** **

**UNITED STATES OF AMERICASECURITIES AND EXCHANGE COMMISSIONWASHINGTON, DC 20549**

**FORM 10-Q**
| **(Mark One)** |       |                                                                                                    |
|----------------|------------|---------------------------------------------------------------------------------------------------------|
| **x**          | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(D) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
| ** **     | ** ** | ** **                                                                                              |
| ** **     |       | **FOR THE QUARTERLY PERIOD ENDED: SEPTEMBER 30,  2006**                                                 |
| ** **     |       | ** **                                                                                              |
| **o**          | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(D) OF THE SECURITIES EXCHANGE ACT OF 1934** |

** **

**For the transition period from                 to               **

**Commission File Number: 001-32325**

**CALLISTO PHARMACEUTICALS, INC.**(Exact name of Registrant as specified in its charter)

 

| **Delaware**                                                     | ** ** | **13-3894575**                         |
|------------------------------------------------------------------|------------|----------------------------------------|
| (State or Other  Jurisdiction of  Incorporation or Organization) |       | (I.R.S. Employer    dentification No.) |
|                                                             |       |                                   |
| **420  Lexington Avenue, Suite 1609, New York, New York**   |       | **10170**                              |
| (Address of  principal executive offices)                        |       | (Zip Code)                             |

 

**(212)297-0010**(Registrant’s telephone number)

 

(Former Name, FormerAddress and Former Fiscal Year, if changed since last report)

Indicate by check markwhether the registrant: (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filing requirementsfor the past 90 days.

Yes      x                     No      o

Indicate by checkmark whether the Registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 LargeacceleratedFiler                 o         Acceleratedfiler         o           Non-acceleratedfiler           x

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).

Yes      o                     No       x

The number of the registrant’s shares of common stockoutstanding was 39,111,596 as of November 13, 2006.

 

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**CALLISTO PHARMACEUTICALS, INC.**

**FORM 10-Q**

**CONTENTS**

 
| **PART I — FINANCIAL  INFORMATION** |                                                                                                                                                                                                          |       |
|-----------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                                          |                                                                                                                                                                                                          |       |   |
| Item 1.                                       | Condensed  Consolidated Financial Statements                                                                                                                                                                  |       |   |
|                                          |                                                                                                                                                                                                          |       |   |
|                                          | Condensed Consolidated  Balance Sheets as of September 30, 2006 (unaudited) and December 31,  2005                                                                                                       |       | 1 |
|                                          |                                                                                                                                                                                                          |       |   |
|                                          | Condensed  Consolidated Statements of Operations for the Three and Nine Months Ended September  30, 2006 and 2005 (unaudited) and the period June 5, 1996 (Inception) to  September 30, 2006 (unaudited) |       | 2 |
|                                          |                                                                                                                                                                                                          |       |   |
|                                          | Condensed  Consolidated Statements of Changes in Stockholders’ Equity for the period  June 5, 1996 (Inception) to September 30, 2006 (unaudited)                                                    |       | 3 |
|                                          |                                                                                                                                                                                                          |       |   |
|                                          | Condensed  Consolidated Statements of Cash Flows for the Nine Months Ended September 30,  2006 and 2005 (unaudited) and for the period June 5, 1996 (Inception) to  September 30, 2006 (unaudited)       |       | 9 |
|                                          |                                                                                                                                                                                                          |       |   |
|                                          | Notes to  Condensed Consolidated Financial Statements (unaudited)                                                                                                                                             |       | 10 |
|                                          |                                                                                                                                                                                                          |       |   |
| Item 2.                                       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                                                                                   |       | 16 |
|                                          |                                                                                                                                                                                                          |       |   |
| Item 3.                                       | Quantitative  and Qualitative Disclosures About Market Risk                                                                                                                                                   |       | 25 |
|                                          |                                                                                                                                                                                                          |       |   |
| Item 4.                                       | Controls and  Procedures                                                                                                                                                                                      |       | 25 |
| ** **                                    | ** **                                                                                                                                                                                                    | ** ** | ** ** |
| **PART II — OTHER  INFORMATION**    |                                                                                                                                                                                                          |       |
|                                          |                                                                                                                                                                                                          |       |   |
| Item  1A.                                     | Risk  Factors                                                                                                                                                                                                 |       | 26 |
|                                          |                                                                                                                                                                                                          |       |   |
| Item 4.                                       | Submission of  Matters to a Vote of Security Holders                                                                                                                                                          |       | 26 |
|                                          |                                                                                                                                                                                                          |       |   |
| Item  6.                                      | Exhibits                                                                                                                                                                                                      |       | 27 |
|                                          |                                                                                                                                                                                                          |       |   |
| Signatures                                    |                                                                                                                                                                                                          |       |   | 28 |
|                                               |                                                                                                                                                                                                               |            |  |  |

 

** **

i

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** **

**INTRODUCTORY NOTE**

**ThisReport on Form 10-Q for Callisto Pharmaceuticals, Inc. (“Callisto” orthe “Company”) may contain forward-looking statements. You can identifythese statements by forward-looking words such as “may,” “will,” “expect,” “intend,”“anticipate,” believe,” “estimate” and “continue” or similar words.Forward-looking statements include information concerning possible or assumedfuture business success or financial results. You should read statements thatcontain these words carefully because they discuss future expectations andplans, which contain projections of future results of operations or financialcondition or state other forward-looking information.  We believe that itis important to communicate future expectations to investors. However, theremay be events in the future that we are not able to accurately predict orcontrol. Accordingly, we do not undertake any obligation to update anyforward-looking statements for any reason, even if new information becomesavailable or other events occur in the future.**

**Theforward-looking statements included herein are based on current expectationsthat involve a number of risks and uncertainties set forth under “Risk Factors”in our Annual Report on Form 10-K/A for the year ended December 31,2005 and other periodic reports filed with the SEC. Accordingly, to the extentthat this Report contains forward-looking statements regarding the financialcondition, operating results, business prospects or any other aspect of theCompany, please be advised that Callisto’s actual financial condition,operating results and business performance may differ materially from thatprojected or estimated by the Company in forward-looking statements.**

ii

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**PART I -FINANCIAL INFORMATION**

**Item 1. CondensedConsolidated Financial Statements**

**CALLISTO PHARMACEUTICALS, INC.(A development stage company)**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                                            | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                            | ** ** | **(Unaudited)**              | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                                                                            |       |                         |       |                        |       |
| Current assets:                                                                                                                                                       |       |                         |       |                        |       |
| Cash and cash  equivalents                                                                                                                                            |       | $                            | 124,017    |                        | $          | 1,420,510 |   |
| Prepaid expenses                                                                                                                                                      |       | 117,837                      |       | 181,284                     |       |
|                                                                                                                                                                  |       | 241,854                      |       | 1,601,794                   |       |
|                                                                                                                                                                  |       |                         |       |                        |       |
| Property and equipment  — net                                                                                                                                    |       | 7,168                        |       | —                      |       |
| Rent deposits                                                                                                                                                         |       | 73,716                       |       | 82,196                      |       |
|                                                                                                                                                                  |       | $                            | 322,738    |                        | $          | 1,683,990 |   |
| **Liabilities  and Stockholders’ Deficit**                                                                                                                       |       |                         |       |                        |       |
| Current liabilities:                                                                                                                                                  |       |                         |       |                        |       |
| Accounts payable                                                                                                                                                      |       | $                            | 1,737,415  |                        | 1,424,612  |   |
| Accrued expenses                                                                                                                                                      |       | 969,045                      |       | 592,297                     |       |
| Liquidated  damages payable                                                                                                                                           |       | 185,159                      |       | —                      |       |
|                                                                                                                                                                  |       | 2,891,619                    |       | 2,016,909                   |       |
| Stockholders’ deficit:                                                                                                                                           |       |                         |       |                        |       |
| Common stock,  par value $.0001, 100,000,000 shares authorized, 38,454,931 and 33,233,096  outstanding at September 30, 2006 and December 31, 2005, respectively |       | 3,845                        |       | 3,323                       |       |
|                                                                                                                                                                  |       |                         |       |                        |       |
| Additional  paid-in capital                                                                                                                                           |       | 52,288,874                   |       | 46,387,875                  |       |
| Unamortized  deferred stock-based compensation                                                                                                                        |       | —                       |       | (1,583,463                  | )          |
| Deficit  accumulated during development stage                                                                                                                         |       | (54,861,600                  | )          | (45,140,654                 | )          |
|                                                                                                                                                                  |       | (2,568,881                   | )          | (332,919                    | )          |
|                                                                                                                                                                  |       | $                            | 322,738    |                        | $          | 1,683,990 |   |

 

The accompanying notes are an integral part ofthese condensed consolidated financial statements.

1

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** **

**CALLISTO PHARMACEUTICALS, INC.(A development stage company)**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS(Unaudited)**
| ** **                                     | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** | **June 5, 1996  (Inception) to** | ** ** |
|------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                     | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006**                                        | ** ** | **2005** | ** ** | **September 30, 2006** | ** ** |
|                                           |       |                                                 |       |                                                |       |                                            |       |   |   |   |   |
| Revenues                                       |       | $                                                    | —     |                                                | $          | —                                          |       | $ | — |   | $ | — |   | $ | — |   |
|                                           |       |                                                 |       |                                                |       |                                            |       |   |   |   |   |
| Costs and  expenses:                           |       |                                                 |       |                                                |       |                                            |       |   |   |   |   |
|                                           |       |                                                 |       |                                                |       |                                            |       |   |   |   |   |
| Research and  development                      |       | 1,139,094                                            |       | 1,787,956                                           |       | 4,898,524                                       |       | 4,946,525 |   | 20,904,386 |   |
|                                           |       |                                                 |       |                                                |       |                                            |       |   |   |   |   |
| Government grants                              |       | (43,956                                              | )          | (152,866                                            | )          | (299,378                                        | )          | (152,866 | ) | (791,194 | ) |
|                                           |       |                                                 |       |                                                |       |                                            |       |   |   |   |   |
| Purchased in  process research and development |       | —                                               |       | —                                              |       | —                                          |       | — |   | 6,944,553 |   |
|                                           |       |                                                 |       |                                                |       |                                            |       |   |   |   |   |
| General and  administrative                    |       | 800,803                                              |       | 1,212,480                                           |       | 4,012,012                                       |       | 3,312,858 |   | 19,652,878 |   |
|                                           |       |                                                 |       |                                                |       |                                            |       |   |   |   |   |
| Stock based  compensation — non employees |       | (139,501                                             | )          | 506,199                                             |       | 820,747                                         |       | 509,931 |   | 9,145,317 |   |
|                                           |       |                                                 |       |                                                |       |                                            |       |   |   |   |   |
| Loss from  operations                          |       | (1,756,440                                           | )          | (3,353,769                                          | )          | (9,431,905                                      | )          | (8,616,448 | ) | (55,855,940 | ) |
|                                           |       |                                                 |       |                                                |       |                                            |       |   |   |   |   |
| Interest and  investment income                |       | 3,304                                                |       | 33,200                                              |       | 45,405                                          |       | 91,071 |   | 700,390 |   |
| Other income (expense)                         |       | (177,010                                             | )          | —                                              |       | (334,446                                        | )          | — |   | 293,950 |   |
|                                           |       |                                                 |       |                                                |       |                                            |       |   |   |   |   |
| Net loss                                       |       | $                                                    | (1,930,146 | )                                                   | $          | (3,320,569                                      | )          | $ | (9,720,946 | ) | $ | (8,525,377 | ) | $ | (54,861,600 | ) |
|                                           |       |                                                 |       |                                                |       |                                            |       |   |   |   |   |
| Weighted average  shares outstanding:          |       |                                                 |       |                                                |       |                                            |       |   |   |   |   |
| basic and diluted                              |       | 38,454,931                                           |       | 31,867,103                                          |       | 37,558,910                                      |       | 30,954,422 |   |   |   |
|                                           |       |                                                 |       |                                                |       |                                            |       |   |   |   |   |
| Net loss per  common share:                    |       |                                                 |       |                                                |       |                                            |       |   |   |   |   |
| basic and diluted                              |       | $                                                    | (0.05      | )                                                   | $          | (0.10                                           | )          | $ | (0.26 | ) | $ | (0.28 | ) |   |   |

 

The accompanying notes are an integral part of thesecondensed consolidated financial statements

