**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

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**FORM 10-K**

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| **x**                                                    | ** ** | **ANNUAL REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE  SECURITIES AND EXCHANGE ACT OF 1934** |
|----------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|
| **For the Fiscal Period Ended: December 31,  2006** |
| **o**                                                    | ** ** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |

 

**CommissionFile No: 000-51436**

**ADVANCED LIFE SCIENCES HOLDINGS, INC**.

**(Exact name of registrant as specified in its charter)**

| **DELAWARE**                    |   | **30-0296543**      |
|---------------------------------|--------|---------------------|
| (State or other jurisdiction of |   | (I.R.S. Employer    |
| incorporation or organization)  |   | Identification no.) |

 

**1440 Davey Road**

**Woodridge, IL 60517**

**(Address of principal executiveoffices) (Zip code)**

**Registrant’s telephonenumber: (630) 739-6744**

**Securitiesregistered pursuant to Section 12 (b) of the Act**

| **Title  of Each Class** |   | **Name of exchange on which registered** |
|--------------------------|--------|------------------------------------------|
| None                     |   | Nasdaq                                   |

 

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act.  o Yes x No

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Act. o Yes xNo

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days.  x Yes o No

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K isnot contained herein, and will not be contained, to the best of the registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment tothis Form 10-K. o

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and large acceleratedfiler” in Rule 12b-2 of the Exchange Act. (Check one): 

Large accelerated filer o     Accelerated filer o    Non-accelerated filer x

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2of the Act). o Yes x No

The aggregate market valueof voting common stock held by non-affiliates of the registrant as of June 30,2006 was approximately $54.1 million (based upon the closing price of$2.90 per common share as quoted on the Nasdaq National Market). The registranthas no outstanding non-voting stock. For purposes of this computation, it isassumed that the shares of voting stock held by directors and officers would bedeemed to be stock held by affiliates. Non-affiliated common stock outstandingat June 30, 2006 was 18,667,035 shares.

Total common stockoutstanding as of March 16, 2007 was 28,287,677 shares.

**Documents incorporated byreference**

Certainsections of the Registrant’s Notice of Annual Meeting of Stockholders and ProxyStatement for its Annual Meeting of Stockholders for the year ended December 31,2006 (the “2007 Proxy Statement”) are to be filed with the Securities andExchange Commission within 120 days after the registrant’s fiscal year ended December 31,2006 and are incorporated by reference into Part III of this Report.

 

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**ADVANCED LIFESCIENCES HOLDINGS, INC**

**INDEX**

**Form 10-K**

|              | ** ** | **PART I**                                                                                                                                                                |   |   |   |
|--------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|
| Item 1. |       | Business                                                                                                                                                                       |   | 2      |   |
| Item  1A.    |       | Risk  Factors                                                                                                                                                                  |   | 14     |   |
| Item 1B.     |       | Unresolved Staff Comments                                                                                                                                                      |   | 26     |   |
| Item 2.      |       | Properties                                                                                                                                                                     |   | 26     |   |
| Item  3.     |       | Legal  Proceedings                                                                                                                                                             |   | 26     |   |
| Item 4.      |       | Submission of Matters to a Vote of Security Holders                                                                                                                            |   | 26     |   |
|         | ** ** | **PART II**                                                                                                                                                               |   |   |   |
| Item 5. |       | Market  for Registrants Common Equity, Related Stockholder Matters and Issuer  Purchases of Equity Securities                                                                  |   | 27     |   |
| Item 6.      |       | Selected Financial Data                                                                                                                                                        |   | 29     |   |
| Item 7.      |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                                                                                    |   | 30     |   |
| Item 7A.     |       | Quantitative and Qualitative Disclosures About Market  Risk                                                                                                                    |   | 36     |   |
| Item 8.      |       | Financial Statements and Supplementary Data                                                                                                                                    |   | 37     |   |
|         |       | Consolidated  Balance Sheets as of December 31, 2006 and December 31, 2005                                                                                           |   | 39     |   |
|         |       | Consolidated Statements of Operations for the years  ended December 31, 2006, 2005, 2004 and period from inception  (January 1, 1999) through December 31, 2006 |   | 40     |   |
|         |       | Consolidated Statements of Stockholders’ Equity for  period from inception (January 1, 1999) through December 31, 2006                                          |   | 41     |   |
|         |       | Consolidated Statements of Cash Flows for the years  ended December 31, 2006, 2005, 2004 and period from inception  (January 1, 1999) through December 31, 2006 |   | 42     |   |
|         |       | Notes to Consolidated Financial Statements                                                                                                                                     |   | 43     |   |
| Item 9.      |       | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure                                                                                          |   | 56     |   |
| Item 9A.     |       | Controls and Procedures                                                                                                                                                        |   | 56     |   |
| Item  9B.    |       | Other  Information                                                                                                                                                             |   | 56     |   |
|         | ** ** | **PART III**                                                                                                                                                              |   |   |   |
| Item 10.     |       | Directors and Executive Officers of the Registrant                                                                                                                             |   | 56     |   |
| Item 11.     |       | Executive Compensation                                                                                                                                                         |   | 56     |   |
| Item 12.     |       | Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters                                                                                |   | 56     |   |
| Item 13.     |       | Certain Relationships and Related Transactions                                                                                                                                 |   | 56     |   |
| Item 14.     |       | Principal Accountant Fees and Services                                                                                                                                         |   | 56     |   |
|         | ** ** | **PART IV**                                                                                                                                                               |   |   |   |
| Item 15.     |       | Exhibits                                                                                                                                                                       |   | 57     |   |

 

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**PART I**

**Item 1.**                        *Business.*

*This annual reporton Form 10-K contains forward-looking statements that involve risksand uncertainties, as well as assumptions that, if they never materialize orprove incorrect, could cause the results of Advanced Life Sciences Holdings todiffer materially from those expressed or implied by such forward-lookingstatements. All statements other than statements of historical fact that couldbe deemed forward-looking statements, including any projections of revenue,expenses, earnings or losses from operations, or other financial items; anystatements of the plans, strategies and objectives of management for futureoperations; any statements concerning product research, development andcommercialization timelines; any statements of expectation or belief; and anystatements of assumptions underlying any of the foregoing. The risks,uncertainties and assumptions referred to above include risks that aredescribed in Item 1A “Risk Factors” in this annual report and that areotherwise described from time to time in our Securities and Exchange Commissionreports filed after this report.*

*The forward-looking statements included in this annualreport represent our estimates as of the date of this annual report. Wespecifically disclaim any obligation to update these forward-looking statementsin the future. These forward-looking statements should not be relied upon asrepresenting our estimates or views as of any date subsequent to the date ofthis annual report. In this annual report on Form 10-K, “we”, “our”and “us” refer to Advanced Life Sciences Holdings, Inc. and its subsidiaryincluded in the consolidated financial statements, except as otherwiseindicated or as the context otherwise requires.*

**Overview**

We are abiopharmaceutical company focused on the discovery, development andcommercialization of novel drugs in the areas of infectious disease, oncologyand inflammation. Using our internal discovery capabilities and our network ofpharmaceutical and academic partners, we have assembled a promising pipeline ofclinical and preclinical product candidates. The following is a summary of eachof our primary programs:

·       *Infectious Disease.*We have an exclusive worldwide license(excluding Japan) from Abbott Laboratories to develop and commercializecethromycin, a second generation ketolide antibiotic in Phase III clinicaldevelopment for the treatment of respiratory tract infections. In December 2005,we initiated our pivotal Phase III clinical program for the treatment ofmild-to-moderate community acquired pneumonia, the indication for which weinitially plan to seek Food and Drug Administration (“FDA”) approval. Cethromycinhas been tested in 4,400 human subjects in clinical trials to date.  Cethromycin has also been demonstrated to havesignificant *in vitro* activity against over 30anthrax (*Bacillus anthracis*) strains. In additionto our Phase III clinical trials for the treatment of mild-to-moderatecommunity acquired pneumonia, we are currently testing cethromycin in non-humanprimates to determine its efficacy in treating inhalation anthrax post-exposurefor prophylaxis.

·       *Oncology.*ALS-357 is a compound that has shownevidence of anti-tumor activity against malignant melanoma in preclinicalstudies. Currently available therapies have not had significant success atprolonging survival for patients with melanoma that has spread beyond theprimary growth site. We believe that ALS-357 has the potential for eithera topical or systemic formulation. We established an open investigational newdrug application (“IND”) for ALS-357 with the FDA. The expected Phase Iclinical trial protocol involves treating 16 patients with in-transitmetastatic melanoma by topical application of ALS-357. We intend to seeka partner to assist in the funding and advancement of this program.

·       *Inflammation.*ALS-886 is a novel therapeutic inpreclinical development for the treatment of inflammation-related tissuedamage, including tissue damage associated with acute respiratory 

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distress syndrome (“ARDS”).Patients suffering from ARDS have a high fatality rate, and there are currentlyonly limited treatment options available. We have established an INDapplication for ALS-886 with the FDA. We expect that the first clinicalstudy will involve approximately 40 patients to determine the safety profile ofthe compound in human subjects. We intend to seek a partner to assist in thefunding and advancement of this program.

In addition to thecompounds summarized above, we have additional product candidates inpreclinical development. These include compounds derived from natural productsto treat infectious diseases, a novel class of synthetic chemotherapeutics totreat various cancers and small molecule inhibitors that may lead to atreatment for Alzheimer’s disease. We have not received FDA approval for any ofour product candidates. Our revenues to date have consisted solely ofmanagement fees and one-time or limited payments associated with ourcollaborations or grants. Our cumulative net loss was $67.3 million as of December 31,2006, and we do not anticipate generating any significant revenues for at leastthe next several years. Since our inception in 1999, we have financed ouroperations primarily through public and private equity offerings, loans fromour founder and borrowings under our bank line of credit. We will continue todo so until we are able to generate revenues from our product candidates, ifever.

**Our Background**

On January 1, 1999, MediChem Life Sciences, Inc.(“MediChem”) contributed all of the net assets of its proprietary drugdevelopment business, including MediChem’s 50% interest in Sarawak MediChemPharmaceuticals, Inc. (“SMP”) to a wholly-owned subsidiary, Advanced LifeSciences, Inc. (“ALS Inc.”) in exchange for 1,588,000 shares of commonstock.

In June 1999, MediChem exchanged its investmentin 100% of the outstanding common stock of ALS Inc. for nonvoting preferredstock issued by ALS Inc. affecting a spin-off of ALS Inc. Prior to thespin-off, Dr. Michael Flavin, the sole stockholder, owned 100% of MediChemand ALS Inc., then a wholly-owned subsidiary of MediChem. As a result of thespin-off, Dr. Flavin became the sole common stockholder of ALS Inc. MediChemholds 100% of the preferred stock of ALS Inc., which was issued in exchange forcommon stock held at the June 1999 spin-off.

In August 2001, ALS Inc. formed a generalpartnership, Advanced Life Sciences General Partnership (“ALS GP”), with Dr. Flavin,ALS Inc.’s chief executive officer. ALS Inc. contributed all of its assets andliabilities to ALS GP, with the exception of debt due to Dr. Flavin. In2002, Dr. Flavin transferred his interest in ALS GP to Flavin Ventures,LLC (“Flavin Ventures”), which he controls. Flavin Ventures is not included inthe consolidated financial statements of Advanced Life Sciences Holdings, Inc.(“the Company”).

In December 2004, ALS Inc. executed a plan ofreorganization. The Company was formed as a Delaware corporation, with Dr. Flavinas its chief executive officer. Common shareholders of ALS, Inc. exchangedtheir 1,629,685 common shares for 1,629,685 shares of common stock of theCompany. Under the terms of the reorganization, Flavin Ventures exchanged its40% ownership of ALS GP for 7,852,330 shares of the Company’s common stock. Afterthe exchange was completed, ALS GP was dissolved and its assets and liabilitieswere assumed by ALS Inc. ALS Ventures, LLC (“ALS Ventures”), a Delaware limitedliability company, was formed pursuant to the plan of reorganization. After itsformation, Dr. Flavin and Flavin Ventures simultaneously contributed allof their common shares, 1,588,000 and 7,852,330, respectively, to ALS Ventures.

In April 2005, the Company filed a registrationstatement with the Securities and Exchange Commission (“the SEC”) covering theproposed sale by the Company of its common stock to the public. In June 2005,the Board approved the amendment and restatement of the Company’s Articles ofIncorporation to provide for an increase in the number of authorized shares ofcommon stock and preferred stock to 60,000,000 shares and 5,000,000 shares,respectively, and a 3.97-for-1 stock split of the 

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Company’s common stock.All references in the consolidated financial statements to shares of commonstock, common stock options, common stock prices and per share of common stockamounts have been adjusted retroactively for all periods presented to reflectthis stock split. In August 2005, the Company completed the initial publicoffering (“IPO”) of its common stock in which the Company sold 6,400,000 sharesof common stock to the public at $5.00 per share, resulting in gross proceedsof $32.0 million. The Company also completed a concurrent offering of 600,000shares to an existing stockholder in exchange for a $3.0 million reduction of amilestone payment obligation under its license agreement with the stockholder. InSeptember 2005, the Company’s underwriters exercised their option topurchase 100,000 shares to cover over-allotments resulting in additional grossproceeds of $500,000. In connection with these offerings, the Company paidapproximately $2.3 million in underwriting discounts and incurred otheroffering expenses of approximately $1.5 million. The net cash proceeds from theofferings were approximately $28.7 million.

In March 2006, the Company raised approximately$33.4 million, net of underwriting discounts and offering expenses, inconnection with the issuance of 10,233,464 shares of its common stock andwarrants to purchase an additional 5,116,732 shares of its common stock at anexercise price of $3.81 per share.

In December 2006, theCompany completed the sale of ALS Inc’s 50% equity interest in SMP to theSarawak Government for $1.0 million. Upon the closing of the Stock PurchaseAgreement, the Sarawak Government became the sole owner of SMP and itsHIV-therapeutic candidate, Calanolide A. The net cash proceeds from the salewere approximately $940,000. In connection with the sale, the Company madecustomary representations and warranties and provided indemnification forlosses not to exceed the purchase price of $1.0 million. The parties mutuallyagreed to waive any future legal claims otherwise arising out of the SMP jointventure.

**Our Strategy**

Our objective is to becomea fully integrated pharmaceutical company that discovers and develops smallmolecule therapeutics to treat life-threatening diseases in the areas ofinfectious disease, oncology and inflammation, and then markets these productsdirectly to healthcare providers including, but not limited to, physicians andhospitals. We plan to sustain our drug development pipeline through ourinternal drug discovery capabilities and by opportunistically in-licensingpromising compounds that fit into our areas of focus. Specific key aspects ofour strategy include the following:

*Maximize theCommercial Potential of Cethromycin*

Initially, we intend to focus a significant portion ofour business efforts on the further development and commercialization ofcethromycin for the treatment of mild-to-moderate community acquired pneumonia.Human clinical trials have been performed to determine the safety and efficacyof cethromycin in approximately 4,400 human subjects. We initiated our pivotalPhase III clinical trials in December 2005 for the treatment ofmild-to-moderate community acquired pneumonia using a 300 mg once-daily dosingregimen.

In addition to treating mild-to-moderate communityacquired pneumonia in pivotal Phase III clinical trials, we intend to pursueopportunities for cethromycin in the treatment of other respiratory tractinfections such as bronchitis, sinusitis, pharyngitis and inhalation anthrax.

*Advance theDevelopment of our Other Infectious Disease, Oncology and Inflammation ProductCandidates as Funds are Available or Through a Partnership.*

Whereas the development ofcethromycin remains our highest priority, we intend to leverage our existingclinical trial experience to advance product candidates in our oncology andinflammation programs through clinical trials. For instance, to develop ALS-357for the treatment of malignant melanoma, we 

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intendto conduct Phase I clinical trials with a topical formulation to test safetyand provide preliminary data regarding efficacy. We also plan to develop asystemic formulation of ALS-357 and initiate related clinical trials. Toadvance ALS-886 for the treatment of inflammation-related tissue damage,we plan to conduct Phase I clinical trials that test safety and providepreliminary data regarding efficacy in preventing lung tissue damage in ARDSpatients.

*Leverage our DrugDiscovery and Development Capabilities*

We intend to expand ourproduct portfolio by exploiting and enhancing our internal drug discovery anddevelopment capabilities using our integrated chemistry and biology skills. Weplan to continue utilizing our integrated chemistry and biology drug discoveryplatform to design, optimize and evaluate high-potential product candidates.

*Continue to DevelopStrategic Collaborations*

We plan to continuedeveloping relationships with key pharmaceutical and biotechnology companies,governmental institutions and academic laboratories in order to in-licensepromising compounds that are not core to their strategy but fit closely withour corporate strengths. We also intend to identify co-development partners forthe out-licensing of certain product candidates. Further, we may choose toestablish collaborative partnerships through which certain of our clinicalcandidates can be marketed and commercialized.

*Build CommercialInfrastructure to Market our Products*

We plan to retain U.S.marketing and sales rights or co-promotion rights for certain of our productsthat we believe can be marketed through a focused sales force targetingspecialists and high patient volume physicians. For situations in which a largesales force is required to access the market, and for markets outside the UnitedStates, we generally plan to commercialize our product candidates through avariety of collaboration arrangements with leading pharmaceutical companies andcontract sales organizations.

**Our Lead Program**

Our most advanced product candidate, cethromycin, is asecond generation ketolide antibiotic in Phase III clinical development for thetreatment of respiratory tract infections. We are initially developingcethromycin as a treatment for mild-to-moderate community acquired pneumonia.Over the last decade, the rapid rise in severe and fatal infections caused byantibiotic-resistant bacteria has posed a serious threat to public health.There is a need to discover new antibiotics that are effective againstresistant bacteria. As a new class of antibiotics, ketolides have shownactivity against penicillin- and macrolide-resistant Gram-positive pathogens.Cethromycin has demonstrated activity toward drug-resistant *Streptococcus pneumoniae*and*Haemophilus influenzae,*twoof the pathogens commonly found in mild-to-moderate community acquiredpneumonia, when compared to published data on antibiotics currently on themarket. Cethromycin has also shown *in vitro*evidence of an extended post-antibioticeffect, meaning that the suppression of bacterial growth persists in theabsence of measurable antibiotic concentration. Six Phase III clinical trialshave been completed for the treatment of respiratory tract infections, andcethromycin has demonstrated a clinical cure rate as high as 93% for subjectswith mild-to-moderate community acquired pneumonia.

In December 2004,Abbott Laboratories granted us an exclusive worldwide license, except in Japan,to commercialize cethromycin. In December 2005, we initiated our pivotalPhase III clinical trials for the treatment of mild-to-moderate communityacquired pneumonia. The trials include two controlled pivotal Phase IIIcomparator studies which involve approximately 1,000 subjects.

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*Market Overview*

Bacterial infections occur when bacteria thatnaturally exist in the body, or that are acquired through inhalation, ingestionor direct penetration, are not controlled by the normal immune defense system.These uncontrolled bacteria can multiply and either excrete toxins or provokethe immune system to mount a response, in either case damaging tissue.Antibiotics work by binding to specific targets in a bacterial pathogen,thereby inhibiting a function that is essential to the pathogen’s survival.Many antibiotics were developed and introduced into the market during the 1970sand 1980s and have proven to be effective in treating most bacterialinfections. We believe this historic efficacy prompted pharmaceutical companiesto shift their resources to other areas of drug discovery and development. As aresult, very few antibiotics from new chemical classes have been introduced inthe last several years.

Antibiotic resistance is widely considered asignificant threat to public health, and the problem continues to worsen. TheCenters for Disease Control, (“CDC”), continues to report on new strains ofbacteria that are resistant to one or more antibiotics currently on the market.The increasing prevalence of drug-resistant bacteria has led to prolongedillnesses and hospitalizations, increased healthcare costs and significantlyhigher mortality rates. As a result, there is a strong demand for newtreatments that are more effective against resistant strains and do not showpotential for inducing the rapid development of additional resistant strains.We do not believe that this demand for new antibiotic therapies is being met bylarge pharmaceutical companies because of a shift in research and developmentfocus in these companies toward chronic conditions that require sustainedmedication over long periods of time.

Respiratory tractinfections arise when bacterial infections develop in the inhalationpassageway, including the nose, throat, sinuses and lungs. The four main typesof respiratory tract infections are pneumonia, bronchitis, pharyngitis andsinusitis. Many of these bacterial infections can be life threatening if nottreated quickly. Bacterial pneumonia, which involves an infection of the lungitself, is the most severe of the common respiratory tract infections.Pneumonia is often classified as mild-to-moderate community acquired pneumoniaor hospital acquired pneumonia, depending upon the setting in which contractionof the bacterial infection occurred. The Textbook of Primary and Acute CareMedicine estimates that, in the United States alone, there are approximately 5-6million cases of mild-to-moderate community acquired pneumonia each year.

*Current TreatmentOptions and Limitations*

Until recently, there have been three main classes ofantibiotics prescribed for respiratory tract infections such asmild-to-moderate community acquired pneumonia. These are semi-syntheticpenicillins (also known as beta-lactams), such as Augmentin® (amoxicillinand clavulanate potassium) sold by GlaxoSmithKline; macrolides, such aserythromycin or Zithromax® (azithromycin) sold by Pfizer; and fluoroquinolones,such as Cipro®(ciprofloxacin) sold by Bayer. Penicillins, macrolides and fluoroquinoloneshave all been shown to have certain shortcomings with respect to the treatmentof respiratory tract infections. Studies have shown that, in the United States,approximately 26% of *Streptococcuspneumoniae*isolates, the most common pathogens that causerespiratory tract infections such as mild-to-moderate community acquiredpneumonia, are resistant to macrolides. In addition, numerous reports in themedical literature have noted the emergence of penicillin-resistantpneumococci. The wide use of fluoroquinolones increases the potential fordevelopment of bacterial resistance, cross-resistance to the same or otherclasses of antibiotics as well as promotes *Clostridium difficile*associated disease (“CDAD”)*.*

Increased bacterial resistance to many of thecurrently available antibiotics has been caused by certain common medicalpractices and sociological factors. By necessity, a wide variety of antibioticsare often administered before the specific disease-causing pathogen has beenidentified. Bacterial resistance is fostered through the erroneous prescriptionof antibiotics for non-bacterial infections. The lack of full 

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patient compliance withprescribed courses of therapies has further contributed to bacterial resistanceagainst currently marketed antibiotics. Patients will frequently discontinue aprescribed dosing regimen after symptoms subside, but bacteria that are notentirely eradicated may re-emerge in resistant forms.

Ketolides are a new classof antibiotics that show promise to address many of the shortcomings found inthe current treatment options for mild-to-moderate community acquired pneumoniaand other respiratory tract infections, such as bronchitis, sinusitis andpharyngitis. Ketolides are effective against penicillin- andmacrolide-resistant pathogens known to cause respiratory tract infections. Theonly ketolide available for sale in the United States, Ketek®(telithromycin), was approved by the FDA in April 2004 and launchedcommercially by Aventis Pharmaceuticals in August 2004. Ketek has beenavailable for sale in Europe since the summer of 2002. When Ketek was approvedfor marketing, the FDA imposed a labeling requirement indicating that it maycause visual disturbances including double-vision, blurred vision anddifficulty focusing. More recently in December 2006, a joint advisorycommittee recommended to the FDA that Ketek continue to be marketed forcommunity acquired pneumonia with a boxed warning, and that it no longer allowit to be marketed for bronchitis and sinusitis in the United States.

**ALS Solution**

We are developing cethromycin, a second generationketolide antibiotic licensed from Abbott Laboratories, in response to theemerging antibiotic resistance observed in the treatment of mild-to-moderatecommunity acquired pneumonia. Prior to the initiation of our clinical trials,cethromycin had been tested by Abbott in approximately 4,400 human subjectsduring clinical trials. We are conducting two pivotal Phase III clinical trialsof cethromycin for the treatment of mild-to-moderate community acquiredpneumonia. We also intend to pursue opportunities for cethromycin in thetreatment of other respiratory tract infections such as bronchitis, sinusitisand pharyngitis.

