** **

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549**

** **

**FORM 10-Q**

 

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

 

**For thequarterly period ended March 31, 2008.**

 

**OR**

 

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

 

**For thetransition periodfrom                 to                 .**

 

**Commission file number 000-50785**

 

**METABASIS THERAPEUTICS, INC.******(Exact name ofregistrant as specified 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  x         |   |
|------------------------------------------------|--------|-------------------------------------------------|-----------------------------------------|--------|
|                                           |   |                                            |                                    |   |
|                                           |   |   Non-accelerated  filer  o | Smaller  reporting company  o |   |
| (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 April 29, 2008 was 34,930,843

 

 

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**METABASIS THERAPEUTICS, INC.**

 

**FORM 10-QFOR THE QUARTERLY PERIOD ENDED March 31, 2008**

 

**TABLE OF CONTENTS**

 
| PART I—FINANCIAL  INFORMATION                                                             | 3      |
|-----------------------------------------------------------------------------------------------------|--------|
|                                                                                                |   |
| Item 1.  Financial Statements                                                                       | 3      |
|                                                                                                |   |
| Balance Sheets at March 31, 2008  (Unaudited) and December 31, 2007                       | 3      |
|                                                                                                |   |
| Statements of Operations for the three  months ended March 31, 2008 and 2007 (Unaudited)       | 4      |
|                                                                                                |   |
| Statements of Cash Flows for the three  months ended March 31, 2008 and 2007 (Unaudited)       | 5      |
|                                                                                                |   |
| Notes to Financial Statements (Unaudited)                                                           | 6      |
|                                                                                                |   |
| Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations | 11     |
|                                                                                                |   |
| 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                                | 41     |
|                                                                                                |   |
| Item 3. Defaults Upon Senior Securities                                                             | 41     |
|                                                                                                |   |
| Item 4. Submission of Matters to a Vote of Security  Holders                                        | 42     |
|                                                                                                |   |
| Item  5. Other Information                                                                          | 42     |
|                                                                                                |   |
| Item 6.  Exhibits                                                                                   | 42     |
|                                                                                                |   |
| SIGNATURES                                                                                          | 43     |

 

2

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**PART I - FINANCIAL INFORMATION**

 

**Item 1.Financial Statements**

 

**MetabasisTherapeutics, Inc.**

**Balance Sheets**

**(Inthousands, except par value data)**

 
| ** **                                                                                                                                                                                                                      | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                      | ** ** | **2008**           | ** ** | **2007**              | ** ** |
| ** **                                                                                                                                                                                                                      | ** ** | **(Unaudited)**    | ** ** | ** **            | ** ** |
| **Assets**                                                                                                                                                                                                                      |       |               |       |                  |       |
| Current assets:                                                                                                                                                                                                                 |       |               |       |                  |       |
| Cash and cash  equivalents                                                                                                                                                                                                      |       | $                  | 20,141     |                  | $          | 14,141 |   |
| Securities  available-for-sale                                                                                                                                                                                                  |       | 16,226             |       | 28,297                |       |
| Trade accounts  receivable                                                                                                                                                                                                      |       | —             |       | 61                    |       |
| Prepaids and  other current assets                                                                                                                                                                                              |       | 1,174              |       | 1,096                 |       |
| Total current  assets                                                                                                                                                                                                           |       | 37,541             |       | 43,595                |       |
|                                                                                                                                                                                                                            |       |               |       |                  |       |
| Property and  equipment, net                                                                                                                                                                                                    |       | 6,088              |       | 6,356                 |       |
| Other assets                                                                                                                                                                                                                    |       | 389                |       | 172                   |       |
| Total assets                                                                                                                                                                                                                    |       | $                  | 44,018     |                  | $          | 50,123 |   |
|                                                                                                                                                                                                                            |       |               |       |                  |       |
| **Liabilities  and stockholders’ equity**                                                                                                                                                                                  |       |               |       |                  |       |
| Current  liabilities:                                                                                                                                                                                                           |       |               |       |                  |       |
| Accounts payable                                                                                                                                                                                                                |       | $                  | 325        |                  | $          | 802 |   |
| Accrued  compensation                                                                                                                                                                                                           |       | 3,899              |       | 3,181                 |       |
| Accrued  liabilities                                                                                                                                                                                                            |       | 3,557              |       | 4,132                 |       |
| Deferred  revenue, current portion                                                                                                                                                                                              |       | 853                |       | 1,321                 |       |
| Current portion  of long-term debt                                                                                                                                                                                              |       | 2,798              |       | 2,068                 |       |
| Current portion  of capital lease obligations                                                                                                                                                                                   |       | 24                 |       | 23                    |       |
| Total current  liabilities                                                                                                                                                                                                      |       | 11,456             |       | 11,527                |       |
|                                                                                                                                                                                                                            |       |               |       |                  |       |
| Deferred rent                                                                                                                                                                                                                   |       | 2,728              |       | 2,595                 |       |
| Long-term debt                                                                                                                                                                                                                  |       | 7,591              |       | 3,845                 |       |
| Capital lease  obligations, net of current portion                                                                                                                                                                              |       | 49                 |       | 55                    |       |
| Other long-term  liabilities                                                                                                                                                                                                    |       | 200                |       | —                |       |
| Total  liabilities                                                                                                                                                                                                              |       | 22,024             |       | 18,022                |       |
|                                                                                                                                                                                                                            |       |               |       |                  |       |
| Stockholders’  equity:                                                                                                                                                                                                     |       |               |       |                  |       |
| Preferred stock,  $0.001 par value; 5,000 shares authorized at March 31, 2008 and  December 31, 2007, no shares issued or outstanding                                                                                 |       | —             |       | —                |       |
| Common stock,  $0.001 par value; 100,000 shares authorized at March 31, 2008 and  December 31, 2007; 30,759 and 30,754 shares issued and outstanding at  March 31, 2008 and December 31, 2007, respectively |       | 31                 |       | 31                    |       |
| Additional  paid-in capital                                                                                                                                                                                                     |       | 182,993            |       | 182,003               |       |
| Accumulated deficit                                                                                                                                                                                                             |       | (161,112           | )          | (150,012              | )          |
| Accumulated  other comprehensive loss                                                                                                                                                                                           |       | 82                 |       | 79                    |       |
| Total  stockholders’ equity                                                                                                                                                                                                |       | 21,994             |       | 32,101                |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                                                |       | $                  | 44,018     |                  | $          | 50,123 |   |

 

*See accompanying notes.*

 

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**Metabasis Therapeutics, Inc.**

**Statements of Operations**

**(In thousands, except per share data)**

**(Unaudited)**

 
| ** **                                                   | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                   | ** ** | **March 31,**               | ** ** |
| ** **                                                   | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Revenues:                                                    |       |                             |       |   |   |
| Sponsored  research                                          |       | $                                | 525        |   | $ | 938 |   |
| License fees                                                 |       | 417                              |       | 2,467 |   |
| Other revenue                                                |       | —                           |       | 21 |   |
| Total revenues                                               |       | 942                              |       | 3,426 |   |
|                                                         |       |                             |       |   |   |
| Operating  expenses:                                         |       |                             |       |   |   |
| Research and  development                                    |       | 9,745                            |       | 9,506 |   |
| General and  administrative                                  |       | 2,519                            |       | 3,264 |   |
| Total operating  expenses                                    |       | 12,264                           |       | 12,770 |   |
|                                                         |       |                             |       |   |   |
| Loss from  operations                                        |       | (11,322                          | )          | (9,344 | ) |
| Other income  (expense):                                     |       |                             |       |   |   |
| Interest income                                              |       | 398                              |       | 972 |   |
| Interest expense                                             |       | (176                             | )          | (133 | ) |
| Total other  income                                          |       | 222                              |       | 839 |   |
|                                                         |       |                             |       |   |   |
| Net loss                                                     |       | $                                | (11,100    | ) | $ | (8,505 | ) |
|                                                         |       |                             |       |   |   |
| Basic and  diluted net loss per share                        |       | $                                | (0.36      | ) | $ | (0.28 | ) |
| Shares used to  compute basic and diluted net loss per share |       | 30,758                           |       | 30,458 |   |

 

*See accompanying notes.*

 

4

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**Metabasis Therapeutics, Inc.**

**Statements of Cash Flows**

**(In thousands)**

**(Unaudited)**

 
| ** **                                                                   | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                   | ** ** | **March 31,**               | ** ** |
| ** **                                                                   | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| **Operating  activities**                                                    |       |                             |       |   |   |
| Net loss                                                                     |       | $                                | (11,100    | ) | $ | (8,505 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |                             |       |   |   |
| Stock-based  compensation                                                    |       | 983                              |       | 1,250 |   |
| Depreciation and  amortization                                               |       | 528                              |       | 485 |   |
| Deferred rent                                                                |       | 133                              |       | 282 |   |
| Amortization of  discount and premium on securities available-for-sale       |       | (199                             | )          | (683 | ) |
| Realized gain on  securities available-for-sale                              |       | (7                               | )          | — |   |
| Change in  operating assets and liabilities:                                 |       |                             |       |   |   |
| Trade accounts  receivable                                                   |       | 61                               |       | (325 | ) |
| Other current  assets                                                        |       | (78                              | )          | (224 | ) |
| Other assets                                                                 |       | (7                               | )          | 2 |   |
| Deferred revenue                                                             |       | (468                             | )          | (667 | ) |
| Accounts payable                                                             |       | (477                             | )          | (333 | ) |
| Accrued  compensation and other liabilities                                  |       | 133                              |       | 2,276 |   |
| Net cash flows  used in operating activities                                 |       | (10,498                          | )          | (6,442 | ) |
|                                                                         |       |                             |       |   |   |
| **Investing  activities**                                                    |       |                             |       |   |   |
| Purchases of  securities available-for-sale                                  |       | (2,213                           | )          | (23,902 | ) |
| Sales/maturities  of securities available-for-sale                           |       | 14,493                           |       | 38,908 |   |
| Purchases of  property and equipment                                         |       | (260                             | )          | (476 | ) |
| Net cash flows  provided by investing activities                             |       | 12,020                           |       | 14,530 |   |
|                                                                         |       |                             |       |   |   |
| **Financing  activities**                                                    |       |                             |       |   |   |
| Issuance of  common stock, net                                               |       | 7                                |       | 29 |   |
| Principal  payments on debt and capital lease obligations                    |       | (529                             | )          | (448 | ) |
| Proceeds  received from debt                                                 |       | 5,000                            |       | — |   |
| Net cash flows  provided by (used in) financing activities                   |       | 4,478                            |       | (419 | ) |
| Increase in cash  and cash equivalents                                       |       | 6,000                            |       | 7,669 |   |
| Cash and cash  equivalents at beginning of year                              |       | 14,141                           |       | 12,052 |   |
| Cash and cash  equivalents at end of period                                  |       | $                                | 20,141     |   | $ | 19,721 |   |
|                                                                         |       |                             |       |   |   |
| **Supplemental  schedule of noncash investing and financing activities:**    |       |                             |       |   |   |
| Unrealized gain  (loss) on securities available-for-sale                     |       | $                                | 3          |   | $ | (5 | ) |
| Fair value of  warrants related to loan and security agreement               |       | $                                | 220        |   | $ | — |   |
| Accrued debt  issuance costs                                                 |       | $                                | 210        |   | $ | — |   |

 

*See accompanying notes.*

 

5

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**Metabasis Therapeutics, Inc.**

**Notes to Financial Statements**

**(Unaudited)**

 

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

 

Theaccompanying unaudited financial statements have been prepared in accordancewith U.S. generally accepted accounting principles (“GAAP”) and with the rules andregulations of the Securities and Exchange Commission (“SEC”) related to aquarterly report on Form 10-Q. Accordingly, they do not include all of theinformation and disclosures required by GAAP for complete financial statements.The balance sheet at December 31, 2007 has been derived from the auditedfinancial statements at that date but does not include all information andfootnotes required by GAAP for complete financial statements. The interimfinancial statements reflect all adjustments which, in the opinion ofmanagement, are necessary for a fair presentation of the financial conditionand results of operations for the periods presented. Except as otherwisedisclosed, all such adjustments are of a normal recurring nature.

