** **

**UNITED STATES OF AMERICA**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

 

**FORM 10-Q**

 

**(Mark One)**

**ý****QUARTERLY REPORT PURSUANT TO SECTION 13OR 15(D) OF THE SECURITIES**

**EXCHANGE ACT OF 1934**

 

**FOR THE QUARTERLY PERIOD ENDED: MARCH 31, 2006**

 

**o****TRANSITION REPORT PURSUANTTO SECTION 13 OR 15(D) OF THE**

**SECURITIES EXCHANGE ACT OF 1934**

 

**For the transition period from                  to                  **

 

**Commission File Number: 001-32325**

 

**CALLISTOPHARMACEUTICALS, 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 Identification 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, Former Address and Former Fiscal Year,if changed since last report)

 

Indicateby check mark whether the registrant: (1) has filed all reports requiredto be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.

 

Yes                            ý                                    No                                o

 

Indicateby check mark whether the Registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act.(Check one):

 
| Large accelerated Filer |   | o |   | Accelerated filer |   | o |   | Non-accelerated filer |   | ý |
|-------------------------|--------|---|--------|-------------------|--------|---|--------|-----------------------|--------|--------|

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).

 

Yes                            o                                    No                                ý

 

Thenumber of the registrant’s shares of common stock outstanding was 37,808,316 asof May 15, 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 March 31, 2006 (unaudited) and December 31, 2005 | 1 |
|                                         |       |   |   |
|                                         |       | Condensed Consolidated Statements  of Operations  for the Three Months Ended March 31, 2006 and 2005 (unaudited)  and the period June 5, 1996 (Inception) to March 31, 2006  (unaudited) | 2 |
|                                         |       |   |   |
|                                         |       | Condensed Consolidated Statements  of Changes in Stockholders’ Equity  for the period June 5, 1996 (Inception) to March 31, 2006  (unaudited) | 3 |
|                                         |       |   |   |
|                                         |       | Condensed Consolidated Statements  of Cash Flows  for the Three Months Ended March 31, 2006 and 2005 (unaudited)  and for the period June 5, 1996 (Inception) to March 31, 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 | 14 |
|                                         |       |   |   |
| Item 3.                                      |       | Quantitative and Qualitative  Disclosures About Market Risk | 21 |
|                                         |       |   |   |
| Item 4.                                      |       | Controls and Procedures | 21 |
| ** **                                   | ** ** | ** ** | ** ** |
| **PART II — OTHER INFORMATION**    |       |
|                                         |       |   |   |
| Item 1A.                                     |       | Risk Factors | 22 |
|                                         |       |   |   |
| Item 2.                                      |       | Unregistered sales of Equity  Securities and Use of Proceeds | 22 |
|                                         |       |   |   |
| Item 5.                                      |       | Exhibits | 22 |
|                                         |       |   |   |
| Signatures                                   |       |

 

i

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**INTRODUCTORY NOTE**

 

**This Report on Form 10-Q forCallisto Pharmaceuticals, Inc. (“Callisto” or the “Company”) may containforward-looking statements. You can identify these statements byforward-looking words such as “may,” “will,” “expect,” “intend,” “anticipate,”believe,” “estimate” and “continue” or similar words. Forward-lookingstatements include information concerning possible or assumed future businesssuccess or financial results. You should read statements that contain thesewords carefully because they discuss future expectations and plans, whichcontain projections of future results of operations or financial condition orstate other forward-looking information.  We believe that it is important to communicatefuture expectations to investors. However, there may be events in thefuture that we are not able to accurately predict or control. Accordingly, wedo not undertake any obligation to update any forward-looking statements forany reason, even if new information becomes available or other events occur inthe future.**

 

**The forward-looking statementsincluded herein are based on current expectations that involve a number ofrisks and uncertainties set forth under “Risk Factors” in our Annual Report on Form 10-K/Afor the year ended December 31, 2005 and other periodic reports filed withthe SEC. Accordingly, to the extent that this Report contains forward-lookingstatements regarding the financial condition, operating results, businessprospects or any other aspect of the Company, please be advised that Callisto’sactual financial condition, operating results and business performance may differmaterially from that projected or estimated by the Company in forward-lookingstatements.**

 

ii

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**PART I - FINANCIAL INFORMATION**

 

**Item 1. Condensed Consolidated Financial Statements**

 

**CALLISTO PHARMACEUTICALS, INC.**

**(A development stage company)**

 

**CONDENSED CONSOLIDATED BALANCESHEETS**

 
| ** **                                                                                                                                                              | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                              | ** ** | **(Unaudited)**          | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                                                                              | ** ** | ** **               | ** ** | ** **                  | ** ** |
| Current  assets:                                                                                                                                                        |       |                     |       |                        |       |
| Cash and  cash equivalents                                                                                                                                              |       | $                        | 2,790,502  |                        | $          | 1,420,510 |   |
| Prepaid  expenses                                                                                                                                                       |       | 86,745                   |       | 181,284                     |       |
|                                                                                                                                                                    |       | 2,877,247                |       | 1,601,794                   |       |
|                                                                                                                                                                    |       |                     |       |                        |       |
| Property and  equipment – net                                                                                                                                      |       | 8,602                    |       | —                      |       |
| Rent  deposits                                                                                                                                                          |       | 64,716                   |       | 82,196                      |       |
|                                                                                                                                                                    |       | $                        | 2,950,565  |                        | $          | 1,683,990 |   |
| **Liabilities  and Stockholders’ Equity (Deficit)**                                                                                                                |       |                     |       |                        |       |
| Current  liabilities:                                                                                                                                                   |       |                     |       |                        |       |
| Accounts  payable                                                                                                                                                       |       | $                        | 1,192,196  |                        | 1,424,612  |   |
| Accrued  expenses                                                                                                                                                       |       | 716,554                  |       | 592,297                     |       |
|                                                                                                                                                                    |       | 1,908,750                |       | 2,016,909                   |       |
| Stockholders’  equity:                                                                                                                                             |       |                     |       |                        |       |
| Common  stock, par value $.0001, 100,000,000 shares authorized, 37,713,264 and  33,233,096 outstanding at March 31, 2006 and December 31, 2005,  respectively |       | 3,770                    |       | 3,323                       |       |
| Additional  paid-in capital                                                                                                                                             |       | 50,553,327               |       | 46,387,875                  |       |
| Unamortized  deferred stock-based compensation                                                                                                                          |       | —                   |       | (1,583,463                  | )          |
| Deficit  accumulated during development stage                                                                                                                           |       | (49,515,282              | )          | (45,140,654                 | )          |
|                                                                                                                                                                    |       | 1,041,815                |       | (332,919                    | )          |
|                                                                                                                                                                    |       | $                        | 2,950,565  |                        | $          | 1,683,990 |   |

 

The accompanying notes are an integral part of these condensedconsolidated financial statements.

