**UNITED STATES**

**SECURITIES 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,  2005**                                                |
| **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 registrantas specified in its charter)

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

 

**1440 Davey RoadWoodridge, IL 60517**

(Address of principalexecutive offices) (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 x No

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 Exhange 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 Yesx No

The aggregate market valueof voting common stock held by non-affiliates of the registrant as of August 31,2005 (the last day of the first month in which the common shares of theregistrant were publicly-traded was approximately $34 million  (based upon the closing price of $5.24 percommon share as quoted on the Nasdaq National Market). The registrant has nooutstanding non-voting stock. For purposes of this computation, it is assumedthat the shares of voting stock held by directors and officers would be deemedto be stock held by affiliates. Non-affiliated common stock outstanding at August 31,2005 was 6,512,366 shares.

Total common stockoutstanding as of March 13, 2006 was 28,226,763 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 31,2005 (the “2006 Proxy Statement”) are to be filed with the Securities andExchange Commission within 120 days after the Registrant’s fiscal year ended December 31,2005 and are incorporated by reference into Part III of this Report.

 

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**ADVANCEDLIFE SCIENCES HOLDINGS, INCINDEXForm 10-K**

| **PART I**   |
|-------------------|
| Item 1.      |   | Business |   |   |
| Item 1A.          |   | Risk Factors |   |   |
| Item 1B.          |   | Unresolved Staff Comments |   |   |
| Item 2.           |   | Properties |   |   |
| Item  3.          |   | Legal  Proceedings |   |   |
| Item 4.           |   | Submission of Matters to a Vote of Security Holders |   |   |
| **PART II**  |
| Item 5.      |   | Market for Registrants Common Equity, Related  Stockholder Matters and Issuer Purchases of Equity Securities |   |   |
| Item 6.           |   | Selected Financial Data |   |   |
| Item 7.           |   | Management’s Discussion and Analysis of Financial  Condition and Results of Operations |   |   |
| Item 7A.          |   | Quantitative and Qualitative Disclosures About Market  Risk |   |   |
| Item 8.           |   | Financial Statements and Supplementary Data |   |   |
|              |   | Consolidated  Balance Sheets as of December 31, 2005 and December 31, 2004 |   |   |
|              |   | Consolidated Statements of Operations for the years  ended December 31, 2005, 2004, 2003 and period from inception  (January 1, 1999) through December 31, 2005 |   |   |
|              |   | Consolidated Statements of Stockholders’ Equity for  period from inception (January 1, 1999) through December 31, 2005 |   |   |
|              |   | Consolidated Statements of Cash Flows for the years ended  December 31, 2005, 2004, 2003 and period from inception (January 1,  1999) through December 31, 2005 |   |   |
|              |   | Notes to Consolidated Financial Statements |   |   |
| Item 9.           |   | Changes in and  Disagreements with Accountants on Accounting and Financial Disclosure |   |   |
| Item 9A.          |   | Controls and Procedures |   |   |
| Item  9B.         |   | Other  Information |   |   |
| **PART III** |
| Item 10.          |   | Directors and Executive Officers of the Registrant |   |   |
| Item 11.          |   | Executive Compensation |   |   |
| Item 12.          |   | Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters |   |   |
| Item 13.          |   | Certain Relationships and Related Transactions |   |   |
| Item 14.          |   | Principal Accountant Fees and Services |   |   |
| **PART IV**  |
| Item 15.          |   | Exhibits |   |   |

 

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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 under the heading “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.*

**Overview**

We are a biopharmaceuticalcompany focused on the discovery, development and commercialization of noveldrugs in the areas of infectious disease, inflammation and oncology. Using ourinternal discovery capabilities and our network of pharmaceutical and academicpartners, we have assembled a promising pipeline of clinical and preclinicalproduct candidates. The following is a summary of each of our primary programs:

·       *Infectious Disease.*We have an exclusive worldwide license(excluding Japan) from Abbott Laboratories to develop and commercializecethromycin, a novel ketolide antibiotic in Phase III clinical development forthe treatment of respiratory tract infections. In December 2005, weinitiated our pivotal Phase III clinical program for the treatment ofmild-to-moderate community acquired pneumonia, the indication for which weinitially plan to seek FDA approval. Abbott Laboratories completed six PhaseIII clinical trials of the compound comprising approximately 3,800 humansubjects to test safety and efficacy.