 

Operatingresults for the three months ended March 31, 2008 are not necessarilyindicative of the results that may be expected for the year ending December 31,2008. For further information, see the financial statements and notes theretofor the year ended December 31, 2007 included in our annual report on Form 10-Kfiled with the SEC.

 

Thepreparation of financial statements in conformity with GAAP requires managementto make estimates and assumptions that affect the reported amounts of assetsand liabilities as well as disclosures of contingent assets and liabilities atthe date of the financial statements. Estimates also affect the reportedamounts of revenues and expenses during the reporting period. Actual resultscould differ from those estimates.

 

Theterms “Company” and “we” and “our” are used in this report to refer toMetabasis Therapeutics, Inc.

 

**2.****                                     ****Comprehensive Loss**

 

Statementof Accounting Financial Standard (“SFAS”) No. 130, *ReportingComprehensive Income*, requires that all components of comprehensiveincome (loss), including net loss, be reported in the financial statements inthe period in which they are recognized. Comprehensive income (loss) is definedas the change in equity during a period from transactions and other events andcircumstances from non-owner sources. The Company’s comprehensive income (loss)is as follows (in thousands):

 
| ** **                                                | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                | ** ** | **March 31,**               | ** ** |
| ** **                                                | ** ** | **2008**                         | ** ** | **2007** | ** ** |
|                                                      |       |                             |       |   |   |
| Net loss                                                  |       | $                                | (11,100    | ) | $ | (8,505 | ) |
| Unrealized gain  (loss) on available-for-sale investments |       | 3                                |       | (5 | ) |
| Comprehensive  loss                                       |       | $                                | (11,097    | ) | $ | (8,510 | ) |

 

**3.****                                     ****Net Loss Per Share**

 

The Company calculatesnet loss per share in accordance with SFAS No. 128, *Earnings PerShare*. Basic earnings per share (“EPS”) is calculated by dividingthe net loss by the weighted average number of common shares outstanding forthe period, without consideration for common stock equivalents. Diluted EPS iscomputed by dividing the net loss by the weighted average number of commonshare equivalents outstanding for the period determined using thetreasury-stock method. For purposes of this calculation, common stock subjectto repurchase by the Company, options and warrants are considered to be commonstock equivalents and are only included in the calculation of diluted EPS whentheir effect is dilutive. The total number of shares issuable upon exercise of stock options andwarrants excluded from the calculation of diluted EPS since they areanti-dilutive were 7,143,311 and 6,050,849 for the three months ended March 31,2008 and 2007, respectively.

 

6

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| ** **                                                     | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                     | ** ** | **March 31,**               | ** ** |
| ** **                                                     | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| **Actual:**                                                    |       |                             |       |   |   |
| *Numerator:*                                                   |       |                             |       |   |   |
| Net loss                                                       |       | $                                | (11,100    | ) | $ | (8,505 | ) |
| *Denominator:*                                                 |       |                             |       |   |   |
| Weighted average  common shares                                |       | 30,758                           |       | 30,506 |   |
| Weighted average  unvested common shares subject to repurchase |       | —                           |       | (48 | ) |
| Denominator for  basic and diluted net loss per share          |       | 30,758                           |       | 30,458 |   |
| Basic and  diluted net loss per share                          |       | $                                | (0.36      | ) | $ | (0.28 | ) |

 

**4.****                                     ****Loanand Security Agreement**

 

In March 2008,the Company entered into a Loan and Security Agreement (“Agreement”) withOxford Corporation (“Oxford”), pursuant to which Oxford provided the Companywith a three-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.  The Company has the option to prepay theoutstanding balance of the term loan in full, subject to a prepayment fee.  The loan is collateralized by the generalassets of the Company, excluding intellectual property and assets of certainsubsidiaries.  There are no financialcovenants under the terms of this Agreement.

 

In connection with theAgreement, the Company issued to Oxford a warrant to purchase up to 154,639shares of the Company’s common stock at an exercise price of $1.94 per share,which represents the closing price of the Company’s common stock on the date ofthe Agreement.  The warrant isimmediately exercisable and expires in March 2018.  The warrant holder may elect to exercise thewarrant by physical settlement or net-share settlement.  In accordance with EITF Issue No. 00-19,*Accounting for Derivative Financial InstrumentsIndexed to and Potentially Settled in a Company’s Own Stock*, thewarrant met all criteria within the guidance providing for the classificationof this financial instrument as equity. The fair value of this warrant,totaling $220,000 at March 14, 2008, was determined using theBlack-Scholes model with the following assumptions: risk free interest rate of 3.05%, dividend yield of 0%, expectedvolatility of 81.63%, and an expected term of 5 years.

 

**5.****                                     ****Fair Value of FinancialInstruments**

 

In September 2006,the Financial Accounting Standards Board (the “FASB”) issued SFAS No. 157,*Fair Value Measurements* (“SFAS No. 157”). Thisstatement provides a definition of fair value, establishes a hierarchy formeasuring fair value in generally accepted accounting principles, and requirescertain disclosures about fair values used in financial statements.  This statement does not extend the use offair value beyond what is currently required by other pronouncements, and itdoes not pertain to stock-based compensation under SFAS 123(R), *Share-Based Payment,* or to leases under SFAS No. 13, *Accounting for Leases.*

 

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

 

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

 

The Company applies fairvalue accounting to its securities available-for-sale in accordance with SFAS No. 115,*Accounting for Certain Investments in Debt andEquity Securities* (“SFAS No. 115”)*. *These securities consist oftreasury backed money market funds, corporate bonds, commercial paper, andcredit card asset backed securities.  Thefollowing table

 

7

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shows the fair valuemeasurement for this financial asset at March 31, 2008 and the fair valuehierarchy 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 |       | $                                     | 32,943     |   | $ | 29,441 |   | $ | 3,502 |   | $ | — |   |
|                                |            |                                       |            |  |  |  |  |  |  |  |  |  |  |

 

Asset classes that fallwithin the Level 1 fair value hierarchy are those assets whose fair valueassumptions are based on market data obtained from sources independent of theCompany (observable inputs).  Level 1observable inputs are quoted prices for identical items in active markets thatthe Company has access to at the measurement date.

 

Asset classes that fallwithin the Level 2 fair value hierarchy are those assets whose fair valueassumptions are also based on independent market data.  Level 2 observable inputs are quoted pricesfor similar items in active markets or quoted prices for identical or similaritems in inactive markets.  An inactivemarket is one where there are few transactions, the prices are not current,price quotations vary substantially over time or among market makers, or wherelittle information is released publicly.

 

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

 

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 andlosses and declines in value judged to be other-than-temporary, if any, onavailable-for-sale securities are included in other income. The cost ofsecurities sold is based on the specific-identification method. Interest anddividends on securities classified as available-for-sale are included ininterest income.  Total realized gainsfrom fair value changes included in earnings for the three months ended March 31,2008 were approximately $7,000.  Therewere no cumulative adjustments to beginning retained earnings as a result ofadopting SFAS No. 159.

 

8

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

 

In June 2007,the EITF issued EITF Issue No. 07-3, *Accountingfor Nonrefundable Advance Payments for Goods or Services to be Used in FutureResearch and Development Activities*. The consensus requirescompanies to defer and capitalize prepaid, nonrefundable research anddevelopment payments to third parties over the period that the research anddevelopment activities are performed or the services are provided, subject toan assessment of recoverability. EITF Issue No. 07-3 is effective for newcontracts entered into in fiscal years beginning after December 15, 2007,including interim periods within those fiscal years. The adoption of EITF IssueNo. 07-3 did not have a material impact on the Company’s financialstatements.

 

In November 2007,the EITF issued EITF Issue No. 07-1, *Accountingfor Collaborative Arrangements Related to the Development and Commercializationof Intellectual 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 applied accountingpolicy election. EITF Issue No. 07-1 is effective for collaborativearrangements already in place at the beginning of the annual period beginningafter December 15, 2008 (beginning with our 2009 fiscal year), andretrospective application of this Issue to all prior periods presented shouldbe reported as a change in accounting principle. The Company is in the processof determining the effect, if any, the adoption of EITF Issue No. 07-1will have on its financial statements.

 

**7.****                                      SubsequentEvents**

 

*WarrantExchange and Concurrent Private Placement*

 

In April 2008, theCompany entered into a warrant exchange and concurrent private placement(together, the “Transaction”), which raised $9.9 million in cash.  The investors in the Transaction were certaincurrent investors who held existing warrants for the purchase of the Company’scommon stock issued previously in its October 2001 and October 2005private placements.

 

In connection with theTransaction, the Company entered into a warrant exercise agreement (the “WarrantExercise Agreement”) pursuant to which the Company reduced the exercise pricesof the investors’ warrants to purchase the Company’s common stock acquired inits October 2001 and October 2005 private placements to an exerciseprice of $2.34 per share, in exchange for an irrevocable commitment by theinvestors to exercise such warrants at the closing.  As a result of the Warrant ExerciseAgreement, warrants for the purchase of 127,557 shares of the Company’s commonstock with a prior exercise price of $8.70 per share and warrants for thepurchase 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, inconnection with the Transaction, the Company entered into a securities purchaseagreement (the “Securities Purchase Agreement”) pursuant to which the Companyissued and sold to the investors 2,485,103 shares of its common stock at anexercise price of $2.34 per share, and warrants to purchase up to 1,057,196 sharesof its common stock at an exercise price of $2.69 per share (the “Warrants”).  At the closing, the investors paid anadditional purchase price for the Warrants equal to $0.125 per whole shareissuable upon exercise of the Warrants. In connection with the Securities Purchase Agreement, the Company alsoentered into a registration rights agreement (the “Registration RightsAgreement”) pursuant to which the Company granted to the investors certainregistration rights relating to the securities issued and sold in theSecurities Purchase Agreement.

 

Certain of the Company’sexisting stockholders, including entities affiliated with MPM Capital, HaleBioPharma Ventures and InterWest Partners, invested in the Transaction. Certain of such investors and/or their affiliates are parties to the Company’samended 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 the Company’s board of directors, are associated with MPM Capital,Hale BioPharma Ventures and InterWest Partners, respectively.

 

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*MerckAMPK Collaboration Extension*

 

In April 2008, the Company extendedthe research term of its AMPK collaboration with Merck & Co., Inc.(“Merck”) for an additional year, through June 2009.  Under the extension, which waspermitted under the terms of the companies’ existing collaboration agreement,the Company and Merck will continue in their efforts to identify novel small moleculetherapeutics with the potential to treat several diseases, including type 2diabetes and other metabolic 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. The Companyis eligible to receive payments upon achievement of certain milestones duringdevelopment of a product candidate. Should a product be commercialized, theCompany will receive a royalty on net sales and have the option to co-promotethe product in the United States.  TheCompany will receive $1.5 million over the course of the one year extension tosupport its research efforts.

