Table of Contents

 

** **

** **

**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 June 30, 2008.**

 

**OR**

 

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

 

**For thetransition periodfrom                 to                 .**

 

**Commissionfile number 000-50785**

 

**METABASIS THERAPEUTICS, INC.**

(Exact name of registrant asspecified in its charter)

 

| **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  telephone number, 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 August 5, 2008 was35,043,026.

 

 

 

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**METABASIS THERAPEUTICS, INC.**

 

**FORM 10-Q**

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

 

**TABLE OF CONTENTS**

 
| PART I—FINANCIAL  INFORMATION                                                              | 2      |
|------------------------------------------------------------------------------------------------------|--------|
|                                                                                                 |   |
| Item 1. Financial Statements                                                                         | 2      |
|                                                                                                 |   |
| Balance Sheets at June 30, 2008 (Unaudited) and  December 31, 2007                         | 2      |
|                                                                                                 |   |
| Statements of Operations for the three and six months  ended June 30, 2008 and 2007 (Unaudited) | 3      |
|                                                                                                 |   |
| Statements of Cash Flows for the six months ended  June 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                                  | 20     |
|                                                                                                 |   |
| Item 4. Controls and Procedures                                                                      | 20     |
|                                                                                                 |   |
| PART II—OTHER  INFORMATION                                                                 | 21     |
|                                                                                                 |   |
| Item  1. Legal Proceedings                                                                           | 21     |
|                                                                                                 |   |
| Item 1A. Risk Factors                                                                                | 21     |
|                                                                                                 |   |
| Item 2. Unregistered Sales of Equity Securities and  Use of Proceeds                                 | 42     |
|                                                                                                 |   |
| Item 3. Defaults Upon Senior Securities                                                              | 42     |
|                                                                                                 |   |
| Item 4. Submission of Matters to a Vote of Security  Holders                                         | 42     |
|                                                                                                 |   |
| Item  5. Other Information                                                                           | 42     |
|                                                                                                 |   |
| Item 6. Exhibits                                                                                     | 43     |
|                                                                                                 |   |
| SIGNATURES                                                                                           | 44     |

 

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**PART I- FINANCIAL INFORMATION**

 

**Item 1. Financial Statements**

 

**Metabasis Therapeutics, Inc.**

**BalanceSheets**

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

 
| ** **                                                                                                                                                                                                                    | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                    | ** ** | **2008**          | ** ** | **2007**              | ** ** |
| ** **                                                                                                                                                                                                                    | ** ** | **(Unaudited)**   | ** ** | ** **            | ** ** |
| **Assets**                                                                                                                                                                                                                    |       |              |       |                  |       |
| Current assets:                                                                                                                                                                                                               |       |              |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                                                     |       | $                 | 13,798     |                  | $          | 14,141 |   |
| Securities available-for-sale                                                                                                                                                                                                 |       | 18,703            |       | 28,297                |       |
| Prepaids and other current assets                                                                                                                                                                                             |       | 1,215             |       | 1,157                 |       |
| Total current assets                                                                                                                                                                                                          |       | 33,716            |       | 43,595                |       |
|                                                                                                                                                                                                                          |       |              |       |                  |       |
| Property and equipment, net                                                                                                                                                                                                   |       | 5,726             |       | 6,356                 |       |
| Other assets                                                                                                                                                                                                                  |       | 322               |       | 172                   |       |
| Total assets                                                                                                                                                                                                                  |       | $                 | 39,764     |                  | $          | 50,123 |   |
|                                                                                                                                                                                                                          |       |              |       |                  |       |
| **Liabilities and stockholders’ equity**                                                                                                                                                                                 |       |              |       |                  |       |
| Current liabilities:                                                                                                                                                                                                          |       |              |       |                  |       |
| Accounts payable                                                                                                                                                                                                              |       | $                 | 526        |                  | $          | 802 |   |
| Accrued compensation                                                                                                                                                                                                          |       | 2,702             |       | 3,181                 |       |
| Accrued liabilities                                                                                                                                                                                                           |       | 1,929             |       | 4,132                 |       |
| Deferred revenue, current portion                                                                                                                                                                                             |       | 581               |       | 1,321                 |       |
| Current portion of long-term debt                                                                                                                                                                                             |       | 3,252             |       | 2,068                 |       |
| Current portion of capital lease  obligations                                                                                                                                                                                 |       | 26                |       | 23                    |       |
| Total current liabilities                                                                                                                                                                                                     |       | 9,016             |       | 11,527                |       |
|                                                                                                                                                                                                                          |       |              |       |                  |       |
| Deferred rent                                                                                                                                                                                                                 |       | 2,849             |       | 2,595                 |       |
| Long-term debt                                                                                                                                                                                                                |       | 6,617             |       | 3,845                 |       |
| Capital lease obligations, net of current  portion                                                                                                                                                                            |       | 40                |       | 55                    |       |
| Other long-term liabilities                                                                                                                                                                                                   |       | 200               |       | —                |       |
| Total liabilities                                                                                                                                                                                                             |       | 18,722            |       | 18,022                |       |
|                                                                                                                                                                                                                          |       |              |       |                  |       |
| Stockholders’ equity:                                                                                                                                                                                                    |       |              |       |                  |       |
| Preferred stock, $0.001 par value; 5,000  shares authorized at June 30, 2008 and December 31, 2007, no shares  issued or outstanding                                                                                |       | —            |       | —                |       |
| Common stock, $0.001 par value; 100,000  shares authorized at June 30, 2008 and December 31, 2007; 35,036  and 30,754 shares issued and outstanding at June 30, 2008 and December 31,  2007, respectively |       | 35                |       | 31                    |       |
| Additional paid-in capital                                                                                                                                                                                                    |       | 193,636           |       | 182,003               |       |
| Accumulated deficit                                                                                                                                                                                                           |       | (172,654          | )          | (150,012              | )          |
| Accumulated other comprehensive loss                                                                                                                                                                                          |       | 25                |       | 79                    |       |
| Total stockholders’ equity                                                                                                                                                                                               |       | 21,042            |       | 32,101                |       |
|                                                                                                                                                                                                                          |       |              |       |                  |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                               |       | $                 | 39,764     |                  | $          | 50,123 |   |

 

*See accompanying notes.*

 

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**MetabasisTherapeutics, Inc.**

**Statementsof Operations**

**(Inthousands, except per share data)**

**(Unaudited)**

 
| ** **                                                   | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                   | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                   | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                         |       |                             |       |                           |       |   |   |   |   |
| Revenues:                                                    |       |                             |       |                           |       |   |   |   |   |
| Sponsored research                                           |       | $                                | 514        |                           | $          | 938 |   | $ | 1,039 |   | $ | 1,876 |   |
| License fees                                                 |       | 173                              |       | 666                            |       | 590 |   | 3,133 |   |
| Other revenue                                                |       | —                           |       | —                         |       | — |   | 21 |   |
| Total revenues                                               |       | 687                              |       | 1,604                          |       | 1,629 |   | 5,030 |   |
|                                                         |       |                             |       |                           |       |   |   |   |   |
| Operating expenses:                                          |       |                             |       |                           |       |   |   |   |   |
| Research and development                                     |       | 9,667                            |       | 11,065                         |       | 19,412 |   | 20,571 |   |
| General and administrative                                   |       | 2,569                            |       | 3,186                          |       | 5,088 |   | 6,450 |   |
| Total operating expenses                                     |       | 12,236                           |       | 14,251                         |       | 24,500 |   | 27,021 |   |
|                                                         |       |                             |       |                           |       |   |   |   |   |
| Loss from operations                                         |       | (11,549                          | )          | (12,647                        | )          | (22,871 | ) | (21,991 | ) |
| Other income (expense):                                      |       |                             |       |                           |       |   |   |   |   |
| Interest income                                              |       | 245                              |       | 842                            |       | 643 |   | 1,814 |   |
| Interest expense                                             |       | (238                             | )          | (130                           | )          | (414 | ) | (264 | ) |
| Total other income                                           |       | 7                                |       | 712                            |       | 229 |   | 1,550 |   |
|                                                         |       |                             |       |                           |       |   |   |   |   |
| Net loss                                                     |       | $                                | (11,542    | )                              | $          | (11,935 | ) | $ | (22,642 | ) | $ | (20,441 | ) |
|                                                         |       |                             |       |                           |       |   |   |   |   |
| Basic and diluted net loss per share                         |       | $                                | (0.34      | )                              | $          | (0.40 | ) | $ | (0.70 | ) | $ | (0.67 | ) |
| Shares used to compute basic and diluted net  loss per share |       | 34,244                           |       | 30,213                         |       | 32,501 |   | 30,502 |   |

 

*See accompanying notes.*

 

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**MetabasisTherapeutics, Inc.**

**Statementsof Cash Flows**

**(Inthousands)**

**(Unaudited)**

 
| ** **                                                                | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                | ** ** | **June 30,**              | ** ** |
| ** **                                                                | ** ** | **2008**                       | ** ** | **2007** | ** ** |
|                                                                      |       |                           |       |   |   |
| **Operating activities**                                                  |       |                           |       |   |   |
| Net loss                                                                  |       | $                              | (22,642    | ) | $ | (20,441 | ) |
| Adjustments to reconcile net loss to net  cash                            |       |                           |       |   |   |
| used in operating activities:                                             |       |                           |       |   |   |
| Stock-based compensation                                                  |       | 1,967                          |       | 2,694 |   |
| Depreciation and amortization                                             |       | 1,037                          |       | 978 |   |
| Deferred rent                                                             |       | 254                            |       | 565 |   |
| Amortization of discount and premium on  securities available-for-sale    |       | (334                           | )          | (1,351 | ) |
| Loss on disposal of assets                                                |       | 20                             |       | — |   |
| Realized gain on securities  available-for-sale                           |       | (7                             | )          | — |   |
| Change in operating assets and liabilities:                               |       |                           |       |   |   |
| Trade accounts receivable                                                 |       | 61                             |       | (263 | ) |
| Other current assets                                                      |       | (119                           | )          | 72 |   |
| Other assets                                                              |       | 52                             |       | 4 |   |
| Deferred revenue                                                          |       | (740                           | )          | (1,334 | ) |
| Accounts payable                                                          |       | (276                           | )          | 653 |   |
| Accrued compensation and other liabilities                                |       | (2,684                         | )          | 1,916 |   |
| Net cash flows used in operating activities                               |       | (23,411                        | )          | (16,507 | ) |
|                                                                      |       |                           |       |   |   |
| **Investing activities**                                                  |       |                           |       |   |   |
| Purchases of securities available-for-sale                                |       | (14,111                        | )          | (50,441 | ) |
| Sales/maturities of securities  available-for-sale                        |       | 23,992                         |       | 70,458 |   |
| Purchases of property and equipment                                       |       | (427                           | )          | (1,635 | ) |
| Net cash flows provided by investing  activities                          |       | 9,454                          |       | 18,382 |   |
|                                                                      |       |                           |       |   |   |
| **Financing activities**                                                  |       |                           |       |   |   |
| Issuance of common stock, net                                             |       | 9,670                          |       | 404 |   |
| Principal payments on debt and capital  lease obligations                 |       | (1,056                         | )          | (936 | ) |
| Proceeds received from debt                                               |       | 5,000                          |       | 1,134 |   |
| Net cash flows provided by financing  activities                          |       | 13,614                         |       | 602 |   |
| (Decrease) increase in cash and cash  equivalents                         |       | (343                           | )          | 2,477 |   |
| Cash and cash equivalents at beginning of  year                           |       | 14,141                         |       | 12,052 |   |
| Cash and cash equivalents at end of period                                |       | $                              | 13,798     |   | $ | 14,529 |   |
|                                                                      |       |                           |       |   |   |
| **Supplemental schedule of noncash investing  and financing activities:** |       |                           |       |   |   |
| Accrued debt issuance costs                                               |       | $                              | 202        |   | $ | — |   |
|                                                                      |       |                           |       |   |   |
| Unrealized (loss) gain on securities  available-for-sale                  |       | $                              | (54        | ) | $ | 21 |   |
|                                                                      |       |                           |       |   |   |
| Net share settlement of warrant                                           |       | $                              | —     |   | $ | 56 |   |

 

*See accompanying notes.*

 

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**MetabasisTherapeutics, Inc.**

**Notes toFinancial Statements**

**(Unaudited)**

 

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

 

The accompanying unaudited financialstatements have been prepared in accordance with U.S. generally acceptedaccounting principles (“GAAP”) and with the rules and regulations of theSecurities and Exchange Commission (“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 sixmonths ended June 30, 2008 are not necessarily indicative of the resultsthat may be expected for the year ending December 31, 2008. For further information,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” areused in this report to refer to Metabasis Therapeutics, Inc.

 

**2.****                                      ComprehensiveLoss**

 

Statement of Accounting Financial Standard (“SFAS”)No. 130, *Reporting Comprehensive Income*,requires that all components of comprehensive income (loss), including netloss, be reported 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 income (loss) is as follows (inthousands):

 
| ** **                                                | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                      |       |                             |       |                           |       |   |   |   |   |
| Net loss                                                  |       | $                                | (11,542    | )                              | $          | (11,935 | ) | $ | (22,642 | ) | $ | (20,441 | ) |
| Unrealized (loss) gain on available-for-sale  investments |       | (57                              | )          | 26                             |       | (54 | ) | 21 |   |
| Comprehensive loss                                        |       | $                                | (11,599    | )                              | $          | (11,909 | ) | $ | (22,696 | ) | $ | (20,420 | ) |

 

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

 

The Company calculates net loss per share in accordance with SFAS No. 128,*Earnings Per Share*. Basic earnings pershare (“EPS”) is calculated by dividing the net loss by the weighted averagenumber of common shares outstanding for the period, without consideration forcommon stock equivalents. Diluted EPS is computed by dividing the net loss bythe weighted average number of common share equivalents outstanding for theperiod determined using the treasury-stock method. For purposes of thiscalculation, common stock subject to repurchase by the Company, options andwarrants are considered to be common stock equivalents and are only included inthe calculation of diluted EPS when their effect is dilutive. Thetotal number of shares issuable upon exercise of stock options and warrantsexcluded from the calculation of diluted EPS since they are anti-dilutive were7,381,142 and 7,523,754 for the three months ended June 30, 2008 and 2007,respectively, and 7,168,734 and 7,145,040 for the six months ended June 30,2008 and 2007, respectively.

 

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| ** **                                                     | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                     | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                     | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Actual:**                                                    |       |                             |       |                           |       |   |   |   |   |
| *Numerator:*                                                   |       |                             |       |                           |       |   |   |   |   |
| Net loss                                                       |       | $                                | (11,542    | )                              | $          | (11,935 | ) | $ | (22,642 | ) | $ | (20,441 | ) |
| *Denominator:*                                                 |       |                             |       |                           |       |   |   |   |   |
| Weighted average common shares                                 |       | 34,244                           |       | 30,228                         |       | 32,501 |   | 30,533 |   |
| Weighted average unvested common shares subject  to repurchase |       | —                           |       | (15                            | )          | — |   | (31 | ) |
| Denominator for basic and diluted net loss  per share          |       | 34,244                           |       | 30,213                         |       | 32,501 |   | 30,502 |   |
| Basic and diluted net loss per share                           |       | $                                | (0.34      | )                              | $          | (0.40 | ) | $ | (0.70 | ) | $ | (0.67 | ) |

 

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

 

In September 2006, the FinancialAccounting 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 effective for financialstatements issued for fiscal years beginning after November 15, 2007(beginning with the Company’s 2008 fiscal year), although earlier applicationwas encouraged.

 

On February 14, 2008, FASB StaffPosition (“FSP”) FAS 157-2, *Effective Date of FASBStatement No. 157*, was issued. FSP FAS 157-2 defers application of SFAS No. 157 for non-financialassets 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 andliabilities until it is required to apply this pronouncement to its non-financialassets and liabilities beginning with fiscal year 2009.

