**Table of Contents**

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**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

** **

**FORM 10-Q**

 
| **x** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|--------------------------------------------------------------------------------------------------------|

 

**For thequarterly period ended September 30, 2008.**

 

**OR**

 
| **o** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|---------------------------------------------------------------------------------------------------------|

 

**For thetransition periodfrom                 to                 .**

 

**Commission file number 000-50785**

 

**METABASIS THERAPEUTICS, INC.**

(Exact name of registrant as specified in itscharter)

 

| **Delaware**                              | ** ** | **33-0753322**       |
|-------------------------------------------|------------|----------------------|
| (State or other  jurisdiction of          |       | (I.R.S. Employer     |
| incorporation or  organization)           |       | Identification  No.) |
| ** **                                | ** ** | ** **           |
| **11119  North Torrey Pines Road,**       | ** ** | ** **           |
| **La  Jolla, CA**                         | ** ** | **92037**            |
| (Address of  principal executive offices) |       | (Zip code)           |

 

**(858)587-2770**

(Registrant’s telephonenumber, including area code)

 

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

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, a non-accelerated filer, or asmaller reporting company. See the definitions of “large accelerated filer,” “acceleratedfiler” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.(Check one):

 
| Large  accelerated filer  o          |   | Accelerated  filer  o         |   |
|------------------------------------------------|--------|-----------------------------------------|--------|
|                                           |   |                                    |   |
| Non-accelerated  filer  o            |   | Smaller  reporting company  x |   |
| (Do not check if  a smaller reporting company) |   |                                    |   |

 

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

 

The number of outstanding shares of the registrant’scommon stock, par value $0.001 per share, as of November 6, 2008 was35,043,026.

 

 

 

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**METABASIS THERAPEUTICS, INC.**

 

**FORM 10-Q**

**FOR THE QUARTERLY PERIOD ENDED September 30, 2008**

 

**TABLE OF CONTENTS**

 
| PART I—FINANCIAL  INFORMATION                                                                    | 2      |
|------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                       |   |
| Item 1. Financial Statements                                                                               | 2      |
|                                                                                                       |   |
| Balance Sheets at September 30, 2008 (Unaudited)  and December 31, 2007                          | 2      |
|                                                                                                       |   |
| Statements of Operations for the three and nine months  ended September 30, 2008 and 2007 (Unaudited) | 3      |
|                                                                                                       |   |
| Statements of Cash Flows for the nine months ended  September 30, 2008 and 2007 (Unaudited)           | 4      |
|                                                                                                       |   |
| Notes to Financial Statements (Unaudited)                                                                  | 5      |
|                                                                                                       |   |
| Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations        | 9      |
|                                                                                                       |   |
| Item 3. Quantitative and Qualitative Disclosures About  Market Risk                                        | 18     |
|                                                                                                       |   |
| Item 4. Controls and Procedures                                                                            | 18     |
|                                                                                                       |   |
| PART II—OTHER  INFORMATION                                                                       | 19     |
|                                                                                                       |   |
| Item  1. Legal Proceedings                                                                                 | 19     |
|                                                                                                       |   |
| Item 1A. Risk Factors                                                                                      | 19     |
|                                                                                                       |   |
| Item 2. Unregistered Sales of Equity Securities and  Use of Proceeds                                       | 39     |
|                                                                                                       |   |
| Item 3. Defaults Upon Senior Securities                                                                    | 39     |
|                                                                                                       |   |
| Item 4. Submission of Matters to a Vote of Security  Holders                                               | 39     |
|                                                                                                       |   |
| Item  5. Other Information                                                                                 | 39     |
|                                                                                                       |   |
| Item 6. Exhibits                                                                                           | 40     |
|                                                                                                       |   |
| SIGNATURES                                                                                                 |   |

 

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**PART I - FINANCIALINFORMATION**

 

**Item 1. Financial Statements**

 

**Metabasis Therapeutics, Inc.**

**Balance Sheets**

**(In thousands, except par value data)**

 
| ** **                                                                                                                                                                                                                              | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                              | ** ** | **2008**               | ** ** | **2007**              | ** ** |
|                                                                                                                                                                                                                                    |       | **(Unaudited)**        |       |                  |       |
| **Assets**                                                                                                                                                                                                                              |       |                   |       |                  |       |
| Current assets:                                                                                                                                                                                                                         |       |                   |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                                                               |       | $                      | 17,109     |                  | $          | 14,141 |   |
| Securities available-for-sale                                                                                                                                                                                                           |       | 15,673                 |       | 28,297                |       |
| Prepaids and other current assets                                                                                                                                                                                                       |       | 1,369                  |       | 1,157                 |       |
| Total current assets                                                                                                                                                                                                                    |       | 34,151                 |       | 43,595                |       |
|                                                                                                                                                                                                                                    |       |                   |       |                  |       |
| Property and equipment, net                                                                                                                                                                                                             |       | 5,285                  |       | 6,356                 |       |
| Other assets                                                                                                                                                                                                                            |       | 297                    |       | 172                   |       |
| Total assets                                                                                                                                                                                                                            |       | $                      | 39,733     |                  | $          | 50,123 |   |
|                                                                                                                                                                                                                                    |       |                   |       |                  |       |
| **Liabilities and stockholders’ equity**                                                                                                                                                                                           |       |                   |       |                  |       |
| Current liabilities:                                                                                                                                                                                                                    |       |                   |       |                  |       |
| Accounts payable                                                                                                                                                                                                                        |       | $                      | 662        |                  | $          | 802 |   |
| Accrued compensation                                                                                                                                                                                                                    |       | 3,018                  |       | 3,181                 |       |
| Accrued liabilities                                                                                                                                                                                                                     |       | 2,142                  |       | 4,132                 |       |
| Deferred revenue, current portion                                                                                                                                                                                                       |       | 5,721                  |       | 1,321                 |       |
| Current portion of long-term debt                                                                                                                                                                                                       |       | 3,717                  |       | 2,068                 |       |
| Current portion of capital lease obligations                                                                                                                                                                                            |       | 26                     |       | 23                    |       |
| Total current liabilities                                                                                                                                                                                                               |       | 15,286                 |       | 11,527                |       |
|                                                                                                                                                                                                                                    |       |                   |       |                  |       |
| Deferred revenue, net of current portion                                                                                                                                                                                                |       | 3,458                  |       | —                |       |
| Deferred rent                                                                                                                                                                                                                           |       | 2,964                  |       | 2,595                 |       |
| Long-term debt                                                                                                                                                                                                                          |       | 5,634                  |       | 3,845                 |       |
| Capital lease obligations, net of current portion                                                                                                                                                                                       |       | 33                     |       | 55                    |       |
| Other long-term liabilities                                                                                                                                                                                                             |       | 200                    |       | —                |       |
| Total liabilities                                                                                                                                                                                                                       |       | 27,575                 |       | 18,022                |       |
|                                                                                                                                                                                                                                    |       |                   |       |                  |       |
| Stockholders’ equity:                                                                                                                                                                                                              |       |                   |       |                  |       |
| Preferred stock, $0.001 par value; 5,000 shares authorized at  September 30, 2008 and December 31, 2007, no shares issued or  outstanding                                                                                     |       | —                 |       | —                |       |
| Common stock, $0.001 par value; 100,000 shares authorized at  September 30, 2008 and December 31, 2007; 35,043 and 30,754 shares issued  and outstanding at September 30, 2008 and December 31, 2007,  respectively |       | 35                     |       | 31                    |       |
| Additional paid-in capital                                                                                                                                                                                                              |       | 194,576                |       | 182,003               |       |
| Accumulated deficit                                                                                                                                                                                                                     |       | (182,488               | )          | (150,012              | )          |
| Accumulated other comprehensive loss                                                                                                                                                                                                    |       | 35                     |       | 79                    |       |
| Total stockholders’ equity                                                                                                                                                                                                         |       | 12,158                 |       | 32,101                |       |
|                                                                                                                                                                                                                                    |       |                   |       |                  |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                         |       | $                      | 39,733     |                  | $          | 50,123 |   |

 

*Seeaccompanying notes.*

 

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**Metabasis Therapeutics, Inc.**

**Statements of Operations**

**(In thousands, except per sharedata)**

**(Unaudited)**

 
| ** **                                                  | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                  | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                                  | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                        |       |                             |       |                            |       |   |   |   |   |
| Revenues:                                                   |       |                             |       |                            |       |   |   |   |   |
| Sponsored research                                          |       | $                                | 659        |                            | $          | 937 |   | $ | 1,698 |   | $ | 2,813 |   |
| License fees                                                |       | 743                              |       | 1,417                           |       | 1,333 |   | 4,550 |   |
| Other revenue                                               |       | —                           |       | 299                             |       | — |   | 320 |   |
| Total revenues                                              |       | 1,402                            |       | 2,653                           |       | 3,031 |   | 7,683 |   |
|                                                        |       |                             |       |                            |       |   |   |   |   |
| Operating expenses:                                         |       |                             |       |                            |       |   |   |   |   |
| Research and development                                    |       | 8,480                            |       | 10,866                          |       | 27,892 |   | 31,437 |   |
| General and administrative                                  |       | 2,659                            |       | 2,834                           |       | 7,747 |   | 9,284 |   |
| Total operating expenses                                    |       | 11,139                           |       | 13,700                          |       | 35,639 |   | 40,721 |   |
|                                                        |       |                             |       |                            |       |   |   |   |   |
| Loss from operations                                        |       | (9,737                           | )          | (11,047                         | )          | (32,608 | ) | (33,038 | ) |
| Other income (expense):                                     |       |                             |       |                            |       |   |   |   |   |
| Interest income                                             |       | 169                              |       | 708                             |       | 812 |   | 2,522 |   |
| Interest expense                                            |       | (266                             | )          | (141                            | )          | (680 | ) | (405 | ) |
| Total other (expense) income                                |       | (97                              | )          | 567                             |       | 132 |   | 2,117 |   |
|                                                        |       |                             |       |                            |       |   |   |   |   |
| Net loss                                                    |       | $                                | (9,834     | )                               | $          | (10,480 | ) | $ | (32,476 | ) | $ | (30,921 | ) |
|                                                        |       |                             |       |                            |       |   |   |   |   |
| Basic and diluted net loss per share                        |       | $                                | (0.28      | )                               | $          | (0.34 | ) | $ | (0.97 | ) | $ | (1.01 | ) |
| Shares used to compute basic and diluted net loss per share |       | 35,042                           |       | 30,650                          |       | 33,354 |   | 30,552 |   |

 

*Seeaccompanying notes.*

 

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**Metabasis Therapeutics, Inc.**

**Statements of Cash Flows**

**(In thousands)**

**(Unaudited)**

** **
| ** **                                                                   | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                   | ** ** | **September 30,**          | ** ** |
| ** **                                                                   | ** ** | **2008**                        | ** ** | **2007** | ** ** |
| **Operating activities**                                                     |       |                            |       |   |   |
| Net loss                                                                     |       | $                               | (32,476    | ) | $ | (30,921 | ) |
| Adjustments to reconcile net loss to net cash used in operating  activities: |       |                            |       |   |   |
| Stock-based compensation                                                     |       | 2,904                           |       | 3,938 |   |
| Depreciation and amortization                                                |       | 1,558                           |       | 1,496 |   |
| Deferred rent                                                                |       | 369                             |       | 847 |   |
| Amortization of discount and premium on securities available-for-sale        |       | (407                            | )          | (1,883 | ) |
| Loss on disposal of assets                                                   |       | 29                              |       | — |   |
| Realized gain on securities available-for-sale                               |       | (7                              | )          | — |   |
| Change in operating assets and liabilities:                                  |       |                            |       |   |   |
| Trade accounts receivable                                                    |       | 61                              |       | (225 | ) |
| Other current assets                                                         |       | (273                            | )          | (94 | ) |
| Other assets                                                                 |       | 75                              |       | 5 |   |
| Deferred revenue                                                             |       | 7,858                           |       | (2,751 | ) |
| Accounts payable                                                             |       | (140                            | )          | (502 | ) |
| Accrued compensation and other liabilities                                   |       | (2,153                          | )          | 2,571 |   |
| Net cash flows used in operating activities                                  |       | (22,602                         | )          | (27,519 | ) |
|                                                                         |       |                            |       |   |   |
| **Investing activities**                                                     |       |                            |       |   |   |
| Purchases of securities available-for-sale                                   |       | (24,498                         | )          | (63,977 | ) |
| Sales/maturities of securities available-for-sale                            |       | 37,492                          |       | 93,707 |   |
| Purchases of property and equipment                                          |       | (516                            | )          | (2,094 | ) |
| Net cash flows provided by investing activities                              |       | 12,478                          |       | 27,636 |   |
|                                                                         |       |                            |       |   |   |
| **Financing activities**                                                     |       |                            |       |   |   |
| Issuance of common stock, net                                                |       | 9,673                           |       | 425 |   |
| Principal payments on debt and capital lease obligations                     |       | (1,581                          | )          | (1,447 | ) |
| Proceeds received from debt                                                  |       | 5,000                           |       | 2,047 |   |
| Net cash flows provided by financing activities                              |       | 13,092                          |       | 1,025 |   |
| Increase in cash and cash equivalents                                        |       | 2,968                           |       | 1,142 |   |
| Cash and cash equivalents at beginning of year                               |       | 14,141                          |       | 12,052 |   |
| Cash and cash equivalents at end of period                                   |       | $                               | 17,109     |   | $ | 13,194 |   |
|                                                                         |       |                            |       |   |   |
| **Supplemental schedule of noncash investing and  financing activities:**    |       |                            |       |   |   |
| Accrued debt issuance costs                                                  |       | $                               | 200        |   | $ | — |   |
|                                                                         |       |                            |       |   |   |
| Unrealized (loss) gain on securities available-for-sale                      |       | $                               | (44        | ) | $ | 55 |   |
|                                                                         |       |                            |       |   |   |
| Net share settlement of warrant                                              |       | $                               | —     |   | $ | 56 |   |

 

*Seeaccompanying notes.*

 

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**Metabasis Therapeutics, Inc.**

**Notes to FinancialStatements**

**(Unaudited)**

 

**1.****                                     ****Basis of Presentation**

 

The accompanying unaudited financial statements havebeen prepared in accordance with U.S. generally accepted accounting principles(“GAAP”) and with the rules and regulations of the Securities and ExchangeCommission (“SEC”) related to a quarterly report on Form 10-Q.Accordingly, they do not include all of the information and disclosuresrequired by GAAP for complete financial statements. The balance sheet at December 31,2007 has been derived from the audited financial statements at that date butdoes not include all information and footnotes required by GAAP for completefinancial statements. The interim financial statements reflect all adjustmentswhich, in the opinion of management, are necessary for a fair presentation ofthe financial condition and results of operations for the periods presented.Except as otherwise disclosed, all such adjustments are of a normal recurringnature.

 

Operating results for the three and nine monthsended September 30, 2008 are not necessarily indicative of the resultsthat may be expected for the year ending December 31, 2008. For furtherinformation, see the financial statements and notes thereto for the year ended December 31,2007 included in our annual report on Form 10-K filed with the SEC.

 

The preparation of financial statements inconformity with GAAP requires management to make estimates and assumptions thataffect the reported amounts of assets and liabilities as well as disclosures ofcontingent assets and liabilities at the date of the financial statements.Estimates also affect the reported amounts of revenues and expenses during thereporting period. Actual results could differ from those estimates.

 

The terms “Company” and “we” and “our” are used inthis report to refer to Metabasis Therapeutics, Inc.

 

**2.****                                     ****ComprehensiveLoss**

 

Statement of Financial Accounting Standard (“SFAS”) No. 130,*Reporting Comprehensive Income*, requiresthat all components of comprehensive income (loss), including net loss, bereported in the financial statements in the period in which they arerecognized. Comprehensive income (loss) is defined as the change in equityduring a period from transactions and other events and circumstances fromnon-owner sources. The Company’s comprehensive loss is as follows (inthousands):

 
| ** **                                               | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                               | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                               | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                     |       |                             |       |                            |       |   |   |   |   |
| Net loss                                                 |       | $                                | (9,834     | )                               | $          | (10,480 | ) | $ | (32,476 | ) | $ | (30,921 | ) |
| Unrealized gain (loss) on available-for-sale investments |       | 10                               |       | 35                              |       | (44 | ) | 55 |   |
| Comprehensive loss                                       |       | $                                | (9,824     | )                               | $          | (10,445 | ) | $ | (32,520 | ) | $ | (30,866 | ) |

 

**3.****                                     ****NetLoss Per Share**

 

The Companycalculates net loss per share in accordance with SFAS No. 128, *Earnings Per Share*. Basic earnings per share (“EPS”) iscalculated by dividing the net loss by the weighted average number of commonshares outstanding for the period, without consideration for common stockequivalents. Diluted EPS is computed by dividing the net loss by the weightedaverage number of common share equivalents outstanding for the perioddetermined using the treasury-stock method. For purposes of this calculation,common stock subject to repurchase by the Company, options and warrants areconsidered to be common stock equivalents and are only included in thecalculation of diluted EPS when their effect is dilutive. The totalnumber of shares issuable upon exercise of stock options and warrants excludedfrom the calculation of diluted EPS since they are anti-dilutive were 7,906,668and 7,575,946 for the three months ended September 30, 2008 and 2007,respectively, and 7,580,525 and 7,262,816 for the nine months ended September 30,2008 and 2007, respectively.

 

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| ** **                                                    | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                    | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                                    | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Actual:**                                                   |       |                             |       |                            |       |   |   |   |   |
| *Numerator:*                                                  |       |                             |       |                            |       |   |   |   |   |
| Net loss                                                      |       | $                                | (9,834     | )                               | $          | (10,480 | ) | $ | (32,476 | ) | $ | (30,921 | ) |
| *Denominator:*                                                |       |                             |       |                            |       |   |   |   |   |
| Weighted average common shares                                |       | 35,042                           |       | 30,652                          |       | 33,354 |   | 30,573 |   |
| Weighted average unvested common shares subject to repurchase |       | —                           |       | (2                              | )          | — |   | (21 | ) |
| Denominator for basic and diluted net loss per share          |       | 35,042                           |       | 30,650                          |       | 33,354 |   | 30,552 |   |
| Basic and diluted net loss per share                          |       | $                                | (0.28      | )                               | $          | (0.34 | ) | $ | (0.97 | ) | $ | (1.01 | ) |

 

**4.****                                     ****FairValue of Financial Instruments**

 

In September 2006, theFinancial Accounting Standards Board (the “FASB”) issued SFAS No. 157, *Fair Value Measurements* (“SFAS No. 157”). Thisstatement provides a definition of fair value, establishes a hierarchy formeasuring fair value in GAAP, and requires certain disclosures about fairvalues used in financial statements. This statement does not extend the use of fair value beyond what iscurrently required by other pronouncements, and it does not pertain tostock-based compensation under SFAS No. 123(R), *Share-BasedPayment,* or to leases under SFAS No. 13, *Accountingfor Leases.*

 

This statement was effectivefor financial statements issued for fiscal years beginning after November 15,2007 (beginning with the Company’s 2008 fiscal year), although earlierapplication was encouraged.