Based on publiclyavailable data regarding current antibiotic compounds, we believe that there isa potential opportunity for further development of cethromycin in the treatmentof respiratory tract infections for a number of reasons:

·       cethromycin has shownhigher *in vitro***potency and a broaderrange of activity than macrolides and Ketek against Gram-positive bacteriaassociated with respiratory tract infections;

·       cethromycin appears to beclinically effective against penicillin- and macrolide-resistant bacteria;

·       cethromycin has a mechanismof action, unique to ketolides, that may slow the onset of future resistance;

·       cethromycinhas shown specific activity against Gram-positive pathogens, unlike fluoroquinolones,while leaving normally-present Gram-negative bacteria undisturbed;

·       cethromycin has shown *in vitro* evidence of extended post-antibiotic effectsagainst the pathogens commonly seen in respiratory tract infections; and

·       cethromycin, unlike Ketek,has not demonstrated visual disturbance side effects in clinical trials.

We believe thatcethromycin, if approved, would address a growing need in the marketplace toovercome bacterial resistance.

**Abbott LaboratoriesCollaboration**

In December 2004, we entered into an agreementwith Abbott Laboratories under which we acquired from Abbott a license tocertain patent applications, patents and proprietary technology relating tocethromycin. Under the terms of the initial agreement which was subsequentlymodified on August 1, 2005, we paid $13.0 million in license fees andmilestones and issued 1,722,569 shares of our common stock 

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to Abbott. We will oweAbbott $10.0 million if we submit a new drug application (“NDA”) and $30.0million if and when the FDA approves the NDA. We also agreed to pay to Abbott$2.5 million upon cethromycin reaching $200 million in aggregate net sales and$5.0 million upon the drug reaching $400 million in aggregate net sales.Finally, we will owe Abbott royalty payments of 19.0% on the first $100 millionof aggregate net sales of cethromycin, 18.0% on net sales once aggregate netsales exceed $100 million but are less than $200 million, and 17.0% on all netsales once aggregate net sales exceed $200 million.

The term of the agreement commenced on December 13,2004 and continues until the expiration of the last patent licensed under theagreement, unless the agreement is otherwise terminated. The primary patentlicensed under the agreement, used by us in connection with cethromycin,expires in the U.S. on September 4, 2016, and in most foreign countries orjurisdictions on September 2, 2017, all subject to any term restorationthat may be granted for the time necessary for regulatory approval in eachrespective jurisdiction. Upon the expiration of the license agreement, we maintaina non-exclusive, perpetual and irrevocable license to use Abbott’s proprietarytechnology and other types of information directly related or used inconnection with cethromycin and its manufacture into pharmaceutical productswithout any further payment obligations to Abbott, except for those paymentobligations accruing prior to such expiration. The agreement may be terminatedby either party on 30 days notice if the other party ceases its businessoperations or if the other party passes a resolution or a court of competentjurisdiction makes an order for winding up its business. Either party may alsoterminate the agreement for material breach if not cured within 90 days ofnotice or if not cured within 30 days of notice if the breach relates to a paymentprovision.

We have the right tosublicense our rights under the agreement at our discretion. In addition, if wedetermine to co-market or co-distribute cethromycin, Abbott has a 90-dayexclusive right of first negotiation to be the co-marketer, co-distributor orexclusive distributor.

**OtherCollaborations and License Agreements**

In addition to our collaboration with AbbottLaboratories, we have entered into a number of license agreements forintellectual property and other rights needed to develop our products.

*Universityof Illinois at Chicago.**  *In 1999, we acquired an exclusive worldwide license,under patent rights and know-how controlled by UIC, to develop, make, use andsell ALS-357 and related compounds to treat melanoma and other forms ofcancer. In consideration for this license, we paid an upfront license fee of$15,000 upon the execution of the agreement. We are also obligated to make upto $135,000 in aggregate milestone payments upon the achievement of variousdevelopment and commercialization milestonesfor each of ALS-357 and any other compound developed by us under thelicensed technology. To date, we have paid $10,000 in milestone payments whichresulted from an Initial New Drug Application (“IND”) for ALS-357 filedwith the FDA in December 2004. Under the terms of the agreement, we areobligated to reimburse UIC for past patent preparation, filing and prosecutionexpenses, and have agreed to reimburse UIC for similar expenses related toforeign patents throughout the term of the agreement. To date we have paid UICapproximately $436,000 for patent reimbursement. In addition, we agreed to payroyalties equal to 6% of net sales to UIC based on sales of licensed productsby us, our affiliates and sublicensees, as well as a percentage of all otherincome we receive from sublicensees, but in any event, a minimum royalty of$5,000 annually once commercial sales commence.

*BaxterInternational.**  *Aspart of our spin-off from MediChem Life Sciences in 1999, we obtained theentire right, title and interest to certain patented inventions relating to ALS-886that were assigned by Baxter International, Inc. to Dr. Michael T.Flavin. We have assumed the obligation of Dr. Flavin to pay Baxter, as apayment for the assignment, 3% of net sales of ALS-886. Further, we arealso obliged to share with Baxter 50% of thesublicensing fees we collect, other than royalties. In addition, if we sellthe 

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ongoing business ofmaking, using or selling ALS-886, we are obligated to pay Baxter 50% ofthe fair market value of the right or licenseto manufacture, use or sell ALS-886 that is conveyed as part ofthe sale.

*Argonne NationalLaboratory.**  *In2003, we acquired an exclusive license, under patent rights and know-howcontrolled by Argonne National Laboratory, to develop, make, use and sell inthe United States and its territories a class of peptides and related compoundsto inhibit the formation of amyloid fibrils.These fibrils are implicated in a number of diseases such as Alzheimer’sdisease and amyloidosis. In consideration of this license, we agreed topay royalties to Argonne equal to 4% of net sales of licensed products by us,our affiliates and sublicensees, as well as 10% of any benchmark or milestone fees we receive from sublicensees. We also agreedto reimburse Argonne for the cost of ongoing patent prosecution andmaintenance. The license is subject to certain reserved rights for the U.S.Government based on Federal statutes,including the Government’s right to develop, make, use, and sell the amyloidinhibiting peptides pursuant to any treaties or agreements with foreigngovernments that the U.S. Government may enter, and the Government’s right torequire us to sublicense the rights granted in certain limited circumstances.We are obligated to provide at least one half-time employee to this projectuntil completion of Phase I clinical trials. Argonne has the right to terminatethe agreement if due diligence requirements, including the devotion of onehalf-time employee, are not met.

**IntellectualProperty**

*Patents and TradeSecrets*

We have assembled a broadintellectual property portfolio encompassing the use, methods of preparationand methods of manufacture for our product candidates in the areas ofinfectious disease, oncology and inflammation. We currently have exclusiveaccess to 62 issued U.S. and internationalpatents. In addition, 23 U.S. and international patent applications havebeen filed and are in various stages of processing.

**KeyU.S. Patents and Expiration Dates**

| **Drug Candidate** | ** ** | ** ** | ** ** | **U.S. Patent Number** | ** ** | **Expiration Date** | ** ** |
|-------------------------|------------|------------|------------|----------------------------------|------------|--------------------------|------------|
| Cethromycin             |       |       | 5866549    |                             |       |                     | 9/4/2016   |   |   |
| ALS-357                 |       |       | 5658947    |                             |       |                     | 8/19/2014  |   |   |
| ALS-886                 |       |       | 5504111    |                             |       |                     | 4/2/2013   |   |   |

 

Thepatent positions of companies like ours are generally uncertain and involvecomplex legal and factual questions. Our ability to maintain andsolidify our proprietary position for our technology will depend on our successin obtaining effective claims and enforcing those claims once granted. We do not know whether any of our patent applications orthose patent applications that we license will result in the issuance ofany patents. Our issued patents and those that may issue in the future, orthose licensed to us, may be challenged, invalidated or circumvented, whichcould limit our ability to stop competitors from marketing related products orthe length of term of patent protection that we may have for our products. Inaddition, there can be no assurance that this patent coverage will be broad enough to prevent third parties from developing orcommercializing similar or identical technologies and thus the rights grantedunder any issued patents may not provide us with any meaningful competitiveadvantages against our competitors. Furthermore, because of the extensive timerequired for development, testing and regulatory review of a potential product,it is possible that, before any of our products can be commercialized, anyrelated patent may expire or remain in force for only a short period followingcommercialization, thereby reducing any advantage of the patent. There can alsobe no assurance that our technologies will not be deemed to infringe the IPrights of third 

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parties or that we will be able to acquire licenses to theIP rights of third parties under satisfactory terms or at all.

**Competition**

The biotechnology and pharmaceutical industries arecharacterized by rapidly advancing technologies, intense competition and astrong emphasis on proprietary products. We face competition from manydifferent sources, including commercial pharmaceutical and biotechnologyenterprises, academic institutions, government agencies and private and publicresearch institutions. We believe that our most significant competitors areAventis, Pfizer, GlaxoSmithKline and Johnson & Johnson.

Many of our competitors have significantly greaterfinancial resources and expertise in research and development, manufacturing,preclinical testing, clinical trials, regulatory approvals and marketingapproved products than we do. Smaller or early-stage companies may also proveto be significant competitors, particularly through collaborative arrangementswith large and established companies. Our commercial opportunity will bereduced or eliminated if our competitors develop and commercialize productsthat are safer, more effective, have fewer side effects or are less expensivethan any products that we may develop. These third parties compete with us inrecruiting and retaining qualified scientific and management personnel,establishing clinical trial sites and patient registration for clinical trials,as well as in acquiring technologies and technology licenses complementary toour programs or advantageous to our business.

We rely upon our collaborators for support inadvancing certain of our product candidates and intend to rely on ourcollaborators for the commercialization of these products. Our collaboratorsmay be conducting multiple product development efforts within the same diseaseareas that are the subjects of their agreements with us. Generally, ouragreements with our collaborators do not preclude them from pursuingdevelopment efforts using a different approach from that which is the subjectof our agreement with them. Therefore, any of our product candidates may besubject to competition with a product candidate under development by acollaborator.

There are also a number ofcompanies working to develop new drugs and other therapies for these diseasesthat are undergoing clinical trials. The key competitive factors affecting thesuccess of all of our product candidates are likely to be their efficacy,safety, price and convenience. See ‘‘Risk Factors—We will face significantcompetition from other biotechnology and pharmaceutical companies, and ouroperating results will suffer if we fail to compete effectively.’’

**GovernmentRegulation**

Government authorities inthe United States, at the federal, state and local level, and other countriesextensively regulate, among other things, the research, development, testing,manufacture, labeling, promotion, advertising, distribution, marketing andexport and import of pharmaceutical products such as those we are developing.The process of obtaining regulatory approvals and the subsequent substantialcompliance with appropriate federal, state, local and foreign statutes andregulations require the expenditure of substantial time and financialresources.

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*U.S. GovernmentRegulation*

In the United States, the FDA regulates drugs underthe Federal Food, Drug, and Cosmetic Act and implementing regulations. If wefail to comply with the applicable United States requirements at any timeduring the product development process, approval process or after approval, wemay become subject to administrative or judicial sanctions. These sanctionscould include the FDA’s refusal to approve pending applications, withdrawal ofan approval, clinical holds, warning letters, product recalls, productseizures, total or partial suspension of production or distribution,injunctions, fines, civil penalties or criminal prosecution. Any agencyenforcement action could have a material adverse effect on us.

The steps requiredbefore a drug may be marketed in the United States include:

·       preclinical laboratorytests, animal studies and formulation studies under the FDA’s good laboratorypractices regulations;

·       submission to the FDA of anIND application for human clinical testing, which must become effective beforehuman clinical trials may begin;

·       adequate andwell-controlled clinical trials in accordance with FDA good clinical practiceregulations, to establish the safety and efficacy of the product for eachindication;

·       submission to the FDA of anNDA;

·       satisfactory completion ofan FDA inspection of the manufacturing facility or facilities at which theproduct is produced to assess compliance with current good manufacturingpractices, (“cGMP”); and

·       FDA review and approval ofthe NDA.

Preclinical tests include laboratory evaluations ofproduct chemistry, toxicity and formulation, as well as animal studies. An INDsponsor must submit the results of the preclinical tests, together withmanufacturing information and analytical data, to the FDA as part of the IND.The IND must become effective before human clinical trials may begin. An INDwill automatically become effective 30 days after receipt by the FDA, unlessbefore that time the FDA raises concerns or questions about issues such as theconduct of the trials as outlined in the IND. In that case, the IND sponsor andthe FDA must resolve any outstanding FDA concerns or questions before clinicaltrials can proceed. If these issues are unresolved, the FDA may not allow theclinical trials to commence.

Clinical trials involve the administration of theinvestigational product to human subjects under the supervision of qualifiedinvestigators. Clinical trials are conducted under protocols detailing, amongother things, the objectives of the study, the parameters to be used inmonitoring safety and the effectiveness criteria to be evaluated. Each protocolmust be submitted to the FDA as part of the IND.

Clinical trials typically are conducted in threesequential phases, but the phases may overlap or be combined. Each trial mustbe reviewed and approved by an independent Institutional Review Board before itcan begin. Phase I clinical trials usually involve the initial introduction ofthe investigational drug into humans to evaluate the product’s safety, dosagetolerance and pharmacodynamics and, if possible, to gain an early indication ofits effectiveness.

Phase II clinicaltrials usually involve controlled trials in a limited patient population to:

·       evaluate dosage toleranceand appropriate dosage;

·       identify possible adverseeffects and safety risks; and

·       evaluate preliminarily theefficacy of the drug for specific indications.

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Phase III clinical trials usually further evaluateclinical efficacy and test further for safety in an expanded patientpopulation. Phase I, Phase II and Phase III clinical trials may not becompleted successfully within any specified period, if at all. Furthermore, theFDA or we may suspend or terminate clinical trials at any time on variousgrounds, including a finding that the subjects or patients are being exposed toan unacceptable health risk.

Assuming successful completion of the requiredclinical testing, the results of the preclinical studies and of the clinicalstudies, together with other detailed information, including information on themanufacture and composition of the product, are submitted to the FDA in theform of an NDA requesting approval to marketthe product for one or more indications. The FDA reviews an NDA to determine,among other things, whether a product is safe and effective for its intendeduse and has a favorable risk/benefit profile.

Under the Pediatric Research Equity Act of 2003, orPREA, NDAs or supplements to NDAs must containdata to assess the safety and effectiveness of the drug for the claimedindications in all relevant pediatric subpopulations and to supportdosing and administration for each pediatric subpopulation for which the drugis safe and effective. The FDA may grant deferrals for submission of data orfull or partial waivers. In most cases, the NDA must be accompanied by asubstantial user fee.

Before approving an application, the FDA will inspectthe facility or the facilities where the product is manufactured. The FDA willnot approve the product unless cGMP compliance is considered satisfactory. TheFDA will issue an approval letter if it determines that the application,manufacturing process and manufacturing facilities are acceptable. If the FDAdetermines the application, manufacturing process or manufacturing facilitiesare not acceptable; it will outline the deficienciesin the submission and often will request additional testing or information.Notwithstanding the submission of any requested additional information,the FDA ultimately may decide that the application does not satisfy theregulatory criteria for approval.

The testing and approval process requires substantialtime, effort and financial resources, and each may take several years tocomplete. The FDA may not grant approval on a timely basis, or at all. We mayencounter difficulties or unanticipated costs in our efforts to securenecessary governmental approvals, which could delay or preclude us frommarketing our products. The FDA may limit the indications for use or placeother conditions on any approvals that could restrict the commercialapplication of the products. After approval, some types of changes to theapproved product, such as adding new indications, manufacturing changes andadditional labeling claims, are subject to further FDA review and approval.

After regulatory approval of a product is obtained, weare required to comply with a number of post-approval requirements. Forexample, as a condition of approval of an application, the FDA may require post-marketing testing and surveillance tomonitor the product’s safety or efficacy. In addition, holders of anapproved NDA are required to report certain adverse reactions and productionproblems to the FDA, to provide updated safety and efficacy information and tocomply with requirements concerning advertising and promotional labeling fortheir products. Also, quality control and manufacturing procedures mustcontinue to conform to cGMP after approval. The FDA periodically inspects manufacturing facilities to assesscompliance with cGMP, which imposes numerous procedural anddocumentation requirements. Accordingly, manufacturers must continue to expendtime, money and effort in the area of production and quality control tomaintain compliance with cGMP and other regulations.

We rely, and expect tocontinue to rely, on third parties for the production of clinical andcommercial quantities of our product candidates. Future FDA inspections mayidentify compliance issues at our facilities or at the facilities of ourcontract manufacturers that may disrupt production or distribution, or requiresubstantial resources to correct. In addition, discovery of problems with aproduct, or the failure to comply with requirements, may result in restrictionson a product, manufacturer or holder of an approved NDA, including withdrawalor recall of the product from the market orother voluntary or FDA-

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initiated action that could delay further marketing. Newlydiscovered or developed safety or efficacy data may require changes to aproduct’s approved labeling, including the addition of new warnings andcontraindications. Also, new government requirements may be established thatcould delay or prevent regulatory approval of our products under development.

*Foreign Regulation*

In addition to regulations in the United States, wewill be subject to a variety of foreign regulationsgoverning clinical trials and commercial sale and distribution of our products.Whether or not we obtain FDA approval for a product, we must obtainapproval of a product by the comparable regulatoryauthorities of foreign countries before we can commence clinical trials ormarketing of the product in those countries. The approval process variesfrom country to country, and the time may be longer or shorter than thatrequired for FDA approval. The requirements governing the conduct of clinicaltrials, product licensing, pricing and reimbursement vary greatly from countryto country.

Under European Unionregulatory systems, we may submit marketing authorization applications eitherunder a centralized or decentralized procedure. The centralized procedure,which is compulsory for medicines produced by biotechnology and optional forthose which are highly innovative, provides for the grant of a single marketingauthorization that is valid for all European Union member states. The decentralized procedure provides for mutualrecognition of national approval decisions. Under this procedure, theholder of a national marketing authorization may submit an application to theremaining member states. Within 90 days of receiving the applications andassessment report, each member state must decide whether to recognize approval.If a member state does not recognize the marketing authorization, the disputedpoints are eventually referred to the European Commission, whose decision isbinding on all member states.

**PharmaceuticalPricing and Reimbursement**

In both domestic and foreign markets, sales of anyproducts for which we receive regulatory approval for commercial sale willdepend in part on the availability of reimbursement from third party payors.Third party payors include government health administrative authorities,managed care providers, private health insurers and other organizations. Thesethird party payors are increasingly challengingthe price and examining the cost-effectiveness of medical products andservices. In addition, significant uncertainty exists as to thereimbursement status of newly approved healthcare product candidates. We mayneed to conduct expensive pharmacoeconomic studies in order to demonstrate thecost-effectiveness of our products. Our product candidates may not beconsidered cost-effective. Adequate third party reimbursement may not beavailable to enable us to maintain price levels sufficient to realize anappropriate return on our investment in product development.

In 2003, the United States government enactedlegislation providing a partial prescription drug benefit for Medicarerecipients, beginning in 2006. Government payment for some of the costs ofprescription drugs may increase demand for any products for which we receivemarketing approval. However, to obtain payments under this program, we would berequired to sell products to Medicare recipients through drug procurementorganizations operating pursuant to this legislation. These organizations wouldnegotiate prices for our products, which are likely to be lower than we mightotherwise obtain. Federal, state, and local governments in the United Statescontinue to consider legislation to limit the growth of healthcare costs,including the cost of prescription drugs. Future legislation could limitpayments for pharmaceuticals such as the product candidates that we aredeveloping.

The marketability of any productsfor which we receive regulatory approval for commercial sale may sufferif the government and third party payors fail to provide adequate coverage andreimbursement. 

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In addition, an increasingemphasis on managed care in the United States has increased and will continueto increase the pressure on pharmaceutical pricing.

Another development thatmay affect the pricing of drugs is proposed Congressional action regarding drugreimportation into the United States. Proposed legislation would allow thereimportation of approved drugs originally manufactured in the United Statesback into the United States from other countries where the drugs are sold at alower price. If legislation or regulations are passed allowing thereimportation of drugs, they could reduce the price we receive for any productsthat we may develop, negatively affecting our revenues and prospects forprofitability. Even without legislationauthorizing reimportation, patients have been purchasing prescription drugsfrom Canadian and other non-United States sources, which have reducedthe price received by pharmaceutical companies for their products.

**Employees**

As of December 31,2006, we employed 28 people of which there are 12 in research and 16 inadministration. Our employees are not represented by any collective bargainingagreements and we believe our employee relations are good.

**AvailableInformation**

Copies of our AnnualReport on Form 10-K, Quarterly Reports on Form 10-Q,Current Reports on Form 8-K and amendments to those reports filed orfurnished pursuant to Section 13(a) or 15(d) of the Securitiesand Exchange Act of 1934 are available free of charge through our website(www.advancedlifesciences.com) as soon as reasonably practicable after weelectronically file the material with, or furnish it to, the Securities andExchange Commission at 450 Fifth Street, N.W., Washington DC 20549.

**Item 1A.**                *Risk Factors.*

*Our business,financial condition, operating results and cash flows may be impacted by anumber of factors. In addition to the factors affecting specific businessoperations identified in connection with the description of these operationsand the financial results of these operations elsewhere in this Report, themost significant factors affecting our operations include the following:*

***Without obtaining adequate capital funding, we may notbe able to continue as a going concern.***

If we are unable to obtain adequate capital funding inthe future, we may not be able to continue as a going concern, which would havean adverse effect on our business and operations, and investors’ investment inus may decline.

***We are at an early stage of development and may neverattain product sales.***

We have not received FDA approval for any of ourproduct candidates. Any compounds that we discover or in-license will requireextensive and costly development, preclinical testing and/or clinical trialsprior to seeking regulatory approval for commercial sales. Our most advancedproduct candidate, cethromycin, and any other compounds we discover, develop orin-license, may never be approved for commercial sale. The time required to attainproduct sales and profitability is lengthy and highly uncertain, and we cannotassure you that we will be able to achieve or maintain product sales.

***We expect our net operating losses to continue for atleast several years, and we are unable to predict the extent of future lossesor when we will become profitable, if ever.***

We have incurredsignificant net losses since our formation in 1999. Our cumulative net loss was$67.3 million as of December 31, 2006. Our operating losses are due inlarge part to the significant research and development costs required toidentify, validate and license potential product candidates, conduct 

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preclinicalstudies and conduct clinical trials of our more advanced product candidates. Todate, we have generated only limited revenues, consisting of management feesand one-time or limited payments associated with our collaborations or grants,and we do not anticipate generating any significant revenues for at least thenext several years, if ever. We expect to increase our operating expenses overthe next several years as we plan to:

·       expandthe clinical trial program for cethromycin and prepare for its commercialdevelopment;

·       continuethe preclinical development and commence the clinical development of our otherproduct candidates, such as ALS-357 and ALS-886;

·       expandour research and development activities;

·       acquireor in-license new technologies and product candidates; and

·       increaseour required corporate infrastructure and overhead.

As a result, we expect to continue to incursignificant and increasing operating losses for the foreseeable future. Becauseof the numerous risks and uncertainties associated with our research andproduct development efforts, we are unable to predict the extent of any futurelosses or when we will become profitable, if ever. Even if we do achieveprofitability, we may not be able to sustain or increase profitability on anongoing basis.

***We will require additional funding to satisfy ourfuture capital needs, and future financing strategies may adversely affectholders of our common stock.***

Our operations will require significant additionalfunding in large part due to our research and development expenses, futurepreclinical and clinical testing costs, the possibility of expanding ourfacilities, and the absence of any meaningful revenues in the near future. Wedo not know whether additional financing will be available to us on favorableterms or at all. If we cannot raise additional funds, we may be required toreduce our capital expenditures, scale back product development or programs,reduce our workforce and license to others products or technologies that we mayotherwise be able to commercialize.

To the extent we raise additional capital by issuingequity securities, our stockholders could experience substantial dilution. Anyadditional equity securities we issue may have rights, preferences orprivileges senior to those of existing holders of stock. To the extent that weraise additional funds through collaboration and licensing arrangements, we maybe required to relinquish some rights to our technologies or productcandidates, or grant licenses on terms that are not favorable to us.

***Our business would be materially harmed if our pivotalPhase III clinical trials of cethromycin are unsuccessful.***

We anticipate that our ability to generate anysignificant product revenues in the near future will depend solely on thesuccessful development and commercialization of cethromycin, our most advancedproduct candidate. We are currently conducting two pivotal Phase IIIclinical trials of cethromycin for the treatment of mild-to-moderate communityacquired pneumonia. As a company, we do not have any prior experience inconducting Phase III clinical trials. If we are unable to complete thesetrials successfully or ultimately receive FDA marketing approval forcethromycin, our ability to generate revenues and our business will bematerially harmed.