 

The Company applies fair value accounting to its securitiesavailable-for-sale in accordance with SFAS No. 115, *Accountingfor Certain Investments in Debt and Equity Securities. *These securities consist oftreasury backed money market funds, corporate bonds, commercial paper, andcredit card asset backed securities.  Thefollowing table shows the fair value measurement for this financial asset at June 30,2008 and the fair value 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 |       | $                                     | 18,703     |   | $ | 16,451 |   | $ | 2,252 |   | $ | — |   |
|                               |            |                                       |            |  |  |  |  |  |  |  |  |  |  |

 

Asset classes that fall within the Level 1 fair value hierarchy arethose assets whose fair value assumptions are based on market data obtainedfrom sources independent of the Company (observable inputs).  Level 1 observable inputs are quoted pricesfor identical items in active markets that the Company has access to at themeasurement date.

 

Asset classes that fall within the Level 2 fair value hierarchy arethose assets whose fair value assumptions are also based on independent marketdata.  Level 2 observable inputs arequoted prices for similar items in active markets or quoted prices foridentical or similar items in inactive markets. An inactive market is one where there are few transactions, the pricesare not current, price quotations vary substantially over time or among marketmakers, or where little information is released publicly.

 

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Asset classes thatfall within the Level 3 fair value hierarchy are those assets whose fair valueassumptions are based on the Company’s own information.

 

In February 2007, the FASB issued SFAS No. 159,*The Fair Value Option for Financial Assetsand Financial Liabilities, including an amendment of SFAS No. 115* (“SFAS No. 159”).  SFAS No. 159 expands the use of fairvalue accounting but does not affect existing standards that require assets orliabilities to be carried at fair value. Under SFAS No. 159, a company mayelect 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 an instrument-by-instrumentbasis, even if a company has similar instruments that it elects not to measurebased on fair value. At the adoption date, unrealized gains and losses onexisting items for which fair value has been elected are reported as acumulative adjustment to beginning retained earnings. Subsequent to theadoption 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).

 

TheCompany considers the carrying amount of cash and cash equivalents, prepaidexpenses and other current assets, securities available-for-sale, accountsreceivable, accounts payable, accrued liabilities and deferred revenue to berepresentative of their respective fair values because of the short-term natureof those instruments. Based on the borrowing rates currently available to theCompany for loans with similar terms, management believes the fair value of thelong-term obligations approximate their carrying value.  Therefore, the Company has elected not toapply the fair value option to these financial assets and liabilities underSFAS No. 159.  However, the Companydoes apply fair value accounting to its securities available-for-sale inaccordance with SFAS No. 115.

 

Realized gains and losses and declines invalue 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 six months ended June 30, 2008 wereapproximately $0 and $7,000, respectively. There were no cumulative adjustments to beginning retained earnings as aresult of adopting SFAS No. 159.

 

**5.****                                      WarrantExchange and Concurrent Private Placement**

 

In April 2008, the Company entered into a warrant exchange andconcurrent private placement (together, the “Transaction”), which raised $9.9million in cash.  The investors in theTransaction were certain current investors who held existing warrants for thepurchase of the Company’s common stock issued previously in its October 2001and October 2005 private placements. Investment banking fees and other offering expenses were approximately$0.4 million.

 

In connection with the Transaction, the Company entered into a warrantexercise agreement (the “Warrant Exercise Agreement”) pursuant to which theCompany reduced the exercise prices of the investors’ warrants to purchase theCompany’s common stock acquired in its 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 the Company’scommon stock with a prior exercise price of $8.70 per share and warrants forthe purchase of 1,558,279 shares of the Company’s common stock with a priorexercise price of $6.74 per share were exercised at $2.34 per share.

 

Additionally, in connection with the Transaction, the Company enteredinto a securities purchase agreement (the “Securities Purchase Agreement”)pursuant to which the Company issued and sold to the investors 2,485,103 sharesof its common stock at an exercise price of $2.34 per share, and warrants topurchase up to 1,057,196 shares of its common stock at an exercise price of$2.69 per share (the “Warrants”).  TheWarrants are exercisable commencing six months after the Transaction date untilApril 16, 2013.  At the closing, theinvestors paid an additional purchase price for the Warrants equal to $0.125per whole share issuable upon exercise of the Warrants.  In connection with the Securities PurchaseAgreement, the Company also entered into a registration rights agreement (the “RegistrationRights Agreement”) pursuant to which the Company granted to the investorscertain registration rights relating to the securities issued and sold in theSecurities Purchase Agreement.  TheCompany filed a registration statement pursuant to the Registration RightsAgreement on May 9, 2008 and the SEC declared the registration statementeffective on May 30, 2008.

 

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Certain of the Company’s existing stockholders, including entitiesaffiliated with MPM Capital, Hale BioPharma Ventures and InterWest Partners,invested in the Transaction.  Certain of such investors and/or theiraffiliates are parties to the Company’s amended and restated investors’ rightsagreement dated October 28, 2003.  Luke B. Evnin, Ph.D., David F.Hale and Arnold L. Oronsky, Ph.D., members of the Company’s board of directors,are associated with MPM Capital, Hale BioPharma Ventures and InterWestPartners, respectively.

 

TheCompany accounted for the Warrants issued under the Securities PurchaseAgreement in accordance with Emerging Issues Task Force (“EITF”) Issue No. 00-19, *Accounting for Derivative Financial Instruments Indexed to andPotentially Settled in a Company’s Own Stock* (“EITF No. 00-19”).According to EITF No. 00-19, the Warrants met all criteria within theguidance providing for the classification of these financial instruments asequity.  The fair values of the Warrantswere approximately $1.5 million in aggregate and was determined using theBlack-Scholes model using the following assumptions: risk-free interest ratesof 3.02%; dividend yield of 0%; expected volatility of 81.9%; and a term of 5years.

 

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

 

In June 2007, the EITF issued EITF IssueNo. 07-3, *Accounting for NonrefundableAdvance Payments for Goods or Services to be Used in Future Research andDevelopment Activities* (“EITFIssue No. 07-3”). The consensus requires companies to defer andcapitalize prepaid, nonrefundable research and development payments to thirdparties over the period that the research and development activities areperformed or the services are provided, subject to an assessment ofrecoverability. EITF Issue No. 07-3 is effective for new contracts enteredinto in fiscal years beginning after December 15, 2007, including interimperiods within those fiscal years. The adoption of EITF Issue No. 07-3 didnot have a material impact on the Company’s financial statements.

 

In November 2007, the EITF issued EITFIssue No. 07-1, *Accounting forCollaborative Arrangements Related to the Development and Commercialization ofIntellectual Property* (“EITFIssue No. 07-1”)*.*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 other applicableGAAP or, in the absence of other applicable GAAP, based on analogy toauthoritative accounting literature or a reasonable, rational, and consistentlyapplied accounting 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) 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 (theCompany’s 2009 fiscal year). The Company does not anticipate that the impact ofadopting SFAS No. 141(R) will have a material effect on its financialstatements.

 

In December 2007, FASB issued SFAS No. 160, *Noncontrolling Interests in Consolidated FinancialStatements — an amendment of ARB No. 51,* (“SFAS No. 160”).  This statement improves therelevance, comparability, and transparency of the financial information that areporting entity provides in its consolidated financial statements byestablishing accounting and reporting standards that require the ownershipinterests in subsidiaries held by parties other than the parent and the amountof consolidated net income attributable to the parent and to the non-controllinginterest be clearly identified and presented on the face of the consolidatedstatement of income; changes in a parent’s ownership interest while the parentretains its controlling financial interest in its subsidiary be accounted forconsistently; when a subsidiary is deconsolidated, any retained non-controllingequity investment in the former subsidiary be initially measured at fair value,and entities to provide sufficient disclosures that clearly identify anddistinguish between the interests of the parent and the interests of the 

 

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non-controllingowners.  SFAS No. 160 affects those entities that have an outstandingnon-controlling interest in one or more subsidiaries or that deconsolidate asubsidiary.  SFAS No. 160 is effective for fiscal years, andinterim periods within those fiscal years, beginning on or after December 15,2008 (beginning with the Company’s fiscal year 2009). Early adoption isprohibited. The adoption of SFAS No. 160 is not expected to have amaterial effect on the Company’s financial statements.

 

In March 2008, the FASB issued SFAS No. 161, *Disclosures about Derivative Instruments and Hedging Activities, anamendment of FASB Statement No. 133*, (“SFAS No. 161”).This statement is intended to improve transparency in financial reporting byrequiring enhanced disclosures of an entity’s derivative instruments andhedging activities and their effects on the entity’s financial position,financial performance, and cash flows. SFAS No. 161 applies to allderivative instruments within the scope of SFAS No. 133, *Accounting for Derivative Instruments and Hedging Activities*,as well as related hedged items, bifurcated derivatives, and nonderivativeinstruments that are designated and qualify as hedging instruments. Entitieswith instruments subject to SFAS No. 161 must provide more robustqualitative disclosures and expanded quantitative disclosures. SFAS No. 161is effective prospectively for financial statements issued for fiscal years andinterim periods beginning after November 15, 2008 (beginning with theCompany’s 2009 fiscal year), with early application permitted. The Company doesnot anticipate that the impact of adopting SFAS No. 161 will have amaterial effect on its financial statements.

 

In May 2008, the FASB issued SFAS No. 162, *The Hierarchy of Generally Accepted Accounting Principles* (“SFASNo. 162”).  SFAS No. 162identifies the sources of accounting principles and provides entities with aframework for selecting the principles used in preparation of financialstatements that are presented in conformity with GAAP. The current GAAPhierarchy has been criticized because it is directed to the auditor rather thanthe entity, it is complex, and it ranks FASB Statements of Financial AccountingConcepts, which are subject to the same level of due process as FASB SFAS,below industry practices that are widely recognized as generally accepted butthat are not subject to due process. The FASB believes the GAAP hierarchyshould be directed to entities because it is the entity (not its auditors) thatis responsible for selecting accounting principles for financial statementsthat are presented in conformity with GAAP. SFAS No. 162 iseffective 60 days following the SEC’s approval of the Public Company AccountingOversight Board amendments to AU Section 411, *The Meaning of**Present Fairly inConformity With Generally Accepted Accounting Principles*.  Theadoption of SFAS No. 162 is not expected to have a material impact on theCompany’s financial statements.

 

**7.****                                      SubsequentEvent**

 

InAugust 2008, the Company announced the establishment of a two-yearresearch collaboration with Roche,  inwhich the Company’s HepDirect liver-targeting technology will be applied toRoche’s proprietary lead nucleosides for the treatment of hepatitis C virus(HCV). Under the terms of the agreement, the Company is entitled to an upfrontpayment of $10.0 million. 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.

 

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

##  

*You should read thefollowing discussion and analysis together with our unaudited financialstatements and the notes to those statements included elsewhere in thisquarterly report on Form 10-Q, as well as our audited financial statementsand notes to those statements as of and for the year ended December 31,2007 included in our annual report on Form 10-K filed with the Securitiesand Exchange Commission on March 17, 2008. This discussion containsforward-looking statements that involve risks and uncertainties. As a result ofmany factors, such as those set forth under “Risk Factors” and elsewhere inthis quarterly report on Form 10-Q and in our other filings with theSecurities and Exchange Commission, our actual results may differ materiallyfrom those anticipated in these forward-looking statements. Readers arecautioned not to place undue reliance on forward-looking statements. Theforward-looking statements speak only as of the date on which they are made,and we undertake no obligation to update such statements to reflect events thatoccur or circumstances that exist after the date on which they are made.*

 

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**Overview**

 

We are a biopharmaceutical company focused ondiscovering, developing and commercializing novel drugs by applying ourproprietary technologies, scientific expertise and unique capabilities fortargeting the liver and liver pathways. We have established a broad pipeline ofproduct candidates and advanced research programs targeting large markets withsignificant unmet needs. Our product pipeline includes product candidates andadvanced research programs for the treatment of metabolic diseases such asdiabetes and hyperlipidemia, which we refer to as our “core assets,” as well asproduct candidates and advanced research programs for the treatment of liverdiseases such 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 atthe clinical stage of development. These product candidates include our coremetabolic disease product candidates, MB07803 and MB07811, which are beingdeveloped as potential treatments for type 2 diabetes and hyperlipidemia,respectively, and our non-core liver disease product candidates, pradefovir andMB07133, which have been developed as potential treatments for hepatitis B andprimary liver cancer, respectively.

 

*Recent Events*

 

In August 2008, we entered into a two year Research CollaborationAgreement with Roche.  Under the terms of the agreement, Metabasis’HepDirect liver-targeting technology will be applied to proprietary Rochecompounds to develop second-generation nucleoside analog drug candidates forthe treatment of hepatitis C virus. We will receive an upfront payment of$10.0 million from Roche. In the event a development candidate is identified,Roche will assume development responsibility and we will be eligible to receiveup to $193 million in additional payments upon achievement of predeterminedpreclinical and clinical development events as well as regulatory and commercializationevents.  Roche will retain fullcommercial rights for any marketed products resulting from the collaborationand will pay us a royalty on net sales of such products.

 

In June 2008, we announced the resultsof our 14-day, Phase 1b multiple-dose clinical trial of MB07811 in subjectswith mild hypercholesterolemia, which showed that MB07811 was safe and welltolerated across the seven doses tested. The clinical trial results also showed dose-related reductions infasting low-density lipoprotein cholesterol (LDL-C) and fasting triglyceride(TG) levels at day 14.  We are continuingto review these results and currently expect to initiate a 12-week Phase 2aclinical trial later in 2008 or early in 2009.

 

InApril 2008, we announced that MB07803 met its primary efficacy endpointwith results demonstrating a statistically and clinically significant reductionin fasting plasma glucose at day 28 in its Phase 2a clinical trial. The studyalso showed that MB07803 was safe and well tolerated. We intend to  initiate a clinical trial later in 2008 onMB07803 to test higher doses in patients, with the aim of using the results ofthis trial to select doses for a Phase 2b clinical trial, which we currentlyexpect to begin in 2009.

 

In April 2008, we entered into a warrant exchange and concurrentprivate placement, which raised $9.9 million in cash.  The participants in the transaction werecertain current investors who held existing warrants for the purchase of commonstock issued previously by us in our October 2001 and October 2005private placements. Pursuant to the transaction, we reduced the exercise pricesof the existing warrants held by the participants in exchange for the immediateexercise of the warrants. We also sold additional shares of common stock andwarrants for the purchase of common stock in a concurrent private placement. Weintend to use the proceeds from the transaction for general corporate purposes,including the further clinical development of MB07803 and MB07811 for thetreatment of type 2 diabetes and hyperlipidemia, respectively.

 

Also in April 2008,we extended the research term of our AMPK collaborationwith Merck & Co. Inc., or Merck, for an additional year, through June 2009.  Under the extension, which waspermitted under the terms of our existing collaboration agreement, we willcontinue working with Merck to identify novel small molecule therapeutics with thepotential to treat several diseases, including type 2 diabetes and othermetabolic diseases, by activation of an AMPK enzyme.  Merck will continue to fund researchefforts for this project and has primary responsibility, including financialresponsibility, for clinical development of any resulting product candidates aswell as the right to market such products worldwide, if approved. We areeligible to receive payments upon achievement of certain milestones duringdevelopment of a product candidate. Should a product be commercialized, we willreceive a royalty on net sales and have the option to co-promote the product inthe United States.  We will receive $1.5million over the course of the one year extension to support our researchefforts.

 

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*Strategic Plan*

 

Under our strategic plan we will focus ourinternal resources primarily on our clinical and advanced research coremetabolic disease programs. This includes funding the further clinicalevaluation of our core assets, MB07803 and MB07811, with a focus on achievingkey milestones. Continued development of these core assets thereafter willrequire significant resources. Therefore, we plan to establish strategiccollaborations for these core assets at appropriate times to secure additional resources,accelerate progress and share risk. In addition, we plan to advance additionalmetabolic disease product candidates discovered by our research group intoclinical development either independently, or potentially with current orfuture strategic collaborators.

 

In order to reduce future expenses and tominimize the potential dilution associated with financing internal development,we intend to license pradefovir and MB07133 for further development andcommercialization.