##  

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

##  

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

 

**Overview**

 

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

 

We currently havefour product candidates at the clinical stage of development. These productcandidates include our core metabolic disease product candidates, MB07803 andMB07811, which are being developed as potential treatments for type 2diabetes and hyperlipidemia, respectively, and our non-core liver diseaseproduct candidates, pradefovir and MB07133, which have been developed aspotential treatments for hepatitis B and primary liver cancer, respectively.

 

*Recent Events*

 

In April 2008, weannounced that MB07803 met its primary efficacy endpoint with resultsdemonstrating a statistically and clinically significant reduction in fastingplasma glucose at day 28 in its Phase 2a clinical trial. The study also showedthat MB07803 was safe and well tolerated. We are currently evaluating thefuture development plans for this program.

 

In April 2008, weentered into a warrant exchange and concurrent private placement, which raised$9.9 million in cash.  The participantsin the transaction were certain current investors who held existing warrantsfor the purchase of common stock issued previously by us in our October 2001and October 2005 private placements. Pursuant to the transaction, wereduced the exercise prices of the existing warrants held by the participantsin exchange for the immediate exercise of the warrants. We also sold additionalshares of common stock and warrants for the purchase of common stock in aconcurrent private placement. We intend to use the proceeds from thetransaction for general corporate purposes, including the further clinicaldevelopment of MB07803 and MB07811 for the treatment of type 2 diabetes andhyperlipidemia, respectively.

 

Also in April 2008, we extendedthe research term of our AMPK collaboration with Merck & Co., orMerck, 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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In March 2008,we entered into a Loan and Security Agreement with Oxford Corporation, orOxford, pursuant to which Oxford provided us with a three-year, $5 million termloan.  In connection with the agreement,we issued to Oxford a warrant to purchase shares of our common stock.

 

*Strategic Plan*

 

Under ourstrategic plan we will focus our internal resources primarily on our clinicaland advanced research core metabolic disease programs. This includes fundingthe further clinical evaluation of our core assets, MB07803 and MB07811, with afocus on achieving key milestones. Continued development of these core assetsthereafter will require significant resources. Therefore, we plan to establishstrategic collaborations for these core assets at appropriate times to secureadditional resources, accelerate progress and share risk. In addition, we planto advance additional metabolic disease product candidates discovered by ourresearch group into clinical development either independently, or potentiallywith current or future strategic collaborators.

 

In order to reducefuture expenses and to minimize the potential dilution associated withfinancing internal development, we intend to license pradefovir and MB07133 forfurther development and commercialization.

 

Our strategic planhas the potential to significantly reduce current and future expenses and toprovide additional financial resources by:

 

·                  selectively funding only our coreassets,

 

·                  licensing or selling our non-coreassets,

 

·                  seeking to offset current and futureresearch and development costs via additional strategic collaborations on ourcore advanced research and clinical programs, and

 

·                  utilizing our existing financingfacilities, such as the Committed Equity Financing Facility, or CEFF.

 

We believe thatthese measures, if successful, along with our existing resources, including theproceeds from our April 2008 warrant exchange and concurrent privateplacement and venture debt, will be sufficient to execute our strategic plan.

 

*History of Losses, Prior Funding*

 

We have incurred annualnet losses since inception. As of March 31, 2008, our accumulated deficitwas approximately $161.1 million. We expect to incur losses for the nextseveral years as we:

 

·                  continue to develop our current andfuture core metabolic disease clinical development candidates,

 

·                  participate in the commercializationof our product candidates, if any, that receive regulatory approval and forwhich we retain commercialization rights, and

 

·                  continue our research and developmentprograms.

 

We have a limitedhistory of operations and, to date, we have not generated any product revenues.In addition to our initial public offering in June 2004, our privateplacement of common stock and warrants in October 2005, our registereddirect offering of common stock in March 2006 and our warrant exchange andconcurrent private placement in April 2008, we have financed ouroperations and internal growth through private placements of preferred stock aswell as direct payments of sponsored research funding, license fees, milestonepayments, equity investments from collaborative partners, debt financing and,to a lesser extent, the sale of common stock through our stockholder approvedequity incentive plans.

 

*Commercial,Manufacturing Rights, Risks*

 

We currently donot have strategic collaborations in place related to our core assets, MB07803or MB07811, and we intend to license our non-core assets, pradefovir andMB07133. We retain worldwide commercialization rights to all of the compoundsthat we have generated from our past and current research programs, with theexception of any potential future 

 

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product candidatescovered by our collaborations with Merck and Idenix Pharmaceuticals, Inc.,or Idenix. Our potential future agreements with strategic collaborators mayinclude joint marketing or promotion arrangements which may allow us toeventually co-market one or more of our product candidates through our ownsales force or with a co-promotion partner. Alternatively, we may grantexclusive marketing rights to our collaborators in exchange for up-front fees,milestones and royalties on future sales, if any.

 

We will rely onour collaborators or third-party manufacturers to produce sufficient quantitiesof our product candidates for clinical studies and large-scalecommercialization upon their approval. 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, we planto enter into additional collaborative agreements to assist in the developmentand commercialization of some or all of our product candidates. However, ourdiscussions with potential collaborators may not lead to the establishment ofnew collaborations on acceptable terms, if at all, or it may take longer thanexpected to establish new collaborations, leading to development andcommercialization delays.

 

Our business is subjectto significant risks, including the risks inherent in our ongoing clinicaltrials and the regulatory review and approval process, the results of ourresearch and development efforts, reliance on third parties for the developmentand commercialization of our product candidates, competition from otherproducts and uncertainties associated with obtaining and enforcing patentrights.

 

**Research and Development**

 

Our research anddevelopment expenses consist primarily of cash and stock-based compensation andother expenses for research and development personnel, costs associated withthe development and clinical trials of our product candidates, facility costs,supplies and materials, costs for consultants and related contract research anddepreciation. We charge all research and development expenses to operations asthey are incurred. Beginning January 1, 2008, we revised our estimate ofthe rate we use to allocate occupancy and information systems costs betweenresearch and development expenses 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 developmentactivities are focused on the clinical development of our core metabolicdisease assets, MB07803 and MB07811. Our activities related to our non-coreliver disease assets, pradefovir and MB07133, are currently limited toplanning, consultation, design and other efforts preparatory to their potentialfuture clinical development by licensees. In addition, our research activitiesinclude work on a variety of compounds in our other advanced research programs.We are responsible for all costs incurred for our product candidates and ouradvanced research programs with the exception of the AMPK program partneredwith Merck and the hepatitis C programs partnered with Merck and Idenix.

 

Our AMPKcollaboration with Merck seeks to develop and commercialize new products totreat type 2 diabetes and potentially other metabolic diseases. Under theterms of our AMPK collaboration agreement with Merck, we have receivedapproximately $11.2 million in cumulative sponsored research and licensefees funding through March 31, 2008, which includes funding for sponsoredresearch efforts through June 2008. In April 2008, we agreed with Merck to extend the research term foran additional year through June 2009, in connection with which we areentitled to receive approximately $1.5 million in additional sponsored researchfunding.

 

Our collaborationswith Merck and Idenix seek to develop and commercialize new products fortreating hepatitis C infection. Our efforts and internal costs related to thehepatitis C collaboration with Merck ceased upon completion of its researchterm in December 2005. Under the terms of the Merck agreement, we havereceived approximately $3.2 million in cumulative license fees andsponsored research funding through December 31, 2005. Our efforts andinternal costs related to the hepatitis C collaboration with Idenix ceased uponcompletion of its research term in October 2007. Under the terms of theIdenix agreement, we have received approximately $3.4 million incumulative license fees and sponsored research funding through December 31,2007.

 

Although thefunded research phases of the hepatitis C collaborations are completed, Merckand Idenix are currently evaluating certain candidate compounds discoveredduring the collaboration to determine if one or more will be recommended forclinical development. Merck and Idenix are solely responsible for conductingand funding all development work for compounds resulting from thesecollaborations and for commercializing any resulting products. If a product issuccessfully developed, we will receive substantial milestone payments as wellas receive a portion of the revenue from sales of a drug in the form of aroyalty on net sales.

 

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At this time, dueto the risks inherent in the clinical trial process and given the early stageof development of our product candidates and lead compounds from our researchprograms, we are unable to estimate with any certainty the costs we will incurin the continued development of our product candidates for commercialization.Other than costs for outsourced services associated with our clinical programs,we generally do not track our research and development expenses by project;rather, we track such expenses by the type of cost incurred. Due to these andother factors, we are unable to determine the anticipated completion dates forour current research and development projects. However, we expect our researchand development costs to be substantial as we continue the development of ourcore assets, as well as continue to expand our research programs.

 

Generally,Phase 1 clinical trials can be expected to last from 6 to 18 months,Phase 2 clinical trials can be expected to last from 12 to 24 monthsand Phase 3 clinical trials can be expected to last from 18 to36 months. However, clinical development timelines vary widely, as do thetotal costs of clinical trials and the likelihood of success. Although we arecurrently focused primarily on advancing MB07803 and MB07811 through clinicaldevelopment, we anticipate that we will make determinations as to which researchand development projects to pursue and how much funding to direct to eachproject on an ongoing basis in response to the scientific and clinical successof each product candidate, our ongoing assessment of its market potential andconsideration of our available financial resources.

 

The lengthyprocess of seeking regulatory approvals for our product candidates, and thecompliance with applicable regulations, require the expenditure of substantialresources. Any failure by us to obtain, or any delay in obtaining, regulatoryapprovals could cause our research and development expenditures to increaseand, in turn, have a material unfavorable effect on our results ofoperations.  Additionally, under ourstrategic plan, we intend to establish strategic collaborations for our coreassets and non-core assets at appropriate times to secure additional resources,accelerate progress and share risk. However, delays in finding appropriate partnerships could also have amaterial unfavorable effect on our results of operations.  We cannot be certain when or if any net cashinflow due to sales of any of our current product candidates will commence.

 

**General and Administrative**

 

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

 

**Other Income (Expense)**

 

Other income(expense) includes interest earned on our cash, cash equivalents and securitiesavailable-for-sale, net of interest expense on capital lease obligations, debt,and the related issuance costs.

 

**CriticalAccounting Policies**

 

Our discussion andanalysis of our financial condition and results of operations are based on ourfinancial statements, which have been prepared in accordance with U.S.generally accepted accounting principles, or GAAP. The preparation of thesefinancial statements requires us to make estimates and judgments that affectthe reported amounts of assets, liabilities, revenues and expenses and relateddisclosure of contingent assets and liabilities. We review our estimates on anon-going basis. We base our estimates on historical experience and on variousother assumptions that we believe to be reasonable under the circumstances, theresults of which form the basis for making judgments about the carrying valuesof assets and liabilities. Actual results may differ from these estimates underdifferent assumptions or conditions. We believe the following accountingpolicies to be critical to the judgments and estimates used in the preparationof our financial statements.