2

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**CALLISTOPHARMACEUTICALS, INC.(A Development Stage Company)CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (DEFICIT)(Unaudited)**

 
| ** **                                                  | ** ** | **Preferred  Shares** | ** ** | **Preferred  Stock,  Par Value** | ** ** | **Common  Shares** | ** ** | **Common  Stock,  Par Value** | ** ** | **Additional  Paid  in Capital** | ** ** |
|-------------------------------------------------------------|------------|-----------------------|------------|---------------------------------------|------------|--------------------|------------|------------------------------------|------------|---------------------------------------|------------|
| Balance at inception, June 5, 1996 |       | —                |       | $                                     | —     |               | —     |                               | $          | —                                |       | $ | — |   |
| Net loss for the period                                     |       |                  |       |                                  |       |               |       |                               |       |                                  |       |
| Issuance of founder  shares                                 |       | —                |       | —                                |       | 2,642,500          |       | 264                                |       | 528                                   |       |
| Common stock issued                                         |       | —                |       | —                                |       | 1,356,194          |       | 136                                |       | 272                                   |       |
| Common stock issued via  private placement                  |       | —                |       | —                                |       | 1,366,667          |       | 137                                |       | 1,024,863                             |       |
| Balance,  December 31, 1996                            |       | —                |       | —                                |       | 5,365,361          |       | 537                                |       | 1,025,663                             |       |
| Net loss for the year                                       |       | —                |       | —                                |       | —             |       | —                             |       | —                                |       |
| Common stock issued via  private placement                  |       | —                |       | —                                |       | 1,442,666          |       | 144                                |       | 1,081,855                             |       |
| Balance,  December 31, 1997                            |       | —                |       | —                                |       | 6,808,027          |       | 681                                |       | 2,107,518                             |       |
| Net loss for the year                                       |       | —                |       | —                                |       | —             |       | —                             |       | —                                |       |
| Amortization of Stock  based Compensation                   |       | —                |       | —                                |       | —             |       | —                             |       | 52,778                                |       |
| Common stock issued via  private placement                  |       | —                |       | —                                |       | 1,416,667          |       | 142                                |       | 1,062,358                             |       |
| Common stock issued for  services                           |       | —                |       | —                                |       | 788,889            |       | 79                                 |       | 591,588                               |       |
| Common stock  repurchased and cancelled                     |       | —                |       | —                                |       | (836,792           | )          | (84                                | )          | (96,916                               | )          |
| Balance,  December 31, 1998                            |       | —                |       | —                                |       | 8,176,791          |       | 818                                |       | 3,717,326                             |       |
| Net loss for the year                                       |       | —                |       | —                                |       | —             |       | —                             |       | —                                |       |
| Deferred Compensation -  stock options                      |       | —                |       | —                                |       | —             |       | —                             |       | 9,946                                 |       |
| Amortization of Stock  based Compensation                   |       | —                |       | —                                |       | —             |       | —                             |       | —                                |       |
| Common stock issued for  services                           |       | —                |       | —                                |       | —             |       | —                             |       | 3,168,832                             |       |
| Common stock issued via  private placement                  |       | —                |       | —                                |       | 346,667            |       | 34                                 |       | 259,966                               |       |
| Balance,  December 31, 1999                            |       | —                |       | —                                |       | 8,523,458          |       | 852                                |       | 7,156,070                             |       |
| Net loss for the year                                       |       | —                |       | —                                |       | —             |       | —                             |       | —                                |       |
| Amortization of Stock  based Compensation                   |       | —                |       | —                                |       | —             |       | —                             |       | —                                |       |
| Common stock issued                                         |       | —                |       | —                                |       | 4,560,237          |       | 455                                |       | 250,889                               |       |
| Other                                                       |       | —                |       | —                                |       | —             |       | —                             |       | 432                                   |       |
| Preferred shares issued                                     |       | 3,485,299             |       | 348                                   |       | —             |       | —                             |       | 5,986,302                             |       |
| Preferred stock issued  for services                        |       | 750,000               |       | 75                                    |       | —             |       | —                             |       | 1,124,925                             |       |
| Balance,  December 31, 2000                            |       | 4,235,299             |       | 423                                   |       | 13,083,695         |       | 1,307                              |       | 14,518,618                            |       |
| Net loss for the year                                       |       | —                |       | —                                |       | —             |       | —                             |       | —                                |       |
| Deferred Compensation -  stock Options                      |       | —                |       | —                                |       | —             |       | —                             |       | 20,000                                |       |
| Amortization of Stock  based Compensation                   |       | —                |       | —                                |       | —             |       | —                             |       | —                                |       |
| Balance,  December 31, 2001                            |       | 4,235,299             |       | 423                                   |       | 13,083,695         |       | 1,307                              |       | 14,538,618                            |       |
| Net loss for the year                                       |       | —                |       | —                                |       | —             |       | —                             |       | —                                |       |
| Amortization of Stock  based Compensation                   |       | —                |       | —                                |       | —             |       | —                             |       | —                                |       |
| Balance, December 31, 2002                             |       | 4,235,299             |       | $                                     | 423        |               | 13,083,695 |                               | $          | 1,307                                 |       | $ | 14,538,618 |   |

 

The accompanying notes are an integral part ofthese condensed consolidated financial statements

3

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| ** **                                 | ** ** | **Unamortized  Deferred  Stock Based  Compensation** | ** ** | **Deficit  Accumulated  during the  Development  Stage** | ** ** | **Total  Stockholders’  Equity** | ** ** |
|--------------------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------|------------|
| Balance at  inception, June 5, 1996   |       | $                                                         | —     |                                                          | $          | —                                |       | $ | — |   |
| Net loss for the  year                     |       |                                                      |       | (404,005                                                      | )          | (404,005                              | )          |
| Issuance of  founder shares                |       | —                                                    |       | —                                                        |       | 792                                   |       |
| Common stock  issued                       |       | —                                                    |       | —                                                        |       | 408                                   |       |
| Common stock  issued via private placement |       | —                                                    |       | —                                                        |       | 1,025,000                             |       |
| Balance,  December 31, 1996           |       | —                                                    |       | (404,005                                                      | )          | 622,195                               |       |
| Net loss for the  year                     |       | —                                                    |       | (894,505                                                      | )          | (894,505                              | )          |
| Common stock  issued via private placement |       | —                                                    |       | —                                                        |       | 1,081,999                             |       |
| Balance,  December 31, 1997           |       | —                                                    |       | (1,298,510                                                    | )          | 809,689                               |       |
| Net loss for the  year                     |       | —                                                    |       | (1,484,438                                                    | )          | (1,484,438                            | )          |
| Amortization of  Stock based Compensation  |       | —                                                    |       | —                                                        |       | 52,778                                |       |
| Common stock  issued                       |       |                                                      |       |                                                          |       | 1,062,500                             |       |
| Common stock  issued for services          |       | —                                                    |       | —                                                        |       | 591,667                               |       |
| Common Stock  repurchased and cancelled    |       | —                                                    |       | —                                                        |       | (97,000                               | )          |
| Balance,  December 31, 1998           |       | —                                                    |       | (2,782,948                                                    | )          | 935,196                               |       |
| Net loss for the  year                     |       | —                                                    |       | (4,195,263                                                    | )          | (4,195,263                            | )          |
| Deferred  Compensation - stock options     |       | (9,946                                                    | )          | —                                                        |       | —                                |       |
| Amortization of  Stock based Compensation  |       | 3,262                                                     |       | —                                                        |       | 3,262                                 |       |
| Common stock  issued for services          |       | —                                                    |       | —                                                        |       | 3,168,832                             |       |
| Common stock  issued via private placement |       | —                                                    |       | —                                                        |       | 260,000                               |       |
| Balance,  December 31, 1999           |       | (6,684                                                    | )          | (6,978,211                                                    | )          | 172,027                               |       |
| Net loss for the  year                     |       |                                                      |       | (2,616,261                                                    | )          | (2,616,261                            | )          |
| Amortization of  Stock based Compensation  |       | 4,197                                                     |       |                                                          |       | 4,197                                 |       |
| Common stock  issue                        |       | —                                                    |       | —                                                        |       | 251,344                               |       |
| Other                                      |       | —                                                    |       | —                                                        |       | 432                                   |       |
| Preferred shares  issued                   |       | —                                                    |       | —                                                        |       | 5,986,650                             |       |
| Preferred stock  issued for services       |       | —                                                    |       | —                                                        |       | 1,125,000                             |       |
| Balance,  December 31, 2000           |       | (2,487                                                    | )          | (9,594,472                                                    | )          | 4,923,389                             |       |
| Net loss for the  year                     |       | —                                                    |       | (1,432,046                                                    | )          | (1,432,046                            | )          |
| Deferred  Compensation - stock options     |       | (20,000                                                   | )          | —                                                        |       | —                                |       |
| Amortization of  Stock based Compensation  |       | 22,155                                                    |       | —                                                        |       | 22,155                                |       |
| Balance,  December 31, 2001           |       | (332                                                      | )          | (11,026,518                                                   | )          | 3,513,498                             |       |
| Net loss for the  year                     |       | —                                                    |       | (1,684,965                                                    | )          | (1,684,965                            | )          |
| Amortization of  Stock based Compensation  |       | 332                                                       |       | —                                                        |       | 332                                   |       |
| Balance,  December 31, 2002           |       | $                                                         | —     |                                                          | $          | (12,711,483                           | )          | $ | 1,828,865 |   |

 

The accompanying notes are an integral part ofthese condensed consolidated financial statements

4

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| ** **                                                   | ** ** | **Preferred  Stock** | ** ** | **Preferred  Stock  Par  Value** | ** ** | **Common  Stock** | ** ** | **Common  Stock  Par  Value** | ** ** | **Additional  Paid in  Capital** | ** ** | **Unamortized  Deferred  Stock Based  Compensation** | ** ** | **Deficit  Accumulated  during the  Development  Stage** | ** ** | **Total  Stockholders’  Equity** | ** ** |
|--------------------------------------------------------------|------------|----------------------|------------|----------------------------------|------------|-------------------|------------|-------------------------------|------------|---------------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------|------------|
| Balance  December 31, 2002                              |       | 4,235,299            |       | $                                | 423        |              | 13,083,695 |                          | $          | 1,307                                 |       | $                                                         | 14,538,618 |                                                          | $          | —                                |       | $ | (12,711,483 | ) | $ | 1,828,865 |   |
|                                                         |       |                 |       |                             |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| Net loss for the  year                                       |       | —               |       | —                           |       | —            |       | —                        |       | —                                |       | —                                                    |       | (13,106,247                                                   | )          | (13,106,247                           | )          |
|                                                         |       |                 |       |                             |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| Conversion of  preferred stock in connection with the Merger |       | (4,235,299           | )          | (423                             | )          | 4,235,299         |       | 423                           |       | —                                |       | —                                                    |       | —                                                        |       | —                                |       |
|                                                         |       |                 |       |                             |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| Common stock  issued to former Synergy stockholders          |       | —               |       |                             |       | 4,329,927         |       | 432                           |       | 6,494,458                             |       | —                                                    |       | —                                                        |       | 6,494,890                             |       |
|                                                         |       |                 |       |                             |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| Common stock  issued in exchange for Webtronics common stock |       | —               |       |                             |       | 1,503,173         |       | 150                           |       | (150                                  | )          | —                                                    |       | —                                                        |       | —                                |       |
|                                                         |       |                 |       |                             |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| Deferred  Compensation - stock options                       |       | —               |       |                             |       | —            |       | —                        |       | 9,313,953                             |       | (9,313,953                                                | )          | —                                                        |       | —                                |       |
|                                                         |       |                 |       |                             |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| Amortization of  deferred Stock based Compensation           |       | —               |       | —                           |       |              |       | —                        |       | —                                |       | 3,833,946                                                 |       | —                                                        |       | 3,833,946                             |       |
|                                                         |       |                 |       |                             |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| Private placement  of common stock, net                      |       | —               |       | —                           |       | 2,776,666         |       | 278                           |       | 3,803,096                             |       | —                                                    |       | —                                                        |       | 3,803,374                             |       |
| Balance,  December 31, 2003                             |       | —               |       | $                                | —     |              | 25,928,760 |                          | $          | 2,590                                 |       | $                                                         | 34,149,975 |                                                          | $          | (5,480,007                            | )          | $ | (25,817,730 | ) | $ | 2,854,828 |   |

 

The accompanying notes are an integral part ofthese condensed consolidated financial statements