 

Our strategic plan has the potential toreduce future expenses and to provide additional financial resources by:

 

·                  selectivelyfunding only our core assets,

 

·                  licensingor selling our non-core assets,

 

·                  seekingto offset current and future research and development costs via additionalstrategic collaborations on our core advanced research and clinical programs,and

 

·                  utilizingour existing financing facilities, such as the Committed Equity FinancingFacility, or CEFF.

 

We believe that these measures, ifsuccessful, along with our existing resources, will be sufficient to executeour strategic plan.

 

*History of Losses, Prior Funding*

 

We have incurred annual net losses since inception. Asof June 30, 2008, our accumulated deficit was approximately$172.7 million. We expect to incur losses for the next several years aswe:

 

·                  continueto develop our current and future core metabolic disease clinical developmentcandidates,

 

·                  participatein the commercialization of our product candidates, if any, that receiveregulatory approval and for which we retain commercialization rights, and

 

·                  continueour research and development programs.

 

We have a limited history of operations and,to date, we have not generated any product revenues. In addition to our initialpublic offering in June 2004, our private placement of common stock andwarrants in October 2005, our registered direct offering of common stockin March 2006 and our warrant exchange and concurrent private placement inApril 2008, we have financed our operations and internal growth throughprivate placements of preferred stock as well as direct payments of sponsoredresearch funding, license fees, milestone payments, equity investments fromcollaborative partners, debt financing and, to a lesser extent, the sale ofcommon stock through our stockholder approved equity incentive plans.

 

*Commercial, Manufacturing Rights, Risks*

 

We currently do not have strategiccollaborations in place related to our core assets, MB07803 or MB07811, and weintend to license our non-core assets, pradefovir and MB07133. We retainworldwide commercialization rights to all of the compounds that we havegenerated from our past and current research programs, with the exception ofany potential future product candidates that may result from our collaborationswith Merck, Idenix Pharmaceuticals, Inc., or Idenix, and Roche. Ourpotential future agreements with strategic collaborators may include jointmarketing or promotion arrangements which may allow us to eventually co-marketone or more of our product candidates through our own sales force or with aco-promotion partner. Alternatively, we may grant exclusive marketing rights toour collaborators in exchange for up-front fees, milestones and royalties onfuture sales, if any.

 

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We will rely on our collaborators orthird-party manufacturers to produce sufficient quantities of our productcandidates for clinical studies and large-scale commercialization upon theirapproval. 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, we plan to enter into additionalcollaborative agreements to assist in the development and commercialization of someor all of our product candidates. However, our discussions with potentialcollaborators may not lead to the establishment of new collaborations onacceptable terms, if at all, or it may take longer than expected to establishnew collaborations, leading to development and commercialization delays.

 

Our business is subject to significant risks,including the risks inherent in our ongoing clinical trials and the regulatoryreview and approval process, the results of our research and developmentefforts, reliance on third parties for the development and commercialization ofour product candidates, competition from other products and uncertaintiesassociated with obtaining and enforcing patent rights.

 

**Research andDevelopment**

 

Our research and development expenses consistprimarily of cash and stock-based compensation and other expenses for researchand development personnel, costs associated with the development and clinicaltrials of our product candidates, facility costs, supplies and materials, costsfor consultants 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 allocateoccupancy and information systems costs between research and developmentexpenses and general and administrative expenses.  We feel the current allocation is morereflective of the actual consumption of these expenses in these operationalfunctions for fiscal 2008.

 

Our development activities are focused on theclinical development of our core metabolic disease assets, MB07803 and MB07811.Our activities related to our non-core liver disease assets, pradefovir andMB07133, are currently limited to planning, consultation, design and otherefforts preparatory to their potential future clinical development bylicensees. In addition, our research activities include work on a variety ofcompounds in our other advanced research programs. We are responsible for allcosts incurred for our product candidates and our advanced research programswith the exception of the AMPK program partnered with Merck and the hepatitis Cprograms partnered with Merck, Idenix and Roche (excluding costs associatedwith manufacturing compounds that Idenix is currently evaluating, for which weare responsible).

 

Our AMPK collaboration with Merck seeks todevelop and commercialize new products to treat type 2 diabetes andpotentially other metabolic diseases. Under the terms of our AMPK collaborationagreement with Merck, we have received approximately $11.6 million incumulative sponsored research and license fees funding through June 30,2008, which includes funding for sponsored research efforts through September 2008.  In April 2008, we agreed with Merck toextend the research term for an additional year through June 2009, inconnection with which we are entitled to receive approximately $1.5 million inadditional sponsored research funding.

 

Our collaborations with Merck and Idenixsought to develop and commercialize new products for treating hepatitis Cinfection. Our efforts and internal costs related to the hepatitis Ccollaboration with Merck ceased upon completion of its research term in December 2005.Under the terms of the Merck agreement, we have received approximately$3.2 million in cumulative license fees and sponsored research fundingthrough December 31, 2005. Our efforts and internal costs related to thehepatitis C collaboration with Idenix ceased upon completion of its researchterm in October 2007. Under the terms of the Idenix agreement, we havereceived approximately $3.4 million in cumulative license fees andsponsored research funding through December 31, 2007.

 

Although the funded research phases of thehepatitis C collaborations with Merck and Idenix are completed, Merck andIdenix are currently evaluating certain candidate compounds discovered duringthe collaborations to determine if one or more will be recommended for clinicaldevelopment. Merck and Idenix are solely responsible for conducting and fundingall development work for any compounds resulting from these collaborations(excluding costs and work associated with manufacturing candidate compoundsIdenix is currently evaluating, for which we are responsible) and forcommercializing any resulting products. If a product is successfully developed,we will receive substantial milestone payments as well as receive a portion ofthe revenue from sales of a drug in the form of a royalty on net sales.

 

Our new two-year collaboration with Rochealso seeks to develop and commercialize new products for treating hepatitis Cinfection.  Under the terms of the Rocheagreement, we are entitled to receive an upfront license fee of $10.0 millionin August 2008.

 

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At this time, due to the risks inherent inthe clinical trial process and given the early stage of development of ourproduct candidates and lead compounds from our research programs, we are unableto estimate with any certainty the costs we will incur in the continueddevelopment of our product candidates for commercialization. Other than costsfor outsourced services associated with our clinical programs, we generally donot track our research and development expenses by project; rather, we tracksuch expenses by the type of cost incurred. Due to these and other factors, weare unable to determine the anticipated completion dates for our currentresearch and development projects. However, we expect our research anddevelopment costs to be substantial as we continue the development of our coreassets, as well as continue to expand our research programs.

 

Generally, Phase 1 clinical trials canbe expected to last from 6 to 18 months, Phase 2 clinical trials canbe expected to last from 12 to 24 months and Phase 3 clinical trialscan be expected to last from 18 to 36 months. However, clinicaldevelopment timelines vary widely, as do the total costs of clinical trials andthe likelihood of success.  Although weare currently focused primarily on advancing MB07803 and MB07811 throughclinical development, we anticipate that we will make determinations as towhich research and development projects to pursue and how much funding todirect to each project on an ongoing basis in response to the scientific andclinical success of each product candidate, our ongoing assessment of itsmarket potential and consideration of our available financial resources.

 

The lengthy process of seeking regulatoryapprovals for our product candidates, and the compliance with applicableregulations, require the expenditure of substantial resources. Any failure byus to obtain, or any delay in obtaining, regulatory approvals could cause our researchand development expenditures to increase and, in turn, have a materialunfavorable effect on our results of operations.  Additionally, under our strategic plan, weintend to establish strategic collaborations for our core assets and non-coreassets at appropriate times to secure additional resources, accelerate progressand share risk.  However, delays infinding appropriate partnerships could also have a material unfavorable effecton our results of operations.  We cannotbe certain when or if any net cash inflow due to sales of any of our currentproduct candidates will commence.

 

**General andAdministrative**

 

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 interestearned on our cash, cash equivalents and securities available-for-sale, net ofinterest expense on capital lease obligations, debt, and the related issuancecosts.

 

**Critical Accounting Policies**

 

Our discussion and analysis of our financialcondition and results of operations are based on our financial statements,which have been prepared in accordance with U.S. generally accepted accountingprinciples, or GAAP. The preparation of these financial statements requires usto make estimates and judgments that affect the reported amounts of assets,liabilities, revenues and expenses and related disclosure of contingent assetsand liabilities. We review our estimates on an on-going basis. We base ourestimates on historical experience and on various other assumptions that webelieve to be reasonable under the circumstances, the results of which form thebasis for making judgments about the carrying values of assets and liabilities.Actual results may differ from these estimates under different assumptions orconditions. We believe the following accounting policies to be critical to thejudgments and estimates 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, 

 

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includingaccess to our proprietary technologies and research and development services.Payments under our collaborations are generally made in the form of up-frontlicense fees, milestone payments and downstream royalties. All fees arenonrefundable. Revenue from milestones is recognized when earned, providedthat:

 

1)                                      themilestone event is substantive and its achievability was not reasonably assuredat the inception 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, themilestone payment is recognized over the remaining minimum period of ourperformance obligations under the agreement. Upfront, nonrefundable fees underour collaborations are recognized over the period the related services areprovided. Nonrefundable upfront fees not associated with our future performanceare recognized when received. Amounts received for sponsored research fundingare recognized as revenues as the services are performed. Amounts received forsponsored research funding for a specific number of full-time researchers arerecognized as revenue as the services are provided, as long as the amountsreceived are not refundable 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 successfulenrollment of patients or the completion of clinical trial milestones. Expensesrelated to clinical trials generally are accrued based on contracted amountsapplied to the actual level of patient enrollment and activity according to theprotocol. Other incidental costs related to patient enrollment are accrued whenknown. If contracted amounts are modified based upon changes in the clinicaltrial protocol or scope of work to be performed, we modify our accrualsaccordingly on 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 commonstock at a discount through payroll deductions. The benefits provided under allof these 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 andtherefore have not restated results for prior periods. The valuation provisionsof SFAS No. 123R apply to new awards and to awards that are outstanding onthe adoption date and subsequently modified or cancelled.

 

We estimate the fair value of stock optionsgranted using the Black-Scholes Merton, or Black-Scholes, option valuationmodel. This fair value is then amortized over the requisite service periods ofthe awards. The Black-Scholes option valuation model requires the input ofsubjective assumptions, including the option’s expected life and pricevolatility of the underlying stock. Expected volatility is based on theweighted average volatility of our stock factoring in daily share priceobservations and the historical price volatility of certain peers within ourindustry sector. In computing expected volatility, the length of the historicalperiod used is equal to the length of the expected term of the option and theshare purchase right. The expected life of employee stock options representsthe average of the contractual term of the options and the weighted averagevesting period, as permitted under the simplified method, under SAB No. 107.

 

As stock-based compensation expense is basedon awards ultimately expected to vest, it has been reduced for estimatedforfeitures. SFAS No. 123R requires forfeitures to be estimated at thetime of grant and revised, if necessary, in subsequent periods if actualforfeitures differ from those estimates. Forfeitures were estimated based onhistorical experience. We may elect to use different assumptions under theBlack-Scholes option valuation model in the future, which could materiallyaffect our net loss and net loss per share. In our pro forma informationrequired under SFAS No. 123, *Accountingfor Stock-Based Compensation*, for the periods prior to fiscal 2006,we accounted for forfeitures as they occurred.

 

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**Recently Issued Accounting Pronouncements**

 

In June 2007, the EITF issued EITF IssueNo. 07-3, *Accounting for NonrefundableAdvance Payments for Goods or Services to be Used in Future Research andDevelopment Activities*. The consensus requires companies to deferand capitalize prepaid, nonrefundable research and development payments tothird parties over the period that the research and development activities areperformed or the services are provided, subject to an assessment ofrecoverability. EITF Issue No. 07-3 is effective for new contracts enteredinto in fiscal years beginning after December 15, 2007, including interimperiods within those fiscal years. The adoption of EITF Issue No. 07-3 didnot have a material impact on our financial statements.

 

In November 2007, the EITF issued EITFIssue No. 07-1, *Accounting forCollaborative Arrangements Related to the Development and Commercialization ofIntellectual Property.* Companies may enter into arrangements withother companies to jointly develop, manufacture, distribute, and market aproduct. Often the activities associated with these arrangements are conductedby the collaborators without the creation of a separate legal entity (that is,the arrangement is operated as a “virtual joint venture”). The arrangementsgenerally provide that the collaborators will share, based on contractuallydefined calculations, the profits or losses from the associated activities.Periodically, the collaborators share financial information related to productrevenues generated (if any) and costs incurred that may trigger a sharingpayment 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. Weare in the process of determining the effect, if any, the adoption of EITFIssue No. 07-1 will have on our financial statements.

 

In December 2007, the Financial Accounting Standards Board, orFASB, issued SFAS No. 141(R), *Business Combinations,*or 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 (beginning with our 2009 fiscal year). We do not anticipate that theimpact of adopting SFAS No. 141(R) will have a material effect on ourfinancial statements.

 

In December 2007, FASB issued SFAS No. 160, *Noncontrolling Interests in Consolidated FinancialStatements – an amendment of ARB No. 51,* or SFAS No. 160.  This statement improves therelevance, comparability, and transparency of the financial information that areporting entity provides in its consolidated financial statements byestablishing accounting and reporting standards that require the ownershipinterests in subsidiaries held by parties other than the parent and the amountof consolidated net income attributable to the parent and to thenon-controlling interest be clearly identified and presented on the face of theconsolidated statement of income; changes in a parent’s ownership interestwhile the parent retains its controlling financial interest in its subsidiarybe accounted for consistently; when a subsidiary is deconsolidated, anyretained non-controlling equity investment in the former subsidiary beinitially measured at fair value, and entities to provide sufficientdisclosures that clearly identify and distinguish between the interests of theparent and the interests of the non-controlling owners.  SFAS No. 160affects those entities that have an outstanding non-controlling interest in oneor more subsidiaries or that deconsolidate a subsidiary.  SFAS No. 160is effective for fiscal years, and interim periods within those fiscal years,beginning on or after December 15, 2008 (beginning with our fiscal year2009). Early adoption is prohibited. The adoption of SFAS No. 160 is notexpected to have a material effect on our financial statements.

 

In March 2008, the FASB issued SFAS No. 161, *Disclosures about Derivative Instruments and Hedging Activities, anamendment of FASB Statement No. 133*, or SFAS No. 161. Thisstatement is intended to improve transparency in financial reporting byrequiring enhanced disclosures of an entity’s derivative instruments andhedging activities and their effects on the entity’s financial position,financial performance, and cash flows. SFAS No. 161 applies to allderivative instruments within the scope of SFAS No. 133, *Accounting for Derivative Instruments and Hedging Activities*,as well as related hedged items, bifurcated derivatives, and nonderivativeinstruments that are designated and qualify as hedging instruments. Entitieswith instruments subject to SFAS No. 161 must provide more robustqualitative disclosures and expanded quantitative disclosures. SFAS No. 161is effective prospectively for financial statements issued for fiscal years andinterim periods beginning after November 15, 2008 (beginning with our 2009fiscal year), with early application permitted. We do not anticipate that theimpact of adopting SFAS No. 161 will have a material effect on ourfinancial statements.

 

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In May 2008, the FASB issued SFAS No. 162,*The Hierarchy of Generally Accepted AccountingPrinciples*, or SFAS No. 162. SFAS No. 162 identifies the sources of accounting principles andprovides entities with a framework for selecting the principles used inpreparation of financial statements that are presented in conformity with GAAP.The current GAAP hierarchy has been criticized because it is directed to the auditorrather than the entity, it is complex, and it ranks FASB Statements ofFinancial Accounting Concepts, which are subject to the same level of dueprocess as FASB SFAS, below industry practices that are widely recognized asgenerally accepted but that are not subject to due process. The FASB believesthe GAAP hierarchy should be directed to entities because it is the entity (notits auditors) that is responsible for selecting accounting principles forfinancial 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**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.