 

1

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**CALLISTO PHARMACEUTICALS, INC.**

**(A development stage company)**

 

**CONDENSED CONSOLIDATED STATEMENTSOF OPERATIONS**

**(Unaudited)**

 
| ** **                                                                       | ** ** | ** **                                           | ** ** | ** **              | ** ** | **For the Period**         | ** ** |
|----------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-------------------------|------------|--------------------------------------|------------|
| ** **                                                                       | ** ** | ** **                                           | ** ** | ** **              | ** ** | **From June 5, 1996** | ** ** |
| ** **                                                                       | ** ** | **Three months ended March 31,** | ** ** | **(inception) to** | ** ** |
| ** **                                                                       | ** ** | **2006**                                             | ** ** | **2005**                | ** ** | **March 31, 2006**         | ** ** |
|                                                                             |       |                                                 |       |                    |       |                                 |       |
| Revenues                                                                         |       | $                                                    | —     |                    | $          | —                               |       | $ | — |   |
|                                                                             |       |                                                 |       |                    |       |                                 |       |
| Costs and Expenses:                                                              |       |                                                 |       |                    |       |                                 |       |
| Research and  development                                                        |       | 2,193,840                                            |       | 1,575,769               |       | 18,199,702                           |       |
| Government  grant                                                                |       | (54,267                                              | )          | —                  |       | (546,083                             | )          |
| Purchased  in-process research and development                                   |       | —                                               |       | —                  |       | 6,944,553                            |       |
| General and  administrative                                                      |       | 1,754,090                                            |       | 1,007,816               |       | 17,394,954                           |       |
| Stock based  compensation – non employees – general and administrative |       | 504,047                                              |       | 30,137                  |       | 8,828,617                            |       |
| Loss from  operations                                                            |       | (4,397,710                                           | )          | (2,613,722              | )          | (50,821,743                          | )          |
|                                                                             |       |                                                 |       |                    |       |                                 |       |
| Interest  income                                                                 |       | 23,082                                               |       | 19,591                  |       | 678,066                              |       |
| Other income                                                                     |       | —                                               |       | —                  |       | 628,395                              |       |
|                                                                             |       |                                                 |       |                    |       |                                 |       |
| Net loss                                                                         |       | $                                                    | (4,374,628 | )                       | $          | (2,594,131                           | )          | $ | (49,515,282 | ) |
|                                                                             |       |                                                 |       |                    |       |                                 |       |
| Weighted  average number of common shares outstanding:                           |       |                                                 |       |                    |       |                                 |       |
| Basic and  diluted                                                               |       | 35,978,019                                           |       | 29,743,937              |       |                                 |       |
|                                                                             |       |                                                 |       |                    |       |                                 |       |
| Net loss per  common share: basic and diluted                                    |       | $                                                    | (0.12      | )                       | $          | (0.09                                | )          |   |   |

 

See accompanying notes tocondensed consolidated financial statements.

 

2

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****CALLISTO PHARMACEUTICALS, INC.****

(A Development Stage Company)

****CONDENSEDCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (DEFICIT)****

 
| **** ****                             | **** **** | ****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’  Equity (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 quarter ended March 31, 2006                      |           | —                |           | —                            |           | —                                    |           | —                                                        |           | (4,374,628                                                        | )              | (4,374,628                                          | )              |
|                                                                    |           |                  |           |                              |           |                                      |           |                                                          |           |                                                              |           |                                                |           |
| Amortization and reclassification of deferred  stock-based compensation |           | —                |           | —                            |           | (675,057                                  | )              | 1,583,463                                                     |           | —                                                            |           | 908,406                                             |           |
|                                                                    |           |                  |           |                              |           |                                      |           |                                                          |           |                                                              |           |                                                |           |
| Variable accounting for stock options                                   |           | —                |           | —                            |           | 54,159                                    |           | —                                                        |           | —                                                            |           | 54,159                                              |           |
|                                                                    |           |                  |           |                              |           |                                      |           |                                                          |           |                                                              |           |                                                |           |
| Common stock issued via private placement:                              |           |                  |           |                              |           |                                      |           |                                                          |           |                                                              |           |                                                |           |
| February 2006                                                      |           | 4,283,668             |           | 428                               |           | 5,139,782                                 |           | —                                                        |           | —                                                            |           | 5,140,210                                           |           |
|                                                                    |           |                  |           |                              |           |                                      |           |                                                          |           |                                                              |           |                                                |           |
| Finders fees and expenses                                               |           | —                |           | —                            |           | (561,808                                  | )              | —                                                        |           | —                                                            |           | (561,808                                            | )              |
|                                                                    |           |                  |           |                              |           |                                      |           |                                                          |           |                                                              |           |                                                |           |
| Exercise of common stock warrant                                        |           | 184,500               |           | 18                                |           | 190,017                                   |           | —                                                        |           | —                                                            |           | 190,035                                             |           |
|                                                                    |           |                  |           |                              |           |                                      |           |                                                          |           |                                                              |           |                                                |           |
| Common stock issued for services                                        |           | 12,000                |           | 1                                 |           | 18,359                                    |           | —                                                        |           | —                                                            |           | 18,360                                              |           |
| Balance, March 31, 2006                                            |           | 37,713,264            |           | $                                 | 3,770          |                                      | $              | 50,553,327                                                    |           | —                                                            |           | $                                                   | (49,515,282    | ) | $ | 1,041,815 |   |

 

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

 

8

----

 

****CALLISTO PHARMACEUTICALS, INC.****

(A Development Stage Company)

****CONSOLIDATEDSTATEMENTS OF CASH FLOWS****

 
| **** ****                                                               | **** **** | ****Three months Ended March 31,****** ** | ** **     | ****Period from  June 5, 1996  (inception) to**** | ** ** |
|------------------------------------------------------------------------------|----------------|--------------------------------------------------------------------|----------------|-----------------------------------------------------------------------|------------|
| **** ****                                                               | **** **** | ****2006****                                                       | **** **** | ****2005****                                                          | ** ** | **** March 31, 2006**** | ** ** |
| Cash flows  from operating activities:                                       |           |                                                               |           |                                                                  |       |   |   |
| Net loss                                                                     |           | $                                                                  | (4,374,628     | )                                                                     | $          | (2,594,131 | ) | $ | (49,515,282 | ) |
| Adjustments  to reconcile net loss to net cash used in operating activities: |           |                                                               |           |                                                                  |       |   |   |
| Depreciation                                                                 |           | —                                                             |           | 5,072                                                                 |       | 84,637 |   |
| Stock based  compensation expense                                            |           | 994,050                                                            |           | 412,741                                                               |       | 14,765,017 |   |
| Purchased  in-process research and development (non-cash portion)            |           | —                                                             |           | —                                                                |       | 6,841,053 |   |
| Changes in  operating assets and liabilities:                                |           |                                                               |           |                                                                  |       |   |   |
| Prepaid  expenses                                                            |           | 81,415                                                             |           | 1,090                                                                 |       | (106,433 | ) |
| Rent  deposits                                                               |           | 17,480                                                             |           | —                                                                |       | (64,716 | ) |
| Accounts  payable and accrued expenses                                       |           | (108,160                                                           | )              | 611,026                                                               |       | 1,668,822 |   |
| Total  adjustments                                                           |           | 984,785                                                            |           | 1,029,929                                                             |       | 23,188,380 |   |
| Net cash  used in operating activities                                       |           | (3,389,843                                                         | )              | (1,564,202                                                            | )          | (26,326,902 | ) |
| 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                  |           | 5,140,210                                                          |           | 3,018,401                                                             |       | 30,425,673 |   |
| Finders fees  and expenses                                                   |           | (561,808                                                           | )              | (25,000                                                               | )          | (1,533,815 | ) |
| Exercise of  common stock warrants                                           |           | 190,035                                                            |           | —                                                                |       | 318,785 |   |
| Net cash  provided by financing activities                                   |           | 4,768,437                                                          |           | 2,993,401                                                             |       | 29,210,643 |   |
|                                                                         |           |                                                               |           |                                                                  |       |   |   |
| Net increase  in cash and cash equivalents                                   |           | 1,369,992                                                          |           | 1,429,199                                                             |       | 2,790,502 |   |
|                                                                         |           |                                                               |           |                                                                  |       |   |   |
| Cash and  cash equivalents at beginning of period                            |           | 1,420,510                                                          |           | 5,323,384                                                             |       | — |   |
| Cash and  cash equivalents at end of period                                  |           | $                                                                  | 2,790,502      |                                                                  | $          | 6,752,583 |   | $ | 2,790,502 |   |
| Supplementary  disclosure of cash flow information:                          |           |                                                               |           |                                                                  |       |   |   |
| Cash paid  for taxes                                                         |           | $                                                                  | 12,146         |                                                                  | $          | 27,800 |   | $ | 121,753 |   |
| Cash paid  for interest                                                      |           | $                                                                  | —         |                                                                  | $          | — |   | $ | — |   |

 

The accompanying notes are an integral part of these condensedconsolidated financial statements.