 

On February 14, 2008,FASB Staff Position (“FSP”) FAS 157-2, *Effective Date of FASBStatement No. 157* (“FSP FAS 157-2”), was issued.  FSP FAS 157-2 defers application of SFAS No. 157for non-financial assets and liabilities to years beginning after November 15,2008 (beginning with the Company’s 2009 fiscal year).  As a result, the Company is only partiallyadopting SFAS No. 157 as it relates to the Company’s financial assets and liabilitiesuntil it is required to apply this pronouncement to its non-financial assetsand liabilities beginning with fiscal year 2009.

 

The Company applies fair value accounting to itssecurities available-for-sale in accordance with SFAS No. 115, *Accounting for Certain Investments in Debt and Equity Securities*(“SFAS No. 115”)*. *These securities consist oftreasury backed money market funds, corporate bonds and commercial paper.  Due to the current market conditions, theCompany no longer invests in asset backed securities.  The following table shows the fair valuemeasurement for its financial assets at September 30, 2008 and the fairvalue hierarchy level, as defined in SFAS No. 157.

 
| ** **                    | ** ** | **Fair Value Measurements** | ** ** |
|-------------------------------|------------|---------------------------------------|------------|
| ** **                    | ** ** | **(in thousands)**               | ** ** |
| ** **                    | ** ** | **Asset**                             | ** ** | **Quoted Prices in  Active Markets  for Identical  Assets** | ** ** | **Significant  Other  Observable  Inputs** | ** ** | **Significant  Unobservable  Inputs** | ** ** |
| **Description**               | ** ** | **Total**                             | ** ** | **(Level 1)** | ** ** | **(Level 2)** | ** ** | **(Level 3)** | ** ** |
| Securities available-for-sale |       | $                                     | 15,673     |   | $ | 15,673 |   | $ | — |   | $ | — |   |
|                               |            |                                       |            |  |  |  |  |  |  |  |  |  |  |

 

Asset classes that fall within the Level 1 fairvalue hierarchy are those assets whose fair value assumptions are based onmarket data obtained from sources independent of the Company (observableinputs).  Level 1 observable inputs arequoted prices for identical items in active markets that the Company has accessto at the measurement date.

 

Asset classes that fall within the Level 2 fairvalue hierarchy are those assets whose fair value assumptions are also based onindependent market data.  Level 2observable inputs are quoted prices for similar items in active markets orquoted prices for identical or similar items in inactive markets.  An inactive market is one where there are fewtransactions, the prices are not current, price quotations vary substantiallyover time or among market makers or where little information is releasedpublicly.

 

Assetclasses that fall within the Level 3 fair value hierarchy are those assetswhose fair value assumptions are based on the Company’s own information.

 

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In February 2007, theFASB issued SFAS No. 159, *The FairValue Option for Financial Assets and Financial Liabilities, including anamendment of SFAS No. 115*(“SFAS No. 159”).  SFAS No. 159expands the use of fair value accounting but does not affect existing standardsthat require assets or liabilities to be carried at fair value. Under SFAS No. 159,a company may elect to use fair value to measure accounts and loans receivable,available-for-sale and held-to-maturity securities, equity method investments,accounts payable, guarantees and issued debt. Other eligible items include firmcommitments for financial instruments that otherwise would not be recognized atinception and non-cash warranty obligations where a warrantor is permitted topay a third party to provide the warranty goods or services. If the use of fairvalue is elected, any upfront costs and fees related to the item must berecognized in earnings and cannot be deferred, such as debt issuance costs. Thefair value election is irrevocable and generally made on aninstrument-by-instrument basis, even if a company has similar instruments thatit elects not to measure based on fair value. At the adoption date, unrealizedgains and losses on existing items for which fair value has been elected arereported as a cumulative adjustment to beginning retained earnings. Subsequentto the adoption of SFAS No. 159, changes in fair value are recognized inearnings. SFAS No. 159 was effective for fiscal years beginning after November 15,2007 (beginning with the Company’s 2008 fiscal year).

 

The Company considers the carrying amount of cash and cashequivalents, prepaid expenses and other current assets, securitiesavailable-for-sale, accounts receivable, accounts payable, accrued liabilitiesand deferred revenue to be representative of their respective fair valuesbecause of the short-term nature of those instruments. Based on the borrowingrates currently available to the Company for loans with similar terms,management believes the fair value of the long-term obligations approximatetheir carrying value.  Therefore, theCompany has elected not to apply the fair value option to these financialassets and liabilities under SFAS No. 159. However, the Company does apply fair value accounting to its securitiesavailable-for-sale in accordance with SFAS No. 115.

 

Realized gains and lossesand declines in value judged to be other-than-temporary, if any, on available-for-salesecurities are included in other income. The cost of securities sold is basedon the specific-identification method. Interest and dividends on securitiesclassified as available-for-sale are included in interest income.  Total realized gains from fair value changesincluded in earnings for the three and nine months ended September 30,2008 were immaterial.  There were nocumulative adjustments to beginning retained earnings as a result of adoptingSFAS No. 159.

 

**5.****                                     ****CollaborationAgreements**

 

In September 2008, the Company, ValeantPharmaceuticals North America (“Valeant”) and Schering Corporation (“Schering”)entered into an agreement (the “Amendment Agreement”) to amend certain terms ofthe Assignment and Assumption Agreement, dated January 9, 2007 (the “AssignmentAgreement”) and the Termination Agreement, dated September 19, 2007 (the “TerminationAgreement”), each entered into by Valeant, Schering and the Company. Pursuant to the Amendment Agreement, among other things, the AssignmentAgreement was amended to provide for a reduction in the total number and valueof milestone payments payable by the Company to Valeant upon the achievement ofcertain specified events to a single milestone payment due upon the firstregulatory approval of pradefovir, and to reduce certain royalty payments duefrom the Company to Valeant upon commercialization of pradefovir. In addition,the Termination Agreement was amended to transfer certain patient registryobligations, should they be required, to the Company from Valeant (excludingthe cost thereof, up to a specified limit). The Company does not anticipate incurring any costs related to theAmendment Agreement.

 

In August 2008, theCompany entered into a two-year Research Collaboration and License Agreementwith Hoffmann-La Roche Inc., F. Hoffmann-La Roche LTD and Roche Palo Alto LLC(collectively, “Roche”).  Under the termsof the Roche agreement, the Company’s HepDirect liver-targeted technology willbe applied to proprietary Roche compounds to develop second-generationnucleoside analog drug candidates for treating hepatitis C virus.  The Company received an upfront payment of$10.0 million from Roche in August 2008. Roche may also pay up to $2.1 million in sponsored research funding atthe beginning of the second year of the research term, if applicable.  In the event a development candidate isidentified, Roche will assume development responsibility and the Company willbe eligible to receive up to $193 million in additional payments uponachievement of predetermined preclinical and clinical development events aswell as regulatory and commercialization events.  Roche will retain full commercial rights forany marketed products resulting from the collaboration and will pay the Companya royalty on net sales of such products.

 

Pursuant to SEC StaffAccounting Bulletin No. 104, *Revenue Recognition,*and Emerging Issues Task Force (“EITF”) Issue No. 00-21, *Revenue Arrangements with Multiple Deliverables,* the Companyhas determined that the $10.0 million upfront payment should be accounted foras a single unit of accounting with two deliverables: access to the licensedtechnology over the two-year research term and research and developmentservices over the first year of the research term.  The $10.0 million payment shall be allocatedto each deliverable based on its relative fair value and shall be deferred andrecognized over each deliverable’s period of performance.  If Roche pays up to an additional $2.1million for sponsored research at the beginning of the second year of theresearch term, such amounts would also be deferred and recognized over thesecond year of the research term as earned. Amounts attributable to any milestone payments or royalties will berecognized as earned.

 

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**6.****                                     ****RecentAccounting Pronouncements**

 

In June 2007, the EITFissued EITF Issue No. 07-3, *Accountingfor Nonrefundable Advance Payments for Goods or Services to be Used in FutureResearch and Development Activities* (“EITF Issue No. 07-3”). The consensus requires companiesto defer and capitalize prepaid, nonrefundable research and developmentpayments to third parties over the period that the research and developmentactivities are performed or the services are provided, subject to an assessmentof recoverability. EITF Issue No. 07-3 is effective for new contractsentered into in fiscal years beginning after December 15, 2007, includinginterim periods within those fiscal years. The adoption of EITF Issue No. 07-3did not have a material impact on the Company’s financial statements.

 

In November 2007, the EITF issued EITF Issue No. 07-1, *Accounting for Collaborative Arrangements Related tothe Development and Commercialization of Intellectual Property* (“EITF Issue No. 07-1”)*.* Companies may enter intoarrangements with other companies to jointly develop, manufacture, distributeand market a product. Often the activities associated with these arrangementsare conducted by the collaborators without the creation of a separate legalentity (that is, the arrangement is operated as a “virtual joint venture”). Thearrangements generally provide that the collaborators will share, based oncontractually defined calculations, the profits or losses from the associatedactivities. Periodically, the collaborators share financial information relatedto product revenues generated (if any) and costs incurred that may trigger asharing payment for the combined profits or losses. The consensus requirescollaborators in such an arrangement to present the result of activities forwhich they act as the principal on a gross basis and report any paymentsreceived from (made to) other collaborators based on other applicable GAAP or,in the absence of other applicable GAAP, based on analogy to authoritativeaccounting literature or a reasonable, rational and consistently appliedaccounting policy election. EITF Issue No. 07-1 is effective forcollaborative arrangements already in place at the beginning of the annualperiod beginning after December 15, 2008 (beginning with our 2009 fiscalyear), and retrospective application of EITF Issue No. 07-1 to all priorperiods presented should be reported as a change in accounting principle. TheCompany is in the process of determining the effect, if any, the adoption ofEITF Issue No. 07-1 will have on its financial statements.

 

In December 2007,the FASB issued SFAS No. 141(R), *Business Combinations*(“SFAS No. 141(R)”).  SFAS No. 141(R) replacesSFAS No. 141. SFAS No. 141(R) requires the acquirer of abusiness to recognize and measure the identifiable assets acquired, theliabilities assumed and any non-controlling interest in the acquiree at fairvalue. SFAS No. 141(R) also requires transaction costs related to thebusiness combination to be expensed as incurred. SFAS No. 141(R) appliesprospectively to business combinations for which the acquisition date is on orafter the beginning of the first annual reporting period beginning on or after December 15,2008 (the Company’s 2009 fiscal year). The adoption of SFAS No. 141(R) isnot expected to  have a material impacton the Company’s financial statements.

 

In May 2008,the FASB issued SFAS No. 162, *The Hierarchy of GenerallyAccepted Accounting Principles* (“SFAS No. 162”).  SFAS No. 162 identifies the sources ofaccounting principles and provides entities with a framework for selecting theprinciples used in preparation of financial statements that are presented inconformity with GAAP. The current GAAP hierarchy has been criticized because itis directed to the auditor rather than the entity, it is complex and it ranksFASB Statements of Financial Accounting Concepts, which are subject to the samelevel of due process as FASB SFAS, below industry practices that are widelyrecognized as generally accepted but that are not subject to due process. TheFASB believes the GAAP hierarchy should be directed to entities because it isthe entity (not its auditors) that is responsible for selecting accountingprinciples for financial statements that are presented in conformity with GAAP. SFAS No. 162is effective 60 days following the SEC’s approval of the Public CompanyAccounting Oversight Board amendments to AU Section 411, *The Meaning of**Present Fairlyin Conformity With Generally Accepted Accounting Principles*.  The adoption of SFAS No. 162 is notexpected to have a material impact on the Company’s financial statements.

 

In June 2008,the EITF issued EITF No. 08-3, *Accounting by Lessees forMaintenance Deposits under Lease Agreements*(“EITF No. 08-3”).  Under certain lease arrangements, the lesseeis contractually responsible for repair and maintenance of the leased asset,and the lessee is required to make deposits with the lessor to fund that maintenance.  The deposit is refunded to the lessee only tothe extent that the lessee incurs qualified maintenance costs.  Questions have arisen as to the properaccounting for these deposits as some companies account for the maintenancedeposits as deposits, while other companies account for them as contingentrental expense.  EITF No. 08-3concludes that maintenance deposits should be considered deposits when paid tothe lessor if it is probable that the deposits will be refunded to thelessee.  If it is not probable, then thedeposits are recognized as rental expense. If it is determined at the inception of the lease that a portion of thedeposits is not probable of being refunded to the lessee, then the lesseeshould recognize as expense a pro-rata portion of the deposits as they arepaid.  The cost of maintenance activitiesshould be expensed or capitalized, as appropriate.  The definition of “probable” will fall underthe guidance of FASB Concept Statement No. 6, *Elements ofFinancial Statements.*  EITF No. 08-3is effective for fiscal years beginning after December 15, 2008 (beginningwith the Company’s fiscal year 2009). Early application is not permitted. The adoption of EITF No. 08-3 is not expected to have a materialimpact on the Company’s financial statements.

 

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## **Item 2.Management’s Discussion and Analysis of Financial Condition and Results ofOperations**

##  

*You should read the followingdiscussion and analysis together with our unaudited financial statements andthe notes to those statements included elsewhere in this quarterly report on Form 10-Q,as well as our audited financial statements and notes to those statements as ofand for the year ended December 31, 2007 included in our annual report on Form 10-Kfiled with the Securities and Exchange Commission on March 17, 2008. Thisdiscussion contains forward-looking statements that involve risks anduncertainties. As a result of many factors, such as those set forth under “RiskFactors” and elsewhere in this quarterly report on Form 10-Q and in ourother filings with the Securities and Exchange Commission, our actual resultsmay differ materially from those anticipated in these forward-lookingstatements. Readers are cautioned not to place undue reliance onforward-looking statements. The forward-looking statements speak only as of thedate on which they are made, and we undertake no obligation to update such statementsto reflect events that occur or circumstances that exist after the date onwhich they are made.*

 

**Overview**

 

We are a biopharmaceutical company focused on discovering, developingand commercializing novel drugs by applying our proprietary technologies,scientific expertise and unique capabilities for targeting the liver and liverpathways. We have established a broad pipeline of product candidates andadvanced research programs targeting large markets with significant unmetneeds. Our product pipeline includes product candidates and advanced researchprograms for the treatment of metabolic diseases such as diabetes andhyperlipidemia, which we refer to as our “core assets,” as well as productcandidates and advanced research programs for the treatment of liver diseasessuch as hepatitis and primary liver cancer, which we refer to as our “non-coreassets.” All of our product candidates were developed internally using ourproprietary technologies.

 

We currently have four product candidates at the clinical stage ofdevelopment. These product candidates include our core metabolic diseaseproduct candidates, MB07803 and MB07811, which are being developed as potentialtreatments for type 2 diabetes and hyperlipidemia, respectively, and ournon-core liver disease product candidates, pradefovir and MB07133, which havebeen developed as potential treatments for hepatitis B and primary livercancer, respectively.  In addition, ourcore assets include our glucagon antagonist program, which is in the advancedresearch stage of development for the treatment of diabetes.

 

*RecentEvents*

 

InSeptember 2008, we, Valeant Pharmaceuticals North America, or Valeant, andSchering Corporation, or Schering, entered into an agreement, or the AmendmentAgreement, to amend certain terms of the Assignment and Assumption Agreement,dated January 9, 2007, or the Assignment Agreement, and the TerminationAgreement, dated September 19, 2007, or the Termination Agreement, eachentered into by Valeant, Schering and us.  Pursuant to the AmendmentAgreement, among other things, the Assignment Agreement was amended to providefor a reduction in the total number and value of milestone payments payable byus to Valeant upon the achievement of certain specified events to a singlemilestone payment due upon the first regulatory approval of pradefovir, and toreduce certain royalty payments due from us to Valeant upon commercializationof pradefovir. In addition, the Termination Agreement was amended to transfercertain patient registry obligations, should they be required, to us fromValeant (excluding the cost thereof, up to a specified limit).  We do not anticipate incurring any costsrelated to the Amendment Agreement.

 

InAugust 2008, we entered into a two-year Research Collaboration Agreementwith Hoffman-La Roche Inc., F. Hoffman-La Roche LTD and Roche Palo Alto LLC,collectively referred to as Roche.  Under the terms of the Rocheagreement, Metabasis’ HepDirect liver-targeting technology will be applied toproprietary Roche compounds to develop second-generation nucleoside analog drugcandidates for the treatment of hepatitis C virus. We received an upfrontpayment of $10.0 million from Roche in August 2008. In the event adevelopment candidate is identified, Roche will assume development responsibilityand we will be eligible to receive up to $193 million in additional paymentsupon achievement of predetermined preclinical and clinical development eventsas well as regulatory and commercialization events.  Roche will retain full commercial rights forany marketed products resulting from the collaboration and will pay us aroyalty on net sales of such products.

 

*StrategicPlan*

 

Under our strategic plan we are focusing our internal resourcesprimarily on our clinical and advanced research core metabolic diseaseprograms. This includes funding the further clinical evaluation of our coreassets, MB07803 and MB07811, with a focus on achieving key milestones.Continued development of these core assets thereafter will require significantresources. Therefore, we plan to establish strategic collaborations for thesecore assets at appropriate times to secure additional resources, accelerateprogress and share risk. In addition, we plan to advance additional metabolicdisease product candidates discovered by our research group into clinicaldevelopment either independently, or with current or future strategiccollaborators.

 

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In order to reduce future expenses and to minimize the potentialdilution associated with financing internal development, we intend to licenseour glucagon antagonist program, pradefovir and MB07133 for further developmentand commercialization for upfront fees, milestones and royalties on futuresales, if any, or we may directly sell these assets. If we are unsuccessful inmonetizing these assets, we may be required to raise additional capital byissuing securities or obtaining debt financing, or consider other strategicalternatives. The recent global financial crisis and other current negativemacroeconomic indicators may negatively impact our ability to issue securities or obtain debtfinancing.Given theeconomic and corporate uncertainties, the Company is planning to institutevarious cost saving measures to be announced when final decisions are made.

 

*History of Losses, Prior Funding*

 

We have incurred annual net losses since inception. Asof September 30, 2008, our accumulated deficit was approximately $182.5million. We expect to incur losses for the next several years as we:

 

·                  continue to develop ourcurrent and future core metabolic disease clinical development candidates,

 

·                  participate in thecommercialization of our product candidates, if any, that receive regulatoryapproval and for which we retain commercialization rights, and

 

·                  continue our research anddevelopment programs.

 

We have a limited history of operations and, to date, we have notgenerated any product revenues. In addition to our initial public offering in June 2004,our private placement of common stock and warrants in October 2005, ourregistered direct offering of common stock in March 2006 and our warrantexchange and concurrent private placement in April 2008, we have financedour operations and internal growth through private placements of preferredstock as well as direct payments of sponsored research funding, license fees,milestone payments, equity investments from collaborative partners, debtfinancing and, to a lesser extent, the sale of common stock through ourstockholder approved equity incentive plans.