 

**Results of Operations**

 

*Comparison of the Three Months Ended June 30, 2008 and 2007*

 

*Revenues*.    Revenueswere $0.7 million for the three months ended June 30, 2008, comparedwith $1.6 million for the three months ended June 30, 2007. The $0.9million decrease was mainly due to decreased license fee revenue of $0.5million and decreased sponsored research revenue of $0.4 million.  The decrease in license fee revenue wasrelated to the absence of the Idenix license fee as a result of the end of thesponsored research term of our collaboration in October 2007. The decreasewas also related to a decrease in the recognized amount of the Merck AMPKlicense fee as a result of a change in the period by which we recognize theremaining balance of the upfront $5.0 million license fee we received in June 2005over an additional year due to extension of the research term through June 2009.  The decrease in sponsored research revenueprimarily relates to the completion of the sponsored research portion of ouragreement with Idenix in October 2007.

 

*Research and Development Expenses*.    Researchand development expenses were $9.7 million for the three months ended June 30,2008, compared with $11.1 million for the three months ended June 30,2007. The $1.4 million decrease was mainly due to a net decrease of $1.8million in clinical and development expenses for the MB07803, MB07133 andMB07811 programs and $0.3 million in non-cash stock-based compensationexpense.  These decreases were offset byan 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 $0.2 million in payrolland related benefits due to a higher average headcount in the second quarter of2008 as compared to the second quarter of 2007.

 

*General and AdministrativeExpenses*.    General and administrative expenses were $2.6 million for thethree months ended June 30, 2008, compared with $3.2 million for the threemonths ended June 30, 2007. The $0.6 million decrease was mainlydue to a decrease of $0.4 million in occupancy and non-cash depreciation due toa change in the allocation rate of these costs, as discussed under “General andAdministrative” above, $0.2 million in non-cash stock-based compensation and$0.1 million in payroll and related benefits due to a decrease in the averageheadcount for the second quarter of 2008 as compared to the second quarter of2007.  These decreases were offset by anincrease of approximately $0.1 million in professional services.

 

*Other Income (Expense).*    Netinterest income was $7,000 for the three months ended June 30, 2008,compared to net interest income of $0.7 million for the three months ended June 30,2007. The $0.7 million decrease was a result of lower cash balances in thesecond quarter of 2008 as compared to the second quarter of 2007 as well asincreased interest expense related to long-term debt acquired in the firstquarter of 2008.

 

*Comparison of the Six Months Ended June 30, 2008 and 2007*

 

*Revenues*.    Revenueswere $1.6 million for the six months ended June 30, 2008, compared with$5.0 million for the six months ended June 30, 2007. The $3.4 milliondecrease was mainly due to decreased license fee revenue of $2.5 million anddecreased sponsored research revenue of $0.8 million.  The decrease in license fee revenue primarilyrelates to the absence of license fees of $1.8 million recognized in the firsthalf of 2007 in conjunction with our former collaboration arrangement withSchering Corporation, which was terminated in September 2007, the absenceof license fees of $0.5 million recognized in the first half of 2007 related toIdenix as a result of the sponsored research portion of our agreement ending inOctober 2007, and $0.2 million less recognized revenue related toextending the recognition period for the remaining unrecognized balance of theupfront $5.0 million Merck AMPK license fee received in June 2005 over theadditional one 

 

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year extension of the researchterm through June 2009.  Thedecrease in sponsored research revenue primarily relates to the completion ofthe sponsored research portion of our agreement with Idenix in October 2007.

 

*Research and Development Expenses*.    Researchand development expenses were $19.4 million for the six months ended June 30,2008, compared with $20.6 million for the six months ended June 30, 2007.The $1.2 million decrease was mainly due to a decrease of $1.9 million inclinical and development expenses for the MB07803, MB07133, and MB07811 programsand $0.5 million in non-cash stock-based compensation expense.  These decreases were offset by an increase ofapproximately $0.8 million of non-cash depreciation and occupancy costs as aresult of a change in the allocation rate of these costs, as discussed above,and $0.4 million in payroll and related benefits due to a higher averageheadcount in the first half of 2008 as compared to the first half of 2007.

 

*General and AdministrativeExpenses*.    General and administrative expenses were $5.1 million for thesix months ended June 30, 2008, compared with $6.5 million for the sixmonths ended June 30, 2007. The $1.4 million decrease was mainlydue to a decrease of $0.6 million in occupancy and non-cash depreciation due toa change in the allocation rate of these costs, as discussed above, $0.3million in professional services, $0.2 million in non-cash stock-basedcompensation, $0.2 million in payroll and related benefits due to a decrease inthe average headcount for the first half of 2008 as compared to the first halfof 2007 and $0.1 million in other operating expenses.

 

*Other Income (Expense).*    Netinterest income was $0.2 million for the six months ended June 30, 2008,compared to net interest income of $1.6 million for the six months ended June 30,2007. The $1.4 million decrease was a result of lower cash balances in thefirst half of 2008 as compared to the first half of 2007 as well as interestexpense incurred in the first half of 2008 as a result of the long-term debtacquired in March 2008.

 

**Liquidity and Capital Resources**

 

Since our inception, we have funded ouroperations primarily with $55.8 million in net proceeds from equityfinancings prior to becoming a public company and $117.4 million in aggregatenet proceeds from our initial public offering in June 2004, a privateplacement of common stock and warrants in October 2005, a registereddirect offering of common stock in March 2006 and our warrant exchange andconcurrent private placement in April 2008.

 

In April 2008, we entered into a warrant exchange and concurrentprivate placement, referred to together as the Transaction, which raised $9.9million in 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.

 

In connection with the Transaction, we entered into a Warrant ExerciseAgreement pursuant to which we reduced the exercise prices of the investors’warrants to purchase 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 aSecurities Purchase Agreement pursuant to which we issued and sold to theinvestors 2,485,103 shares of our common stock at an exercise price of $2.34per share, and warrants to purchase up to 1,057,196 shares of our common stockat an exercise price of $2.69 per share. At the closing, the investors paid an additional purchase price for thewarrants equal to $0.125 per whole share issuable upon exercise of thewarrants.  In connection with theSecurities Purchase Agreement, we also entered into a Registration RightsAgreement pursuant to which we granted to the investors certain registrationrights relating to the securities issued and sold in the Securities PurchaseAgreement.  We filed a registrationstatement pursuant to the Registration Rights Agreement on May 9, 2008 andthe Securities and Exchange Commission declared the registration statementeffective on May 30, 2008.

 

Certain of our existing stockholders, including entities affiliatedwith MPM Capital, Hale BioPharma Ventures and InterWest Partners, invested inthe Transaction.  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.,members of our board of directors, are associated with MPM Capital, HaleBioPharma Ventures and InterWest Partners, respectively.

 

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In March 2008, we entered into a venturedebt facility with a lender, pursuant to which the lender provided us with athree-year, $5.0 million term loan. Interest accrues at an annual rate of 9.83%, with six interest-onlymonthly payments, made in arrears, beginning in May 2008, followed by 30equal monthly payments of principal 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 certainsubsidiaries.  There are no financialcovenants associated with the venture debt facility.  In connection with the venture debt facility,we issued to the lender a warrant to purchase up to 154,639 shares of ourcommon stock at an exercise price of $1.94 per share.  The warrant is currently exercisable andexpires in March 2018.

 

In April 2007, we filed an additionalshelf registration statement to increase the amount of common stock andwarrants available for issuance under our existing shelf registration statementby 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 CEFF with aninstitutional investor, under the terms of which, the investor is committed toproviding us up to $50 million or 6,046,471 shares of common stock, basedon certain market capitalization levels, in funding from time to time for aperiod up to 36 months that commenced in December 2006 through thepurchase of newly-issued shares of our common stock. In February 2008, theCEFF was amended to reduce the minimum market capitalization required to permita draw down and to eliminate certain termination rights maintained by theinvestor, among other things. Under the amended CEFF, we may access capital,subject to certain conditions, under this facility in tranches of up to thelesser of $10 million or:

 

·                 1.0% of ourmarket capitalization if, at the time of the draw down of such tranche, ourmarket capitalization equals or exceeds $53 million but is less than$100 million,

 

·                 1.25% of ourmarket capitalization if, at the time of the draw down of such tranche, ourmarket capitalization equals or exceeds $100 million but is less than$175 million, and

 

·                 1.5% of ourmarket capitalization if, at the time of the draw down of such tranche, ourmarket capitalization equals or exceeds $175 million.

 

If our market capitalization is less than$53 million, we will not have access to this capital.

 

In the event of a draw down, the investorwill purchase shares of our common stock pursuant to the CEFF at discountsranging from 6% to 10%, depending on the average market price of our commonstock during an eight-day pricing period, provided that the minimum acceptablepurchase price for any shares to be issued to the investor during the eight-daypricing period is determined by the higher of $1.75 or 90% of our share pricethe day before the commencement of each draw down. Pursuant to the agreement wefiled a registration statement with the Securities and Exchange Commission forthe resale of the shares of common stock issuable in connection with the CEFFand the shares of common stock underlying the warrant issued in connection withthis transaction, which became effective on December 22, 2006.  As of June 30, 2008, we have notutilized the CEFF.

 

As of June 30, 2008, we had $32.5million in cash and cash equivalents and securities available-for-sale ascompared to $42.4 million as of December 31, 2007, a decrease of $9.9million. The decrease is primarily a result of net cash used in operations of$23.4 million offset by $13.6 million of net cash flows provided by financingactivities.

 

As of June 30, 2008, we have financedthrough leases and loans the purchase of equipment and leasehold improvementstotaling approximately $12.4 million, of which $4.9 million wasoutstanding at that date. The loans are collateralized with the purchasedequipment, bear interest at rates ranging from approximately 8.0% to 12.85%,and are due in monthly installments through October 2015. We currentlyanticipate capital spending on equipment and leasehold improvements to be inthe range of $0.5 million to $1.0 million in 2008.  We do not plan on financing our equipment andleasehold improvements through fiscal 2008, as we no longer have availablefunds through this financing facility.

 

We intend to use our existing cashreserves,  proceeds from our ongoingcollaboration with Merck, proceeds from our new collaboration with Roche, ourCEFF, if available, and proceeds from other planned business developmentactivities to execute our strategic plan through 2008.  Under our strategic plan, we will focus ourinternal resources primarily on our core metabolic disease clinical andadvanced research programs. This includes funding the further clinicalevaluation of our 

 

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core assets,MB07803 and MB07811, with a focus on achieving key milestones. Continueddevelopment of these core assets thereafter will require significant resources.Therefore, we plan to establish strategic collaborations for these productcandidates 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 potentially with current or futurestrategic collaborators. In order to reduce future expenses and to minimize thepotential dilution associated with financing their internal development, weintend to license pradefovir and MB07133 for further development andcommercialization.

 

We may not be successful in entering into additional collaborationagreements, or in receiving milestone or royalty payments under current orfuture agreements. Also, based on recent Food and Drug Administration, or FDA,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 these programs.  Additionally, we may be required torelinquish greater or all rights to product candidates at an earlier stage ofdevelopment or on less favorable terms than we would otherwise choose. Noassurances can be made that additional funding, through any resources includingour CEFF, will be available when needed or that, if available, financing willbe obtained on terms favorable to us or our stockholders. To the extent that weraise additional capital by issuing equity securities, our existingstockholders’ ownership will be diluted. Any debt financing we enter into mayinvolve covenants that restrict our operations. These restrictive covenants mayinclude limitations on additional borrowing, specific restrictions on the useor sales of our assets as well as prohibitions on our ability to create liens,pay dividends, redeem our stock or make investments. Failure to obtain adequatefinancing and to curtail or delay cash expenditures adequately will have asignificant negative impact on our future operations and our ability to continueas a going concern.

 

The following summarizes our long-termcontractual obligations as of June 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           |       | $          | 23,399     |                                      | $          | 2,501 |   | $ | 6,207 |   | $ | 6,552 |   | $ | 8,139 |   |
| Long-term debt             |       | 9,870      |       | 3,252                                     |       | 6,369 |   | 156 |   | 93 |   |
| Interest on long-term debt |       | 1,883      |       | 1,024                                     |       | 828 |   | 22 |   | 9 |   |
| Purchase commitments       |       | 2,238      |       | 2,238                                     |       | — |   | — |   | — |   |
| Capital leases             |       | 60         |       | 23                                        |       | 37 |   | — |   | — |   |
| Interest on capital leases |       | 10         |       | 6                                         |       | 4 |   | — |   | — |   |
|                       |       |       |       |                                      |       |   |   |   |   |   |   |
| Total                      |       | $          | 37,460     |                                      | $          | 9,044 |   | $ | 13,445 |   | $ | 6,730 |   | $ | 8,241 |   |

 

We also enter into agreements with clinicalsites and contract research organizations for the conduct of our clinicaltrials. We will make payments to these sites and organizations based upon thenumber of patients enrolled and the length of their participation in theclinical trials. In addition, under certain agreements, we may be subject topenalties in the event we prematurely discontinue performance under theseagreements. At this time, due to the variability associated with theseagreements, we are unable to estimate with certainty the future costs we willincur.

 

We have entered into employment agreementswith our executive officers and certain other key employees that, under certaincircumstances, provide for the continuation of salary and certain otherbenefits if terminated under specified circumstances. These agreementsgenerally expire upon termination for cause or when we have met our obligationsunder these agreements. As of June 30, 2008, no events have occurredresulting in the obligation of any such payments.

 

Our future capital uses and requirementsdepend on numerous forward-looking factors. These factors may include but arenot limited to the following:

 

·                  therate of progress and cost of our clinical trials and other research anddevelopment activities,

 

·                  thescope, prioritization and number of clinical development and research programswe pursue,

 

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

 

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

 

·                  thecosts and timing of regulatory approvals,

 

·                  thecosts of establishing or contracting for manufacturing, sales and marketingcapabilities, and

 

·                  theeffect of competing technological and market developments.

 

**FORWARD-LOOKING STATEMENTS**

 

This quarterly report on Form 10-Q contains forward-lookingstatements that are based on our management’s beliefs and assumptions and oninformation currently available to our management.  Forward-looking statements includeinformation concerning our possible or assumed future results of operations,business strategies, financing plans, competitive position, industryenvironment, potential growth opportunities, the effects of future regulationand the effects of competition. Forward-looking statements include all statements that are nothistorical facts and can be identified by terms such as “anticipates,” “believes,”“could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,”“projects,” “should,” “will,” “would” or similar expressions.

 

Forward-looking statements involve known and unknown risks,uncertainties and other factors which may cause our actual results, performanceor achievements to be materially different from any future results,performances or achievements expressed or implied by the forward-lookingstatements.  We discuss these risks ingreater detail in the section entitled “Risk Factors” and elsewhere in thisquarterly report on Form 10-Q and in our other filings with the Securitiesand Exchange Commission, including our annual report on Form 10-K for theyear ended December 31, 2007 and our quarterly report on Form 10-Qfor the quarter ended March 31, 2008. Given these uncertainties, you should not place undue reliance on theseforward-looking statements.

 

Also, forward-looking statements represent our management’s beliefs andassumptions only 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 ininterest rates relates primarily to the increase or decrease in the amount ofinterest income we can earn on our investment portfolio. Our risk associatedwith fluctuating interest income is limited to our investments in interest ratesensitive financial instruments. Under our current policies, we do not useinterest rate derivative instruments to manage this exposure to interest ratechanges. We seek to ensure the safety and preservation of our investedprincipal by limiting default risk, market risk, and reinvestment risk. Wemitigate default risk by investing in short-term investment grade securities.We do not invest in auction rate securities. A 100 basis point increase ordecrease in interest rates would increase or decrease our current investmentbalance by approximately $80,000 annually. While changes in our interest rates may affect the fair value of ourinvestment portfolio, any gains or losses are not recognized in our statementof operations 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 otherderivative financial instruments.

 

Our long-term capital lease obligations anddebt bear interest at fixed rates and therefore we do not have significantmarket risk exposure with respect to these obligations.