 

*RevenueRecognition.*  Ourrevenue recognition policies are in accordance with Securities and ExchangeCommission Staff Accounting Bulletin, or SAB, No. 104, *Revenue Recognition* and EITFIssue 00-21, *Revenue Arrangements withMultiple Deliverables*. Our agreements generally contain multipleelements, including access to our proprietary technologies and research anddevelopment services. Payments under our collaborations are generally made inthe 

 

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form of up-front licensefees, milestone payments and downstream royalties. All fees are nonrefundable.Revenue from milestones is recognized when earned, provided that:

 

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 thesecriteria are not met, the milestone payment is recognized over the remainingminimum period of our performance obligations under the agreement. Upfront,nonrefundable fees under our collaborations are recognized over the period therelated services are provided. Nonrefundable upfront fees not associated withour future performance are recognized when received. Amounts received forsponsored research funding are recognized as revenues as the services areperformed. Amounts received for sponsored research funding for a specificnumber of full-time researchers are recognized as revenue as the services areprovided, as long as the amounts received are not refundable regardless of theresults of the research project.

 

*ClinicalTrial Expenses.*  Ourclinical trials are often conducted under contracts with multiple researchinstitutions and clinical research organizations that conduct and manageclinical trials on our behalf. The financial terms of these agreements aresubject to negotiation and vary from contract to contract and may result inuneven payment flows. Generally, these agreements set forth the scope of workto be performed at a fixed fee or unit price. Payments under the contractsdepend on factors such as the successful enrollment of patients or thecompletion of clinical trial milestones. Expenses related to clinical trialsgenerally are accrued based on contracted amounts applied to the actual levelof patient enrollment and activity according to the protocol. Other incidentalcosts related to patient enrollment are accrued when known. If contractedamounts are modified based upon changes in the clinical trial protocol or scopeof work to be performed, we modify our accruals accordingly on a prospectivebasis.

 

*Stock-BasedCompensation.*  We grantequity based awards under three stockholder-approved share-based compensationplans. We may grant options and restricted stock awards to employees, directorsand consultants under our Amended and Restated 2001 Equity Incentive Plan. Wealso grant awards to non-employee directors under our 2004 Non-EmployeeDirectors’ Stock Option Plan. All of our employees are eligible to participatein our 2004 Employee Stock Purchase Plan which provides a means for employeesto purchase common stock at a discount through payroll deductions. The benefitsprovided under all of these plans are subject to the provisions of revisedStatement of Financial Accounting Standards, or SFAS, No. 123R, *Share-Based Payment*, which we adoptedeffective January 1, 2006. We elected to use the modified prospectiveapplication in adopting SFAS No. 123R and therefore have not restatedresults for prior periods. The valuation provisions of SFAS No. 123R applyto new awards and to awards that are outstanding on the adoption date andsubsequently modified or cancelled.

 

We estimate thefair value of stock options granted using the Black-Scholes Merton, orBlack-Scholes, option valuation model. This fair value is then amortized overthe requisite service periods of the awards. The Black-Scholes option valuationmodel requires the input of subjective assumptions, including the option’sexpected life and price volatility of the underlying stock. Expected volatilityis based on the weighted average volatility of our stock factoring in dailyshare price observations and the historical price volatility of certain peerswithin our industry sector. In computing expected volatility, the length of thehistorical period used is equal to the length of the expected term of theoption and the share purchase right. The expected life of employee stockoptions represents the average of the contractual term of the options and theweighted average vesting period, as permitted under the simplified method,under SAB No. 107.

 

As stock-basedcompensation expense is based on awards ultimately expected to vest, it hasbeen reduced for estimated forfeitures. SFAS No. 123R requires forfeituresto be estimated at the time of grant and revised, if necessary, in subsequentperiods if actual forfeitures differ from those estimates. Forfeitures wereestimated based on historical experience. We may elect to use differentassumptions under the Black-Scholes option valuation model in the future, whichcould materially affect our net loss and net loss per share. In our pro formainformation required 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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**RecentlyIssued Accounting Pronouncements**

 

In June 2007,the EITF issued EITF Issue No. 07-3, *Accountingfor Nonrefundable Advance Payments for Goods or Services to be Used in FutureResearch and Development Activities*. The consensus requirescompanies to defer and capitalize prepaid, nonrefundable research anddevelopment payments to third parties over the period that the research anddevelopment activities are performed or the services are provided, subject toan assessment of recoverability. EITF Issue No. 07-3 is effective for newcontracts entered into in fiscal years beginning after December 15, 2007,including interim periods within those fiscal years. The adoption of EITF IssueNo. 07-3 did not have a material impact on our financial statements.

 

In November 2007,the EITF issued EITF Issue No. 07-1, *Accountingfor Collaborative Arrangements Related to the Development and Commercializationof Intellectual 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 this Issue to all prior periodspresented should be reported as a change in accounting principle. We are in theprocess of determining the effect, if any, the adoption of EITF Issue No. 07-1will have on our financial statements.

 

**Resultsof Operations**

 

*Comparison of the Three MonthsEnded March 31, 2008 and 2007*

 

*Revenues*.    Revenueswere $0.9 million for the three months ended March 31, 2008, comparedwith $3.4 million for the three months ended March 31, 2007. The$2.5 million decrease was mainly due to decreased license fee revenue of$2.1 million and decreased sponsored research revenue of $0.4 million.  The decrease in license fee revenue primarilyrelates to the absence of license fees of $1.8 million recognized in the firstquarter of 2007 in conjunction with our former collaboration arrangement withSchering Corporation, or Schering, which was terminated in September 2007.  The decrease in sponsored research revenueprimarily relates to the completion of the sponsored research portion of ouragreement with Idenix in October 2007.

 

*Researchand Development Expenses*.    Research anddevelopment expenses were $9.7 million for the three months ended March 31,2008, compared with $9.5 million for the three months ended March 31,2007. The $0.2 million increase was mainly due to an increase of approximately$0.4 million of non-cash depreciation and occupancy costs as a result of achange in the allocation rate of these costs, as previously discussed, and $0.1million in payroll and related benefits due to a higher average headcount inthe first quarter of 2008 as compared to the first quarter of 2007.  These increases were offset by a net decreaseof $0.3 million in clinical and development expenses for the MB07803 andMB07133 programs and in non-cash stock-based compensation expense.

 

*General and Administrative Expenses*.    General and administrative expenses were $2.5 million for thethree months ended March 31, 2008, compared with $3.3 million for thethree months ended March 31, 2007. The $0.8 million decrease wasmainly due to a decrease of $0.5 million in payroll and related benefits due toa decrease in the average headcount for the first quarter of 2008 as comparedto the first quarter of 2007, occupancy and non-cash depreciation due to achange in the allocation rate of these costs and non-cash stock-basedcompensation, as well as a decreased of $0.3 million in professional services.

 

*OtherIncome (Expense).*    Net interest incomewas $0.2 million for the three months ended March 31, 2008, compared tonet interest income of $0.8 million for the three months ended March 31,2007. The $0.6 million decrease was a result of lower cash balances in thefirst quarter of 2008 as compared to the first quarter of 2007.

 

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**Liquidity and Capital Resources**

 

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

 

In April 2008, weentered into a warrant exchange and concurrent private placement, referredtogether as the Transaction, which raised $9.9 million in cash.  The investors in the Transaction were certaincurrent investors who held existing warrants for the purchase of our commonstock issued previously by us in our October 2001 and October 2005private placements.

 

In connection with theTransaction, we entered into a warrant exercise agreement (the “WarrantExercise Agreement”) pursuant to which we reduced the exercise prices of theinvestors’ warrants to purchase our common stock acquired in our October 2001and October 2005 private placements to an exercise price of $2.34 pershare, in exchange for an irrevocable commitment by the investors to exercisesuch warrants at the closing.  As aresult of the Warrant Exercise Agreement, warrants for the purchase of 127,557shares of our common stock with a prior exercise price of $8.70 per share andwarrants for the purchase of 1,558,279 shares of our common stock with a priorexercise price of $6.74 per share were exercised at $2.34 per share.

 

Additionally, inconnection with the Transaction, we entered into a securities purchaseagreement (the “Securities Purchase Agreement”) pursuant to which we issued andsold to the investors 2,485,103 shares of our common stock at an exercise priceof $2.34 per share, and warrants to purchase up to 1,057,196 shares of ourcommon stock at an exercise price of $2.69 per share (the “Warrants”).  At the closing, the investors paid anadditional purchase price for the Warrants equal to $0.125 per whole shareissuable upon exercise of the Warrants. In connection with the Securities Purchase Agreement, we also enteredinto a registration rights agreement (the “Registration Rights Agreement”)pursuant to which we granted to the investors certain registration rights relatingto the securities issued and sold in the Securities Purchase Agreement.

 

Certain of our existingstockholders, including entities affiliated with MPM Capital, Hale BioPharmaVentures and InterWest Partners, invested in the Transaction.  Certain ofsuch investors and/or their affiliates are parties to our amended and restatedinvestors’ rights agreement dated October 28, 2003.  Luke B. Evnin,Ph.D., David F. Hale and Arnold L. Oronsky, Ph.D., members of our board ofdirectors, are associated with MPM Capital, Hale BioPharma Ventures andInterWest Partners, respectively.

 

In March 2008,we entered into a venture debt facility with a lender, pursuant to which thelender provided us with a three-year, $5.0 million term loan.  Interest accrues at an annual rate of 9.83%,with six interest-only monthly payments, made in arrears, beginning in May 2008,followed by 30 equal 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 under the terms of this Agreement.

 

In connection with theventure debt facility, we issued to the lender a warrant to purchase up to154,639 shares of our common stock at an exercise price of $1.94 per share,which represents the closing price of our common stock on the effective date ofthe closing of this agreement.  Thewarrant is immediately exercisable and expires in March 2018.

 

In April 2007,we filed an additional shelf registration statement to increase the amount ofcommon stock and warrants available for issuance under our existing shelfregistration statement by approximately $40 million to a total of$75 million, subject to substantial limitations relating to the aggregatemarket value of our common stock held by non-affiliates. The additional shelfregistration statement was declared effective in May 2007.

 

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

 

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

 

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

 

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

 

If our marketcapitalization is less than $53 million, we will not have access to thiscapital.

 

The investor willpurchase shares of our common stock pursuant to the CEFF at discounts rangingfrom 6% to 10%, depending on the average market price of our common stockduring 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 March 31, 2008, we have notutilized the CEFF.

 

As of March 31,2008, we had $36.4 million in cash and cash equivalents and securitiesavailable-for-sale as compared to $42.4 million as of December 31,2007, a decrease of $6.0 million. The decrease is primarily a result of netcash used in operations of $10.5 million offset by $4.5 million of net cashflows provided by financing activities.

 

As of March 31,2008, we have financed through leases and loans the purchase of equipment andleasehold improvements totaling approximately $12.4 million, of which$5.5 million was outstanding at that date. The loans are collateralized withthe purchased equipment, bear interest at rates ranging from approximately 8.0%to 12.85%, and are due in monthly installments through October 2015. Wecurrently anticipate capital spending on equipment and leasehold improvementsto be in the 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 useour existing cash reserves, the CEFF, proceeds received in April 2008 fromour warrant exchange and concurrent private placement, proceeds from ourventure debt facility, and proceeds from our ongoing collaboration with Merckto execute our strategic plan through 2008. Under our strategic plan, we will focus our internal resources primarilyon our core metabolic disease clinical and advanced research programs. Thisincludes funding the further clinical evaluation of our core assets, MB07803and MB07811, with a focus on achieving key milestones. Continued development ofthese core assets thereafter will require significant resources. Therefore, weplan to establish strategic collaborations for these product candidates atappropriate times to secure additional resources, accelerate progress and sharerisk. In addition, we plan to advance additional metabolic disease productcandidates discovered by our research group into clinical development eitherindependently or potentially with current or future strategic collaborators. Inorder to reduce future expenses and to minimize the potential dilutionassociated with financing their internal development, we intend to licensepradefovir and MB07133 for further development and commercialization.