 

9

----

 

**CALLISTO PHARMACEUTICALS, INC.**

 

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**(Unaudited)**

 

1. Basis of presentation:

 

The accompanying unauditedcondensed consolidated financial statements of Callisto Pharmaceuticals, Inc.(“Callisto”), which include its wholly owned subsidiaries: (1) CallistoResearch Labs, LLC (including its wholly owned but inactive subsidiary,Callisto Pharma, GmbH (Germany)) and (2) Synergy Pharmaceuticals Inc. (“Synergy”, including its wholly owned but inactive subsidiary IgX, Ltd (Ireland)), havebeen prepared in accordance with (i) accounting principles generallyaccepted in the United States of America (“GAAP”) for interim financialinformation and (ii) the rules of the Securities and ExchangeCommission (the “SEC”) for quarterly reports on Form 10-Q. The results ofoperations of Synergy are included in the condensed consolidated financialstatements since May 1, 2003. All intercompany balances and transactionshave been eliminated and certain expense items in prior periods have beenreclassified to conform to current financial statement presentation. Thesecondensed consolidated financial statements do not include all of theinformation and footnote disclosures required by GAAP for complete financialstatements. These statements should be read in conjunction with Callisto’saudited financial statements and notes thereto for the year ended December 31,2005, included in Form 10-K/A filed with the SEC on April 18, 2006. Inthe opinion of management, the accompanying unaudited condensed consolidatedfinancial statements include all adjustments, primarily consisting of normaladjustments, necessary for the fair presentation of the balance sheet andresults of operations for the interim periods. The results of operations forthe three months ended March 31, 2006 are not necessarily indicative ofthe results of operations to be expected for the full year ending December 31,2006.

 

Theaudited financial statements and notes thereto for the year ended December 31,2005, included in Form 10-K/A filed with the SEC on April 18, 2006,have been prepared under the assumption that Callisto will continue as a goingconcern for the twelve months ending December 31, 2006. Callisto’sindependent registered public accounting firm has issued a report dated March 29,2006 that 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 uncertainty. Callisto will be required to raiseadditional capital within the next twelve months to complete the developmentand commercialization of current product candidates and to continue to fundoperations at our current cash expenditure levels.

 

2. Accounting for stockbased compensation

 

In December 2004, theFinancial Accounting Standards Board (FASB) issued Statement of FinancialAccounting Standard (“SFAS”) No. 123 (Revised 2004), *Share-Based Payments* (“SFAS 123R”). SFAS123R requires a public entity to measure the cost of employee services receivedin exchange for the award of equity instruments based on the fair value of theaward at the date of grant. The expense is to be recognized over the periodduring which an employee is required to provide services in exchange for theaward. SFAS 123R is effective as of the beginning of the first interim orannual reporting period that begins after December 15, 2005 andaccordingly Callisto adopted this standard on January 1 , 2006.

 

Forall awards granted prior to January 1, 2006, the unearned deferred fairvalue of stock based compensation will be recognized as an expense on astraight line basis over the remaining requisite service period, ranging fromsix months to three years. Our financial results for prior periods have notbeen restated. The adoption of SFAS 123R increased net loss for the threemonths ended March 31, 2006 by approximately $107,000 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 March 31, 2006, as measuredat the date of grant, was approximately$1,652,000.

 

Effective with the adoptionof SFAS 123R stock-based compensation expense related to Callisto’s share-basedcompensation arrangements attributable to employees is being recorded as acomponent of general and administrative expense and research and developmentexpense in accordance with the guidance of Staff Accounting Bulletin 107**,**Topic 14, paragraph F*.Classification of Compensation Expense Associated with Share-Based PaymentArrangements*(“SAB 107”). Prior period financial statement accountshave been reclassified to conform to this presentation. Stock based compensation cost related toemployee stock options recognized in the operating results for the three monthsended March 31, 2006, March 31, 2005 and for the period from June 6,1996 (inception, through March 31, 2006 included approximately $341,000, $314,000and $3,656,000 in general and administrative expenses and approximately$149,000, $69,000 and $2,280,000 included in the research and developmentexpenses, respectively. For the three months ended March 31, 2006, March31, 2005 and for the period from June 6, 1996 (inception) through March 31,2006, Callisto recognized approximately $504,000, $30,000 and $8,800,000respectively of non-employee share-based compensation expense.

 

10

----

 

Theestimated fair value of each employee option award granted was determined inaccordance with SFAS 123R on the date of grant using the Black-Scholes optionvaluation model with the following weighted-average assumptions for option grantedduring the three months ended March 31, 2006 and 2005:

 
| ** **               | ** ** | **Employee options granted during  the three months ended March 31,** | ** ** |
|--------------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|
| ** **               | ** ** | **2006**                                                                                                      | ** ** | **2005** | ** ** |
| Risk free  interest rate |       | 4.25                                                                                                          | %          | 4.25 | % |
| Dividend  yield          |       | 0.0                                                                                                           | %          | 0.0 | % |
| Volatility               |       | 79                                                                                                            | %          | 79 | % |
| Expected  Life           |       | 3 to 7 years                                                                                                  |       | 7 years |   |

 

Therisk-free interest rate assumption is based upon observed interest ratesappropriate for the expected term of Callisto’s employee stock options. Theexpected volatility is based on the historical volatility of Callisto’s stock.The Company has not paid any dividends on common stock since its inception anddoes not anticipate paying dividends on its common stock in the foreseeablefuture. The computation of the expected option term is based on expectationsregarding future exercises of options which generally vest over 3 yearsand have a 10 year life.

 

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 inestimated fair 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 three months ended March 31,2006, estimated as of the grant date using the Black-Scholes option valuationmodel, was $1.19 per share. A summary of the status of Callisto’s stock optionplans as of March 31, 2006 and of changes in options outstanding under Callisto’splans during the three months ended March 31, 2006 is as follows: 

 
| ** **                                  | ** ** | **Number of** | ** ** | **Weighted Average**     | ** ** |
|---------------------------------------------|------------|--------------------|------------|-------------------------------|------------|
| ** **                                  | ** ** | **Shares**         | ** ** | **Price Per Share** | ** ** |
| Outstanding  at January 1, 2006        |       | 8,008,210          |       | $                             | 1.79       |   |
| Granted                                     |       | 850,000            |       | 1.57                          |       |
| Exercised                                   |       | —             |       |                          |       |
| Terminated                                  |       | (350,000           | )          |                          | 1.32       |   |
| Outstanding  at March 31, 2006         |       | 8,508,210          |       | $                             | 1.79       |   |
| Options  exercisable at March 31, 2006 |       | 4,370,052          |       | $                             | 1.62       |   |

 

Theweighted average remaining term of all options outstanding decreased from 7.4years at December 31, 2005 to 7.3 years at March 31, 2006. At March 31,2006 Callisto had 850,000 stock options outstanding under the 2005 Equity Plan,52,500 stock options outstanding under the 2005 Director’s Plan and 7,605,710stock options outstanding under the 1996 Plan.

 

SFAS123R requires that cash flows resulting from tax deductions in excess of thecumulative compensation cost recognized for options exercised (excess taxbenefits) be classified as cash inflows from financing activities and cashoutflows from operating activities. Due to Callisto’s accumulated deficitposition, no tax benefits have been recognized in the cash flow statement.