 

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

##  

We maintain disclosure controls andprocedures that are designed to ensure that information required to bedisclosed in our Exchange Act reports is recorded, processed, summarized andreported within the time periods specified in the Securities and ExchangeCommission’s rules and forms, and that such information is accumulated andcommunicated to our management, including our chief executive officer and chieffinancial officer, as appropriate, to allow timely decisions 

 

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regardingrequired disclosure. In designing and evaluating the disclosure controls andprocedures, management recognized that any controls and procedures, no matterhow well designed and operated, can provide only reasonable and not absoluteassurance of achieving the desired control objectives. In reaching a reasonablelevel of assurance, management necessarily was required to apply its judgmentin evaluating the cost-benefit relationship of possible controls andprocedures. In addition, the design of any system of controls also is based inpart upon certain assumptions about the likelihood of future events, and therecan be no assurance that any design will succeed in achieving its stated goalsunder all potential future conditions; over time, a control may becomeinadequate because of changes in conditions, or the degree of compliance withpolicies or procedures may deteriorate. Because of the inherent limitations ina cost-effective control system, misstatements due to error or fraud may occurand not be detected.

 

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 common stock.We believe the risks described below are the risks that are material to us asof 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 onthe success of one or more of our current product candidates and we cannot becertain that any of them will receive regulatory approval or be commercialized.***

 

We have expended significant time, money andeffort in the development of our core metabolic disease assets, MB07803 andMB07811, and our non-core liver disease assets, pradefovir and MB07133.Clinical trials conducted to date have provided initial evidence of safety withall of our product candidates and initial evidence of efficacy in certain ofour 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.

 

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We do not anticipate that any of our currentproduct candidates will be eligible to receive regulatory approval and begincommercialization for a number of years, if at all. Even if we were ultimatelyto receive regulatory approval for these product candidates, we and/or ourpotential future partners, as applicable, may be unable to commercialize themsuccessfully for a variety of reasons. These include, for example, theavailability of alternative treatments, lack of cost effectiveness, the cost ofmanufacturing the product on a commercial scale and the effect of competitionwith other drugs. The success of our product candidates may also be limited bythe prevalence and severity of any adverse side effects. If we fail tocommercialize one or more of our current product candidates, we may be unableto generate sufficient revenues to attain or maintain profitability, and ourreputation in our industry and the investment community may be damaged.

 

***If development ofour product candidates does not produce favorable results, we and ourcollaborators, as applicable, may be unable to commercialize these products.***

 

To receive regulatory approval for thecommercialization of our core metabolic disease assets, MB07803 and MB07811,our non-core liver disease assets, pradefovir and MB07133, or any other productcandidates that we may develop, adequate and well-controlled clinical trialsmust be conducted to demonstrate safety and efficacy in humans to thesatisfaction of the FDA in the U.S. and other regulatory agencies elsewhere inthe world. In order to support marketing approval, these agencies typicallyrequire successful results in one or more Phase 3 clinical trials, whichour current product candidates have not yet reached and may never reach. Inaddition, regulatory approval of our product candidates may be affected byadverse results in animal studies conducted during clinical development to,among other things, evaluate their toxicology, carcinogenicity andpharmacokinetics and optimize their formulation.

 

The development process is expensive, cantake many years and has an uncertain outcome. Failure can occur at any stage ofthe process. We may experience numerous unforeseen events during, or as aresult of, the development process that could delay or preventcommercialization of our current or future product candidates, including thefollowing:

 

·                 clinical trialsmay produce negative or inconclusive results,

 

·                 animal studiesconducted on product candidates during clinical development to, among otherthings, evaluate their toxicology and pharmacokinetics and optimize theirformulation may produce unfavorable results,

 

·                 patientrecruitment and enrollment in clinical trials may be slower than we anticipate,

 

·                 costs ofdevelopment may be greater than we anticipate,

 

·                 our productcandidates may cause undesirable side effects that delay or preclude regulatoryapproval or limit their commercial use or market acceptance if approved,

 

·                 collaborators whoare responsible for development of our product candidates may not devotesufficient resources to these clinical trials or other studies of thesecandidates or conduct them in a timely manner, or

 

·                 we may facedelays in obtaining regulatory approvals to commence a clinical trial.

 

Success in early development does not meanthat later development will be successful because, for example, productcandidates in later-stage clinical trials may fail to demonstrate sufficientsafety and efficacy despite having progressed through initial clinical testing.For example, in July 2007, we were informed by Daiichi Sankyo, ourcollaborative partner on CS-917, that results from a completed Phase 2bclinical trial showed that this product candidate failed to achieve the primaryendpoint of the clinical trial despite having successfully achieved the primaryendpoints of other earlier clinical trials. In January 2008, we andDaiichi Sankyo agreed to terminate our strategic collaboration on CS-917 and returnthe rights to this product candidate to us. We do not intend to further developthis product candidate.

 

Our clinical experience with our productcandidates is limited, and to date our product candidates have been tested inless than the number of patients that will likely need to be studied to gainregulatory approval. The data collected from clinical trials with largerpatient populations may not demonstrate sufficient safety and efficacy tosupport regulatory approval of these product candidates. In addition, therequirements for regulatory approval of our product candidates may change,making it more difficult for us to achieve such approval in a timely manner orat all. For example, in February 2008 the FDA released draft guidanceregarding clinical trials for product candidates treating diabetes that mayresult in more stringent requirements for the clinical testing andregulatory approval of such product candidates. If formally adopted, these 

 

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and any future guidance thatmay result from recent FDA advisory panel discussions may make it moreexpensive 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 collaborationsin place for any of our current product candidates. Therefore, in the future,we and/or any potential future collaborative partner will be responsible forestablishing the targeted endpoints and goals for development of our productcandidates. These targeted endpoints and goals may be inadequate to demonstratethe safety and efficacy levels required for regulatory approvals. Even if webelieve data collected during the development of our product candidates arepromising, such data may not be sufficient to support marketing approval by theFDA or other regulatory agencies abroad. Further, data generated duringdevelopment can be interpreted in different ways, and the FDA or other foreignregulatory agencies may interpret such data in different ways than us or ourcollaborators. Our failure to adequately demonstrate the safety and efficacy ofour product candidates would prevent our receipt of regulatory approval, andultimately the commercialization of these product candidates.

 

***We may not be ableto enter into collaborations with respect to our non-core assets, pradefovirand MB07133, and certain metabolic disease advanced research programs onacceptable terms, if at all, which would lead to development andcommercialization delays.***

 

Since we do not currently possess theresources necessary to independently develop and commercialize all of thepotential product candidates that may be based upon our technologies, includingMB07803, MB07811, pradefovir and MB07133, and as a component of our strategicplan, we plan to enter into additional collaborative agreements to assist inthe development and commercialization of some or all of these 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, which would adversely affect ourbusiness.

 

***Our productcandidates may cause undesirable side effects that could delay or prevent theirregulatory approval or commercialization or have other significant adverseimplications on our business.***

 

Prior to receiving regulatory approval,undesirable side effects observed in human clinical trials or in supportiveanimal studies with our product candidates could interrupt, delay or halt theirdevelopment and could result in the denial of regulatory approval by the FDA orother regulatory authorities for any or all targeted indications or adversely affectthe marketability of any such product candidates that receive regulatoryapproval. In turn, this could eliminate or limit our ability to commercializeour product candidates and generate revenues from their sale.

 

For example, data from 24-month oral carcinogenicitystudies of pradefovir in rats and mice showed that the incidence of rats ormice with tumors was increased in the animals dosed with the highest doselevels tested and was slightly increased at the intermediate dose levels. Thelow dose levels were considered “no-effect” dose levels in both studies. As aresult of numerous factors which may include these findings, we entered into anagreement with Schering and Valeant Pharmaceuticals North America, or Valeant,to terminate 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 exhibitadverse interactions with other drugs. For example, in earlier clinical trialsconducted by Daiichi Sankyo, CS-917, our first generation product candidate fortype 2 diabetes which we are no longer developing, was associated withincidents of lactic acidosis in two patients when it was combined withmetformin in a Phase 1 clinical trial. After extensive analysis, DaiichiSankyo concluded that these incidents were likely due to significantlyincreased blood levels of metformin. CS-917 was also associated in a limitednumber of patients with episodes of hypoglycemia, asymptomatic lactateelevation as well as lactate elevation with clinical symptoms that could beconsidered signs of lactic acidosis. We are currently conducting clinicaltrials of our second-generation product candidate for type 2 diabetes,MB07803, which works by the same mechanism as CS-917 and thus may be subject tosome or all of the same risks as CS-917. To date, no incidents of lacticemia,lactic acidosis, hypoglycemia or other significant adverse side effects havebeen observed in clinical trials of MB07803.

 

The unique nature of our proprietarytechnologies including HepDirect and NuMimetic may cause undesirable sideeffects in future clinical trials or supportive animal studies. In addition,our product candidates may have greater or lesser 

 

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degrees ofpotential risk of undesirable side effects relative to other product candidatesbased on the nature of their molecular targets and the various physiologicalresponses associated with those targets. For example, MB07811 is a productcandidate designed to exploit the beneficial hepatic effects of thyroid hormoneagonists while avoiding toxicities related to systemic exposure to these typesof compounds. If MB07811 is not successful in this regard, it could beassociated with undesirable side effects.

 

Undesirable side effects involving ourproduct candidates may have other significant adverse implications on ourbusiness, for example:

 

·                 we may be unableto obtain additional financing on acceptable terms, if at all,

 

·                 our stock pricecould decline,

 

·                 our collaboratorsmay ultimately terminate development of our partnered products, may furtherdecide not to develop backup product candidates and may terminate ouragreements,

 

·                 if theseagreements were terminated we may determine not to further develop the affectedproduct candidates due to resource constraints and may not be able to establishadditional collaborations for their further development on acceptable terms, ifat all,

 

·                 if we were tolater continue the development of these product candidates and receiveregulatory approval, earlier findings may significantly limit theirmarketability and thus significantly lower our potential future revenues fromtheir sale,

 

·                  wemay be subject to product liability or stockholder litigation, and

 

·                  wemay be unable to attract and retain key employees.

 

In addition, if any of our product candidatesreceive marketing approval and we or others later identify undesirable sideeffects caused by the product:

 

·                 regulatoryauthorities may withdraw their approval of the product, or we may decide tocease marketing and sale of the product voluntarily,

 

·                 we may berequired to change the way the product is administered, conduct additionalstudies, change the labeling of the product, or change the product’smanufacturing facilities, and

 

·                 our reputationmay suffer.

 

Any of these events could prevent us fromachieving or maintaining market acceptance of the affected product or couldsubstantially increase the costs and expenses of commercializing the product,which in turn could delay or prevent us from generating significant revenuesfrom the sale of the product.

 

***We are currentlydependent on our collaborations with Merck, Idenix and Roche for thedevelopment and commercialization of product candidates related to thosecollaborations, and we may be dependent on future collaborators for thedevelopment of our current and future product candidates. Events involving ourcollaborations with Merck,  Idenix andRoche, or any future collaborations could prevent us from developing andcommercializing our product candidates and achieving or sustainingprofitability.***

 

We have entered into two collaborations withMerck, a collaboration with Idenix and a collaboration with Roche. The firstcollaboration with Merck sought to develop and commercialize new products fortreating hepatitis C infection and the second seeks to develop andcommercialize new products to treat type 2 diabetes and potentially othermetabolic diseases. Our collaboration with Idenix sought to develop andcommercialize new products for treating hepatitis C infection, and our newcollaboration with Roche seeks to develop and commercialize new products fortreating hepatitis C.  Although thefunded research phases of the hepatitis C collaborations with Merck and Idenixare completed, certain candidate compounds discovered during the collaborationsare being evaluated to determine if one or more will be recommended forclinical development.  The sponsoredresearch term of our second collaboration with Merck continues through June 2009,and the 

 

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research termof 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 andtiming of resources that Merck, Idenix, Roche or any future collaboratorsdevote to our programs or potential product candidates. These collaborationswith us may end or may be terminated or our collaborators may otherwise fail toconduct their collaborative activities successfully and in a timely manner.Further, our collaborators may not develop product candidates that arise out ofour collaborative arrangements or devote sufficient resources to thedevelopment, manufacture, marketing or sale of these products. In the eventthat one of our collaborations is terminated, and we believe that the continueddevelopment or commercialization of a product candidate or drug compoundcovered by the collaboration is warranted, we may seek to obtain rights todevelop and commercialize the product candidate or drug compound, if we do notalready have those rights. We would then determine whether to continue thedevelopment or commercialization of the product candidate or drug compoundindependently or together with a new collaborator. However, in the event thatwe do not have sufficient resources to independently develop or commercializethe product candidate or drug compound, and we cannot establish a newcollaboration on acceptable terms, we would be forced to discontinue itsdevelopment or commercialization. For example, at this time, we do not intendto independently develop pradefovir or MB07133 and intend to license theseproduct candidates for further development and commercialization.

 

We and our present and future collaboratorsmay fail to develop or effectively commercialize products or drug compoundscovered by our present and future collaborations if:

 

·                 we do not achieveour objectives under our collaboration agreements,

 

·                 our productcandidates do not meet the primary endpoints of any clinical trials conductedon them or exhibit undesirable side effects,

 

·                 weare unable to obtain patent protection for the product candidates orproprietary technologies we discover in our collaborations,

 

·                 weare unable to manage multiple simultaneous product discovery and developmentcollaborations,

 

·                 ourpotential collaborators are less willing to expend their resources on ourprograms due to their focus on other programs or as a result of general marketconditions,

 

·                 ourcollaborators become competitors of ours or enter into agreements with ourcompetitors,

 

·                 weor our collaborators encounter regulatory hurdles that preventcommercialization of our product candidates,

 

·                 wedevelop products and processes or enter into additional collaborations thatconflict with the business objectives of our other collaborators,

 

·                 consolidationin our target markets limits the number of potential collaborators, or

 

·                 weare unable to negotiate additional collaboration agreements under termssatisfactory to us.

 

If we areunable to develop or commercialize our products as a result of the occurrenceof any of these events, we may not be able to generate sufficient revenues toachieve or maintain profitability.

 

***Because our collaborations with Merck,  Idenix and Roche  may involve Merck’s, Idenix’s or Roche’sproprietary compounds, if Merck, Idenix or Roche  terminates development of product candidatescontaining these compounds,  we may nothave the right to pursue development of these product candidates on our own.***

 

The objectiveof our hepatitis C collaboration with Merck was to discover productcandidates for the treatment of this disease by applying our technology tocertain compounds provided by Merck. The funded research phase of thiscollaboration has ended. Merck has evaluated and may continue to evaluate thedrug compounds discovered under the research phase of the collaboration todetermine if one or more will be recommended for clinical development. If Merckso 

 

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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 agreementwith Merck to develop and commercialize new products to treat type 2diabetes and potentially other metabolic diseases may include the developmentof compounds owned or controlled by Merck. Accordingly, if Merck terminatesthis collaboration, it may prove difficult for us to continue development ofsuch compounds. 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 andcommercialize new products to treat hepatitis C infection may include thedevelopment of compounds owned or controlled by Roche.  If our collaborationwith Roche is terminated, we may not have any right to develop or commercializeproduct candidates developed in connection with the collaboration.

 

***Conflicts may arise between us and any of ourcollaborators that could delay or prevent the development or commercializationof our product candidates.***

 

Conflicts mayarise between our collaborators and us, such as conflicts concerning theinterpretation of clinical data, the achievement of milestones or the ownershipof intellectual property developed during the collaboration. If any conflictsarise with Merck, Idenix, Roche or any future collaborators, they may act intheir self-interest, which may be adverse to our best interests. Any suchdisagreement between us and a collaborator could result in one or more of thefollowing, each of which could delay or prevent the development orcommercialization of our product candidates, and in turn prevent us fromgenerating sufficient revenues to achieve or maintain profitability:

 

·                 unwillingnesson the part of a collaborator to pay us research funding, milestone payments orroyalties we believe are due to us under our collaboration agreement,

 

·                 uncertaintyregarding ownership 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,

 

·                 unwillingnesson the part of a collaborator to keep us informed regarding the progress of itsdevelopment and commercialization activities or to permit public disclosure ofthe results of those activities, or

 

·                 slowingor cessation of a collaborator’s development or commercialization efforts withrespect to our product candidates.

