CONSOLIDATED BALANCE SHEETS
 (In thousands, except share and per share data)
 December 31,
    
    
    December 31,2006
    
    
    2005AssetsCurrent assets:Cash and cash equivalents
    
    $
    62,387
    
    
    $
    93,659Securities available-for-sale
    
    
    19,762
    
    
    
    11,192Accounts receivable
    
    
    1,175
    
    
    
    6,025Prepaid expenses and other current assets
    
    
    941
    
    
    
    651Total current assets
    
    
    84,265
    
    
    
    111,527Property and equipment, net
    
    
    3,749
    
    
    
    3,809Other assets, net
    
    
    1,387
    
    
    
    1,640Total assets
    
    $
    89,401
    
    
    $
    116,976Liabilities and Stockholders EquityCurrent liabilities:Accounts payable
    
    $
    794
    
    
    $
    1,016Accrued expenses
    
    
    3,317
    
    
    
    3,863Current portion of long-term debt
    
    
    
    
    
    
    854Current portion of deferred rent
    
    
    467
    
    
    
    433Deferred revenue
    
    
    4,633
    
    
    
    6,679Total current liabilities
    
    
    9,211
    
    
    
    12,845Long-term debt, net of current portion
    
    
    
    
    
    
    682Long-term portion of deferred rent
    
    
    931
    
    
    
    1,370Long-term portion of deferred revenue
    
    
    18,934
    
    
    
    23,143Commitments and contingenciesStockholders equity:Preferred stock, $0.001 par value;
10,000,000 shares authorized at December
31, 2006 and December 31, 2005,
respectively; no shares issued and
outstanding at December 31, 2006 and
December 31, 2005.
    
    
    
    
    
    
    Common stock, $0.001 par value;
90,000,000 shares authorized at December
31, 2006 and December 31, 2005;
28,596,198 and 28,374,136 shares issued
and outstanding at December 31, 2006 and
December 31, 2005, respectively
    
    
    29
    
    
    
    28Additional paid-in capital
    
    
    274,798
    
    
    
    267,499Deferred compensation
    
    
    
    
    
    
    (839
    )Accumulated other comprehensive loss
    
    
    (22
    )
    
    
    (32
    )Accumulated deficit
    
    
    (214,480
    )
    
    
    (187,720
    )Total stockholders equity
    
    
    60,325
    
    
    
    78,936Total liabilities and stockholders equity
    
    $
    89,401
    
    
    $
    116,976
  F-3




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##### Table of Contents



ANADYS PHARMACEUTICALS, INC.
 
 CONSOLIDATED STATEMENTS OF OPERATIONS
 (In thousands, except net loss per share)
 For the Years Ended December 31,2006
    
    
    2005
    
    
    2004Revenues:Collaborative agreements
    
    $
    5,354
    
    
    $
    4,408
    
    
    $
    1,672Grants
    
    
    66
    
    
    
    479
    
    
    
    90Total revenues
    
    
    5,420
    
    
    
    4,887
    
    
    
    1,762Operating Expenses:Research and development
    
    
    25,419
    
    
    
    20,901
    
    
    
    26,711General and administrative
    
    
    11,308
    
    
    
    7,705
    
    
    
    8,260Total operating expenses
    
    
    36,727
    
    
    
    28,606
    
    
    
    34,971Loss from operations
    
    
    (31,307
    )
    
    
    (23,719
    )
    
    
    (33,209
    )Other income (expense):Interest income
    
    
    4,727
    
    
    
    2,103
    
    
    
    525Interest expense
    
    
    (69
    )
    
    
    (189
    )
    
    
    (228
    )Other, net
    
    
    (111
    )
    
    
    (118
    )
    
    
    (67
    )Total other income (expense)
    
    
    4,547
    
    
    
    1,796
    
    
    
    230Net loss
    
    
    (26,760
    )
    
    
    (21,923
    )
    
    
    (32,979
    )Accretion to redemption value of redeemable convertible preferred stock
    
    
    
    
    
    
    
    
    
    
    (175
    )Net loss applicable to common stockholders
    
    $
    (26,760
    )
    
    $
    (21,923
    )
    
    $
    (33,154
    )Net loss per share, basic and diluted
    
    $
    (0.94
    )
    
    $
    (0.89
    )
    
    $
    (1.92
    )Shares used in calculating net loss per share, basic and diluted
    
    
    28,512
    
    
    
    24,756
    
    
    
    17,233
  F-4




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##### Table of Contents



ANADYS PHARMACEUTICALS, INC.
 
 CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
 (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
    
    
    equityBalance 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
cost 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 Companys 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 compensation related to the issuance of stock options to employees
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,968
    
    
    
    (5,968
    )
    
    
    
    
    
    
    
    
    
    
    Amortization 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
    )
    
    
    31,285Issuance of common stock from a follow-on public common stock offering,
net of underwriters discount and offering expenses
    
    
    
    
    
    
    
    
    
    
    5,750,000
    
    
    
    5
    
    
    
    66,432
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    66,437Issuance of common stock pursuant to the exercise of stock options
    
    
    
    
    
    
    
    
    
    
    222,593
    
    
    
    1
    
    
    
    702
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    703Issuance of common stock pursuant to the Companys Employee Stock Purchase
Plan
    
    
    
    
    
    
    
    
    
    
    67,022
    
    
    
    
    
    
    
    354
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    354Compensation related to stock options and warrants issued to non-employees
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    333
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    333Amortization of deferred compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,711
    
    
    
    
    
    
    
    
    
    
    
    1,711Reversal of deferred compensation associated with cancelled stock options
to employees
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (312
    )
    
    
    312
    
    
    
    
    
    
    
    
    
    
    
    Comprehensive loss:
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Unrealized gain on short-term investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    36
    
    
    
    
    
    
    
    36Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (21,923
    )
    
    
    (21,923
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (21,887
    )
  F-5




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##### Table of Contents



ANADYS PHARMACEUTICALS, INC.
 CONSOLIDATED
STATEMENTS OF STOCKHOLDERS EQUITY(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
    
    
    equityBalance at December 31, 2005
    
    
    
    
    
    $
    
    
    
    
    28,374,136
    
    
    $
    28
    
    
    $
    267,499
    
    
    $
    (839
    )
    
    $
    (32
    )
    
    $
    (187,720
    )
    
    $
    78,936Issuance of common stock pursuant to the exercise of stock
options and warrants
    
    
    
    
    
    
    
    
    
    
    143,335
    
    
    
    1
    
    
    
    562
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    563Issuance of common stock pursuant to the Employee Stock
Purchase Plan
    
    
    
    
    
    
    
    
    
    
    78,727
    
    
    
    
    
    
    
    391
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    391Compensation related to stock options and warrants issued to
non-employees
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    326
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    326SFAS 123R stock-based compensation expense including forfeitures
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,859
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,859Reversal of deferred compensation upon the adoption of SFAS 123R
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (839
    )
    
    
    839
    
    
    
    
    
    
    
    
    
    
    
    Comprehensive loss:Unrealized gain on short-term investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10
    
    
    
    
    
    
    
    10Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (26,760
    )
    
    
    (26,760
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (26,750
    )Balance at December 31, 2006
    
    
    
    
    
    $
    
    
    
    
    28,596,198
    
    
    $
    29
    
    
    $
    274,798
    
    
    $
    
    
    
    $
    (22
    )
    
    $
    (214,480
    )
    
    $
    60,325
  F-6




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##### Table of Contents



ANADYS PHARMACEUTICALS, INC.
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 (In thousands)
 For the years ended December 31,2006
    
    
    2005
    
    
    2004Operating Activities:Net loss
    
    $
    (26,760
    )
    
    $
    (21,923
    )
    
    $
    (32,979
    )Adjustments
to reconcile net loss to net cash provided by (used in)
operating activities:Depreciation and amortization
    
    
    1,509
    
    
    
    1,468
    
    
    
    1,465Stock-based compensation
    
    
    6,859
    
    
    
    
    
    
    
    Amortization of deferred compensation
    
    
    
    
    
    
    1,711
    
    
    
    4,915Compensation related to restricted stock
    
    
    
    
    
    
    
    
    
    
    172Compensation related to stock option issuances to non-employees
    
    
    276
    
    
    
    280
    
    
    
    45Interest expense related to warrants issued in connection with debt
    
    
    23
    
    
    
    49
    
    
    
    48Rent expense related to warrants issued in connection with lease
    
    
    50
    
    
    
    53
    
    
    
    30Loss from disposal of property and equipment and related deposits
    
    
    73
    
    
    
    89
    
    
    
    28Cash received from lease incentives
    
    
    
    
    
    
    
    
    
    
    1,550Changes in operating assets and liabilities:Accounts receivable
    
    
    4,850
    
    
    
    (5,839
    )
    
    
    339Prepaid expenses and other current assets
    
    
    (290
    )
    