 

*Commercial, Manufacturing Rights, Risks*

 

We currently do not have strategic collaborations in place related toMB07803 or MB07811 and we intend to license our glucagon antagonist program,pradefovir and MB07133. We retain worldwide commercialization rights to all ofthe compounds that we have generated from our past and current researchprograms, with the exception of any potential future product candidates that mayresult from our collaborations with Merck & Co. Inc., or Merck, IdenixPharmaceuticals, Inc., or Idenix, and Roche. Our potential futureagreements with strategic collaborators may include joint marketing orpromotion arrangements which may allow us to eventually co-market one or moreof our product candidates through our own sales force or with a co-promotionpartner. Alternatively, we may grant exclusive rights to our collaborators inexchange for upfront fees, milestones and royalties on future sales, if any, ordirectly sell certain of our assets.

 

We will rely on our collaborators or third-party manufacturers toproduce sufficient quantities of our product candidates for clinical studiesand large-scale commercialization upon their approval. Since we do notcurrently possess the resources necessary to independently develop andcommercialize all of the potential product candidates that may be based uponour technologies, we plan to enter into additional collaborative agreements toassist in the development and commercialization of some or all of our productcandidates. However, our discussions with potential collaborators may not leadto the establishment of new collaborations on acceptable terms, if at all, orit may take longer than expected to establish new collaborations, leading todevelopment and commercialization delays.

 

Our business is subject to significant risks, including the risksinherent in our ongoing clinical trials and the regulatory review and approvalprocess, the results of our research and development efforts, reliance on thirdparties for the development and commercialization of our product candidates,competition from other products and uncertainties associated with obtaining andenforcing patent rights.

 

**Research and Development**

 

Our research and development expenses consist primarily of cash andstock-based compensation and other expenses for research and developmentpersonnel, costs associated with the development and clinical trials of ourproduct candidates, facility costs, supplies and materials, costs forconsultants and related contract research and depreciation. We charge allresearch and development expenses to operations as they are incurred. BeginningJanuary 1, 2008, we revised our estimate of the rate we use to allocate occupancyand information systems costs between research and development expenses andgeneral and administrative expenses.  Wefeel the current allocation is more reflective of the actual consumption ofthese expenses in these operational functions for fiscal 2008.

 

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Our development activities are focused on the clinical development ofour core metabolic disease assets, MB07803 and MB07811. Our activities relatedto our non-core liver disease assets, pradefovir and MB07133, are currentlylimited to planning, consultation, design and other efforts preparatory totheir potential future clinical development by licensees. In addition, ourresearch activities include work on a variety of compounds in our advancedresearch programs. We are responsible for all costs incurred for our productcandidates and our advanced research programs with the exception of the AMPKprogram partnered with Merck and the hepatitis C programs partnered with Merck,Idenix and Roche (excluding costs associated with manufacturing compounds thatIdenix is currently evaluating, for which we are responsible).

 

Our AMPK collaboration with Merck seeks to develop and commercializenew products to treat type 2 diabetes and potentially other metabolicdiseases. Under the terms of our AMPK collaboration agreement with Merck, wehave received approximately $11.6 million in cumulative sponsored researchand license fees funding through September 30, 2008, which includesfunding for sponsored research efforts through June 2009.

 

Our collaborations with Merck and Idenix sought to develop andcommercialize new products for treating hepatitis C infection. Our efforts andinternal costs related to the hepatitis C collaboration with Merck ceased uponcompletion of its research term in December 2005. Under the terms of theMerck agreement, we have received approximately $3.2 million in cumulativelicense fees and sponsored research funding through December 31, 2005. Ourefforts and internal costs related to the hepatitis C collaboration with Idenixceased upon completion of its research term in October 2007. Under theterms of the Idenix agreement, we have received approximately $3.4 millionin cumulative license fees and sponsored research funding through December 31,2007.

 

Although the funded research phases of the hepatitis C collaborationswith Merck and Idenix are completed, Merck and Idenix are currently evaluatingcertain candidate compounds discovered during the collaborations to determineif one or more will be recommended for clinical development. Merck and Idenixare solely responsible for conducting and funding all development work for anycompounds resulting from these collaborations (excluding costs and workassociated with manufacturing candidate compounds Idenix is currentlyevaluating, for which we are responsible) and for commercializing any resultingproducts. If a product is successfully developed, we will receive substantialmilestone payments as well as receive a portion of the revenue from sales of adrug in the form of a royalty on net sales.

 

Our new two-year collaboration with Roche also seeks to develop andcommercialize new products for treating hepatitis C infection.  Under the terms of the Roche agreement, wereceived an upfront payment of $10.0 million in August 2008. We areentitled to receive payments on the achievement of certain milestones andduring the second year of the agreement, we are entitled to additionalsponsored research funding.

 

At this time, due to the risks inherent in the clinical trial processand given the early stage of development of our product candidates and leadcompounds from our research programs, we are unable to estimate with anycertainty the costs we will incur in the continued development of our productcandidates for commercialization. Other than costs for outsourced servicesassociated with our clinical programs, we generally do not track our researchand development expenses by project; rather, we track such expenses by the typeof cost incurred. Due to these and other factors, we are unable to determinethe anticipated completion dates for our current research and developmentprojects. However, we expect our research and development costs to besubstantial as we continue the development of our core assets, as well ascontinue to expand our research programs.

 

Generally, Phase 1 clinical trials can be expected to last from 6to 18 months, Phase 2 clinical trials can be expected to last from 12to 24 months and Phase 3 clinical trials can be expected to last from18 to 36 months. However, clinical development timelines vary widely, asdo the total costs of clinical trials and the likelihood of success.  Although we are currently focused primarilyon advancing MB07803 and MB07811 through clinical development, we anticipatethat we will make determinations as to which research and development projectsto pursue and how much funding to direct to each project on an ongoing basis inresponse to the scientific and clinical success of each product candidate, ourongoing assessment of its market potential and consideration of our availablefinancial resources.

 

The lengthy process of seeking regulatory approvals for our productcandidates, and the compliance with applicable regulations, require theexpenditure of substantial resources. Any failure by us to obtain, or any delayin obtaining, regulatory approvals could cause our research and developmentexpenditures to increase and, in turn, have a material unfavorable effect onour results of operations.  Additionally,under our strategic plan, we intend to establish strategic collaborations forour core assets and non-core assets at appropriate times to secure additionalresources, accelerate progress and share risk. However, delays in finding appropriate partnerships could also have amaterial unfavorable effect on our results of operations.  We cannot be certain when or if any net cashinflow due to sales of any of our current product candidates will commence.

 

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**General and Administrative**

 

General and administrative expenses consist primarilyof salaries, stock-based compensation and other related costs for personnel inexecutive, finance, accounting, business development, investor relations,information systems, legal and human resource functions. Other costs includefacility costs not otherwise included in research and development expenses,depreciation and professional fees for legal and accounting services.  Beginning January 1, 2008, we revisedour estimate of the rate we use to allocate occupancy and information systemscosts between research and development expenses and general and administrativeexpenses.  We feel the current allocationis more reflective of the actual consumption of these expenses in theseoperational functions for fiscal 2008.

 

**Other Income (Expense)**

 

Other income (expense) includes interest earned on our cash, cashequivalents and securities available-for-sale, net of interest expense oncapital lease obligations, debt, and the related issuance costs.

 

**Critical Accounting Policies**

 

Our discussion and analysis of our financial condition and results ofoperations are based on our financial statements, which have been prepared inaccordance with U.S. generally accepted accounting principles, or GAAP. Thepreparation of these financial statements requires us to make estimates andjudgments that affect the reported amounts of assets, liabilities, revenues andexpenses and related disclosure of contingent assets and liabilities. We reviewour estimates on an on-going basis. We base our estimates on historicalexperience and on various other assumptions that we believe to be reasonableunder the circumstances, the results of which form the basis for makingjudgments about the carrying values of assets and liabilities. Actual resultsmay differ from these estimates under different assumptions or conditions. Webelieve the following accounting policies to be critical to the judgments andestimates used in the preparation of our financial statements.

 

*Revenue Recognition.*  Our revenue recognition policies are inaccordance with Securities and Exchange Commission Staff Accounting Bulletin,or SAB, No. 104, *Revenue Recognition*and Emerging Issues Task Force, or EITF, Issue 00-21, *Revenue Arrangements with Multiple Deliverables*.Our agreements generally contain multiple elements, including access to ourproprietary technologies and research and development services. Payments underour collaborations are generally made in the form of upfront license fees,milestone payments and downstream royalties. All fees are nonrefundable.Revenue from milestones is recognized when earned, provided that:

 

1)                                      the milestoneevent is substantive and its achievability was not reasonably assured at theinception of the agreement, and

 

2)                                      collaboratorfunding, if any, of our performance obligations after the milestone achievementwill continue at a level comparable to before the milestone achievement.

 

If both of these criteria are not met, the milestone payment isrecognized over the remaining minimum period of our performance obligationsunder the agreement. Upfront, nonrefundable fees under our collaborations arerecognized over the period the related services are provided. Nonrefundableupfront fees not associated with our future performance are recognized whenreceived. Amounts received for sponsored research funding are recognized asrevenues as the services are performed. Amounts received for sponsored researchfunding for a specific number of full-time researchers are recognized asrevenue as the services are provided, as long as the amounts received are notrefundable regardless of the results of the research project.

 

*Clinical Trial Expenses.*  Our clinical trials are often conducted undercontracts with multiple research institutions and clinical researchorganizations that conduct and manage clinical trials on our behalf. Thefinancial terms of these agreements are subject to negotiation and vary fromcontract to contract and may result in uneven payment flows. Generally, theseagreements set forth the scope of work to be performed at a fixed fee or unitprice. Payments under the contracts depend on factors such as the successful enrollmentof patients or the completion of clinical trial milestones. Expenses related toclinical trials generally are accrued based on contracted amounts applied tothe actual level of patient enrollment and activity according to the protocol.Other incidental costs related to patient enrollment are accrued when known. Ifcontracted amounts are modified based upon changes in the clinical trialprotocol or scope of work to be performed, we modify our accruals accordinglyon a prospective basis.

 

*Stock-Based Compensation.*  We grant equity based awards under threestockholder-approved share-based compensation plans. We may grant options andrestricted stock awards to employees, directors and consultants under ourAmended and Restated 2001 Equity Incentive Plan. We also grant awards tonon-employee directors under our 2004 Non-Employee Directors’ Stock OptionPlan. All of our employees are eligible to participate in our 2004 EmployeeStock Purchase Plan which provides a means for employees to purchase common stockat a discount through payroll deductions. The benefits provided under all ofthese plans are subject to the provisions of revised Statement of FinancialAccounting Standards, or SFAS, No. 123R, *Share-BasedPayment*, which we adopted effective January 1, 2006. We electedto use the modified prospective application in adopting SFAS No. 123R and thereforehave not restated results for prior periods. The valuation provisions of SFAS No. 123Rapply to new awards and to awards that are outstanding on the adoption date andsubsequently modified or cancelled.

 

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We estimate the fair value of stock options granted using theBlack-Scholes Merton, or Black-Scholes, option valuation model. This fair valueis then amortized over the requisite service periods of the awards. TheBlack-Scholes option valuation model requires the input of subjectiveassumptions, including the option’s expected life and price volatility of theunderlying stock. Expected volatility is based on the weighted averagevolatility of our stock factoring in daily share price observations and thehistorical price volatility of certain peers within our industry sector. Incomputing expected volatility, the length of the historical period used isequal to the length of the expected term of the option and the share purchaseright. The expected life of employee stock options represents the average ofthe contractual term of the options and the weighted average vesting period, aspermitted under the simplified method, under SAB No. 107.

 

As stock-based compensation expense is based on awards ultimatelyexpected to vest, it has been reduced for estimated forfeitures. SFAS No. 123Rrequires forfeitures to be estimated at the time of grant and revised, ifnecessary, in subsequent periods if actual forfeitures differ from thoseestimates. Forfeitures were estimated based on historical experience. We mayelect to use different assumptions under the Black-Scholes option valuationmodel in the future, which could materially affect our net loss and net lossper share. In our pro forma information required under SFAS No. 123, *Accounting for Stock-Based Compensation*,for the periods prior to fiscal 2006, we accounted for forfeitures as theyoccurred.

 

**Recently Issued Accounting Pronouncements**

 

In June 2007, the EITF issued EITF Issue No. 07-3, *Accounting for Nonrefundable Advance Payments forGoods or Services to be Used in Future Research and Development Activities*.The consensus requires companies to defer and capitalize prepaid, nonrefundableresearch and development payments to third parties over the period that theresearch and development activities are performed or the services are provided,subject to an assessment of recoverability. EITF Issue No. 07-3 iseffective for new contracts entered into in fiscal years beginning after December 15,2007, including interim periods within those fiscal years. The adoption of EITFIssue No. 07-3 did not have a material impact on our financial statements.

 

In November 2007, the EITF issued EITF Issue No. 07-1, *Accounting for Collaborative Arrangements Related tothe Development and Commercialization of Intellectual Property.*Companies may enter into arrangements with other companies to jointly develop,manufacture, distribute, and market a product. Often the activities associatedwith these arrangements are conducted by the collaborators without the creationof a separate legal entity (that is, the arrangement is operated as a “virtualjoint venture”). The arrangements generally provide that the collaborators willshare, based on contractually defined calculations, the profits or losses fromthe associated activities. Periodically, the collaborators share financialinformation related to product revenues generated (if any) and costs incurredthat may trigger a sharing payment for the combined profits or losses. Theconsensus requires collaborators in such an arrangement to present the resultof activities for which they act as the principal on a gross basis and reportany payments received from (made to) other collaborators based on otherapplicable GAAP or, in the absence of other applicable GAAP, based on analogyto authoritative accounting literature or a reasonable, rational, andconsistently applied accounting policy election. EITF Issue No. 07-1 iseffective for collaborative arrangements already in place at the beginning ofthe annual period beginning after December 15, 2008 (beginning with our2009 fiscal year), and retrospective application of EITF Issue No. 07-1 toall prior periods presented should be reported as a change in accountingprinciple. We are in the process of determining the effect, if any, theadoption of EITF Issue No. 07-1 will have on our financial statements.

 

In December 2007,the Financial Accounting Standards Board, or FASB, issued SFAS No. 141(R),*Business Combinations*.  SFAS No. 141(R) replaces SFAS No. 141.SFAS No. 141(R) requires the acquirer of a business to recognize andmeasure the identifiable assets acquired, the liabilities assumed, and anynon-controlling interest in the acquiree at fair value. SFAS No. 141(R) alsorequires transaction costs related to the business combination to be expensedas incurred. SFAS No. 141(R) applies prospectively to businesscombinations for which the acquisition date is on or after the beginning of thefirst annual reporting period beginning on or after December 15, 2008(beginning with our 2009 fiscal year). We do not anticipate that the impact ofadopting SFAS No. 141(R) will have a material effect on our financialstatements.

 

In May 2008, the FASB issued SFAS No. 162, *The Hierarchy of Generally Accepted Accounting Principles*.  SFAS No. 162 identifies the sources ofaccounting principles and provides entities with a framework for selecting theprinciples used in preparation of financial statements that are presented inconformity with GAAP. The current GAAP hierarchy has been criticized because itis directed to the auditor rather than the entity, it is complex, and it ranksFASB Statements of Financial Accounting Concepts, which are subject to the samelevel of due process as FASB SFAS, below industry practices that are widelyrecognized as generally accepted but that are not subject to due process. TheFASB believes the GAAP hierarchy should be directed to entities because it isthe entity (not its auditors) that is responsible for selecting accountingprinciples for financial statements that are presented in conformity with GAAP.SFAS No. 162 is effective 60 days following the SEC’s approval of thePublic Company Accounting Oversight Board amendments to AU Section 411, *The Meaning of**PresentFairly in Conformity With Generally Accepted Accounting Principles*.  The adoption of SFAS No. 162 is notexpected to have a material impact on our financial statements.

 

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In June 2008,the EITF issued EITF 08-3, *Accounting by Lessees forMaintenance Deposits under Lease Agreements*.  Under certain lease arrangements, the lesseeis contractually responsible for repair and maintenance of the leased asset,and the lessee is required to make deposits with the lessor to fund thatmaintenance.  The deposit is refunded tothe lessee only to the extent that the lessee incurs qualified maintenancecosts.  Questions have arisen as to theproper accounting for these deposits as some companies account for themaintenance deposits as deposits, while other companies account for them ascontingent rental expense.  EITF 08-3concludes that maintenance deposits should be considered deposits when paid tothe lessor if it is probable that the deposits will be refunded to thelessee.  If it is not probable, then thedeposits are recognized as rental expense. If it is determined at the inception of the lease that a portion of thedeposits is not probable of being refunded to the lessee, then the lesseeshould recognized as expense a pro-rata portion of the deposits as they arepaid.  The cost of maintenance activitiesshould be expensed or capitalized, as appropriate.  The definition of “probable” will fall underthe guidance of FASB Concept Statement No. 6, *Elements ofFinancial Statements.*  EITF08-3 is effective for fiscal years beginning after December 15, 2008(beginning with our fiscal year 2009). Early application is not permitted. The adoption of EITF 08-3 is not expected to have a material impact onour financial statements.

 

**Results of Operations**

 

*Comparisonof the Three Months Ended September 30, 2008 and 2007*

 

*Revenues*.    Revenues were$1.4 million for the three months ended September 30, 2008, comparedwith $2.7 million for the three months ended September 30, 2007. The$1.3 million decrease was mainly due to lower license fee and sponsoredresearch revenues of  $1.4 million fromIdenix as a result of the end of the sponsored research term of ourcollaboration in October 2007, and a decrease in the Merck AMPK licensefee revenue recognized as a result of an extension of the research term throughJune 2009.  These reductions werepartially offset by license fees and sponsored research revenues recognized inconnection with the Roche agreement we entered into in August 2008.

 

*Research and Development Expenses*.    Researchand development expenses were $8.5 million for the three months ended September 30,2008, compared with $10.9 million for the three months ended September 30,2007. The $2.4 million decrease was mainly due to net decreases of $2.8 millionin clinical and development expenses for the MB07803, MB07811 and MB07133programs and $0.1 million in non-cash stock-based compensation expense.  These decreases were partially offset by anaggregate increase of approximately $0.5 million of non-cash depreciation andoccupancy costs as a result of a change in the allocation rate of these costs,as discussed under “Research and Development” above, and payroll and relatedbenefits.

 

*General and Administrative Expenses*.    General and administrative expenses were $2.7 million for thethree months ended September 30, 2008, compared with $2.8 million for thethree months ended September 30, 2007. The $0.1 million decreasewas mainly due to an aggregate decrease of $0.5 million in occupancy andnon-cash depreciation due to a change in the allocation rate of these costs, asdiscussed under “General and Administrative” above, and non-cash stock-basedcompensation, partially offset by increases in professional services andpayroll and related benefits.