 

***Our efforts to discover product candidatesbeyond our current product candidates may not succeed, and any productcandidates we recommend for clinical development may not actually beginclinical trials.***

 

We intend touse our proprietary 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 

 

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clinicaltrials. Such findings would potentially impede our ability to maintain orexpand our clinical development pipeline. Our ability to identify new drug compoundsand advance them into clinical development also depends upon our ability tofund our research and development operations, and we cannot be certain thatadditional funding will be available on acceptable terms, or at all.

 

***Delays in the commencement or completion ofclinical trials could result in increased costs to us and delay our ability togenerate significant revenues.***

 

Delays in thecommencement or completion of clinical trials could significantly impact ourproduct development costs. We do not know whether planned clinical trials willbegin on time or be completed on schedule, if at all. The commencement ofclinical trials can be delayed for a variety of reasons, including delaysrelated to:

 

·                 obtainingregulatory approval to commence a clinical trial,

 

·                 reachingagreement on acceptable terms with prospective contract research organizationsand clinical trial sites,

 

·                 manufacturingsufficient quantities of a product candidate or other materials necessary toconduct the clinical trial,

 

·                 obtaininginstitutional review board approval to conduct a clinical trial at aprospective site,

 

·                 recruitingand enrolling patients to participate in a clinical trial, and

 

·                 thefailure of our collaborators to adequately resource our product candidates due totheir focus on other programs or as a result of general market conditions.

 

In addition,once a clinical trial has begun, it may be suspended or terminated by us, ourcollaborators, the FDA or other regulatory authorities due to a number offactors, including:

 

·                  failureto conduct the clinical trial in accordance with regulatory requirements orclinical protocols,

 

·                 inspectionof the clinical trial operations or clinical trial site by the FDA or otherregulatory authorities resulting in the imposition of a clinical hold,

 

·                 unforeseensafety issues, or

 

·                 lackof adequate funding to continue the clinical trial.

 

If weexperience significant delays in the commencement or completion of clinicaltesting, our product development costs may increase, we may lose any competitiveadvantage associated with early market entry and our ability to generatesignificant revenues may be delayed. In addition, many of the factors thatcause, or lead to, a delay in the commencement or completion of clinical trialsmay also ultimately lead to the denial of regulatory approval of a productcandidate.

 

***We rely on third parties in connection withthe development of our product candidates. If these third parties do notsuccessfully meet their obligations under our agreements, we may not be able toobtain regulatory approval for or commercialize our product candidates.***

 

We rely onthird parties, such as contract research organizations, medical institutions,clinical investigators and contract laboratories, to assist in the developmentof MB07803 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 licensethese product candidates for further development and commercialization. We mayrely on strategic collaborators for the development of our core metabolicdisease assets, MB07803 and MB07811, in the future. If successful in enteringinto these future collaborations and license agreements, we will be dependentupon our collaborative partners and licensees for the further development andcommercialization of these product candidates. Although our collaborations withMerck, Idenix and Roche have not yet yielded product candidates, should they doso, we will be dependent on Merck, Idenix and/or Roche, as applicable, toconduct the development of any resulting product candidates. If Merck, Idenix,Roche or these other third 

 

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parties do notsuccessfully meet their obligations under our agreements, or if the quality or accuracyof the data they obtain is compromised due to the failure to adhere toapplicable protocols or for other reasons, clinical trials or other studies maybe extended, delayed or terminated, and these product candidates may notreceive regulatory approval or be successfully commercialized.

 

***Because our product candidates, researchprograms and collaborative efforts depend on our proprietary technologies,adverse events affecting our proprietary technologies may delay or prevent thecommercialization of our product candidates.***

 

We used ourNuMimetic technology to identify MB07803. We used our HepDirect technology todiscover pradefovir, MB07811 and MB07133, and have applied it in certain otherprograms as well. We intend to use these and future proprietary technologies toexpand our product pipeline in the future. We may also leverage our HepDirectand other liver-targeting technology through strategic alliances andcollaborations with other companies, such as our hepatitis C collaborationswith Merck, Idenix and Roche in which we applied our technology to certainMerck, Idenix and Roche compounds. Our proprietary technologies are subject tomany of the same risks as our product candidates, including risks related to:

 

·                  obtainingand maintaining patent and trade secret protection for these technologies,

 

·                  avoidinginfringement of the proprietary rights of third parties,

 

·                  thedevelopment of competing technologies by others, and

 

·                  inHepDirect’s case, the safety and effectiveness of this technology in humans.

 

Becausecertain of our product candidates and research programs are dependent on ourproprietary technologies, adverse events affecting our proprietary technologiesmay in turn delay or prevent the development or commercialization of ourproduct candidates, which could impede our ability to generate revenues andachieve or maintain profitability.

 

***Our product candidates are subject toextensive regulation, which can be costly and time consuming, causeunanticipated delays or prevent the receipt of the required approvals tocommercialize our product candidates.***

 

The clinicaldevelopment, manufacturing, labeling, storage, record-keeping, advertising,promotion, export, marketing and distribution of our product candidates aresubject to extensive regulation by the FDA and other regulatory agencies in theU.S. and by comparable governmental authorities in foreign markets. In theU.S., neither we, nor our collaborators, are permitted to market our productcandidates until we or our collaborators receive approval of a New DrugApplication, or NDA, from the FDA or receive similar approvals abroad. Theprocess of obtaining these approvals is expensive, often takes many years, andcan vary substantially based upon the type, complexity and novelty of theproduct candidates involved. Approval policies or regulations may changeand may be influenced by the results of other similar or competitive products. Forexample, in February 2008 the FDA released draft guidance regardingclinical trials for product candidates treating diabetes that may result inmore stringent requirements for the clinical testing and regulatory approval ofsuch 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.  Inaddition, as a company, we have not previously filed NDAs with the FDA or filedsimilar applications with other foreign regulatory agencies. This lack ofexperience may impede our ability to obtain FDA or other foreign regulatoryagency approval in a timely manner, if at all, for our product candidates forwhich development and commercialization is our responsibility.

 

Despite thetime and expense invested, regulatory approval is never guaranteed. The FDA orother foreign regulatory agencies can delay, limit or deny approval of aproduct candidate for many reasons, including:

 

·                  aproduct candidate may not be safe and effective,

 

·                  FDAor other foreign regulatory agency officials may not find the data frompreclinical testing and clinical trials generated during developmentsufficient,

 

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·                  theFDA or other foreign regulatory agency may not approve of our third-partymanufacturers’ processes or facilities, or

 

·                  theFDA or other foreign regulatory agency may change its approval policies oradopt new regulations.

 

Any delay inobtaining, or inability to obtain, these approvals would prevent us fromcommercializing our product candidates.

 

***Even if any of our product candidates receiveregulatory approval, our product candidates may still face future developmentand regulatory difficulties.***

 

If any of ourproduct candidates receive regulatory approval, the FDA or other foreignregulatory agencies may still impose significant restrictions on the indicateduses or marketing 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 and otherpost-market information on the drug. If our product candidates fail to complywith applicable regulatory requirements, a regulatory agency may:

 

·                  issuewarning letters or other notices of possible violations,

 

·                  imposecivil or criminal penalties or seek disgorgement of revenue or profits,

 

·                  suspendregulatory approval,

 

·                  suspendany ongoing clinical trials,

 

·                  refuseto approve pending applications or supplements to approved applications filedby us or our collaborators,

 

·                  imposerestrictions on operations, including costly new manufacturing requirements, or

 

·                  seizeor detain products or require a product recall.

 

In order tomarket any products outside of the U.S., we and our collaborators mustestablish and comply with numerous and varying regulatory requirements of othercountries regarding safety and efficacy. Approval procedures vary amongcountries and can involve additional product testing and additionaladministrative review periods. The time required to obtain approval in othercountries might differ from that required to obtain FDA approval. Theregulatory approval process in other countries may include all of the risksregarding FDA approval in the U.S. Regulatory approval in one country does notensure regulatory approval in another, but a failure or delay in obtainingregulatory approval in one country may negatively impact the regulatory processin others. Failure to obtain regulatory approval in other countries or anydelay or setback in obtaining such approval could have the same adverse impactregarding FDA approval in the U.S., including the risk that our productcandidates may not be approved for all indications requested, which could limitthe uses of our product candidates and adversely impact potential royalties andproduct sales, and that such approval may be subject to limitations on theindicated uses for which the product may be marketed or require costly,post-marketing follow-up studies.

 

If we and ourcollaborators fail to comply with applicable foreign regulatory requirements,we and our collaborators may be subject to fines, suspension or withdrawal ofregulatory approvals, product recalls, seizure of products, operatingrestrictions and criminal prosecution.

 

***If our competitors have products that areapproved faster, marketed more effectively or demonstrated to be more effectivethan ours, our commercial opportunity will be reduced or eliminated.***

 

Thebiotechnology and biopharmaceutical industries are characterized by rapidlyadvancing technologies, intense competition and a strong emphasis onproprietary products. We face competition from many different sources,including 

 

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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 awareof many competitive products currently marketed or under development that areused to treat 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 member of the biguanide drug class, related to guanidine andcurrently is the most widely prescribed first line therapy for type 2diabetes,

 

·                  sulfonylureas,which increase the secretion of insulin by the pancreas, thereby lowering thelevel of the sugar glucose in the blood,

 

·                  insulins,which mimic insulin, the naturally occurring hormone made by the pancreas tocontrol blood glucose levels,

 

·                  PPARagonists, which improve insulin sensitivity by activating certain genesinvolved in fat synthesis and carbohydrate metabolism,

 

·                  incretinmimetics, which lower glucose levels by increasing the levels of certainnaturally occurring hormones from the pancreas, including glucagon-likepeptide-1, or GLP-1, a peptide that facilitates the response of the pancreasand liver to fluctuations in glucose levels by its action on pancreatic betaand alpha cells. This drug class includes dipeptidyl peptidase IV, or DPP-IVinhibitors, and BYETTA® (exenatide) injection. DPP-IV is an enzymein the bloodstream that cleaves and inactivates GLP-1. Inhibition of DPP-IVthus increases the half-life of endogenous GLP-1 by preventing cleavage andinactivation of GLP-1. BYETTA is an injectable medication that exhibits many ofthe same glucose regulating actions of GLP-1. The overall effect of drugs inthis class is to enhance glucose-dependent insulin secretion and suppressinappropriate glucagon 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 stimulate the pancreas’ beta-cells to produce insulin, and

 

·                  combinationtherapies, which combine metformin with members of several or one of theabove-mentioned classes, particularly sulfonylureas and PPAR agonists.

 

Metformin is adrug that inhibits liver glucose production like MB07803 but does so through anunknown mechanism. Because it does not cause weight gain, metformin is oftenprescribed as a first line therapy to obese patients with type 2 diabetes,who are reported to comprise more than 90% of patients newly diagnosed withtype 2 diabetes. Generic forms of metformin have recently becomeavailable. Accordingly, unless MB07803 demonstrates significant benefits whencompared to metformin or demonstrates that it can be used in the patientpopulation who do not tolerate and/or adequately respond to metformintreatment, the price required to effectively compete with the generic form ofmetformin may be so low that it may limit the market’s potential or make ituneconomical to market MB07803. In addition, many companies are developingnovel therapies that target diabetes. These companies may develop and introduceproducts competitive with or superior to MB07803.

 

If MB07811 isultimately determined safe and effective and approved for marketing, it wouldcompete with products marketed by several large pharmaceutical companies thatcurrently comprise a large share of the hyperlipidemia market. Major classes ofhyperlipidemia drugs include, but are not limited to:

 

·                  statins,which reduce serum cholesterol levels by inhibiting a key enzyme involved inthe biosynthesis of cholesterol,

 

·                  fibrates,which reduce the amount of cholesterol and triglycerides (fatty substances) inblood,

 

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·                  nicotinicacid derivatives, which lower cholesterol, triglycerides and low densitylipoproteins and increase high density lipoproteins,

 

·                  CAIs,which inhibit the absorption of dietary and biliary cholesterol,

 

·                  bileacid sequestrants, which bind with cholesterol-containing bile acids in theintestines and remove them in bowel movements, and

 

·                  statincombination therapies, which combine statins with members of theabove-mentioned classes, particularly CAIs.

 

Several largepharmaceutical companies are also developing novel therapies that targethyperlipidemia. These companies may develop and introduce products competitivewith or superior to MB07811. Lipitor (atorvastatin; a statin marketed byPfizer) is currently one of the best selling prescription medicines. Inaddition, generic statins (cholesterol-reducers) have recently been approved inthe major pharmaceutical markets and would also compete with MB07811.

 

If pradefoviris ultimately determined safe and effective and approved for marketing, it maycompete for market share with established therapies from a number ofcompetitors, including large pharmaceutical companies. Such marketed products include,but are not limited to the following classes:

 

·                  interferons,which mimic interferon, the naturally occurring infection-fighting immunesubstance produced by the body,

 

·                  nucleosideanalogues, which are chemically engineered nucleoside compounds that areconverted inside cells into other compounds that are structurally similar tothe building blocks of DNA and RNA that interfere with the replication of HBV,and

 

·                  nucleotideanalogues, which are chemically engineered nucleotide compounds that areconverted inside cells into other compounds that are structurally similar tothe building blocks of DNA and RNA that interfere with the replication of HBV.

 

A competitorto pradefovir would be Hepsera (adefovir dipivoxil), which is a nucleotideanalogue currently marketed in the U.S. and Europe by Gilead Sciences, Inc.Pradefovir and Hepsera are prodrugs of the same active drug, and therefore maydirectly compete. In order to effectively compete with Hepsera, pradefovir mayhave to be significantly more beneficial or less expensive than Hepsera. Inaddition, the nucleotide analogue, tenofovir, has been shown to be veryeffective in treating hepatitis B infection and has recently been approved formarketing in Europe.

 

Nexavar(sorafenib), a chemotherapy approved for treating kidney cancer, received FDAapproval in November 2007 for the treatment of primary liver cancer. Thisfollows the decision of the European Medicines Agency, or EMEA, in October 2007to approve Nexavar in Europe. Nexavar is now the only drug approved for primaryliver cancer in the United States or Europe.

 

In addition,companies are developing therapies for other solid tumors which may beefficacious in treating primary liver cancer. These companies may develop andintroduce products competitive with or superior to MB07133.

 

In addition,many other companies are developing products for the treatment of the diseaseswe are targeting and if successful, these products could compete with ourproducts. If we receive approval to market and sell any of our productcandidates, we may compete with these companies and their products as well asothers in varying stages of development.

 

Many of ourcompetitors have significantly greater financial resources and expertise inresearch and development, manufacturing, preclinical testing, clinical trials,regulatory approvals and marketing approved products than we do. Smaller orearly-stage companies may also prove to be significant competitors,particularly through collaborative arrangements with large and establishedcompanies. Our competitors may succeed in developing technologies and therapiesthat are more effective, better tolerated or less costly than any which we aredeveloping, or that would render our product candidates obsolete andnoncompetitive. Our competitors may succeed in obtaining approvals from the FDAand foreign regulatory authorities for their products sooner than we do forours. We will also face competition from these third parties in recruiting andretaining qualified scientific and management personnel, establishing clinicaltrial sites and patient registration for 

 

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clinicaltrials, and in acquiring and in-licensing technologies and products complementaryto our programs or advantageous to our business.

 

***We do not have internal manufacturingcapabilities, and if we fail to develop and maintain supply relationships withcollaborators or other third-party manufacturers, we may be unable to developor commercialize our products.***

 

Our ability todevelop and commercialize our products depends in part on our ability tomanufacture, or arrange for collaborators or other third parties tomanufacture, our products at a competitive cost, in accordance with regulatoryrequirements and in sufficient quantities for development and eventualcommercialization. We have relied on a number of suppliers to manufacturesufficient quantities of MB07803 and MB07811 for use in clinical trials duringdevelopment. Although our suppliers have manufactured other companies’ productson a commercial scale, we have not yet determined if they are capable ofmanufacturing our products on a commercial scale. We, our current and potentialfuture collaborators and third-party manufacturers may encounter difficultieswith the small- and large-scale formulation and manufacturing processesrequired to manufacture our product candidates, resulting in delays in ourclinical trials development and regulatory submissions, in the commercializationof our product candidates or, if any of our product candidates is approved, inthe recall or withdrawal of the product from the market. Further, developmentof large-scale manufacturing processes may require additional validationstudies, which the FDA and other foreign regulatory agencies must review andapprove. Our inability to enter into or maintain agreements with collaboratorsor capable third-party manufacturers on acceptable terms could delay or preventthe commercialization of our products, which would adversely affect our abilityto generate revenues and could prevent us from achieving or maintainingprofitability.