    
    487
    
    
    
    30Other assets, net
    
    
    253
    
    
    
    281
    
    
    
    (999
    )Accounts payable
    
    
    (222
    )
    
    
    (104
    )
    
    
    355Accrued expenses
    
    
    (546
    )
    
    
    256
    
    
    
    1,943Deferred rent
    
    
    (405
    )
    
    
    (31
    )
    
    
    284Deferred revenue
    
    
    (6,255
    )
    
    
    29,222
    
    
    
    200Net cash provided by (used in) operating activities
    
    
    (20,585
    )
    
    
    5,999
    
    
    
    (22,574
    )Investing ActivitiesPurchase of securities available-for-sale
    
    
    (14,310
    )
    
    
    (11,886
    )
    
    
    (42,619
    )Proceeds from sale and maturity of securities available-for-sale
    
    
    5,750
    
    
    
    28,416
    
    
    
    17,398Purchase of property and equipment
    
    
    (1,522
    )
    
    
    (1,338
    )
    
    
    (880
    )Proceeds from the sale of property and equipment
    
    
    
    
    
    
    2
    
    
    
    35Acquisition of leasehold improvements from lease incentives
    
    
    
    
    
    
    
    
    
    
    (1,550
    )Net cash provided by (used in) investing activities
    
    
    (10,082
    )
    
    
    15,194
    
    
    
    (27,616
    )Financing ActivitiesProceeds from exercise of stock options and employee stock purchase plan
    
    
    954
    
    
    
    1,057
    
    
    
    560Proceeds from the sale of common stock, net of issuance costs
    
    
    
    
    
    
    66,437
    
    
    
    43,656Proceeds from issuance of long-term debt
    
    
    
    
    
    
    393
    
    
    
    1,198Principal payments on long-term debt
    
    
    (1,559
    )
    
    
    (1,409
    )
    
    
    (1,204
    )Net cash provided by (used in) financing activities
    
    
    (605
    )
    
    
    66,478
    
    
    
    44,210Net increase (decrease) in cash and cash equivalents
    
    
    (31,272
    )
    
    
    87,671
    
    
    
    (5,980
    )Cash and cash equivalents at beginning of year
    
    
    93,659
    
    
    
    5,988
    
    
    
    11,968Cash and cash equivalents at end of year
    
    $
    62,387
    
    
    $
    93,659
    
    
    $
    5,988Supplemental Disclosure of Cash Flow Information:Cash paid during the year for interest
    
    $
    69
    
    
    $
    189
    
    
    $
    228Supplemental Disclosure of Non-Cash Investing and Financing Activities:Reversal of deferred compensation upon the adoption of SFAS 123R
    
    $
    839
    
    
    $
    
    
    
    $
    Conversion of redeemed convertible preferred stock to common stock
    
    $
    
    
    
    $
    
    
    
    $
    45,012Conversion of convertible preferred stock to common stock
    
    $
    
    
    
    $
    
    
    
    $
    80,779Accretion of costs on redeemable convertible preferred stock
    
    $
    
    
    
    $
    
    
    
    $
    175Unrealized gain (loss) on securities available-for-sale
    
    $
    10
    
    
    $
    36
    
    
    $
    (66
    )
  F-7




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##### Table of Contents



ANADYS PHARMACEUTICALS, INC.
 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 1. Organization and Summary of Significant Accounting Policies
 Organization and Business
  Principles of Consolidation
   Use of Estimates
  Cash and Cash Equivalents
  Securities Available-for-Sale
  Fair Value of Financial Instruments
  Concentration of Credit Risk
  F-8




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##### Table of Contents



ANADYS PHARMACEUTICALS, INC.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
   Property and Equipment
  Impairment of Long-Lived Assets
 Accounting for the Impairment or Disposal of Long-Lived
Assets
 Research and Development
   Accumulated Other Comprehensive Income (Loss)
 Reporting Comprehensive Income
 Deferred Rent
  F-9




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##### Table of Contents



ANADYS PHARMACEUTICALS, INC.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 Stock-Based Compensation
 Accounting for Stock Issued to Employees
 Share-Based Payments,
 Accounting for
Equity Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction with
Selling Goods or Services
 Share-Based Payment
 Net Loss Per Share
 Earnings Per Share
 F-10




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##### Table of Contents



ANADYS PHARMACEUTICALS, INC.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  For the years ended December 31,2006
    
    
    2005
    
    
    2004(in thousands)Historical:Numerator:Net loss
    
    $
    (26,760
    )
    