Prior to licensing the compound to us, AbbottLaboratories conducted initial clinical trials of cethromycin for the treatmentof mild-to-moderate community acquired pneumonia in different dosing regimens,i.e., 150 mg, 300 mg and 600 mg once-daily as well as 150 mg twice-daily. Eventhough the antibacterial efficacy of cethromycin has been demonstrated in alldosing regimens, no controlled studies have been conducted to comparecethromycin with an approved antibiotic agent to establish non-

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inferiority in clinicalcure rate, which is required by the FDA for an antibiotic product approval. Ourtwo pivotal Phase III clinical trials include a standard of care comparator armin anticipation of demonstrating the non-inferiority of cethromycin 300 mgonce-daily dosing in clinical cure rate. Antibiotic products currently in themarketplace are generally effective and, for this reason, the requiredthreshold to demonstrate non-inferiority for a new antibiotic compound is oftenvery high. There can be no assurance that our pivotal Phase III clinical trialsof cethromycin will establish non-inferiority with the comparator used in ourpivotal trials.

Our business would be materially harmed if our pivotalPhase III clinical trials in treating mild-to-moderate community acquiredpneumonia suggest that the safety and efficacy of cethromycin are unfavorable.Further, the success of our pivotal Phase III clinical trials in treatingmild-to-moderate community acquired pneumonia depends on many factors that arebeyond our control. For instance, due to the seasonality of the disease and theavailability of standard of care medicines, it may not be possible to enroll asufficient number of patients to our studies. The side effects of cethromycinmay be intolerable so that patients may not complete or adhere to the requiredtreatment protocol.

***The FDA may change its approval policies orrequirements, or apply interpretations to its policies or requirements, in amanner that could delay or prevent commercialization of cethromycin.***

Regulatory requirements for approval of antibioticsmay change in a manner that requires us to conduct additional clinical trials,which may delay or prevent commercialization of cethromycin. Historically, the FDA and foreign regulatoryauthorities have not required placebo-controlled clinical trials for approvalof antibiotics but instead have relied on non-inferiority studies. In anon-inferiority study, a drug candidate is compared with an approved antibiotictreatment and it must be shown that the product candidate is not less effectivethan the approved treatment. After consultation with the FDA, we designed ourongoing pivotal Phase III clinicaltrials of cethromycin for the treatment of mild-to-moderate community acquiredpneumonia as non-inferiority studies. It appears, based on recentpronouncements by the FDA, that any requirement to conduct placebo-controlledstudies will be limited to self-resolving diseases such as sinusitis and pharyngitis and will not apply tomild-to-moderate community acquired pneumonia. However, we cannotprovide any assurance that the FDA will not require placebo-controlled trialsto demonstrate the superiority of cethromycinto placebo before considering the approval of cethromycin for the treatmentof mild-to-moderate community acquired pneumonia.

An FDA Advisory Panel recently met to review the risk/benefitprofile of Ketek®, the only approved ketolide antibiotic, which is marketed byone of our competitors, Aventis Pharmaceuticals. Due to instances of blurredvision, elevated liver toxicity and reports of exacerbation of myasthenia gravis symptoms in patients with thedisease, the FDA recommended that the Ketek® label be changed to include aboxed safety warning. The FDA may interpret the Advisory Panel’srecommendations in a manner that may result in the heightened scrutiny ofcethromycin for the treatment ofmild-to-moderate community acquired pneumonia.

***Because we are heavily dependent on our licenseagreement with Abbott Laboratories and our collaborations with other thirdparties, our product development programs may be delayed or terminated by factorsbeyond our control.***

In December 2004, we entered into a licenseagreement with Abbott Laboratories for certain patent applications, patents andproprietary technology relating to cethromycin. We have also entered into anumber of license agreements for intellectual property and other rights neededto develop our product candidates that are in earlier stages of development.Our primary collaborators other than Abbott include the University of Illinoisat Chicago, Argonne National Laboratory and Baxter International. A descriptionof our agreements with collaborators can be found under the headings “Business—AbbottLaboratories Collaboration” and “Business—Other Collaborations and LicenseAgreements”. Our collaborations generally present additional risks to ourbusiness, such as the risk that our collaborators encounter conflicts 

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of interest to theirarrangements with us, inadequately defend our intellectual property rights ordevelop other products that compete with us. Our ability to generate any significantproduct revenues in the near future will depend solely on the successfulcommercialization of cethromycin. If for any reason we are unable to realizethe expected benefits of our license agreement with Abbott, or under any of ourother collaborations, then our business and financial condition may bematerially harmed.

***We will depend on outside parties to conduct ourclinical trials, and any failure of those parties to fulfill their obligationscould result in costs and delays beyond our control that prevent us fromobtaining regulatory approval or successfully commercializing productcandidates.***

We have engaged contract research organizations toperform data collection and analysis and other aspects of our clinical trialsof cethromycin and our other product candidates. We do not have the physicaland human resources to conduct our clinical trials independently. The contractresearch organizations we engage will interact with clinical investigators andmedical institutions to enroll patients in our clinical trials. As a result, wewill depend on these clinical investigators, medical institutions and contractresearch organizations to perform the studies and trials properly. If theseparties do not successfully carry out their contractual duties or obligationsor meet expected deadlines, or if the quality, completeness or accuracy of theclinical data they obtain is compromised due to fraud or the failure to adhereto our clinical protocols or for other reasons, our clinical trials may beextended, delayed or terminated. Many of these factors will be outside of ouroversight and beyond our control. We may not be able to enter into replacementarrangements without undue delays or considerable expenditures. If there aredelays in testing or regulatory approvals as a result of the failure to performby third parties, our drug discovery and development costs will increase, andwe may not be able to obtain regulatory approval for our product candidates. Inaddition, we may not be able to establish or maintain relationships with theseparties on favorable terms, if at all.

***Even if we successfully complete clinical trials ofcethromycin or any other product candidate, we may fail to obtain FDA approvalof a new drug application.***

The FDA may not approve in a timely manner, or at all,any New Drug Application (NDA) that we submit. If we are unable to submit anNDA for cethromycin or any other product candidate, or if any NDA we submit isnot approved by the FDA, we will be unable to commercialize that product in theUnited States. The FDA can and does reject NDAs, and often requires additionalclinical trials, even when product candidates performed well or achievedfavorable results in large-scale Phase III clinical trials. The FDAimposes substantial requirements on the introduction of pharmaceutical productsthrough lengthy and detailed laboratory and clinical testing procedures,sampling activities and other costly and time-consuming procedures.Satisfaction of these requirements typically takes several years and may varysubstantially based upon the type and complexity of the pharmaceutical product.A number of our product candidates are novel compounds, which may furtherincrease the period of time required for satisfactory testing procedures.

Data obtained from preclinical and clinical activitiesare susceptible to varying interpretations, which could delay, limit or preventregulatory approval. In addition, delays or rejections may be encountered basedon changes in, or additions to, regulatory policies for drug approval duringthe period of product development and regulatory review. The effect ofgovernment regulation may be to delay or prevent the commencement of clinicaltrials or marketing of our product candidates for a considerable period oftime, to impose costly procedures upon our activities and to provide anadvantage to our competitors that have greater financial resources or are moreexperienced in regulatory affairs. The FDA may not approve our productcandidates for clinical trials or marketing on a timely basis or at all. Delaysin obtaining or failure to obtain such approvals would adversely affect themarketing of our product candidates and our liquidity and capital resources.

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Drug products and their manufacturers are subject tocontinual regulatory review after the product receives FDA approval. Laterdiscovery of previously unknown problems with a product or manufacturer mayresult in additional clinical testing requirements or restrictions on suchproduct or manufacturer, including withdrawal of the product from the market.Failure to comply with applicable regulatory requirements can, among otherthings, result in fines, injunctions and civil penalties, suspensions orwithdrawals of regulatory approvals, product recalls, operating restrictions orshutdown and criminal prosecution. We may lack sufficient resources andexpertise to address these and other regulatory issues as they arise.

***Our collaborators and third party manufacturers maynot be able to manufacture our product candidates in larger quantities, whichwould prevent us from commercializing our product candidates.***

To date, each of our product candidates has beenmanufactured in small quantities by our collaborators and third partymanufacturers for preclinical and clinical trials. If any of our productcandidates is approved by the FDA or other regulatory agencies for commercialsale, we will need third parties to manufacture the product in largerquantities. Due to factors beyond our control, our collaborators and thirdparty manufacturers may not be able to increase their manufacturing capacityfor any of our product candidates in a timely or economic manner, or at all. Significantscale-up of manufacturing may require additional validation studies, which theFDA must review and approve. If we are unable to increase the manufacturingcapacity for a product candidate successfully, the regulatory approval orcommercial launch of that product candidate may be delayed or there may be ashortage in the supply of the product candidate. Our product candidates requireprecise, high-quality manufacturing. The failure of our collaborators and thirdparty manufacturers to achieve and maintain these high manufacturing standards,including the incidence of manufacturing errors, could result in patient injuryor death, product recalls or withdrawals, delays or failures in product testingor delivery, cost overruns or other problems that could seriously harm ourbusiness.

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

We do not currently have product sales and marketingcapabilities. If we receive regulatory approval to commence commercial sales ofany of our product candidates, we will have to establish a sales and marketingorganization with appropriate technical expertise and distribution capabilitiesor make arrangements with third parties to perform these services. If wereceive approval to commercialize cethromycin for the treatment ofmild-to-moderate community acquired pneumonia, we intend to engage otherpharmaceutical or health care companies with existing distribution systems anddirect sales organizations to assist us in North America and abroad. We may notbe able to negotiate favorable distribution partnering arrangements, if at all.To the extent we enter co-promotion or other licensing arrangements, anyrevenues we receive will depend on the efforts of third parties and will not beunder our control. If we are unable to establish adequate sales, marketing anddistribution capabilities, whether independently or with third parties, ourability to generate product revenues, and become profitable, would be severelylimited.

Our ability togenerate any significant revenues in the near-term is dependent entirely on thesuccessful commercialization and market acceptance of cethromycin. Factors thatmay inhibit our efforts to commercialize cethromycin or other productcandidates without strategic partners or licensees include:

·       difficultyrecruiting and retaining adequate numbers of effective sales and marketingpersonnel;

·       theinability of sales personnel to obtain access to, or persuade adequate numbersof, physicians to prescribe our products;

·       thelack of complementary products to be offered by sales personnel, which may putus at a competitive disadvantage against companies with broader product lines;and

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·       unforeseencosts associated with creating an independent sales and marketing organization.

***Our most advanced product candidate, cethromycin, willface significant competition in the marketplace if it receives marketingapproval from the FDA.***

We are conducting pivotalPhase III clinical trials of cethromycin for the treatment ofmild-to-moderate community acquired pneumonia. We also intend to pursueopportunities for cethromycin in the treatment of other respiratory tractinfections such as bronchitis, sinusitis, pharyngitis and inhalation anthrax.There are several classes of antibiotics that are primary competitors for thetreatment of one or more of these indications, including:

·       macrolidessuch as Biaxin® (clarithromycin), a product of Abbott Laboratories; andZithromax® (azithromycin), a product of Pfizer Inc.;

·       oneother ketolide antibiotic, Ketek® (telithromycin), launched in the UnitedStates and Europe by Aventis Pharmaceuticals;

·       semi-syntheticpenicillins such as Augmentin® (amoxicillin and clavulanate potassium), aproduct of GlaxoSmithKline; and

·       fluoroquinolonessuch as Levaquin® (levofloxacin), a product of Ortho-McNeilPharmaceutical, Inc.; Tequin® (gatifloxacin), a product of Bristol-MyersSquibb Company; FACTIVE® (gemifloxacin mesylate) tablets, a product of OscientPharmaceuticals; and Cipro® (ciprofloxacin) and Avelox® (moxifloxacin), bothproducts of Bayer Corporation.

Cethromycin may show evidence of side effects thatcould diminish its prospects for commercialization and wide market acceptance. Ifcethromycin is approved by the FDA, it will not be the first ketolideantibiotic introduced to the marketplace. Ketek® has been available for sale inEurope since 2002 and in the United States since August 2004. There areadditional ketolide product candidates in preclinical development or inclinical development. If ultimately approved by the FDA, these productcandidates may have improved efficacy, ease of administration or more favorableside effect profiles when compared to cethromycin. The availability ofadditional ketolide antibiotics may have an adverse affect on our ability togenerate product revenues and achieve profitability.

***The availability of generic equivalents may adverselyaffect our ability to generate product revenues from cethromycin.***

Many generic antibiotics are currently prescribed totreat respiratory tract infections. As competitive products lose patentprotection, makers of generic drugs will likely begin to market additionalcompeting products. Companies that produce generic equivalents are generallyable to offer their products at lower prices. Ketek® may lose patent protectionas early as 2015, which would enable generic drug manufacturers to sell genericketolide antibiotics at a lower cost than cethromycin. Generic equivalents ofBiaxin® and Zithromax®, two macrolide antibiotic products, are currentlyavailable. Cethromycin, if approved for commercial sale, may be at acompetitive disadvantage because of its higher cost relative to genericproducts. This may have an adverse effect on our ability to generate productrevenues from cethromycin.

***Our inability to expand cethromycin into indicationssuch as bronchitis, pharyngitis and sinusitis would harm our ability togenerate additional revenues in the future.***

Abbott Laboratories conducted four pivotalPhase III comparator trials for cethromycin in treating bronchitis andpharyngitis at a dosing level of 150 mg once-daily. Each of these trials failedto establish non-inferiority against comparator antibiotics. While we believethat the negative outcomes of the Abbott comparator trials were related todosing levels, we may be incorrect. The failure to meet primary endpoints inthe Abbott trials may not have been dose related, but rather a result of thecompound’s lack of sufficient 

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clinical efficacy.Clinical trials using a 300 mg once-daily regimen are also likely to increasethe occurrence of adverse side effects. Even if we receive FDA approval tomarket cethromycin for the treatment of mild-to-moderate community acquiredpneumonia, our failure to expand cethromycin into other indications would harmour ability to generate additional revenues in the future.

***Even if we successfully develop and obtain approvalfor cethromycin or any of our other product candidates, our business will notbe profitable if those products do not achieve and maintain market acceptance.***

Even if any of ourproduct candidates are approved for commercial sale by the FDA or otherregulatory authorities, the degree of market acceptance of any approved productcandidate by physicians, healthcare professionals, patients and third-partypayors, and our resulting profitability and growth, will depend on a number offactors, including:

·       ourability to provide acceptable evidence of safety and efficacy;

·       relativeconvenience and ease of administration;

·       theprevalence and severity of any adverse side effects;

·       theavailability of alternative treatments;

·       thedetails of FDA labeling requirements, including the scope of approvedindications and any safety warnings;

·       pricingand cost effectiveness;

·       theeffectiveness of our or our collaborators’ sales and marketing strategy;

·       ourability to obtain sufficient third-party insurance coverage orreimbursement; and

·       ourability to have the product listed on insurance company formularies.

If any of our product candidates achieve marketacceptance, we may not be able to maintain that market acceptance over time ifnew products or technologies are introduced that are received more favorably orare more cost effective. Complications may also arise, such as antibiotic orviral resistance, that render our products obsolete. We rely on the favorableresistance profile of cethromycin observed to be a potential competitivedistinction from currently marketed compounds. Even if we receive FDA approvalto market cethromycin, resistance may emerge that will substantially harm ourability to generate revenues from its sale.

We are initially seeking FDA approval for cethromycinas a seven-day treatment regimen. There are currently a number of antibioticproducts that are marketed as five-day therapies. In the event that the marketplaceconsiders this to be a significant competitive distinction, it is uncertainwhether we will be able to make cethromycin available for a lower dosingperiod. In addition, we expect that cethromycin, if approved for sale, would beused primarily in the outpatient setting.

***Because the results of preclinical studies for ourpreclinical product candidates are not necessarily predictive of futureresults, our product candidates may not have favorable results in laterclinical trials or ultimately receive regulatory approval.***

Only one product candidate in our developmentpipeline, cethromycin, has been tested in clinical trials. Our other productcandidates have only been through preclinical studies. Positive results frompreclinical studies, particularly in vitro studies, are no assurance that laterclinical trials will succeed. Preclinical trials are not designed to establishthe clinical efficacy of our preclinical product candidates. We will berequired to demonstrate through clinical trials that these product candidatesare safe and effective for use before we can seek regulatory approvals fortheir commercial sale. There is typically an extremely high rate of failure asproduct candidates proceed through clinical trials. If our product candidatesfail to 

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demonstrate sufficientsafety and efficacy in any clinical trial, we would experience potentiallysignificant delays in, or be required to abandon, development of that productcandidate. This would adversely affect our ability to generate revenues and maydamage our reputation in the industry and in the investment community.

***The future clinical testing of our product candidatescould be delayed, resulting in increased costs to us and a delay in our abilityto generate revenues.***

Our product candidates will require preclinicaltesting and extensive clinical trials prior to submitting a regulatoryapplication for commercial sales. We do not know whether clinical trials willbegin on time, if at all. Delays in the commencement of clinical testing couldsignificantly increase our product development costs and delay productcommercialization. In addition, many of the factors that may cause, or lead to,a delay in the commencement of clinical trials may also ultimately lead todenial of regulatory approval of a product candidate. Each of these resultswould adversely affect our ability to generate revenues.

The commencement ofclinical trials can be delayed for a variety of reasons, including delays in:

·       demonstratingsufficient safety to obtain regulatory approval to commence a clinical trial;

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

·       manufacturingsufficient quantities of a product candidate; and

·       obtaininginstitutional review board approvals to conduct clinical trials at prospectivesites.

In addition, the commencement of clinical trials maybe delayed due to insufficient patient enrollment, which is a function of manyfactors, including the size of the patient population, the nature of the protocol,the proximity of patients to clinical sites, the availability of effectivetreatments for the relevant disease, and the eligibility criteria for theclinical trial. Because mild-to-moderate community acquired pneumonia isgenerally seasonal in nature, achieving sufficient patient enrollment for ourpivotal Phase III clinical trials of cethromycin may be particularlydifficult.  If the FDA determines thatour geographic enrollment ratios are insufficient or if we are unable to enrolla sufficient number of microbiologically evaluable patients, our clinicaltrials could be delayed until sufficient numbers are achieved.

***If we fail to obtain regulatory approvals in othercountries for our product candidates under development, we will not be able togenerate revenues in such countries.***

In order to market our products outside of the UnitedStates, we must comply with numerous and varying regulatory requirements ofother countries. Approval procedures vary among countries and can involveadditional product testing and additional administrative review periods. Thetime required to obtain approval in other countries might differ from thatrequired to obtain FDA approval in the United States. Regulatory approval inone country does not ensure regulatory approval in another, but a failure ordelay in obtaining regulatory approval in one country may negatively impact theregulatory process in others. The risks involved in the non-U.S. regulatoryapproval process, as well as the consequences for failing to comply withapplicable regulatory requirements, generally include the same considerationsas in the United States. A description of U.S. regulatory considerations can befound under the section entitled “—Even if we successfully complete clinicaltrials of cethromycin or any other product candidate, we may fail to obtain FDAapproval of a new drug application.”

***We will face significant competition from otherbiotechnology and pharmaceutical companies, and our operating results willsuffer if we fail to compete effectively.***

We are a development stage company with 28 employees.Many of our competitors, such as Pfizer, GlaxoSmithKline and Bayer, are largepharmaceutical companies with substantially greater financial, 

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technical and humanresources than we have. The biotechnology and pharmaceutical industries areintensely competitive and subject to rapid and significant technologicalchange. Many of the drugs that we are attempting to discover or develop willcompete with existing therapies if we receive marketing approval. Because oftheir significant resources, our competitors may be able to use discoverytechnologies and techniques, or partnerships with collaborators, in order todevelop competing products that are more effective or less costly than theproduct candidates we develop. This may render our technology or productcandidates obsolete and noncompetitive. Academic institutions, governmentagencies, and other public and private research organizations may seek patentprotection with respect to potentially competitive products or technologies andmay establish exclusive collaborative or licensing relationships with ourcompetitors.

As a company, we do not have any prior experience inconducting Phase III clinical trials. Our competitors may succeed inobtaining FDA or other regulatory approvals for product candidates more rapidlythan us. Companies that complete clinical trials, obtain required regulatoryagency approvals and commence commercial sale of their drugs before we do mayachieve a significant competitive advantage, including certain FDA marketingexclusivity rights that would delay or prevent our ability to market certainproducts. Any approved drugs resulting from our research and developmentefforts, or from our joint efforts with our existing or future collaborativepartners, might not be able to compete successfully with our competitors’existing or future products.

***Off-label promotion of our products could result insubstantial penalties.***

If any of our product candidates receive marketingapproval, we will only be permitted to promote the product for the usesindicated on the label cleared by the FDA. Our pivotal Phase III clinicaltrials of cethromycin are for the treatment of mild-to-moderate communityacquired pneumonia, although we believe that cethromycin may have otherapplications in bronchitis, pharyngitis, sinusitis and inhalation anthrax. Ifwe request additional label indications for cethromycin or our other productcandidates, the FDA may deny those requests outright, require extensive clinicaldata to support any additional indications or impose limitations on theintended use of any approved products as a condition of approval. U.S.Attorneys’ offices and other regulators, in addition to the FDA, have recentlyfocused substantial attention on off-label promotional activities and haveinitiated civil and criminal investigations related to such practices. If it isdetermined by these or other regulators that we have promoted our products foroff-label use, we could be subject to fines, legal proceedings, injunctions orother penalties.

***If our efforts to obtain rights to new products orproduct candidates from third parties are not successful, we may not generateproduct revenues or achieve profitability.***

Our long-termability to earn product revenues depends on our ability to identify, throughinternal research programs, potential product candidates that may be developedinto new pharmaceutical products and/or obtain new products or productcandidates through licenses from third parties. If our internal researchprograms do not generate sufficient product candidates, we will need to obtainrights to new products or product candidates from third parties. We may beunable to obtain suitable products or product candidates from third parties fora number of reasons, including:

·       wemay be unable to purchase or license products or product candidates on termsthat would allow us to make an appropriate return from resulting products;

·       competitorsmay be unwilling to assign or license product or product candidate rights tous;

·       wemay not have access to the capital necessary to purchase or license products orproduct candidates; or

·       wemay be unable to locate suitable products or product candidates within, orcomplementary to, our areas of interest.

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If we are unable to obtain rights to new products orproduct candidates from third parties, our ability to generate product revenuesand achieve profitability may suffer.

***Because our productcandidates and development and collaboration efforts depend on our intellectualproperty rights, adverse events affecting our intellectual property rights willharm our ability to commercialize products.***

Our success will depend toa large degree on our own, our licensees’ and our licensors’ ability to obtainand defend patents for each party’s respective technologies and the compoundsand other products, if any, resulting from the application of suchtechnologies. The patent positions of pharmaceutical and biotechnologycompanies can be highly uncertain and involve complex legal and factualquestions. No consistent policy regarding the breadth of claims allowed inbiotechnology patents has emerged to date. Accordingly, we cannot predict thebreadth of claims that will be allowed or maintained, after challenge, in ouror other companies’ patents.

Thedegree of future protection for our proprietary rights is uncertain, and wecannot ensure that:

·       wewere the first to make the inventions covered by each of our pending patentapplications;

·       wewere the first to file patent applications for these inventions;

·       otherswill not independently develop similar or alternative technologies or duplicateany of our technologies;

·       anyof our pending patent applications will result in issued patents;

·       anypatents issued to us or our collaborators will provide a basis for commerciallyviable products, will provide us with any competitive advantages or will not bechallenged by third parties;

·       wewill develop additional proprietary technologies that are patentable; or

·       thepatents of others will not have a negative effect on our ability to dobusiness.

We are a party to certainin-license agreements that are important to our business, and we generally donot control the prosecution of in-licensed technology. Accordingly, we areunable to exercise the same degree of control over this intellectual propertyas we exercise over our internally developed technology. Moreover, some of ouracademic institution licensors, research collaborators and scientific advisorshave rights to publish data and information in which we have rights. If wecannot maintain the confidentiality of our technology and other confidentialinformation in connection with our collaborations, then our ability to receivepatent protection or protect our proprietary information will be impaired. Inaddition, some of the technology we have licensed relies on patented inventionsdeveloped using U.S. government resources. Under applicable law, the U.S.government has the right to require us to grant a nonexclusive, partiallyexclusive or exclusive license for such technology to a responsible applicantor applicants, upon terms that are reasonable under the circumstances, if thegovernment determines that such action is necessary.