 

We may not besuccessful in entering into additional collaboration agreements, or inreceiving milestone or royalty payments under current or future agreements.Additionally, we may be required to relinquish greater or all rights to productcandidates at an earlier stage of development or on less favorable terms thanwe would otherwise choose. No assurances can be made that additional funding,through any resources including our CEFF, will be available when needed orthat, if available, financing will be obtained on terms favorable to us or ourstockholders. To the extent that we raise additional capital by issuing equitysecurities, our existing stockholders’ ownership will be diluted. Any debtfinancing we enter into may involve covenants that restrict our operations.These restrictive covenants may include limitations on additional borrowing,specific restrictions on the use or sales of our assets as well as prohibitionson our ability to create liens, pay dividends, redeem our stock or makeinvestments. Failure to obtain adequate financing and to curtail or delay cashexpenditures adequately will have a significant negative impact on our futureoperations.

 

The followingsummarizes our long-term contractual obligations as of March 31, 2008 (inthousands):

 

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| ** **                  | ** ** | ** ** | ** ** | **Payments Due by Period** | ** ** |
|-----------------------------|------------|------------|------------|-------------------------------------------|------------|
| ** **                  | ** ** | ** ** | ** ** | **Less than**                        | ** ** | **1 to 3** | ** ** | **4 to 5** | ** ** | **After 5** | ** ** |
| ** **                  | ** ** | **Total**  | ** ** | **1 Year**                           | ** ** | **Years** | ** ** | **Years** | ** ** | **Years** | ** ** |
| Operating leases            |       | $          | 24,001     |                                      | $          | 2,403 |   | $ | 6,117 |   | $ | 6,503 |   | $ | 8,978 |   |
| Long-term debt              |       | 10,389     |       | 2,798                                     |       | 6,986 |   | 503 |   | 102 |   |
| Interest on  long-term debt |       | 1,933      |       | 892                                       |       | 800 |   | 230 |   | 11 |   |
| Purchase  commitments       |       | 2,765      |       | 2,765                                     |       | — |   | — |   | — |   |
| Capital leases              |       | 73         |       | 24                                        |       | 49 |   | — |   | — |   |
| Interest on  capital leases |       | 11         |       | 6                                         |       | 5 |   | — |   | — |   |
|                        |       |       |       |                                      |       |   |   |   |   |   |   |
| Total                       |       | $          | 39,172     |                                      | $          | 8,888 |   | $ | 13,957 |   | $ | 7,236 |   | $ | 9,091 |   |

 

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

 

We have enteredinto employment agreements with our executive officers and certain other keyemployees that, under certain circumstances, provide for the continuation ofsalary and certain other benefits if terminated under specified circumstances.These agreements generally expire upon termination for cause or when we havemet our obligations under these agreements. As of March 31, 2008, noevents have occurred resulting in the obligation of any such payments.

 

Our future capitaluses and requirements depend on numerous forward-looking factors. These factorsmay include but are not limited to the following:

 

·                  the rate of progress and cost of our clinical trials and other researchand development activities,

 

·                  the scope, prioritization and number of clinical development andresearch programs we pursue,

 

·                  the terms and timing of any collaborative, licensing and otherarrangements that we may establish,

 

·                  the costs of filing, prosecuting, defending and enforcing any patentclaims and other intellectual property rights,

 

·                  the costs and timing of regulatory approvals,

 

·                  the costs of establishing or contracting for manufacturing, sales andmarketing capabilities, and

 

·                  the effect of competing technological and market developments.

 

**FORWARD-LOOKINGSTATEMENTS**

 

This quarterly report on Form 10-Qcontains forward-looking statements that are based on our management’s beliefsand assumptions and on information 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 regulation andthe 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-lookingstatements involve known and unknown risks, uncertainties and other factorswhich may cause our actual results, performance or achievements to bematerially different from any future results, performances or achievementsexpressed or implied by the forward-looking statements.  We discuss these risks in greater detail inthe section entitled “Risk Factors” and elsewhere in this quarterly report on Form 10-Qand in our other filings with the Securities and Exchange 

 

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Commission, including ourannual report on Form 10-K for the year ended December 31, 2007.  Given these uncertainties, you should notplace undue reliance on these forward-looking statements.

 

Also, forward-lookingstatements represent our management’s beliefs and assumptions only as of thedate 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 tomarket risk for changes in interest rates relates primarily to the increase ordecrease in the amount of interest income we can earn on our investmentportfolio. Our risk associated with fluctuating interest income is limited toour investments in interest rate sensitive financial instruments. Under ourcurrent policies, we do not use interest rate derivative instruments to managethis exposure to interest rate changes. We seek to ensure the safety andpreservation of our invested principal by limiting default risk, market risk,and reinvestment risk. We mitigate default risk by investing in short-terminvestment grade securities. We do not invest in auction rate securities. A 100basis point increase or decrease in interest rates would increase or decreaseour current investment balance by approximately $80,000 annually.  While changes in our interest rates mayaffect the fair value of our investment portfolio, any gains or losses are notrecognized in our statement of operations until the investment is sold or if areduction in fair value is determined to be a permanent impairment.

 

We do not have anyforeign currency or other derivative financial instruments.

 

Our long-termcapital lease obligations and debt bear interest at fixed rates and thereforewe do not have significant market risk exposure with respect to theseobligations.

 

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

##  

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

 

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.

 

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**PART II - OTHER INFORMATION**

 

**Item 1.Legal Proceedings**

 

None.

 

**Item 1A.Risk Factors**

 

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

* *

**RisksRelated to our Business**

 

***We are dependent on the success of one or more of ourcurrent product candidates and we cannot be certain that any of them willreceive regulatory approval or be commercialized.***

 

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

 

We do notanticipate that any of our current product candidates will be eligible toreceive regulatory approval and begin commercialization for a number of years,if at all. Even if we were ultimately to receive regulatory approval for theseproduct candidates, we and/or our potential future partners, as applicable, maybe unable to commercialize them successfully for a variety of reasons. Theseinclude, for example, the availability of alternative treatments, lack of costeffectiveness, the cost of manufacturing the product on a commercial scale andthe effect of competition with other drugs. The success of our productcandidates may also be limited by the prevalence and severity of any adverseside effects. If we fail to commercialize one or more of our current productcandidates, we may be unable to generate sufficient revenues to attain ormaintain profitability, and our reputation in our industry and the investmentcommunity may be damaged.

 

***If development of our product candidates does not producefavorable results, we and our collaborators, as applicable, may be unable tocommercialize these products.***

 

To receiveregulatory approval for the commercialization of our core metabolic diseaseassets, MB07803 and MB07811, our non-core liver disease assets, pradefovir andMB07133, or any other product candidates that we may develop, adequate andwell-controlled clinical trials must be conducted to demonstrate safety andefficacy in humans to the satisfaction of the Food and Drug Administration, orFDA, in the U.S. and other regulatory agencies elsewhere in the world. In orderto support marketing approval, these agencies typically require successfulresults in one or more Phase 3 clinical trials, which our current productcandidates have not yet reached and may never reach. In addition, regulatoryapproval of our 

 

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product candidates may beaffected by adverse results in animal studies conducted during clinicaldevelopment to, among other things, evaluate their toxicology, carcinogenicityand pharmacokinetics and optimize their formulation.

 

The developmentprocess is expensive, can take many years and has an uncertain outcome. Failurecan occur at any stage of the process. We may experience numerous unforeseenevents during, or as a result of, the development process that could delay orprevent commercialization of our current or future product candidates, includingthe following:

 

·                 clinical trials may produce negative orinconclusive results,

 

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

 

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

 

·                 costs of development may be greater thanwe anticipate,

 

·                 our product candidates may causeundesirable side effects that delay or preclude regulatory approval or limittheir commercial use or market acceptance if approved,

 

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

 

·                 we may face delays in obtainingregulatory approvals to commence a clinical trial.

 

Success in earlydevelopment does not mean that later development will be successful because,for example, product candidates in later-stage clinical trials may fail todemonstrate sufficient safety and efficacy despite having progressed throughinitial clinical testing. For example, in July 2007, we were informed byDaiichi Sankyo, our collaborative partner on CS-917, that results from acompleted Phase 2b clinical trial showed that this product candidatefailed to achieve the primary endpoint of the clinical trial despite havingsuccessfully achieved the primary endpoints of other earlier clinical trials. InJanuary 2008, we and Daiichi Sankyo agreed to terminate our strategiccollaboration on CS-917 and return the rights to this product candidate to us.We do not intend to further develop this product candidate.

 

Our clinicalexperience with our product candidates is limited, and to date our productcandidates have been tested in less than the number of patients that willlikely need to be studied to gain regulatory approval. The data collected fromclinical trials with larger patient populations may not demonstrate sufficientsafety and efficacy to support regulatory approval of these product candidates.In addition, the requirements for regulatory approval of our product candidatesmay change, making it more difficult for us to achieve such approval in a timelymanner or at all. For example, in March 2008 the FDA released draftguidance regarding clinical trials for product candidates that treat diabetes,which may result in more stringent requirements for the clinical testing andregulatory approval of such product candidates.

 

We currently donot have strategic collaborations in place for any of our current productcandidates. Therefore, in the future, we and/or any potential futurecollaborative partner will be responsible for establishing the targeted endpointsand goals for development of our product candidates. These targeted endpointsand goals may be inadequate to demonstrate the safety and efficacy levelsrequired for regulatory approvals. Even if we believe data collected during thedevelopment of our product candidates are promising, such data may not besufficient to support marketing approval by the FDA or other regulatoryagencies abroad. Further, data generated during development can be interpretedin different ways, and the FDA or other foreign regulatory agencies mayinterpret such data in different ways than us or our collaborators. Our failureto adequately demonstrate the safety and efficacy of our product candidateswould prevent our receipt of regulatory approval, and ultimately the commercializationof these product candidates.

 

***We may not be able to enter into collaborations with respectto our non-core assets, pradefovir and MB07133, and certain metabolic diseaseadvanced research programs on acceptable terms, if at all, which would lead todevelopment and commercialization delays.***

 

Since we do notcurrently possess the resources necessary to independently develop andcommercialize all of the potential product candidates that may be based uponour technologies, including MB07803, MB07811, pradefovir and MB07133, and as acomponent of our strategic plan, we plan to enter into additional collaborativeagreements to assist in the 

 

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development andcommercialization of some or all of these product candidates. However, ourdiscussions with potential collaborators may not lead to the establishment ofnew collaborations on acceptable terms, if at all, or it may take longer thanexpected to establish new collaborations, leading to development and commercializationdelays, which would adversely affect our business.