 

*Other Income (Expense).*    Netinterest expense was $0.1 million for the three months ended September 30,2008, compared to net interest income of $0.6 million for the three monthsended September 30, 2007. The $0.7 million decrease was a result of lowercash balances in the third quarter of 2008 as compared to the third quarter of2007 as well as increased interest expense related to long-term debt acquiredin the first quarter of 2008.

 

*Comparisonof the Nine Months Ended September 30, 2008 and 2007*

 

*Revenues*.    Revenues were $3.0 millionfor the nine months ended September 30, 2008, compared with$7.7 million for the nine months ended September 30, 2007. The $4.7million decrease was mainly due to lower license fee and sponsored researchrevenues of $3.5 million from Idenix as a result of the end of the sponsoredresearch term of our collaboration in October 2007 and a decrease in theMerck AMPK license fee revenue recognized as a result of the extension of theresearch term through June 2009. The decrease was also due to the absence of $1.8 million in license feesdue to the termination of our Schering collaboration in September 2007.  These reductions were partially offset by anincrease of $1.0 million in license fees and sponsored research revenuesrecognized in connection with the Roche agreement we entered into in August 2008.

 

*Research and Development Expenses*.    Researchand development expenses were $27.9 million for the nine months ended September 30,2008, compared with $31.4 million for the nine months ended September 30,2007. The $3.5 million decrease was mainly due to net decreases of $4.8 millionin clinical and development expenses for the MB07803, MB07133 and MB07811programs and $0.6 million in non-cash stock-based compensation expense.  These decreases were partially offset by anincrease of approximately $1.3 million of non-cash depreciation and occupancycosts as a result of a change in the allocation rate of these costs, asdiscussed above, and $0.6 million in payroll and related benefits due to ourAnn Arbor, Michigan office being fully staffed during the first nine months of2008 as compared to a proportional two months of 2007.

 

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*General and Administrative Expenses*.    General and administrative expenses were $7.7 million for thenine months ended September 30, 2008, compared with $9.3 million for thenine months ended September 30, 2007. The $1.6 million decrease wasmainly due to a decrease of $0.9 million in occupancy and non-cash depreciationdue to a change in the allocation rate of these costs, as discussed above, andan aggregate of $0.6 million in non-cash stock-based compensation, payroll andrelated benefits and  professionalservices.

 

*Other Income (Expense).*    Netinterest income was $0.1 million for the nine months ended September 30,2008, compared to net interest income of $2.1 million for the nine months endedSeptember 30, 2007. The $2.0 million decrease was a result of lower cashbalances in the first nine months of 2008 as compared to the first nine monthsof 2007 as well as interest expense incurred in 2008 as a result of thelong-term debt acquired in March 2008.

 

**Liquidityand Capital Resources**

 

Since our inception, we have funded our operations primarily with$55.8 million in net proceeds from equity financings prior to becoming apublic company and $117.4 million in aggregate net proceeds from our initialpublic offering in June 2004, a private placement of common stock andwarrants in October 2005, a registered direct offering of common stock in March 2006and our warrant exchange and concurrent private placement in April 2008.

 

InAugust 2008, we entered into a two-year collaboration with Roche todevelop new products for treating hepatitis C infection.  Under the terms of the Roche agreement, wereceived an upfront payment of $10.0 million in August 2008. We areentitled to receive payments on the achievement of certain milestones andduring the second year of the agreement, we are entitled to additionalsponsored research funding.

 

InApril 2008, we entered into a warrant exchange and concurrent privateplacement, referred to together as the Transaction, which raised $9.9 millionin cash.  The investors in theTransaction were certain current investors who held existing warrants for thepurchase of our common stock issued previously by us in our October 2001and October 2005 private placements.

 

Inconnection with the Transaction, we entered into a Warrant Exercise Agreementpursuant to which we reduced the exercise prices of the investors’ warrants topurchase our common stock acquired in our October 2001 and October 2005private placements to an exercise price of $2.34 per share, in exchange for anirrevocable commitment by the investors to exercise such warrants at theclosing.  As a result of the WarrantExercise Agreement, warrants for the purchase of 127,557 shares of our commonstock with a prior exercise price of $8.70 per share and warrants for thepurchase of 1,558,279 shares of our common stock with a prior exercise price of$6.74 per share were exercised at $2.34 per share.

 

Additionally,in connection with the Transaction, we entered into a Securities PurchaseAgreement pursuant to which we issued and sold to the investors 2,485,103shares of our common stock at an exercise price of $2.34 per share, andwarrants to purchase up to 1,057,196 shares of our common stock at an exerciseprice of $2.69 per share.  At theclosing, the investors paid an additional purchase price for the warrants equalto $0.125 per whole share issuable upon exercise of the warrants.  In connection with the Securities PurchaseAgreement, we also entered into a Registration Rights Agreement pursuant towhich we granted to the investors certain registration rights relating to thesecurities issued and sold in the Securities Purchase Agreement.  We filed a registration statement pursuant tothe Registration Rights Agreement on May 9, 2008 and the Securities andExchange Commission declared the registration statement effective on May 30,2008.

 

Certainof our existing stockholders, including entities affiliated with MPM Capital,Hale BioPharma Ventures and InterWest Partners, invested in theTransaction.  Certain of such investors and/or their affiliates areparties to our amended and restated investors’ rights agreement dated October 28,2003.  Luke B. Evnin, Ph.D., David F. Hale and Arnold L. Oronsky, Ph.D., membersof our board of directors, are associated with MPM Capital, Hale BioPharmaVentures and InterWest Partners, respectively.

 

In March 2008, we entered into a venture debt facility with alender, pursuant to which the lender provided us with a three-year, $5.0million term loan.  Interest accrues atan annual rate of 9.83%, with six interest-only monthly payments, made inarrears, beginning in May 2008, followed by 30 equal monthly payments ofprincipal and interest beginning in November 2008.  We have the option to prepay the outstandingbalance of the term loan in full, subject to a prepayment fee.  The loan is collateralized by our generalassets, excluding intellectual property and assets of certain subsidiaries.  There are no financial covenants associatedwith the venture debt facility.  Inconnection with the venture debt facility, we issued to the lender a warrant topurchase up to 154,639 shares of our common stock at an exercise price of $1.94per share.  The warrant is currentlyexercisable and expires in March 2018.

 

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In April 2007, we filed an additional shelf registration statementto increase the amount of common stock and warrants available for issuanceunder our existing shelf registration statement by approximately$40 million to a total of $75 million, subject to substantiallimitations relating to the aggregate market value of our common stock held bynon-affiliates. The additional shelf registration statement was declaredeffective in May 2007.

 

We have entered into a Committed Equity Financing Facility, or CEFF,with an institutional investor, under the terms of which, the investor iscommitted to providing us up to $50 million or 6,046,471 shares of commonstock, based on certain market capitalization levels, in funding from time totime for a period up to 36 months that commenced in December 2006through the purchase of newly-issued shares of our common stock. In February 2008,the CEFF was amended to reduce the minimum market capitalization required topermit a draw down and to eliminate certain termination rights maintained bythe investor, among other things. Under the amended CEFF, we may accesscapital, subject to certain conditions, under this facility in tranches of upto the lesser of $10 million or:

 

·                 1.0% of our market capitalization if, at thetime of the draw down of such tranche, our market capitalization equals orexceeds $53 million but is less than $100 million,

 

·                 1.25% of our market capitalization if, at thetime of the draw down of such tranche, our market capitalization equals orexceeds $100 million but is less than $175 million, and

 

·                 1.5% of our market capitalization if, at thetime of the draw down of such tranche, our market capitalization equals orexceeds $175 million.

 

If our market capitalization is less than $53 million, we will nothave access to this capital.  As of September 30,2008, our market capitalization did not meet the minimum threshold of $53million, and therefore, we did not have access to this capital as of such date.

 

In the event of a draw down, the investor will purchase shares of ourcommon stock pursuant to the CEFF at discounts ranging from 6% to 10%,depending on the average market price of our common stock during an eight-daypricing period, provided that the minimum acceptable purchase price for anyshares to be issued to the investor during the eight-day pricing period isdetermined by the higher of $1.75 or 90% of our share price the day before thecommencement of each draw down. Pursuant to the agreement we filed aregistration statement with the Securities and Exchange Commission for theresale of the shares of common stock issuable in connection with the CEFF andthe shares of common stock underlying the warrant issued in connection withthis transaction, which became effective on December 22, 2006.  As of September 30, 2008, we have notutilized the CEFF.

 

As of September 30, 2008, we had $32.8 million in cash and cashequivalents and securities available-for-sale as compared to $42.4 millionas of December 31, 2007, a decrease of $9.6 million. The decrease isprimarily a result of net cash used in operations of $22.6 million offset by$13.1 million of net cash flows provided by financing activities.

 

As of September 30, 2008, we have financed through leases andloans the purchase of equipment and leasehold improvements totalingapproximately $12.4 million, of which $4.4 million was outstanding atthat date. The loans are collateralized with the purchased equipment, bearinterest at rates ranging from approximately 8.0% to 12.85%, and are due inmonthly installments through October 2015. We currently anticipate capitalspending on equipment and leasehold improvements to be in the range of$0.5 million to $1.0 million in 2008. We do not plan on financing our equipment and leasehold improvementsthrough fiscal 2008, as we no longer have available funds through thisfinancing facility.

 

We intend to use our existing cash reserves, proceeds from our ongoingcollaboration with Merck, proceeds from our new collaboration with Roche andproceeds from other planned business development activities to execute ourstrategic plan through 2008.  Under ourstrategic plan, we will focus our internal resources primarily on our coremetabolic disease clinical and advanced research programs. This includesfunding the further clinical evaluation of our core assets, MB07803 andMB07811, with a focus on achieving key milestones. Continued development ofthese core assets thereafter will require significant resources. Therefore, weplan to establish strategic collaborations for these product candidates atappropriate times to secure additional resources, accelerate progress and sharerisk. In addition, we plan to advance additional metabolic disease productcandidates discovered by our research group into clinical development eitherindependently or with current or future strategic collaborators. In order toreduce future expenses and to minimize the potential dilution associated withfinancing their internal development, we intend to license our glucagonantagonist program, pradefovir and MB07133 for further development andcommercialization for upfront fees, milestones and royalties on future sales,if any, or we may directly sell these assets.

 

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Our strategic plancontemplates funding the ongoing development of our core assets by monetizingour glucagon antagonist program and certain non-core assets. We may not besuccessful in entering into additional collaboration agreements, or inreceiving milestone or royalty payments under current or future agreements.Additionally, we may be required to relinquish greater or allrights to product candidates at an earlier stage of development or on lessfavorable terms than we would otherwise choose. Also, based on recent Food and Drug Administration, orFDA, draft guidelines and advisory panel discussions, the cost to develop andcommercialize our diabetes programs may increase beyond current expectationsand such increases may make it more difficult to obtain favorable terms in thecollaborative arrangements we require to maximize the value of theseprograms.  Having insufficient fundsmay require us to delay, scale back or eliminate some or all of our research ordevelopment programs. No assurances can be made that additional funding, throughany resources, including our CEFF, will be available when needed or that, ifavailable, financing will be obtained on terms favorable to us or ourstockholders. To the extent that we raise additional capital by issuing equitysecurities, our existing stockholders’ ownership will be diluted. Any debtfinancing we enter into may involve covenants that restrict our operations.These restrictive covenants may include limitations on additional borrowing,specific restrictions on the use or sales of our assets as well as prohibitionson our ability to create liens, pay dividends, redeem our stock or makeinvestments. The recent global financial crisis and other current negativemacroeconomic indicators may negatively impact our ability to issue securities or obtain debtfinancing.Given theeconomic and corporate uncertainties, the Company is planning to institutevarious cost saving measures to be announced when final decisions are made. Failure toobtain adequate financing and to curtail or delay cash expenditures adequatelywill have a significant negative impact on our future operations and ourability to continue as a going concern. Based on our current rate of cash usage and absent any cash sources frombusiness development, financings or other strategic initiatives, we anticipatethat our cash balances as of September 30, 2008 will fund our operationsthrough mid-2009.

 

The following summarizes our long-term contractual obligations as of September 30,2008 (in thousands):

 
| ** **                 | ** ** | ** ** | ** ** | **Payments Due by Period** | ** ** |
|----------------------------|------------|------------|------------|-------------------------------------------|------------|
| ** **                 | ** ** | ** ** | ** ** | **Less than**                        | ** ** | **1 to 3** | ** ** | **4 to 5** | ** ** | **After 5** | ** ** |
| ** **                 | ** ** | **Total**  | ** ** | **1 Year**                           | ** ** | **Years** | ** ** | **Years** | ** ** | **Years** | ** ** |
| Operating leases           |       | $          | 22,823     |                                      | $          | 2,658 |   | $ | 6,259 |   | $ | 6,606 |   | $ | 7,300 |   |
| Long-term debt             |       | 9,351      |       | 3,717                                     |       | 5,472 |   | 79 |   | 83 |   |
| Interest on long-term debt |       | 1,475      |       | 773                                       |       | 676 |   | 19 |   | 7 |   |
| Purchase commitments       |       | 1,462      |       | 1,462                                     |       | — |   | — |   | — |   |
| Capital leases             |       | 59         |       | 26                                        |       | 33 |   | — |   | — |   |
| Interest on capital leases |       | 8          |       | 5                                         |       | 3 |   | — |   | — |   |
|                       |       |       |       |                                      |       |   |   |   |   |   |   |
| Total                      |       | $          | 35,178     |                                      | $          | 8,641 |   | $ | 12,443 |   | $ | 6,704 |   | $ | 7,390 |   |

 

We also enter into agreements with clinical sites and contract researchorganizations for the conduct of our clinical trials. We will make payments tothese sites and organizations based upon the number of patients enrolled andthe length of their participation in the clinical trials. In addition, undercertain agreements, we may be subject to penalties in the event we prematurelydiscontinue performance under these agreements. At this time, due to thevariability associated with these agreements, we are unable to estimate withcertainty the future costs we will incur.

 

We have entered into employment agreements with our executive officersand certain other key employees that, under certain circumstances, provide forthe continuation of salary and certain other benefits if terminated under specifiedcircumstances. These agreements generally expire upon termination for cause orwhen we have met our obligations under these agreements. As of September 30,2008, no events have occurred resulting in the obligation of any such payments.

 

Our future capital uses and requirements depend on numerousforward-looking factors. These factors may include but are not limited to thefollowing:

 

·                  the rate of progress andcost of our clinical trials and other research and development activities,

 

·                  the scope, prioritizationand number of clinical development and research programs we pursue,

 

·                  the terms and timing of anycollaborative, licensing and other arrangements that we may establish,

 

·                  the costs of filing,prosecuting, defending and enforcing any patent claims and other intellectualproperty rights,

 

·                  the costs and timing ofregulatory approvals,

 

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·                  the costs of establishing orcontracting for manufacturing, sales and marketing capabilities, and

 

·                  the effect of competingtechnological and market developments.

 

We have no material contractual obligations that are not fully recordedon our Balance Sheets or disclosed in the Notes to our Financial Statements. Wehave no off-balance sheet arrangements as defined in S-K 303(a)(4)(ii).

 

**FORWARD-LOOKING STATEMENTS**

 

Thisquarterly report on Form 10-Q contains forward-looking statements that arebased on our management’s beliefs and assumptions and on information currentlyavailable to our management. Forward-looking statements include information concerning our possibleor assumed future results of operations, business strategies, financing plans,competitive position, industry environment, potential growth opportunities, theeffects of future regulation and the effects of competition.  Forward-looking statements include allstatements that are not historical facts and can be identified by terms such as“anticipates,” “believes,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,”“potential,” “predicts,” “projects,” “should,” “will,” “would” or similarexpressions.

 

Forward-lookingstatements involve known and unknown risks, uncertainties and other factorswhich may cause our actual results, performance or achievements to bematerially different from any future results, performances or achievements expressedor implied by the forward-looking statements. We discuss these risks in greater detail in the section entitled “RiskFactors” and elsewhere in this quarterly report on Form 10-Q and in ourother filings with the Securities and Exchange Commission, including our annualreport on Form 10-K for the year ended December 31, 2007 and ourquarterly reports on Form 10-Q for the quarters ended March 31, 2008and June 30, 2008.  Given theseuncertainties, you should not place undue reliance on these forward-lookingstatements.

 

Also,forward-looking statements represent our management’s beliefs and assumptionsonly as of the date of this quarterly report on Form 10-Q.  Our actual future results may be materiallydifferent from what we expect.  Except asrequired by law, we assume no obligation to update these forward-lookingstatements publicly, or to update the reasons actual results could differmaterially from those anticipated in these forward-looking statements, even ifnew information becomes available in the future.

 

## **Item 3.Quantitative and Qualitative Disclosures About Market Risk**

##  

Our exposure to market risk for changes in interest rates relatesprimarily to the increase or decrease in the amount of interest income we canearn on our investment portfolio. Our risk associated with fluctuating interestincome is limited to our investments in interest rate sensitive financialinstruments. Under our current policies, we do not use interest rate derivativeinstruments to manage this exposure to interest rate changes. We seek to ensurethe safety and preservation of our invested principal by limiting default risk,market risk, and reinvestment risk. We mitigate default risk by investing inshort-term investment grade securities such as treasury-backed money marketfunds, corporate bonds and commercial paper. Due to the current marketconditions, we no longer invest in asset-backed securities.  In accordance with our investment policy, wedo not invest in auction rate securities. A 100 basis point increase or decreasein interest rates would increase or decrease our current investment balance byapproximately $80,000 annually.  Whilechanges in our interest rates may affect the fair value of our investmentportfolio, any gains or losses are not recognized in our statement ofoperations until the investment is sold or if a reduction in fair value isdetermined to be a permanent impairment.

 

We do not have any foreign currency or other derivative financialinstruments.

 

Our long-term capital lease obligations and debt bear interest at fixedrates and therefore we do not have significant market risk exposure withrespect to these obligations.

 

## **Item 4. Controls and Procedures**

##  

We maintain disclosure controls and procedures that are designed toensure that information required to be disclosed in our Exchange Act reports isrecorded, processed, summarized and reported within the time periods specifiedin the Securities and Exchange Commission’s rules and forms, and that suchinformation is accumulated and communicated to our management, including ourchief executive officer and chief financial officer, as appropriate, to allowtimely decisions regarding required disclosure. In designing and evaluating thedisclosure controls and procedures, management recognized that any controls andprocedures, no matter how well designed and operated, can provide onlyreasonable and not absolute assurance of achieving the desired controlobjectives. In reaching a reasonable level of assurance, management necessarilywas required to apply its judgment in evaluating the cost-benefit relationshipof possible controls and procedures. In addition, the design of any system ofcontrols also is based in part upon certain assumptions about the likelihood offuture events, and there can be no assurance that any design will succeed inachieving its stated goals under all potential future conditions; over time, acontrol may become inadequate because of changes in conditions, or the degreeof compliance with policies or procedures may deteriorate. Because of theinherent limitations in a cost-effective control system, misstatements due toerror or fraud may occur and not be detected.