5

----

 

 
| ** **                                                                       | ** ** | **Preferred  Stock** | ** ** | **Preferred  Stock  Par  Value** | ** ** | **Common  Stock** | ** ** | **Common  Stock  Par  Value** | ** ** | **Additional  Paid in  Capital** | ** ** | **Unamortized  Deferred  Stock Based  Compensation** | ** ** | **Deficit  Accumulated  during the  Development  Stage** | ** ** | **Total  Stockholders’  Equity** | ** ** |
|----------------------------------------------------------------------------------|------------|----------------------|------------|----------------------------------|------------|-------------------|------------|-------------------------------|------------|---------------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------|------------|
| Balance,  December 31, 2003                                                 |       | —               |       | $                                | —     |              | 25,928,760 |                          | $          | 2,590                                 |       | $                                                         | 34,149,975 |                                                          | $          | (5,480,007                            | )          | $ | (25,817,730 | ) | $ | 2,854,828 |   |
|                                                                             |       |                 |       |                             |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| Net loss for the  period                                                         |       | —               |       | —                           |       | —            |       | —                        |       | —                                |       | —                                                    |       | (7,543,467                                                    | )          | (7,543,467                            | )          |
|                                                                             |       |                 |       |                             |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| Amortization of  deferred Stock-based compensation expense                       |       | —               |       | —                           |       | —            |       | —                        |       | —                                |       | 3,084,473                                                 |       | —                                                        |       | 3,084,473                             |       |
|                                                                             |       |                 |       |                             |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| Variable accounting  for stock options                                           |       | —               |       | —                           |       | —            |       | —                        |       | (816,865                              | )          | —                                                    |       | —                                                        |       | (816,865                              | )          |
|                                                                             |       |                 |       |                             |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| Stock-based  compensation net of forfeitures                                     |       | —               |       | —                           |       | —            |       | —                        |       | 240,572                               |       | 93,000                                                    |       | —                                                        |       | 333,572                               |       |
|                                                                             |       |                 |       |                             |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| Common stock  issued via private placements, net                                 |       | —               |       | —                           |       | 3,311,342         |       | 331                           |       | 6,098,681                             |       | —                                                    |       | —                                                        |       | 6,099,012                             |       |
|                                                                             |       |                 |       |                             |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| Warrant and  stock-based compensation for services in connection with the Merger |       | —               |       | —                           |       | —            |       | —                        |       | 269,826                               |       | —                                                    |       | —                                                        |       | 269,826                               |       |
|                                                                             |       |                 |       |                             |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| Common stock  returned from former Synergy stockholders                          |       | —               |       | —                           |       | (90,000           | )          | (9                            | )          | (159,083                              | )          | —                                                    |       | —                                                        |       | (159,092                              | )          |
|                                                                             |       |                 |       |                             |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| Stock issued for  patent rights                                                  |       | —               |       | —                           |       | 25,000            |       | 3                             |       | 56,247                                |       | —                                                    |       | —                                                        |       | 56,250                                |       |
|                                                                             |       |                 |       |                             |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                  |       |
| Common stock  issued for services                                                |       | —               |       | —                           |       | 44,000            |       | 7                             |       | 70,833                                |       | —                                                    |       | —                                                        |       | 70,840                                |       |
| Balance,  December 31, 2004                                                 |       | —               |       | $                                | —     |              | 29,219,102 |                          | $          | 2,922                                 |       | $                                                         | 39,910,187 |                                                          | $          | (2,302,534                            | )          | $ | (33,361,197 | ) | $ | 4,249,378 |   |

 

The accompanying notes are an integral part ofthese condensed consolidated financial statements

6

----

 
| ** **                                         | ** ** | **Common  Stock** | ** ** | **Common  Stock  Par  Value** | ** ** | **Additional  Paid in  Capital** | ** ** | **Unamortized  Deferred  Stock Based  Compensation** | ** ** | **Deficit  Accumulated  during the  Development  Stage** | ** ** | **Total  Stockholders’  Equity (Deficit)** | ** ** |
|----------------------------------------------------|------------|-------------------|------------|-------------------------------|------------|---------------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------------------------------|------------|------------------------------------------------------|------------|
| Balance,  December 31, 2004                   |       | 29,219,102        |       | $                             | 2,922      |                                  | $          | 39,910,187                                                |       | $                                                             | (2,302,534 | )                                                    | $          | (33,361,197 | ) | $ | 4,249,378 |   |
|                                               |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                                 |       |
| Net loss for the year                              |       | —            |       | —                        |       | —                                |       | —                                                    |       | (11,779,457                                                   | )          | (11,779,457                                          | )          |
|                                               |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                                 |       |
| Deferred stock-based  compensation - new grants    |       | —            |       | —                        |       | 1,571,772                             |       | (1,571,772                                                | )          | —                                                        |       | —                                               |       |
|                                               |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                                 |       |
| Amortization of  deferred stock-based compensation |       | —            |       | —                        |       | —                                |       | 2,290,843                                                 |       | —                                                        |       | 2,290,843                                            |       |
|                                               |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                                 |       |
| Variable accounting for  stock options             |       | —            |       | —                        |       | 75,109                                |       | —                                                    |       | —                                                        |       | 75,109                                               |       |
|                                               |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                                 |       |
| Common stock issued via  private placement:        |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                                 |       |
| March 2005                                    |       | 1,985,791         |       | 198                           |       | 3,018,203                             |       | —                                                    |       | —                                                        |       | 3,018,401                                            |       |
| August 2005                                   |       | 1,869,203         |       | 187                           |       | 1,812,940                             |       | —                                                    |       | —                                                        |       | 1,813,127                                            |       |
| Finders fees and  expenses                         |       | —            |       | —                        |       | (176,250                              | )          | —                                                    |       | —                                                        |       | (176,250                                             | )          |
|                                               |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                                 |       |
| Exercise of common  stock warrant                  |       | 125,000           |       | 13                            |       | 128,737                               |       | —                                                    |       | —                                                        |       | 128,750                                              |       |
|                                               |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                                 |       |
| Common stock issued for  services                  |       | 34,000            |       | 3                             |       | 47,177                                |       | —                                                    |       | —                                                        |       | 47,180                                               |       |
| Balance, December 31, 2005                    |       | 33,233,096        |       | $                             | 3,323      |                                  | $          | 46,387,875                                                |       | $                                                             | (1,583,463 | )                                                    | $          | (45,140,654 | ) | $ | (332,919 | ) |

 

The accompanying notes are an integral part ofthese condensed consolidated financial statements

7

----

 
| ** **                                                                                   | ** ** | **Common  Stock** | ** ** | **Common  Stock  Par  Value** | ** ** | **Additional  Paid in  Capital** | ** ** | **Unamortized  Deferred  Stock Based  Compensation** | ** ** | **Deficit  Accumulated  during the  Development  Stage** | ** ** | **Total  Stockholders’  Deficit** | ** ** |
|----------------------------------------------------------------------------------------------|------------|-------------------|------------|-------------------------------|------------|---------------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------------------------------|------------|----------------------------------------|------------|
| Balance,  December 31, 2005                                                             |       | 33,233,096        |       | $                             | 3,323      |                                  | $          | 46,387,875                                                |       | $                                                             | (1,583,463 | )                                      | $          | (45,140,654 | ) | $ | (332,919 | ) |
|                                                                                         |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                   |       |
| Net loss for the  nine months ended September 30, 2006                                       |       | —            |       | —                        |       | —                                |       | —                                                    |       | (9,720,946                                                    | )          | (9,720,946                             | )          |
|                                                                                         |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                   |       |
| Reclassification  of deferred unamortized stock-based compensation upon adoption of FAS 123R |       | —            |       | —                        |       | (1,583,463                            | )          | 1,583,463                                                 |       | —                                                        |       | —                                 |       |
|                                                                                         |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                   |       |
| Stock based  compensation expense                                                            |       | —            |       | —                        |       | 1,836,437                             |       | —                                                    |       | —                                                        |       | 1,836,437                              |       |
|                                                                                         |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                   |       |
| Common stock  issued via private placement:                                                  |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                   |       |
| February 2006                                                                           |       | 4,283,668         |       | 428                           |       | 5,139,782                             |       | —                                                    |       | —                                                        |       | 5,140,210                              |       |
| Finders’ fees  and expenses - February 2006                                             |       | —            |       | —                        |       | (561,808                              | )          | —                                                    |       | —                                                        |       | (561,808                               | )          |
| April 2006                                                                                   |       | 666,667           |       | 67                            |       | 799,933                               |       | —                                                    |       | —                                                        |       | 800,000                                |       |
| Finders’ fees  and legal exp - April 2006                                               |       | —            |       | —                        |       | (41,000                               | )          | —                                                    |       | —                                                        |       | (41,000                                | )          |
|                                                                                         |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                   |       |
| Exercise of  common stock warrants                                                           |       | 184,500           |       | 18                            |       | 190,017                               |       | —                                                    |       | —                                                        |       | 190,035                                |       |
|                                                                                         |       |              |       |                          |       |                                  |       |                                                      |       |                                                          |       |                                   |       |
| Common stock  issued for services                                                            |       | 87,000            |       | 9                             |       | 121,101                               |       |                                                      |       |                                                          |       | 121,110                                |       |
| Balance, September 30,  2006                                                                 |       | 38,454,931        |       | $                             | 3,845      |                                  | $          | 52,288,874                                                |       | $                                                             | —     |                                   | $          | (54,861,600 | ) | $ | (2,568,881 | ) |

 

The accompanying notes are an integral part ofthese condensed consolidated financial statements

8

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** **

**CALLISTO PHARMACEUTICALS, INC.(A Development Stage Company)**

**CONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS(Unaudited)**

 
| ** **                                                                   | ** ** | **Nine months Ended September 30,** | ** ** | **Period from  June 5, 1996  (inception) to** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2006**                                                | ** ** | **2005**                                                          | ** ** | **September 30, 2006** | ** ** |
| Cash flows from  operating activities:                                       |       |                                                    |       |                                                              |       |   |   |
| Net loss                                                                     |       | $                                                       | (9,720,946 | )                                                                 | $          | (8,525,377 | ) | $ | (54,861,600 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |                                                    |       |                                                              |       |   |   |
| Depreciation                                                                 |       | 1,434                                                   |       | 15,217                                                            |       | 86,071 |   |
| Stock based  compensation expense                                            |       | 1,996,921                                               |       | 1,657,743                                                         |       | 15,767,889 |   |
| Purchased  in-process research and development (non-cash portion)            |       | —                                                  |       | —                                                            |       | 6,841,053 |   |
| Changes in  operating assets and liabilities:                                |       |                                                    |       |                                                              |       |   |   |
| Prepaid expenses                                                             |       | 63,447                                                  |       | (44,241                                                           | )          | (117,837 | ) |
| Rent deposits                                                                |       | 8,480                                                   |       | —                                                            |       | (73,716 | ) |
| Accounts payable  and accrued expenses                                       |       | 835,336                                                 |       | 459,261                                                           |       | 2,605,753 |   |
| Total  adjustments                                                           |       | 2,905,618                                               |       | 2,087,980                                                         |       | 25,109,213 |   |
| Net cash used in  operating activities                                       |       | (6,815,328                                              | )          | (6,437,397                                                        | )          | (29,752,387 | ) |
|                                                                         |       |                                                    |       |                                                              |       |   |   |
| Cash flows from  investing activities:                                       |       |                                                    |       |                                                              |       |   |   |
| Acquisition of  equipment                                                    |       | (8,602                                                  | )          | —                                                            |       | (93,239 | ) |
| Net cash used in  investing activities                                       |       | (8,602                                                  | )          | —                                                            |       | (93,239 | ) |
|                                                                         |       |                                                    |       |                                                              |       |   |   |
| Cash flows from  financing activities:                                       |       |                                                    |       |                                                              |       |   |   |
| Issuance of  common and preferred stock, net of repurchases                  |       | 5,940,210                                               |       | 4,831,528                                                         |       | 31,225,673 |   |
| Finders’ fees  and expenses                                             |       | (602,808                                                | )          | (176,250                                                          | )          | (1,574,815 | ) |
| Exercise of  common stock warrants                                           |       | 190,035                                                 |       | —                                                            |       | 318,785 |   |
| Net cash  provided by financing activities                                   |       | 5,527,437                                               |       | 4,655,278                                                         |       | 29,969,643 |   |
|                                                                         |       |                                                    |       |                                                              |       |   |   |
| Net (decrease) increase  in cash and cash equivalents                        |       | (1,296,493                                              | )          | (1,782,119                                                        | )          | 124,017 |   |
|                                                                         |       |                                                    |       |                                                              |       |   |   |
| Cash and cash  equivalents at beginning of period                            |       | 1,420,510                                               |       | 5,323,384                                                         |       | — |   |
| Cash and cash  equivalents at end of period                                  |       | $                                                       | 124,017    |                                                              | $          | 3,541,265 |   | $ | 124,017 |   |
| Supplementary  disclosure of cash flow information:                          |       |                                                    |       |                                                              |       |   |   |
| Cash paid for  taxes                                                         |       | $                                                       | 6,409      |                                                              | $          | 43,043 |   | $ | 116,016 |   |
| Cash paid for interest                                                       |       | $                                                       | —     |                                                              | $          |   |   | $ |   |   |

 

The accompanying notes are an integral part ofthese condensed consolidated financial statements.

9

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**CALLISTO PHARMACEUTICALS, INC.**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS(Unaudited)**

1. Basis of presentation:

The accompanyingunaudited condensed consolidated financial statements of CallistoPharmaceuticals, Inc. (“Callisto”), which include its wholly ownedsubsidiaries: (1) Callisto Research Labs, LLC (including its wholly ownedbut inactive subsidiary, Callisto Pharma, GmbH (Germany)) and (2) SynergyPharmaceuticals Inc. (“Synergy” , including its wholly owned but inactivesubsidiary IgX, Ltd (Ireland)), have been prepared in accordance with(i) accounting principles generally accepted in the United States ofAmerica (“GAAP”) for interim financial information and (ii) therules of the Securities and Exchange Commission (the “SEC”) for quarterlyreports on Form 10-Q. The results of operations of Synergy are included inthe condensed consolidated financial statements since May 1, 2003. Allintercompany balances and transactions have been eliminated and certain expenseitems in prior periods have been reclassified to conform to currentfinancial statement presentation. These condensed consolidated financialstatements do not include all of the information and footnote disclosuresrequired by GAAP for complete financial statements. These statements should beread in conjunction with Callisto’s audited financial statements and notesthereto for the year ended December 31, 2005, included in Form 10-K/Afiled with the SEC on April 18, 2006. In the opinion of management, theaccompanying unaudited condensed consolidated financial statements include alladjustments, primarily consisting of normal adjustments, necessary for the fairpresentation of the balance sheet and results of operations for the interimperiods. The results of operations for the three and nine months endedSeptember 30, 2006 are not necessarily indicative of the results of operationsto be expected for the full year ending December 31, 2006.