Through our 50/50 jointventure, Sarawak MediChem Pharmaceuticals, we have managed the development ofCalanolide A, a non-nucleoside reverse transcriptase inhibitor for thetreatment of HIV. We completed a series of Phase I clinical trials forCalanolide A, which was well-tolerated by patients and demonstratedeffectiveness in reducing viral load in HIV-infected patients. Subject toreaching a satisfactory agreement with our joint venture partner regarding ourcurrent business arrangement and our respective funding obligations for thenext phase of development, we plan to enroll HIV-infected patients for a PhaseIIa clinical trial of Calanolide A.

·       *Inflammation.*ALS-886 is a novel therapeutic inpreclinical development for the treatment of inflammation-related tissuedamage, including tissue damage associated with acute respiratory distresssyndrome (“ARDS”). Patients suffering from ARDS have a high fatality rate, andthere are currently only limited treatment options available. We haveestablished an open investigational new drug application (“IND”) for ALS-886with the FDA. We expect that the first clinical study will involveapproximately 40 patients to determine the safety profile of the compound inhuman subjects. We intend to seek a partner to assist in the funding andadvancement of this program.

·       *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 at 

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prolonging survival forpatients with melanoma that has spread beyond the primary growth site. Webelieve that ALS-357 has the potential for either a topical or systemicformulation. We established an open IND for ALS-357 with the FDA. Theexpected Phase I clinical trial protocol contemplates treating 16 patients within-transit metastatic melanoma by topical application of ALS-357. Weintend to seek a partner to assist in the funding and advancement of thisprogram.

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 payment associated with ourcollaborations or grants. Our cumulative net loss was $46.7 million as of December 31,2005, 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. ALS Ventures is not included in theconsolidated financial statements of Advanced Life Sciences Holdings, Inc.(“the Company”).

In March of 2002, MediChem was acquired by deCODEgenetics, Inc. (“deCODE”). As a result of the merger, Dr. Flavin’sownership in the merged entity was reduced to a noncontrolling interest with Dr. Flavinholding approximately 1% of the common shares of deCODE genetics, Inc. Afterthe merger was complete, Dr. Flavin resigned his position as chiefexecutive officer of MediChem to focus on his role as chief executive officerof ALS Inc.

In December 2004, ALS Inc. executed a plan ofreorganization. The Company, a Delaware corporation, was formed with Dr. Flavinas its chief executive officer. Common shareholders of ALS, Inc. exchangedtheir 1,629,685 common shares for 1,629,685 common stock of the Company. Underthe terms of the reorganization, Flavin Ventures exchanged their 40% ownershipof ALS GP for 7,852,330 shares of the Company’s common stock. After theexchange was completed, ALS GP was dissolved, its assets and liabilitiesassumed by ALS Inc.

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In December 2004, according to the plan ofreorganization, ALS Ventures, LLC (“Ventures”), a Delaware Limited LiabilityCompany was formed. After its formation, Dr. Flavin and Flavin Venturessimultaneously contributed all of their common shares, 1,588,000 and 7,852,330,respectively, to Ventures.

In April 2005, the Board of Directors of theCompany (“the Board”) authorized the Company to file 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 concurrentoffering of 600,000 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 $2.3 million in underwriting discounts andincurred other offering expenses of approximately $1.5 million. The netcash proceeds from the offerings were approximately $28.7 million.

In March 2006, theCompany raised approximately $33.6 million, net of underwriting discounts,in connection 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.

**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, inflammation and cancer, and then markets these productsdirectly to healthcare providers, including but not limited to,  physicians and hospitals. We plan to sustainour drug development pipeline through our internal drug discovery capabilitiesand by opportunistically in-licensing promising compounds that fit into ourareas of focus. Specific key aspects of our strategy include the following:

*Maximize theCommercial Potential of Cethromycin*

Initially, we intend to focus a significant portion ofour business efforts on the further development of cethromycin for thetreatment of mild-to-moderate community acquired pneumonia. AbbottLaboratories, which granted us an exclusive worldwide license (except in Japan)to commercialize cethromycin, completed six Phase III clinical trials of thecompound to determine the safety and efficacy of 150 mg once-daily andtwice-daily regimens, testing approximately 3,800 human subjects. We initiatedthe first of two pivotal Phase III clinical trials in December 2005 forthe treatment of mild-to-moderate community acquired pneumonia using a 300 mgonce-daily dosing regimen.