    $
    (21,923
    )
    
    $
    (32,979
    )Accretion to redemption value of redeemable convertible
preferred stock
    
    
    
    
    
    
    
    
    
    
    (175
    )Net loss applicable to common stockholders
    
    $
    (26,760
    )
    
    $
    (21,923
    )
    
    $
    (33,154
    )Denominator:Weighted-average common shares
    
    
    28,512
    
    
    
    24,756
    
    
    
    17,287Weighted-average unvested common shares subject to repurchase
    
    
    
    
    
    
    
    
    
    
    (54
    )Denominator for basic and diluted earnings per share
    
    
    28,512
    
    
    
    24,756
    
    
    
    17,233Basic and diluted net loss per share
    
    $
    (0.94
    )
    
    $
    (0.89
    )
    
    $
    (1.92
    )
 For the years ended December 31,2006
    
    2005
    
    2004(in thousands)Historical outstanding
antidilutive securities not
included in diluted net loss
per share calculationOptions to purchase common stock
    
    
    5,047
    
    
    
    3,089
    
    
    
    2,365Warrants
    
    
    279
    
    
    
    376
    
    
    
    3765,326
    
    
    
    3,465
    
    
    
    2,741
 Revenue Recognition
 Revenue Recognition, Revenue Arrangements with Multiple Deliverables.
 
    
    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) the Companys
performance obligations after the milestone achievement will continue to be funded by the
collaborator at the comparable level and (iii) the milestone is not refundable or
creditable. If all 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 collaborations, such as technology access fees, are recognized over the
period the related services are provided. Non-refundable upfront fees not associated with
the Companys future performance are recognized when received.
    
    Fees that the Company receives for research services are generally recognized as the
services are provided, as long as the amounts received are not refundable regardless of the
results of the research project. Research services may include activities in which the
Company deploys its internal capabilities such as its medicinal chemistry and screening
capabilities to assist a collaborator in advancing their drug discovery effort.
 F-11




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##### Table of Contents



ANADYS PHARMACEUTICALS, INC.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 Recent Accounting Pronouncements
 Accounting for Uncertainty in Income
Taxes, an interpretation of FASB Statement No. 109
 Fair Value Measurements
 2. Investments
  December 31, 2006UnrealizedAmortized
    
    
    
    
    
    
    
    
    
    
    MarketCost
    
    
    Gain
    
    
    Loss
    
    
    ValueU.S. Government agency securities
    
    $
    8,944
    
    
    $
    
    
    
    $
    (20
    )
    
    $
    8,924Corporate debt securities
    
    
    10,840
    
    
    
    
    
    
    
    (2
    )
    
    
    10,838$
    19,784
    
    
    $
    
    
    
    $
    (22
    )
    
    $
    19,762
 December 31, 2005UnrealizedAmortized
    
    
    
    
    
    
    
    
    
    
    MarketCost
    
    
    Gain
    
    
    Loss
    
    
    ValueU.S. Government agency securities
    
    $
    8,470
    
    
    $
    
    
    
    $
    (28
    )
    
    $
    8,442Corporate debt securities
    
    
    2,754
    
    
    
    
    
    
    
    (4
    )
    
    
    2,750$
    11,224
    
    
    $
    
    
    
    $
    (32
    )
    
    $
    11,192
  December 31, 2006UnrealizedAmortized
    
    
    
    
    
    
    
    
    
    
    MarketCost
    
    
    Gain
    
    
    Loss
    
    
    ValueWithin one year
    
    $
    9,950
    
    
    $
    
    
    
    $
    (20
    )
    
    $
    9,930After one year through three years
    
    
    9,834
    
    
    
    
    
    
    
    (2
    )
    
    
    9,832$
    19,784
    
    
    $
    
    
    
    $
    (22
    )
    
    $
    19,762
  F-12




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##### Table of Contents



ANADYS PHARMACEUTICALS, INC.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 3. Property and Equipment
  For the years ended December 31,2006
    
    
    2005Furniture and fixtures
    
    $
    68
    
    
    $
    119Equipment
    
    
    7,012
    
    
    
    8,057Computers and software
    
    
    2,141
    
    
    
    1,922Leasehold improvements
    
    
    1,829
    
    
    
    1,81811,051
    
    
    
    11,916Less accumulated depreciation and amortization
    
    
    (7,301
    )
    