The audited financialstatements and notes thereto for the year ended December 31, 2005, includedin Form 10-K/A filed with the SEC on April 18, 2006, have beenprepared under the assumption that Callisto will continue as a going concernfor the twelve months ending December 31, 2006. Callisto’s independentregistered public accounting firm has issued a report dated March 29, 2006that included an explanatory paragraph referring to recurring losses fromoperations and expressing substantial doubt in Callisto’s ability to continueas a going concern without additional capital becoming available. The financialstatements do not include any adjustments that might result from theunfavorable outcome of this ongoing uncertainty. Callisto will be required toraise additional capital to complete the development and commercialization ofcurrent product candidates and to continue to fund operations at our currentcash expenditure levels. The assets and liability carrying amounts do notrepresent net realizable or settlement values.

To date, oursources of cash have been primarily limited to the sale of our equitysecurities. We cannot be certain that additional funding will be available onacceptable terms, or at all. To the extent that we raise additional funds byissuing equity securities, our stockholders may experience significantdilution. Any debt financing, if available, may involve restrictive covenantsthat impact our ability to conduct our business. As of September 30, 2006Callisto’s cash balance was $124,017.  OnOctober 23, 2006 Callisto closed on the sale of shares of Series A PreferredStock and warrants to purchase common stock for net proceeds of $1,010,000 (SeeNote 7 “Subsequent events”). If we are unable to raise additional capital whenrequired or on acceptable terms, we may have to significantly delay, scale backor discontinue the development and/or commercialization of one or more of ourproduct candidates.

2. Accounting forstock based compensation

InDecember 2004, the Financial Accounting Standards Board (FASB) issuedStatement of Financial Accounting Standard (“SFAS”) No. 123 (Revised 2004),*Share-Based Payments* (“SFAS 123R”).SFAS 123R requires a public entity to measure the cost of employee servicesreceived in exchange for the award of equity instruments based on the fairvalue of the award at the date of grant. The expense is to be recognized overthe period during which an employee is required to provide services in exchangefor the award. SFAS 123R is effective as of the beginning of the first interimor annual reporting period that begins after December 15, 2005 andaccordingly Callisto adopted SFAS 123R on January 1 , 2006.

SFAS 123R providesfor two transition methods. The “modified *prospective”*method requires that share-based compensation expense be recorded for anyemployee options granted after the adoption date and for the unvested portionof any employee options outstanding as of the adoption date. The “ *modified retrospective**”* method requires that, beginning in thefirst quarter of 2006, all prior periods presented be restated to reflect theimpact of share-based compensation expense consistent with the proformadisclosures previously required under SFAS 123. Callisto has elected to use the“modified *prospective*” inadopting this standard.

10

----

 

Prior toJanuary 1, 2006, Callisto had adopted SFAS No. 123, “Accounting forStock-Based Compensation” (“SFAS 123”). As provided for by SFAS 123, Callistohad elected to continue to account for stock-based compensation according tothe provisions of Accounting Principles Board Opinion No. 25, “Accountingfor Stock Issued to Employees” (“APB 25”). Accordingly, compensation expensehad been recognized to the extent of employee or director services renderedbased on the intrinsic value of stock options granted under the plan. Callistoaccounts for common stock, stock options, and warrants granted to non-employeesbased on the fair market value of the instrument, using the Black-Scholesoption pricing model based on assumptions for expected stock price volatility,term of the option, risk-free interest rate and expected dividend yield at thegrant date.

For all awards grantedprior to January 1, 2006, the unearned deferred fair value of stock basedcompensation is being recognized as an expense on a straight line basis overthe remaining requisite service period, ranging from nine months to threeyears. Our financial results for prior periods have not been restated. Theadoption of SFAS 123R increased net loss for the three and nine months endedSeptember 30, 2006 by $225,401 and $1,176,174, respectively, for stock basedcompensation cost related to employee stock options. The unrecognizedcompensation cost related to non-vested share-based compensation arrangementsfor all employee stock options outstanding at September 30, 2006, as measuredat the date of grant, was approximately $899,000

Effective with theadoption of SFAS 123R stock-based compensation expense related to Callisto’sshare-based compensation arrangements attributable to employees is beingrecorded as a component of general and administrative expense and research anddevelopment expense in accordance with the guidance of Staff AccountingBulletin 107 **,** Topic 14, paragraphF *. Classification of Compensation ExpenseAssociated with Share-Based Payment Arrangements* (“SAB 107”). Priorperiod financial statement accounts have been reclassified to conform tothis presentation.

Stock basedcompensation expense related to employee and non-employee stock optionsrecognized in operating results for the three and nine months ended September30, 2006, September 30, 2005 and for the period from June 6, 1996 (inception),through September 30, 2006 were as follow:

 
| ** **                                               | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** | **June 5, 1996  (Inception) to**September 30, | ** ** |
|----------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| **Stock based compensation expense**      | ** ** | **2006**                                                 | ** ** | **2005**                                                | ** ** | **2006**                                                          | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                               | ** ** | ** **                                               | ** ** | ** **                                              | ** ** | ** **                                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Employees — included  in research and development   |       | $                                                        | 74,059     |                                                    | $          | 69,063                                                            |       | $ | 363,662 |   | $ | 207,189 |   | $ | 2,495,523 |   |
| Employees — included  in general and administrative |       | 151,342                                                  |       | 313,541                                                 |       | 812,512                                                           |       | 940,623 |   | 4,127,049 |   |
| Subtotal  employee stock option grants                   |       | 225,401                                                  |       | 382,604                                                 |       | 1,176,174                                                         |       | 1,147,812 |   | 6,622,572 |   |
|                                                     |       |                                                     |       |                                                    |       |                                                              |       |   |   |   |   |
| Non-employee — research  and development            |       | —                                                   |       | —                                                  |       | 102,750                                                           |       | — |   | 102,750 |   |
| Non-employee — general  and administrative          |       | (139,501                                                 | )          | 506,199                                                 |       | 717,997                                                           |       | 509,931 |   | 9,042,567 |   |
| Subtotal  non-employee stock option grants               |       | (139,501                                                 | )          | 506,199                                                 |       | 820,747                                                           |       | 509,931 |   | 9,145,317 |   |
| Total stock based  compensation expense                  |       | $                                                        | 85,900     |                                                    | $          | 888,803                                                           |       | $ | 1,996,921 |   | $ | 1,657,743 |   | $ | 15,767,889 |   |

 

The estimated fair valueof employee options granted was determined in accordance with SFAS 123R on thedate of grant using the Black-Scholes option valuation model with the followingweighted-average assumptions for options granted during the nine months andthree months ended September 30, 2006: Risk free interest rate 4.25%; Dividendyield 0% and expected life of 3 to 7 years. The risk-free interest rateassumption is based upon observed interest rates appropriate for the expectedterm of Callisto’s employee stock options. Callisto has not paid any dividendson common stock since its inception and does not anticipate paying dividends onits common stock in the foreseeable future. The computation of the expectedoption term is based on expectations regarding future exercises of optionswhich generally vest over 3 years and have a 10 year life. The expectedvolatility is based on the historical volatility of Callisto’s stock and was79% for all options granted through June 30, 2006 and 60% for options grantsince July 1, 2006.

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SFAS 123R requiresforfeitures to be estimated at the time of grant and revised, if necessary, insubsequent periods if actual forfeitures differ from those estimates. Based onhistorical Company experience Callisto estimated future unvested optionforfeitures at 20% as of January 1, 2006 and incorporated this rate in estimatedfair value of employee option grants.

Callisto’sdetermination of fair value is affected by Callisto’s stock price as well asthe assumptions discussed above that require judgment. The weighted-averagefair value of all options granted during the nine months ended September 30,2006, estimated as of the grant date using the Black-Scholes option valuationmodel, was $1.17 per share. A summary of the status of Callisto’s stock optionplans as of September 30, 2006 and of changes in options outstanding underCallisto’s plans during the nine months ended September 30, 2006 is as follows:

 
| ** **                                 | ** ** | **Number of** | ** ** | **Weighted Average**     | ** ** |
|--------------------------------------------|------------|--------------------|------------|-------------------------------|------------|
| ** **                                 | ** ** | **Shares**         | ** ** | **Price Per Share** | ** ** |
| Outstanding at  January 1, 2006       |       | 8,008,210          |       | $                             | 1.79       |   |
| Granted                                    |       | 925,000            |       | 1.52                          |       |
| Exercised                                  |       | —             |       |                          |       |
| Terminated                                 |       | (508,335           | )          | 1.04                          |       |
| Outstanding at  September 30, 2006         |       | 8,424,875          |       | $                             | 1.79       |   |
| Options exercisable at  September 30, 2006 |       | 5,066,546          |       | $                             | 1.63       |   |

 

The weighted averageremaining term of all options outstanding decreased from 7.4 years atDecember 31, 2005 to 7.2 years at September 30, 2006. At September 30,2006 Callisto had 850,000 stock options outstanding under the 2005 Equity Plan,52,500 stock options outstanding under the 2005 Director’s Plan and 7,522,375stock options outstanding under the 1996 Plan.

SFAS 123R requiresthat cash flows resulting from tax deductions in excess of the cumulativecompensation cost recognized for options exercised (excess tax benefits) beclassified as cash inflows from financing activities and cash outflows fromoperating activities. Due to Callisto’s accumulated deficit position, no taxbenefits have been recognized in the cash flow statement.

Had compensationcost for stock options granted to employees and directors prior toJanuary 1, 2006 been determined based upon the fair value at the grantdate for awards, consistent with the methodology prescribed under SFAS 123,Callisto’s net loss for the three and nine months ended September 30, 2005would have been as follows:

 
| ** **                                                                                        | ** ** | **Three Months**               | ** ** | **Nine Months**                | ** ** |
|---------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                        | ** ** | **Ended  September 30,  2005** | ** ** | **Ended  September 30,  2005** | ** ** |
| Net loss, as  reported                                                                            |       | $                                   | (3,320,569 | )                                   | $          | (8,525,377 | ) |
| Add: Stock-based  employee compensation expense recorded under APB No. 25 intrinsic value  method |       | 382,604                             |       | 1,147,812                           |       |
|                                                                                              |       |                                |       |                                |       |
| Deduct:  Stock-based employee compensation expense determined under fair value method             |       | (672,488                            | )          | (1,857,890                          | )          |
|                                                                                              |       |                                |       |                                |       |
| Pro forma net  loss                                                                               |       | $                                   | (3,610,453 | )                                   | $          | (9,235,455 | ) |
|                                                                                              |       |                                |       |                                |       |
| Net loss per  share:                                                                              |       |                                |       |                                |       |
| Basic and  diluted -as reported                                                                   |       | $                                   | (0.10      | )                                   | $          | (0.28 | ) |
|                                                                                              |       |                                |       |                                |       |
| Basic and  diluted -pro forma                                                                     |       | $                                   | (0.11      | )                                   | $          | (0.30 | ) |
| Black-Scholes  Methodology Assumptions:                                                           |       |                                |       |                                |       |
| Dividend yield                                                                                    |       | 0                                   | %          | 0                                   | %          |
| Risk free  interest rate                                                                          |       | 4.25                                | %          | 4.25                                | %          |
| Expected lives of  options                                                                        |       | 7 to 10 years                       |       | 7 to 10 years                       |       |

 

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Volatility of 0% was useduntil Callisto’s common stock began to trade publicly on June 16, 2003. FromJune 13, 2003 through June 30, 2005 Callisto used 100% volatility to determinethe fair value of options granted to employees. From July 1, 2005 to June30, 2006 Callisto has used a volatility factor of 79%. Effective for all grantsawarded subsequent to June 30, 2006 Callisto has used a volatility factor of60%.

3. Net Loss perShare

Basic and dilutednet loss per share is presented in conformity with SFAS No. 128, “Earningsper Share,” for all periods presented. In accordance with SFAS No. 128,basic and diluted net loss per common share was determined by dividing net lossapplicable to common stockholders by the weighted-average common sharesoutstanding during the period. Diluted weighted-average shares are the same asbasic weighted-average shares since the inclusion of issuable shares pursuantto the exercise of stock options and warrants, would have been antidilutive. Asof September 30, 2006 there were 4,864,601 warrants and 8,424,875 stock optionsoutstanding, and at September 30, 2005 there were 2,552,317 warrants and8,675,710 stock options outstanding.

4. GovernmentGrants

On April 1, 2005Callisto was awarded a research grant for work on a biodefense program from theNational Institute of Allergy and Infectious Diseases (“NIAID”) to develop amonoclonal antibody and vaccine against bacterial superantigen toxins under anexclusive license with Rockefeller University entered into on August 20, 1996.Callisto receives cash funding under approved grants and records the receipt asan offset to research and development expense only when the expense isincurred. Funds received as an offset to research and development expensesincurred totaled $ 43,956 and $299,378, during the three and nine months endedSeptember 30, 2006, respectively and have been reported on our CondensedConsolidated Statements of Operations as a separate line item entitled “GovernmentGrant”. In addition as of September 30, 2006 Callisto had receivedapproximately $78,000 of cash advances under the NIAID grant for which it hadnot yet incurred any expenses.   During October 2006 Callisto advancedan additional amount of $270,000 for research expenses not yet incurred andused some funds to pay operating expenses not specifically related to the workon the biodefense program.