In addition to treatingmild-to-moderate community acquired pneumonia in pivotal Phase III clinicaltrials, we intend to pursue opportunities for cethromycin in the treatment ofother respiratory tract infections such as bronchitis, sinusitis andpharyngitis.

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*Advance the Development of our Other InfectiousDisease, Inflammation and Oncology Product Candidates as Funds are Available orThrough a Partnership.*

Whereas the development ofcethromycin remains our number one priority, we intend to leverage our existingclinical trial experience from developing Calanolide A to advance productcandidates in our inflammation and oncology programs through clinical trials.For instance, to advance ALS-886 for the treatment ofinflammation-related tissue damage, we plan to conduct Phase I clinical trialsthat test safety and provide preliminary data regarding efficacy in preventinglung tissue damage in ARDS patients. To develop ALS-357 for the treatmentof malignant melanoma, we intend to conduct Phase I clinical trials with atopical formulation to test safety and provide preliminary data regardingefficacy. We also plan to develop a systemic formulation of ALS-357 andinitiate related clinical trials. Subject to reaching a satisfactory agreementwith our joint venture partner regarding our current business arrangement andour respective obligations for the next phase of development, we plan to enrollHIV-infected patients for a Phase IIa clinical trial of Calanolide A.

*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 theUnited States, we generally plan to commercialize our product candidatesthrough a variety of collaboration arrangements with leading pharmaceuticalcompanies and contract sales organizations.

**Our Lead Program**

Our most advanced product candidate, cethromycin, is anovel ketolide antibiotic in Phase III clinical development for the treatmentof respiratory tract infections. We are initially developing cethromycin as atreatment for mild-to-moderate community acquired pneumonia. Over the lastdecade, 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.Clinical trials indicate that cethromycin has enhanced activity towardsdrug-resistant *Streptococcuspneumoniae*and *Haemophilusinfluenzae,*two of the pathogens commonly found in mild-to-moderatecommunity acquired pneumonia, when compared to published data on antibioticscurrently on the market. Cethromycin has also shown *in vitro*evidence of an extendedpost-antibiotic effect, meaning that the suppression of bacterial growthpersists in the absence of measurable antibiotic concentration. Six 

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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 will include two controlled pivotal Phase IIIcomparator studies and any other studies the FDA may require for new drugapplication (“NDA”) approval. The pivotal Phase III program will involveapproximately 1,000 subjects. During 2005, we expended approximately $1.9 milliontowards the development of cethromycin.

*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 has become widely considered asignificant threat to public health, and the problem continues to worsen. TheCenters for Disease Control, or CDC, continue 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. Wedo 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 and sinusitis.Many of these bacterial infections can be life threatening if not treatedquickly. Bacterial pneumonia, which involves an infection of the lung itself,is the most severe of the common respiratory tract infections. Pneumonia isoften classified as mild-to-moderate community acquired pneumonia or hospitalacquired pneumonia, depending upon the setting in which contraction of thebacterial infection occurred. The Textbook of Primary and Acute Care Medicineestimates that, in the United States alone, there are approximately 5-6 millioncases of community acquired pneumonia each year.

*Current TreatmentOptions and Limitations*

Until recently, there have been three main classes ofantibiotics prescribed for respiratory tract infections such as community acquiredpneumonia. These are semi-synthetic penicillins (also known as beta-lactams),such as Augmentin® (amoxicillin and clavulanatepotassium) sold by GlaxoSmithKline; macrolides, such as erythromycin orZithromax® (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 

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common pathogens thatcause respiratory tract infections such as community acquired pneumonia, areresistant to macrolides. In addition, numerous reports in the medicalliterature have noted the emergence of penicillin-resistant pneumococci.Because fluoroquinolones have a broad-spectrum activity against bothGram-negative and Gram-positive bacteria, there is a greater potential forbacterial resistance. The wide use of fluoroquinolones also increases thepotential for development of resistance among *Streptococcus pneumoniae.*