    
    (8,107
    )$
    3,749
    
    
    $
    3,809
  4. Other Balance Sheet Captions
 As of December 31,2006
    
    
    2005(in thousands)Prepaid expenses and other current assets consisted of the following:Prepaid expenses
    
    $
    475
    
    
    $
    320Prepaid insurance
    
    
    195
    
    
    
    199Interest receivable
    
    
    271
    
    
    
    132$
    941
    
    
    $
    651Other assets consisted of the following:Lab compounds, net
    
    $
    127
    
    
    $
    380Deposits
    
    
    1,260
    
    
    
    1,260$
    1,387
    
    
    $
    1,640Accrued expenses consisted of the following:Accrued personnel costs
    
    $
    509
    
    
    $
    445Accrued employee bonus
    
    
    905
    
    
    
    822Accrued drug development
    
    
    1,325
    
    
    
    1,886Accrued legal and patent costs
    
    
    100
    
    
    
    301Accrued facility costs
    
    
    106
    
    
    
    105Other accrued expenses
    
    
    372
    
    
    
    304$
    3,317
    
    
    $
    3,863
 5. Debt
  F-13




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##### Table of Contents



ANADYS PHARMACEUTICALS, INC.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 6. Commitments and Contingencies
   2007
    
    $
    2,0412008
    
    
    2,1392009
    
    
    1,285Total
    
    $
    5,465
 7. Collaboration and License Agreements
  Hoffman-La Roche, Inc.
   Aphoenix, Inc.
  Novartis International Pharmaceutical Ltd.
   F-14




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##### Table of Contents



ANADYS PHARMACEUTICALS, INC.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
     LG Life Sciences, Ltd.
    Valeant Pharmaceuticals International
  F-15




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##### Table of Contents



ANADYS PHARMACEUTICALS, INC.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 Grants
  8. Stockholders Equity
 Common Stock
  Warrants
  Stock Options
      F-16




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##### Table of Contents



ANADYS PHARMACEUTICALS, INC.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
   Options Outstanding
    
    Options ExercisableWeighted
    
    Weighted
    
    
    
    
    
    WeightedRange of
    
    
    
    
    
    Average
    
    Average
    
    
    
    
    
    AverageExercise
    
    Number
    
    Remaining
    
    Exercise
    
    Number
    
    ExercisePrice
    
    Outstanding
    
    Contractual Life
    
    Price
    
    Exercisable
    
    Price$2.80-$  2.95
    
    
    1,127,884
    
    
    
    6.4
    
    
    $
    2.94
    
    
    
    903,024
    
    
    $
    2.95$2.96-$  4.36
    
    
    1,083,749
    
    
    
    9.8
    
    
    $
    3.80
    
    
    
    3,896
    
    
    $
    3.94$4.37-$  4.88
    
    
    774,651
    
    
    
    9.9
    
    
    $
    4.75
    
    
    
    125
    
    
    $
    4.60$4.89-$  7.80
    
    
    746,950
    
    
    
    7.5
    
    
    $
    6.16
    
    
    
    499,257
    
    
    $
    6.06$7.81-$  8.37
    
    
    728,459
    
    
    
    8.9
    
    
    $
    8.17
    
    
    
    333,996
    
    
    $
    8.17$8.38-$16.11
    
    
    585,487
    
    
    
    8.9
    
    
    $
    12.75
    
    
    
    109,084
    
    
    $
    11.815,047,180
    
    
    
    
    
    
    
    
    
    
    
    1,849,382
 F-17




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##### Table of Contents



Weighted-Weighted
    
    
    AverageAverage
    
    
    Remaining
    
    
    AggregateOptions
    
    
    Exercise
    
    
    Contractual
    
    
    Intrinsic ValueOutstanding
    
    
    Price
    
    
    Term
    
    
    (in thousands)Balance 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
    
    
    
    4.12Granted
    
    
    1,178,351
    
    
    
    9.13Exercised
    
    
    (222,593
    )
    
    
    3.16Cancelled
    
    
    (231,641
    )
    
    
    4.65Balance at December 31, 2005
    
    
    3,089,271
    
    
    
    6.06Granted
    
    
    2,220,900
    
    
    
    5.37Exercised
    
    
    (140,225
    )
    
    
    4.01Cancelled
    
    
    (122,766
    )
    
    
    8.14Balance at December 31, 2006
    
    
    5,047,180
    
    
    $
    5.77
    
    
    
    8.49
    
    
    $
    3,579Exercisable at December 31, 2006
    
    
    1,849,382
    
    
    $
    5.26
    
    
    