 

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As required by the Securities and Exchange Commission Rule 13a-15(b),we carried out an evaluation, under the supervision and with the participationof our management, including our chief executive officer and chief financialofficer, of the effectiveness of the design and operation of our disclosurecontrols and procedures as of the end of the period covered by this report.Based on the foregoing, our chief executive officer and chief financial officerconcluded that our disclosure controls and procedures were effective at thereasonable assurance level.

 

There has been no change in our internal control overfinancial reporting during our most recent fiscal quarter that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

 

**PART II - OTHER INFORMATION**

 

**Item 1. Legal Proceedings**

 

None.

 

**Item 1A. Risk Factors**

 

*Youshould consider carefully the following information about the risks describedbelow, together with the other information contained in this quarterly reporton Form 10-Q and in our other filings with the Securities and ExchangeCommission, before you decide to buy or maintain an investment in our commonstock. We believe the risks described below are the risks that are material tous as of the date of this quarterly* report. If any of the following risks actually occur, our business,financial condition, results of operations and future growth prospects wouldlikely be materially and adversely affected. In these circumstances, the marketprice of our common stock could decline, and you may lose all or part of themoney you paid to buy our common stock. The risks described below includecertain revisions to the risks set forth in our annual report on Form 10-Kfor the fiscal year ended December 31, 2007 and our subsequentfilings with the Securities and Exchange Commission.

* *

**RisksRelated to our Business**

 

***We are dependent on the success ofone or more of our current product candidates and we cannot be certain that anyof them will receive regulatory approval or be commercialized.***

 

We have expended significant time, money and effort in the developmentof our core metabolic disease assets, MB07803 and MB07811, and our non-coreliver disease assets, pradefovir and MB07133. Early clinical trials conductedto date have provided initial evidence of safety and therapeutic effect withall of our product candidates. However, to date, no pivotal, adequate andwell-controlled clinical trials designed to provide clinical and statisticallysignificant proof of efficacy, or to provide sufficient evidence of safety tojustify approval, have been completed with any of our product candidates. Allof our product candidates will require additional development, includingclinical trials as well as further animal studies to evaluate their toxicology,carcinogenicity and pharmacokinetics and optimize their formulation, andregulatory clearances before they can be commercialized. Positive resultsobtained during early development do not necessarily mean later developmentwill succeed or that regulatory clearances will be obtained. Our productdevelopment efforts may not lead to commercial drugs, either because ourproduct candidates fail to be safe and effective or because we have inadequatefinancial or other resources to pursue our product candidates through theclinical development and approval processes. If any of our product candidatesfail to demonstrate safety or efficacy at any time or during any phase ofdevelopment, we would experience potentially significant delays in, or berequired to abandon, development of the product candidate.

 

We do not anticipate that any of our current product candidates will beeligible to receive regulatory approval and begin commercialization for anumber of years, if at all. Even if we were ultimately to receive regulatoryapproval for these product candidates, we and/or our potential future partners,as applicable, may be unable to commercialize them successfully for a varietyof reasons. These include, for example, the availability of alternativetreatments, lack of cost effectiveness, the cost of manufacturing the producton a commercial scale and the effect of competition with other drugs. Thesuccess of our product candidates may also be limited by the prevalence andseverity of any adverse side effects. If we fail to commercialize one or moreof our current product candidates, we may be unable to generate sufficientrevenues to attain or maintain profitability, and our reputation in ourindustry and the investment community may be damaged.

 

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***If development of our productcandidates does not produce favorable results, we and our collaborators, asapplicable, may be unable to commercialize these products.***

 

To receive regulatory approval for the commercialization of our coremetabolic disease assets, MB07803 and MB07811, our non-core liver diseaseassets, pradefovir and MB07133, or any other product candidates that we maydevelop, adequate and well-controlled clinical trials must be conducted todemonstrate safety and efficacy in humans to the satisfaction of the FDA in theU.S. and other regulatory agencies elsewhere in the world. In order to supportmarketing approval, these agencies typically require successful results in oneor more Phase 3 clinical trials, which our current product candidates havenot yet reached and may never reach. In addition, regulatory approval of ourproduct candidates may be affected by adverse results in animal studiesconducted during clinical development to, among other things, evaluate theirtoxicology, carcinogenicity and pharmacokinetics and optimize theirformulation.

 

The development process is expensive, can take many years and has anuncertain outcome. Failure can occur at any stage of the process. We mayexperience numerous unforeseen events during, or as a result of, thedevelopment process that could delay or prevent commercialization of ourcurrent or future product candidates, including the following:

 

·                 clinical trials may produce negative orinconclusive results,

 

·                 animal studies conducted on productcandidates during clinical development to, among other things, evaluate theirtoxicology and pharmacokinetics and optimize their formulation may produceunfavorable results,

 

·                 patient recruitment and enrollment inclinical trials may be slower than we anticipate,

 

·                 costs of development may be greater than weanticipate,

 

·                 our product candidates may cause undesirableside effects that delay or preclude regulatory approval or limit theircommercial use or market acceptance if approved,

 

·                 collaborators who are responsible fordevelopment of our product candidates may not devote sufficient resources tothese clinical trials or other studies of these candidates or conduct them in atimely manner, or

 

·                 we may face delays in obtaining regulatoryapprovals to commence a clinical trial.

 

Success in early development does not mean that later development willbe successful because, for example, product candidates in later-stage clinicaltrials may fail to demonstrate sufficient safety and efficacy despite havingprogressed through initial clinical testing. For example, in July 2007, wewere informed by Daiichi Sankyo, our collaborative partner on CS-917, thatresults from a completed Phase 2b clinical trial showed that this productcandidate failed to achieve the primary endpoint of the clinical trial despitehaving successfully achieved the primary endpoints of other earlier clinicaltrials. In January 2008, we and Daiichi Sankyo agreed to terminate ourstrategic collaboration on CS-917 and return the rights to this productcandidate to us. We do not intend to further develop this product candidate.

 

Our clinical experience with our product candidates is limited, and todate our product candidates have been tested in less than the number ofpatients that will likely need to be studied to gain regulatory approval. Thedata collected from clinical trials with larger patient populations may notdemonstrate sufficient safety and efficacy to support regulatory approval ofthese product candidates. In addition, the requirements for regulatory approvalof our product candidates may change, making it more difficult for us toachieve such approval in a timely manner or at all. For example, in February 2008the FDA released draft guidance regarding clinical trials for productcandidates treating diabetes that may result in more stringent requirements for the clinicaltesting and regulatory approval of such product candidates.  If formally adopted, these and any futureguidance that may result from recent FDA advisory panel discussions may make itmore expensive to develop and commercialize such product candidates.  Suchincreased expense could make it more difficult to obtain favorable terms in thecollaborative arrangements we require to maximize the value of our programsseeking to develop new product candidates for diabetes.

 

We currently do not have strategic collaborations in place for any ofour current product candidates. Therefore, in the future, we and/or anypotential future collaborative partner will be responsible for establishing thetargeted endpoints and goals for development of our product candidates. Thesetargeted endpoints and goals may be inadequate to demonstrate the safety andefficacy levels required for regulatory approvals. Even if we believe datacollected during the development of our product candidates are promising, suchdata may not be sufficient to support marketing approval by the FDA or otherregulatory agencies abroad. Further, data generated during development can beinterpreted in different ways, and the FDA or other foreign regulatory agenciesmay interpret such data in different ways than us or our collaborators. Ourfailure to adequately demonstrate the safety and efficacy of our productcandidates would prevent our receipt of regulatory approval, and ultimately thecommercialization of these product candidates.

 

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***We may not be able to enter intocollaborations with respect to our glucagon antagonist program and our non-coreassets, pradefovir and MB07133, on acceptable terms, if at all, which wouldlead to development and commercialization delays.***

 

Since we do not currently possess the resources necessary toindependently develop and commercialize all of the potential product candidatesthat may be based upon our technologies, including MB07803, MB07811, ourglucagon antagonist program, pradefovir and MB07133,  we plan to enter into additionalcollaborative agreements to assist in the development and commercialization ofsome or all of these assets as a component of our strategic plan. However, ourdiscussions with potential collaborators may not lead to the establishment ofnew collaborations on acceptable terms, if at all, or it may take longer thanexpected to establish new collaborations, leading to development andcommercialization delays, which would adversely affect our business.

 

***Our product candidates may causeundesirable side effects that could delay or prevent their regulatory approvalor commercialization or have other significant adverse implications on ourbusiness.***

 

Prior to receiving regulatory approval, undesirable side effectsobserved in human clinical trials or in supportive animal studies with ourproduct candidates could interrupt, delay or halt their development and couldresult in the denial of regulatory approval by the FDA or other regulatoryauthorities for any or all targeted indications or adversely affect themarketability of any such product candidates that receive regulatory approval.In turn, this could eliminate or limit our ability to commercialize our productcandidates and generate revenues from their sale.

 

For example, data from 24-month oral carcinogenicity studies ofpradefovir in rats and mice showed that the incidence of rats or mice withtumors was increased in the animals dosed with the highest dose levels testedand was slightly increased at the intermediate dose levels. The low dose levelswere considered “no-effect” dose levels in both studies. As a result ofnumerous factors which may include these findings, we entered into an agreementwith Schering and Valeant Pharmaceuticals North America, or Valeant, toterminate our agreements for the development and commercialization ofpradefovir, and all commercial rights to pradefovir have been returned to ussubject to certain milestone and royalty payments we may be required to make toValeant should pradefovir be subsequently developed.

 

Our product candidates could also exhibit adverse interactions withother drugs. For example, in earlier clinical trials conducted by DaiichiSankyo, CS-917, our first generation product candidate for type 2 diabeteswhich we are no longer developing, was associated with incidents of lacticacidosis in two patients when it was combined with metformin in a Phase 1clinical trial. After extensive analysis, Daiichi Sankyo concluded that theseincidents were likely due to significantly increased blood levels of metformin.CS-917 was also associated in a limited number of patients with episodes ofhypoglycemia, asymptomatic lactate elevation as well as lactate elevation withclinical symptoms that could be considered signs of lactic acidosis. We arecurrently conducting clinical trials of our second-generation product candidatefor type 2 diabetes, MB07803, which works by the same mechanism as CS-917and thus may be subject to some or all of the same risks as CS-917. To date, noincidents of lacticemia, lactic acidosis, hypoglycemia or other significantadverse side effects have been observed in clinical trials of MB07803.

 

The unique nature of our proprietary technologies including HepDirectand NuMimetic may cause undesirable side effects in future clinical trials orsupportive animal studies. In addition, our product candidates may have greateror lesser  degrees of potential risk ofundesirable side effects relative to other product candidates based on thenature of their molecular targets and the various physiological responsesassociated with those targets. For example, MB07811 is a product candidatedesigned to exploit the beneficial hepatic effects of thyroid hormone agonistswhile avoiding toxicities related to systemic exposure to these types ofcompounds. If MB07811 is not successful in this regard, it could be associatedwith undesirable side effects.

 

Undesirable side effects involving our product candidates may haveother significant adverse implications on our business, for example:

 

·                 we may be unable to obtain additionalfinancing on acceptable terms, if at all,

 

·                 our stock price could decline,

 

·                 our collaborators may ultimately terminatedevelopment of our partnered products, may further decide not to develop backupproduct candidates and may terminate our agreements,

 

·                 if these agreements were terminated we maydetermine not to further develop the affected product candidates due toresource constraints and may not be able to establish additional collaborationsfor their further development on acceptable terms, if at all,

 

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·                 if we were to later continue the developmentof these product candidates and receive regulatory approval, earlier findingsmay significantly limit their marketability and thus significantly lower ourpotential future revenues from their sale,

 

·                  we may be subject to productliability or stockholder litigation, and

 

·                  we may be unable to attractand retain key employees.

 

In addition, if any of our product candidates receive marketingapproval and we or others later identify undesirable side effects caused by theproduct:

 

·                 regulatory authorities may withdraw theirapproval of the product, or we may decide to cease marketing and sale of theproduct voluntarily,

 

·                 we may be required to change the way theproduct is administered, conduct additional studies, change the labeling of theproduct, or change the product’s manufacturing facilities, and

 

·                 our reputation may suffer.

 

Any of these events could prevent us from achieving or maintainingmarket acceptance of the affected product or could substantially increase thecosts and expenses of commercializing the product, which in turn could delay orprevent us from generating significant revenues from the sale of the product.

 

***We are currently dependent on ourcollaborations with Merck, Idenix and Roche for the development andcommercialization of product candidates related to those collaborations, and wemay be dependent on future collaborators for the development of our current andfuture product candidates. Events involving our collaborations with Merck,Idenix and Roche, or any future collaborations could prevent us from developingand commercializing our product candidates and achieving or sustainingprofitability.***

 

We have entered into two collaborations with Merck, a collaborationwith Idenix and a collaboration with Roche. The first collaboration with Mercksought to develop and commercialize new products for treating hepatitis Cinfection and the second seeks to develop and commercialize new products totreat type 2 diabetes and potentially other metabolic diseases. Ourcollaboration with Idenix sought to develop and commercialize new products fortreating hepatitis C infection, and our new collaboration with Roche seeksto develop new products for treating hepatitis C.  Although the funded research phases of thehepatitis C collaborations with Merck and Idenix are completed, certaincandidate compounds discovered during the collaborations are being evaluated todetermine if one or more will be recommended for clinical development.  The sponsored research term of our secondcollaboration with Merck continues through June 2009, and the researchterm of our collaboration with Roche continues through August 2010.  Although our collaborations with Merck,Idenix and Roche have not yet yielded any product candidates, should theyultimately be successful, we will be dependent on Merck, Idenix and/or Roche,as applicable, for further development and commercialization of any resultingproduct candidates.

 

We have limited control over the amount and timing of resources thatMerck, Idenix, Roche or any future collaborators devote to our programs orpotential product candidates. These collaborations with us may end or may beterminated or our collaborators may otherwise fail to conduct theircollaborative activities successfully and in a timely manner. Further, ourcollaborators may not develop product candidates that arise out of ourcollaborative arrangements or devote sufficient resources to the development,manufacture, marketing or sale of these products. In the event that one of ourcollaborations is terminated, and we believe that the continued development orcommercialization of a product candidate or drug compound covered by thecollaboration is warranted, we may seek to obtain rights to develop andcommercialize the product candidate or drug compound, if we do not already havethose rights. We would then determine whether to continue the development orcommercialization of the product candidate or drug compound independently ortogether with a new collaborator. However, in the event that we do not havesufficient resources to independently develop or commercialize the productcandidate or drug compound, and we cannot establish a new collaboration onacceptable terms, we would be forced to discontinue its development orcommercialization. For example, at this time, we do not intend to independentlydevelop pradefovir or MB07133 and intend to license or sell these product candidates.

 

We and our present and future collaborators may fail to develop oreffectively commercialize products or drug compounds covered by our present andfuture collaborations if:

 

·                 we do not achieve our objectives under ourcollaboration agreements,

 

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·                 our product candidates do not meet theprimary endpoints of any clinical trials conducted on them or exhibitundesirable side effects,

 

·                 we are unable to obtainpatent protection for the product candidates or proprietary technologies wediscover in our collaborations,

 

·                 we are unable to managemultiple simultaneous product discovery and development collaborations,

 

·                 our potential collaboratorsare less willing to expend their resources on our programs due to their focuson other programs or as a result of general market conditions,

 

·                 our collaborators becomecompetitors of ours or enter into agreements with our competitors,

 

·                 we or our collaboratorsencounter regulatory hurdles that prevent commercialization of our productcandidates,

 

·                 we develop products andprocesses or enter into additional collaborations that conflict with thebusiness objectives of our other collaborators,

 

·                 consolidation in our targetmarkets limits the number of potential collaborators, or

 

·                 we are unable to negotiateadditional collaboration agreements under terms satisfactory to us.

 

If we are unable to developor commercialize our products as a result of the occurrence of any of theseevents, we may not be able to generate sufficient revenues to achieve ormaintain profitability.

 

***Because our collaborations with Merck, Idenix and Roche  may involve Merck’s, Idenix’s or Roche’s proprietarycompounds, if Merck, Idenix or Roche terminates development of product candidates containing thesecompounds,  we may not have the right topursue development of these product candidates on our own.***

 

The objective of ourhepatitis C collaboration with Merck was to discover product candidatesfor the treatment of this disease by applying our technology to certaincompounds provided by Merck. The funded research phase of this collaborationhas ended. Merck has evaluated and may continue to evaluate the drug compoundsdiscovered under the research phase of the collaboration to determine if one ormore will be recommended for clinical development. If Merck so designates aproduct candidate and then subsequently terminates this collaboration before adefined stage of development of that product candidate, which it may do withoutcause at any time upon 90 days’ advance written notice to us, we will nothave any right to develop or commercialize that product candidate. In addition,if this collaboration with Merck terminates and Merck successfully developsproducts based on these proprietary compounds without applying our technology,we will not be entitled to milestone payments or royalties with respect tothose products.

 

Our agreement with Merck todevelop and commercialize new products to treat type 2 diabetes andpotentially other metabolic diseases may include the development of compoundsowned or controlled by Merck. Accordingly, if Merck terminates thiscollaboration, it may prove difficult for us to continue development of suchcompounds. Similarly, our former agreement with Idenix to develop andcommercialize new products to treat hepatitis C infection may include thedevelopment of compounds owned or controlled by Idenix. Although the fundedresearch phase of our collaboration with Idenix has ended, certain compoundsare under evaluation for further development. It may prove difficult for us tocontinue development of such compounds if Idenix chooses not to develop themupon further evaluation. Our agreement with Roche to develop new products to treat hepatitis Cinfection may include the development of compounds owned or controlled byRoche.  If our collaboration with Roche is terminated, we may not have anyright to develop product candidates developed in connection with thecollaboration.

 

***Conflicts may arise between us and any of our collaborators that coulddelay or prevent the development or commercialization of our productcandidates.***

 

Conflicts may arise betweenour collaborators and us, such as conflicts concerning the interpretation ofclinical data, the achievement of milestones or the ownership of intellectualproperty developed during the collaboration. If any conflicts arise with Merck,Idenix, Roche or any future collaborators, they may act in their self-interest,which may be adverse to our best interests. Any such disagreement between usand a collaborator could result in one or more of the following, each of whichcould delay or prevent the development or commercialization of our productcandidates, and in turn prevent us from generating sufficient revenues toachieve or maintain profitability:

 

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·                 unwillingness on the part ofa collaborator to pay us research funding, milestone payments or royalties webelieve are due to us under our collaboration agreement,

 

·                 uncertainty regardingownership of intellectual property rights arising from our collaborativeactivities, which could prevent us from entering into additional collaborationsor independently pursuing the development and/or commercialization of productcandidates, or disagreements with our collaborators regarding the protection ofintellectual property rights,

 

·                 unwillingness on the part ofa collaborator to keep us informed regarding the progress of its developmentand commercialization activities or to permit public disclosure of the resultsof those activities, or

 

·                 slowing or cessation of acollaborator’s development or commercialization efforts with respect to ourproduct candidates.