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 antibioticsis 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 patientcompliance with prescribed courses of therapies has further contributed tobacterial resistance against currently marketed antibiotics. Patients willfrequently discontinue a prescribed dosing regimen after symptoms subside, butbacteria that are not entirely 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 community acquired pneumonia and otherrespiratory tract infections, such as bronchitis, sinusitis and pharyngitis.Ketolides are effective against penicillin- and macrolide-resistant pathogensknown to cause respiratory tract infections. When compared to published data oncurrent fluoroquinolone antibiotic treatments, ketolides have shown a favorablesafety profile. The only ketolide available for sale in the United States,Ketek ® (telithromycin), was approved by the FDA in April 2004and launched commercially by Aventis Pharmaceuticals in August 2004. Ketekhas been available for sale in Europe since the summer of 2002. According todata compiled by IMS Health, an independent pharmaceutical information andconsulting firm, sales of Ketek in the United States totaled approximately $193 millionin 2005. While Ketek has been determined to be effective against resistantpathogens, the FDA has imposed a labeling requirement for Ketek indicating thatit may cause visual disturbances including double-vision, blurred vision anddifficulty focusing.

**ALS Solution**

We are developing cethromycin, a novel ketolideantibiotic licensed from Abbott Laboratories, in response to the emergingantibiotic resistance observed in the treatment of community acquiredpneumonia. Prior to the initiation of our clinical trials, cethromycin has beentested by Abbott in approximately 3,800 human subjects during clinical trials. Weintend to conduct two pivotal Phase III clinical trials of cethromycin for thetreatment of mild-to-moderate community acquired pneumonia. We also intend topursue opportunities for cethromycin in the treatment of other respiratorytract infections such as bronchitis, sinusitis and 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 broader range ofactivity than macrolides and Ketek against Gram-positive bacteria associatedwith 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;

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

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·       cethromycin has shown *invitro*evidence of extended post-antibiotic effects againstthe 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 build upon the growing market acceptance ofketolide compounds in the antibiotic marketplace.

**Abbott Laboratories Collaboration**

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 and ABT-210, a second-generation ketolide antibiotic productcandidate in preclinical development. Under the terms of the license agreement,we have an exclusive worldwide license (excluding Japan) to develop andcommercialize cethromycin. On August 1, 2005, we agreed to amend ourlicense agreement with Abbott in order to terminate our in-license of ABT-210.The license for cethromycin includes rights under U.S. Patent No. 5,866,549(for cethromycin) and foreign equivalents other than in Japan, and all relatedapplications and patents that are entitled to benefit from the original filingof applications that issued as U.S. Patent No. 5,866,549 or their foreignequivalents. We intend to conduct and fund the remaining clinical development ofcethromycin and commercialize the product for the treatment of mild-to-moderatecommunity acquired pneumonia. In February 2005, Abbott transferred to usall of its interests in Investigational New Drug application No. 57,836relating to cethromycin. Under the terms of our agreement, Abbott received1,122,569 shares of our common stock and had the right to receive $11.0 millionin cash, which was paid in 2005. Of the $11.0 million in payments madeduring 2005, $9.0 million related to the purchase of the remainingcethromycin inventory from Abbott. We believe that the supply of cethromycinwill be sufficient to conduct the clinical trials.  The remaining $2.0 million represented amilestone payment which was due on October 31, 2005, or, if earlier, uponour initiation of pivotal Phase III clinical trials for cethromycin. Theoriginal amount of this milestone, $5.0 million, was reduced by $3.0 millionin exchange for issuing 600,000 shares of our common stock to AbbottLaboratories through a concurrent offering with our IPO. To date, we have paida total of $2.0 million in milestone payments under the license agreement.We will owe Abbott $10.0 million if we submit an NDA and $30.0 millionif and when the FDA approves the NDA. Pursuant to the August 1, 2005 amendment,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 drugreaching $400 million in aggregate net sales. Finally, we were originallyobligated to pay Abbott royalties, generally equal to 19.0% of net sales, forcommercialized products on a country-by-country basis. In exchange for ouragreement with Abbott on August 1, 2005 to terminate our in-license of ABT-210and provide the $2.5 million and $5.0 million sales-related milestonepayments, Abbott agreed to reduce its royalty rights for cethromycin if it isapproved for commercialization. Under the new terms, we will owe Abbott royaltypayments of 19.0% on the first $100 million of aggregate net sales ofcethromycin, 18.0% on net sales once aggregate net sales exceed $100 millionbut are less than $200 million, and 17.0% on all net sales once aggregatenet 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, wemaintain a non-exclusive, perpetual and irrevocable license to use Abbott’sproprietary technology and other types of information directly related or usedin connection 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 