***Confidentialityagreements with employees and others may not adequately prevent disclosure oftrade secrets and other proprietary information and may not adequately protectour intellectual property.***

We rely on trade secretsto protect our technology, particularly when we do not believe patentprotection is appropriate or obtainable. However, trade secrets are difficultto protect. In order to protect our proprietary technology and processes, werely in part on confidentiality and intellectual property assignment agreementswith our corporate partners, employees, consultants, outside scientificcollaborators and sponsored researchers and other advisors. These agreementsmay not effectively prevent disclosure of confidential information nor resultin the effective assignment to us of intellectual property, and may not providean adequate remedy in the event of unauthorized disclosure of confidentialinformation or other breaches of the agreements. In addition, others mayindependently discover our trade secrets and proprietary information, and insuch case we could not assert any trade secret rights against such party.Enforcing a claim that a party illegally obtained and is using our tradesecrets is difficult, 

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expensiveand time consuming, and the outcome is unpredictable. In addition, courtsoutside the United States may be less willing to protect trade secrets. Costlyand time-consuming litigation could be necessary to seek to enforce anddetermine the scope of our proprietary rights, and failure to obtain ormaintain trade secret protection could adversely affect our competitivebusiness position.

***Market acceptanceand sales of our product candidates will be severely limited if we cannotarrange for favorable reimbursement policies.***

Our ability tocommercialize any product candidates successfully will depend in part on theextent to which governmental authorities, private health insurers and otherorganizations establish reimbursement levels for the cost of our products andrelated treatments. Third-party payors are increasingly challenging theprices charged for medical products and services. Also, the trend towardmanaged healthcare in the United States, as well as legislative proposals toreform healthcare, control pharmaceutical prices or reduce government insuranceprograms, may also result in exclusion of our product candidates fromreimbursement programs. Because many generic antibiotics are available for thetreatment of respiratory tract infections, our ability to list cethromycin oninsurance company formularies will depend on its effectiveness compared to lower-costproducts. The cost containment measures that health care payors and providersare instituting, and the effect of any health care reform, could materially andadversely affect our ability to earn revenues from the sales of cethromycin andour other product candidates.

***The Medicareprescription drug coverage legislation and future legislative or regulatoryreform of the healthcare system could limit future revenues from our productcandidates.***

In the United States,there have been a number of legislative and regulatory proposals to change thehealthcare system in ways that could affect our ability to market and sell ourproduct candidates profitably. In particular, in December 2003, PresidentBush signed into law new Medicare prescription drug coverage legislation. Underthis legislation, the Centers for Medicare and Medicaid Services, or CMS, theagency within the Department of Health and Human Services that administersMedicare and will be responsible for reimbursement of the cost of drugs, has assertedthe authority of Medicare to elect not to cover particular drugs if CMSdetermines that the drugs are not “reasonable and necessary” for Medicarebeneficiaries or to elect to cover a drug at a lower rate similar to that ofdrugs that CMS considers to be “therapeutically comparable.” Changes inreimbursement policies or health care cost containment initiatives that limitor restrict reimbursement for our products may cause our revenues to decline.

Another development thatmay affect the pricing of drugs is regulatory action regarding drugreimportation into the United States. The Medicare Prescription Drug,Improvement and Modernization Act of 2003 requires the Secretary of the U.S.Department of Health and Human Services to promulgate regulations allowing drugreimportation from Canada into the United States under certain circumstances.These provisions will become effective only if the Secretary certifies thatsuch imports will pose no additional risk to the public’s health and safety andresult in significant cost savings to consumers. To date, the Secretary hasmade no such finding, but he could do so in the future. Proponents of drugreimportation may also attempt to pass legislation that would remove therequirement for the Secretary’s certification or allow reimportation undercircumstances beyond those anticipated under current law. If legislation isenacted, or regulations issued, allowing the reimportation of drugs, it coulddecrease the reimbursement we receive for any products that we may commercialize,negatively affecting our anticipated revenues and prospects for profitability.

***We will need toincrease the size of our organization, and we may encounter difficultiesmanaging our growth, which could adversely affect our results of operations.***

We are currently adevelopment stage company with 28 employees. We will need to expand andeffectively manage our managerial, operational, financial and other resourcesin order to successfully pursue our research, development and commercializationeffort. To manage any growth, we will be required to continue to improve ouroperational, financial and management controls, reporting systems 

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andprocedures and to attract and retain sufficient numbers of talented employees.We may be unable to successfully manage the expansion of our operations oroperate on a larger scale and, accordingly, may not achieve our research,development and commercialization goals.

***If we are unable toattract and retain qualified scientific, technical and key managementpersonnel, or if any of our key executives, Michael T. Flavin, Ph.D., Ze-Qi Xu,Ph.D., David A. Eiznhamer, Ph.D. or John L. Flavin, discontinues theiremployment with us, it may delay our research and development efforts.***

We are highly dependentupon the efforts of our senior management team and scientific staff. The lossof the services of one or more members of the senior management team mightimpede the achievement of our development objectives. In particular, we arehighly dependent upon and our business would be significantly harmed if we lostthe services of Michael T. Flavin, Ph.D., our founder and Chairman and ChiefExecutive Officer, Ze-Qi Xu, Ph.D., our Executive Vice President and ChiefScientific Officer, David A. Eiznhamer, Ph.D., our Executive Vice President ofClinical Development or John L. Flavin, our President. We do not currently haveany key man life insurance policies. We have entered into employment agreementswith members of our senior management team, but this does not ensure that wewill retain their services for any period of time in the future. Our researchand drug discovery programs also depend on our ability to attract and retainhighly skilled chemists, biologists and preclinical and clinical personnel. Wemay not be able to attract or retain qualified scientific personnel in thefuture due to intense competition among biotechnology and pharmaceuticalbusinesses, particularly in the Chicago area. If we are not able to attract andretain the necessary personnel to accomplish our business objectives, we mayexperience constraints that will significantly impede the achievement of ourresearch and development objectives and our ability to meet the demands of ourcollaborators in a timely fashion.

***Our business willexpose us to potential product liability risks and there can be no assurancethat we will be able to acquire and maintain sufficient insurance to provideadequate coverage against potential liabilities.***

Our business will exposeus to potential product liability risks that are inherent in the testing,manufacturing and marketing of pharmaceutical products. The use of our productcandidates in clinical trials also exposes us to the possibility of productliability claims and possible adverse publicity. These risks will increase tothe extent our product candidates receive regulatory approval and arecommercialized. We do not currently have any product liability insurance,although we plan to obtain product liability insurance in connection withfuture clinical trials of our product candidates. There can be no assurancethat we will be able to obtain or maintain any such insurance on acceptableterms. Moreover, our product liability insurance may not provide adequatecoverage against potential liabilities. On occasion, juries have awarded large judgmentsin class action lawsuits based on drugs that had unanticipated side effects. Asuccessful product liability claim or series of claims brought against us woulddecrease our cash reserves and could cause our stock price to fallsignificantly.

***We face regulationand risks related to hazardous materials and environmental laws, violations ofwhich may subject us to claims for damages or fines that could materiallyaffect our business, cash flows, financial condition and results of operations.***

Our research anddevelopment activities involve the controlled use of hazardous materials andchemicals. The risk of accidental contamination or injury from these materialscannot be completely eliminated. In the event of an accident, we could be heldliable for any damages or fines that result, and the liability could have amaterial adverse effect on our business, financial condition and results ofoperations. We are also subject to federal, state and local laws andregulations governing the use, manufacture, storage, handling and disposal ofhazardous materials and waste products. If we fail to comply with these lawsand regulations or with the conditions attached to our operating licenses, thelicenses could be revoked, and we could be subjected to criminal sanctions andsubstantial liability or be required to suspend or modify our operations. Inaddition, we may have to incur significant costs to comply with future 

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environmentallaws and regulations. We do not currently have a pollution and remediationinsurance policy.

***Our business and operations would suffer in the eventof system failures.***

Despite the implementationof security measures, our internal computer systems are vulnerable to damagefrom computer viruses, unauthorized access, natural disasters, terrorism, war,telecommunication and electrical failures. Our drug discovery and preclinicaltesting systems are highly technical and proprietary. Any system failure,accident or security breach that causes interruptions in our operations couldresult in a material disruption of our drug discovery programs. To the extentthat any disruption or security breach results in a loss or damage to our dataor applications, or inappropriate disclosure of confidential or proprietaryinformation, we may incur liability as a result, our drug discovery programsmay be adversely affected and the further development of our product candidatesmay be delayed. In addition, we may incur additional costs to remedy thedamages caused by these disruptions or security breaches.

**Item 1B.**               *Unresolved Staff Comments.*

None.

**Item 2.**                        *Properties.*

Our corporate offices andchemistry and biology laboratories are located in the Advanced Life SciencesProduct Development Center in Woodridge, Illinois. The Product Development Center consists of approximately 15,000 squarefeet of laboratory and office space. We believe that our currentfacilities are adequate to meet our needs for the foreseeable future. Ourfacilities are leased and our current lease expires in September 2008. Webelieve that suitable additional or alternative space will be available in thefuture on commercially reasonable terms as needed.

**Item 3.**                        *Legal Proceedings.*

None.

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

No matters were submitted to a vote of security holdersduring the quarter ended December 31, 2006.

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**PART II**

**Item 5.****                        *Market for Registrant’s Common Equity, Related Stockholder Matters andIssuer Purchases of Equity Securities*.**

Ourcommon stock is listed on the Nasdaq National Market under the symbol ADLS. Thefollowing table provides the high and low sales prices as reported by Nasdaqfor the periods indicated.

| ** **     | ** ** | **High**   | ** ** | **Low**    | ** ** |
|----------------|------------|------------|------------|------------|------------|
| **2006**       | ** ** | ** ** | ** ** | ** ** | ** ** |
| First Quarter  |       | $          | 4.24       |       | $          | 2.98 |   |
| Second Quarter |       | 3.64       |       | 2.31       |       |
| Third Quarter  |       | 3.25       |       | 2.70       |       |
| Fourth Quarter |       | $          | 3.75       |       | $          | 2.13 |   |

 

| ** **                                                  | ** ** | **High**   | ** ** | **Low**    | ** ** |
|-------------------------------------------------------------|------------|------------|------------|------------|------------|
| **2005**                                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Period from  August 4, 2005 to September 30, 2005 |       | $          | 5.81       |       | $          | 4.61 |   |
| Fourth Quarter                                              |       | $          | 5.06       |       | $          | 3.00 |   |

 

As of March 16, 2007,there were approximately 37 shareholders of record of our common stock.

**Dividends**

We have neither declarednor paid dividends on our common stock or the preferred stock of oursubsidiary, Advanced Life Sciences, Inc., since our inception and do notplan to pay dividends in the foreseeable future. Any determination in thefuture to pay cash dividends will depend on our financial condition, capitalrequirements, result of operations, contractual limitations and other factorsdeemed relevant by our Board of Directors. As of December 31, 2006,cumulative accrued undeclared dividends on our subsidiary’s preferred stocktotaled approximately $1.3 million.

**Equity CompensationPlan Information**

Thefollowing table sets forth information regarding all securities that could beissued through the exercise of stock options and warrants:

| ** **                                                  | ** ** | ** **                                                                                 | ** ** | ** **                                       | ** ** | **Number of securites  remaining available for**           | ** ** |
|-------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------------------------------------|------------|
| ** **                                                  | ** ** | **Number of securities to be  issued upon exercise of** | ** ** | **Weighted-average exercise**               | ** ** | **future issuance under  equity compensation plans ** | ** ** |
| ** **                                                  | ** ** | **outstanding options,**                                                              | ** ** | **price of outstanding options,** | ** ** | **(excluding securities**                                                 | ** ** |
| ** **                                                  | ** ** | **warrants and rights**                                                          | ** ** | **warrants and rights**                | ** ** | **reflected in column a)**                                      | ** ** |
| **Plan Category**                                      | ** ** | ** **                                                                                 | ** ** | **(a)**                                          | ** ** | **(b)**                                                                        | ** ** | **(c)** | ** ** |
| Equity  compensation plans approved by security holders     |       |                                                                                       | 6,294,079  |                                             |       |                                                                           | $          | 3.54 |   |   |   | 1,459,147 |   |   |
| Equity  compensation plans not approved by security holders |       |                                                                                       | —     |                                             |       |                                                                           | —     |   |   |   | — |   |   |
| Total                                                       |       |                                                                                       | 6,294,079  |                                             |       |                                                                           | $          | 3.54 |   |   |   | 1,459,147 |   |   |
|                                                             |            |                                                                                            |            |                                                  |            |                                                                                |            |  |  |  |  |  |  |  |  |  |

 

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**Recent Sales of Unregistered Securities**

None.

The following graph illustrates the cumulative totalstockholder return on our common stock during the period from August 5,2005, which is the date our common stock was initially listed on the NasdaqNational Market, through December 31, 2006 and compares it with thecumulative total return on the NASDAQ Composite Index, the NASDAQ BiotechComposite Index, and the AMEX Biotech Composite Index. The comparison assumes$100 was invested on August 5, 2005 in our common stock and in each of theforegoing indices and assumes reinvestment of dividends, if any. Theperformance shown is not necessarily indicative of futre performance.

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**Item 6.****                        *Selected Financial Data*.**

Thefollowing selected consolidated financial data should be read in conjunctionwith our consolidated financial statements and the notes thereto and “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”included elsewhere in this Annual Report. 
|                                                       | ** ** | ** **                                  | ** **  | ** **               | ** ** |
|-------------------------------------------------------|------------|---------------------------------------------|-------------|--------------------------|------------|
| ** **                                            | ** ** | ** **                                  | ** **  | ** **               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Period from** | ** ** |
| ** **                                            | ** ** | ** **                                  | ** **  | ** **               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Inception** | ** ** |
| ** **                                            | ** ** | ** **                                  | ** **  | ** **               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **(January 1, 1999)** | ** ** |
| ** **                                            | ** ** | **Years ended December 31,** | ** **  | **to December 31,** | ** ** |
| ** **                                            | ** ** | **2006**                                    | ** **  | **2005**                 | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2006** | ** ** |
| **Statement of Operations Data:**                     | ** ** | ** **                                  |        | ** **               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** |   |
| Revenue                                               |       | $                                           | 39,788      |                     | $          | 121,451 |   | $ | 319,780 |   | $ | 180,427 |   | $ | 496,207 |   |   | $ | 2,241,989 |   |   |
| Operating expenses                                    |       |                                        |        |                     |       |   |   |   |   |   |   |   |   |   |   |
| Research and  development(1)                          |       | 17,202,113                                  |        | 3,121,616                |       | 25,661,868 |   | 1,362,255 |   | 924,799 |   |   | 57,115,648 |   |   |
| Selling, general and  administrative                  |       | 5,457,395                                   |        | 3,237,997                |       | 1,649,953 |   | 1,198,722 |   | 668,622 |   |   | 13,092,513 |   |   |
| Loss from operations                                  |       | (22,619,720                                 | )           | (6,238,162               | )          | (26,992,041 | ) | (2,380,550 | ) | (1,097,214 | ) |   | (67,966,172 | ) |   |
| Interest income                                       |       | (1,651,916                                  | )           | (272,216                 | )          | — |   | — |   | — |   |   | (1,924,132 | ) |   |
| Interest expense                                      |       | 511,884                                     |        | 478,300                  |       | 194,877 |   | 170,938 |   | 164,337 |   |   | 2,156,187 |   |   |
| Gain on disposal(4)                                   |       | (939,052                                    | )           | —                   |       | — |   | — |   | — |   |   | (939,052 | ) |   |
| Net other (income)  expense                           |       | (2,079,084                                  | )           | 206,084                  |       | 194,877 |   | 170,938 |   | 164,337 |   |   | (706,997 | ) |   |
| Net loss                                              |       | (20,540,636                                 | )           | (6,444,246               | )          | (27,186,918 | ) | (2,551,488 | ) | (1,261,551 | ) |   | (67,259,175 | ) |   |
| Less accumulating  preferred dividends for the period |       | 175,000                                     |        | 175,000                  |       | 175,000 |   | 175,000 |   | 175,000 |   |   | 1,319,792 |   |   |
| Net loss allocable to  common shareholders            |       | $                                           | (20,715,636 | )                        | $          | (6,619,246 | ) | $ | (27,361,918 | ) | $ | (2,726,488 | ) | $ | (1,436,551 | ) |   | $ | (68,578,967 | ) |   |
| Basic and diluted loss  per common share(3)           |       | $                                           | (0.78       | )                        | $          | (0.49 | ) | $ | (13.27 | ) | $ | (1.72 | ) | $ | (0.90 | ) |   |   |   |   |
| Weighted average shares outstanding(3)                |       | 26,546,785                                  |        | 13,610,694               |       | 2,062,351 |   | 1,588,000 |   | 1,588,000 |   |   |   |   |   |

 

| ** **                                          | ** ** | **2006**    | ** ** | **2005**    | ** ** | **2004**    | ** ** | **2003**    | ** **  | **2002**    | ** ** |
|-----------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|-------------|-------------|-------------|------------|
| **Consolidated Balance Sheet Data:** |       |        |       |        |       |        |       |        |        |        |       |
| Cash, Cash  equivalents and investments             |       | $           | 27,054,947 |        | $          | 15,224,932  |       | $           | 194,555     |        | $          | 61,203 |   | $ | 18,739 |   |
| Total assets                                        |       | 30,509,679  |       | 16,021,910  |       | 1,015,932   |       | 255,127     |        | 146,917     |       |
| Long-term debt,  less current portion               |       | 3,923,810   |       | 5,905,634   |       | 2,027,279   |       | 2,000,000   |        | 2,000,000   |       |
| Total  liabilities(2)                               |       | 9,115,174   |       | 7,726,173   |       | 19,289,733  |       | 2,661,806   |        | 2,339,836   |       |
| Deficit  accumulated during development stage       |       | (67,259,175 | )          | (46,718,539 | )          | (40,274,293 | )          | (13,087,375 | )           | (10,535,887 | )          |
| Total stockholders equity  (deficit)                |       | $           | 21,394,505 |        | $          | 8,295,737   |       | $           | (18,273,801 | )           | $          | (2,406,679 | ) | $ | (2,192,919 | ) |

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(1)           Amount for 2004 includes approximately$24.5 million of in-process research and development expense related tocompounds licensed from Abbott Laboratories in December 2004. See Note 11to the consolidated financial statements.

(2)           Amount for 2004 includes $14.0 million inpayments made in 2005 under our license agreement with Abbott Laboratories executedin December 2004. See Note 11 to the consolidated financial statements. 

(3)           Amounts for 2002 through 2004 have beenrestated to give effect to a 3.97-to-1 stock split authorized inJune of 2005. See Note 1 to the consolidated financial statements.

(4)           Amount for 2006 results from sale of ALSInc.’s  50% interest in Sarawak MediChemPharmaceuticals. See Note 3 to the consolidated financial statements.

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**Item7.**                        *Management’s Discussion and Analysis of Financial Condition and Resultsof Operations.*

*You should read the following discussion of ourfinancial condition and results of operations in conjunction with ourconsolidated financial statements and the related notes included elsewhere inthis Annual Report. This discussion contains forward-looking statements thatinvolve risks and uncertainties. As a result of many factors, including thoseset forth under the section entitled “Risk Factors” and elsewhere in thisAnnual Report, our actual results may differ materially from those anticipatedin these forward-looking statements.*

**Overview**

We are a biopharmaceutical company focused on thediscovery, development and commercialization of novel drugs in the areas ofinfectious disease, oncology and inflammation. Using our internal discoverycapabilities and our network of pharmaceutical and academic partners, we haveassembled a promising pipeline of clinical and preclinical product candidates.Our most advanced product candidate, cethromycin, is a second generationketolide antibiotic in Phase III clinical development for the treatment ofrespiratory tract infections. We also have product candidates in earlier stagesof development for the treatment of indications including inflammation-relatedtissue damage and malignant melanoma.

None of our product candidates have been approved bythe FDA or any comparable foreign agencies, and we have not generated anysignificant revenues to date. Our ability to generate revenues in the futurewill depend on our ability to meet development or regulatory milestones underany license agreements that trigger payments to us, to enter into new licenseagreements for other products or territories and to receive regulatoryapprovals for, and successfully commercialize, our product candidates eitherdirectly or through commercial partners.

Since our inception, we have incurred net losses eachyear. Our net losses for the year ended December 31, 2006 was $20.5million. As of December 31, 2006, we had an accumulated deficit of$67.3 million. Our operations to date have been funded principally throughproceeds from our initial public offering, our private placement inMarch 2006, debt and capital contributions made principally by our founderand Chief Executive Officer and borrowings under our bank line of credit. Wecurrently do not have sufficient cash or other funding available to completeour anticipated business activities during 2007. As a result, there issignificant doubt about our ability to continue as a going concern.

In March 2006, we raised approximately $33.4million, net of underwriting discounts and offering expenses, in connectionwith the issuance of 10,233,464 shares of our common stock at $3.53 per share.In addition to the shares sold, we issued warrants to purchase 5,116,732 sharesof our common stock at a price of $3.81 per share.

We expect to significantly increase the rate of ourresearch and development expenditures as we accelerate our development ofcethromycin. Accordingly, our total expenses and net losses will similarlyincrease. If the clinical testing for our product candidates is delayed, wecould incur increased development costs and a delay in our ability to generaterevenues.

In December 2005, we initiated Phase III clinicaltrials for cethromycin. Our Phase III trials compare cethromycin with standardof care therapies for mild-to-moderate community acquired pneumonia (CAP) inthe United States, Canada, Europe, South America and South Africa. Thisapproach positioned us to recruit patients for our CAP studies in bothhemispheres during each respective peak CAP season. The objective is toestablish statistical non-inferiority against comparators.  Each trial will seek to demonstratestatistical non-inferiority to a comparator agent using a 95% confidenceinterval. Clinical cure rate will serve as the primary endpoint in each trialwith bacteriological eradication serving as a secondary endpoint. We expect tohave comprehensive data available by the end of the second quarter of 2007.This timeline depends on the severity of the CAP season and the successfultreatment of patients in the clinical trials 

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sites we have established.We will continue to enroll in all geographies until we have enrolled therequisite number of patients to complete our studies.

Cethromycin has also been demonstrated to havesignificant *in vitro* activity against over 30anthrax (*Bacillus anthracis*) strains. It iscurrently being tested in non-human primates to determine its efficacy in treatinginhalation anthrax post-exposure for prophylaxis.

Even if our pivotal Phase III clinical trials ofcethromycin are successfully completed, we do not expect to receive FDAapproval for commercialization until 2008 at the earliest. As ofDecember 31, 2006, we estimate that our cethromycin development programwill require an additional $60.9 million in research and development expenseswhich includes $40.0 million in additional milestone payments to Abbott, $16.0million to complete the cethromycin clinical trials, $4.9 million for thepreparation of the cethromycin NDA and other commercialization-related costsand $2.0 million to complete Anthrax studies. Our $10.0 million and $30.0million Abbott milestone payments are triggered upon submitting an NDA andreceiving FDA approval, respectively. Development timelines and related costsare difficult to estimate and may vary significantly from our currentestimates.

If cethromycin is approvedfor marketing by the FDA, we plan to sell cethromycin using a commercialpartner to access the primary care physician market and to build and utilize afocused internal sales force that will market directly to early adopters suchas, but not limited to, pulmonary medicine and infectious disease physicians.

**Results of Operations**

***Fiscal year ended December 31, 2006 compared tothe fiscal year ended December 31, 2005***

*Revenue.*   Totalrevenue decreased by $82,000 to $40,000 for the twelve months ended December 31,2006 and consisted entirely of revenue earned from small business innovativeresearch (“SBIR”) grants. The majority of this decrease, approximately $61,000,relates to the cessation of our management agreement with Flavin Ventures in2005. The remaining decrease is attributable to lower SBIR grant revenue as aresult of the completion of a phase I grant in 2006.