5. Stockholders’ equity:

OnFebruary 3, 2006, Callisto closed on a private placement of 4,283,668shares of common stock and 1,070,917 common stock purchase warrants to certainaccredited investors. The warrants are exercisable for 18 months from closingat an exercise price of $1.60 per share. The securities were sold at a price of$1.20 per share for aggregate gross proceeds of approximately $5.14 million.Net proceeds, after fees and expenses, were $4.58 million. As provided for byEmerging Issues Task Force Issue 00-19: *Accountingfor Derivative Financial Instruments Indexed to, and Potentially Settled in, aCompany’s Own Stock* (“EITF 00-19”) the warrants wereclassified as permanent equity. The fair value of the investor warrants onFebruary 3, 2006, the date of grant was $662,680 using Black Scholesassumptions of 79% volatility, a risk free interest rate of 4.25%, no dividend,an expected life of 18 months and a stock price on that date of $1.59 pershare. This fair value allocated to the investor warrants was recorded asadditional paid in capital during the quarter ended March 31, 2006.

On April 7,2006 Callisto had a second closing of the financing described above, in whichwe sold an additional 666,667 shares of common stock and issued 166,667 commonstock purchase warrants at the same terms, for gross proceeds of $800,000,bringing the total gross proceeds of the financing to $5.94 million and netproceeds to $5.34 million. Placement agent fees of  $41,000 were paid onthis second closing and three year warrants to purchase a total of 66,667common shares at a per share price of $1.25 were issued to several sellingagents.

In conjunctionwith this financing Callisto agreed to file, within 60 days after the firstclosing, a registration statement covering the resale of the shares of commonstock and the shares underlying the warrants, and to use our commerciallyreasonable efforts to cause such registration statement to be declaredeffective within 120 days after closing or pay financial liquidated damages tothe investors. Callisto has not yet filed a registration statement and isincurring liquidated damages at the rate of approximately $59,400 for every30-day period that a registration statement has not been filed, up to a maximumof 8% of the gross proceeds.  As ofSeptember 30, 2006 Callisto has incurred $334,446 in liquidated damages relatedto the registration rights agreement, or approximately 5.6%, which have beenclassified as other expense on our condensed consolidated statement of operations.$149,287 of these damages was paid in cash during the nine months endedSeptember 30, 2006 and $185,159 was due and payable as of September 30, 2006.

6. Commitments andcontingencies:

Licensingagreements:

OnJanuary 10, 2006, Callisto entered into a Patent and Technology LicenseAgreement with The University of Texas M.D. Anderson Cancer Center. Pursuant tothe license agreement, Callisto was granted the exclusive right to manufacture,have manufactured, use, import, offer to sell and/or sell anti-cancer compoundscalled tyrphostins (renamed Degrasyns). In addition, at any time after twoyears from January 10, 2006, The University of Texas M.D. Anderson CancerCenter has the right to terminate the license if Callisto fails to provide evidencewithin 90 days of written notice that it has commercialized or is actively andeffectively attempting to commercialize the licensed technology.

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Employment and consultingagreements:

On March 23,2006, Callisto entered into a 2-year sponsored laboratory study agreement withthe University of Texas M. D. Anderson Cancer Center whereby Dr. NicholasDonato, as principal investigator, will analyze the anti-tumor activity andmechanism of action of Callisto’s WP1130 Degrasyn compound and analogs. Theagreement calls for payment of $145,900 to M.D. Anderson in two installments of$72,950 with the first payment due within 30 days of the effective date of theagreement, and the second payment due within six months of execution.

On March 27,2006, Callisto entered into a 2-year sponsored laboratory study agreement withthe University of Texas M. D. Anderson Cancer Center whereby Dr. WilliamBornmann, as principal investigator, will perform molecular modeling andsynthesize a library of compounds based on Callisto’s Degrasynplatform technology. The agreement calls for payment of $127,145 to M.D.Anderson in two installments of $63,572 with the first payment due within 30days of the effective date  of theagreement, and the second payment due within six months of execution.

7.Subsequent events

OnOctober 3, 2006, Callisto received notice (the “Deficiency Letter”) fromthe staff of the American Stock Exchange (“AMEX”) indicating that it is not incompliance with certain continued listing standards, specifically, Section 1003(a)(i)of the Company Guide with shareholders’ equity of less than $2,000,000 andlosses from continuing operations and/or net losses in two of its three mostrecent fiscal years and Section 1003(a)(iv) of the Company Guide in thatit has sustained losses which are so substantial in relation to its overalloperations or its existing financial resources, or its financial condition hasbecome so impaired that it appears questionable, in the opinion of theExchange, as to whether it will be able to continue operations and/or meet itsobligations as they mature.

**On November 2, 2006 Callistosubmitted a plan advising AMEX of the actions it has taken, or will take, thatwould bring it into compliance with Section 1003(a)(iv) of the CompanyGuide by April 3, 2007 and with ** **Section1003(a)(i) of the Company Guide by April 3, 2008**.If AMEX accepts Callisto’s plan, it may be able to continue its listing duringthe plan period of up to 18 months, during which time Callisto will be subjectto periodic review to determine if it is making progress consistent with theplan. If it is not in compliance with the continued listing standards at theend of the plan period, or it does not make progress consistent with the planduring the plan period, AMEX staff may initiate delisting proceedings. There isno guarantee that the plan will be accepted by AMEX, or that Callisto will beable to make progress consistent with the plan if it is accepted. While theplan is under review by AMEX, Callisto expects that its common stock willcontinue to trade without interruption on AMEX. If the plan is not accepted by AMEX, it may be subject to delistingproceedings.

**On October 23, 2006, **Callisto**closed a privateplacement of 105,000 shares of Series A Convertible Preferred Stock (the “SeriesA Preferred Stock”) and 1,400,000 warrants (the “Warrants”) to certaininvestors (the “Investors”) for aggregate gross proceeds of $1,050,000. TheInvestors also are parties to a Registration Rights Agreement, dated as ofOctober 23, 2006 pursuant to which** **Callisto agreed to file,within 60 days of closing, a registration statement covering the resale of theshares of common stock underlying the Series A Preferred Stock and the Warrantsissued to the Investors. The Warrants are immediately exercisable at $0.75 pershare,** **willexpire five years from the date of issuance, and have certain antidilutionrights for the twelve month period beginning on the effective date of theregistration statement registering the shares of common stock underlying theWarrants. ** **Callisto paid an aggregate $40,000 and issued an aggregate 53,334warrants to purchase common stock to certain selling agents. The warrants areimmediately exercisable at $0.75 per share, will expire five years afterissuance and have the same antidilution rights as the Investor Warrants. **Callisto’sCertificate of Incorporation has been amended to provide for the issuance of400,000 shares of Series A Preferred Stock pursuant to the Certificate ofDesignations, Number, Voting Powers, Preferences and Rights of Series AConvertible Preferred Stock filed with the State of Delaware on October 24,2006.

**Callisto is currently evaluating whether theWarrants will be treated as “permanent equity” in accordance with EmergingIssues Task Force Issue 00-19:*Accounting for DerivativeFinancial Instruments Indexed to, and Potentially Settled in, a Company’s OwnStock***(“EITF 00-19”). The fairvalue of the Warrants on October 23, 2006, the date of grant, was $725,000using Black Scholes assumptions of 60% volatility, a risk free interest rate of4.25%, no dividend, an expected life of five years and a stock price on thatdate of $0.88 per share. In addition Callisto is currently evaluating theSeries A Preferred Stock conversion feature in accordance with Emerging IssuesTask Force Issue 00-27:***Applicationof Issue No. 98-5 to Certain Convertible Instruments**,***(“EITF00-27) to determine whether the embedded beneficial conversion feature shouldbe measured, during the quarter ended December 31, 2006, using the fair valueor intrinsic method. The fair value of **theSeries A Preferred Stock conversion feature** on October23, 2006 was approximately $725,000 using Black Scholes assumptions of 60%volatility, a risk free interest rate of 4.25%, no dividend, an expected lifeof 5 years and a stock price on that date of $0.88 per share and the intrinsicvalue was approximately $182,000.

On September 8, 2006Callisto entered into a Letter Agreement with certain investors (the “Investors”)who participated in a private placement of our common stock and warrants inFebruary and April 2006 (the “Prior Placement”).  Pursuant to this LetterAgreement, the Investors agreed to amend (the “Amendment”) the securitiespurchase agreement (the “Securities Purchase Agreement”), entered into inconnection with the Prior Placement, to (i) delete the mandatory registrationrights set forth in the Securities Purchase Agreement and add piggyback

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registration rights and(ii) waive any unpaid penalties pursuant to the liquidated damages provisionscontained in the Securities Purchase Agreement. In addition, the Investorsagreed to enter into a lock-up agreement (the “Lock-up Agreement”) pursuant towhich they agreed not to sell or transfer the shares of common stock andwarrants acquired in the Prior Placement for a period of nine months beginningSeptember 1, 2006. In exchange for the Investors entering into the Amendmentand the Lock-Up Agreement, Callisto agreed to issue to each Investor one shareof common stock and 2.35 five year warrants exercisable at $1.00 per share (the“New Warrants”) for every five shares of common stock they purchased in thePrior Placement.  In addition, Callisto agreed in the Letter Agreement toamend the warrants (the “Old Warrants”) issued in the Prior Placement to theInvestors to (i) extend the expiration date of the Old Warrants by 42 monthsthereby making them 5 year warrants and (ii) eliminate the provision in the OldWarrants by which Callisto can force exercise of the unexercised warrants.  During October and November 2006 Callistoentered into the Amendment and Lock-up Agreements with each Investor pursuantto which Callisto issued 740,067 shares of common stock and 1,739,157 NewWarrants. Approximately $150,000 in cash liquidated damages, payable to theseInvestors as of September 30, 2006, was concurrently waived.

The fair value ofthe New Warrants when issued was approximately $700,000 using Black Scholesassumptions of 60% volatility, a risk free interest rate of 4.25%, no dividend,an expected life of 5 years and a stock price on that date of $0.82 per share.The fair value of the shares issued to the Investors in October and November2006 was approximately $600,000 using a volume weighted average price forOctober and November of $0.82 per share. Callisto is currently evaluating theappropriate basis for allocating a portion, or all, of this fair value toliquidated damages expense during the quarter ended December 31, 2006.

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**ITEM 2. MANAGEMENT’SDISCUSSION AND ANALYSIS AND RESULTS OF OPERATIONS**

The following discussion should be read in conjunctionwith our condensed consolidated financial statements and other financialinformation appearing elsewhere in this Quarterly Report. In addition tohistorical information, the following discussion and other parts of thisquarterly report contain forward-looking information that involves risks anduncertainties.

**OVERVIEW**

Since inception in June 1996 our efforts havebeen principally devoted to research and development, securing patentprotection, obtaining corporate relationships and raising capital. Sinceinception through September 30, 2006, we have sustained cumulative netlosses of $54,861,600. Our losses have resulted primarily from expendituresincurred in connection with clinical development of licensed products, thepurchase of in-process research and development, stock based compensationexpense, patent filing and maintenance, outside accounting and legal servicesand regulatory consulting fees.  From inception through September 30,2006 we have not generated any revenue from operations. We expect to incursubstantial and increasing losses for the next several years as we develop ourproduct candidates, expand our clinical development team and prepare for thecommercial launch of our product candidates. We do not currently have anycommercial biopharmaceutical products, and do not expect to have such forseveral years, if at all.

**On October 23, 2006, **we**closed a privateplacement of 105,000 shares of Series A Convertible Preferred Stock (the “SeriesA Preferred Stock”) and 1,400,000 warrants (the “Warrants”) to certaininvestors (the “Investors”) for aggregate gross proceeds of $1,050,000. TheInvestors also are parties to a Registration Rights Agreement, dated as ofOctober 23, 2006 pursuant to which** **we agreed to file, within60 days of closing, a registration statement covering the resale of theshares of common stock underlying the Series A Preferred Stock and the Warrantsissued to the Investors. The Warrants are immediately exercisable at $0.75 pershare,** **willexpire five years from the date of issuance, and have certain antidilutionrights for the twelve month period beginning on the effective date of theregistration statement registering the shares of common stock underlying theWarrants. ** **We paid an aggregate $40,000 and issued an aggregate 53,334 warrants topurchase common stock to certain selling agents. The warrants are immediatelyexercisable at $0.75 per share, will expire five years after issuance and havethe same antidilution rights as the Investor Warrants**

**HISTORY**

In March 2002, CallistoPharmaceuticals, Inc. (“Old Callisto”), a non-public company, purchased99.7% of the outstanding common shares of Webtronics, Inc., (“Webtronics”)a public company for $400,000. Webtronics was incorporated in Florida onFebruary 2, 2001 and had limited operations at December 31, 2002.