 

We currentlyexpect that in any future development activities related to MB07803 andMB07811, we will rely on our current suppliers to manufacture these compounds.However, we do not have long-term supply agreements with these third parties,and we may not be able to enter into new supply agreements with them in atimely manner or on acceptable terms, if at all. These third parties may alsobe subject to capacity constraints that would cause them to limit the amount ofthese compounds 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, our collaborators or other third-party manufacturers of our products mustcomply with current good manufacturing practices, or CGMP, requirementsenforced by the FDA and other foreign regulatory agencies through theirfacilities inspection programs. These requirements include quality control,quality assurance and the maintenance of records and documentation. Inaddition, product manufacturing facilities in California are subject tolicensing requirements of the California Department of Health Services and maybe inspected by the California Department of Health Services, and otherapplicable regulatory authorities, at any time. We, our collaborators or otherthird-party manufacturers of our products may be unable to comply with theseCGMP requirements and with other FDA, state and foreign regulatoryrequirements. We have little control over third-party manufacturers’ compliancewith these regulations and standards. A failure to comply with theserequirements may result in fines and civil penalties, suspension of production,suspension or delay in product approval, product seizure or recall, orwithdrawal of product approval.

 

***If we are unable to establish sales andmarketing capabilities or enter into agreements with third parties to sell andmarket our product candidates, we may be unable to generate significantrevenues.***

 

We do not havea sales and marketing organization, and we have no experience as a company inthe sales, marketing and distribution of pharmaceutical products. Although our hepatitisC and metabolic disease collaborations with Merck have not yet yielded productcandidates, should they be successful, Merck will be responsible for worldwidemarketing and commercialization of any resulting product candidates (subjectto, in the case of our metabolic disease collaboration, our option toco-promote the product in the U.S. with certain financial assistance fromMerck). Similarly, should our hepatitis C collaborations with Idenix and Rocheyield any product candidates, Idenix and Roche will be responsible forworldwide marketing and commercialization of any resulting product candidates.In order to co-promote any of these products, or to commercialize MB07803,MB07811, pradefovir, MB07133 or any future product candidates for which we retaincommercialization rights, we may be required to develop our sales, marketingand distribution capabilities, or make arrangements with a third party toperform these services. Even though we may receive financial assistance fromMerck if we exercise 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, 

 

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if at all, andany sales force we do establish may not be capable of generating sufficientdemand for our product candidates. To the extent that we enter intoarrangements with collaborators or other third parties to perform sales andmarketing services, our product revenues are likely to be lower than if wedirectly 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.

 

***The commercial success of our productcandidates depends upon their market acceptance among physicians, patients,healthcare payors and the medical community.***

 

Even if ourproduct candidates obtain regulatory approval, our products, if any, may notgain market acceptance among physicians, patients, healthcare payors and themedical community. The degree of market acceptance of any of our approvedproduct candidates will depend on a number of factors, including:

 

·                  ourability to provide acceptable evidence of safety and efficacy,

 

·                  relativeconvenience and ease of administration,

 

·                  theprevalence and severity of any adverse side effects,

 

·                  restrictionson use in combination with other products,

 

·                  availabilityof alternative treatments,

 

·                  pricingand cost effectiveness assuming either competitive or potential premium pricingrequirements, based on the profile of our product candidates and targetmarkets,

 

·                  effectivenessof our or our partners’ sales and marketing strategy, and

 

·                  ourability to obtain sufficient third-party coverage or reimbursement.

 

***Weare subject to uncertainty relating to health care reform measures andreimbursement policies which, if not favorable to our product candidates, couldhinder or prevent our product candidates’ commercial success.***

 

The continuing efforts of the government,insurance companies, managed care organizations and other payers of health carecosts to contain or reduce costs of health care may adversely affect:

 

·                  ourability to set a price we believe is fair for our products,

 

·                  ourability to generate revenues and achieve or maintain profitability,

 

·                  thefuture revenues and profitability of our potential customers, suppliers andcollaborators, and

 

·                  theavailability of capital.

 

In certainforeign markets, the pricing of prescription drugs is subject to governmentcontrol. In the U.S., given recent federal and state government initiativesdirected at lowering the total cost of health care, Congress and statelegislatures will likely continue to focus on health care reform, the cost ofprescription drugs and the reform of the Medicare and Medicaid systems. Forexample, in January 2007, the House of Representatives passed the MedicarePrescription Drug Price Negotiation Act of 2007. The bill requires the federalgovernment (specifically the Department of Health and Human Services) tonegotiate with drug companies over the price of drugs for Medicareparticipants. In addition, the Medicare Prescription Drug, Improvement andModernization Act of 2003 provides a Medicare prescription drug benefit thatbegan in 2006 and mandates other reforms. While we cannot predict the fulloutcome of the implementation of these legislations, it is possible that thenew Medicare prescription drug benefit, which will be managed by private healthinsurers and other managed care organizations, will result in decreasedreimbursement for prescription drugs, which may further exacerbateindustry-wide pressure to reduce prescription drug prices. This could harm ourability to market our products and generate revenues. It is also possible thatother similar proposals will be adopted.

 

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Our ability tocommercialize our product candidates successfully will depend in part on theextent to which governmental authorities, private health insurers and otherorganizations establish appropriate coverage and reimbursement levels for thecost of our products and related treatments. Third-party payors including stategovernments are increasingly challenging the prices charged for medicalproducts and services. Also, the trend toward managed health care in the U.S.,which could significantly influence the purchase of health care services andproducts, as well as legislative proposals to reform health care or reducegovernment insurance programs, may result in lower prices for our productcandidates or exclusion of our product candidates from coverage andreimbursement programs. The cost containment measures that health care payorsand providers are instituting and the effect of any health care reform couldsignificantly reduce our revenues from the sale of any approved product.

 

***We may need to decrease the size of ourorganization, and we may experience difficulties in managing thoseorganizational changes.***

 

Since webecame an independent company in 1999, we have increased the number of ourfull-time employees from 50 to 126 as of June 30, 2008. We may need todecrease the number of our full-time employees in the future in response toadverse business events. Reducing our workforce may lead to additionalunanticipated attrition. If our future staffing is inadequate because of additionalunanticipated attrition or because we failed to retain the staffing levelrequired to accomplish our business objectives we may be delayed or unable tocontinue the development or commercialization of our product candidates, whichcould impede our ability to generate revenues and achieve or maintainprofitability.

 

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

 

Our successdepends on our continued ability to attract, retain and motivate highlyqualified management and scientific personnel. The loss of the services ofcertain principal members of our management or scientific staff could delay orprevent the commercialization of our product candidates. We employ theseindividuals on an “at-will” basis and their employment can be terminated by usor them at any time, for any reason and with or without notice, subject to theterms of their stock restriction agreements and severance agreements.

 

Competitionfor qualified personnel in the biotechnology field is intense. We will need tohire additional personnel as we establish and/or expand our sales,manufacturing, research and development activities in the future. We may not beable to attract and retain quality personnel on acceptable terms given thecompetition for such personnel among biotechnology, pharmaceutical and othercompanies.

 

We haveestablished a scientific advisory board, the members of which assist us informulating our research, development and clinical strategies. These scientificadvisors are not our employees and may have commitments to, or consulting oradvisory contracts with, other entities that may limit their availability tous. In addition, our scientific advisors may have arrangements with othercompanies to assist those companies in developing products or technologies thatmay compete with ours

 

**Risks Related to our Finances and CapitalRequirements**

 

***We will need substantial additional fundingand may be unable to raise capital when needed, which would force us to delay,reduce or eliminate our research and development programs or commercializationefforts and affect our ability to continue as a going concern.***

 

We intend touse our existing cash reserves,  proceedsfrom our ongoing collaboration with Merck, proceeds from our new collaborationwith Roche, our CEFF, if available, and proceeds from other planned businessdevelopment activities to execute our strategic plan through 2008. Under ourstrategic plan we will need to secure additional cash proceeds through futurestrategic collaborations and the CEFF or other financing sources to fundcertain studies on the MB07803 and MB07811 programs in 2008. In the event weare not able to generate sufficient financing through the use of our CEFF orother planned financing and business development activities we have the abilityand intent to, and will be required to, delay, scale back or eliminate some orall of our research or development programs and other outlays of cash in orderto meet our cash requirements through 2008. Additionally, we may be required torelinquish greater or all rights to product candidates at an earlier stage ofdevelopment or on less favorable terms than we would otherwise choose.Alternatively, we may determine that seeking additional resources throughtraditional financing transactions may be appropriate to achieve certain keyvalue-driving 

 

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developmentmilestones. No assurances can be made that additional funding through anyresources including, our CEFF, will be available when needed. Failure to obtainadequate financing and to curtail or delay cash expenditures adequately willhave a significant negative impact on our future operations and our ability tocontinue as a going concern. Because we do not anticipate that we will generatesignificant continuing revenues for several years, if at all, we will need toraise substantial additional capital to finance our operations in the future.Our additional funding requirements will depend on, and could increasesignificantly as a result of, many factors, including:

 

·                  therate of progress and cost of our clinical trials and other research anddevelopment activities,

 

·                  thescope, prioritization and number of clinical development and research programswe pursue,

 

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

 

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

 

·                  thecosts and timing of regulatory approvals,

 

·                  thecosts of establishing or contracting for sales and marketing capabilities, and

 

·                  theeffect of competing technological and market developments.

 

Until we cangenerate significant continuing revenues, if ever, we expect to satisfy ourfuture cash needs through public or private equity offerings, debt financings,grants or corporate collaboration and licensing arrangements, as well asthrough interest income earned on cash balances.

 

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, reduce thescope of or eliminate one or more of our research and development programs orour commercialization efforts and we may be unable to continue as a goingconcern.

 

***We have a history of net losses, which weexpect to continue for the foreseeable future, and we are unable to predictwhen we will become profitable, if ever.***

 

We haveincurred net losses from our inception. As of June 30, 2008, we had anaccumulated deficit of approximately $172.7 million. While we are unable atthis time to determine whether our net losses will increase or decrease in thefuture, we expect to continue to incur net losses during the next several yearsas we conduct operations. Because of the numerous risks and uncertaintiesassociated with our product development efforts, we are unable to predict whenwe will become profitable, if ever.

 

***Wecurrently lack a significant continuing revenue source and may not become orremain profitable.***

 

Our ability tobecome and remain profitable depends upon our ability to generate continuing revenues.To date, 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:

 

·                  successfulcompletion of ongoing development activities for our product candidates,

 

·                  achievementof regulatory approval for our product candidates,

 

·                  successfulcompletion of our current and future strategic collaborations, and

 

·                  successfulsales, manufacturing, distribution and marketing of our products.

 

We do notanticipate that we will generate significant continuing revenues for severalyears. If we are unable to eventually generate significant continuing revenues,we will not become or remain profitable, and we may be unable to continue ouroperations.

 

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***Raising additional funds by issuingsecurities or through collaboration and licensing arrangements will causedilution to existing stockholders, restrict our operations or require us torelinquish proprietary rights.***

 

We may raiseadditional funds through public or private equity offerings, corporate collaborationand licensing arrangements, debt financings, grants or our CEFF, if available.For example, we have an effective shelf registration statement on file with theSecurities and Exchange Commission which allow us to issue shares of our commonstock and warrants to purchase our common stock in the future for an aggregateinitial offering price of up to $75 million, subject to substantiallimitations relating to the aggregate market value of our common stock held bynon-affiliates. We have also filed a registration statement with the Securitiesand Exchange Commission covering the resale of shares issuable under the CEFFthough to date, no shares have been issued under this resale registrationstatement. We may sell additional securities from time to time in one or moreofferings in amounts, at prices and on terms that we will determine at the timeof the offering. To the extent that we raise additional capital by issuingequity securities, pursuant to our effective shelf registration statements orotherwise, 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 of our assets as well as prohibitions on ourability to create liens, pay dividends, redeem our stock or make investments.In addition, if we raise additional funds through collaboration and licensingarrangements, it may be necessary to relinquish potentially valuable rights toour potential products or proprietary technologies, or grant licenses on termsthat are not favorable to us.

 

***Certain provisions of our financingfacilities may require us to pay any outstanding balance of indebtedness and could limit our ability to fund ongoingoperations or obtain additional financing.***

 

If we are required to pay any outstanding balance of indebtednessimmediately, we may be faced with the following negative consequences:

 

·                  wewill need a substantial portion of our cash flow to pay the principal andinterest on our indebtedness,

 

·                  paymentsof our indebtedness will reduce the funds that would otherwise be available forour operations and future strategic initiatives, and

 

·                  therewould be a material adverse effect on our business and financial condition ifwe were unable to service our indebtedness or obtain additional financing.

 

***Our quarterly operating results and stockprice may fluctuate significantly.***

 

We expect ouroperating results to be subject to quarterly fluctuations. The revenues wegenerate, if any, and our operating results will be affected by numerousfactors, including:

 

·                  thedevelopment status of our product candidates, including results of our clinicaltrials and other studies,

 

·                  ourrecommendation of additional drug compounds for clinical development,

 

·                  ouraddition or termination of research programs or funding support,

 

·                  variationsin the level of expenses related to our product candidates or researchprograms,

 

·                  ourexecution of collaborative, licensing or other arrangements, and the timing ofpayments we may make or receive under these arrangements, and

 

·                  changesin the use assumptions or the use of different valuation methods in theapplication of SFAS No. 123R in future periods.

 

Quarterlyfluctuations in our operating results may, in turn, cause the price of ourstock to fluctuate substantially. We believe that quarterly comparisons of ourfinancial results are not necessarily meaningful and should not be relied uponas an indication of our future performance.

 

***Our CEFF may not be available to us if weelect to make a draw down, may require us to make additional “blackout” or***

 

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***other payments to an institutional investorand may result in dilution to our stockholders.***

 

We have weentered into a CEFF with an institutional investor that entitles us to sell andobligates the investor to purchase, from time to time over a period of up to36 months which commenced in December 2006, shares of our commonstock at a discount of up to 10% for cash consideration up to an aggregate of$50.0 million, or 6,046,701 shares, of common stock, subject to specifiedconditions and restrictions. The investor will not be obligated to purchaseshares under the CEFF unless specified conditions are met, which include aminimum price for our common stock; a minimum amount of our marketcapitalization, the accuracy of representations and warranties made to theinvestor; compliance with laws; and the effectiveness of a registrationstatement registering for resale the shares of common stock to be issued inconnection with the CEFF. In addition, among other termination rights, theinvestor is permitted to terminate the CEFF by providing written notice to uswithin 10 business days after it obtains actual knowledge that an event hasoccurred resulting in a material and adverse effect on our business,operations, properties or financial condition (subject to specified exceptions,including conditions or events that are reasonably expected to occur in theordinary course of our business). If we are unable to access funds through theCEFF, or if the investor terminates the CEFF, we may be unable to accesscapital on favorable terms, or at all.

 

We areentitled, in certain circumstances, to deliver a “blackout” notice to theinvestor to suspend the use of the prospectus covering the shares of commonstock issued in connection with the CEFF and prohibit the investor from sellingshares under that prospectus for a certain period of time. If we deliver ablackout notice in the 15 trading days following the settlement of a draw down,or if the registration statement covering the resale of the shares of commonstock to be issued in connection with the CEFF is not effective incircumstances not permitted by our registration rights agreement with theinvestor, then we must make a payment to the investor, or issue the investoradditional shares in lieu of this payment, calculated on the basis of aspecified number of shares held by the investor immediately prior to theblackout period and the change in the market price of our common stock duringthe period in which the use of the resale registration statement is suspended.If the trading price of our common stock declines during a suspension of theresale registration statement, the blackout or other payment could besignificant.