*Researchand development expense.*   Research anddevelopment expense increased $14.1 million to $17.2 million for the twelvemonths ended December 31, 2006. Research and development expensesprimarily consist of costs to administer our phase III clinical trials for ourlead compound cethromycin, which we administer under contracts withthird-parties. In addition, these costs include the salaries and relatedbenefits of our scientific and clinical trial management staff as well as costsrelated to the operation of our laboratory facilities. Clinical trial andrelated costs associated with the development of cethromycin totaled $16.3million for 2006, representing an increase of $14.3 million over the previousyear. We estimate that the cost to complete the trials, which includes thecosts to compile and submit the NDA to the FDA, are $30.9 million and will berecognized over 2007.  In addition to ourcethromycin clinical trials, we initiated a study of cethromycin in non-humanprimates to determine its efficacy in treating inhalation anthrax. Expendituresunder this program totaled $389,000 in 2006. We expect to incur an additional$2.0 million in 2007 to complete the study. Researchand development expenses incurred to develop our intellectual propertyportfolio, excluding development costs related to the cethromycin and anthraxprograms, totaled approximately $530,000 for the year ended December 31,2006.

*Generaland administrative expense.**  *Generaland administrative expense increased $2.2 million to $5.5 million for thetwelve months ended December 31, 2006. Incremental costs as we operated asa public company for a full year totaled $1.7 million representing an increaseof $1.1 million over the previous year. Marketing and travel expenses totaled$557,000, an increase of $487,000 over the previous year, the result of agreater presence at key industry conferences held throughout 2006. Compensationand related expenses totaled $2.5 million or an increase of $382,000 the resultof hiring additional personnel in our 

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accounting, businessdevelopment and investor relations functions. The remaining increase of$231,000 was primarily attributable to overall expenses of additional personnelhired throughout the year as well as higher patent protection costs for ourproprietary portfolio of compounds.

*Gainon sale of SMP.**  *In December 2006,we completed the sale of ALS Inc.’s 50% interest in SMP. Under the terms of thestock purchase agreement, ALS Inc. sold 900 shares of SMP common stock,representing its entire interest in SMP, to its joint venture partner, CRAUNResearch Sdn. Bhd., for $1.0 million. A gain of $940,000, net of legal costsincurred directly for the transaction, was recognized as the carrying value ofthe investment was zero.

*Interestincome.**  *Interestincome increased $1.4 million to $1.7 million for the twelve months ended December 31,2006. Interest income is derived through the investment of our IPO and privateplacement proceeds in money market funds, until they are used in operations.

*Interest expense.**  *Interest expense increased $34,000 to $512,000 forthe twelve months ended December 31, 2006. Interest expense increased dueto a 2.0% increase in the prime rate between June 2005 and April 2006as well as incremental borrowings of $915,000 on our line of credit for thesame period. In April 2006, we restructured our line of credit to a fixedrate of 6.75%, which decreased the rate on outstanding borrowings approximatelyby 1.8%. In May 2006, we paid all outstanding accumulated and capitalizedinterest to our Chief Executive Officer in connection with his $2.0 millionnote, reducing the balance upon which interest is calculated by $837,000, theamount of accumulated and capitalized interest.

***Fiscal year ended December 31, 2005 compared tothe fiscal year ended December 31, 2004***

*Revenue.*   Totalrevenue decreased by 62% to $121,000 for the twelve months ended December 31,2005 from $320,000 for the twelve months ended December 31, 2004. Revenueearned in 2005 was partly derived through our management agreement with FlavinVentures wherein we provided management and administrative services to a seriesof companies jointly owned by Flavin Ventures. The decline in revenue isattributable to a reduction in management fees earned from our management agreementwith Flavin Ventures. We were notified in December 2005 by Flavin Venturesthat these management services would no longer be needed.

Revenue derived through SBIR grants was $60,000 forthe twelve months ended December 31, 2005 compared to $38,000 for 2004. Weregularly submit grants to the National Institutes of Health and receivedapproval for a Phase I grant in August 2005.

Royalties from a related party were $0 and $10,000 forthe years ended December 31, 2005 and 2004, respectively. Royalty revenuein 2004 was derived through a license with deCODE genetics and is based upondeCODE’s sales of licensed technology.

*Researchand Development expense.**  *Totalresearch and development expense decreased 88% to approximately $3.1 millionfor the twelve months ended December 31, 2005 from approximately $25.7million for the twelve months ended December 31, 2004. The total expenserealized in 2004 of $25.7 million includes an in-process research anddevelopment charge totaling approximately $24.5 million related to the licensewith Abbott Laboratories. Excluding the Abbott expense, total research anddevelopment expenditures increased by approximately $1.9 million in 2005. Approximately$1.3 million of the costs incurred were for manufacturing of clinical suppliesand the preparation for the clinical trial of cethromycin. Approximately$408,000 of the costs incurred related to bonuses paid to our management teamand compensation expense related to stock options. The remainder of theincreases, approximately $332,000, represents additional scientific headcountcompensation costs.  A decrease ofapproximately $40,000 related to supplies, materials and other direct andindirect cost resulted from a shift in work related to our discovery portfolioto a concentration in the development of cethromycin. Of the total research anddevelopment expenses incurred during the twelve months ended December 31,2005, 

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approximately $1.9 millionwas related to our development of cethromycin. The remainder of our researchand development expenditures in 2005, totaling approximately $1.2 million, wasexpended under our other earlier-stage development programs.

*Generaland administrative expense.*   General andadministrative expense increased 96% to approximately $3.2 million for the yearended December 31, 2005 from $1.6 million for the year-ended December 31,2004. Of the approximate $1.6 million increase in administrative expense,approximately $776,000 related to bonus and stock option compensation chargespaid in connection with the completion of our IPO. In addition, we incurredincremental payroll, benefit and payroll related costs of approximately$480,000 related to professional staff hired in 2005 primarily in our financeand investor relations functions.  Theremainder of the 2005 increase, approximately $300,000, was attributable toincremental administrative and regulatory costs incurred as we operate as apublic company beginning with our August 2005 IPO.

*Interestincome.*   Interest income totaled approximately$272,000 for the twelve months ended December 31, 2005 compared to $0 forthe same period of 2004 and was derived through investments made from our IPOproceeds.

*Interest expense.**  *Interest expense increased $283,000 to $478,000 forthe twelve months ended December 31, 2005 from $195,000 for the twelvemonths ended December 31, 2004 and resulted from $1.6 million ofborrowings under our line of credit. Total borrowings under the line credit andour loan with our Chief Executive Officer were approximately $3.9 million and$2.8 million as of December 31, 2005 and 2004, respectively.

**Liquidity andCapital Resources**

We have devoted substantially all of our cashresources to research and development and general and administrative expenses.To date, we have not generated any revenues from the sale of products, and wedo not expect to generate any such revenues for a number of years, if at all.As a result, we have incurred an accumulated deficit of $67.3 million asof December 31, 2006 and we expect to incur significant and increasingoperating losses for the foreseeable future. Our working capital as of December 31,2006 amounted to $24.9 million. Cash, cash equivalents and investmentswere $27.1 million as of December 31, 2006. Since our inception in 1999 toAugust 2005, we financed our operations primarily through debt and capitalcontributions principally from our founder and Chief Executive Officer andborrowings under our bank line of credit. In August 2005 we completed ourinitial public offering in which we raised $28.7 million, net of underwritersdiscount and offering costs. In March 2006 we completed a privateplacement in which we raised $33.4 million, net of underwriters discount andoffering costs.

In September 2001, our Chief Executive Officermade a $2.0 million loan to us. The loan accrues interest at the rate of7.75%, and is due and payable on December 31, 2007.  The balance of the loan was $2.0 million as ofDecember 31, 2006.

We have a $4.0 million line of credit with a localfinancial institution. As of December 31, 2006, the line of credit had anoutstanding balance of $3.9 million bearing interest of 6.75% per annum. Interestis payable monthly, and matures on January 1, 2008. The line of credit issecured by substantially all of the assets of the Company, excluding any rightsthat we may have as result of our license agreement with Abbott Laboratoriesfor cethromycin. The line of credit is also secured by 2.5 million shares ofour common stock held by Flavin Ventures. See Note 5 to the consolidatedfinancial statements.

During the year ended December 31,2006, cash used in operating activities totaled $22.2 million. Approximately$16.6 million was used for the development of cethromycin, $793,000 forresearch activities related to our proprietary portfolio of compounds, net of$40,000 received from SBIR grant funding, and $6.4 million was used for generaloperations, with net interest income of $1.6 million offsetting the cash 

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expenditures.Cash provided by investing activities totaled $11.1 million during the yearended December 31, 2006 and related primarily to investments sold that hadreached maturity and were subsequently reinvested in cash equivalents as wellas $940,000 from the sale of our interest in SMP. Cash provided from financingactivities totaled $33.4 million during the year ended December 31,2006, due primarily to the sale of our common stock in of our privateplacement.

*ContractualObligations*

As of December 31,2006, the annual amounts of future minimum payments under debt obligations,interest, lease obligations and other long term liabilities consisting ofresearch, development and license agreements including the potential productbased milestones which could be due to Abbott, are as follows:

| ** **                     | ** ** | **Payments Due by December 31,** | ** ** | ** ** | ** ** |
|--------------------------------|------------|------------------------------------------------------|------------|------------|------------|
| ** **                     | ** ** | **2007**                                             | ** ** | **2008**   | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
| Notes payable                  |       | $                                                    | 2,000,000  |       | $          | 3,915,000 |   | $ | — |   | $ | — |   |   | $ | — |   |   |   | $ | — |   |   | $ | 5,915,000 |   |
| Interest                       |       | 424,037                                              |       | 2,842      |       | 1,633 |   | 304 |   |   | — |   |   |   | — |   |   | 428,816 |   |
| Abbott license  payments       |       | 10,000,000                                           |       | 30,000,000 |       | — |   | — |   |   | — |   |   |   | — |   |   | 40,000,000 |   |
| Cethromycin  development costs |       | 19,119,000                                           |       | 8,000      |       | — |   | — |   |   | — |   |   |   | — |   |   | 19,127,000 |   |
| Anthrax clinical  studies      |       | 1,931,000                                            |       | —     |       | — |   | — |   |   | — |   |   |   | — |   |   | 1,931,000 |   |
| ALS-357  clinical supplies     |       | 315,000                                              |       | 12,000     |       | — |   | — |   |   | — |   |   |   | — |   |   | 327,000 |   |
| Operating leases               |       | 225,878                                              |       | 154,708    |       | — |   | — |   |   | — |   |   |   | — |   |   | 380,586 |   |
| Capital leases                 |       | 19,437                                               |       | 7,258      |       | 8,468 |   | 4,350 |   |   | — |   |   |   | — |   |   | 39,513 |   |
| Total                          |       | $                                                    | 34,034,352 |       | $          | 34,099,808 |   | $ | 10,101 |   | $ | 4,654 |   |   | $ | — |   |   |   | $ | — |   |   | $ | 68,148,915 |   |

 

We will owe Abbott $10.0 million if we submit an NDAfor cethromycin and $30.0 million if and when the FDA approves the NDA, whichwe estimate will occur in 2007 and 2008, respectively. Thereafter, we would oweAbbott an additional $2.5 million upon reaching $200 million in aggregate netsales of cethromycin and $5.0 million upon reaching $400 million in aggregatenet sales. The periods in which milestone obligations become payable are onlyestimates due to uncertainties in the regulatory approval process.

Our long-term commitments under operating leases shownabove consist of payments made to a related party relating to our facilitylease in Woodridge, Illinois, which expires in September of 2008.

In the year ended December 31, 2006 we executedcontracts totaling $32.6 million related to our clinical development ofcethromycin. Of this amount, $20.0 million represents the costs we will incurto complete the Phase III pivotal clinical trials; $5.8 million relates tocardiac safety studies, clinical laboratory support for the trials, and themanufacture and analysis of clinical supplies for the trials; $4.8 million forthe manufacture of test batches of cethromycin required for the NDA, which weanticipate submitting  to the FDA in thesecond half of 2007; $1.8 million for the compilation of the cethromycin NDAwhich includes $700,000 in time and material based consulting agreements thatcould fluctuate from our estimates if the actual consulting time spentcompiling the NDA varies from our current projections; and $200,000 forpreliminary marketing and branding related activities for cethromycin. Remainingpayments due under these contracts total $19.1 million and will be madeprimarily over the next twelve months. In addition, we executed contracts totaling$2.5 million to measure the efficacy of cethromycin against inhalation anthraxin non-human primates. The majority of these payments are milestone based andthe periods in which milestone obligations become payable are only estimatesdue to uncertainties in patient enrollment. We expect to pay the remainingbalance of $1.9 million due under these contracts in 2007.

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Additionally, we executed contracts totaling $401,000in 2006 to manufacture clinical supplies related to our ALS-357 compoundwhich has shown evidence of anti-tumor activity against malignant melanoma inpreclinical studies. In the first quarter of 2007, we executed additionalcontracts totaling $709,000 for the compilation of the cethromycin NDA. Paymentsdue under these contracts are expected to be made throughout 2007.

To fund thesecontracts and our existing development commitments, indebtedness and generaloperating expenses we anticipate raising additional operating capital during2007 after data from our trials is available. Such a capital raise could beachieved by the sale of additional common stock, the receipt of milestonepayments which would be paid to us as a result of entering into a commercialpartnership for cethromycin, or a combination of both. Based upon currentmarket conditions and discussions with potential commercial partners, webelieve sufficient funds can be raised in 2007 to continue our development ofcethromycin and fund our other research and corporate expenditures through theexpected approval of our cethromycin NDA. Although we believe we can obtainsufficient financing, there can be no assurances that such financing will beavailable in the future at terms acceptable to us. We currently do not havesufficient cash or other funding available to complete our anticipated businessactivities during 2007. As a result, there is significant doubt about ourability to continue as a going concern.  

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

·                    progress inour clinical development programs, as well as the magnitude of these programs;

·                    the timing,receipt and amount of milestone and other payments, if any, from present and future collaborators;

·                    our ability toestablish and maintain additional collaborative arrangements;

·                    the resources,time and costs required to successfully initiate and complete our preclinicaland clinical trials, obtain regulatory approvals, protect our intellectualproperty and obtain and maintain licenses to third-party intellectual property;

·                    the cost of preparing, filing, prosecuting,maintaining and enforcing patent claims; and

·                    the timing, receipt and amount of sales androyalties, if any, from our potential products.

If, at any time, our prospectsfor financing our clinical development programs are limited, we may decide toreduce research and development expenses by delaying or discontinuing certainprograms.

**Off-Balance SheetArrangements**

Under the definitioncontained in Item 303 (a)(4)(ii) of Regulation S-K, we do not have anyoff-balance sheet arrangements.

**Critical AccountingPolicies and Estimates**

Our discussion andanalysis of our financial condition and results of operations are based on ourfinancial statements, which have been prepared in accordance with accountingprinciples generally accepted in the United States of America. The preparationof these financial statements requires us to make estimates and judgments that affect the reported amounts of assets,liabilities and expenses and related disclosure of contingent assets andliabilities. We review our estimates on an ongoing basis. We base our estimateson historical experience and on various other assumptions that we believe to bereasonable under the circumstances. Actual results may differ from theseestimates under different assumptions orconditions. While our significant accounting policies are described in moredetail in 

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the notes to our financial statements included inthis annual report, we believe the following accounting policies to be criticalto the judgments and estimates used in the preparation of our financialstatements.

*In-Process Researchand Development*

We recognize in-process researchand development in accordance with FASB Interpretation No. 4, *Applicability of FASB Statement No. 2 to Business CombinationsAccounted for by the Purchase Method*and the AICPA TechnicalPractice Aid, *Assets Acquired in a Business Combination tobe used in Research and Development Activities: A Focus on Software, Electronic Devices, and Pharmaceutical  Industries.*Assets to be used in research and developmentactivities, specifically, compounds that have yet to receive new drug approvalfrom the FDA and would have no alternative use should approval not be given,are immediately charged to income when acquired.

In December 2004, weincurred $24.5 million of in-process research and development expense as aresult of entering into our exclusive license with Abbott Laboratories forcethromycin. We determined to immediately expense the purchased in-processresearch and development costs because the ultimate outcome of clinical trialsfor cethromycin is unknown and, therefore, FDA approval is uncertain. As partof the consideration for the cethromycin license, we issued to Abbott shares ofour common stock. In order to determine the value of the common stock issued toAbbott, we relied on the arms-length nature of the transaction, precedentmarket data and several internal valuation models and studies. An independentappraisal was also obtained to provide additional support for the valuationmethodologies utilized. By their nature, valuations involve judgments ofmanagement that rely on estimates regarding the timing and amount of cash flowsand discount rates that, if changed, could significantly affect the conclusionsas to value.

*Research andDevelopment*

Research and developmentexpenses consist of internal research costs and fees paid for contract researchin conjunction with the research and development of our proprietary productportfolio. All such costs are expensed as incurred. Clinical trial costsincurred by third parties are expensed as the contracted work is performed. Weestimate both the total cost and time period of the trials and the percentcompleted as of that accounting date. We believe that the estimates made as of December 31,2006 are reflective of the actual expenses incurred as of that date.

*Stock-basedCompensation*

Weaccount for stock-based awards to employees and non-employees using theaccounting provisions of Statement of Financial Accounting Standards No. 123(R) *Share-based Payments* which provides for the use of the fairvalue based method to determine compensation for all arrangements where sharesof stock or equity instruments are issued for compensation. We use theBlack-Scholes options-pricing model to determine the fair value of each optiongrant as of the date of grant for expense incurred. The Black-Scholes modelrequires inputs for risk-free interest rate, dividend yield, volatility andexpected lives of the options. Since the Company has a limited history of stockactivity, expected volatility is based on historical data from several peerpublic companies with similar product portfolios to us. The risk-free rate forperiods within the contractual life of the option is based on theU.S. Treasury yield curve in effect at the time of the grant. The expectedlives for options granted represents the period of time that options grantedare expected to be outstanding and is derived from the contractual terms of theoptions granted.

**Item 7A.**                *Quantitative and Qualitative Disclosures About Market Risk.*

Our exposure to market risk is currently confined toour cash and cash equivalents. We currently do not hedge interest rateexposure. We have not used derivative financial instruments for speculation or 

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trading purposes. Becauseof the short-term maturities of our cash and cash equivalents, we do notbelieve that an increase in market rates would have any significant impact ontheir realized value.

Ourmost liquid assets are cash and cash equivalents. Because of their liquidity,these assets are not directly affected by inflation. We also believe that wehave intangible assets in the value of our intellectual property. In accordancewith generally accepted accounting principles, we have not capitalized thevalue of this intellectual property on our balance sheet. Due to the nature ofthis intellectual property, we believe that these intangible assets are notaffected by inflation. Because we intend to retain and continue to use ourequipment, furniture and fixtures and leasehold improvements, we believe thatthe incremental inflation related to replacement costs of such items will notmaterially affect our operations. However, the rate of inflation affects ourexpenses, such as those for employee compensation and contract services, whichcould increase our level of expenses and the rate at which we use ourresources.

**Item 8.**                        *Financial Statements and Supplementary Data.*

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**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directors and Stockholders ofAdvanced Life Sciences Holdings, Inc.

We have audited the accompanying consolidated balancesheets of Advanced Life Sciences Holdings, Inc. (a Delaware corporation inthe development stage) and its subsidiary (the “Company”) as of December 31,2006 and 2005, and the related consolidated statements of operations,stockholders’ equity, and cash flows for each of the three years in the periodended December 31, 2006 and for the period from January 1, 1999(inception) through December 31, 2006. These financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on the financial statements based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. The Company is not required to have, nor were we engaged toperform, an audit of its internal control over financial reporting. Our auditsincluded consideration of internal control over financial reporting as a basisfor designing audit procedures that are appropriate in the circumstances, butnot for the purpose of expressing an opinion on the effectiveness of theCompany’s internal control over financial reporting. Accordingly, we express nosuch opinion. An audit also includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements, assessingthe accounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statementspresent fairly, in all material respects, the financial position of AdvancedLife Sciences Holdings, Inc. and its subsidiary as of December 31,2006 and 2005, and the results of their operations and their cash flows foreach of the three years in the period ended December 31, 2006, and for theperiod from January 1, 1999 (inception) to December 31, 2006 inconformity with accounting principles generally accepted in the United Statesof America.

The accompanying financial statements have beenprepared assuming that the Company will continue as a going concern. As discussedin Note 1 to the financial statements, the Company does not have sufficientcash on-hand or other funding available to meet its obligations and sustain itsoperations, which raises substantial doubt about its ability to continue as agoing concern. Management’s plans in regard to these matters are also discussedin Note 1 to the financial statements. The financial statements do not includeany adjustments that might result from the outcome of this uncertainty.

As discussed in Note 1,the Company is in development stage.

*/s/ DELOITTE &TOUCHE LLP*

Chicago, IllinoisMarch 19, 2007

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**ADVANCED LIFESCIENCES HOLDINGS, INC. AND SUBSIDIARY(A Development Stage Company)**

**CONSOLIDATED BALANCE SHEETS**

| ** **                                                                                                         | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                                                                         | ** ** | **2006**              | ** ** | **2005**              | ** ** |
| ** **                                                                                                         | ** ** | ** **            | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                         | ** ** | ** **            | ** ** | ** **            | ** ** |
| CURRENT ASSETS:                                                                                                    |       |                  |       |                  |       |
| Cash and cash equivalents                                                                                          |       | $                     | 27,054,947 |                  | $          | 4,749,932 |   |
| Investments—available for  sale                                                                               |       | —                |       | 10,475,000            |       |
| Accounts receivable—related  party                                                                            |       | —                |       | 6,160                 |       |
| Prepaid insurance                                                                                                  |       | 380,083               |       | 362,241               |       |
| Management fees—related  party                                                                                |       | 2,364,512             |       | 4,500                 |       |
| Other prepaid expenses  and deposits                                                                               |       | 273,572               |       | 113,763               |       |
| Total current assets                                                                                               |       | 30,073,114            |       | 15,711,596            |       |
| PROPERTY AND EQUIPMENT:                                                                                            |       |                  |       |                  |       |
| Furniture and fixtures                                                                                             |       | 250,308               |       | 147,275               |       |
| Laboratory equipment                                                                                               |       | 142,928               |       | 142,928               |       |
| Computer software and  equipment                                                                                   |       | 231,022               |       | 187,771               |       |
| Leasehold improvements                                                                                             |       | 182,839               |       | 40,646                |       |
| Total property and  equipment—at cost                                                                         |       | 807,097               |       | 518,620               |       |
| Less accumulated  depreciation                                                                                     |       | (398,486              | )          | (267,372              | )          |
| Property and  equipment—net                                                                                   |       | 408,611               |       | 251,248               |       |
| OTHER LONG-TERM ASSETS:                                                                                            |       |                  |       |                  |       |
| Deferred financing costs                                                                                           |       | 26,502                |       | 53,004                |       |
| Other assets                                                                                                       |       | 1,452                 |       | 6,062                 |       |
| Total other long-term  assets                                                                                      |       | 27,954                |       | 59,066                |       |
| TOTAL ASSETS                                                                                                       |       | $                     | 30,509,679 |                  | $          | 16,021,910 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                      |       |                  |       |                  |       |
| CURRENT LIABILITIES:                                                                                               |       |                  |       |                  |       |
| Accounts payable                                                                                                   |       | $                     | 1,011,396  |                  | $          | 294,816 |   |
| Accrued clinical trial  expenses                                                                                   |       | 1,410,894             |       | 83,186                |       |
| Other accrued expenses                                                                                             |       | 226,881               |       | 157,575               |       |
| Accrued interest payable                                                                                           |       | 22,756                |       | 5,334                 |       |
| Short-term lease payable                                                                                           |       | 19,437                |       | 14,114                |       |
| Short-term grant payable                                                                                           |       | 476,708               |       | —                |       |
| Short-term notes payable—related  party                                                                       |       | 2,000,000             |       | —                |       |
| Total current liabilities                                                                                          |       | 5,168,072             |       | 555,025               |       |
| Long-term lease payable                                                                                            |       | 20,076                |       | 13,166                |       |
| Accrued interest payable—related  party                                                                       |       | —                |       | 765,514               |       |
| Long-term grant payable                                                                                            |       | 23,292                |       | 500,000               |       |
| Notes payable—net of  $11,266 debt discount December 31, 2006 & $22,532  December 31, 2005 |       | 3,903,734             |       | 3,892,468             |       |
| Long-term notes payable—related  party                                                                        |       | —                |       | 2,000,000             |       |
| Total liabilities                                                                                                  |       | 9,115,174             |       | 7,726,173             |       |
| COMMITMENTS AND CONTINGENCIES:                                                                                     |       |                  |       |                  |       |
| MINORITY INTEREST                                                                                                  |       | —                |       | —                |       |
| STOCKHOLDERS’ EQUITY:                                                                                         |       |                  |       |                  |       |
| Common stock, $0.01 par value—60,000,000 shares  authorized;                                                  |       |                  |       |                  |       |
| December 31, 2006 28,282,677 issued and  outstanding;  December 31, 2005                                 |       |                  |       |                  |       |
| 17,990,322 shares issued  and outstanding;                                                                         |       | 282,827               |       | 179,903               |       |
| Additional paid-in  capital                                                                                        |       | 88,370,853            |       | 54,834,373            |       |
| Deficit accumulated  during the development stage                                                                  |       | (67,259,175           | )          | (46,718,539           | )          |
| Total stockholders’  equity                                                                                   |       | 21,394,505            |       | 8,295,737             |       |
| TOTAL LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                   |       | $                     | 30,509,679 |                  | $          | 16,021,910 |   |

 

 

See notes to consolidated financial statements.