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business operations or ifthe other party passes a resolution or a court of competent jurisdiction makesan order for winding up its business. Either party may also terminate theagreement for material breach if not cured within 90 days of notice or if notcured within 30 days of notice if the breach relates to a payment provision.

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. This exclusive right begins when we notify Abbott of ourmarketing and/or distributing plans, and we have no further obligation to Abbott, from a marketing perspective, after the 90-dayperiod of time elapses.

**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.

*SarawakMediChem Pharmaceuticals, Inc.**  *In 1996, weentered into a 50/50 joint venture with Craun Research Sdn. Bhd., acting asagent for the State Government of Sarawak, Malaysia (“Sarawak Government”), tofinance the development of Calanolide A. This joint venture is a Delawarecorporation named Sarawak MediChem Pharmaceuticals, Inc (“SMP”). Upon theformation of the joint venture, the Sarawak Government contributed $9.0 millionin equity and MediChem Life Sciences, Inc., which assigned its interest inSarawak MediChem Pharmaceuticals to us, received its 50% equity interest inexchange for its contribution of intellectual property. Subsequent to theformation of the joint venture, the Sarawak Government issued $12.0 millionin long-term debt to the joint venture. According to the terms of the debtinstruments, $12.0 million of this debt is past due. As a result of thisdefault in payment by SMP, the Sarawak Government has the option under the loanagreement to take over the control and management of the Calanolide A projector the affairs of the joint venture until such time as the loan is repaid infull. To date, the Sarawak Government has not pursued the collection of thisdebt or sought to control or manage the Calanolide A project. In July 2005,the Sarawak Government exercised certain of its contractual rights by notifyingSMP of its intention to appoint its representative as an officer of the jointventure for purposes of assuming control of the affairs and management of SMPeffective immediately. In December of 2005, the Sarawak Government nominatedand the Board of Directors of SMP approved the appointment of Mr. Jumastaphabin Lamat as the controlling officer of SMP. Since that time we have beentransitioning access to the joint venture’s accounting, financial and corporaterecords to representatives of Mr. Lamat. The Sarawak Government alsoexpressly reserved all contractual and legal remedies available in light of thedefault and indicated its intent to fully exercise its rights as a creditor ofthe joint venture. Ultimately, we believe that for the joint venture tocontinue, the terms of the debt must be amended to extend its maturity to adate after commercialization of Calanolide A.

We previously commenceddiscussions with the Sarawak Government to restructure and extend theexisting $12.0 million debt and determine the source of financing for aPhase IIa clinical trial of Calanolide A. We do not intend to expend anymeaningful funds advancing the development of Calanolide A unless and until werestructure the joint venture’s debt and reach a satisfactory agreement withthe Sarawak Government to amend our joint venture relationship and establishour respective obligations regarding the future funding of the next phase ofdeveloping Calanolide A.

If we are able to restructure our joint venturerelationship and determine to proceed with the Phase IIa clinical trialfor Calanolide A, upon completion of this trial we will evaluate our strategicalternatives for the joint venture relationship and the future advancement ofCalanolide A. We may determine to continue the program through our jointventure, independently or under a new joint venture arrangement. It is alsopossible that we will elect to transfer our rights in the compound to our current joint venture partner or an independentthird party. Factors that we will consider in making this

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decision include thesuccess of the Phase IIa clinical trial, the relative financial obligations ofus and our joint venture partner and our capabilities at such time to continuedevelopment independently.