 

***Our efforts to discover product candidates beyond our current productcandidates may not succeed, and any product candidates we recommend forclinical development may not actually begin clinical trials.***

 

We intend to use ourproprietary technologies and our knowledge and expertise to develop andcommercialize novel drugs to address some of the world’s most widespread andcostly chronic diseases. Our goal is to expand our core metabolic diseaseclinical development pipeline by continuing to develop and move additional newdrug compounds into clinical development. However, the process of researchingand discovering drug compounds is expensive, time-consuming and unpredictable.Data from our current research programs may not support the clinicaldevelopment of our lead compounds or other compounds from these programs, andwe may not identify any additional drug compounds suitable for recommendationfor clinical development. Moreover, any drug compounds we recommend forclinical development may not demonstrate, through preclinical testing,indications of safety and potential efficacy, that such drug compounds warrantadvancement into clinical trials. Such findings would potentially impede ourability to maintain or expand our clinical development pipeline. Our ability toidentify new drug compounds and advance them into clinical development alsodepends upon our ability to fund our research and development operations, andwe cannot be certain that additional funding will be available on acceptableterms, or at all.

 

***Delays in the commencement or completion of clinical trials couldresult in increased costs to us and delay our ability to generate significantrevenues.***

 

Delays in the commencementor completion of clinical trials could significantly impact our productdevelopment costs. We do not know whether planned clinical trials will begin ontime or be completed on schedule, if at all. The commencement of clinicaltrials can be delayed for a variety of reasons, including, but not limited to,delays related to:

 

·                 obtaining regulatoryapproval to commence a clinical trial,

 

·                 reaching agreement onacceptable terms with prospective contract research organizations and clinicaltrial sites,

 

·                 manufacturing sufficientquantities of a product candidate or other materials necessary to conduct theclinical trial,

 

·                 obtaining institutionalreview board approval to conduct a clinical trial at a prospective site,

 

·                 recruiting and enrollingpatients to participate in a clinical trial, and

 

·                 the failure of ourcollaborators to adequately resource our product candidates due to their focuson other programs or as a result of general market conditions.

 

In addition, once a clinicaltrial has begun, it may be suspended or terminated by us, our collaborators,the FDA or other regulatory authorities due to a number of factors, including:

 

·                  failure to conduct theclinical trial in accordance with regulatory requirements or clinicalprotocols,

 

·                 inspection of the clinicaltrial operations or clinical trial site by the FDA or other regulatoryauthorities resulting in the imposition of a clinical hold,

 

·                 unforeseen safety issues, or

 

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·                 lack of adequate funding tocontinue the clinical trial.

 

If we experience significantdelays in the commencement or completion of clinical testing, our productdevelopment costs may increase, we may lose any competitive advantageassociated with early market entry and our ability to generate significantrevenues may be delayed. In addition, many of the factors that cause, or leadto, a delay in the commencement or completion of clinical trials may alsoultimately lead to the denial of regulatory approval of a product candidate.

 

***We rely on third parties in connection with the development of ourproduct candidates. If these third parties do not successfully meet theirobligations under our agreements, we may not be able to obtain regulatoryapproval for or commercialize our product candidates.***

 

We rely on third parties,such as contract research organizations, medical institutions, clinicalinvestigators and contract laboratories, to assist in the development ofMB07803 and MB07811 and intend to rely on similar organizations to assist inthe development of any other future product candidates that we may develop forwhich a collaborator is not responsible for development. At this time, we donot intend to independently develop pradefovir or MB07133 and intend to licenseor sell these product candidates. We may rely on strategic collaborators forthe development of our core metabolic disease assets, MB07803 and MB07811, inthe future. If successful in entering into these future collaborations andlicense agreements, we will be dependent upon our collaborative partners andlicensees for the further development and commercialization of these productcandidates. Although our collaborations with Merck, Idenix and Roche have notyet yielded product candidates, should they do so, we will be dependent onMerck, Idenix and/or Roche, as applicable, to conduct the development of anyresulting product candidates. If Merck, Idenix, Roche or these other thirdparties do not successfully meet their obligations under our agreements, or ifthe quality or accuracy of the data they obtain is compromised due to thefailure to adhere to applicable protocols or for other reasons, clinical trialsor other studies may be extended, delayed or terminated, and these productcandidates may not receive regulatory approval or be successfullycommercialized.

 

***Because our product candidates, research programs and collaborativeefforts depend on our proprietary technologies, adverse events affecting ourproprietary technologies may delay or prevent the commercialization of ourproduct candidates.***

 

We used our NuMimetictechnology to identify MB07803. We used our HepDirect technology to discoverpradefovir, MB07811 and MB07133, and have applied it in certain other programsas well. We intend to use these and future proprietary technologies to expandour product pipeline in the future. We may also leverage our HepDirect andother liver-targeting technology through strategic alliances and collaborationswith other companies, such as our hepatitis C collaborations with Merck, Idenixand Roche in which we applied our technology to certain Merck, Idenix and Rochecompounds. Our proprietary technologies are subject to many of the same risksas our product candidates, including risks related to:

 

·                  obtaining and maintainingpatent and trade secret protection for these technologies,

 

·                  avoiding infringement of theproprietary rights of third parties,

 

·                  the development of competingtechnologies by others, and

 

·                  in HepDirect’s case, thesafety and effectiveness of this technology in humans.

 

Because certain of ourproduct candidates and research programs are dependent on our proprietarytechnologies, adverse events affecting our proprietary technologies may in turndelay or prevent the development or commercialization of our productcandidates, which could impede our ability to generate revenues and achieve ormaintain profitability.

 

***Our product candidates are subject to extensive regulation, which canbe costly and time consuming, cause unanticipated delays or prevent the receiptof the required approvals to commercialize our product candidates.***

 

The clinical development,manufacturing, labeling, storage, record-keeping, advertising, promotion,export, marketing and distribution of our product candidates are subject toextensive regulation by the FDA and other regulatory agencies in the U.S. andby comparable governmental authorities in foreign markets. In the U.S., neitherwe, nor our collaborators, are permitted to market our product candidates untilwe or our collaborators receive approval of a New Drug Application, or NDA,from the FDA or receive similar approvals abroad. The process of obtainingthese approvals is expensive, often takes many years, and can varysubstantially based upon the type, complexity and novelty of the productcandidates involved. Approvalpolicies or regulations may change and may be influenced by the results ofother similar or competitive products. For example, in February 2008the FDA released draft guidance regarding clinical trials for productcandidates treating diabetes that may result in more stringent requirements forthe clinical testing and regulatory approval of such product candidates.  If formally adopted, these and any future guidancethat may result from

 

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recentFDA advisory panel discussions may make it more expensive to develop andcommercialize such product candidates.  Such increased expense could makeit more difficult to obtain favorable terms in the collaborative arrangementswe require to maximize the value of our programs seeking to develop new productcandidates for diabetes.  In addition, as a company, we have notpreviously filed NDAs with the FDA or filed similar applications with otherforeign regulatory agencies. This lack of experience may impede our ability toobtain FDA or other foreign regulatory agency approval in a timely manner, ifat all, for our product candidates for which development and commercializationis our responsibility.

 

Despite the time and expenseinvested, regulatory approval is never guaranteed. The FDA or other foreign regulatoryagencies can delay, limit or deny approval of a product candidate for manyreasons, including:

 

·                  a product candidate may notbe safe and effective,

 

·                  FDA or other foreignregulatory agency officials may not find the data from preclinical testing andclinical trials generated during development sufficient,

 

·                  the FDA or other foreignregulatory agency may not approve of our third-party manufacturers’ processesor facilities, or

 

·                  the FDA or other foreignregulatory agency may change its approval policies or adopt new regulations.

 

Any delay in obtaining, orinability to obtain, these approvals would prevent us from commercializing ourproduct candidates.

 

***Even if any of our product candidates receive regulatory approval, ourproduct candidates may still face future development and regulatorydifficulties.***

 

If any of our productcandidates receive regulatory approval, the FDA or other foreign regulatoryagencies may still impose significant restrictions on the indicated uses ormarketing of the product candidates or impose ongoing requirements forpotentially costly post-approval studies. In addition, regulatory agenciessubject a product, its manufacturer and the manufacturer’s facilities tocontinual review and periodic inspections. If a regulatory agency discoverspreviously unknown problems with a product, including adverse events ofunanticipated severity or frequency, or problems with the facility where theproduct is manufactured, a regulatory agency may impose restrictions on thatproduct, our collaborators or us, including requiring withdrawal of the productfrom the market. Our product candidates will also be subject to ongoing FDA andother foreign regulatory agency requirements for the labeling, packaging,storage, advertising, promotion, record-keeping and submission of safety andother post-market information on the drug. If our product candidates fail tocomply with applicable regulatory requirements, a regulatory agency may:

 

·                  issue warning letters orother notices of possible violations,

 

·                  impose civil or criminalpenalties or seek disgorgement of revenue or profits,

 

·                  suspend regulatory approval,

 

·                  suspend any ongoing clinicaltrials,

 

·                  refuse to approve pendingapplications or supplements to approved applications filed by us or ourcollaborators,

 

·                  impose restrictions onoperations, including costly new manufacturing requirements, or

 

·                  seize or detain products orrequire a product recall.

 

In order to market anyproducts outside of the U.S., we and our collaborators must establish andcomply with numerous and varying regulatory requirements of other countriesregarding safety and efficacy. Approval procedures vary among countries and caninvolve additional product testing and additional administrative reviewperiods. The time required to obtain approval in other countries might differfrom that required to obtain FDA approval. The regulatory approval process inother countries may include all of the risks regarding FDA approval in the U.S.Regulatory approval in one country does not ensure regulatory approval inanother, but a failure or delay in obtaining regulatory approval in one countrymay negatively impact the regulatory process in others. Failure to obtainregulatory approval in other countries or any delay or setback in obtainingsuch approval could have the same adverse impact regarding FDA approval in theU.S., including the risk that our product candidates may not be approved forall indications requested, which could limit the uses of our product candidatesand adversely impact potential royalties and product sales, and that suchapproval may be subject to limitations on the indicated uses for which theproduct may be marketed or require costly, post-marketing follow-up studies.

 

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If we and our collaboratorsfail to comply with applicable foreign regulatory requirements, we and ourcollaborators may be subject to fines, suspension or withdrawal of regulatoryapprovals, product recalls, seizure of products, operating restrictions andcriminal prosecution.

 

***If our competitors have products that are approved faster, marketed moreeffectively or demonstrated to be more effective than ours, our commercialopportunity will be reduced or eliminated.***

 

The biotechnology andbiopharmaceutical industries are characterized by rapidly advancingtechnologies, intense competition and a strong emphasis on proprietaryproducts. We face competition from many different sources, including commercialpharmaceutical and biotechnology enterprises, academic institutions, governmentagencies and private and public research institutions. Due to the high demandfor treatments for liver and metabolic diseases, research is intense and newtreatments are being sought out and developed by our competitors.

 

We are aware of manycompetitive products currently marketed or under development that are used totreat some of the diseases we have targeted. If MB07803 is ultimatelydetermined safe and effective and approved for marketing, it may compete formarket share with established therapies from a number of competitors, includinglarge pharmaceutical companies. Such marketed products include, but are notlimited to the following classes:

 

·                  metformin, which is a memberof the biguanide drug class, related to guanidine and currently is the mostwidely prescribed first line therapy for type 2 diabetes,

 

·                  sulfonylureas, whichincrease the secretion of insulin by the pancreas, thereby lowering the levelof the sugar glucose in the blood,

 

·                  insulins, which mimicinsulin, the naturally occurring hormone made by the pancreas to control bloodglucose levels,

 

·                  PPAR agonists, which improveinsulin sensitivity by activating certain genes involved in fat synthesis andcarbohydrate metabolism,

 

·                  incretin-based therapies,including incretin mimetics and dipeptidyl peptidase IV, or DPP-IVinhibitors.  Incretin mimetics lowerglucose levels by increasing the levels of certain naturally occurring hormonesfrom the pancreas, including glucagon-like peptide-1, or GLP-1, a peptide thatfacilitates the response of the pancreas and liver to fluctuations in glucoselevels by its action on pancreatic beta and alpha cells. Incretin mimeticsinclude BYETTA® (exenatide), an injectable medication that exhibitsmany of the same glucose regulating actions of GLP-1.  DPP-IV is an enzyme in the bloodstream thatcleaves and inactivates GLP-1. DPP-IV inhibitors inhibit this enzyme, thusincreasing the half-life of endogenous GLP-1 by preventing cleavage andinactivation of GLP-1. The overall effect of both of these classes of drugs isto enhance glucose-dependent insulin secretion and suppress inappropriateglucagon secretion,

 

·                  alpha-glucosidaseinhibitors, which decrease the absorption of carbohydrates from the intestine,resulting in a slower and lower rise in blood glucose throughout the day,

 

·                  glinides, which stimulatethe pancreas’ beta-cells to produce insulin, and

 

·                  combination therapies, whichcombine metformin with members of several or one of the above-mentionedclasses, particularly sulfonylureas and PPAR agonists.

 

Metformin is a drug thatinhibits liver glucose production like MB07803 but does so through an unknownmechanism. Because it does not cause weight gain, metformin is often prescribedas a first line therapy to obese patients with type 2 diabetes, who arereported to comprise more than 90% of patients newly diagnosed with type 2diabetes. Generic forms of metformin have recently become available. Accordingly,unless MB07803 demonstrates significant benefits when compared to metformin ordemonstrates that it can be used in the patient population who do not tolerateand/or adequately respond to metformin treatment, the price required toeffectively compete with the generic form of metformin may be so low that itmay limit the market’s potential or make it uneconomical to market MB07803. Inaddition, many companies are developing novel therapies that target diabetes.These companies may develop and introduce products competitive with or superiorto MB07803.

 

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If MB07811 is ultimatelydetermined safe and effective and approved for marketing, it would compete withproducts marketed by several large pharmaceutical companies that currentlycomprise a large share of the hyperlipidemia market. Major classes ofhyperlipidemia drugs include, but are not limited to:

 

·                  statins, which reduce serumcholesterol levels by inhibiting a key enzyme involved in the biosynthesis ofcholesterol,

 

·                  fibrates, which reduce theamount of cholesterol and triglycerides (fatty substances) in blood,

 

·                  nicotinic acid derivatives,which lower cholesterol, triglycerides and low density lipoproteins andincrease high density lipoproteins,

 

·                  CAIs, which inhibit theabsorption of dietary and biliary cholesterol,

 

·                  bile acid sequestrants,which bind with cholesterol-containing bile acids in the intestines and removethem in bowel movements, and

 

·                  statin combinationtherapies, which combine statins with members of the above-mentioned classes,particularly CAIs.

 

Several large pharmaceuticalcompanies are also developing novel therapies that target hyperlipidemia. Thesecompanies may develop and introduce products competitive with or superior toMB07811. Lipitor (atorvastatin; a statin marketed by Pfizer) is currently oneof the best selling prescription medicines. In addition, generic statins(cholesterol-reducers) have recently been approved in the major pharmaceuticalmarkets and would also compete with MB07811.

 

If pradefovir is ultimatelydetermined safe and effective and approved for marketing, it may compete formarket share with established therapies from a number of competitors, includinglarge pharmaceutical companies. Such marketed products include, but are notlimited to the following classes:

 

·                  interferons, which mimicinterferon, the naturally occurring infection-fighting immune substanceproduced by the body,

 

·                  nucleoside analogues, whichare chemically engineered nucleoside compounds that are converted inside cellsinto other compounds that are structurally similar to the building blocks ofDNA and RNA that interfere with the replication of HBV, and

 

·                  nucleotide analogues, whichare chemically engineered nucleotide compounds that are converted inside cellsinto other compounds that are structurally similar to the building blocks ofDNA and RNA that interfere with the replication of HBV.

 

A competitor to pradefovirwould be Hepsera (adefovir dipivoxil), which is a nucleotide analogue currentlymarketed in the U.S. and Europe by Gilead Sciences, Inc. Pradefovir andHepsera are prodrugs of the same active drug, and therefore may directlycompete. In order to effectively compete with Hepsera, pradefovir may have tobe significantly more beneficial or less expensive than Hepsera. In addition,the nucleotide analogue, tenofovir, has been shown to be very effective intreating hepatitis B infection and has recently been approved for marketing inEurope.

 

Nexavar (sorafenib), achemotherapy approved for treating kidney cancer, received FDA approval in November 2007for the treatment of primary liver cancer. This follows the decision of theEuropean Medicines Agency, or EMEA, in October 2007 to approve Nexavar inEurope. Nexavar is now the only drug approved for primary liver cancer in theUnited States or Europe.

 

In addition, companies aredeveloping therapies for other solid tumors which may be efficacious intreating primary liver cancer. These companies may develop and introduceproducts competitive with or superior to MB07133.

 

In addition, many othercompanies are developing products for the treatment of the diseases we aretargeting and if successful, these products could compete with our products. Ifwe receive approval to market and sell any of our product candidates, we maycompete with these companies and their products as well as others in varyingstages of development.

 

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Many of our competitors havesignificantly greater financial resources and expertise in research anddevelopment, manufacturing, preclinical testing, clinical trials, regulatoryapprovals and marketing approved products than we do. Smaller or early-stagecompanies may also prove to be significant competitors, particularly throughcollaborative arrangements with large and established companies. Ourcompetitors may succeed in developing technologies and therapies that are moreeffective, better tolerated or less costly than any which we are developing, orthat would render our product candidates obsolete and noncompetitive. Ourcompetitors may succeed in obtaining approvals from the FDA and foreignregulatory authorities for their products sooner than we do for ours. We willalso face competition from these third parties in recruiting and retainingqualified scientific and management personnel, establishing clinical trialsites and patient registration for clinical trials, and in acquiring and in-licensing technologies andproducts complementary to our programs or advantageous to our business.

 

***We do not have internal manufacturing capabilities, and if we fail todevelop and maintain supply relationships with collaborators or otherthird-party manufacturers, we may be unable to develop or commercialize ourproducts.***

 

Our ability to develop andcommercialize our products depends in part on our ability to manufacture, orarrange for collaborators or other third parties to manufacture, our productsat a competitive cost, in accordance with regulatory requirements and insufficient quantities for development and eventual commercialization. We haverelied on a number of suppliers to manufacture sufficient quantities of MB07803and MB07811 for use in clinical trials during development. Although oursuppliers have manufactured other companies’ products on a commercial scale, wehave not yet determined if they are capable of manufacturing our products on acommercial scale. We, our current and potential future collaborators andthird-party manufacturers may encounter difficulties with the small- andlarge-scale formulation and manufacturing processes required to manufacture ourproduct candidates, resulting in delays in our clinical trials development andregulatory submissions, in the commercialization of our product candidates or,if any of our product candidates is approved, in the recall or withdrawal ofthe product from the market. Further, development of large-scale manufacturingprocesses may require additional validation studies, which the FDA and otherforeign regulatory agencies must review and approve. Our inability to enter intoor maintain agreements with collaborators or capable third-party manufacturerson acceptable terms could delay or prevent the commercialization of ourproducts, which would adversely affect our ability to generate revenues andcould prevent us from achieving or maintaining profitability.