On April 30, 2003, pursuant to an Agreement andPlan of Merger dated March 10, 2003, as amended April 4, 2003,Synergy Acquisition Corp., a wholly-owned subsidiary of Webtronics merged intoSynergy Pharmaceuticals Inc. (“Synergy”) and Callisto Acquisition Corp., awholly-owned subsidiary of Webtronics merged into Old Callisto (collectively,the “Merger”). As a result of the Merger, Old Callisto and Synergy becamewholly-owned subsidiaries of Webtronics. In the Merger Webtronics issued17,318,994 shares of its common stock in exchange for outstanding Old Callistocommon stock and an additional 4,395,684 shares in exchange for outstandingSynergy common stock. Old Callisto changed its name to Callisto ResearchLabs, LLC (“Callisto Research”) and Webtronics changed its name toCallisto Pharmaceuticals, Inc. and changed its state of incorporation fromFlorida to Delaware. Subsequently, 171,818 shares of common stock issued toformer Synergy shareholders were returned to us under the terms of certainindemnification agreements.

 

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**PLAN OF OPERATIONS**

Our plan of operations for the next twelve months isto focus primarily on the clinical development of our two drugs, Atiprimod andL-Annamycin, to treat advanced carcinoid cancer, adult and pediatric acuteleukemia (a disease of the white blood cells) and multiple myeloma (anincurable blood cancer that invades and proliferates in bone marrow).

Our lead drug candidate,Atiprimod, is an orally administered drug with antiproliferative andantiangiogenic activity.  Atiprimod ispresently in three clinical trials in advanced carcinoid cancer, relapsed orrefractory multiple myeloma and advanced cancer patients at a number ofclinical sites in the U.S.  OnNovember 7, 2006, we announced the initiation of a multi-center open-label  Phase II clinical trial of Atiprimod inadvanced carcinoid cancer patients. This trial is based on earlier encouragingclinical results from an ongoing trial of Atiprimod in advanced cancer patientsthat showed a clear response in a patient with advanced carcinoid cancer plusadditional encouraging clinical data on other carcinoid patients. Atiprimod isalso in a multi-center, dose-escalation Phase I/IIa clinical trial in relapsedor refractory multiple myeloma patients. In December 2005, we announced interim results from this trial on15 patients treated with Atiprimod, including 3 patients at the highestdose level of 180 mg/day. Two patients exhibited stable disease, with onepatient having a 34% decrease in M protein (measure of tumor burden) over3 months of treatment. In 2006, we amended the protocol to continue the trialat higher dose levels and currently have this trial underway at 4 clinicalsites in the U.S.

Our second lead drugcandidate, L-Annamycin, earlier completed an initial Phase I/IIa clinical trialin relapsed or refractory leukemia patients with a prior sponsor. L-Annamycinis a novel compound from the anthracycline family of proven anti-cancer drugs,which has a novel therapeutic profile, including activity against drugresistant tumors and significantly reduced cardiotoxicity, or damage to theheart. L-Annamycin was in-licensed by Callisto in October, 2004 and ispresently in a Phase I/IIa clinical trial in adult relapsed or refractory acutelymphocytic leukemia (ALL) patients at three clinical sites in the U.S.  We are also planning to evaluate the drug inpediatric patients with relapsed or refractory ALL and relapsed or refractoryacute myelocytic leukemia (AML).

**ATIPRIMOD TO TREAT MULTIPLE MYELOMAAND ADVANCED CARCINOID CANCER PATIENTS**

On August 28, 2002, Synergy entered into aworldwide license agreement with AnorMED to research, develop, sell andcommercially exploit the Atiprimod patent rights. The license agreementprovides for aggregate milestone payments of up to $14 million based uponachieving certain regulatory submissions and approvals for an initialindication, and additional payments of up to $16 million for eachadditional indication based on achieving certain regulatory submissions andapprovals. In addition the agreement requires Synergy to pay AnorMED royaltieson net sales. Commencing on January 1, 2004 and on January 1 of eachsubsequent year, Synergy is obligated to pay AnorMED a maintenance fee of$200,000 until the first commercial sale of the product. The first of theseannual maintenance fee payments under this agreement was made onJanuary 22, 2004. Pursuant to the license agreement, failure to pay themaintenance fee is a material breach of the license agreement. The licenseagreement will terminate in 2018.

**DEVELOPMENT STRATEGY****FOR ATIPRIMOD**

Advanced Cancer and Advanced Carcinoid Cancer:

On March 15, 2005 we announced the initiation ofa Phase I/IIa clinical trial of Atiprimod in advanced cancer patients. Thetrial is entitled: “An Open Label Study of the Safety and Efficacy of AtiprimodTreatment for Patients with Advanced Cancer”. The primary objective is toassess the safety and determine the maximum tolerated dose (MTD) of Atiprimodin advanced cancer patients. The secondary objectives are to measure thepharmacokinetics of Atiprimod and evaluate the response in a variety ofrelapsed solid tumors and hematologic malignancies. The trial protocol receivedIRB approval on February 22, 2005 at The University of Texas M.D. AndersonCancer Center with Dr. Razelle Kurzrock acting as the PrincipalInvestigator. Site initiation was completed on March 3, 2005, and patientscreening and dosing began in April, 2005. On June 2, 2006 at the AmericanSociety of Clinical Oncology (ASCO) annual meeting abstract number 13050,titled “Phase I Study of the Safety and Efficacy of Atiprimod, a NovelAzaspirane, for Patients with Advanced Cancer” described data from thePhase I/IIa clinical trial of Atiprimod in advanced cancer patients. The abstract stated that 14 patients had been treated at that date with60 mg tablets (n=3), 60 mg capsules (n=3), 90 mg capsules (n=3)and 120 mg capsules (n=5).  Of the 14 patients, 4 had carcinoidtumors and 3 of these patients had shown responses with one patient being ondrug for 7 cycles of therapy (7 months).  Due to encouraging resultsin the carcinoid patients from the Phase I trial in advanced cancer, onJune 27, 2006 we announced plans to begin a Phase II trial inadvanced carcinoid patients to include approximately 30 patients.

 

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On November 7, 2006, we announced thecommencement of the multi-center, open-label Phase II clinical trial ofAtiprimod to treat low to intermediate grade neuroendocrine carcinomasincluding advanced carcinoid cancers. The first study site to enter this trialwas the Hematology Oncology Services of Arkansas in Little Rock, Arkansas.  The primary objective of the Phase IIclinical trial is to evaluate efficacy of Atiprimod in patients with low tointermediate grade neuroendocrine carcinoma who have metastatic or unresectablecancer and who have either symptoms, despite standard therapy (octreotide), orprogression of neuroendocrine tumors. Patients, after signing an informed consent, are required to completetwo weeks of a symptoms diary to establish their symptoms baseline beforecommencing Atiprimod dosing.  A maximumof 40 evaluable patients will be enrolled in this trial.  Efficacy evaluations will include the measureof target lesions (per RECIST), and the quantization of multiple myelomasymptom relief:

Atiprimod commenced a Phase I/IIa clinical trialin relapsed or refractory multiple myeloma patients on May 26, 2004. Theseare patients that have a re-occurrence of active disease, and no longer respondto approved therapies. The Phase I/IIa clinical trial presently includesfour sites, The University of Texas M.D. Anderson Cancer Center (Houston,TX), the University of Michigan Medical Center (Ann Arbor, MI), Fred HutchinsonCancer Research Center (Seattle, WA), and the Roswell Park Cancer Institute(Buffalo, NY).  The clinical trial is anopen label study, with the primary objective of assessing the safety of thedrug and identifying the maximum tolerated dose. The secondary objectives areto measure the pharmacokinetics, evaluate the response in patients withrefractory disease and to identify possible surrogate responses to drug tobetter determine the mechanism of drug action.  In December 2005, weannounced interim results from this trial on 15 patients treated withAtiprimod, including 3 patients at the highest dose level of 180 mg/day.Two patients exhibited stable disease, with one patient having a 34% decreasein M protein (measure of tumor burden) over 3 months of treatment. In early2006, we amended the protocol to continue the trial at higher dose levels andto include the use of an FDA approved liver-protecting drug, Ursodiol, incombination with Atiprimod to enable dosing of Atiprimod at higher levels.  We currently have this trial underway at 4clinical sites in the U.S. and plan to continue this study until a maximumtolerated dose has been established for Atiprimod, and it has been determinedwhat level of efficacy is observed with Atiprimod in relapsed or refractorymultiple myeloma patients.

**L-ANNAMYCINTO TREAT RELAPSED OR REPRACTORY ACUTE LEUKEMIA**

On August 12, 2004, we entered into a world-widelicense agreement with The University of Texas M.D. Anderson Cancer Centerto research, develop, sell and commercially exploit the patent rights forL-Annamycin, an anthracycline cancer drug for leukemia therapy. Considerationpaid for this license amounted to $31,497 for reimbursement of out-of-pocket costsfor filing, enforcing and maintaining the L-Annamycin patent rights and a$100,000 initial license fee. We also agreed to pay The University of Texas M.D. AndersonCancer Center royalties based on net sales from any licensed products, plusaggregate milestone payments of up to $750,000 based upon achieving certainregulatory submissions and approvals. The term of the agreement is fromAugust 12, 2004 until November 2, 2019. Under the terms of thelicense agreement, we are required to make certain good faith expenditurestowards the clinical development of at least one licensed product within theone year period after March 2006. In addition, at any time after fiveyears from August 12, 2004, The University of Texas M.D. AndersonCancer Center has the right to terminate the license if we fail to provideevidence within 90 days of written notice that we have commercialized orwe are actively and effectively attempting to commercialize L-Annamycin.

L-Annamycin was discovered by scientists at TheUniversity of Texas M.D. Anderson Cancer Center and initially evaluated ina Phase I clinical trial in 36 patients with relapsed solid tumors, aPhase II clinical trial in 13 patients with doxorubicin-resistantbreast cancer, and a Phase I/IIa trial in 20 patients with relapsedor refractory AML or ALL.

**DEVELOPMENT STRATEGY FOR L-ANNAMYCIN**

We began a clinical trial at The University of Texas M.D. AndersonCancer Center in adult relapsed or refractory ALL patients on December 1,2005. This single-arm, open-label Phase I/IIa clinical trial was designed toenroll up to 12 patients in a dose-escalation portion, to obtain themaximum tolerated dose, followed by 10 patients at this final fixed dose. Asmany as 34 patients can be treated under this protocol.

Additionally, we plan to commence in late 2006 asingle-arm, open label, dose escalation Phase I/IIa clinical trial ofL-Annamycin in pediatric relapsed or refractory ALL and AML patients.

**GUANYLATE CYCLASE RECEPTOR AGONISTTECHNOLOGY**

Our guanylate cyclase receptor agonist (GCRA) programis based on control of cyclic guanosine monophosphate (“cyclic GMP”), animportant second messenger involved in key cellular processes that areessential for maintaining the balance between proliferation and cellular death(apoptosis). Uroguanylin, a hormone produced by and secreted by specializedcells in the human GI tract, helps to maintain this balance by activatingsynthesis of cyclic GMP through activation of guanylate cyclase receptor.Recent findings suggest a role of cyclic GMP in gastrointestinal (GI)inflammatory diseases.

 

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We have successfully developed a potent analog(synthetic molecule) of uroguanylin called Guanilib (also called SP304).Guanilib has been demonstrated to be superior to uroguanylin in its biologicalactivity, protease stability and pH characteristics. Guanilib was evaluated ina pre-clinical animal model of ulcerative colitis, an inflammatory boweldisease, in a collaboration involving clinical gastroenterologistDr. Scott Plevy of the University of North Carolina. Those data, alongwith independent animal data obtained by Callisto, showed that Guanilibsignificantly reduced inflammation in mouse models of experimental ulcerativecolitis.  Callisto presently has Guanilibin pre-clinical development. On May 9, 2006 the U.S. Patent and TrademarkOffice (USPTO) notified Callisto that its patent issued covering a novel drugcandidate, Guanilib, developed by Callisto scientists to treat and prevent avariety of inflammatory diseases of the bowel. The drug candidate isfirst-in-class of a new category of compounds with the potential to treatgastro-intestinal diseases such as ulcerative colitis.

On January 10, 2006, we entered into a licenseagreement with the University of Texas M.D. Anderson Cancer Center wherebywe were granted the exclusive right to manufacture, have manufactured, use,import, offer to sell and/or sell anti-cancer compounds called tyrphostins(renamed Degrasyns). Degrasyns are a second-generation class oftyrphostins developed by scientists at the University of Texas M.D. AndersonCancer Center that have a novel anti-cancer mechanism-of-action that centers ontheir ability to promote selective degradation of key proteins that areinvolved in tumor cell proliferation and survival. We have been working closelywith scientists at the University of Texas M.D. Anderson Cancer Centerduring 2006 to bring forward a pre-clinical candidate for development in theclinic.