The term of the joint venture agreement continuesindefinitely unless terminated by the written agreement of both parties not toproceed further with the development of Calanolide A. In the event only one ofthe parties wishes to discontinue development of Calanolide A, the other partyhas the right, but not the obligation, to purchase the discontinuing party’sequity interest in the joint venture for $9.0 million. If the other partydoes not choose to exercise its purchase right within six months of receivingwritten notice from the discontinuing party, then the joint venture is deemedmutually terminated. Upon such mutual termination, the joint venture agreementprovides that any liabilities of the joint venture will be settled by theparties equally and all patents or licenses of the joint venture shall be reassigned back to us, including rights toclinical trials. We believe that the equal settlement of liabilitiesprovision in the joint venture agreement was intended to recognize the 50/50equity ownership of the joint venture and does not constitute our guaranty ofthe joint venture’s indebtedness to the Sarawak Government. Consequently, ifthe joint venture is mutually terminated, the joint venture partners would worktogether to monetize the joint venture’s assets for the purpose of satisfyingits liabilities, which currently are solely comprised of indebtedness to a 50%partner, the Sarawak Government. In the event the joint venture’s assets areinsufficient to settle its liabilities, we do not believe that the equalsettlement of liabilities provision obligates us to contribute funds to thejoint venture.

In addition to the financing provided by our jointventure partner, the joint venture’s product portfolio and discovery andpreclinical programs have been funded through small business innovativeresearch (“SBIR”) grants awarded by the National Institutes of Health. SarawakMediChem Pharmaceuticals has been successful in being awarded over $1.5 millionin SBIR funding to advance the Calanolide analogue development pipeline. Thejoint venture is also building upon its relationship with the SarawakGovernment by collaborating with the Sarawak Biodiversity Center in Malaysia todiscover future drug leads for treating infectious diseases and cancer. To date, this drug discovery collaboration with theSarawak Biodiversity Center has not produced any drug leads for futuredevelopment.

*NationalInstitutes of Health.**  *In1996, our joint venture, Sarawak MediChem Pharmaceuticals, acquired an exclusive worldwide license, underpatent rights and know-how controlled by the National Institutes ofHealth (NIH), to develop, make, use and sell Calanolide A and related compoundsto treat HIV and other viral infections. The license was originally entered byMediChem Research, Inc., and MediChemsubsequently assigned the license to our joint venture. In consideration ofthis license, our joint venture is obligated to make up to $350,000 inaggregate milestone payments upon the achievement of various development andcommercialization milestones. To date, the joint venture has not been requiredto make any milestone payments. MediChem made an up-front payment of $20,000 toNIH. Since our inception in 1999, the joint venture has paid NIH approximately$133,000 for the reimbursement of patent maintenance expenses, as required bythe license agreement. In addition, the joint venture agreed to pay royaltiesto NIH based on net sales of licensed products. Even if there are no sales oflicensed products, the joint venture is obligated to pay NIH a minimum annualroyalty of approximately $6,700. Minimum annual royalties paid by the jointventure to NIH since our inception in 1999 are approximately $83,000. Thelicense from NIH is subject to certain reserved rights for the U.S. Government,including the Government’s right to develop, make, use and sell Calanolide Apursuant to any treaties or agreements with foreign governments that the U.S.Government may enter, and the Government’s rights to require us to sublicensethe rights granted in the interest of public health and safety. This licensemay be terminated by NIH if NIH determines we have not achieved certainbenchmarks for drug development or we cannot reasonably satisfy unmet healthand safety needs of the public.

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*University of Illinois atChicago.**  *In1999, we acquired an exclusive worldwide license, under patent rights andknow-how controlled by UIC, to develop, make, use and sell ALS-357 andrelated compounds to treat melanoma and other forms of cancer. In considerationfor this license, we paid an upfront license fee of $15,000 upon the executionof the agreement. We are also obligated to make up to $135,000 in aggregatemilestone payments upon the achievement of various development and commercialization milestones for each of ALS-357and any other compound developed by us under the licensed technology. Todate, we have paid $10,000 in milestone payments. Under the terms of theagreement, we are obligated to reimburse UIC for past patent preparation,filing and prosecution expenses, and have agreed to reimburse UIC for similarexpenses related to foreign patents throughout the term of the agreement. Todate we have paid UIC approximately $322,000 for patent reimbursement. Inaddition, we agreed to pay royalties to UIC based on net 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.

*ArgonneNational Laboratory.**  *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 one half-timeemployee, are not met.

*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 ongoing business of making, using or selling ALS-886, we areobligated to pay Baxter 50% of the fairmarket value of the right or license to manufacture, use or sell ALS-886that is conveyed as part of the sale.