39

----

**ADVANCED LIFESCIENCES HOLDINGS, INC. AND SUBSIDIARY(A Development Stage Company)**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

| ** **                                                                  | ** ** | ** **                       | ** **  | ** **            | ** ** | ** **  | ** ** | **Period From**       | ** **  |
|-----------------------------------------------------------------------------|------------|----------------------------------|-------------|-----------------------|------------|-------------|------------|-----------------------|-------------|
| ** **                                                                  | ** ** | ** **                       | ** **  | ** **            | ** ** | ** **  | ** ** | **Inception**         | ** **  |
| ** **                                                                  | ** ** | ** **                       | ** **  | ** **            | ** ** | ** **  | ** ** | **(January 1, 1999)** | ** **  |
| ** **                                                                  | ** ** | ** **                       | ** **  | ** **            | ** ** | ** **  | ** ** | **Through**           | ** **  |
| ** **                                                                  | ** ** | **Year ended December 31,** | ** **  | **December 31,** | ** ** |
| ** **                                                                  | ** ** | **2006**                         | ** **  | **2005**              | ** ** | **2004**    | ** ** | **2006**              | ** **  |
| Revenue:                                                                    |       |                             |        |                  |       |        |       |                  |        |   |   |
| Management fees—related party                                          |       | $                                | —      |                  | $          | 61,239      |       | $                     | 271,644     |   |   | $ | 1,161,180 |   |   |
| Grants                                                                      |       | 39,788                           |        | 60,212                |       | 38,136      |       |                  | 1,035,571   |   |   |
| Royalty—related party                                                  |       | —                           |        | —                |       | 10,000      |       |                  | 45,238      |   |   |
| Total revenue                                                               |       | 39,788                           |        | 121,451               |       | 319,780     |       |                  | 2,241,989   |   |   |
| Expenses:                                                                   |       |                             |        |                  |       |        |       |                  |        |   |   |
| Research and development                                                    |       | 17,202,113                       |        | 3,121,616             |       | 25,661,868  |       |                  | 49,135,349  |   |   |
| Contracted research and development— related party                     |       | —                           |        | —                |       | —      |       |                  | 7,980,299   |   |   |
| Selling, general and administrative                                         |       | 5,457,395                        |        | 3,237,997             |       | 1,649,953   |       |                  | 13,092,513  |   |   |
| Total expenses                                                              |       | 22,659,508                       |        | 6,359,613             |       | 27,311,821  |       |                  | 70,208,161  |   |   |
| Loss from  operations                                                       |       | (22,619,720                      | )           | (6,238,162            | )          | (26,992,041 | )          |                  | (67,966,172 | ) |   |
| Other (income) expense:                                                     |       |                             |        |                  |       |        |       |                  |        |   |   |
| Interest Income                                                             |       | (1,651,916                       | )           | (272,216              | )          | —      |       |                  | (1,924,132  | ) |   |
| Interest expense                                                            |       | 511,884                          |        | 478,300               |       | 194,877     |       |                  | 2,156,187   |   |   |
| Gain on sale of  interest in Sarawak Medichem Pharmaceuticals joint venture |       | (939,052                         | )           | —                |       | —      |       |                  | (939,052    | ) |   |
| Net other  (income) expense                                                 |       | (2,079,084                       | )           | 206,084               |       | 194,877     |       |                  | (706,997    | ) |   |
| Net loss                                                                    |       | (20,540,636                      | )           | (6,444,246            | )          | (27,186,918 | )          |                  | (67,259,175 | ) |   |
| Less accumulated  preferred dividends for the period                        |       | 175,000                          |        | 175,000               |       | 175,000     |       |                  | 1,319,792   |   |   |
| Net loss allocable  to common shareholders                                  |       | $                                | (20,715,636 | )                     | $          | (6,619,246  | )          | $                     | (27,361,918 | ) |   | $ | (68,578,967 | ) |   |
| Net loss per  share available to common shareholders—basic and diluted |       | $                                | (0.78       | )                     | $          | (0.49       | )          | $                     | (13.27      | ) |   |   |   |   |
| Weighted average  shares outstanding- basic and diluted                     |       | 26,546,785                       |        | 13,610,694            |       | 2,062,351   |       |                  |        |   |   |

 

See notes to consolidated financial statements.

40

----

**ADVANCED LIFE SCIENCESHOLDINGS, INC. AND SUBSIDIARY(A Development Stage Company)**

**CONSOLIDATED STATEMENTS OFSTOCKHOLDERS’ EQUITY**FOR THE PERIOD FROMINCEPTION (JANUARY 1, 1999) THROUGH DECEMBER 31, 2006

| ** **                                                       | ** ** | ** **            | ** ** | ** **  | ** ** | ** **      | ** ** | **Deficit**         | ** ** | ** **  | ** **  |
|------------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|-----------------|------------|---------------------|------------|-------------|-------------|
| ** **                                                       | ** ** | ** **            | ** ** | ** **  | ** ** | ** **      | ** ** | **Accumulated**     | ** ** | ** **  | ** **  |
| ** **                                                       | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional**  | ** ** | **During the** | ** ** | ** **  | ** **  |
| ** **                                                       | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Development** | ** ** | ** **          | ** ** |
| ** **                                                       | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**     | ** ** | **Stage**           | ** ** | **Total**   | ** **  |
| BALANCE—January 1,  1999 (inception)                        |       | —                |       | $           | —     |            | $          | —              |       | $           | —      |   | $ | — |   |
| Issuance of stock (since  inception)                             |       | 1,588,000             |       | 250,000     |       |            |       |                |       | 250,000     |        |
| Compensation expense  related to stock options (since inception) |       |                  |       |        |       | 15,097          |       |                |       | 15,097      |        |
| Capital contributions  (since inception)                         |       | —                |       | —      |       | 10,415,599      |       | —              |       | 10,415,599  |        |
| Net loss (since  inception)                                      |       | —                |       | —      |       | —          |       | (13,087,375         | )          | (13,087,375 | )           |
| BALANCE—December 31,  2003                             |       | 1,588,000             |       | 250,000     |       | 10,430,696      |       | (13,087,375         | )          | (2,406,679  | )           |
| Issuance of common stock  at $0.157 per share                    |       | 41,685                |       | 6,563       |       | —          |       | —              |       | 6,563       |        |
| Compensation expense  related to stock options                   |       | —                |       | —      |       | 5,604           |       | —              |       | 5,604       |        |
| Exchange of shares under  recapitalization                       |       | (1,629,685            | )          | (256,563    | )          | —          |       | —              |       | (256,563    | )           |
| Issuance of shares under  recapitalization                       |       | 9,482,015             |       | 94,820      |       | 161,743         |       | —              |       | 256,563     |        |
| Capital contributions                                            |       | —                |       | —      |       | 2,295,731       |       | —              |       | 2,295,731   |        |
| Issuance of 14,887  warrants                                     |       | —                |       | —      |       | 11,898          |       | —              |       | 11,898      |        |
| Issuance of common stock  in exchange for licenses               |       | 1,122,569             |       | 11,226      |       | 8,988,774       |       | —              |       | 9,000,000   |        |
| Net loss                                                         |       | —                |       | —      |       | —          |       | (27,186,918         | )          | (27,186,918 | )           |
| BALANCE—December 31,  2004                             |       | 10,604,584            |       | 106,046     |       | 21,894,446      |       | (40,274,293         | )          | (18,273,801 | )           |
| Issuance of common stock,  net of offering costs                 |       | 6,721,814             |       | 67,218      |       | 29,210,558      |       | —              |       | 29,277,776  |        |
| Issuance of stock related  to option exercises                   |       | 63,924                |       | 639         |       | 14,240          |       | —              |       | 14,879      |        |
| Compensation expense  related to stock options                   |       | —                |       | —      |       | 696,204         |       | —              |       | 696,204     |        |
| Issuance of common stock in exchange for                         |       |                  |       |        |       |            |       |                |       |        |        |
| reduction of milestones  payable                                 |       | 600,000               |       | 6,000       |       | 3,000,000       |       | —              |       | 3,006,000   |        |
| Modification of 14,887  warrants                                 |       | —                |       | —      |       | 18,925          |       | —              |       | 18,925      |        |
| Net loss                                                         |       | —                |       | —      |       | —          |       | (6,444,246          | )          | (6,444,246  | )           |
| BALANCE—December 31,  2005                             |       | 17,990,322            |       | 179,903     |       | 54,834,373      |       | (46,718,539         | )          | 8,295,737   |        |
| Issuance of common stock,  net of offering costs                 |       | 10,233,464            |       | 102,335     |       | 33,266,653      |       | —              |       | 33,368,988  |        |
| Issuance of stock related  to option exercises                   |       | 58,891                |       | 589         |       | 8,656           |       | —              |       | 9,245       |        |
| Compensation expense  related to stock options                   |       | —                |       | —      |       | 261,171         |       | —              |       | 261,171     |        |
| Net loss                                                         |       | —                |       | —      |       | —          |       | (20,540,636         | )          | (20,540,636 | )           |
| BALANCE—December 31, 2006                              |       | 28,282,677            |       | $           | 282,827    |            | $          | 88,370,853          |       | $           | (67,259,175 | ) | $ | 21,394,505 |   |

 

See notes to consolidated financial statements.

41

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**ADVANCED LIFESCIENCES HOLDINGS, INC. AND SUBSIDIARY(A Development Stage Company)**

**CONSOLIDATED STATEMENTS OFCASH FLOWS**

| ** **                                                                         | ** ** | ** **                  | ** **  | ** **  | ** **            | ** ** | ** ** | ** ** | **Period From** | ** ** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------|-------------|-------------|-----------------------|------------|------------|------------|----------------------|------------|------------|
| ** **                                                                         | ** ** | ** **                  | ** **  | ** **  | ** **            | ** ** | ** ** | ** ** | **Inception**        | ** ** | ** ** |
| ** **                                                                         | ** ** | ** **                  | ** **  | ** **  | ** **            | ** ** | ** ** | ** ** | **(January 1,** | ** ** | ** ** |
| ** **                                                                         | ** ** | ** **                  | ** **  | ** **  | ** **            | ** ** | ** ** | ** ** | **1999)**            | ** ** | ** ** |
| ** **                                                                         | ** ** | ** **                  | ** **  | ** **  | ** **            | ** ** | ** ** | ** ** | **Through**          | ** ** | ** ** |
| ** **                                                                         | ** ** | **Year Ended December 31,** | ** **  | ** **  | **December 31,** | ** ** | ** ** |
| ** **                                                                         | ** ** | **2006**                    | ** **  | **2005**    | ** **            | **2004**   | ** ** | ** ** | **2006**             | ** ** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                             |       |                        |        |        |                  |       |       |       |                 |       |       |
| Net loss                                                                           |       | $                           | (20,540,636 | )           | $                     | (6,444,246 | )          | $          | (27,186,918          | )          |       | $ | (67,259,175 | ) |   |
| Adjustments to reconcile net loss to net cash flows  used in operating activities: |       |                        |        |        |                  |       |       |       |                 |       |       |
| Depreciation and  amortization                                                     |       | 131,114                     |        | 86,565      |                  | 68,334     |       |       | 416,019              |       |       |
| Non-cash interest expense                                                          |       | 37,768                      |        | 25,155      |                  | 132        |       |       | 63,055               |       |       |
| Stock compensation  expense                                                        |       | 261,171                     |        | 696,204     |                  | 5,604      |       |       | 978,076              |       |       |
| Non-cash research and  development                                                 |       | —                      |        | —      |                  | 24,466,667 |       |       | 24,466,667           |       |       |
| Non-cash settlement of  milestone payment                                          |       | —                      |        | 6,000       |                  | —     |       |       | 6,000                |       |       |
| Gain on sale of interest  in Sarawak Medichem Pharmaceuticals (SMP)                |       | (939,052                    | )           | —      |                  | —     |       |       | (939,052             | )          |       |
| Loss on disposal                                                                   |       | —                      |        | —      |                  | —     |       |       | 11,533               |       |       |
| Changes in operating assets and liabilities:                                       |       |                        |        |        |                  |       |       |       |                 |       |       |
| Clinical supplies                                                                  |       | —                      |        | 533,333     |                  | —     |       |       | 533,333              |       |       |
| Accounts receivable,  related party                                                |       | 6,160                       |        | 18,708      |                  | (24,868    | )          |       | —               |       |       |
| Prepaid expenses                                                                   |       | (2,537,663                  | )           | (454,698    | )                     | 4,027      |       |       | (3,018,167           | )          |       |
| Other assets                                                                       |       | 4,610                       |        | (4,610      | )                     | 5,602      |       |       | (1,452               | )          |       |
| Accounts payable                                                                   |       | 745,823                     |        | 9,693       |                  | 45,309     |       |       | 1,011,396            |       |       |
| Accrued expenses                                                                   |       | 1,397,014                   |        | 55,413      |                  | 111,797    |       |       | 1,637,775            |       |       |
| Licenses payable                                                                   |       | —                      |        | (11,000,000 | )                     | —     |       |       | (11,000,000          | )          |       |
| Accrued interest on debt                                                           |       | (748,092                    | )           | 199,926     |                  | 193,239    |       |       | 600,819              |       |       |
| Net cash flows from  operating activities                                          |       | (22,181,783                 | )           | (16,272,557 | )                     | (2,311,075 | )          |       | (52,493,173          | )          |       |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                              |       |                        |        |        |                  |       |       |       |                 |       |       |
| Purchase of property and  equipment                                                |       | (288,027                    | )           | (87,652     | )                     | (90,777    | )          |       | (671,912             | )          |       |
| Proceeds from the sale of  SMP                                                     |       | 939,052                     |        | —      |                  | —     |       |       | 939,052              |       |       |
| Proceeds from the sales  of investments                                            |       | 14,807,158                  |        | 16,750,000  |                  | —     |       |       | 31,557,158           |       |       |
| Purchase of investments                                                            |       | (4,332,158                  | )           | (27,225,000 | )                     | —     |       |       | (31,557,158          | )          |       |
| Net cash flows from  investing activities                                          |       | 11,126,025                  |        | (10,562,652 | )                     | (90,777    | )          |       | 267,140              |       |       |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                              |       |                        |        |        |                  |       |       |       |                 |       |       |
| Proceeds  from issuance of common stock and capital contributions                  |       | 33,368,988                  |        | 29,277,776  |                  | 2,295,731  |       |       | 69,856,339           |       |       |
| Proceeds from issuance of  notes payable                                           |       | 3,915,000                   |        | 1,610,000   |                  | 235,000    |       |       | 12,933,691           |       |       |
| Payments on notes payable                                                          |       | (3,915,000                  | )           | —      |                  | —     |       |       | (3,915,000           | )          |       |
| Proceeds from grants                                                               |       | —                      |        | 500,000     |                  | —     |       |       | 500,000              |       |       |
| Proceeds from stock  options exercised                                             |       | 9,245                       |        | 14,879      |                  | 6,563      |       |       | 30,687               |       |       |
| Payments on capital  leases                                                        |       | (17,460                     | )           | (12,069     | )                     | (2,090     | )          |       | (124,737             | )          |       |
| Net cash flows from  financing activities                                          |       | 33,360,773                  |        | 31,390,586  |                  | 2,535,204  |       |       | 79,280,980           |       |       |
| NET INCREASE IN CASH                                                               |       | 22,305,015                  |        | 4,555,377   |                  | 133,352    |       |       | 27,054,947           |       |       |
| CASH—Beginning of year/period                                                 |       | 4,749,932                   |        | 194,555     |                  | 61,203     |       |       | —               |       |       |
| CASH—End of year/period                                                       |       | $                           | 27,054,947  |        | $                     | 4,749,932  |       | $          | 194,555              |       |       | $ | 27,054,947 |   |   |
| SUPPLEMENTAL DISCLOSURE OF  CASHFLOW INFORMATION:                                  |       |                        |        |        |                  |       |       |       |                 |       |       |
| Cash paid during the  period for interest                                          |       | $                           | 1,232,651   |        | $                     | 247,341    |       | $          | 1,511                |       |       | $ | 1,496,223 |   |   |
| SUPPLEMENTAL DISCLOSURE OF NONCASH TRANSACTIONS                                    |       |                        |        |        |                  |       |       |       |                 |       |       |
| Noncash investment  activity:                                                      |       |                        |        |        |                  |       |       |       |                 |       |       |
| Purchase of property and  equipment under capital leases                           |       | $                           | 29,693      |        | $                     | —     |       | $          | 41,438               |       |       | $ | 164,249 |   |   |
| Capital expenses included  in accounts payable                                     |       | —                      |        | 29,243      |                  |       |       |       | —               |       |       |
| Noncash financing  activity:                                                       |       |                        |        |        |                  |       |       |       |                 |       |       |
| Issuance of common shares  for licenses                                            |       | —                      |        | —      |                  | 9,000,000  |       |       | 9,000,000            |       |       |
| Issuance of common shares  for reduction of milestone payment                      |       | —                      |        | 3,000,000   |                  |       |       |       | 3,000,000            |       |       |
| Debt discount                                                                      |       | —                      |        | 18,925      |                  | 11,898     |       |       | 30,823               |       |       |
| Deferred financing costs                                                           |       | $                           | —      |        | $                     | 15,000     |       | $          | 15,000               |       |       | $ | 30,000 |   |   |

 

See notes to consolidated financial statements.

42

----

**ADVANCED LIFESCIENCES HOLDINGS, INC. AND SUBSIDIARY (A Development Stage Company)**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTSYEARS ENDED DECEMBER 31, 2006, 2005 AND 2004 AND FOR THE PERIOD FROMINCEPTION  (JANUARY 1, 1999) THROUGHDECEMBER 31, 2006**

**1.   Nature ofBusiness**

In January 1999, MediChem Life Sciences, Inc.(“MediChem”) contributed all of the net assets of its proprietary drugdevelopment business, including MediChem’s 50% interest in Sarawak MediChemPharmaceuticals, Inc. (“SMP”) to a wholly- owned subsidiary, Advanced LifeSciences, Inc. (“ALS Inc.”) in exchange for 1,588,000 shares of commonstock.

In June 1999, MediChem exchanged its investmentin 100% of the outstanding common stock of ALS Inc. for nonvotingpreferred stock issued by ALS Inc. effecting a spin-off of ALS Inc. Prior tothe spin-off, Dr. Michael Flavin, the sole stockholder, owned 100% ofMediChem and ALS Inc., then a wholly-owned subsidiary of MediChem. As a resultof the spin-off, Dr. Flavin became the sole common stockholder of ALS Inc.MediChem holds 100% of the preferred stock of ALS Inc., which was issued inexchange for common stock held at the June 1999 spin-off.

In August 2001, ALS Inc. formed a generalpartnership, Advanced Life Sciences General Partnership (“ALS GP”), with Dr. Flavin,ALS Inc.’s chief executive officer. ALS Inc. contributed all of its assets andliabilities to ALS GP, with the exception of debt due to Dr. Flavin. In2002, Dr. Flavin transferred his interest in ALS GP to Flavin Ventures,LLC (“Flavin Ventures”), which he controls. Flavin Ventures is not included inthe consolidated financial statements of Advanced Life Sciences Holdings, Inc.(“the Company”).

In December 2004, ALS Inc. executed a plan ofreorganization. The Company was formed as a Delaware corporation with Dr. Flavinas its chief executive officer. Common shareholders of ALS, Inc. exchangedtheir 1,629,685 common shares for 1,629,685 shares of common stock of theCompany. Under the terms of the reorganization, Flavin Ventures exchanged its 40%ownership of ALS GP for 7,852,330 shares of the Company’s common stock. Afterthe exchange was completed, ALS GP was dissolved and its assets and liabilitieswere assumed by ALS Inc. ALS Ventures, LLC (“ALS Ventures”), a Delaware limitedliability company was formed pursuant to the plan of reorganization. After itsformation, Dr. Flavin and Flavin Ventures simultaneously contributed allof their common shares, 1,588,000 and 7,852,330, respectively, to ALS Ventures.

In April 2005, we filed a registration statementwith the Securities and Exchange Commission (“the SEC”) covering the proposedsale by the Company of its common stock to the public. In June 2005, theBoard approved the amendment and restatement of the Company’s Articles ofIncorporation to provide for an increase in the number of authorized shares ofcommon stock and preferred stock to 60,000,000 shares and 5,000,000 shares,respectively, and a 3.97-for-1 stock split of the Company’s commonstock. All references in the consolidated financial statements to shares ofcommon stock, common stock options, common stock prices and per share of commonstock amounts have been adjusted retroactively for all periods presented toreflect this stock split. In August 2005, the Company completed theinitial public offering of its common stock in which the Company sold 6,400,000shares of common stock to the public at $5.00 per share, resulting in grossproceeds of $32.0 million. The Company also completed a concurrent offering of600,000 shares to an existing stockholder in exchange for a $3.0 millionreduction of a milestone payment obligation under its license agreement withthe stockholder. In September 2005, the Company’s underwriters exercisedtheir option to purchase 100,000 shares to cover over-allotments resulting inadditional gross proceeds of $500,000. In connection with these offerings, theCompany paid approximately 

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$2.3 million inunderwriting discounts and incurred other offering expenses of approximately$1.5 million. The net cash proceeds from the offerings were approximately$28.7 million.

In March 2006, the Company raised approximately$33.4 million, net of underwriting discounts and offering expenses, inconnection with the issuance of 10,233,464 shares of its common stock at aprice of $3.53 per share and warrants to purchase an additional 5,116,732shares of its common stock at an exercise price of $3.81 per share.

In December 2006, the Company completed the saleof ALS Inc.’s 50% equity interest in SMP to the State Government of Sarawak,Malaysia (“Sarawak Government”), through Craun Sdn. Bhd. (“CRAUN”) for $1.0million. Upon the closing of the Stock Purchase Agreement, the SarawakGovernment became the sole owner of SMP and its HIV-therapeutic candidate,Calanolide A. The net cash proceeds from the sale were approximately $940,000. Inconnection with the sale, the Company made customary representations andwarranties and provided indemnification for losses not to exceed the purchaseprice of $1 million. The parties mutually agree to waive any future legalclaims otherwise arising out of the SMP joint venture.

The Company’s principal business activity is toconduct new drug research and development in the fields of infectious disease,oncology and inflammation. Since inception, the Company has devotedsubstantially all of its efforts to activities such as financial planning,capital raising and product development, and has not derived significantrevenues from its primary business activity. Accordingly, the Company is in thedevelopment stage, as defined by Statement of Financial Accounting Standards (“SFAS”)No. 7, *Accounting and Reporting byDevelopment Stage Enterprises*.

The consolidated financial statements have beenprepared on a going concern basis, which contemplates continuity of operationsand the realization of assets and liquidation of liabilities in the ordinarycourse of business. However, as a result of the Company’s continued losses andcurrent cash and financing position, such realization of assets or liquidationof liabilities, without substantial adjustments is uncertain. Given thisuncertainty, there is significant doubt as to the Company’s ability to continueas a going concern.

***Business and CreditRisks—***The Company is subject to risks anduncertainties common to drug discovery companies, including technologicalchange, potential infringement on intellectual property of third parties, newproduct development, regulatory approval and market acceptance of its products,activities of competitors and its limited operating history.