    7.16
    
    
    $
    1,783
   Adoption of SFAS No. 123R, Share-Based Payment
 Share-Based Payments,
 Year endedDecember 31, 2006Research and development expense
    
    $
    2,889General and administrative expense
    
    
    4,241Total share-based compensation expense
    
    $
    7,130Net share-based compensation expense, per common share
basic and diluted
    
    $
    0.25
  F-18




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##### Table of Contents



ANADYS PHARMACEUTICALS, INC.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
   For the years ended December 31,2006
    
    2005
    
    2004Risk-free interest rate
    
    
    4.66
    %
    
    
    4.27
    %
    
    
    3.25
    %Dividend yield
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %Volatility factors of the expected market price
of the Companys common stock
    
    
    67
    %
    
    
    67
    %
    
    
    70
    %Weighted-average expected life of option (years)
    
    
    6
    
    
    
    6
    
    
    
    5
      Pro Forma Information under SFAS No. 123 for Periods Prior to January 1, 2006
 Accounting for Stock
Appreciation Rights and Other Variable Stock Option or Award Plans
 F-19




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##### Table of Contents



ANADYS PHARMACEUTICALS, INC.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  For the years ended December 31,2005
    
    
    2004Net loss applicable to common shareholders, as reported
    
    $
    (21,923
    )
    
    $
    (33,154
    )Add: Stock-based employee compensation included in
reported net loss
    
    
    1,711
    
    
    
    4,903Deduct: Total stock-based employee compensation
determined under fair value based method for all awards
    
    
    (4,205
    )
    
    
    (3,620
    )Adjusted pro forma net loss
    
    $
    (24,417
    )
    
    $
    (31,871
    )Adjusted pro forma basic and diluted net loss per share
    
    $
    (0.99
    )
    
    $
    (1.85
    )
 Employee Stock Purchase Plan
   Shares Reserved for Issuance
  December 31, 2006Warrants
    
    
    279,078Stock options under the Companys Plans:Granted and outstanding
    
    
    5,047,180Reserved for future grant
    
    
    472,0275,798,285
 F-20




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##### Table of Contents



ANADYS PHARMACEUTICALS, INC.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 9. Income Taxes
 Accounting for Income Taxes
 For the years ended December 31,2006
    
    
    2005(in thousands)Deferred tax assets:Net operating loss carryforwards
    
    $
    40,853
    
    
    $
    35,163Research and development credits
    
    
    7,256
    
    
    
    6,614Depreciation and amortization
    
    
    1,497
    
    
    
    1,559Non-qualified stock options
    
    
    2,793
    
    
    
    1,368Capitalized research and development expense
    
    
    16,227
    
    
    
    19,322Accruals
    
    
    376
    
    
    
    435Deferred Revenue
    
    
    9,603
    
    
    
    4,016Other
    
    
    11
    
    
    
    3Total deferred tax assets
    
    
    78,616
    
    
    
    68,480Valuation allowance for deferred tax assets
    
    
    (78,616
    )
    
    
    (68,480
    )Net deferred taxes
    
    $
    
    
    
    $
    
    10. Savings Plan
  F-21




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##### Table of Contents



ANADYS PHARMACEUTICALS, INC.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 11. Unaudited Quarterly Results of Operations
  First
    
    Second
    
    Third
    
    FourthFiscal year 2006
    
    Quarter
    
    Quarter
    
    Quarter
    
    Quarter(in thousands, expect net loss per share)Revenues
    
    $
    1,542
    
    
    $
    1,582
    
    
    $
    1,145
    
    
    $
    1,151Net loss
    
    
    (5,805
    )
    
    
    (7,078
    )
    
    
    (6,259
    )
    
    
    (7,618
    )Basic and diluted net loss per share
    
    
    (0.20
    )
    
    
    (0.25
    )
    
    
    (0.22
    )
    
    
    (0.27
    )
 First
    
    Second
    
    Third
    
    FourthFiscal year 2005
    
    Quarter
    
    Quarter
    
    Quarter
    
    Quarter(in thousands, expect net loss per share)Revenues
    
    $
    563
    
    
    $
    581
    
    
    $
    1,737
    
    
    $
    2,006Net loss attributable to common shareholders
    
    
    (8,383
    )
    
    
    (7,058
    )
    
    
    (3,414
    )
    
    
    (3,068
    )Basic and diluted net loss per share
    
    
    (0.38
    )
    
    
    (0.31
    )
    
    
    (0.13
    )
    
    
    (0.11
    )
 F-22