 

***Our product candidates may cause undesirable side effectsthat could delay or prevent their regulatory approval or commercialization orhave other significant adverse implications on our business.***

 

Prior to receivingregulatory approval, undesirable side effects observed in human clinical trialsor in supportive animal studies with our product candidates could interrupt,delay or halt their development and could result in the denial of regulatoryapproval by the FDA or other regulatory authorities for any or all targetedindications or adversely affect the marketability of any such productcandidates that receive regulatory approval. In turn, this could eliminate orlimit our ability to commercialize our product candidates and generate revenuesfrom their sale.

 

For example, datafrom 24-month oral carcinogenicity studies of pradefovir in rats and miceshowed that the incidence of rats or mice with tumors was increased in theanimals dosed with the highest dose levels tested and was slightly increased atthe intermediate dose levels. The low dose levels were considered “no-effect”dose levels in both studies. As a result of numerous factors which may includethese findings, we entered into an agreement with Schering and ValeantPharmaceuticals North America, or Valeant, to terminate our agreements for thedevelopment and commercialization of pradefovir, and all commercial rights topradefovir have been returned to us subject to certain milestone and royaltypayments we may be required to make to Valeant should pradefovir besubsequently developed.

 

Our productcandidates could also exhibit adverse interactions with other drugs. Forexample, in earlier clinical trials conducted by Daiichi Sankyo, CS-917 wasassociated with incidents of lactic acidosis in two patients when it wascombined with metformin in a Phase 1 clinical trial. After extensiveanalysis, Daiichi Sankyo concluded that these incidents were likely due tosignificantly increased blood levels of metformin. CS-917 was also associatedin a limited number of patients with episodes of hypoglycemia, asymptomaticlactate elevation as well as lactate elevation with clinical symptoms thatcould be considered signs of lactic acidosis. We are currently conductingclinical trials of our second-generation product candidate for type 2diabetes, MB07803, which works by the same mechanism as CS-917 and thus may besubject to some 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 natureof our proprietary technologies including HepDirect and NuMimetic may causeundesirable side effects in future clinical trials or supportive animalstudies. In addition, our product candidates may have greater or lesser degreesof potential risk of undesirable side effects relative to other productcandidates based on the nature of their molecular targets and the variousphysiological responses associated with those targets. For example, MB07811 isa product candidate designed to exploit the beneficial hepatic effects ofthyroid hormone agonists while avoiding toxicities related to systemic exposureto these types of compounds. If MB07811 is not successful in this regard, itcould be associated with undesirable side effects.

 

Undesirable sideeffects involving our product candidates may have other significant adverseimplications on our business, for example:

 

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

 

·                 our stock price could decline,

 

·                 our collaborators may ultimatelyterminate development of our partnered products, may further decide not todevelop backup product candidates and may terminate our agreements,

 

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

 

·                 if we were to later continue thedevelopment of these product candidates and receive regulatory approval,earlier findings may significantly limit their marketability and thussignificantly lower our potential future revenues from their sale,

 

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·                  we may be subject to product liability or stockholder litigation, and

 

·                  we may be unable to attract and retain key employees.

 

In addition, ifany of our product candidates receive marketing approval and we or others lateridentify undesirable side effects caused by the product:

 

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

 

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

 

·                 our reputation may suffer.

 

Any of theseevents could prevent us from achieving or maintaining market acceptance of theaffected product or could substantially increase the costs and expenses ofcommercializing the product, which in turn could delay or prevent us fromgenerating significant revenues from the sale of the product.

 

***We are currently dependent on our collaborations with Merckand Idenix for the development and commercialization of product candidatesrelated to those collaborations, and we may be dependent on futurecollaborators for the development of our current and future product candidates.Events involving our collaborations with Merck and Idenix, or any futurecollaborations could prevent us from developing and commercializing our productcandidates and achieving or sustaining profitability.***

 

We have enteredinto two collaborations with Merck and a collaboration with Idenix. The firstcollaboration with Merck seeks to develop and commercialize new products forthe treatment of 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 seeks to develop andcommercialize new products for the treatment of hepatitis C infection.Although our collaborations with Merck and Idenix have not yet yielded anyproduct candidates, should they ultimately be successful, we will be dependenton Merck and/or Idenix, as applicable, for further development andcommercialization of any resulting product candidates. In October 2007,the sponsored research term of our collaboration agreement with Idenix wasended upon the first anniversary of the agreement in accordance with its terms.While the sponsored research portion of our collaboration with Idenix ended,certain compounds are under evaluation for further development.

 

We have limitedcontrol over the amount and timing of resources that Merck, Idenix or anyfuture collaborators devote to our programs or potential product candidates.These collaborations with us may end or may be terminated or our collaboratorsmay otherwise fail to conduct their collaborative activities successfully andin a timely manner. Further, our collaborators may not develop productcandidates that arise out of our collaborative arrangements or devotesufficient resources to the development, manufacture, marketing or sale ofthese products. In the event that one of our collaborations is terminated, andwe believe that the continued development or commercialization of a productcandidate or drug compound covered by the collaboration is warranted, we mayseek to obtain rights to develop and commercialize the product candidate ordrug compound, if we do not already have those rights. We would then determinewhether to continue the development or commercialization of the product candidateor drug compound independently or together with a new collaborator. However, inthe event that we do not have sufficient resources to independently develop orcommercialize the product candidate or drug compound, and we cannot establish anew collaboration 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 presentand future collaborators may fail to develop or effectively commercializeproducts or drug compounds covered by our present and future collaborations if:

 

·                 we do not achieve our objectives underour collaboration agreements,

 

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

 

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·                 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 are unableto develop or commercialize our products as a result of the occurrence of anyof these events, we may not be able to generate sufficient revenues to achieveor maintain profitability.

 

***Because our collaborations with Merck and Idenix may involveMerck’s or Idenix’s proprietary compounds, if Merck or Idenix terminatedevelopment of product candidates we may not have the right to pursuedevelopment of these product candidates on our own.***

 

The objective ofour hepatitis C collaboration with Merck has been 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 designates a product candidate and then subsequently terminates thiscollaboration before a defined stage of development of that product candidate,which it may do without cause at any time upon 90 days’ advance writtennotice to us, we will not have any right to develop or commercialize thatproduct candidate. In addition, if this collaboration with Merck terminates andMerck successfully develops products based on these proprietary compoundswithout applying our technology, we will not be entitled to milestone paymentsor royalties with respect to those products.

 

Our agreement withMerck to develop and commercialize new products to treat type 2 diabetesand potentially other metabolic diseases may include the development ofcompounds owned or controlled by Merck. Accordingly, if Merck terminates thiscollaboration, it may prove difficult for us to continue development of suchcompounds. Similarly, our agreement with Idenix to develop and commercializenew products to treat hepatitis C infection may include the development ofcompounds owned or controlled by Idenix. In October 2007, the sponsoredresearch term of our collaboration agreement with Idenix ended upon the first anniversaryof the agreement in accordance with its terms. While the sponsored researchportion of our collaboration with Idenix ended, certain compounds are underevaluation for further development. Idenix may not choose to develop thecompounds discovered during the research term, should it do so and then decideto terminate this collaboration, it may prove difficult for us to continuedevelopment of such compounds.

 

***Conflicts may arise between us and any of our collaboratorsthat could delay or prevent the development or commercialization of our productcandidates.***

 

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 or any future collaborators, they may act in theirself-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:

 

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·                 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 candidates beyond ourcurrent product candidates may not succeed, and any product candidates werecommend for clinical development may not actually begin clinical trials.***

 

We intend to useour 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 clinical trials. Such findings would potentially impede ourability to maintain or expand our clinical development pipeline. Our ability toidentify new drug compounds and advance them into clinical development alsodepends upon our ability to fund our research and development operations, andwe cannot be certain that additional funding will be available on acceptableterms, or at all.

 

***Delays in the commencement or completion of clinical trialscould result in increased costs to us and delay our ability to generatesignificant revenues.***

 

Delays in the commencementor completion of clinical trials could significantly impact our productdevelopment costs. We do not know whether planned clinical trials will begin ontime or be completed on schedule, if at all. The commencement of clinicaltrials can be delayed for a variety of reasons, including delays related 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 dueto their focus on other programs or as a result of general market conditions.

 

In addition, oncea 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:

 

·                  failure to conduct the clinical trialin accordance with regulatory requirements or clinical protocols,

 

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

 

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

 

We rely on thirdparties, 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 and Idenix have not yet yielded product candidates, should they be successful,we will be dependent on Merck and/or Idenix, as applicable, to conduct thedevelopment of any resulting product candidates. If Merck, Idenix or theseother third parties do not successfully meet their obligations under ouragreements, or if the quality or accuracy of the data they obtain iscompromised due to the failure to adhere to applicable protocols or for otherreasons, clinical trials or other studies may be extended, delayed orterminated, and these product candidates may not receive regulatory approval orbe successfully commercialized.

 

***Because our product candidates, research programs andcollaborative efforts depend on our proprietary technologies, adverse eventsaffecting our proprietary technologies may delay or prevent the commercializationof 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 collaborations withMerck and Idenix in which we applied our technology to certain Merck and Idenixcompounds. Our proprietary technologies are subject to many of the same risksas our product candidates, including risks related to:

 

·                  obtaining and maintaining patent andtrade secret protection for these technologies,

 

·                  avoiding infringement of theproprietary rights of third parties,

 

·                  the development of competingtechnologies by others, and

 

·                  in HepDirect’s case, the safety andeffectiveness of this technology in humans.

 

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

 

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***Our product candidates are subject to extensive regulation,which can be costly and time consuming, cause unanticipated delays or preventthe receipt of the required approvals to commercialize 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 product candidatesuntil we or our collaborators receive approval of a New Drug Application, orNDA, from the FDA or receive similar approvals abroad. The process of obtainingthese approvals is expensive, often takes many years, and can varysubstantially based upon the type, complexity and novelty of the productcandidates involved. Approval policies or regulations may change and may beinfluenced by the results of other similar or competitive products. 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 the timeand expense invested, regulatory approval is never guaranteed. The FDA or otherforeign regulatory agencies can delay, limit or deny approval of a productcandidate for many reasons, including:

 

·                  a product candidate may not be safeand effective,

 

·                  FDA or other foreign regulatoryagency officials may not find the data from preclinical testing and clinicaltrials generated during development sufficient,

 

·                  the FDA or other foreign regulatoryagency may not approve of our third-party manufacturers’ processes orfacilities, or

 

·                  the FDA or other foreign regulatoryagency may change its approval policies or adopt 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 receive regulatoryapproval, our product candidates may still face future development andregulatory 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 of unanticipatedseverity or frequency, or problems with the facility where the product ismanufactured, a regulatory agency may impose restrictions on that product, ourcollaborators or us, including requiring withdrawal of the product from themarket. Our product candidates will also be subject to ongoing FDA and otherforeign 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:

 

·                  issue warning letters or othernotices of possible violations,

 

·                  impose civil or criminal penalties orseek disgorgement of revenue or profits,

 

·                  suspend regulatory approval,

 

·                  suspend any ongoing clinical trials,

 

·                  refuse to approve pending applicationsor supplements to approved applications filed by us or our collaborators,

 

·                  impose restrictions on operations,including costly new manufacturing requirements, or

 

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·                  seize or detain products or require aproduct recall.