The Company has incurredlosses since its incorporation in January 1999, and, prior to itsincorporation, its business activities as a segment of MediChem incurred losses.The Company has funded its operations to date primarily from debt financingsand capital contributions from its founder and Chief Executive Officer,proceeds of the IPO and the subsequent private placement. The Company will notbe generating revenues or realizing cash flows from operations in the nearterm, and will require additional equity or debt financing to meet workingcapital needs, to fund operating losses associated with research anddevelopment and to fund clinical trials. In order to address its workingcapital shortfall the Company intends to raise additional capital during 2007through the issuance of equity securities or the receipt of milestone paymentswhich would be paid as a result of a consummating a commercial partnership forcethromycin, or a combination of both.  Although management believes the Company couldobtain such financing, there can be no assurances that such financing will beavailable in the future at terms acceptable to the Company, if at all. To theextent the Company raises additional capital by issuing equity securities; ourstockholders could experience substantial dilution. The accompanying financialstatements do not include any adjustments that might result from the outcome ofthese uncertainties.

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**2.   Summary ofSignificant Accounting Policies**

***Basis ofPresentation—***The consolidated financial statementsinclude the accounts of the Company and its subsidiary ALS Inc. All significantintercompany balances and transactions have been eliminated.

***Cash and CashEquivalents—***The Company considers all highlyliquid investments with original maturities of three months or less whenpurchased to be cash equivalents.

***Investments—***TheCompany has, at times, invested in marketable debt securities which wereclassified as available-for-sale, the fair value of which was determined usingcurrently available market prices. The Company reviews the carrying value ofinvestments each quarter to determine whether an other than temporary declinein market value exists. If such a decline is deemed to have occurred, theinvestment is written-down with a charge to other (income) expense, net.  Available-for-sale securities are carried atfair value, with the unrealized gains and losses, net of tax, reported as acomponent of stockholders’ equity in accumulated other comprehensive loss.  Marketable securities available for currentoperations are classified in the balance sheet as current assets; marketablesecurities held for long-term purposes are classified as noncurrent assets.Interest income and realized gains and losses on securities are included in “Interestincome” in the statements of operations.  As of December 31, 2006, the Company hadno marketable securities and therefore no unrealized holding gains or losseswere recognized in the statements of operations and stockholders equity.

***Property andEquipment—***Propertyand equipment are recorded at cost and depreciated using the straight-linemethod over the estimated useful life of three to five years. Assets undercapital leases were recorded at the present value of the minimum lease paymentsand are amortized over the shorter of their estimated useful lives or the termof the respective leases using the straight-line method. Maintenance and repaircosts are expensed as incurred. Fixed assets capitalized under capital leasesamounted to $71,000 and $41,000 as of December 31, 2006 and 2005, net ofaccumulated depreciation of $34,000 and $16,000, as of December 31, 2006and 2005, respectively.

***Use of Estimates—***Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements. Estimates also affect the reported amounts ofrevenues and expenses during the reporting period. Actual results could differfrom those estimates.

***Fair ValueMeasurements—***In September 2006, the FASBissued SFAS No. 157, *Fair Value Measurements*(“FAS 157”). FAS 157 provides a definition of fair value, establishesacceptable methods of measuring fair value and expands disclosures for fairvalue measurements. The principles apply under accounting pronouncements whichrequire measurement of fair value. The Company does not expect the adoption ofFAS 157 to have a material impact on its financial statements.

In February 2007, the FASB issued FAS No. 159,*The Fair Value Option for Financial Assetsand Financial Liabilities*(“FAS 159”). FAS 159 permits an entity toirrevocably elect fair value on a contract-by-contract basis as the initial andsubsequent measurement attribute for many financial assets and liabilities andcertain other items including insurance contracts. Entities electing the fairvalue option would be required to recognize changes in fair value in earningsand to expense upfront cost and fees associated with the item for which thefair value option is elected. FAS 159 is effective for fiscal years beginningafter November 15, 2007. Early adoption is permitted as of the beginningof a fiscal year that begins on or before November 15, 2007, provided theentity also elects to apply the provisions of FAS No. 157, *Fair Value Measurements.*The Company doesnot expect the adoption of FAS 159 to have a material impact on its financialstatements.

***Research andDevelopment Expenses—***Research and developmentexpenses consist of internal research costs and fees paid for contract researchin conjunction with the research and development of the 

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Company’s proprietaryproduct portfolio. All such costs are expensed as incurred including in-processresearch and development. Clinical trial costs incurred by third parties areexpensed as the contracted work is performed. The Company estimates both thetotal cost and time period of the trials and the percent completed as of thataccounting date.  Research anddevelopment expenses resulting from contracts that require payments based uponthe progress towards completion of certain milestones are estimated based uponthe percentage of completion method. The Company believes that the estimatesmade as of December 31, 2006 are reflective of the actual expensesincurred as of that date.

The company recognizes in-process research anddevelopment in accordance with FASB Interpretation No. 4, *Applicability of FASB Statement No. 2 to Business CombinationsAccounted for by the Purchase Method*and the AICPA TechnicalPractice Aid, *Assets Acquired in a Business Combination tobe used in Research and Development activities: A Focus on Software, ElectronicDevices, and Pharmaceutical Industries.*Assets to be used inresearch and development activities, specifically, compounds that have yet toreceive new drug approval from the FDA and would have no alternative use shouldapproval not be given, are immediately charged to expense when acquired.

***Clinical Supplies—***Clinicalsupplies consist of clinical trial raw material purchased from AbbottLaboratories which were valued at the lower of cost or market. Such supplieswere expensed to research and development expense as they were manufacturedinto tablets for use in clinical trials.

***Revenue Recognition—***SmallBusiness Innovation Research grant revenue is recorded as expenses are incurredand services performed in accordance with the terms of the grant agreements. Royaltyrevenue is earned from a license of the Company’s chemical process technology. Underthe license, revenue is earned based upon a percentage of reported net salesfrom a subsidiary of deCODE, for services that incorporate the licensedtechnology (see Note 4). Revenue earned through our management agreement withFlavin Ventures is recorded as expenses are incurred and services performed.

***Fair Value ofFinancial Instruments—***The carrying amount of theCompany’s financial instruments, which include cash equivalents, investments,accounts payable and long-term obligations, approximate their fair values.

***Income Taxes—***Deferredtax assets and liabilities are recognized for the future tax consequencesattributable to differences between the financial statement carrying amounts ofexisting assets and liabilities and their respective tax bases. Deferred taxassets and liabilities are measured using enacted tax rates expected to applyto taxable income in the years in which those temporary differences areexpected to be recovered or settled. The effect on the deferred tax assets andliabilities of a change in tax rates is recognized in income in the period thatincludes the enactment date. The Company has determined that the deferred taxasset does not meet the “more likely than not” criteria under SFAS No. 109,*Accounting for Income Taxes,* and,accordingly, a valuation allowance has been recorded to reduce the net deferredtax asset to zero.

***Milestone andIntellectual Property Costs—***Milestone andintellectual property costs consist of milestone payments made for agreed-uponachievements in the course of development of the compounds the Company licenses.Milestone payments are expensed when the milestone is achieved.

***Stock-BasedCompensation—***Stock-based compensation cost ismeasured based on the grant-date fair value of the equity or liabilityinstruments issued. Compensation expense is recognized over the period that anemployee provides service in exchange for the award.

Effective December 2004, the Company adopted SFASNo. 123(R) *Share-Based Payment.*Asprescribed in SFAS No. 123(R) theCompany elected to use the ‘‘prospective method’’, which requiresstock-based compensation expense to be recognized for all awards granted,modified or settled in the year of adoption. In accordance with accountingstandards then in effect, no compensation had been recognized 

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for stock options issuedto employees prior to 2004. The Company utilizes the Black-Scholes optionpricing model to estimate the fair value of options.

***Disclosure About Segments of an Enterprise—***Operatingsegments are identified as components of an enterprise about which separatediscrete financial information is available for evaluation by the chiefoperating decision-maker, or decision-making group, in making decisionsregarding resource allocation and assessing performance. To date, the Companyhas viewed its operations and manages its business as principally one segment.

**3.   JointVenture**

Sarawak MediChem Pharmaceuticals, which was formed in1996, was a joint venture between the Sarawak Government and the Company. TheSarawak Government, through CRAUN, and ALS Inc. each maintained a 50% share inSMP.

In October 2006, the Company and the SarawakGovernment entered into a Stock Purchase Agreement, pursuant to which theSarawak Government, through CRAUN, agreed to purchase ALS Inc.’s 50% equityinterest in SMP, in exchange for a $1.0 million cash payment to ALS Inc. Theparties made certain representations and warranties in the Stock PurchaseAgreement and mutually agreed to waive any future legal claims otherwisearising out of the SMP joint venture. The Company provided indemnificationunder the Stock Purchase Agreement for losses not to exceed the purchase priceof $1.0 million. In connection with this transaction, ALS Inc. and the SarawakGovernment agreed to terminate the joint venture agreement, which released theCompany and ALS Inc. from any future obligations to SMP. As a result of the transaction,the Company no longer has any interest in SMP’s HIV-therapeutic candidate,Calanolide A.

The Company accounted forits investment in SMP under the modified equity method of accounting, whichprovides that the Company record its proportional share of earnings once theaccumulated deficit incurred by SMP has been recovered. At the time of theclosing of the Stock Purchase Agreement in December 2006, SMP had notrecovered its accumulated deficit and accordingly, the Company’s investment inSMP had a carrying value of zero, therefore a gain equal to the purchase priceless transaction costs, or approximately $940,000, was recognized.

**4.   RelatedParty Transactions**

In March 2002, the existing license agreementsbetween the Company and MediChem were renegotiated at the time of MediChem’smerger with deCODE Genetics (“deCODE”). All of the terms and obligations underthe previous licenses were terminated, and a new agreement was formed betweenthe Company and deCODE/MediChem. Under the new agreement, the Company assignedand relinquished all of its rights, title and interest in certain patentedtechnologies in exchange for a 50% royalty on any and all income received bydeCODE/MediChem resulting from the licensing, cross licensing or sale to athird party of the patented technologies. In 2006, 2005 and 2004, the Companyreceived $0, $0 and $10,000, respectively, in royalty payments relating tothese technologies. With the exception of the master laboratory servicesagreement, all other agreements between the Company and MediChem wereterminated at the time of MediChem’s merger with deCODE. deCODE also providesanalytical services to the Company on an as needed basis. Such services totaledapproximately $6,000, $10,000 and $6,000 for the years ended December 31,2006, 2005 and 2004, respectively.

In January 2004, the Company initiated amanagement services agreement with Flavin Ventures whereby the Company providesadministrative management services to Flavin Ventures and its subsidiariesShamrock Structures, BioStart Property Group and Molecular Formulations. Theagreement also requires Flavin Ventures and its related subsidiaries toreimburse the Company for rent and related facility costs based upon the actualsquare footage occupied by each of the companies. Fee income recognized related

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to this agreement for theyear ended December 31, 2006, 2005 and 2004 totaled approximately $0,$61,000 and $272,000, respectively. In December 2005, the Company wasnotified that the management services provided under this agreement would nolonger be required.

The Company’s Chief Executive Officer, Michael T.Flavin, loaned $2.0 million to the Company in 2001 (see Note 5). Interestexpense of $175,000, $199,000 and $185,000 was recorded related to the note,for the twelve months ended December 31, 2006, 2005 and 2004,respectively.

The Company’s line of credit is secured bysubstantially all of the Company’s assets, except that the collateralspecifically excludes any rights that the Company may have a result of itslicense agreement with Abbott Laboratories for cethromycin, and is furthersecured by 2.5 million shares of the Company’s common stock held by ALSVentures, LLC (see Note 5).

The Company leasesfacilities from the BioStart Property Group (“BioStart”), a subsidiary ofFlavin Ventures. Lease payments totaled approximately $263,000, $286,000 and$243,000 for the years ended December 31, 2006, 2005 and 2004,respectively (see Note 10). In April 2006, the Company amended its leaseagreement with BioStart. Under the terms of the amendment, the Company mayreduce its required rental and common area maintenance payments to BioStart tooffset for any shared expenses between the Company and other tenants in thebuilding. In 2006, such rental and common area maintenance reductions totaled$9,700 and $9,100, respectively.

**5.   Long TermObligations**

In September 2001, the Company entered into a$2.0 million promissory note with the Chief Executive Officer of the Companywhich bears interest at 7.75%. Accrued but unpaid interest is added to theoutstanding principal annually. Principal plus accrued interest is due in alump sum on December 31, 2007.    InMay 2006, the Company’s Board of Directors authorized the payment ofaccumulated interest on the loan with the Chief Executive Officer, totaling$837,000. The authorization also provides for monthly payments of accumulatedinterest until the loan matures on December 31, 2007. As of December 31,2006 and 2005, the Company had $2.0 million and $2.8 million includingaccrued interest, respectively, outstanding under the note.

The Company had a $4.0 million line of credit with afinancial institution. Interest under the line was payable monthly, and maturedon December 31, 2007. In connection with the line of credit, the financialinstitution received a warrant entitling it to purchase 14,887 shares of theCompany’s common stock at an exercise price of $5.00 per share, subject tocertain adjustments.  The warrant isimmediately exercisable and will terminate, if not exercised, on December 21,2009. At the time of issue the warrant was valued, using the Black-Scholesoption pricing model, at $11,900. The amount was recorded as a discount to therelated debt and is being amortized to interest expense over the term of thedebt. As a result of a decrease in exercise price under the terms of thewarrant in connection with the Company’s initial public offering, the warrantwas revalued at $27,000. The difference between the carrying value and fairvalue was recorded as a discount to long-term obligations and is beingamortized to interest expense over the remaining term of the line of credit.

In April 2006, theCompany restructured its $4.0 million line of credit. The new line of creditprovides for a fixed interest rate of 6.75% per annum and a maturity date of January 1,2008. The line of credit is secured by substantially all of the Company’sassets, except that the collateral specifically excludes any rights that theCompany may have as a result of its license agreement with Abbott Laboratoriesfor cethromycin, and is further secured by 2.5 million shares of the Company’scommon stock held by ALS Ventures, LLC. The new line of credit alsoprovides for, among other things, the release of guarantees by Flavin Ventures,LLC, Dr. Michael Flavin and his wife, and John L. Flavin. As of December 31,2006 and 2005, the Company had $3.9 million and $3.9 million, respectively,outstanding under the note.

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**6.   Stockholders’Equity**

***Authorized Capital—***As of December 31,2006, the authorized capital stock of the Company consists of 60,000,000 sharesof voting common stock authorized for issuance with a par value of $0.01 and5,000,000 shares of undesignated preferred stock which may be issued from timeto time in one or more series  TheCompany has not issued any preferred stock as of December 31, 2006.

**7.   MinorityInterest**

The Series A preferred stock (“Series APreferred Stock”) of the Company’s subsidiary, ALS, Inc., is held by deCODE Genetics (“deCODE”) as aresult of ALS Inc.’s spin-off from MediChem Life Sciences in January 1999,and MediChem’s subsequent acquisition by deCODE Genetics in March 2002. deCODEprovides analytical services to the Company on an as needed basis.

As of December 31, 2006, ALS Inc. had 250,000shares of Series A Cumulative Preferred Stock authorized, issued andoutstanding to deCODE. The Series A Preferred Stock is nonvoting except asto certain matters including the issuance of any class of stock ranking priorto the shares of Series A Preferred Stock, or the merger or consolidationof ALS Inc. if such merger would adversely affect the powers, preferences orrights of the Series A Preferred Stock. The Series A Preferredstockholder is entitled to receive dividends payable in cash at the rate of7.0% per annum per share on the amount of liquidation preference of the shares.

***LiquidationPreferences—***Upon dissolution or winding up of ALSInc., whether voluntary or involuntary, the holders of the shares of the Series APreferred Stock are entitled to receive a liquidation preference of $10 pershare, plus all accrued and unpaid dividends.

The total liquidationpreference values as of December 31, 2006 and 2005 are approximately $3.8 millionand $3.6 million respectively, including approximately $1.3 million and $1.1million of unpaid dividends.

**8.   IncentiveStock Plan**

In December 1999, our board of directors andstockholders adopted and approved the Company’s Incentive Compensation Plan(the “Plan”). The Plan provides for the grant of stock options and the award ofrestricted stock to selected officers and consultants of the Company. Optionsexpire 10 years from the date of grant. The Plan provides for graduated vestingwhereby options to purchase 1/36th ofthe shares granted vest at the end of each month following the date of grant.Awards of restricted stock are subject to certain terms, conditions,restrictions and limitations as determined by the board of directors. The 1999plan concluded in 2005 when the final options authorized under the plan wereissued.

In April 2005, our board of directors adopted the2005 Stock Incentive Plan. The 2005 Stock Incentive Plan permits awards ofnon-qualified stock options, incentive stock options, stock appreciationrights, restricted stock, restricted stock units and performance shares. Inaddition, the plan provides an opportunity for the deferral of salary andbonuses into restricted stock units and the deferrals of gains or payments dueupon the vesting or exercise of awards under our stock incentive plan. As ofDecember 31, 2006, only non-qualified stock options had been issued underthis plan.

The maximum number of shares of common stock that maybe subject to awards under our incentive plans is 2,786,107. Options grantedunder the 2005 Stock Incentive Plan vest at the discretion of the board ofdirectors and expire 10 years from the date of grant. The vesting term of theoptions granted in 2006 ranged from immediate vesting to 3 years.

The compensation cost that has been charged againstincome for the Company’s Plans was approximately $261,000, $700,000 and $6,000for 2006, 2005 and 2004, respectively.

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Thefollowing schedule details the grants under the Company’s plan for the yearsended December 31, 2006, 2005 and 2004:

| ** **                                           | ** ** | ** ** | ** ** | **Weighted** | ** ** | **Weighted**  | ** ** | ** **    | ** ** |
|------------------------------------------------------|------------|------------|------------|--------------|------------|---------------|------------|---------------|------------|
| ** **                                           | ** ** | ** ** | ** ** | **Average**  | ** ** | **Average**   | ** ** | **Aggregate** | ** ** |
| ** **                                           | ** ** | ** ** | ** ** | **Exercise** | ** ** | **Remaining** | ** ** | **Intrinsic** | ** ** |
| **Options**                                          | ** ** | ** ** | ** ** | **Shares**   | ** ** | **Price**     | ** ** | **Term**      | ** ** | **Value** | ** ** |
| Outstanding at  January 1, 2004                 |       | 554,300    |       |         |       |          |       |          |       |   |   |   |   |
| Granted                                              |       | 110,366    |       |         | $          | 0.16          |       |          |       |   |   |   |   |   |
| Exercised                                            |       | (41,685    | )          |         | $          | 0.16          |       |          |       |   |   |   |   |   |
| Forfeited                                            |       | (3,033     | )          |         | $          | 0.16          |       |          |       |   |   |   |   |   |
| Outstanding at December 31, 2004                |       | 619,948    |       |         | $          | 0.16          |       |          |       | 6.7 |   |   | $ | 4,873,183 |   |
| Granted                                              |       | 379,810    |       |         | $          | 5.23          |       |          |       |   |   |   |   |   |
| Exercised                                            |       | (63,924    | )          |         | $          | 1.78          |       |          |       |   |   |   |   |   |
| Forfeited                                            |       | —     |       |         |       |          |       |          |       |   |   |   |   |
| Outstanding at December 31, 2005                |       | 935,834    |       |         | $          | 4.94          |       |          |       | 7.3 |   |   | $ | 1,998,525 |   |
| Granted                                              |       | 301,618    |       |         | $          | 3.36          |       |          |       |   |   |   |   |   |
| Exercised                                            |       | (58,894    | )          |         | $          | 0.16          |       |          |       |   |   |   |   |   |
| Forfeited                                            |       | (16,098    | )          |         | $          | 7.34          |       |          |       |   |   |   |   |   |
| Outstanding at December 31, 2006                |       | 1,162,460  |       |         | $          | 2.36          |       |          |       | 7.2 |   |   | $ | 422,192 |   |
| Vested or expected to vest at December 31, 2016 |       | 1,138,217  |       |         |       |          |       |          |       |   |   |   |   |
| Options  exercisable at December 31, 2006       |       | 830,935    |       |         | $          | 1.98          |       |          |       | 6.4 |   |   | $ | 611,520 |   |
|                                                      |            |            |            |              |            |               |            |               |            |  |  |  |  |  |  |  |  |

 

The weighted-average grant-date fair value of optionsgranted during the years 2006, 2005 and 2004 was approximately $398,000,$314,000 and $30,000, respectively. The total intrinsic value of optionsexercised during the years ended December 31, 2006, 2005 and 2004 wasapproximately $174,000, $336,000 and $60,000, respectively.

As of December 31, 2006, there was approximately$667,000 of total unrecognized compensation cost related to unvested stockoptions granted under the Plans; that cost is expected to be recognized over aperiod of 3 years.

Cash received from options exercises under the Plansfor the years ended December 31, 2006, 2005 and 2004 was approximately$9,000, $15,000 and $7,000, respectively. The Company issues new shares ofcommon stock as a result of stock option exercises.

TheCompany estimates the fair value of each option award on the date of grantusing the Black-Scholes model that uses assumptions noted in the table below:

| ** **                   | ** ** | **2006**     | ** ** | **2005**   | ** ** | **2004** | ** ** |
|------------------------------|------------|--------------|------------|------------|------------|----------|------------|
| Expected  volatility         |       | 61% - 66     | %          | 54 - 64%   | %          | 54.0     | %          |
| Weighted-average  volatility |       | 61.9         | %          | 61.0       | %          | 54.0     | %          |
| Expected  dividends          |       | 0.0          | %          | 0.0        | %          | 0.0      | %          |
| Expected term (in  years)    |       | 6.5          |       | 5.0 - 6.5  |       | 3        |       |
| Risk-free rate               |       | 4.60% - 4.78 | %          | 3.7% - 4.9 | %          | 3.5      | %          |

 

Due to the limited dataavailable of the Company’s historical stock price volatility, expectedvolatility is computed based upon historical volatilities of peer companieswith similar product portfolios. The 

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expectedterm of options granted is derived from the average of the vesting period andthe term of the option as defined in the Plans, following the guidance in SECStaff Accounting Bulletin No. 107.

**9.   IncomeTaxes**

Net deferred tax assets consist primarily of netoperating loss (“NOL”) carryforwards. Realization of future tax benefitsrelated to deferred tax assets is dependent on many factors, including theCompany’s ability to generate future taxable income in the near term. Due tothe uncertainty of future earnings, management is unable to predict whetherthese net deferred tax assets will be realized and, accordingly, has recorded afull valuation allowance against these assets.

NOL carryforwards of approximately $38.9 million forincome tax purposes are available to offset future taxable income. In addition,federal tax credits for increasing research and development expenditures ofapproximately $1.1 million are available to offset future tax. Thesecarryforwards begin to expire in varying amounts beginning in the year 2019. InMarch 2006, in conjunction with the Company’s issuance of common stock toa group of investors in March of 2006, the Company had an ownership changeas that term is defined in Section 382 of the Internal Revenue Code. Approximately$19.8 million in NOL carryforwards have been limited as a result. Onlyapproximately $4.1 million of the $19.8 million NOL carryforward can be used tooffset taxable income in a particular year. If taxable income exceeds $4.1 millionin a year, $19.1 million of the unaffected NOL carryforwards are available. Ifsome or all of the $4.1 million NOL is not utilized in a tax year, theexcess carries forward. This excess increases the $4.1 million availablein the succeeding year. Tax credits have been similarly limited.

In 2006, the Financial Accounting Standards Boardissued Interpretation No. 48 *Accounting for Uncertaintyin Income Taxes*(“FIN 48”)*.*FIN 48requires reporting of taxes based on tax positions which meet a more likelythan not standard and which are measured at their more likely than nosettlement. Differences between financial and tax reporting which do not meetthis threshold are required to be recorded as unrecognized tax benefits. FIN 48also provides guidance on the presentation of tax matters and the recognitionof potential IRS interest and penalties. FIN 48 is effective for fiscal yearsbeginning after December 15, 2006. Upon adoption, this statement is notexpected to have a material effect on the Company’s financial position, cashflows or results of operations.