 

We currently expect that inany future development activities related to MB07803 and MB07811, we will relyon our current suppliers to manufacture these compounds. However, we do nothave long-term supply agreements with these third parties, and we may not beable to enter into new supply agreements with them in a timely manner or onacceptable terms, if at all. These third parties may also be subject tocapacity constraints that would cause them to limit the amount of thesecompounds that we can purchase. While we believe alternative sources tomanufacture these compounds are readily available, in the event we have to seeksuch alternative sources we will incur costs associated with identifying andqualifying one or more alternate suppliers. In addition, any resultinginterruption or delay we experience in the supply of MB07803 or MB07811 mayimpede the development of these compounds.

 

In addition, we, ourcollaborators or other third-party manufacturers of our products must complywith current good manufacturing practices, or CGMP, requirements enforced bythe FDA and other foreign regulatory agencies through their facilitiesinspection programs. These requirements include quality control, qualityassurance and the maintenance of records and documentation. In addition,product manufacturing facilities in California are subject to licensingrequirements of the California Department of Health Services and may beinspected by the California Department of Health Services, and other applicableregulatory authorities, at any time. We, our collaborators or other third-partymanufacturers of our products may be unable to comply with these CGMPrequirements and with other FDA, state and foreign regulatory requirements. Wehave little control over third-party manufacturers’ compliance with theseregulations and standards. A failure to comply with these requirements mayresult in fines and civil penalties, suspension of production, suspension ordelay in product approval, product seizure or recall, or withdrawal of productapproval.

 

***If we are unable to establish sales and marketing capabilities or enterinto agreements with third parties to sell and market our product candidates,we may be unable to generate significant revenues.***

 

We do not have a sales andmarketing organization, and we have no experience as a company in the sales,marketing and distribution of pharmaceutical products. Although our hepatitis Cand metabolic disease collaborations with Merck have not yet yielded product candidates,should they be successful, Merck will be responsible for worldwide marketingand commercialization of any resulting product candidates (subject to, in thecase of our metabolic disease collaboration, our option to co-promote theproduct in the U.S. with certain financial assistance from Merck). Similarly,should our hepatitis C collaborations with Idenix and Roche yield any productcandidates, Idenix and Roche will be responsible for worldwide marketing andcommercialization of any resulting product candidates. In order to co-promoteany of these products, or to commercialize MB07803, MB07811, pradefovir,MB07133 or any future product candidates for which we retain commercializationrights, we may be required to develop our sales, marketing and distributioncapabilities, or make arrangements with a third party to perform theseservices. Even though we may receive financial assistance from Merck if weexercise our U.S. co-promotion option under the metabolic diseasecollaboration, developing a sales force for any resulting product or anyproduct resulting from any of our other product candidates is expensive andtime consuming and could delay any product launch. We may be unable toestablish and manage an effective sales force in a timely or cost-effectivemanner, if at all, and any sales force we do establish may not be capable ofgenerating sufficient demand for our product candidates. To the extent that weenter into arrangements with collaborators or other third parties to performsales and marketing services, our product revenues are likely to be lower thanif we directly marketed and sold our product candidates. If we are unable toestablish adequate sales and marketing capabilities, independently or withothers, we may not be able to generate significant revenues and may not becomeprofitable.

 

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***The commercial success of our product candidates depends upon theirmarket acceptance among physicians, patients, healthcare payors and the medicalcommunity.***

 

Even if our productcandidates obtain regulatory approval, our products, if any, may not gain marketacceptance among physicians, patients, healthcare payors and the medicalcommunity. The degree of market acceptance of any of our approved productcandidates will depend on a number of factors, including:

 

·                  our ability to provideacceptable evidence of safety and efficacy,

 

·                  relative convenience andease of administration,

 

·                  the prevalence and severityof any adverse side effects,

 

·                  restrictions on use incombination with other products,

 

·                  availability of alternativetreatments,

 

·                  pricing and costeffectiveness assuming either competitive or potential premium pricingrequirements, based on the profile of our product candidates and targetmarkets,

 

·                  effectiveness of our or ourpartners’ sales and marketing strategy, and

 

·                  our ability to obtainsufficient third-party coverage or reimbursement.

 

***We are subject touncertainty relating to health care reform measures and reimbursement policieswhich, if not favorable to our product candidates, could hinder or prevent ourproduct candidates’ commercial success.***

 

The continuing efforts of the government, insurancecompanies, managed care organizations and other payers of health care costs tocontain or reduce costs of health care may adversely affect:

 

·                  our ability to set a pricewe believe is fair for our products,

 

·                  our ability to generaterevenues and achieve or maintain profitability,

 

·                  the future revenues andprofitability of our potential customers, suppliers and collaborators, and

 

·                  the availability of capital.

 

In certain foreign markets,the pricing of prescription drugs is subject to government control. In theU.S., given recent federal and state government initiatives directed atlowering the total cost of health care, Congress and state legislatures willlikely continue to focus on health care reform, the cost of prescription drugsand the reform of the Medicare and Medicaid systems. For example, in January 2007,the House of Representatives passed the Medicare Prescription Drug PriceNegotiation Act of 2007. The bill requires the federal government (specificallythe Department of Health and Human Services) to negotiate with drug companiesover the price of drugs for Medicare participants. In addition, the MedicarePrescription Drug, Improvement and Modernization Act of 2003 provides aMedicare prescription drug benefit that began in 2006 and mandates otherreforms. While we cannot predict the full outcome of the implementation ofthese legislations, it is possible that the new Medicare prescription drugbenefit, which will be managed by private health insurers and other managedcare organizations, will result in decreased reimbursement for prescriptiondrugs, which may further exacerbate industry-wide pressure to reduceprescription drug prices. This could harm our ability to market our productsand generate revenues. It is also possible that other similar proposals will beadopted.

 

Our ability to commercializeour product candidates successfully will depend in part on the extent to whichgovernmental authorities, private health insurers and other organizationsestablish appropriate coverage and reimbursement levels for the cost of ourproducts and related treatments. Third-party payors including state governmentsare increasingly challenging the prices charged for medical products andservices. Also, the trend toward managed health care in the U.S., which couldsignificantly influence the purchase of health care services and products, aswell as legislative proposals to reform health care or reduce governmentinsurance programs, may result in lower prices for our product candidates orexclusion of our product candidates from coverage and reimbursement programs.The cost containment measures that health care payors and providers areinstituting and the effect of any health care reform could significantly reduceour revenues from the sale of any approved product.

 

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***We may need to decrease the size of our organization, and we mayexperience difficulties in managing those organizational changes.***

 

Since we became anindependent company in 1999, we have increased the number of our full-timeemployees from 50 to 122 as of September 30, 2008. We may need to decreasethe number of our full-time employees in the future in response to the recentglobal financial crisis or other adverse business events. Reducing ourworkforce may lead to additional unanticipated attrition. If our futurestaffing is inadequate because of additional unanticipated attrition or becausewe failed to retain the staffing level required to accomplish our businessobjectives we may be delayed or unable to continue the development orcommercialization of our product candidates, which could impede our ability togenerate revenues and achieve profitability.

 

***If we fail to attract and keep key management and scientific personnel,we may be unable to successfully develop or commercialize our product candidates.***

 

Our success depends on ourcontinued ability to attract, retain and motivate highly qualified managementand scientific personnel. The loss of the services of certain principal membersof our management or scientific staff could delay or prevent the commercializationof our product candidates. We employ these individuals on an “at-will” basisand their employment can be terminated by us or them at any time, for anyreason and with or without notice, subject to the terms of their stockrestriction agreements and severance agreements.

 

Competition for qualifiedpersonnel in the biotechnology field is intense. We will need to hireadditional personnel as we establish and/or expand our sales, manufacturing,research and development activities in the future. We may not be able toattract and retain quality personnel on acceptable terms given the competitionfor such personnel among biotechnology, pharmaceutical and other companies.

 

We have established ascientific advisory board, the members of which assist us in formulating ourresearch, development and clinical strategies. These scientific advisors arenot our employees and may have commitments to, or consulting or advisorycontracts with, other entities that may limit their availability to us. Inaddition, our scientific advisors may have arrangements with other companies toassist those companies in developing products or technologies that may competewith ours

 

**Risks Related to our Finances and Capital Requirements**

 

***We will need substantial additional funding and may be unable to raisecapital when needed, which would force us to delay, reduce or eliminate ourresearch and development programs or commercialization efforts and affect ourability to continue as a going concern.***

 

We intend to use ourexisting cash reserves, proceeds from our ongoing collaboration with Merck,proceeds from our new collaboration with Roche and proceeds from other plannedbusiness development activities to execute our strategic plan through 2008.Under our strategic plan we will need to secure additional cash proceedsthrough future strategic collaborations or other financing sources to fundcertain MB07803 and MB07811 studies in 2009. In the event we are not able togenerate sufficient financing through strategic collaborations or otherfinancing activities, we have the ability and intent to, and will be requiredto, delay, scale back or eliminate some or all of our research or developmentprograms and other outlays of cash in order to meet our cash requirementsthrough 2009. Additionally, we may be required to relinquish greater or allrights to product candidates at an earlier stage of development or on lessfavorable terms than we would otherwise choose. Alternatively, we may determinethat seeking additional resources through traditional financing transactionsmay be appropriate to achieve certain key value-driving development milestones.No assurances can be made that additional funding through any resources will beavailable when needed. Given the recent financial crisis in the United Statesand other current negative macroeconomic indicators, such as the recession inthe United States or other economic downturns in the global markets, ourability to issue securities or obtain debt financing may not be available orattainable on favorable terms, if at all. Failure to obtain adequate financing and to curtail or delay cashexpenditures adequately will have a significant negative impact on our futureoperations and our ability to continue as a going concern. Because we do notanticipate that we will generate significant continuing revenues for severalyears, if at all, we will need to raise substantial additional capital tofinance our operations in the future. Our additional funding requirements willdepend on, and could increase significantly as a result of, many factors,including:

 

·                  the rate of progress andcost of our clinical trials and other research and development activities,

 

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·                  the scope, prioritizationand number of clinical development and research programs we pursue,

 

·                  the terms and timing of anycollaborative, licensing and other arrangements that we may establish,

 

·                  the costs of filing,prosecuting, defending and enforcing any patent claims and other intellectualproperty rights,

 

·                  the costs and timing ofregulatory approvals,

 

·                  the costs of establishing orcontracting for sales and marketing capabilities, and

 

·                  the effect of competingtechnological and market developments.

 

Until we can generatesignificant continuing revenues, if ever, we expect to satisfy our future cashneeds through public or private equity offerings, debt financings, grants orcorporate collaboration and licensing arrangements, as well as through interestincome earned on cash balances.

 

As noted above, we cannot becertain that additional funding will be available on acceptable terms, or atall. If adequate funds are not available, we may be required to delay, reducethe scope of or eliminate one or more of our research and development programsor our commercialization efforts and we may be unable to continue as a goingconcern. Based on our current rate of cash usage and absent any cash sourcesfrom business development, financings or other strategic initiatives, weanticipate that our cash balances as of September 30, 2008 will fund ouroperations through mid-2009.

 

***Recent turmoil inthe credit markets and the financial services industry may negatively impactour business, results of operations and financial condition.***

 

Since our inception, we have funded our operations primarily with netproceeds from equity financings, our venture debt facility and collaborativepartnerships.  Recently, the creditmarkets and the financial services industry have been experiencing a period ofunprecedented turmoil and upheaval characterized by the bankruptcy, failure,collapse or sale of various financial institutions and an unprecedented levelof intervention from the United States federal government.  While the ultimate outcome of these eventscannot be predicted, they may have a material adverse effect on our ability toobtain the capital necessary to carry out our strategic plan, which wouldnegatively impact our business, results of operations and financial condition.

 

***We have a history of net losses, which we expect to continue for theforeseeable future, and we are unable to predict when we will becomeprofitable, if ever.***

 

We have incurred net lossesfrom our inception. As of September 30, 2008, we had an accumulateddeficit of approximately $182.5 million. While we are unable at this time todetermine whether our net losses will increase or decrease in the future, weexpect to continue to incur net losses during the next several years as weconduct operations. Because of the numerous risks and uncertainties associatedwith our product development efforts, we are unable to predict when we willbecome profitable, if ever.

 

***We currently lacka significant continuing revenue source and may not become or remainprofitable.***

 

Our ability to become andremain profitable depends upon our ability to generate continuing revenues. Todate, our product candidates and strategic collaborations have not generatedany significant revenues, other than one-time or time-limited paymentsassociated with our collaborations such as milestone payments and option fees.Our ability to generate significant continuing revenues depends on a number offactors, including:

 

·                  successful completion ofongoing development activities for our product candidates,

 

·                  achievement of regulatoryapproval for our product candidates,

 

·                  successful completion of ourcurrent and future strategic collaborations, and

 

·                  successful sales, manufacturing,distribution and marketing of our products.

 

We do not anticipate that wewill generate significant continuing revenues for several years. If we areunable to eventually generate significant continuing revenues, we will notbecome or remain profitable, and we may be unable to continue our operations.

 

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***Raising additional funds by issuing securities, through collaborationand licensing arrangements or otherwise, will cause dilution to existingstockholders and may  restrict ouroperations or require us to relinquish proprietary rights.***

 

We may raise additionalfunds through public or private equity offerings, corporate collaboration andlicensing arrangements, debt financings, grants or our CEFF, if available. Forexample, we have an effective shelf registration statement on file with theSecurities and Exchange Commission which allows us to issue shares of ourcommon stock and warrants to purchase our common stock in the future for anaggregate initial offering price of up to $75 million, subject tosubstantial limitations relating to the aggregate market value of our commonstock held by non-affiliates. We have also filed a registration statement withthe Securities and Exchange Commission covering the resale of shares issuableunder the CEFF though to date, no shares have been issued under this resaleregistration statement. As of September 30, 2008, our marketcapitalization did not meet the CEFF minimum threshold of $53 million, andtherefore, we did not have access to this capital as of such date. We may selladditional securities from time to time in one or more offerings in amounts, atprices and on terms that we will determine at the time of the offering. To theextent that we raise additional capital by issuing equity securities, pursuantto our effective shelf registration statements or otherwise, our existingstockholders’ ownership will be diluted.

 

Any debt financing we enterinto may involve covenants that restrict our operations. These restrictivecovenants may include limitations on additional borrowing, specificrestrictions on the use of our assets as well as prohibitions on our ability tocreate liens, pay dividends, redeem our stock or make investments. In addition,if we raise additional funds through collaboration and licensing arrangements,it may be necessary to relinquish potentially valuable rights to our potentialproducts or proprietary technologies, or grant licenses on terms that are notfavorable to us.

 

Given the recent financialcrisis in the United States and other current negative macroeconomicindicators, such as the recession in the United States or other economicdownturns in the global markets, our ability to issue securities or obtain debtfinancing may not be available or attainable on favorable terms, if at all.

 

***Certain provisions of our financing facilities mayrequire us to pay any outstanding balance of indebtedness and******could limit our ability to fund ongoing operations or obtainadditional financing.***

 

Ifwe are required to pay any outstanding balance of indebtedness immediately, wemay be faced with the following negative consequences:

 

·                  we will need a substantialportion of our cash flow to pay the principal and interest on our indebtedness,

 

·                  payments of our indebtednesswill reduce the funds that would otherwise be available for our operations andfuture strategic initiatives, and

 

·                  there would be a material adverseeffect on our business and financial condition if we were unable to service ourindebtedness or obtain additional financing.

 

***Our quarterly operating results and stock price may fluctuatesignificantly.***

 

We expect our operatingresults to be subject to quarterly fluctuations. The revenues we generate, ifany, and our operating results will be affected by numerous factors, including:

 

·                  the development status ofour product candidates, including results of our clinical trials and otherstudies,

 

·                  our recommendation ofadditional drug compounds for clinical development,

 

·                  our addition or terminationof research programs or funding support,

 

·                  variations in the level ofexpenses related to our product candidates or research programs,

 

·                  our execution ofcollaborative, licensing or other arrangements, and the timing of payments wemay make or receive under these arrangements, and

 

·                  changes in the useassumptions in the application of SFAS No. 123R in future periods.

 

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Quarterly fluctuations inour operating results may, in turn, cause the price of our stock to fluctuatesubstantially. We believe that quarterly comparisons of our financial resultsare not necessarily meaningful and should not be relied upon as an indicationof our future performance.

 

***Our CEFF may not be available to us if we elect to make a draw down,may require us to make additional “blackout” or*** ***other payments to an institutional investor and may resultin dilution to our stockholders.***

 

We have we entered into aCEFF with an institutional investor that entitles us to sell and obligates theinvestor to purchase, from time to time over a period of up to 36 monthswhich commenced in December 2006, shares of our common stock at a discountof up to 10% for cash consideration up to an aggregate of $50.0 million,or 6,046,701 shares, of common stock, subject to specified conditions andrestrictions. The investor will not be obligated to purchase shares under theCEFF unless specified conditions are met, which include a minimum price for ourcommon stock; a minimum amount of our market capitalization, the accuracy ofrepresentations and warranties made to the investor; compliance with laws; andthe effectiveness of a registration statement registering for resale the sharesof common stock to be issued in connection with the CEFF. In addition, amongother termination rights, the investor is permitted to terminate the CEFF byproviding written notice to us within 10 business days after it obtains actualknowledge that an event has occurred resulting in a material and adverse effecton our business, operations, properties or financial condition (subject tospecified exceptions, including conditions or events that are reasonablyexpected to occur in the ordinary course of our business). If we are unable toaccess funds through the CEFF, or if the investor terminates the CEFF, we maybe unable to access capital on favorable terms, or at all.  As of September 30, 2008, our marketcapitalization did not meet the CEFF minimum threshold of $53 million, andtherefore, we did not have access to this capital as of such date.

 

We are entitled, in certaincircumstances, to deliver a “blackout” notice to the investor to suspend theuse of the prospectus covering the shares of common stock issued in connectionwith the CEFF and prohibit the investor from selling shares under thatprospectus for a certain period of time. If we deliver a blackout notice in the15 trading days following the settlement of a draw down, or if the registrationstatement covering the resale of the shares of common stock to be issued inconnection with the CEFF is not effective in circumstances not permitted by ourregistration rights agreement with the investor, then we must make a payment tothe investor, or issue the investor additional shares in lieu of this payment,calculated on the basis of a specified number of shares held by the investorimmediately prior to the blackout period and the change in the market price ofour common stock during the period in which the use of the resale registrationstatement is suspended. If the trading price of our common stock declinesduring a suspension of the resale registration statement, the blackout or otherpayment could be significant.