 

Prior to January 1,2006, Callisto had adopted Statement of Financial Accounting Standard (“SFAS”) No. 123,“Accounting for Stock-Based Compensation.” As provided for by SFAS 123,Callisto had elected to continue to account for its stock-based compensationprograms according to the provisions of Accounting Principles Board Opinion No. 25,“Accounting for Stock Issued to Employees (“APB 25”).” Accordingly,compensation expense had been recognized to the extent of employee or directorservices rendered based on the intrinsic value of stock options granted underthe plan. Callisto accounts for common stock, stock options, and warrantsgranted to non-employees based on the fair market value of the instrument,using the Black-Scholes option pricing model based on assumptions for expectedstock price volatility, term of the option, risk-free interest rate andexpected dividend yield at the grant date.

 

11

----

 

Had compensation cost forstock options granted to employees and directors prior to January 1, 2006been determined based upon the fair value at the grant date for awards,consistent with the methodology prescribed under SFAS 123, Callisto’s net lossfor the three months ended March 31, 2005 would have been as follows:

 
| ** **                                                                                             | ** ** | **Three months ended** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                             | ** ** | **March 31,**               | ** ** |
| ** **                                                                                             | ** ** | **2005**                         | ** ** |
|                                                                                                   |       |                             |       |
| Net loss, as  reported                                                                                 |       | $                                | (2,594,131 | ) |
| Add:  Stock-based employee compensation expense recorded under APB No. 25  intrinsic value method |       | 382,604                          |       |
|                                                                                                   |       |                             |       |
| Deduct:  Stock-based employee compensation expense determined under fair value based  method           |       | (584,440                         | )          |
|                                                                                                   |       |                             |       |
| Pro forma  net loss                                                                                    |       | $                                | (2,795,967 | ) |
|                                                                                                   |       |                             |       |
| Net loss per  share:                                                                                   |       |                             |       |
| Basic and  diluted -as reported                                                                        |       | $                                | (0.09      | ) |
|                                                                                                   |       |                             |       |
| Basic and  diluted -pro forma                                                                          |       | $                                | (0.09      | ) |

 

3. Net Loss per Share

 

Basic and diluted net lossper share is presented in conformity with SFAS No. 128, “Earnings perShare,” for all periods presented. In accordance with SFAS No. 128, basicand 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 March 31, 2006 there were 3,844,018 warrants outstanding and 8,508,210total vested and unvested options outstanding.

 

4. Government Grants

 

Callisto requests cashfunding under approved grants as expenses are incurred (not in advance) andrecords the receipt as an offset to research and development expense. On April 1,2005 Callisto received a research grant for work on a biodefense program fromthe National Institute of Allergy and Infectious Diseases to develop amonoclonal antibody and vaccine against bacterial superantigen toxins under ourAugust 20, 1996 license with Rockefeller University. This amount totaled$54,267 during the three months ended March 31, 2006 and has been reportedon our Condensed Consolidated Statements of Operations as a separate line itementitled “Government Grant”.

 

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: **Accounting for Derivative Financial Instruments Indexedto, and Potentially Settled in, a Company’s Own Stock** (“EITF 00-19”) the warrantswill be classified as permanent equity. The fair value of the investorwarrants on February 3, 2006, the date of grant was $662,680 using BlackScholes assumptions of 79% volatility, a risk free interest rate of 4.25%, nodividend, an expected life of 18 months and a stock price on that date of $1.59per share. This fair value allocated to the investor warrants was recorded asadditional paid in capital during the quarter ended March 31, 2006.

 

OnApril 7, 2006 Callisto had a second closing of the financing describedabove, in which we sold an additional 666,667 shares of common stock and issued166,667 common stock purchase warrants at the same terms, for gross proceeds of$800,000, bringing the total gross proceeds of the financing to $5.94 millionand net proceeds to $5.38 million. No placement agent fees or legal fees wereincurred on this second closing however three year warrants to purchase a totalof 66,667 common shares at a per share price of $1.25 were issued to severalselling agents.

 

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Callistoagreed to file, within 60 days after the first closing, a registrationstatement covering the resale of the shares of common stock and the sharesunderlying the warrants, and to use its commercially reasonable efforts tocause such registration statement to be declared effective within 120 daysafter closing or pay financial penalties to the investors in the event aregistration statement is not filed or declared effective within such timeperiod. Callisto has not yet filed a registration statement within the 60-daytime period and is incurring financial penalties of $51,404 for every 30-dayperiod that a registration statement has not been filed. As of May 22,2006 Callisto has incurred $83,960 for financial penalties related to theregistration rights agreement.

 

6. Commitments andcontingencies:

 

Licensing agreements:

 

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). Callisto paid a nonrefundable fee uponexecution of this agreement and is obligated to pay annual license maintenancefees to The University of Texas M.D. Anderson Cancer Center. Callisto is alsoobligated under this agreement to pay for the legal fees and expensesassociated with establishing and protecting the patent rights worldwide.

 

Callisto also agreed to payThe University of Texas M.D. Anderson Cancer Center royalties based on netsales from any licensed products, plus aggregate milestone payments of up to$1,750,000 based upon achieving certain regulatory submissions and approvals.The term of the agreement is from January 10, 2006 until the end of theterm for which the patent rights associated with the licensed technology haveexpired. If the first pending patent is issued, the agreement is projected toexpire in 2025. In addition, at any time after two years from January 10,2006, The University of Texas M.D. Anderson Cancer Center has the right toterminate the license if Callisto fails to provide evidence within 90 days ofwritten notice that it has commercialized or is actively and effectivelyattempting to commercialize the licensed technology.

 

Employmentand consulting agreements:

 

OnJanuary 31, 2006, Callisto entered into a consulting agreement with Dr. MosheTalpaz, whereby Dr. Talpaz will provide consulting services for Callisto’sDegrasyns program. Under the agreement Dr. Talpaz will be paid $10,000 peryear and was granted 575,000 10-year options to purchase Callisto common stockat $1.60 per share. Such options vest based on milestones related to theDegrasyns compounds being developed towards FDA approval. Callisto also agreedto issue to Dr. Talpaz 75,000 shares of restricted common stock, subjectto shareholder approval. The term of the agreement is for the length of timeCallisto is developing the Degrasyns platform of compounds in allindications.

 

OnFebruary 17, 2006, Pamela Harris, the Chief Medical Officer of Callisto,resigned from the Company. As a result the employment agreement between Dr. Harrisand Callisto dated as of March 28, 2005, as amended, was terminated.

 

On March 23, 2006,Callisto entered into a 2-year sponsored laboratory study agreement with theUniversity of Texas M. D. Anderson Cancer Center whereby Dr. NicholasDonato, as principal investigator, will analyze the anti-tumor activity and mechanismof action of Callisto’s WP1130 Degrasyn compound and analogs. The agreementcalls for payment of $145,900 to M.D. Anderson in two installments of$72,950.00 with the first payment due within 30 days, and the second paymentdue within six months of execution.

 

On March 27, 2006,Callisto entered into a 2-year sponsored laboratory study agreement with theUniversity 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 Degrasyn platform technology.The agreement calls for payment of $127,145 to M.D. Anderson in twoinstallments of $63,572.50 with the first payment due within 30 days, and thesecond payment due within six months of execution.

 

7. Subsequent events:

 

On April 18, 2006 Callisto filed a Definitive Proxy Statement with the SEC to call a special shareholder meeting for shareholders to vote to approve the potential issuance of up to 20,000,000 shares (or up to $30,000,000) of our common stock, $.0001 par value (or securities convertible into or exercisable for common stock) at a price below fair market value and to consider the approval of the issuance of 75,000 shares of our restricted common stock to Dr. Moshe Talpaz pursuant to a consulting agreement between us and Dr. Talpaz.

 

On May 18, 2006 Callisto held a special shareholder meeting and approved (i) the potential issuance and sale of up to 20,000,000 shares of Callisto common stock (or securities convertible into or exercisable for common stock) at a price below fair market value for aggregate gross proceeds of up to $30,000,000 and (ii) the issuance of 75,000 shares of Callisto’s restricted common stock to Dr. Moshe Talpaz pursuant to a consulting agreement between Callisto and Dr. Talpaz.