 

Should we sellshares to the investor under the CEFF, or issue shares in lieu of a blackoutpayment, it will have a dilutive effect on the holdings of our currentstockholders.

 

**Risks Related to our Intellectual Property**

 

***Our success depends upon our ability toprotect our intellectual property, including the proprietary technologies andcompounds used in our business.***

 

Our commercialsuccess depends on obtaining and maintaining patent protection and/or tradesecret protection of our product candidates, proprietary technologies and theiruses, as well as successfully defending any patents that issue againstthird-party challenges. We may only be able to protect our product candidates,proprietary technologies and their uses from unauthorized use by third partiesto the extent that valid and enforceable patents or trade secrets cover them.

 

The filing,prosecution and defense of patents at pharmaceutical and biotechnologycompanies can be highly uncertain and involve complex legal and factualquestions for which important legal principles remain unresolved. No consistentpolicy regarding the breadth of claims allowed in biotechnology patents hasemerged to date in the U.S. The biotechnology patent situation outside the U.S.is even more uncertain. We may be particularly affected by this because weexpect that pradefovir and MB07133, if approved, will be marketed in foreigncountries with high incidences of HBV and primary liver cancer, respectively. Decisionsor actions regarding patent filing and/or changes in either the patent laws orin interpretations of patent laws in the U.S. and other countries may diminishthe value of our intellectual property.

 

Decisions oractions regarding patent filing are complex and we may not be successful inprotecting our products from competition. Patent positions for products arehighly uncertain and involve complex legal and factual questions which mayultimately be decided to the detriment of our products’ competitive positions’in the U.S. and these other countries. We may not be able to develop patentableproducts or processes in the U.S. and these other countries, and may not beable to obtain patents from pending applications. Even if patent claims areallowed in the U.S. and these other countries, the claims may not issue, or inthe event of issuance, may not be sufficient to protect the technology owned byor licensed to us. Any patents or patent rights that we obtain in the U.S. andother countries may be circumvented, challenged or invalidated by ourcompetitors. In addition, we are dependent on outside patent firms for adviceand action regarding our efforts to secure patents. Should these firms fail totake appropriate action to secure or enforce our patents in a timely manner, orshould they 

 

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provide uswith incorrect or inappropriate advice it could be detrimental to our patentpositions.

 

Accordingly,we cannot predict the breadth of claims that may be allowed or enforced in ourpatents or in third-party patents in the U.S. and other countries.

 

The degree offuture protection for our proprietary rights is uncertain because legal meansafford only limited protection and may not adequately protect our rights orpermit us to gain or keep our competitive advantage. For example:

 

·                  wemight not have been the first to make the inventions covered by each of ourpending patent applications and issued patents,

 

·                  wemight not have been the first to file patent applications for these inventions,

 

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

 

·                  itis possible that none of our pending patent applications will result in issuedpatents,

 

·                  ourissued patents may not provide a basis for commercially viable products, maynot provide us with any competitive advantages, or may be challenged by thirdparties,

 

·                  ourissued patents may not be valid or enforceable,

 

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

 

·                  thepatents of others may have an adverse effect on our business.

 

Proprietarytrade secrets and unpatented know-how are also very important to our business.Although we have taken steps to protect our trade secrets and unpatentedknow-how, including entering into proprietary information and inventionsagreements with our employees and consultants and entering into confidentialityagreements with other third parties to whom we disclose our proprietaryinformation, third parties may still obtain this information without ourknowledge and consent. Enforcing a claim that a third party illegally obtainedand is using our trade secrets or unpatented know-how is expensive and timeconsuming, and the outcome is unpredictable. In addition, courts outside theU.S. may be less willing to protect this information. Moreover, our competitorsmay independently develop equivalent knowledge, methods and know-how.

 

***If we are sued for infringing intellectualproperty rights of third parties, it will be costly and time consuming, and anunfavorable outcome in that litigation would have a material adverse effect onour business.***

 

Our commercialsuccess depends upon our ability and the ability of our collaborators todevelop, manufacture, market and sell our product candidates and use ourproprietary technologies without infringing the proprietary rights of thirdparties. Numerous U.S. and foreign issued patents and pending patentapplications, which are owned by third parties, exist in the fields in which weand our collaborators are developing products. Because patent applications cantake many years to issue, there may be currently pending applications, unknownto us, which may later result in issued patents that our product candidates orproprietary technologies may infringe. We have not conducted a complete searchof existing patents to identify existing patents that our product candidates orproprietary technologies may inadvertently infringe.

 

We may beexposed to future litigation by the companies holding these patents or otherthird parties based on claims that our product candidates and/or proprietarytechnologies infringe their intellectual property rights. If one of thesepatents was found to cover our product candidates, proprietary technologies ortheir uses, we or our collaborators could be required to pay damages and couldbe unable to commercialize our product candidates or use our proprietarytechnologies unless we or they obtained a license to the patent. In addition,while we are not currently subject to pending litigation nor are we aware ofany threatened litigation, third parties may contact us or our collaborators inthe ordinary course of business to bring certain patents to our attention. Weand our collaborators evaluate all such communications on a case-by-case basisto assess 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.

 

There is asubstantial amount of litigation involving patent and other intellectualproperty rights in the biotechnology and biopharmaceutical industriesgenerally. If a third party claims that we or our collaborators infringe on itstechnology, we 

 

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may face anumber of issues, including:

 

·                  infringementand other intellectual property claims which, with or without merit, may beexpensive and time-consuming to litigate and may divert our management’sattention from our core business,

 

·                  substantialdamages for infringement, including treble damages and attorneys’ fees, as wellas damages for products developed using allegedly infringing drug discoverytools or methods, which we may have to pay if a court decides that the productor proprietary technology at issue infringes on or violates the third party’srights,

 

·                  acourt prohibiting us from selling or licensing the product or using theproprietary technology unless the third party licenses its technology to us,which it is not required to do,

 

·                  ifa license is available from the third party, we may have to pay substantialroyalties, fees and/or grant cross licenses to our technology, and

 

·                  redesigningour products or processes so they do not infringe, which may not be possible ormay require substantial funds and time.

 

We haveconducted searches of U.S. and foreign patents, but cannot guarantee that thesearches were comprehensive and therefore whether any of our product candidatesor the methods of using, making or identifying our product candidates infringethe patents 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 applicationscovering adefovir or prodrugs of adefovir in the U.S. and foreign countries mayprevent the commercialization of pradefovir in the future.***

 

Our productcandidate pradefovir is a prodrug of adefovir. A third party, Gilead, hasrights to another product called Hepsera that is a non-liver specific prodrugof adefovir. 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 withenvironmental laws and regulations.***

 

We usehazardous materials, including chemicals, biological agents and radioactiveisotopes and compounds that could be dangerous to human health and safety orthe environment. As appropriate, we store these materials and wastes resultingfrom their use at our facility pending their ultimate use or disposal. Wecurrently contract with a third party to dispose of these materials and wastes.We are subject to a variety of federal, state and local laws and regulationsgoverning the use, generation, manufacture, storage, handling and disposal ofthese materials and wastes. We may also incur significant costs complying withenvironmental laws and regulations adopted in the future.

 

***We may incur substantial liabilities from anyproduct liability claims if our insurance coverage for those claims is inadequate.***

 

We face aninherent risk of product liability exposure related to the testing of ourproduct candidates in human clinical trials, and will face an even greater riskif we sell our product candidates commercially. An individual may bring aliability claim against us if one of our product candidates causes, or merelyappears to have caused, an injury. If we cannot successfully defend ourselvesagainst the product liability claim, we will incur substantial liabilities.Regardless of merit or eventual outcome, liability claims may result in:

 

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·                  decreaseddemand for our product candidates,

 

·                  injuryto our reputation,

 

·                  withdrawalof clinical trial participants,

 

·                  costsof related litigation,

 

·                  substantialmonetary awards to patients or other claimants,

 

·                  lossof revenues, and

 

·                  theinability to commercialize our product candidates.

 

We haveproduct liability insurance that covers our clinical trials, up to an annualaggregate limit of $10 million. We intend to expand our insurance coverageto include the sale of commercial products if marketing approval is obtainedfor any of our product candidates. However, insurance coverage is increasinglyexpensive. We may not be able to maintain insurance coverage at a reasonablecost and we may not be able to obtain insurance coverage that will be adequateto satisfy any liability that may arise.

 

***If we use biological and hazardous materialsin a manner that causes injury, we may be liable for damages.***

 

Our researchand development and manufacturing activities involve the use of biological andhazardous materials. Although we believe our safety procedures for handling anddisposing of these materials comply with federal, state and local laws andregulations, we cannot entirely eliminate the risk of accidental injury orcontamination from the use, storage, handling or disposal of these materials.If one of our employees was accidentally injured from the use, storage,handling or disposal of these materials, the medical costs related to his orher treatment would be covered by our workers’ compensation insurance policy.While our property and casualty and general liability insurance policiesspecifically exclude coverage for damages and fines arising from biological orhazardous waste exposure or contamination, we do carry separate pollution legalliability coverage that is intended to cover third party claims for bodilyinjury, property damage and remediation costs. However, in the event ofcontamination or injury, we could be held liable for damages or penalized withfines in an amount exceeding our insurance and/or resources.

 

**Risks Related to the Securities Markets andInvestment in our Common Stock**

 

***Market volatility may affect our stock priceand the value of your investment.***

 

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

 

·                  changesin the regulatory status of our product candidates, including the status andresults of our development activities,

 

·                  establishmentof new collaborative arrangements,

 

·                  eventsaffecting Merck, Idenix, Roche or any future collaborators,

 

·                  announcementsof new products or technologies, commercial relationships or other events by usor our competitors,

 

·                  regulatorydevelopments in the U.S. and foreign countries,

 

·                  fluctuationsin stock market prices and trading volumes of similar companies,

 

·                  variationsin our quarterly operating results,

 

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·                  changesin securities analysts’ estimates of our financial performance,

 

·                  changesin accounting principles,

 

·                  issuancesof new equity securities by us, pursuant to our effective shelf registrationstatements or otherwise,

 

·                  salesof large blocks of our common stock, including sales by our executive officers,directors and significant stockholders,

 

·                  additionsor departures of key personnel, and

 

·                  discussionof us or our stock price by the financial and scientific press and in onlineinvestor communities.

 

***Anti-takeover provisions in our charterdocuments and under Delaware law could make an acquisition of us, which may bebeneficial to our stockholders, more difficult and may prevent attempts by ourstockholders to replace or remove our current management.***

 

Provisions inour amended and restated certificate of incorporation and bylaws may delay orprevent an acquisition of us or a change in our management. These provisionsinclude a classified board of directors, a prohibition on actions by writtenconsent of our stockholders, and the ability of our board of directors to issuepreferred stock without stockholder approval. In addition, because we areincorporated in Delaware, we are governed by the provisions of Section 203of the Delaware General Corporation Law, which prohibits stockholders owning inexcess of 15% of our outstanding voting stock from merging or combining withus. Although we believe these provisions collectively provide for anopportunity to receive higher bids by requiring potential acquirers tonegotiate with our board of directors, they would apply even if the offer maybe considered beneficial by some stockholders. In addition, these provisionsmay frustrate or prevent any attempts by our stockholders to replace or removeour current management by making it more difficult for stockholders to replacemembers of our board of directors, which is responsible for appointing themembers of our management.

 

***We incur costs associated with regulatorycompliance, and these costs could be significant.***

 

There arenumerous regulatory requirements for public companies, including the provisionsof the Sarbanes-Oxley Act of 2002 and rules adopted or proposed by theSecurities and 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 policy limitsand coverage or incur substantially higher costs to obtain the same or similarcoverage. The impact of these events could also make it more difficult for usto attract and retain qualified persons to serve on our board of directors, ourboard committees or as executive officers. We are presently evaluating andmonitoring developments with respect to these laws and regulations and cannotpredict or estimate the amount or timing of additional costs we may incur torespond to their requirements. Compliance with these rules could alsoresult in continued diversion of management’s time and attention, which couldbe disruptive to normal business operations. If we do not satisfactorily ortimely 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.

 

***If our executive officers, directors andlargest stockholders choose to act together, they may be able to control ouroperations and act in a manner that advances their best interests and notnecessarily those of other stockholders.***

 

Our executiveofficers, directors and holders of 5% or more of our outstanding common stock,beneficially owned approximately 76% of our common stock as of June 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 advances their best interests and not necessarilythose of other stockholders.

 

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

 

A largeportion of our shares are held by a small number of persons and investmentfunds. In addition, these persons and funds hold warrants to purchase 2,833,338shares of common stock that, if exercised, will result in these additionalshares becoming available for sale. Moreover, several of our stockholders andwarrant holders have rights, subject to some conditions, to require us to fileregistration statements covering the unregistered shares they currently hold ormay acquire upon exercise of warrants, or to include these shares inregistration statements 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. 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 ofSecurity Holders**

 

We held our 2008 Annual Meeting of Stockholders on June 10,2008.  As of the close of business on April 16, 2008, the record datefor the Annual Meeting, there were 34,930,843 shares of our common stockentitled to vote, of which there were 28,935,112 shares present at the AnnualMeeting in person or by proxy. At the Annual Meeting, our stockholders approvedthe following matters:

 

*Proposal 1.*    Electionof two directors to serve as Class I directors until our 2011 AnnualMeeting of Stockholders.  The vote for the nominees for Class Idirector was as follows:

 

Daniel D. Burgess, M.B.A. – 28,357,613 shares were voted in favor ofthe nominee; 577,499 shares withheld their vote.

 

Luke B. Evnin, Ph.D. – 28,359,613 shares were voted in favor of thenominee; 575,499 shares withheld their vote.

 

Our Class II directors, Mark D. Erion, Ph.D., Arnold L. Oronsky,Ph.D. William R. Rohn and Elizabeth Stoner, M.D., continue in office until our2009 Annual Meeting of Stockholders.  OurClass III directors, David F. Hale, Paul K. Laikind, Ph.D., and George F.Schreiner, M.D., Ph.D., continue in office until our 2010 Annual Meeting ofStockholders.

 

*Proposal 2.*    Ratification of the selection by the Audit Committee of our Board of Directorsof Ernst & Young LLP as our independent registered publicaccounting firm for the fiscal year ending December 31, 2008. 28,926,011 shares voted in favor of the proposal; 9,101 shares votedagainst the proposal; and no shares abstained from voting.

 

**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.                                                                                                                                            |
|                      |       |                                                                                                                                                                              |
| 4.2(3)                    |       | Form of Warrant Exercise Agreement, dated April 14, 2008,  by and among the Company and the individuals and entities identified on the  signature page thereto.    |
|                      |       |                                                                                                                                                                              |
| 4.3(3)                    |       | Form of Securities Purchase Agreement, dated April 14,  2008, by and among the Company and the individuals and entities identified on  the signature page thereto. |
|                      |       |                                                                                                                                                                              |
| 4.4(3)                    |       | Form of Registration Rights Agreement, dated April 14,  2008, by and among the Company and the individuals and entities identified on  the signature page thereto. |
|                      |       |                                                                                                                                                                              |
| 4.5(3)                    |       | Form of Warrant issued pursuant to the Securities Purchase  Agreement.                                                                                                       |
|                      |       |                                                                                                                                                                              |
| 10.1(3)                   |       | 2008 Employee Incentive Compensation Plan.                                                                                                                                        |
|                      |       |                                                                                                                                                                              |
| 10.2(4)                   |       | Collaboration Agreement Extension Letter dated April 16, 2008  between the Company and Merck & Co., Inc.                                                       |
|                      |       |                                                                                                                                                                              |
| 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.                                                                |
|   |   |                                                                                                                                                                                                |
| (3)    |   | Incorporated by  reference to the Company’s Current Report on Form 8-K filed on  April 22, 2008.                                                                                     |
|   |   |                                                                                                                                                                                                |
| (4)    |   | Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the quarter  ended March 31, 2008.                                                                     |

 

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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: August 8, 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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