Thefollowing is a summary of the significant components of the Company’s deferredtax assets as of December 31, 2006 and 2005:

| ** **                          | ** ** | **Years ended December 31,** | ** ** |
|-------------------------------------|------------|---------------------------------------------|------------|
| ** **                          | ** ** | **2006**                                    | ** ** | **2005** | ** ** |
| Deferred tax assets:                |       |                                        |       |   |   |
| Net operating losses                |       | $                                           | 15,169,067 |   | $ | 6,411,965 |   |
| Stock based compensation            |       | 372,328                                     |       | 145,616 |   |
| Depreciation                        |       | 28,209                                      |       | 13,456 |   |
| In-process research and development |       | 7,890,699                                   |       | 8,686,399 |   |
| Other accruals and reserves         |       | 255,028                                     |       | 544,274 |   |
| Less valuation allowance            |       | (23,715,331                                 | )          | (15,801,710 | ) |
| Deferred tax  asset—net        |       | $                                           | —     |   | $ | — |   |

 

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Thereconciliation of the federal statutory rate to the Company’s effective taxrate is as follows:

| ** **                                             | ** ** | **Years ended December 31,** | ** ** |
|--------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                             | ** ** | **2006**                                    | ** ** | **2005** | ** ** |
| Tax provision at  the statutory federal rate           |       | 34                                          | %          | 34 | % |
| State income  taxes, net of federal income tax benefit |       | 5                                           | %          | 5 | % |
| Valuation  allowance                                   |       | -39                                         | %          | -39 | % |
| Effective tax rate                                     |       | 0                                           | %          | 0 | % |

 

**10.   EmployeeBenefit Plan**

The Company hasestablished a 401(k) plan that covers all employees who meet minimumeligibility requirements. Eligible persons can defer a portion of their annualcompensation into the 401(k) plan subject to certain limitations imposedby the Internal Revenue Code. Employees’ elective deferrals are immediatelyvested upon contribution to the 401 (k) plan. The company matches employeecontributions at a rate of 50% up to 6% of the employee’s annual salary.  Company contributions vest 25% per year afterthe first year of service has been completed. Approximately $55,000, $38,000,and $32,000 was recognized as expense in 2006, 2005 and 2004, respectively.

**11.   Commitments**

***Lease Obligations******—***The Company leases facilities underan operating lease with the BioStart Property Group, a subsidiary of FlavinVentures. The lease has a five-year term commencing on September 1, 2003and may be renewed in writing 60 days prior to the lease termination date. Theminimum monthly rental payment is $19,000 with an additional amount based onthe Company’s proportionate share of the variable building costs. Additionally,the Company leases capital equipment of approximately $71,000 under a capitallease.

Minimumannual payments under operating leases and the present value of minimum capitallease payments as of December 31, 2006 are as follows:

| ** **                               | ** ** | **Operating** | ** ** | **Capital lease** | ** ** |
|------------------------------------------|------------|---------------|------------|------------------------|------------|
| ** **                               | ** ** | **Leases**    | ** ** | **Obligations**        | ** ** |
| Year ending  December 31,           |       |          |       |                   |       |   |   |
| 2007                                     |       | $             | 225,878    |                   |       | $ | 24,211 |   |   |
| 2008                                     |       | 154,708       |       |                   | 10,101     |   |   |
| 2009                                     |       | —        |       |                   | 10,101     |   |   |
| 2010                                     |       | —        |       |                   | 4,655      |   |   |
| 2011                                     |       | —        |       |                   | —     |   |   |
| Total                                    |       | $             | 380,586    |                   |       | 49,068 |   |   |
| Less amount representing interest        |       |          |       |                   | 9,555      |   |   |
| Present value of minimum  lease payments |       |          |       |                   | $          | 39,513 |   |   |

 

Rental expense relating to the Flavin Ventures leasetotaled approximately $207,000, $224,000 and $224,000 in 2006, 2005 and 2004,respectively.

Common area maintenance expense totaled approximately$45,000, $48,000 and $19,000 in 2006, 2005 and 2004, respectively.

***EmploymentContracts******—***TheCompany has employment contracts with certain executive officers. In the eventof termination without cause, the contracts provide for severance benefitsranging from six to 24 months of salary and benefit continuation.

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***Vendor Contracts******—***The Company administers itscethromycin development program largely under contracts with third parties. In2006, contracts totaling $35.1 million were executed related to the trials ofwhich approximately $14.0 million of expenses had been incurred as of December 31,2006. The remaining balance of $21.1 million is expected to be incurred in 2007.In addition, the Company executed $400,000 in contracts related to the ALS-357program during 2006, of which the remaining balance of $327,000 is expected tobe incurred in 2007.

***Grant Payable******—***In April 2005, the Company wasawarded a $500,000 grant from the State of Illinois to fund expansion of itscorporate headquarters in Woodridge, IL. Under the terms of the grant, theCompany is to utilize the funds for construction costs associated withexpanding its corporate headquarters and create 100 full-time jobs at the samelocation between January 31, 2005 and June 30, 2007 (“grant period”).Funds that are not expended in a manner consistent with the grant award are tobe repaid at the end of the grant period. In addition, if the Company does notcreate the specified number of full-time jobs, it is required to repay thegrant proceeds on a pro-rata basis of actual jobs created compared to the totaldefined in the grant. As of December 31, 2006, the Company classifiedapproximately $477,000 of the grant proceeds as a short term liability basedupon the actual costs of the facility expansion incurred and the number of jobscreated during the grant period. The remaining $23,000 has been classified as along-term liability as the Company must maintain the positions created duringthe grant period through January 31, 2010. If the Company does notmaintain the positions created until January 31, 2010, it will owe the Stateof Illinois grant proceeds equal to a pro-rata share of the positions that wereretained as compared to the total created during the grant period.

**12.   Researchand Development Alliances**

***Abbott Laboratories******—***In December 2004, the Companyentered into an agreement with Abbott Laboratories under which it acquired fromAbbott a license to certain patent applications, patents and proprietarytechnology relating to cethromycin. Under the terms of the initial agreementwhich was subsequently modified on August 1, 2005, the Company paid $13.0million in license fees and milestones and issued 1,722,569 shares of itscommon stock to Abbott. The Company will owe Abbott $10.0 million if we submitan NDA and $30.0 million if and when the FDA approves the NDA. The Company alsoagreed to pay to Abbott $2.5 million upon cethromycin reaching $200 million inaggregate net sales and $5.0 million upon the drug reaching $400 millionin aggregate net sales. Finally, the Company will owe Abbott royalty paymentsof 19.0% on the first $100 million of aggregate net sales of cethromycin, 18.0%on net sales once aggregate net sales exceed $100 million but are less than$200 million, and 17.0% on all net sales once aggregate net sales exceed $200million.

***University ofIllinois at Chicago******—***OnDecember 2, 1999 the Company entered into a license agreement with theUniversity of Illinois at Chicago (“UIC”) to license an anti-melanoma compound.In consideration of the exclusive, world-wide license, the Company paid anupfront license fee of $15,000 upon the execution of the agreement. The Companyis obligated to make up to $135,000 in aggregate milestone payments upon theachievement of certain objectives. In December 2004, the Company filed anIND with the FDA for the anti-melanoma compound which triggered a $10,000milestone payment to UIC which was classified as research and developmentexpense. Under the terms of the agreement, the Company is obligated toreimburse UIC for patent protection costs which totaled approximately $114,000,$47,000 and $72,000 in 2006, 2005 and 2004, respectively. In addition, theCompany must pay royalties equal to 6% of net sales to UIC based on sales ofthe licensed compound by the Company or its affiliates or sublicensees, as wellas a percentage of all other income the Company receives from sublicensees, butin any event, a minimum royalty of $5,000 annually once commercial salescommence.

***BaxterInternational******—***As part ofthe Company’s spin-off from MediChem Life Sciences in 1999, it obtained theentire right, title and interest to certain patented inventions relating to ALS-886that were assigned by Baxter International, Inc. to Dr. Michael T.Flavin. The Company has assumed the obligation 

53

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of Dr. Flavin to payBaxter, as a payment for the assignment, 3% of net sales of ALS-886.Further, the Company is also obliged to sharewith Baxter 50% of the sublicensing fees it collects, other than royalties. Inaddition, if the Company sells the ongoing business of making, using orselling ALS-886, it is obligated to pay Baxter 50% of the fair market value of the right or license tomanufacture, use or sell ALS-886 that is conveyed as part of thesale.

***Argonne National Laboratory******—***In 2003, the Company acquired anexclusive license, under patent rights and know-how controlled by ArgonneNational Laboratory, to develop, make, use and sell in the United Statesand its territories a class of peptides and related compounds to inhibit theformation of amyloid fibrils. These fibrilsare implicated in a number of diseases such as Alzheimer’s disease andamyloidosis. In consideration of this license, the Company agreed to payroyalties to Argonne equal to 4% of net sales of licensed products by theCompany, its affiliates and sublicensees, as well as 10% of any benchmark ormilestone fees it receives from sublicensees.The Company also agreed to reimburse Argonne for the cost of ongoing patentprosecution and maintenance. The license is subject to certain reserved rightsfor the U.S. Government based on Federalstatutes, including the Government’s right to develop, make, use, and sell theamyloid inhibiting peptides pursuant to any treaties or agreements withforeign governments that the U.S. Government may enter, and the Government’sright to require the Company to sublicense the rights granted in certainlimited circumstances. The Company is obligated to provide at least onehalf-time employee to this project until completion of Phase I clinical trials.Argonne has the right to terminate the agreement if due diligence requirements,including the devotion of one half-time employee, are not met.

**13.**   NetLoss Per Share

Basicloss per share are computed by dividing net loss by the number of weightedaverage common shares outstanding during the reporting period. Diluted loss pershare is calculated to give effect to all potentially dilutive common sharesthat were outstanding during the reporting period. The computation of dilutedshares outstanding for the periods ended December 31, 2006, 2005 and 2004excludes incremental shares of 6,294,079, 950,721, and 634,835 related toemployee stock options and warrants. These shares are excluded due to theiranti-dilutive effect as a result of the Company’s losses for the years endedDecember 31, 2006, 2005 and 2004.

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**14.   UnauditedQuarterly Financial Data**

Selectedquarterly data for 2006 and 2005 is as follows:

| ** **                                        | ** ** | **2006**   | ** ** |
|---------------------------------------------------|------------|------------|------------|
| ** **                                        | ** ** | **First**  | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** |
| Revenue                                           |       | $          | 35,127     |   | $ | — |   | $ | — |   | $ | 4,661 |   |
| Research and  development expenses                |       | 2,260,378  |       | 3,579,038 |   | 5,730,269 |   | 5,632,428 |   |
| Selling, general  and administrative expenses     |       | 1,149,170  |       | 1,338,842 |   | 1,489,502 |   | 1,479,881 |   |
| Operating loss                                    |       | (3,374,421 | )          | (4,917,880 | ) | (7,219,771 | ) | (7,107,648 | ) |
| Net loss  available to commons shareholders(1)    |       | (3,282,183 | )          | (4,569,537 | ) | (6,917,695 | ) | (5,946,221 | ) |
| Loss per share available  to common shareholders: |       |       |       |   |   |   |   |   |   |
| Basic and Diluted                                 |       | $          | (0.15      | ) | $ | (0.16 | ) | $ | (0.24 | ) | $ | (0.21 | ) |

 

| ** **                                        | ** ** | **2005**  | ** ** |
|---------------------------------------------------|------------|-----------|------------|
| ** **                                        | ** ** | **First** | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** |
| Revenue                                           |       | $         | 32,519     |   | $ | 11,860 |   | $ | 8,502 |   | $ | 68,570 |   |
| Research and  development expenses                |       | 317,790   |       | 348,146 |   | 938,813 |   | 1,516,867 |   |
| Selling, general  and administrative expenses     |       | 367,744   |       | 470,828 |   | 1,239,674 |   | 1,159,751 |   |
| Operating loss                                    |       | (653,015  | )          | (807,114 | ) | (2,169,985 | ) | (2,608,048 | ) |
| Net loss  available to common shareholders        |       | (792,076  | )          | (959,802 | ) | (2,251,948 | ) | (2,615,420 | ) |
| Loss per share available  to common shareholders: |       |      |       |   |   |   |   |   |   |
| Basic and Diluted                                 |       | $         | (0.07      | ) | $ | (0.09 | ) | $ | (0.15 | ) | $ | (0.15 | ) |

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(1)          Amount for fourthquarter includes a gain of $940,000 relating to the sale of ALS Inc.’s 50% ownershipof Sarawak MediChem Pharmaceuticals

 

******

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**Item 9.**                        *Changes in and Disagreements with Accountants on Accounting andFinancial Disclosure.*

None.

**Item 9A.**                *Controls and Procedures.*

Our management, under thesupervision and with the participation of our Chief Executive Officer (“CEO”)and Chief Financial Officer (“CFO”), has evaluated the effectiveness of ourdisclosure controls and procedures as defined in SEC Rules 13a-15(e) and15d-15(e) asof the end of the period covered by this report. Based upon that evaluation,management has concluded that our disclosure controls and procedures areeffectively designed to ensure that information we are required to disclose inreports that we file or submit under the Securities Exchange Act of 1934 isaccumulated and communicated to management, including the CEO and CFO, asappropriate to allow timely decisions regarding required disclosure and isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms.

**Changes in InternalControl**

During the period coveredby this report, there have been no significant changes in our internal controlover financial reporting that have materially affected, or are reasonablylikely to materially affect, our internal control over financial reporting.

**Item 9B.**               *Other Information.*

**PART III**

**Item 10.**                 *Directors and Executive Officers of the Registrant.*

The information requiredby this item is incorporated by reference to the information set forth in thesection entitled “Board of Directors and Executive Officers” contained in ourNotice of Annual Stockholders’ Meeting and Proxy Statement to be filed within120 days after the end of our fiscal year (the “2007 Proxy Statement”).

**Item 11.      *Executive Compensation****.*

Theinformation required by this item is incorporated by reference to theinformation set forth in the section entitled “Executive Compensation” withinthe 2007 Proxy Statement.

**Item 12.**                 *Security Ownership of Certain Beneficial Owners and Management andRelated Stockholder Matters.*

Theinformation required by this item is incorporated by reference to theinformation set forth in the section entitled “Stock Ownership” within the 2007Proxy Statement.

**Item 13.**                 *Certain Relationships and Related Transactions.*

Theinformation required by this item is incorporated by reference to theinformation set forth in the section entitled “Certain Transactions” within the2007 Proxy Statement.

**Item 14.**                 *Principal Accountant Fees and Services.*

The information requiredby this item is incorporated by reference to the information set forth in thesection entitled “Fees of Independent Registered Public Accounting Firm andAudit Committee Report” within the 2007 Proxy Statement.

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**PART IV**

**Item 15.**                 *Exhibits and Financial Statement Schedules.*

**(a)   (1) FinancialStatements**

The following consolidatedfinancial statements of Advanced Life Sciences Holdings, Inc. are includedin Part II, Item 8 of this report:

**Report of Independent RegisteredPublic Accounting Firm**

**Consolidated Balance Sheets at December 31,2006 and 2005**

Consolidated Statements of Operations for the YearsEnded December 31, 2006, 2005, 2004 and period from inception (January 1,1999) through December 31, 2006

Consolidated Statements of Stockholders’ Equity forthe Years ended December 31, 2006, 2005 and 2004 and period from inception(January 1, 1999) through December 31, 2006

Consolidated Statements of Cash Flows for the YearsEnded December 31, 2006, 2005, 2004 and period from inception (January 1,1999) through December 31, 2006

**Notes to the Consolidated FinancialStatements**

**(2)    Financial Statement Schedule**

All schedules are omitted because the requiredinformation is not present or is not present in amounts sufficient to requiresubmission of the schedule or because the information required is provided inthe consolidated financial statements or notes thereto.

**(3)    Exhibits**

Exhibits required to be attached by Item 601 ofRegulation S-K are listed in the Exhibit Index attached hereto, which inincorporated herein by this reference.

**(b)   Exhibits:**

See Item 15(a)(3) above.

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**SIGNATURES**

Pursuant to therequirements of Section 13 or 15(d) of the Securities Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized, in the City of Chicago, State ofIllinois, on the 22nd day of March, 2007.

|        |   | ADVANCED LIFE SCIENCES HOLDINGS, INC. |
|--------|--------|---------------------------------------|
|   |   | By:                                   |   | s/ MICHAEL T. FLAVIN, PH.D. |
|   |   | Name:                                 |   | Michael T. Flavin, Ph.D. |
|   |   | Title:                                |   | Chairman and Chief Executive Officer |
|   |   | By:                                   |   | /s/ R. RICHARD WIELAND II |
|   |   | Name:                                 |   | R. Richard Wieland II |
|   |   | Title:                                |   | Chief Financial Officer |

 

Pursuantto the requirements of the Securities Act of 1934, this report has been signedbelow by the following persons, on behalf of the registrant and in thecapacities and on the dates indicated.

|                                | **Signature** | ** **                              | ** ** | ** **           | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|--------------------------------|---------------|-----------------------------------------|------------|----------------------|-----------|------------|------------|------------|----------|------------|
| /s/ MICHAEL T.  FLAVIN, PH. D. |          | Chairman and  Chief Executive Officer   |       | March 22,  2007 |
| Michael  T. Flavin, Ph. D.     |          | (Principal Executive  Officer)          |       |                 |
| /s/ JOHN L.  FLAVIN            |          | President and  Director                 |       | March 22,  2007 |
| John  L. Flavin                |          |                                    |       |                 |
| /s/ R. RICHARD  WIELAND II     |          | Executive Vice  President and Chief     |       | March 22,  2007 |
| R.  Richard Wieland II         |          | Financial Officer  (Principal Financial |       |                 |
|                           |          | and Accounting Officer)                 |       |                 |
| /s/ SCOTT F.  MEADOW           |          | Director                                |       | March 22,  2007 |
| Scott  F. Meadow               |          |                                    |       |                 |
| /s/ TERRY W.  OSBORN, PH.D.    |          | Director                                |       | March 22,  2007 |
| Terry  W. Osborn, Ph. D.       |          |                                    |       |                 |
| /s/ THERON E.  ODLAUG, PH.D.   |          | Director                                |       | March 22,  2007 |
| Theron E. Odlaug,  Ph. D.      |          |                                    |       |                 |

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| /s/ RICHARD  A. RECK             |   | Director |   | March 22,  2007 |
|----------------------------------|--------|----------|--------|----------------------|
| Richard  A. Reck                 |   |     |   |                 |
| /s/ ISRAEL  RUBINSTEIN, M.D.     |   | Director |   | March 22,  2007 |
| Israel  Rubinstein, M.D.         |   |     |   |                 |
| /s/ ROSALIE  SAGRAVES, PHARM. D. |   | Director |   | March 22,  2007 |
| Rosalie  Sagraves, Pharm. D.     |   |     |   |                 |
| /s/ THOMAS V.  THORNTON          |   | Director |   | March 22,  2007 |
| Thomas V.  Thornton              |   |     |   |                 |

 

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**EXHIBITINDEX**

|        | **Exhibit No.** | ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                        | **Description** | ** ** | ** ** |
|--------|----------------------|------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------|------------|------------|
|   | 2.1                  |       |       | Stock Purchase  Agreement, dated October 27, 2006, by and between CRAUN Research Sdn.  Bhd. and Advanced Life Sciences Holdings, Inc. and its subsidiary  Advanced Life Sciences, Inc. (as filed in our Current Report on  Form 8-K as exhibit 10.1 on November 2, 2006) |            |
|   | 3.1                  |       |       | Amended and  Restated Certificate of Incorporation of Advanced Life Sciences  Holdings, Inc. (as filed in our Registration Statement on Form S-1/A  as exhibit 3.2 on July 1, 2005)                                                                                                |            |
|   | 3.2                  |       |       | Certificate of  Incorporation of Advanced Life Sciences, Inc. (as filed in our Amended  Registration Statement on Form S-1/A as exhibit 3.1 on  June 3, 2005)                                                                                                                      |            |
|   | 3.3                  |       |       | By-laws of  Advanced Life Sciences Holdings, Inc. (as filed in our Amended  Registration Statement on Form S-1/A as exhibit 3.3 on  July 28, 2005)                                                                                                                                 |            |
|   | 4.1                  |       |       | Form of  Warrant to Purchase Shares of Common Stock of Advanced Life Sciences  Holdings, Inc. Stock. (as filed in our Current Report on Form 8-K as  exhibit 4.2 on March 2, 2006)                                                                                                 |            |
|   | 10.1                 | **         |       | Amended and  Restated Employment Agreement, dated November 7, 2006, between Advanced  Life Sciences, Inc. and Michael T. Flavin, Ph.D. (as filed in our  Quarterly Report on Form 10-Q as exhibit 10.1 on November 8,  2006)                                                  |            |
|   | 10.2                 | **         |       | Amended and  Restated Employment Agreement, dated November 7, 2006, between Advanced  Life Sciences, Inc. and John L Flavin. (as filed in our Quarterly Report  on Form 10-Q as exhibit 10.2 on November 8, 2006)                                                             |            |
|   | 10.3                 | **         |       | Amended and  Restated Employment Agreement, dated November 7, 2006, between Advanced  Life Sciences, Inc. and R. Richard Wieland II. (as filed in our  Quarterly Report on Form 10-Q as exhibit 10.3 on November 8,  2006)                                                    |            |
|   | 10.4                 | **         |       | Amended and  Restated Employment Agreement, dated November 7, 2006, between Advanced  Life Sciences, Inc. and Suseelan Pookote, Ph.D. (as filed in our  Quarterly Report on Form 10-Q as exhibit 10.4 on November 8,  2006)                                                   |            |
|   | 10.5                 | **         |       | Amended and  Restated Employment Agreement, dated November 7, 2006, between Advanced  Life Sciences, Inc. and Ze-Qi Xu, Ph.D. (as filed in our Quarterly  Report on Form 10-Q as exhibit 10.5 on November 8, 2006)                                                            |            |
|   | 10.6                 | **         |       | Amended and  Restated Employment Agreement, dated November 7, 2006, between Advanced  Life Sciences, Inc. and Patrick W. Flavin. (as filed in our Quarterly  Report on Form 10-Q as exhibit 10.6 on November 8, 2006)                                                         |            |
|   | 10.7                 | **         |       | Amended and  Restated Employment Agreement, dated November 7, 2006, between Advanced  Life Sciences, Inc. and David Eiznhamer, Ph.D. (as filed in our  Quarterly Report on Form 10-Q as exhibit 10.7 on November 8,  2006)                                                    |            |
|   | 10.8                 |       |       | Business Loan  Agreement and related agreements, dated April 20, 2006, between Advanced  Life Sciences Holdings, Inc. and Leaders Bank. (as filed in our Current  Report on Form 8-K as exhibit 10.1 on April 18, 2006)                                                       |            |
|   | 10.9                 |       |       | First Amendment  to Lease Agreement, dated April 20, 2006, by and between Advanced Life  Sciences, Inc. and BioStart Property Group, LLC. (as filed in our  Current Report on Form 8-K as exhibit 10.2 on April 18, 2006)                                                     |            |
|        |                      |            |            |                                                                                                                                                                                                                                                                                                   |                 |            |            |  |  |

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|        | 21.1 |   |   | Subsidiaries of Advanced  Life Sciences Holdings, Inc. (as filed in our Registration Statement on  Form S-1 as exhibit 21.1 on April 28, 2005.) |   |
|--------|------|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|   | 21.2 |   |   | Form of  Indemnification Agreement (as filed in our Amended Registration Statement on  Form S-1/A as exhibit 10.21 on June 3, 2005.)            |   |
|   | 22.1 | *      |   | Certificate and  Report of Inspector of Election.                                                                                                              |   |
|   | 23.1 | *      |   | Consent of  Deloitte & Touche LLP                                                                                                                     |   |
|   | 24.1 |   |   | Power of Attorney  (included on signature page)                                                                                                                |   |
|   | 31.1 | *      |   | Certification of  the Chief Executive Officer pursuant to Exchange Act Rule 13a-14(a)                                                                     |   |
|   | 31.2 | *      |   | Certification of  the Chief Financial Officer pursuant to Exchange Act Rule 13a-14(a)                                                                     |   |
|   | 32.1 | *      |   | Certification of  the Chief Executive Officer pursuant to 18 U.S.C. Section 1350 and  Exchange Act Rule 13a-14(a)                                    |   |
|   | 32.2 | *      |   | Certification of the Chief Financial Officer  pursuant to 18 U.S.C. Section 1350 and Exchange Act Rule 13a-14(a)                                     |   |

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(*)          Filed herewith.

(**)   Compensatory plan orarrangement.

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