 

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**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS AND RESULTS OF OPERATIONS**

 

The following discussionshould be read in conjunction with our condensed consolidated financial statementsand other financial information appearing elsewhere in this Quarterly Report.In addition to historical information, the following discussion and other partsof this quarterly report contain forward-looking information that involvesrisks and uncertainties.

 

**OVERVIEW**

 

Since inception in June 1996our efforts have been principally devoted to research and development, securingpatent protection, obtaining corporate relationships and raising capital. Sinceinception through March 31, 2006, we have sustained cumulative net lossesof $49,515,282. Our losses have resulted primarily from expenditures incurredin connection with clinical development of licensed products, the purchase ofin-process research and development, stock based compensation expense, patentfiling and maintenance, outside accounting and legal services and regulatoryconsulting fees.

 

From inception through March 31,2006 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.

 

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.

 

OnApril 7, 2006 we had a second closing of the financing described above, inwhich we sold an additional 666,667 shares of common stock and issued 166,667common stock purchase warrants at the same terms, for gross proceeds of$800,000, bringing the total gross proceeds of the financing to $5.94 millionand net proceeds to $5.38 million. No placement agent fees or legal fees wereincurred on this second closing however three year warrants to purchase a totalof 66,667 common shares at a per share price of $1.25 were issued to severalselling agents.

 

**HISTORY**

 

InMarch 2002, Callisto Pharmaceuticals, Inc. (“Old Callisto”), anon-public company, purchased 99.7% of the outstanding common shares ofWebtronics, Inc., (“Webtronics”) a public company for $400,000. Webtronicswas incorporated in Florida on February 2, 2001 and had limited operationsat December 31, 2002.

 

OnApril 30, 2003, pursuant to an Agreement and Plan of Merger dated March 10,2003, as amended April 4, 2003, Synergy Acquisition Corp., a wholly-ownedsubsidiary of Webtronics merged into Synergy Pharmaceuticals Inc. (“Synergy”)and Callisto Acquisition Corp., a wholly-owned subsidiary of Webtronics mergedinto Old Callisto (collectively, the “Merger”). As a result of the Merger, OldCallisto and Synergy became wholly-owned subsidiaries of Webtronics. In theMerger Webtronics issued 17,318,994 shares of its common stock in exchange foroutstanding Old Callisto common stock and an additional 4,395,684 shares inexchange for outstanding Synergy common stock. Old Callisto changed its name toCallisto Research Labs, LLC (“Callisto Research”) and Webtronics changed itsname to Callisto Pharmaceuticals, Inc. and changed its state ofincorporation from Florida to Delaware. Subsequently, 171,818 shares of commonstock issued to former Synergy shareholders were returned to us under the termsof certain indemnification agreements.

 

**PLAN OF OPERATIONS**

 

Ourplan of operations for the next twelve months is to focus primarily on thedevelopment of drugs to treat relapsed (re-occurrence of active disease) orrefractory acute leukemia (a disease of the white blood cells), multiplemyeloma (an incurable blood cancer that invades and proliferates in bonemarrow), and advanced carcinoid cancer patients. Our lead drug candidate,L-Annamycin, a drug from the anthracycline family (chemotherapy drugs which arederived from antibiotics), earlier completed an initial Phase I/IIa clinicaltrial in relapsed or refractory leukemia patients with a prior sponsor.L-Annamycin, originally developed by scientists at The University of Texas M.D.Anderson Cancer Center to address the clinical limitations associated withanthracycline drugs such as

 

Adriamycin(doxorubicin) to treat cancer, began a clinical trial at The University ofTexas M.D. Anderson Cancer Center in adult relapsed or refractory acutelymphocytic leukemia (ALL) patients on December 1, 2005. This single-arm,open label trial will enroll 12 patients in a dose escalation Phase I portion,followed by 10 patients in a final fixed dose in the Phase II portion. We planto treat up to 34 patients. We also expect to commence two additional trials ofL-Annamycin in 2006, a single agent trial in pediatric relapsed or refractoryALL patients and a combination therapy trial with Ara-C (cytosine arabinoside)in relapsed or refractory acute myeloid leukemia (AML) patients.

 

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Oursecond drug candidate, Atiprimod, is an orally administered drug withantiproliferative and antiangiogenic activity. Atiprimod commenced a Phase I/IIaclinical trial in relapsed multiple myeloma patients on May 26, 2004.These are patients that have a re-occurrence of active disease, and no longerrespond to approved therapies. The Phase I/IIa clinical trial is beingperformed at four sites, The University of Texas M.D. Anderson Cancer Center(Houston, TX), the Dana-Farber Cancer Institute (Boston, MA), the St. Vincent’sComprehensive Cancer Center (New York, NY) and the Roswell Park CancerInstitute (Buffalo, NY). In December 2005, we announced interim resultsfrom this trial performed in relapsed or refractory multiple myeloma patientswhich consisted of 15 patients treated with Atiprimod, including 3 patients atthe highest dose level of 180 mg/day. Two patients exhibited stable disease,with one patient having a 34% decrease in M protein (measure of tumor burden)over 3 months of treatment. It was also noted that two patients reported asubjective decrease in bone pain. We plan to continue this trial at higher doselevels until the maximum tolerated dose is reached and then treat 10 additionalpatients at that level.

 

OnMarch 15, 2005 we announced a second Phase I/IIa clinical trial ofAtiprimod in advanced cancer patients. The trial is entitled: “An Open LabelStudy of the Safety and Efficacy of Atiprimod Treatment for Patients withAdvanced Cancer”, and is currently being conducted at the University of TexasM.D. Anderson Cancer Center. On February 28, 2006, we announced plans tolaunch an additional indication for clinical development of Atiprimod based onencouraging clinical results from the advanced cancer clinical trial thatshowed a clear response in a patient with advanced carcinoid cancer plusadditional encouraging clinical data on other carcinoid patients. Based onthese new clinical data, we plan to initiate a new Phase I/IIa clinical trialof Atiprimod in carcinoid cancer patients with advanced metastatic tumors atseveral clinical sites in the next few months.

 

****L-ANNAMYCIN TO TREAT RELAPSED ACUTE LEUKEMIA****

 

On August 12, 2004, we entered into a world-wide license agreement with The University of Texas M.D. Anderson Cancer Center to research, develop, sell and commercially exploit the patent rights for L-Annamycin, an anthracycline cancer drug for leukemia therapy. Consideration paid for this license amounted to $31,497 for reimbursement of out-of-pocket costs for 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. Anderson Cancer Center royalties based on net sales from any licensed products, plus aggregate milestone payments of up to $750,000 based upon achieving certain regulatory submissions and approvals. The term of the agreement is from August 12, 2004 until November 2, 2019. Under the terms of the license agreement, we are required to make certain good faith expenditures towards the clinical development of at least one licensed product within the one year period after March 2006. In addition, at any time after five years from August 12, 2004, The University of Texas M.D. Anderson Cancer Center has the right to terminate the license if we fail to provide evidence within 90 days of written notice that we have commercialized or we are actively and effectively attempting to commercialize L-Annamycin.

 

L-Annamycin was discovered by scientists at The University of Texas M.D. Anderson Cancer Center and initially evaluated in a Phase I clinical trial in 36 patients with relapsed solid tumors, a Phase II clinical trial in 13 patients with doxorubicin-resistant breast cancer, and a Phase I/IIa trial in 20 patients with relapsed/refractory acute myeloid leukemia, or AML and acute lymphocytic leukemia, or ALL.