 

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

 

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 are approved faster,marketed more effectively or demonstrated to be more effective than ours, ourcommercial opportunity will be reduced or eliminated.***

 

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

 

We are aware ofmany competitive products currently marketed or under development that are usedto 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 thebiguanide drug class, related to guanidine and currently is the most widelyprescribed first line therapy for type 2 diabetes,

 

·                  sulfonylureas, which increase thesecretion of insulin by the pancreas, thereby lowering the level of the sugarglucose in the blood,

 

·                  insulins, which mimic insulin, thenaturally occurring hormone made by the pancreas to control blood glucoselevels,

 

·                  PPARs, which improve insulinsensitivity by activating certain genes involved in fat synthesis and carbohydratemetabolism,

 

·                  incretin mimetics, which lowerglucose levels by increasing the levels of certain naturally occurring hormonesfrom the pancreas, including glucagon-like peptide-1, or GLP-1, a peptide thatfacilitates the response of the pancreas and liver to fluctuations in glucoselevels by its action on pancreatic beta and alpha cells. This drug classincludes dipeptidyl peptidase IV, or DPP-IV inhibitors, and BYETTA®(exenatide) injection. DPP-IV is an enzyme in the bloodstream that cleaves andinactivates GLP-1. Inhibition of DPP-IV thus increases the half-life ofendogenous GLP-1 by preventing cleavage and inactivation of GLP-1. BYETTA is aninjectable medication that exhibits many of the same glucose regulating actionsof GLP-1. The overall effect of drugs in this class is to enhanceglucose-dependent insulin secretion and suppress inappropriate glucagonsecretion,

 

·                  alpha-glucosidase inhibitors, whichdecrease the absorption of carbohydrates from the intestine, resulting in aslower and lower rise in blood glucose throughout the day,

 

·                  glinides, which stimulate thepancreas’ beta-cells to produce insulin, and

 

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·                  combination therapies, which combinemetformin with members of several or one of the above-mentioned classes,particularly sulfonylureas and PPARs.

 

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 serumcholesterol levels by inhibiting a key enzyme involved in the biosynthesis ofcholesterol,

 

·                  fibrates, which reduce the amount ofcholesterol and triglycerides (fatty substances) in blood,

 

·                  nicotinic acid derivatives, whichlower cholesterol, triglycerides and low density lipoproteins and increase highdensity lipoproteins,

 

·                  CAIs, which inhibit the absorption ofdietary and biliary cholesterol,

 

·                  bile acid sequestrants, which bindwith cholesterol-containing bile acids in the intestines and remove them inbowel movements, and

 

·                  statin combination therapies, whichcombine statins with members of the above-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 pradefovir isultimately 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 productsinclude, but are not limited to the following classes:

 

·                  interferons, which mimic interferon,the naturally occurring infection-fighting immune substance produced by thebody,

 

·                  nucleoside analogues, which arechemically engineered nucleoside compounds that are converted inside cells intoother compounds that are structurally similar to the building blocks of DNA andRNA that interfere with the replication of HBV, and

 

·                  nucleotide analogues, which arechemically engineered nucleotide compounds that are converted inside cells intoother compounds that are structurally similar to the building blocks of DNA andRNA that interfere with the replication of HBV.

 

A competitor topradefovir 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 

 

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beneficial or less expensive than Hepsera. Inaddition, marketed products approved to treat HIV infections are beingevaluated for their effectiveness in treating hepatitis B infections.

 

Nexavar(sorafenib), a chemotherapy approved for treating kidney cancer, received FDAapproval in November, 2007 for the treatment of primary liver cancer. This followsthe European Medicines Agency’s, or EMEA, decision in October of the sameyear to approve Nexavar in the same indication for Europe. Nexavar is now theonly drug approved for primary liver 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, manyother companies are developing products for the treatment of the diseases weare 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 for ours.We will also face competition from these third parties in recruiting andretaining qualified scientific and management personnel, establishing clinicaltrial sites and patient registration for clinical trials, and in acquiring andin-licensing technologies and products complementary to our programs oradvantageous to our business.

 

***We do not have internal manufacturing capabilities, and ifwe fail to develop and maintain supply relationships with collaborators orother third-party manufacturers, we may be unable to develop or commercializeour 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 thecommercialization of our product candidates or, if any of our productcandidates is approved, in the recall or withdrawal of the product from themarket. Further, development of large-scale manufacturing processes may requireadditional validation studies, which the FDA and other foreign regulatoryagencies must review and approve. Our inability to enter into or maintainagreements with collaborators or capable third-party manufacturers onacceptable terms could delay or prevent the commercialization of our products,which would adversely affect our ability to generate revenues and could preventus from achieving or maintaining profitability.

 

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

 

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California Department of Health Services and may beinspected by the California Department of Health Services, and other applicableregulatory authorities, at any time. We, our collaborators or other third-partymanufacturers of our products may be unable to comply with these CGMPrequirements and with other FDA, state and foreign regulatory requirements. Wehave little control over third-party manufacturers’ compliance with theseregulations and standards. A failure to comply with these requirements mayresult in fines and civil penalties, suspension of production, suspension ordelay in product approval, product seizure or recall, or withdrawal of productapproval.

 

***If we are unable to establish sales and marketingcapabilities or enter into agreements with third parties to sell and market ourproduct candidates, we may be unable to generate significant revenues.***

 

We do not have asales and marketing organization, and we have no experience as a company in thesales, marketing and distribution of pharmaceutical products. Although ourhepatitis C and metabolic disease collaborations with Merck have not yetyielded product candidates, should they be successful, Merck will beresponsible for worldwide marketing and commercialization of any resultingproduct candidates (subject to, in the case of our metabolic diseasecollaboration, our option to co-promote the product in the U.S. with certainfinancial assistance from Merck). Similarly, should our hepatitis C collaborationwith Idenix be successful, Idenix will be responsible for worldwide marketingand commercialization of any resulting product candidates. In order toco-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, if at all, and any sales force we do establish may not be capable ofgenerating sufficient demand for our product candidates. To the extent that weenter into arrangements with collaborators or other third parties to performsales and marketing services, our product revenues are likely to be lower thanif we directly marketed and sold our product candidates. If we are unable toestablish adequate sales and marketing capabilities, independently or withothers, we may not be able to generate significant revenues and may not becomeprofitable.

 

***The commercial success of our product candidates dependsupon their market acceptance among physicians, patients, healthcare payors andthe medical community.***

 

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

 

·                  our ability to provide acceptableevidence of safety and efficacy,

 

·                  relative convenience and ease ofadministration,

 

·                  the prevalence and severity of anyadverse side effects,

 

·                  restrictions on use in combinationwith other products,

 

·                  availability of alternativetreatments,

 

·                  pricing and cost effectivenessassuming either competitive or potential premium pricing requirements, based onthe profile of our product candidates and target markets,

 

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

 

·                  our ability to obtain sufficientthird-party coverage or reimbursement.

 

***We are subject to uncertainty relating to health care reformmeasures and reimbursement policies which, if not favorable to our productcandidates, could hinder or prevent our product candidates’ commercial success.***

 

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The continuing efforts ofthe government, insurance companies, managed care organizations and otherpayers of health care costs to contain or reduce costs of health care mayadversely affect:

 

·                  our ability to set a price we believeis fair for our products,

 

·                  our ability to generate revenues andachieve or maintain profitability,

 

·                  the future revenues and profitabilityof our potential customers, suppliers and collaborators, and

 

·                  the availability of capital.

 

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

 

Our ability 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 our organization, and wemay experience difficulties in managing those organizational changes.***

 

Since we became anindependent company in 1999, we have increased the number of our full-timeemployees from 50 to 124 as of March 31, 2008. We may need to decrease thenumber of our full-time employees in the future in response to adverse businessevents. Reducing our workforce may lead to additional unanticipated attrition.If our future staffing is inadequate because of additional unanticipatedattrition or because we failed to retain the staffing level required to accomplishour business objectives we may be delayed or unable to continue the developmentor commercialization of our product candidates, which could impede our abilityto generate revenues and achieve or maintain profitability.

 

***If we fail to attract and keep key management and scientificpersonnel, we may be unable to successfully develop or commercialize ourproduct 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.

 

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

 

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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 andCapital Requirements**

 

***We will need substantial additional funding and may beunable to raise capital when needed, which would force us to delay, reduce oreliminate our research and development programs or commercialization effortsand affect our ability to continue as a going concern.***

 

We intend to useour existing cash reserves, proceeds received in April 2008 from ourwarrant exchange and concurrent private placement, proceeds received in March 2008from our venture debt facility, proceeds from our ongoing collaboration withMerck, our Committed Equity Financing Facility, or CEFF, and proceeds fromother planned financing and business development activities to execute ourstrategic plan through 2008. Under our strategic plan we will need to secureadditional cash proceeds through future strategic collaborations and the CEFFor other financing sources to fund certain studies on the MB07803 and MB07811programs in 2008. In the event we are not able to generate sufficient financingthrough the use of our CEFF or other planned financing and business developmentactivities we have the ability and intent to, and will be required to, delay,scale back or eliminate some or all of our research or development programs andother outlays of cash in order to meet our cash requirements through 2008.Additionally, we may be required to relinquish greater or all rights to productcandidates at an earlier stage of development or on less favorable terms thanwe would otherwise choose. Alternatively, we may determine that seekingadditional resources through traditional financing transactions may beappropriate to achieve certain key value-driving development milestones. Noassurances can be made that additional funding through any resources including,our CEFF, will be available when needed. Failure to obtain adequate financingand to curtail or delay cash expenditures adequately will have a significantnegative impact on our future operations. Because we do not anticipate that wewill generate significant continuing revenues for several years, if at all, wewill need to raise substantial additional capital to finance our operations inthe future. Our additional funding requirements will depend on, and couldincrease significantly as a result of, many factors, including:

 

·                  the rate of progress and cost of ourclinical trials and other research and development activities,

 

·                  the scope, prioritization and numberof clinical development and research programs we pursue,

 

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

 

·                  the costs of filing, prosecuting,defending and enforcing any patent claims and other intellectual propertyrights,

 

·                  the costs and timing of regulatoryapprovals,

 

·                  the costs of establishing or contractingfor sales and marketing capabilities, and

 

·                  the effect of competing technologicaland 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, reducethe scope of or eliminate one or more of our research and development programsor our commercialization efforts and we may be unable to continue as a goingconcern.

 

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

 

We have incurrednet losses from our inception. As of March 31, 2008, we had an accumulateddeficit of approximately $161.1 million. While we are unable at this time todetermine whether our net losses will increase or decrease

 

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in the future, we expect to continue to incur netlosses during the next several years as we conduct operations. Because of thenumerous risks and uncertainties associated with our product developmentefforts, we are unable to predict when we will become profitable, if ever.

 

***We currently lack a significant continuing revenue sourceand may not become or remain profitable.***

 

Our ability tobecome and remain profitable depends upon our ability to generate continuingrevenues. To date, our product candidates and strategic collaborations have notgenerated any significant revenues, other than one-time or time-limitedpayments associated with our collaborations such as milestone payments andoption fees. Our ability to generate significant continuing revenues depends ona number of factors, including:

 

·                  successful completion of ongoingdevelopment activities for our product candidates,

 

·                  achievement of regulatory approvalfor our product candidates,

 

·                  successful completion of our currentand future strategic collaborations, and

 

·                  successful sales, 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.