On March 23, 2006, we entered into a 2-yearsponsored laboratory study agreement with the University of Texas M.D. AndersonCancer Center whereby Dr. Nicholas Donato, as principal investigator, willanalyze the anti-tumor activity and mechanism of action of our WP1130 Degrasyncompound and analogs. The agreement calls for payment of $145,900 to M.D. Andersonin two installments of $72,950, with the first payment due within 30 daysand the second payment due within six months. On March 27, 2006, weentered into a 2-year sponsored laboratory study agreement with the Universityof Texas M.D. Anderson Cancer Center whereby Dr. William Bornmann, asprincipal investigator, will perform molecular modeling and synthesize alibrary of compounds based on our Degrasyn platform technology. Theagreement calls for payment of $127,145 to M.D. Anderson in twoinstallments of $63,572, with the first payment due within 30 days and thesecond payment due within six months.

**MANUFACTURING**

An improved manufacturing method for Annamycin hasbeen developed at Antibioticos S.p.A., our commercial supplier of GoodManufacturing Practice, or GMP, drug substance. GMP material is currently beingproduced in sufficient quantity for all three anticipated Phase I/II trials.Currently, Antibioticos S.p.A. is our sole supplier of Annamycin for ourclinical trials. Our agreement with Antibioticos provides thatAntibioticos S.p.A. will provide 400 grams of GMP drug substance(Annamycin) for our L-Annamycin clinical trials. Upon the conclusion of ourPhase IIb clinical trials, the agreement provides that the parties willnegotiate in good faith towards a commercial supply agreement for Annamycin. Ifour relationship with this contract manufacturer, or any other contractmanufacturer we might use, terminates or if any of their facilities are damagedfor any reason, including fire, flood, earthquake or other similar event, wemay be unable to obtain supply of Annamycin. If any of these events wereto occur, we may need to find alternative manufacturers or manufacturingfacilities. The number of contract manufacturers with the expertise, requiredregulatory approvals and facilities to manufacture Annamycin on a commercialscale is extremely limited, and it would take a significant amount of time toarrange for alternative manufacturers. If we need to change to other commercialmanufacturers, the FDA and comparable foreign regulators must approve thesemanufacturers’ facilities and processes prior to our use, which would requirenew testing and compliance inspections. In addition, we may not have theintellectual property rights, or may have to share intellectual propertyrights, to any improvements in the current manufacturing processes or any newmanufacturing processes for Annamycin. Any of these factors could cause us todelay or suspend clinical trials, regulatory submissions, required approvals orcommercialization of L-Annamycin, entail higher costs, and could result in ourbeing unable to commercialize L-Annamycin successfully. One large-scale GMPproduction run of Atiprimod dimaleate led to the successful release of 10 Kgof material available for future Phase II clinical studies. We plan toenter into a supply contract for Atiprimod with a commercial supplier by theend of 2007 or after confirming activity of the drug candidate in our currenthuman clinical trials.

**EMPLOYEES**

Our plan is to use contract research organizations formost of our development efforts thus minimizing the need to hire full timeemployees. As of November 14, 2006, we had 8 full-time and 3 part-timeemployees. We believe our employee relations are satisfactory.

**OFF-BALANCE SHEET ARRANGEMENTS**

We had no off-balance sheet arrangements as ofSeptember 30, 2006.

 

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**RESULTS OF OPERATIONS**

**THREE MONTHS ENDED SEPTEMBER 30,2006 AND SEPTEMBER 30, 2005**

We had no revenues during the three months endedSeptember 30, 2006 and 2005 because we do not have any commercialbiopharmaceutical products and we do not expect to have such products forseveral years, if at all.

Research and development expenses decreased by$648,862, or 36%, to $1,139,094 for the three months ended September 30,2006 from $1,787,956 for the three months ended September 30, 2005. The factors contributing to the decreased research and development expense duringthe quarter ended September 30, 2006 were the scale back of certainclinical development activities and the curtailment of non-essential in-houseoverhead while we continued to seek additional funding. Overall outsidespending on product candidates, primarily with contract research organizations(“CRO”) was down $150,666 or 13%, to $1,016,670 during the three months endedSeptember 30, 2006 from $1,167,336 during the same period in 2005. CRO spendingfor Atiprimod was down by $242,715 or 35% and L-Annamycin costs were down by$52,138 or 14% from the quarter ended September 30, 2005, partially offsetby an increase in spending for non-clinical products, principally, Degrasynsand Guanilib.  Additionally our in-house research overhead was cut by$498,196 or 80% to $122,424 for the three months ended September 30, 2006from $620,621 in the three months ended September 30, 2005. This in-houseoverhead reduction reflects cost containment, including approximately $87,000or 40% in lower salaries and wages, $84,000 or 54% less in patent legal,$67,000 in license fees recovered on inactive patents, $42,000 or 24% in lowersponsored laboratory studies and a clinical trial insurance rebate of $37,000.

On April 1, 2005 we received an $885,641biodefense partnership grant from the National Institute of Allergy andInfectious Diseases (“NIAID”) to develop a monoclonal antibody and vaccineagainst bacterial superantigen toxins over the next two years. Government grantfunding for the three months ended September 30, 2006 was $43,956 ascompared to $152,866 for the three months ended September 30, 2005. We requestgrant funding to reimburse research and development expenses as incurred.

General and administrative expenses for the threemonths ended September 30, 2006 decreased $411,677 or 34%, to $800,803,from $1,212,480 for the three months ended September 30, 2005. Consistentwith our scaled back research and development activities we also decreased certain non-essential in-house general andadministrative expenses while we continued to seek additional funding.Approximately (i) $75,000 of this decreased spending was on lower investorrelations, a decrease of 55% from investor relations expense for the priorperiod, (ii) $102,000 of this decrease was in lower accounting fees,primarily for Sarbanes-Oxley compliance testing under Section 404 which has nowbeen deferred until 2007 and (iii) $162,000 of lower stock basedcompensation cost for employees and directors.

Stock-based compensation for non employees decreased$645,700 or 128% from $506,199 for the three months ended September 30,2005 to a credit of ($139,501) for the three months ended September 30,2006 primarily attributable to (i) the warrants granted to Trilogy CapitalPartners in July 2005 which expense was being amortized until June 30,2006 and (ii) a decline in our stock price during 2006, which caused thereversal of expense recorded in prior periods on certain option requiringvariable accounting treatment. (See Note 2 “Stock-based Compensation” toour Condensed Consolidated Financial Statements included in this report).

Interest income for the three months endedSeptember 30, 2006 decreased $29,897 or 90% to $3,304 from $33,200 in thethree months ended September 30, 2005 due to decreased average cashbalances.

Other expense for the three months endedSeptember 30, 2006 consisted of $177,010 of liquidated damages accruing toinvestors for failure to register shares of our common stock sold in a privateplacement in February and April 2006.  We had no such payments during thethree months ended September 30, 2005.

Net loss for the three months ended September 30, 2006was $1,930,146 compared to a net loss of $3,320,569 incurred for the threemonths ended September 30, 2005, a 42% decrease for the reasons discussedabove.

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**NINE MONTHS ENDEDSEPTEMBER 30, 2006 AND SEPTEMBER 30, 2005**

We had no revenuesduring the nine months ended September 30, 2006 and 2005 because we do not haveany commercial biopharmaceutical products and we do not expect to have suchproducts for several years, if at all.

Research anddevelopment expenses decreased by $48,001 or 1%, to $4,898,524 for the nine months ended September 30, 2006 from the$4,946,525 we incurred for the nine months ended September 30, 2005.  Spending on product candidates, primarilywith outside CROs was up by $60,076 or 2% to $3,581,810 during the nine monthsended September 30, 2006 from $3,521,734 during the same period in 2005.Spending on our Atiprimod drug candidate was down $186,343 or 12% andL-Annamycin CRO costs were down $668,759 or 36% from the nine months endedSeptember 30, 2005, more than offset by an increase in spending for ournon-clinical products, principally, Degrasyns and Guanilib.  Offsettingthis increase in outside CRO costs during the nine months ended September 30,2006 was the curtailment of in-house research and development overhead .

On April 1, 2005we received an $885,641 biodefense partnership grant from the NationalInstitute of Allergy and Infectious Diseases (“NIAID”) to develop a monoclonalantibody and vaccine against bacterial superantigen toxins over the next twoyears. Government grant funding for the nine months ended September 30, 2006was $299,378 from our NIAID grant versus $152,866 for the nine months endedSeptember 30, 2005.

General andadministrative expenses increased by $699,154 or 21%, to $4,012,012 for thenine months ended September 30, 2006 from $3,312,858 for the nine months endedSeptember 30, 2005. During the nine months ended September 30, 2006 cash-basedgeneral and administrative expenses were $3,199,501 versus $2,372,236 for thenine months ended September 30, 2005, an increase of $827,266 or 35%. Non-cash employee stock based compensation expense was $812,511 for the ninemonths ended September 30, 2006 as compared to $940,623 for the nine monthsended September 30, 2005, a decrease of $128,112 or 14%.  The increase incash-based general and administrative expenses was due primarily toapproximately (i) $660,000 of increased investor relations costs including thefees paid to Trilogy Capital Partners and affiliates, (ii) $139,000 ofadditional staff cost attributable to higher headcount and salary increases,and (iii) $113,000 in higher bonuses.

Stock-basedcompensation — related to non-employee options recorded during the ninemonths ended September 30, 2006 totaled $820,747 as compared to $509,931recorded during the nine months ended September 30, 2005 attributable to thewarrants granted to Trilogy Capital Partners in July 2005. See Note 2 to ourcondensed consolidated financial statements for more detailed discussion ofemployee and non-employee stock based compensation.

Interest incomefor the nine months ended September 30, 2006 decreased $45,666 or 50% to$45,405 from $91,071 for the nine months ended September 30, 2005 due to lowercash balances.

Other expense forthe nine months ended September 30, 2006 was $334,446 recorded for liquidateddamages due to investors for failure to register shares of our common stocksold in a private placement in February and April 2006.  We had no suchexpense during the nine months ended September 30, 2005.

Net loss for thenine months ended September 30, 2006 was $9,720,946 compared to a net loss of$8,525,377 incurred for the nine months ended September 30, 2005. The increasednet loss is primarily the result of higher research and development, generaland administrative expenses, and higher stock based compensation expense, asdiscussed above.

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**LIQUIDITY ANDCAPITAL RESOURCES**

As of September30, 2006 we had $124,017 in cash and cash equivalents, compared to $1,420,510as of December 31, 2005. The decrease in cash of $1,296,493 for the ninemonths ended September 30, 2006 was $485,626 less than the decrease of$1,782,119 during the nine months ended September 30, 2005.  Cash used in operating activities of$6,815,328 for the nine months ended September 30, 2006 was partially offset bya private placement of common stock yielding net proceeds of $5,337,402 andwarrant exercise proceeds of $190,035. Cash used in operating activities of $6,437,397for the nine months ended September 30, 2005 was partially offset by a privateplacement of common stock yielding net proceeds of $4,655,278.

OnFebruary 3, 2006, we closed on a private placement of 4,283,668 shares ofcommon stock and 1,070,917 common stock purchase warrants to certain accreditedinvestors. The warrants are exercisable for 18 months from closing at anexercise price of $1.60 per share. The securities were sold at a price of $1.20per share for aggregate gross proceeds of approximately $5.14 million. The netproceeds, after fees and expenses, were $4.58 million.

On April 7,2006 we had a second closing of the financing described above, in which we soldan additional 666,667 shares of common stock and issued 166,667 common stockpurchase warrants at the same terms, for gross proceeds of $800,000, bringingthe total gross proceeds of the financing to $5.94 million and net proceeds to$5.34 million.  Placement agent fees of $41,000 were incurred on thissecond closing and three year warrants to purchase a total of 66,667 commonshares at a per share price of $1.25 were issued to several selling agents.

In conjunctionwith this financing we agreed to file, within 60 days after the first closing,a registration statement covering the resale of the shares of common stock andthe shares underlying the warrants, and to use our commercially reasonableefforts to cause such registration statement to be declared effective within120 days after closing or pay financial liquidated damages to the investors. Wehave not yet filed a registration statement and we are incurring liquidateddamages at the rate of approximately $59,400 for every 30-day period that aregistration statement has not been filed, up to a maximum of 8% of the grossproceeds.  As of September 30, 2006 wehave incurred $334,446 in liquidated damages related to the registration rightsagreement, or approximately 5.6%, which have been classified as other expenseon our condensed consolidated statement of operations. $149,287 of thesedamages was paid in cash during the nine months ended September 30, 2006 and$185,159 was due and payable as of September 30, 2006.