 

****DEVELOPMENT STRATEGY FOR L-ANNAMYCIN****

 

Webegan a clinical trial at The University of Texas M.D. Anderson Cancer Centerin adult relapsed or refractory acute lymphocytic leukemia (ALL) patients on December 1,2005. This single-arm, open label trial will enroll 12 patients in a doseescalation Phase I portion, followed by 10 patients in a final fixed dose inthe Phase II portion. We plan to treat up to 34 patients. We also expect tocommence two additional trials with L-Annamycin in 2006, a single agent trialof L-Annamycin in pediatric relapsed ALL patients, and a combination trial ofL-Annamycin in combination with Ara-C in adult relapsed or refractory AMLpatients.

 

****ATIPRIMOD TO TREAT MULTIPLE MYELOMA AND ADVANCED CARCINOID CANCERPATIENTS****

 

OnAugust 28, 2002, Synergy entered into a worldwide license agreement withAnorMED to research, develop, sell and commercially exploit the Atiprimodpatent rights. The license agreement provides for aggregate milestone paymentsof up to $14 million based upon achieving certain regulatory submissions andapprovals for an initial indication, and additional payments of up to $16million for each additional indication based on achieving certain regulatorysubmissions and approvals. In addition the agreement requires Synergy to payAnorMED royalties on net sales. Commencing on January 1, 2004 and on January 1of each subsequent year, Synergy is obligated to pay AnorMED a maintenance feeof $200,000 until the first commercial sale of the product. The first of theseannual maintenance fee payments under this agreement was made on January 22,2004. Pursuant to the license agreement, failure to pay the maintenance fee isa material breach of the license agreement. The license agreement willterminate in 2018.

 

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

 

On May 26, 2004, we commenced a Phase I/IIa clinical trial of Atiprimod in relapsed multiple myeloma patients at two sites, the Dana-Farber Cancer Institute (Boston) and The University of Texas M. D. Anderson Cancer Center (Houston). On January 31, 2005, we announced the opening of two additional sites for the Phase I/IIa clinical trial of Atiprimod, the Roswell Park Cancer Institute in Buffalo, New York, and the St. Vincent’s Comprehensive Cancer Center in New York, NY. The clinical trial is an open label study, with the primary objective of assessing the safety of the drug and identifying the maximum tolerated dose. The secondary objectives are to measure the pharmacokinetics, evaluate the response in patients with refractory disease and to identify possible surrogate responses to drug to better determine the mechanism of drug action. The duration of this clinical study depends on the enrollment rate, how well the drug is tolerated, and on drug response. If Atiprimod produces positive responses, we intend to initiate a Phase IIb trial in relapsed multiple myeloma patients in 2006. We have received Institutional Review Board approval to continue our Phase II trial in multiple myeloma at higer doses of Atiprimod. We plan to announce more specifics on this trial shortly.

 

On March 15, 2005 we announced a secondPhase I/IIa clinical trial of Atiprimod in advanced cancer patients. The trialis entitled: “An Open Label Study of the Safety and Efficacy of AtiprimodTreatment for Patients with Advanced Cancer”. The primary objective is to assessthe safety and determine the maximum tolerated dose (MTD) of Atiprimod inadvanced 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. The duration of this study willdepend on the enrollment rate, how well the drug is tolerated and on drugresponse.

 

OnFebruary 28, 2006, we announced plans to launch an additional indicationfor clinical development of Atiprimod based on encouraging clinical resultsfrom the advanced cancer patient clinical trial that showed a clear response ina patient with advanced carcinoid cancer plus additional encouraging clinicaldata on other carcinoid patients. Based on these new clinical data, we plan toinitiate a new Phase I/IIa clinical trial of Atiprimod in carcinoid cancerpatients with advanced metastatic tumors at several clinical sites in the nextfew months.

 

****GUANYLATE CYCLASE RECEPTOR AGONIST TECHNOLOGY****

 

Ourguanylate cyclase receptor agonist (GCRA) program is based on control of cyclicguanosine monophosphate (“cyclic GMP”), an important second messenger involvedin key cellular processes, which are essential for maintenance of the balancebetween proliferation and cellular death (apoptosis). Uroguanylin, a hormoneproduced by and secreted by specialized cells in the human GI tract, helps tomaintain this balance by activating synthesis of cyclic GMP through activationof guanylate cyclase receptor. Recent findings suggest a role of cyclic GMP ingastrointestinal (GI) inflammatory diseases.

 

Wehave successfully developed a potent analog (synthetic molecule) of uroguanylincalled Guanilib (formerly called SP304). Guanilib has been demonstrated to besuperior to uroguanylin in its biological activity, protease stability and pHcharacteristics. Guanilib is currently undergoing pre-clinical animal studiesas a treatment for gastrointestinal or GI inflammation in a collaborative studyinvolving clinical gastroenterologist Dr. Scott Plevy of the University ofPittsburgh. Recent results from his laboratory showed that Guanilib wasefficacious in treatment of ulcerative colitis in mice. A patent coveringcompositions of matter and formulations of Guanilib, alone or in combinationwith a phosphodiesterase inhibitor, an anti-inflammatory agent, an antiviralagent, or an anticancer agent, has recently been issued to us by the U.S.Patent and Trademark Office.

 

****DEGRASYNS****

 

OnJanuary 10, 2006, we entered into a license agreement with the Universityof Texas M.D. Anderson Cancer Center whereby we were granted the exclusiveright to manufacture, have manufactured, use, import, offer to sell and/or sellanti-cancer compounds called tyrphostins (renamed Degrasyns). Degrasyns are asecond-generation class of tyrphostins developed by scientists at theUniversity of Texas M.D. Anderson Cancer Center that have a novel anti-cancermechanism-of-action that centers on their ability to selectively degrade keyproteins that are involved in tumor cell proliferation and survival. We plan towork closely with scientists at the University of Texas M.D. Anderson CancerCenter during 2006 to bring forward a pre-clinical candidate for development inthe clinic.

 

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On March 23, 2006, weentered into a 2-year sponsored laboratory study agreement with the Universityof Texas M. D. Anderson Cancer Center whereby Dr. Nicholas Donato, asprincipal investigator, will analyze the anti-tumor activity and mechanism ofaction of our WP1130 Degrasyn compound and analogs. The agreement calls forpayment of $145,900 to M.D. Anderson in two installments of $72,950.00, withthe first payment due within 30 days and the second payment due within sixmonths.

 

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 two installments of$63,572.50, with the first payment due within 30 days and the second paymentdue within six months.

 

**MANUFACTURING**

 

Animproved manufacturing method for Annamycin has been developed at AntibioticosS.p.A., our commercial supplier of Good Manufacturing Practice, or GMP, drugsubstance. GMP material is currently being produced in sufficient quantity forall three anticipated Phase I/II trials. Currently, Antibioticos S.p.A. is oursole supplier of Annamycin for our clinical trials. Our agreement withAntibioticos provides that Antibioticos S.p.A. will provide 400 grams of GMPdrug substance (Annamycin) for our L-Annamycin clinical trials. Upon theconclusion of our Phase IIb clinical trials, the agreement provides that theparties will negotiate in good faith towards a commercial supply agreement forAnnamycin. If our relationship with this contract manufacturer, or any othercontract manufacturer we might use, terminates or if any of their facilitiesare damaged for any reason, including fire, flood, earthquake or other similarevent, we may be unable to obtain supply of Annamycin. If any of theseevents were to occur, we may need to find alternative manufacturers ormanufacturing facilities. The number of contract manufacturers with theexpertise, required regulatory approvals and facilities to manufactureAnnamycin on a commercial scale is extremely limited, and it would take a significantamount of time to arrange for alternative manufacturers. If we need to changeto other commercial manufacturers, the FDA and comparable foreign regulatorsmust approve these manufacturers’ facilities and processes prior to our use,which would require new testing and compliance inspections. In addition, we may nothave the intellectual property rights, or may have to share intellectualproperty rights, to any improvements in the current manufacturing processes orany new manufacturing processes for Annamycin. Any of these factors could causeus to delay or suspend clinical trials, regulatory submissions, requiredapprovals or commercialization of L-Annamycin, entail higher costs, and couldresult in our being unable to commercialize L-Annamycin successfully.