 

***Raising additional funds by issuing securities or throughcollaboration and licensing arrangements will cause dilution to existingstockholders, restrict our operations or require us to relinquish proprietaryrights.***

 

We may raiseadditional funds through public or private equity offerings, our CEFF,corporate collaboration and licensing arrangements, debt financings or grants.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 certainlimitations 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 debt financingwe enter into may involve covenants that restrict our operations. Theserestrictive covenants may include limitations on additional borrowing, specificrestrictions on the use of our assets as well as prohibitions on our ability tocreate liens, pay dividends, redeem our stock or make investments. In addition,if we raise additional funds through collaboration and licensing arrangements, itmay be necessary to relinquish potentially valuable rights to our potentialproducts or proprietary technologies, or grant licenses on terms that are notfavorable to us.

 

***Certainprovisions of our financing facilities may require us to pay any outstandingbalance of indebtedness andcould limit our ability to fund ongoing operations or obtain additionalfinancing.***

 

If we are required to payany outstanding balance of indebtedness immediately, we may be faced with thefollowing 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.

 

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***Our quarterly operating results and stock price mayfluctuate 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:

 

·                  the development status of our productcandidates, including results of our clinical trials and other studies,

 

·                  our recommendation of additional drugcompounds for clinical development,

 

·                  our addition or termination ofresearch programs or funding support,

 

·                  variations in the level of expensesrelated to our product candidates or research programs,

 

·                  our execution of collaborative,licensing or other arrangements, and the timing of payments we may make orreceive under these arrangements, and

 

·                  changes in the use assumptions or theuse of different valuation methods in the application of SFAS No. 123R infuture 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 we elect to make adraw down, may require us to make additional “blackout” or other payments to aninstitutional investor and may result in dilution to our stockholders.***

 

We have we enteredinto 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 are entitled,in certain circumstances, to deliver a “blackout” notice to the investor tosuspend the use of the prospectus covering the shares of common stock issued inconnection with the CEFF and prohibit the investor from selling shares underthat prospectus for a certain period of time. If we deliver a blackout noticein the 15 trading days following the settlement of a draw down, or if theregistration statement covering the resale of the shares of common stock to beissued in connection with the CEFF is not effective in circumstances notpermitted by our registration rights agreement with the investor, then we mustmake a payment to the investor, or issue the investor additional shares in lieuof this payment, calculated on the basis of a specified number of shares heldby the investor immediately prior to the blackout period and the change in themarket price of our common stock during the period in which the use of theresale registration statement is suspended. If the trading price of our commonstock declines during a suspension of the resale registration statement, theblackout or other payment could be significant.

 

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.

 

36

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**Risks Related to our IntellectualProperty**

 

***Our success depends upon our ability to protect ourintellectual property, including the proprietary technologies and compoundsused 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.Decisions or actions regarding patent filing and/or changes in either thepatent laws or in interpretations of patent laws in the U.S. and othercountries may diminish the 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 provide us with incorrect or inappropriate advice it could bedetrimental to our patent positions.

 

Accordingly, wecannot 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:

 

·                  we might not have been the first tomake the inventions covered by each of our pending patent applications andissued patents,

 

·                  we might not have been the first tofile patent applications for these inventions,

 

·                  others may independently developsimilar or alternative technologies or duplicate any of our technologies,

 

·                  it is possible that none of ourpending patent applications will result in issued patents,

 

·                  our issued patents may not provide abasis for commercially viable products, may not provide us with any competitiveadvantages, or may be challenged by third parties,

 

·                  our issued patents may not be validor enforceable,

 

·                  we may not develop additionalproprietary technologies that are patentable, or

 

·                  the patents of others may have anadverse effect on our business.

 

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Proprietary tradesecrets 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 intellectual property rightsof third parties, it will be costly and time consuming, and an unfavorableoutcome in that litigation would have a material adverse effect on ourbusiness.***

 

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 be exposedto future litigation by the companies holding these patents or other thirdparties 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 may face a number of issues, including:

 

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

 

·                  substantial damages for infringement,including treble damages and attorneys’ fees, as well as damages for productsdeveloped using allegedly infringing drug discovery tools or methods, which wemay have to pay if a court decides that the product or proprietary technologyat issue infringes on or violates the third party’s rights,

 

·                  a court prohibiting us from sellingor licensing the product or using the proprietary technology unless the thirdparty licenses its technology to us, which it is not required to do,

 

·                  if a license is available from thethird party, we may have to pay substantial royalties, fees and/or grant crosslicenses to our technology, and

 

·                  redesigning our products or processesso they do not infringe, which may not be possible or may require substantialfunds and time.

 

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

 

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***Existing patents and patent applications covering adefoviror prodrugs of adefovir in the U.S. and foreign countries may prevent thecommercialization 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 with environmentallaws and regulations.***

 

We use hazardousmaterials, including chemicals, biological agents and radioactive isotopes andcompounds that could be dangerous to human health and safety or theenvironment. As appropriate, we store these materials and wastes resulting fromtheir use at our facility pending their ultimate use or disposal. We currentlycontract with a third party to dispose of these materials and wastes. We aresubject to a variety of federal, state and local laws and regulations governingthe use, generation, manufacture, storage, handling and disposal of thesematerials and wastes. We may also incur significant costs complying withenvironmental laws and regulations adopted in the future.

 

***We may incur substantial liabilities from any productliability 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:

 

·                  decreased demand for our productcandidates,

 

·                  injury to our reputation,

 

·                  withdrawal of clinical trialparticipants,

 

·                  costs of related litigation,

 

·                  substantial monetary awards topatients or other claimants,

 

·                  loss of revenues, and

 

·                  the inability to commercialize ourproduct candidates.

 

We have productliability insurance that covers our clinical trials, up to an annual aggregatelimit of $10 million. We intend to expand our insurance coverage toinclude the sale of commercial products if marketing approval is obtained forany 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.

 

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***If we use biological and hazardous materials in a mannerthat causes injury, we may be liable for damages.***

 

Our research anddevelopment 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 SecuritiesMarkets and Investment in our Common Stock**

 

***Market volatility may affect our stock price and the valueof your investment.***

 

The market pricefor our common stock has been and is likely to continue to be volatile. Inaddition, the market price of our common stock may fluctuate significantly inresponse to a number of factors, most of which we cannot control, including:

 

·                  changes in the regulatory status ofour product candidates, including the status and results of our developmentactivities,

 

·                  establishment of new collaborativearrangements,

 

·                  events affecting Merck, Idenix or anyfuture collaborators,

 

·                  announcements of new products ortechnologies, commercial relationships or other events by us or ourcompetitors,

 

·                  regulatory developments in the U.S.and foreign countries,

 

·                  fluctuations in stock market pricesand trading volumes of similar companies,

 

·                  variations in our quarterly operatingresults,

 

·                  changes in securities analysts’estimates of our financial performance,

 

·                  changes in accounting principles,

 

·                  issuances of new equity securities byus, pursuant to our effective shelf registration statements or otherwise,

 

·                  sales of large blocks of our commonstock, including sales by our executive officers, directors and significantstockholders,

 

·                  additions or departures of keypersonnel, and

 

·                  discussion of us or our stock priceby the financial and scientific press and in online investor communities.

 

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

 

Provisions in ouramended 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

 

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approval. In addition, because we are incorporated inDelaware, we are governed by the provisions of Section 203 of the DelawareGeneral Corporation Law, which prohibits stockholders owning in excess of 15%of our outstanding voting stock from merging or combining with us. Although webelieve these provisions collectively provide for an opportunity to receivehigher bids by requiring potential acquirers to negotiate with our board ofdirectors, they would apply even if the offer may be considered beneficial bysome stockholders. In addition, these provisions may frustrate or prevent any attemptsby our stockholders to replace or remove our current management by making itmore difficult for stockholders to replace members of our board of directors,which is responsible for appointing the members of our management.

 

***We incur costs associated with regulatory compliance, andthese costs could be significant.***

 

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

 

***If our executive officers, directors and largeststockholders choose to act together, they may be able to control our operationsand act in a manner that advances their best interests and not necessarilythose of other stockholders.***

 

Our executiveofficers, directors and holders of 5% or more of our outstanding common stock,beneficially owned approximately 82% of our common stock as of March 31,2008. 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.

 

***Future sales of our common stock may cause our stock priceto decline.***

 

A large portion ofour shares are held by a small number of persons and investment funds. Inaddition, these persons and funds hold warrants to purchase 2,833,338 shares ofcommon stock that, if exercised, will result in these additional sharesbecoming available for sale. Moreover, several of our stockholders and warrantholders 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 otherstockholders.  For example, we haveagreed to file a registration statement with the Securities and ExchangeCommission within 30 days covering the resale of the shares of common stockissued, and the shares of common stock issuable upon exercise of the warrantsissued, in our April 2008 warrant exchange and concurrent privateplacement.  Under the CEFF, an institutionalinvestor is committed to purchase up to $50 million of our common stockover a 36 month period which commenced in December 2006, subject tocertain conditions. Sales by these current and potential future stockholders orwarrant holders of a substantial number of shares could significantly reducethe market price of our common stock.

 

## **Item 2. Unregistered Sales of EquitySecurities and Use of Proceeds**

##  

None.

 

**Item 3.Defaults Upon Senior Securities**

 

None.

 

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

 

None.

 

**Item 5.Other Information**

 

None.

 

**Item 6.Exhibits**

 
| **Exhibit   Number** | ** ** | **Description**                                                                                                                           |
|----------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------|
|                 |       |                                                                                                                                      |
| 3.1(1)               |       | Amended and Restated Certificate of Incorporation of  the Company.                                                                        |
|                 |       |                                                                                                                                      |
| 3.2(2)               |       | Amended and Restated Bylaws of the Company.                                                                                               |
|                 |       |                                                                                                                                      |
| 4.1(1)               |       | Form of Common Stock Certificate.                                                                                                    |
|                 |       |                                                                                                                                      |
| 4.2(3)               |       | Amended and Restated Warrant, dated  February 15, 2008, issued by the Company to Kingsbridge Capital Limited.                        |
|                 |       |                                                                                                                                      |
| 4.3(4)               |       | Warrant to Purchase Shares of Common Stock dated  March 14, 2008 issued by the Company to Oxford Finance Corporation.                |
|                 |       |                                                                                                                                      |
| 10.1(3)              |       | Amendment to Common Stock Purchase Agreement, dated  February 15, 2008, by and between the Company and Kingsbridge Capital  Limited. |
|                 |       |                                                                                                                                      |
| 10.2(4)              |       | Termination Agreement by and between Daiichi Sankyo  Company, Ltd. and the Company dated January 30, 2008.                      |
|                 |       |                                                                                                                                      |
| 10.3(4)              |       | Loan and Security Agreement dated March 14,  2008 between the Company and Oxford Finance Corporation.                                |
|                 |       |                                                                                                                                      |
| 10.4                 |       | 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  February 15, 2008.                                                                                  |
|   |   |                                                                                                                                                                                                |
| (4)    |   | Incorporated by  reference to the Company’s Annual Report on Form 10-K for the fiscal  year ended December 31, 2007.                                                                 |

 

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**SIGNATURES**

 

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

 
| Date: May 2, 2008 | By:      | /s/ John W. Beck                                                                                                                                   |
|-----------------------------|----------|----------------------------------------------------------------------------------------------------------------------------------------------------|
| * *                    | * * | *John W. Beck, C.P.A., Senior Vice President   of Finance, Chief Financial Officer and   Treasurer (Principal Financial and   Accounting Officer)* |

 

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