 

Should we sell shares to theinvestor under the CEFF, or issue shares in lieu of a blackout payment, it willhave a dilutive effect on the holdings of our current stockholders.

 

**Risks Related to our Intellectual Property**

 

***Our success depends upon our ability to protect our intellectualproperty, including the proprietary technologies and compounds used in ourbusiness.***

 

Our commercial successdepends on obtaining and maintaining patent protection and/or trade secretprotection of our product candidates, proprietary technologies and their uses,as well as successfully defending any patents that issue against third-partychallenges. We may only be able to protect our product candidates, proprietarytechnologies and their uses from unauthorized use by third parties to theextent that valid and enforceable patents or trade secrets cover them.

 

The filing, prosecution anddefense of patents at pharmaceutical and biotechnology companies can be highlyuncertain and involve complex legal and factual questions for which importantlegal principles remain unresolved. No consistent policy regarding the breadthof claims allowed in biotechnology patents has emerged to date in the U.S. Thebiotechnology patent situation outside the U.S. is even more uncertain. We maybe particularly affected by this because we expect that pradefovir and MB07133,if approved, will be marketed in foreign countries with high incidences of HBVand primary liver cancer, respectively. Decisions or actions regarding patentfiling and/or changes in either the patent laws or in interpretations of patentlaws in the U.S. and other countries may diminish the value of our intellectualproperty.

 

Decisions or actionsregarding patent filing are complex and we may not be successful in protectingour products from competition. Patent positions for products are highlyuncertain and involve complex legal and factual questions which may ultimatelybe decided to the detriment of our products’ competitive positions’ in the U.S.and these other countries. We may not be able to develop patentable products orprocesses in the U.S. and these other countries, and may not be able to obtainpatents from pending applications. Even if patent claims are allowed in theU.S. and these other countries, the claims may not issue, or in the event ofissuance, may not be sufficient to protect the technology owned by or licensedto us. Any patents or patent rights that we obtain in the U.S. and othercountries may be circumvented, challenged or invalidated by our competitors. Inaddition, we are dependent on outside patent firms for advice and actionregarding our efforts to secure patents. Should these firms fail to takeappropriate action to secure or enforce our patents in a timely manner, orshould they provide us with incorrect or inappropriate advice it could bedetrimental to our patent positions.

 

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Accordingly, we cannotpredict the breadth of claims that may be allowed or enforced in our patents orin third-party patents in the U.S. and other countries.

 

The degree of futureprotection for our proprietary rights is uncertain because legal means affordonly limited protection and may not adequately protect our rights or permit usto gain or keep our competitive advantage. For example:

 

·                  we might not have been thefirst to make the inventions covered by each of our pending patent applicationsand issued patents,

 

·                  we might not have been thefirst to file patent applications for these inventions,

 

·                  others may independentlydevelop similar or alternative technologies or duplicate any of ourtechnologies,

 

·                  it is possible that none ofour pending patent applications will result in issued patents,

 

·                  our issued patents may notprovide a basis for commercially viable products, may not provide us with anycompetitive advantages, or may be challenged by third parties,

 

·                  our issued patents may notbe valid or enforceable,

 

·                  we may not developadditional proprietary technologies that are patentable, or

 

·                  the patents of others mayhave an adverse effect on our business.

 

Proprietary trade secretsand unpatented know-how are also very important to our business. Although wehave taken steps to protect our trade secrets and unpatented know-how,including entering into proprietary information and inventions agreements withour employees and consultants and entering into confidentiality agreements withother third parties to whom we disclose our proprietary information, thirdparties may still obtain this information without our knowledge and consent.Enforcing a claim that a third party illegally obtained and is using our tradesecrets or unpatented know-how is expensive and time consuming, and the outcomeis unpredictable. In addition, courts outside the U.S. may be less willing toprotect this information. Moreover, our competitors may independently developequivalent knowledge, methods and know-how.

 

***If we are sued for infringing intellectual property rights of thirdparties, it will be costly and time consuming, and an unfavorable outcome inthat litigation would have a material adverse effect on our business.***

 

Our commercial successdepends upon our ability and the ability of our collaborators to develop,manufacture, market and sell our product candidates and use our proprietarytechnologies without infringing the proprietary rights of third parties.Numerous U.S. and foreign issued patents and pending patent applications, whichare owned by third parties, exist in the fields in which we and ourcollaborators are developing products. Because patent applications can takemany years to issue, there may be currently pending applications, unknown tous, which may later result in issued patents that our product candidates orproprietary technologies may infringe. We have not conducted a complete search ofexisting patents to identify existing patents that our product candidates orproprietary technologies may inadvertently infringe.

 

We may be exposed to futurelitigation by the companies holding these patents or other third parties basedon claims that our product candidates and/or proprietary technologies infringetheir intellectual property rights. If one of these patents was found to coverour product candidates, proprietary technologies or their uses, we or ourcollaborators could be required to pay damages and could be unable tocommercialize our product candidates or use our proprietary technologies unlesswe or they obtained a license to the patent. In addition, while we are notcurrently subject to pending litigation nor are we aware of any threatenedlitigation, third parties may contact us or our collaborators in the ordinarycourse of business to bring certain patents to our attention. We and ourcollaborators evaluate all such communications on a case-by-case basis toassess whether such patents cover our product candidates or proprietarytechnologies and if so, whether to seek a license from such third parties. Alicense may not be available to us or our collaborators on acceptable terms, ifat all.

 

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There is a substantialamount of litigation involving patent and other intellectual property rights inthe biotechnology and biopharmaceutical industries generally. If a third partyclaims that we or our collaborators infringe on its technology, we may face anumber of issues, including:

 

·                  infringement and otherintellectual property claims which, with or without merit, may be expensive andtime-consuming to litigate and may divert our management’s attention from ourcore business,

 

·                  substantial damages forinfringement, including treble damages and attorneys’ fees, as well as damagesfor products developed using allegedly infringing drug discovery tools ormethods, which we may have to pay if a court decides that the product orproprietary technology at issue infringes on or violates the third party’srights,

 

·                  a court prohibiting us fromselling or licensing the product or using the proprietary technology unless thethird party licenses its technology to us, which it is not required to do,

 

·                  if a license is availablefrom the third party, we may have to pay substantial royalties, fees and/orgrant cross licenses to our technology, and

 

·                  redesigning our products orprocesses so they do not infringe, which may not be possible or may requiresubstantial funds and time.

 

We have conducted searchesof U.S. and foreign patents, but cannot guarantee that the searches werecomprehensive and therefore whether any of our product candidates or themethods of using, making or identifying our product candidates infringe thepatents searched, or that other patents do not exist that cover our productcandidates or these methods. There may also be pending patent applications thatare unknown to us and may prevent us from marketing our product candidates.Other product candidates that we may develop, either internally or in collaborationwith others, could be subject to similar delays and uncertainties.

 

***Existing patents and patent applications covering adefovir or prodrugsof adefovir in the U.S. and foreign countries may prevent the commercializationof pradefovir in the future.***

 

Our product candidatepradefovir is a prodrug of adefovir. A third party, Gilead, has rights toanother product called Hepsera that is a non-liver specific prodrug ofadefovir. We are aware of third party patents and patent applications in theU.S. and in European and other foreign countries with claims to prodrugs ofadefovir. These patents are scheduled to expire in September 2011 overseasand in 2014 in the U.S. Although we do not believe that any valid claim coverspradefovir, we cannot guarantee this. If it is determined that patent claimsare valid and cover pradefovir, we may not be able to commercialize pradefovirin such countries, including those in Europe. Further, we are aware that apatent term extension of one of these prodrug patents has been granted inmultiple European countries based on the regulatory approval of Hepsera therebyextending protection of Hepsera in those countries to September 2016.Additional third party patents covering Hepsera or adefovir may exist, and mayexpire later than our expected date of regulatory approval in the country wherethe patent is in force.

 

**Risks Related to Other Legal Matters**

 

***We may incur significant costs complying with environmental laws andregulations.***

 

We use hazardous materials,including chemicals, biological agents and radioactive isotopes and compoundsthat could be dangerous to human health and safety or the environment. Asappropriate, we store these materials and wastes resulting from their use atour facility pending their ultimate use or disposal. We currently contract witha third party to dispose of these materials and wastes. We are subject to avariety of federal, state and local laws and regulations governing the use,generation, manufacture, storage, handling and disposal of these materials andwastes. We may also incur significant costs complying with environmental lawsand regulations adopted in the future.

 

***We may incur substantial liabilities from any product liability claimsif our insurance coverage for those claims is inadequate.***

 

We face an inherent risk ofproduct liability exposure related to the testing of our product candidates inhuman clinical trials, and will face an even greater risk if we sell ourproduct candidates commercially. An individual may bring a liability claimagainst us if one of our product candidates causes, or merely appears to havecaused, an injury. If we cannot successfully defend ourselves against theproduct liability claim, we will incur substantial liabilities. Regardless ofmerit or eventual outcome, liability claims may result in:

 

·                  decreased demand for ourproduct candidates,

 

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·                  injury to our reputation,

 

·                  withdrawal of clinical trialparticipants,

 

·                  costs of related litigation,

 

·                  substantial monetary awardsto patients or other claimants,

 

·                  loss of revenues, and

 

·                  the inability tocommercialize our product candidates.

 

We have product liabilityinsurance that covers our clinical trials, up to an annual aggregate limit of$10 million. We intend to expand our insurance coverage to include thesale of commercial products if marketing approval is obtained for any of ourproduct candidates. However, insurance coverage is increasingly expensive. Wemay not be able to maintain insurance coverage at a reasonable cost and we maynot be able to obtain insurance coverage that will be adequate to satisfy anyliability that may arise.

 

***If we use biological and hazardous materials in a manner that causesinjury, we may be liable for damages.***

 

Our research and developmentand manufacturing activities involve the use of biological and hazardousmaterials. Although we believe our safety procedures for handling and disposingof these materials comply with federal, state and local laws and regulations,we cannot entirely eliminate the risk of accidental injury or contaminationfrom the use, storage, handling or disposal of these materials. If one of ouremployees was accidentally injured from the use, storage, handling or disposalof these materials, the medical costs related to his or her treatment would becovered by our workers’ compensation insurance policy. While our property andcasualty and general liability insurance policies specifically exclude coveragefor damages and fines arising from biological or hazardous waste exposure orcontamination, we do carry separate pollution legal liability coverage that isintended to cover third party claims for bodily injury, property damage andremediation costs. However, in the event of contamination or injury, we couldbe held liable for damages or penalized with fines in an amount exceeding ourinsurance and/or resources.

 

**Risks Related to the Securities Markets and Investment in ourCommon Stock**

 

***Market volatility may affect our stock price and the value of yourinvestment.***

 

The market price for ourcommon stock has been and is likely to continue to be volatile. In addition,the market price of our common stock may fluctuate significantly in response toa number of factors, most of which we cannot control, including:

 

·                  changes in the regulatorystatus of our product candidates, including the status and results of ourdevelopment activities,

 

·                  establishment of newcollaborative arrangements,

 

·                  events affecting Merck,Idenix, Roche or any future collaborators,

 

·                  announcements of newproducts or technologies, commercial relationships or other events by us or ourcompetitors,

 

·                  regulatory developments inthe U.S. and foreign countries,

 

·                  fluctuations in stock marketprices and trading volumes of similar companies,

 

·                  variations in our quarterlyoperating results,

 

·                  changes in securitiesanalysts’ estimates of our financial performance,

 

·                  changes in accountingprinciples,

 

·                  issuances of new equitysecurities by us, pursuant to our effective shelf registration statements orotherwise,

 

·                  sales of large blocks of ourcommon stock, including sales by our executive officers, directors andsignificant stockholders,

 

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·                  additions or departures ofkey personnel,

 

·                  discussion of us or ourstock price by the financial and scientific press and in online investorcommunities, and

 

·                  changes in industry andgeneral market conditions, including the recent economic crisis.

 

***If we fail to meetone of Nasdaq’s Global Market continued listing requirements, our common stockcould be delisted from the Nasdaq Global Market, which could negatively impactthe price of our common stock and our ability to access the capital markets.***

 

In order to maintain ourlisting on the Nasdaq Global Market, we will need to continue meeting certainminimum listing standards that include, or may include, our shareholders’equity, the market value of our listed or publicly held securities, the numberof publicly held shares, our net income, a minimum bid price for our commonstock, the number of shareholders, the number of market makers and compliancewith certain of our corporate governance policies.  If we fail to maintain the standards requirednow or in the future, our common stock could be delisted from the Nasdaq GlobalMarket.  The delisting of our common stock would significantlyaffect the ability of investors to trade our securities and would negativelyaffect the value and liquidity of our common stock.  In addition, the delisting of our commonstock could materially adversely affect our ability to raise capital on termsacceptable to us, or at all. Delisting from the Nasdaq Global Market could alsohave other negative results, including the potential loss of confidence bysuppliers and employees and the loss of institutional investor interest.

 

***Anti-takeover provisions in our charter documents and under Delawarelaw could make an acquisition of us, which may be beneficial to ourstockholders, more difficult and may prevent attempts by our stockholders toreplace or remove our current management.***

 

Provisions in our amendedand restated certificate of incorporation and bylaws may delay or prevent anacquisition of us or a change in our management. These provisions include aclassified board of directors, a prohibition on actions by written consent ofour stockholders, and the ability of our board of directors to issue preferredstock without stockholder approval. In addition, because we are incorporated inDelaware, we are governed by the provisions of Section 203 of the DelawareGeneral Corporation Law, which prohibits stockholders owning in excess of 15%of our outstanding voting stock from merging or combining with us. Although webelieve these provisions collectively provide for an opportunity to receive higherbids by requiring potential acquirers to negotiate with our board of directors,they would apply even if the offer may be considered beneficial by somestockholders. In addition, these provisions may frustrate or prevent anyattempts by our stockholders to replace or remove our current management bymaking it more difficult for stockholders to replace members of our board ofdirectors, which is responsible for appointing the members of our management.

 

***We incur costs associated with regulatory compliance, and these costscould be significant.***

 

There are numerousregulatory requirements for public companies, including the provisions of theSarbanes-Oxley Act of 2002 and rules adopted or proposed by the Securitiesand Exchange Commission and by the Nasdaq Stock Market. Section 404requires management to report on, and our independent auditors to attest to,our internal controls. These laws and regulations could make it more difficultor more costly for us to obtain certain types of insurance, including directorand officer liability insurance, and we may be forced to accept reduced policylimits and coverage or incur substantially higher costs to obtain the same orsimilar coverage. The impact of these events could also make it more difficultfor us to attract and retain qualified persons to serve on our board ofdirectors, our board committees or as executive officers. We are presentlyevaluating and monitoring developments with respect to these laws andregulations and cannot predict or estimate the amount or timing of additionalcosts we may incur to respond to their requirements. Compliance with these rules couldalso result in continued diversion of management’s time and attention, whichcould be disruptive to normal business operations. If we do not satisfactorilyor timely comply with these requirements, possible consequences could includesanction or investigation by regulatory authorities such as the Securities andExchange Commission or the Nasdaq Stock Market; fines and penalties; incompleteor late filing of our periodic reports, including our annual report on Form 10-K;or civil or criminal liability. Our stock price and business could also beadversely affected.

 

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***If our executive officers, directors and largest stockholders choose toact together, they may be able to control our operations and act in a mannerthat is not necessarily consistent with the interests of other stockholders.***

 

Our executive officers,directors and holders of 5% or more of our outstanding common stock,beneficially owned approximately 76% of our common stock as of September 30,2008. As a result, these stockholders, acting together, are able to control allmatters requiring approval by our stockholders, including the election ofdirectors and the approval of mergers or other business combinationtransactions. The interests of this group of stockholders may not alwayscoincide with our interests or the interests of other stockholders, and theymay act in a manner that is not necessarily consistent with the interests ofother stockholders.

 

***Future sales of our common stock may cause our stock price to decline.***

 

A large portion of our sharesare held by a small number of persons and investment funds. In addition, thesepersons and funds hold warrants to purchase 2,833,338 shares of common stockthat, if exercised, will result in these additional shares becoming availablefor sale. Moreover, several of our stockholders and warrant holders haverights, subject to some conditions, to require us to file registrationstatements covering the unregistered shares they currently hold or may acquireupon exercise of warrants, or to include these shares in registrationstatements that we may file for ourselves or other stockholders.  Under the CEFF, an institutional investor iscommitted to purchase up to $50 million or 6,046,471 shares of our commonstock over a 36 month period which commenced in December 2006,subject to certain conditions. As of September 30, 2008, our marketcapitalization did not meet the CEFF minimum threshold of $53 million, andtherefore, we did not have access to this capital as of such date.  Sales by these current and potential futurestockholders or warrant holders of a substantial number of shares couldsignificantly reduce the market price of our common stock.

 

## **Item2. Unregistered Sales of Equity Securities and Use of Proceeds**

##  

None.

 

**Item 3. Defaults Upon Senior Securities**

 

None.

 

**Item 4. Submission of Matters to a Vote of Security Holders**

 

None.

 

**Item 5. Other Information**

 

None.

 

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**Item 6. Exhibits**

 
| **Exhibit   Number** | ** ** | **Description**                                                                                                                                                |
|---------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                      |       |                                                                                                                                                           |
| 3.1(1)                    |       | Amended  and Restated Certificate of Incorporation.                                                                                                            |
|                      |       |                                                                                                                                                           |
| 3.2(2)                    |       | Amended  and Restated Bylaws.                                                                                                                                  |
|                      |       |                                                                                                                                                           |
| 4.1(1)                    |       | Form of  Common Stock Certificate.                                                                                                                        |
|                      |       |                                                                                                                                                           |
| 10.1                      |       | Collaboration  and License Agreement between the Company and Hoffman-La Roche Inc., F.  Hoffman-La Roche LTD and Roche Palo Alto LLC dated August 7, 2008 |
|                      |       |                                                                                                                                                           |
| 10.2                      |       | Amendment  Agreement between the Company, Schering Corporation and Valeant  Pharmaceuticals North American dated September 24, 2008.                      |
|                      |       |                                                                                                                                                           |
| 31.1                      |       | Certification  of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002.                                                     |
|                      |       |                                                                                                                                                           |
| 31.2                      |       | Certification  of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002.                                                     |
|                      |       |                                                                                                                                                           |
| 32                        |       | Certifications  of Chief Executive Officer and Chief Financial Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                        |

 

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| (1)    |   | Incorporated by  reference to the exhibit of the same number to the Company’s Registration  Statement on Form S-1 (No. 333-112437), originally filed on February 3,  2004. |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                |
| (2)    |   | Incorporated by  reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K  filed on October 2, 2007.                                                                |

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
| Date: November 10,  2008 | By:      | /s/  Paul K. Laikind, Ph.D.                                                             |
|------------------------------------|----------|-----------------------------------------------------------------------------------------|
| * *                           | * * | *Paul  K. Laikind, Ph.D., Chief Executive Officer and  Interim Chief Financial Officer* |

 

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