 

Onelarge-scale GMP production run of Atiprimod dimaleate led to the successfulrelease of 10 Kg of material available for future Phase II clinical studies. Weplan to enter into a supply contract for Atiprimod with a commercial supplierby the end of 2007 or after confirming activity of the drug candidate in ourcurrent human clinical trials.

 

**EMPLOYEES**

 

Our plan is to use contract research organizations for most of our development efforts, including monitoring of clinical trial results, thus minimizing the need to hire full time employees. As of May 15, 2006, we had 9 full-time and 3 part-time employees. We believe our employee relations are satisfactory.

 

**OFF-BALANCE SHEET ARRANGEMENTS**

 

We had no off-balance sheet arrangements as of March 31, 2006.

 

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**RESULTS OFOPERATIONS**

 

**THREEMONTHS ENDED MARCH 31, 2006 AND MARCH 31, 2005**

 

We had no revenues duringthe three months ended March 31, 2006 and 2005 because we do not have anycommercial biopharmaceutical products and we do not expect to have suchproducts for several years, if at all.

 

Research and developmentexpenses increased approximately $618,071 or 39%, to $2,193,840 for the threemonths ended March 31, 2006 from $1,575,769 for the three months ended March 31,2005. The most significant factors contributing to this increase in researchand development expense were an increase in both drug and patient costs as wesignificantly increased the number of patients in our L-Annamycin clinicaltrial during the three months ended March 31, 2006, higher in-license andfees due to our newly in-licensed Degrasyn platform from M. D. Anderson,and higher legal and patent expense. We had a $139,189 increase in expensesrelated to our L-Annamycin drug candidate, an $86,075 increase in clinicaltrials hospital expense and $111,884 increase in patent and legal expenserelated to our Degrasyn platform development for the quarter ended March 31,2006. During the three month period ended March 31, 2005 the research anddevelopment expenses of $1,575,769 were primarily related to costs associatedwith preparing our L-Annamycin drug candidate to enter a Phase I/IIa clinicaltrial, and the ongoing expense of our Atiprimod clinical trial in multiplemyeloma. Stock based compensation expense associated with options granted toemployees increased approximately $80,000 from approximately $69,000 in thequarter March 31, 2005 to approximately $149,000 in the quarter ended March 31,2006, as a result of adopting SFAS 123R on January 1, 2006.

 

Government grant funding forthe three months ended March 31, 2006 was $54,267 as compared to $0 forthe three months ended March 31, 2005. We request grant funding toreimburse research and development expenses as incurred.

 

General and administrativeexpenses for the three months ended March 31, 2006 were $1,754,090, anincrease of $746,274 or 74%, from $1,007,816 for the three months ended March 31,2005. The increase was due primarily to approximately (i) $422,979 ofincreased spending on investor relations to increase public investors’awareness of our stock, (ii) $168,222 of increased bonuses and wages tomanagement due to performance-based compensation and the addition of a seniormedical position, and (iii) $53,279 in higher audit, legal and taxexpenses related to the filing of registration statements for our financingsand (iv) stock based compensation expense associated with options grantedto employees increased $27,000 or 9% from approximately $314,000 in the quarterended March 31, 2005 to approximately $341,000 in the quarter ended March 31,2006 as a result of adopting SFAS 123R on January 1, 2006.

 

Net loss for the threemonths ended March 31, 2006 was $4,374,628 compared to a net loss of$2,594,131 incurred for the three months ended March 31, 2005. Theincreased net loss is the result of higher research and development, andgeneral and administrative expenses both of which are discussed above. Inaddition we recorded higher non-employee stock based compensation expense of$504,047 during the three months ended March 31, 2006, as compared to$30,137 recorded during the same period ended March 31, 2005.

 

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**LIQUIDITYAND CAPITAL RESOURCES**

 

As of March 31, 2006 wehad $2,790,502 in cash and cash equivalents, compared to $1,420,510 as of December 31,2005. This increase in cash of $1,369,992 at March 31, 2006 wasprincipally the result of completing a private placement of common stockyielding net proceeds of $4,578,402. This was partially offset by cash used inoperating activities of $3,389,843, warrant exercise proceeds of $190,035 and$8,602 of equipment purchases during the three months ended March 31,2006. Cash used in operating activities was mainly for research and developmentand general and administrative expenses discussed above totaling $3,947,930plus $108,160 in decreased payables and accrued expenses, less stock basedcompensation expense of $994,050 during the quarter.

 

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. Netproceeds after fees and expenses were $4.58 million.

 

On March 23, 2006, we entered into a 2-year sponsored laboratory studyagreement with the University of Texas M.D. Anderson Cancer Center whereby Dr.Nicholas Donato, as principal investigator,  will analyze the anti-tumor activity andmechanism of action of our WP 1130 Degrasyn compound and analogs. The agreementcalls for payment of $145,900 to M.D. Anderson in two installments of $72,950.00with the first payment due within 30 days, and the second payment due withinsix months of execution.

 

On March 27, 2006, we entered into a 2-year sponsored laboratory studyagreement with the University of Texas M.D. Anderson Cancer Center whereby Dr.William Bornmann, as principal investigator, will perform molecular modelingand synthesize a library of compounds based on our Degrasyn platformtechnology.  The agreement calls forpayment of $127,145 to M.D. Anderson in two installments of $63,572.50 with thefirst payment due within 30 days, and the second payment due within six monthsof execution.

 

OnApril 7, 2006 we had a second closing of the financing described above, inwhich we sold an additional 666,667 shares of common stock and issued 166,667common stock purchase warrants at the same terms, for gross proceeds of$800,000, bringing the total gross proceeds of the financing to $5.94 millionand net proceeds to $5.38 million. No placement agent fees or legal fees wereincurred on this second closing however three year warrants to purchase a totalof 66,667 common shares at a per share price of $1.25 were issued to severalselling agents. We agreed to file, within 60 days after the first closing, aregistration 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 penalties to the investors in the eventa registration statement is not filed or declared effective within such timeperiod. We have not yet filed a registration statement within the 60-day timeperiod and are incurring financial penalties of $51,404 for every 30-day period(or $1,713 per day) that a registration statement has not been filed. As of May 22,2006 we have incurred approximately $83,960 for financial penalties related tothe registration rights agreement.

 

OnMay 3, 2006 we were awarded the second installment of $366,211 from an April 1,2005 grant totaling $885,641 for biodefense partnerships from the NationalInstitute of Allergy and Infectious Diseases (NIAID) to develop a monoclonalantibody and vaccine against bacterial superantigen toxins. BacterialSuperantigens are among the most lethal of toxins that can potentially be usedas bioweapons. Our lead monoclonal antibody (Mab) and antagonist peptide arebeing developed to provide broad-spectrum protection against a variety ofsuperantigen toxins from staphylococcal and streptococcal bacterial strains

 

Our working capitalrequirements will depend upon numerous factors including but not limited to thenature, cost and timing of: pharmaceutical research and development programs;pre-clinical and clinical testing; obtaining regulatory approvals;technological advances and our ability to establish collaborative arrangementswith research organizations and individuals needed to commercialize ourproducts. Our capital resources will be focused primarily on the clinical developmentand regulatory approval of our current product candidates, and the acquisitionof licenses and rights to certain other cancer related drug technologies. Weexpect that our existing capital resources will not be sufficient to fund ouroperations for at least the next 12 months. We will be required to raiseadditional capital to complete the development and commercialization of ourcurrent product 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.