On September 8,2006 Callisto entered into a Letter Agreement with certain investors (the “Investors”)who participated in a private placement of our common stock and warrants inFebruary and April 2006 (the “Prior Placement”).  Pursuant to this LetterAgreement, the Investors agreed to amend (the “Amendment”) the securitiespurchase agreement (the “Securities Purchase Agreement”), entered into inconnection with the Prior Placement, to (i) delete the mandatory registrationrights set forth in the Securities Purchase Agreement and add piggybackregistration rights and (ii) waive any and all penalties pursuant to the liquidateddamages provisions contained in the Securities Purchase Agreement. In addition,the Investors agreed to enter into a lock-up agreement (the “Lock-up Agreement”)pursuant to which they agreed not to sell or transfer the shares of commonstock and warrants acquired in the Prior Placement for a period of six monthsbeginning September 1, 2006. In exchange for the Investors entering into theAmendment and the Lock-Up Agreement, Callisto agreed to issue to each Investorone share of common stock and 2.35 five year warrants exercisable at $1.00 pershare (the “New Warrants”) for every five shares of common stock they purchasedin the Prior Placement.  In addition, Callisto agreed in the LetterAgreement to amend the warrants (the “Old Warrants”) issued in the PriorPlacement to the Investors to (i) extend the expiration date of the OldWarrants by 42 months thereby making them 5 year warrants and (ii) eliminatethe provision in the Old Warrants by which Callisto can force exercise of theunexercised warrants.  During October andNovember 2006 Callisto entered into the Amendment and Lock-up Agreements witheach Investor pursuant to which Callisto issued 740,067 shares of common stockand 1,739,157 New Warrants. Approximately $150,000 in cash liquidated damages,payable to these Investors as of September 30, 2006, was concurrently waived.

**OnOctober 23, 2006, **we**closed a private placement of 105,000 shares of Series A ConvertiblePreferred Stock (the “Series A Preferred Stock”) and 1,400,000 warrants (the “Warrants”)to certain investors (the “Investors”) for aggregate gross proceeds of$1,050,000. The Investors also are parties to a Registration Rights Agreement,dated as of October 23, 2006 pursuant to which** **we agreed to file, within60 days of closing, a registration statement covering the resale of the sharesof common stock underlying the Series A Preferred Stock and the Warrants issuedto the Investors. The Warrants are immediately exercisable at $0.75 per share,** **will expire five yearsfrom the date of issuance, and have certain antidilution rights for thetwelve month period beginning on the effective date of the registrationstatement registering the shares of common stock underlying the Warrants. ** **We paid an aggregate$40,000 and issued an aggregate 53,334 warrants to purchase common stock tocertain selling agents. The warrants are immediately exercisable at $0.75 pershare, will expire five years after issuance and have the same antidilutionrights as the Investor Warrants. Our** Certificate ofIncorporation has been amended to provide for the issuance of 400,000 shares ofSeries A Preferred Stock pursuant to the Certificate of Designations, Number,Voting Powers, Preferences and Rights of Series A Convertible Preferred Stockfiled with the State of Delaware on October 24, 2006.

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OnApril 1, 2005 we were awarded a research grant for work on a biodefenseprogram from the National Institute of Allergy and Infectious Diseases (“NIAID”)to develop a monoclonal antibody and vaccine against bacterial superantigen toxinsunder an exclusive license with Rockefeller University entered into on August20, 1996. We receive cash funding under approved grants and record the receiptas an offset to research and development expense only when the expense isincurred. Funds received as an offset to research and development expensesincurred totaled $ 43,956 and $299,378, during the three and nine months endedSeptember 30, 2006, respectively and have been reported on our CondensedConsolidated Statements of Operations as a separate line item entitled “GovernmentGrant”. In addition as of September 30, 2006 we had received approximately$78,000 of cash advances under the NIAID grant for which we had not yetincurred any expenses.   During October 2006 we advanced anadditional amount of $270,000 for research expenses not yet incurred and usedsome funds to pay operating expenses not specifically related to work on thebiodefense program.

Ourworking capital requirements will depend upon numerous factors including butnot limited to the nature, cost and timing of: pharmaceutical research anddevelopment programs; pre-clinical and clinical testing; obtaining regulatoryapprovals; technological advances and our ability to establish collaborativearrangements with research organizations and individuals needed tocommercialize our products. Our capital resources will be focused primarily onthe clinical development and regulatory approval of our current productcandidates, and the acquisition of licenses and rights to certain other cancerrelated drug technologies. Our existing capital resources will not besufficient to fund our operations and we will be required to raise additionalcapital to complete the development and commercialization of our currentproduct candidates.

Ourconsolidated financial statements as of December 31, 2005 have beenprepared under the assumption that we will continue as a going concern for thetwelve months ending December 31, 2006, Our independent registered publicaccounting firm has issued a report dated March 29, 2006 that included anexplanatory paragraph referring to our recurring losses from operations and netcapital deficiency and expressing substantial doubt in our ability to continueas a going concern without additional capital becoming available. Our abilityto continue as a going concern is dependent upon our ability to obtainadditional equity or debt financing, attain further operating efficiencies and,ultimately, to generate revenue. The financial statements do not include anyadjustments that might result from the outcome of this uncertainty. We will berequired to raise additional capital within the next twelve months to completethe development and commercialization of current product candidates and tocontinue to fund operations at our current cash expenditure levels.

To date, oursources of cash have been primarily limited to the sale of our equitysecurities. We cannot be certain that additional funding will be available onacceptable terms, or at all. Any debt financing, if available, may involverestrictive covenants that impact our ability to conduct our business. If weare unable to raise additional capital when required or on acceptable terms, wemay have to further delay, scale back or discontinue the developmentand/or commercialization of one or more of our product candidates.

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**CRITICALACCOUNTING POLICIES AND ESTIMATES**

Our discussion andanalysis of financial condition and results of operations are based upon ourcondensed consolidated financial statements, which have been prepared by uswithout audit in accordance with the rules and regulations of theSecurities and Exchange Commission. The preparation of our financial statementsrequires us to make estimates that affect the reported amounts of assets,liabilities, revenue and expense, and related disclosure of contingent assetsand liabilities. We base our accounting estimates on historical experience andother factors that are believed to be reasonable under the circumstances.However, actual results may vary from these estimates under differentassumptions or conditions. The following is a summary of our criticalsignificant accounting policies and estimates.

FinancialReporting Release No. 60 requires all companies to include a discussion ofcritical accounting policies or methods used in the preparation of financialstatements. Our accounting policies are described in Note 3 of the notes to ourconsolidated financial statements included in our Annual Report onForm 10-K/A for the fiscal year ended December 31, 2005. The financialstatements are prepared in accordance with accounting principles generallyaccepted in the United States of America, which requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reporting period. Actual results could differ from those estimates.

InDecember 2004, the Financial Accounting Standards Board (FASB) issuedStatement of Financial Accounting Standard (“SFAS”) No. 123 (Revised2004), *Share-Based Payments* (“SFAS123R”). SFAS 123R requires a public entity to measure the cost of employeeservices received in exchange for the award of equity instruments based on thefair value of the award at the date of grant. The expense is to be recognizedover the period during which an employee is required to provide services inexchange for the award. SFAS 123R is effective as of the beginning of the firstinterim or annual reporting period that begins after December 15, 2005 andaccordingly we adopted this standard on January 1, 2006. For all awardsgranted prior to January 1, 2006, the unearned deferred fair value ofstock based compensation, on the date of adoption, will be recognized as anexpense on a straight line basis over the remaining requisite service period.Our financial results for prior periods have not been restated.  See Note2 to our condensed consolidated financial statements for more detaileddiscussion of stock based compensation.

Prior toJanuary 1, 2006 we accounted for stock-based compensation expense inaccordance with Statement of Financial Accounting Standard No. 123, “Accountingfor Stock-Based Compensation” (“SFAS 123”). As provided for by SFAS 123, we hadelected to account for our stock-based compensation programs according to theprovisions of Accounting Principles Board Opinion No. 25, “Accounting forStock Issued to Employees” (“APB 25”).” Accordingly, compensation expense hadbeen recognized based on the intrinsic value of stock issued or options grantedto employees and directors for services rendered. We rely heavily on incentivecompensation in the form of stock options to recruit, retain and motivatedirectors, executive officers, employees and consultants. Incentivecompensation in the form of stock options is designed to provide long-termincentives, develop and maintain an ownership stake and conserve cash duringour development stage. Since inception through September 30, 2006 stock basedcompensation expense totaled $15,767,889 or approximately 29% of ouraccumulated deficit. We account for stock options and warrants granted tonon-employees based on the fair value of the stock option or warrant using theBlack-Scholes option pricing model based on assumptions for expected stockprice volatility, expected term of the option, risk-free interest rate andexpected dividend yield at the grant date.

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**ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

Our exposure tomarket risk on the fair values of certain assets is related to credit riskassociated with short term investment grade commercial paper included in shortterm money market accounts and the FDIC insurance limit on our balances. AtSeptember 30, 2006 our money market balances totaled approximately $124,000.

**ITEM 4. CONTROLSAND PROCEDURES**

Based on anevaluation of our disclosure controls and procedures (as defined inRules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of1934, as amended) required by paragraph (b) of Rule 13a-15 orRule 15d-15, as of September 30, 2006, our Chief Executive Officer andPrincipal Financial Officer have concluded that our disclosure controls andprocedures were effective in ensuring that information required to be disclosedby us in the reports that we file or submit under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in theCommission’s rules and forms. Our Chief Executive Officer and PrincipalFinancial Officer also concluded that, as of September 30, 2006, our disclosurecontrols and procedures were effective in ensuring that information required tobe disclosed by us in the reports that we file or submit under the Exchange Actis accumulated and communicated to our management, including our ChiefExecutive Officer and Principal Financial Officer, to allow timely decisionsregarding required disclosure.

During the threemonths ended September 30, 2006, there were no changes in our internal controlover financial reporting identified in connection with the evaluation requiredby paragraph (d) of Rule 13a-15 or Rule 15d-15 that has materially affected, oris reasonably likely to materially affect, our internal control over financialreporting.

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**PART II.OTHER INFORMATION**

**ITEM 1A. RISKFACTORS**

In addition to theother information set forth in this report, you should carefully consider thefactors discussed in Part I, “Item 1A. Risk Factors” in our Annual Reporton Form 10-K/A for the year ended December 31, 2005, which couldmaterially affect our business, financial condition or future results.

**ITEM 4. SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

At our AnnualMeeting of Stockholders held on October 12, 2006, three matters were votedupon. A description of each matter and a tabulation of the votes for each ofthe matters follow:

1.                                       Proposalto elect seven directors to our Board of Directors to serve for the ensuingyear or until their successors are duly elected and qualified or until their resignationor removal:

 
| ** **            | ** ** | **Votes**  | ** ** |
|-----------------------|------------|------------|------------|
| **Nominee**           | ** ** | ** ** | ** ** | **For** | ** ** | **Abstain** | ** ** | ** ** | ** ** |
| Gabriele M. Cerrone   |       | 26,960,560 |       | 455,721 |   |   |   |
| Gary S. Jacob         |       | 27,249,794 |       | 166,037 |   |   |   |
| Christoph Bruening    |       | 27,233,894 |       | 181,937 |   |   |   |
| John P. Brancaccio    |       | 27,233,960 |       | 181,871 |   |   |   |
| Stephen K. Carter     |       | 27,233,460 |       | 182,371 |   |   |   |
| Randall K. Johnson    |       | 27,233,794 |       | 182,037 |   |   |   |
| Riccardo Dalla-Favera |       | 27,233,460 |       | 182,371 |   |   |   |
|                       |            |            |            |  |  |  |  |  |  |

 

2.                                       Proposalto approve an amendment to our 2005 Directors’ Stock Option Plan allowing thegrant of options to non-employee directors as compensation for service on Boardcommittees

 

 

| Votes      | ** ** |
|------------|------------|
| **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** |
| 18,878,728 |       | 630,294 |   | 14,287 |   |

 

 

 

3.                                       Proposalto ratify the appointment of BDO Seidman, LLP as our independent registeredpublic accountants for the year ending December 31, 2006.

 

 

| Votes      | ** ** |
|------------|------------|
| **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** |
| 27,293,591 |       | 102,285 |   | 19,954 |   |

 

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**ITEM 6. EXHIBITS**

(a) Exhibits

 
|   | 31.1   |   | Certification of Chief Executive Officer required  under Rule 13a-14(a)/15d-14(a) under the Exchange Act.                                               |
|--------|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                              |
|   | 31.2   |   | Certification of Principal Financial Officer  required under Rule 13a-14(a)/15d-14(a) under the Exchange Act.                                           |
|   |   |   |                                                                                                                                                              |
|   | 32.1   |   | Certification of Chief Executive Officer pursuant to  18 U.S.C Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.     |
|   |   |   |                                                                                                                                                              |
|   | 32.2   |   | Certification of Principal Financial Officer  pursuant to 18 U.S.C Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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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, thereuntoduly authorized.

 
|                               | ** ** | **CALLISTO PHARMACEUTICALS, INC.** |   |
|-------------------------------|------------|-----------------------------------------|--------|
|                          |       |    (Registrant)          |   |
|                          |       |                                    |   |   |   |
| Date: November  20, 2006      |       | By:                                     |   | /s/ GARY S. JACOB |   |
|                          |       |                                    |   |   |   |
|                          |       |                                    |   | Gary S. Jacob |   |
|                          |       |                                    |   | Chief Executive Officer |   |
|                          |       |                                    |   |   |   |
| Date:  November 20, 2006 |       | By:                                     |   | /s/ BERNARD F. DENOYER |   |
|                          |       |                                    |   |   |   |
|                          |       |                                    |   | Bernard F. Denoyer |   |
|                          |       |                                    |   | Vice President, Finance |   |

 

 

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