 

On May 18, 2006 we helda special shareholder meeting and approved (i) the potential issuance and sale of up to 20,000,000 shares of ourcommon stock (or securities convertible into or exercisable for common stock)at a price below fair market value for aggregate gross proceeds of up to$30,000,000 and (ii) the issuance of 75,000 shares of our restrictedcommon stock to Dr. Moshe Talpaz pursuant to a consulting agreementbetween us and Dr. Talpaz.

 

To date, our sources of cashhave been primarily limited to the sale of our equity securities. We cannot be certainthat additional funding will be available on acceptable terms, or at all. Anydebt financing, if available, may involve restrictive covenants thatimpact our ability to conduct our business. If we are unable to raiseadditional capital when required or on acceptable terms, we may have tosignificantly delay, scale back or discontinue the development and/orcommercialization of one or more of our product candidates.

 

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**CRITICAL ACCOUNTING POLICIES****ANDESTIMATES**

 

Our discussion and analysisof financial condition and results of operations are based upon our condensedconsolidated financial statements, which have been prepared by us without auditin accordance with the rules and regulations of the Securities andExchange Commission. The preparation of our financial statements requires us tomake estimates that affect the reported amounts of assets, liabilities, revenueand expense, and related disclosure of contingent assets and liabilities. Webase our accounting estimates on historical experience and other factors thatare believed to be reasonable under the circumstances. However, actual results may varyfrom these estimates under different assumptions or conditions. The followingis a summary of our critical significant 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 on Form 10-K/Afor the fiscal year ended December 31, 2005. The financial statements areprepared in accordance with accounting principles generally accepted in theUnited States of America, which requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period. Actual results could differ from those estimates.

 

In December 2004, theFinancial Accounting Standards Board (FASB) issued Statement of FinancialAccounting Standard (“SFAS”) No. 123 (Revised 2004), *Share-Based Payments* (“SFAS 123R”). SFAS123R 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 and accordinglyCallisto adopted this standard on January 1, 2006. For all awards grantedprior to January 1, 2006, the unearned deferred fair value of stock basedcompensation, on the date of adoption, will be recognized as an expense on astraight line basis over the remaining requisite service period. Our financialresults for prior periods have not been restated. The adoption of SFAS 123Rincreased net loss by approximately $107,000 for the three months ended March 31,2006. The remaining requisite service period for employee options thusaccounted for ranged from six months to three years. Based on historicalinformation the Company estimated future unvested option forfeitures at 20% asof January 1, 2006.

 

Priorto January 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 March 31, 2006 stock basedcompensation expense totaled $14,765,016 or approximately 30% 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.

 

Thesingle most significant factor impacting our operating results is the price ofour stock which is used in the computation of stock-based compensation expense,particularly for variable options. Our stock price fluctuated from $3.95 pershare as of December 31, 2003 to $1.46 per share as of March 31, 2006.As of March 31, 2006, 803,500 of our non-employee options requiredvariable accounting treatment in accordance with FASB Interpretation No. 44“Accounting for Certain Transactions Involving Stock Compensation, anInterpretation of APB Opinion No. 25” (“FIN 44”). Our stock-basedcompensation expense associated with these non-employee variable options duringthe three months ended March 31, 2006 was $54,159.

 

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

 

Ourexposure to market risk on the fair values of certain assets is related tocredit risk associated with short term investment grade commercial paperincluded in short term money market accounts and the FDIC insurance limit onour balances. At March 31, 2006 our money market balances totaledapproximately $2.0 million.

 

**ITEM 4. CONTROLS AND PROCEDURES**

 

Basedon an evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) of the Securities Exchange Act of 1934, as amended) required byparagraph (b) of Rule 13a-15 or Rule 15d-15, as of March 31,2006, our Chief Executive Officer and Principal Financial Officer haveconcluded that our disclosure controls and procedures were effective inensuring that information required to be disclosed by us in the reports that wefile or submit under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in the Commission’s rules andforms. Our Chief Executive Officer and Principal Financial Officer alsoconcluded that, as of March 31, 2006, 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 isaccumulated and communicated to our management, including our Chief ExecutiveOfficer and Principal Financial Officer, to allow timely decisions regardingrequired disclosure.

 

Indesigning and evaluating our disclosure controls and procedures, managementrecognizes that any controls and procedures, no matter how well designed andoperated, can provide only reasonable assurance of achieving the desiredcontrol objectives, and management necessarily is required to apply itsjudgment in evaluating the relationship between the benefit of desired controlsand procedures and the cost of implementing new controls and procedures.

 

During the quarter ended March 31,2006 we took the following actions which we believe materially affected or arereasonable likely to materially affect our internal controls over financialreporting:  

 
| (i)    |   | formed a Disclosure Committee, comprising members of our senior  management and corporate counsel, charged with the task of discussing and  reviewing all transactions occurring during each quarter prior to filing our  periodic reports with the SEC; |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                     |
| (ii)   |   | tightened our policy regarding review and approval of all contractual  obligations;                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                     |
| (iii)  |   | created a policy of including our Chief Business Officer and our  Principal Financial and Accounting Officer in all Board of Directors  meetings;                                                                                                        |
|   |   |                                                                                                                                                                                                                                                     |
| (iv)   |   | segregated financial reporting and accounting duties more effectively  between our Chief Business Officer and our Principal Financial and Accounting  Officer in preparing all periodic reports filed with the SEC; and                                  |
|   |   |                                                                                                                                                                                                                                                     |
| (v)    |   | retained a third party GAAP advisor to assist the Principal Financial  and Accounting Officer, as well as advise the Audit Committee from time to  time.                                                                                                 |

 

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**PART II. OTHER INFORMATION**

 

**ITEM 1A.RISK FACTORS**

 

Inaddition to the other information set forth in this report, you shouldcarefully consider the factors discussed in Part I, “Item 1A. Risk Factors”in our Annual Report on Form 10-K/A for the year ended December 31,2005, which could materially affect our business, financial condition or futureresults.

 

**ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OFPROCEEDS**

 

OnApril 7, 2006, we had a second closing of a previously announced privateplacement in which we sold an additional 666,667 shares of common stock and166,667 common stock purchase warrants to certain accredited investors. The warrantsare exercisable for 18 months from closing at an exercise price of $1.60 pershare. The securities were sold pursuant to a securities purchase agreementdated April 7, 2006. The securities were sold at a price of $1.20 pershare for aggregate proceeds of $800,000. We issued an aggregate 66,667warrants to certain selling agents. The selling agent warrants are exercisableat $1.25 per share and will expire three years after closing.

 

Inconnection with the offer and sale of securities to the investors, we relied onthe exemption from registration provided by Section 4(2) of theSecurities Act of 1933, as amended, (the “Securities Act”) and Rule 506promulgated thereunder. We believe that the investors are “accredited investors”,as such term is defined in Rule 501(a) promulgated under theSecurities Act.

 

**ITEM 5. 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 the requirementsof the Securities Exchange Act of 1934, the Registrant has duly caused thisreport to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 
|                      | **CALLISTO  PHARMACEUTICALS, INC.** |
|---------------------------|------------------------------------------|
|                      | (Registrant)                             |
|                      |                                     |
|                      |                                     |
| *Date: May 22, 2006* | *By:*                                    | */s/ Gary  S. Jacob* |   |
| * *                  | * *                                 | * * |   |
| * *                  | * *                                 | *Gary S.  Jacob* |   |
| * *                  | * *                                 | *Chief  Executive Officer* |   |
|                      |                                     |
|                      |                                     |
| *Date: May 22, 2006* | *By:*                                    | */s/  Bernard F. Denoyer* |   |
| * *                  | * *                                 | * * |   |
| * *                  | * *                                 | *Bernard  F. Denoyer* |   |
| * *                  | * *                                 | *Vice  President, Finance* |   |

 

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