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**Intellectual Property**

*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, inflammation and cancer. Together with our joint venture,we currently have exclusive access to 105issued U.S. and international patents. In addition, 28 U.S. and internationalpatent applications have been filed and are in various stages ofprocessing.

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

| **Drug Candidate** | ** ** | ** ** | ** ** | **U.S. Patent Number** | ** ** | **Expiration Date** | ** ** |
|-------------------------|------------|------------|------------|----------------------------------|------------|--------------------------|------------|
| Cethromycin             |       |       | 5866549    |                             |       |                     | 9/4/2016   |   |   |
| Calanolide A            |       |       | 5591770    |                             |       |                     | 1/7/2014   |   |   |
| ALS-886                 |       |       | 5504111    |                             |       |                     | 4/2/2013   |   |   |
| ALS-357                 |       |       | 5658947    |                             |       |                     | 8/19/2014  |   |   |

 

The patent positions of companieslike ours are generally uncertain and involve complex legal and factualquestions. Our ability to maintain and solidify our proprietary position forour technology will depend on our success in obtaining effective claims andenforcing those claims once granted. We do notknow whether any of our patent applications or those patent applications thatwe license will result in the issuance of any patents. Our issuedpatents and those that may issue in the future, or those licensed to us, may bechallenged, invalidated or circumvented, which could limit our ability to stopcompetitors from marketing related products or the length of term of patentprotection that we may have for our products. In addition, there can be noassurance that this patent coverage will be broad enough to prevent third parties from developing or commercializingsimilar or identical technologies and thus the rights granted under any issuedpatents may not provide us with any meaningful competitive advantages againstour competitors. Furthermore, because of the extensive time required fordevelopment, testing and regulatory review of a potential product, it ispossible that, before any of our products can be commercialized, any relatedpatent 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 parties or that we will be able to acquire licenses to the IPrights of third parties under satisfactory terms or at all.

Research and developmentexpenses incurred to develop our intellectual property portfolio, excludingdevelopment costs related to cethromycin, totaled approximately $1.2 millionfor the twelve months ended December 31, 2005.

**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 

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products that are safer,more effective, have fewer side effects or are less expensive than any productsthat we may develop. These third parties compete with us in recruiting andretaining qualified scientific and management personnel, establishing clinicaltrial sites and patient registration for clinical trials, as well as inacquiring technologies and technology licenses complementary to our programs oradvantageous 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, our agreementswith our collaborators do not preclude them from pursuing development effortsusing a different approach from that which is the subject of our agreement withthem. Therefore, any of our product candidates may be subject to competitionwith a product candidate under development by a collaborator.

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.’’

**Government Regulation**

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.

*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 agency enforcementaction 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, or cGMP; and

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·       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 clinical trialscan proceed. If these issues are unresolved, the FDA may not allow the clinicaltrials 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.

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 market the product for one or moreindications. The FDA reviews an NDA to determine, among other things, whether aproduct is safe and effective for its intended use and has a favorablerisk/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 current good manufacturing practices (“cGMP”)compliance is considered satisfactory. The FDA will issue an approval letter ifit determines that the application, manufacturing process and manufacturingfacilities are acceptable. If the FDA determines the application, manufacturingprocess or manufacturing facilities are not acceptable; it will outline the deficiencies in the submission and often willrequest additional testing or information. 

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Notwithstandingthe submission of any requested additional information, the FDA ultimately maydecide that the application does not satisfy the regulatory criteria forapproval.

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 the approvedproduct, such as adding new indications, manufacturing changes and additionallabeling 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 must continueto conform to cGMP after approval. The FDA periodically inspects manufacturing facilities to assess compliance with cGMP, whichimposes numerous procedural and documentation requirements. Accordingly,manufacturers must continue to expend time, money and effort in the area ofproduction and quality control to maintain compliance with cGMP and otherregulations.

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 a product,or the failure to comply with requirements, may result in restrictions on aproduct, manufacturer or holder of an approved NDA, including withdrawal orrecall of the product from the market orother voluntary or FDA-initiated action that could delay further marketing.Newly discovered or developed safety or efficacy data may requirechanges to a product’s approved labeling, including the addition of newwarnings and contraindications. Also, new government requirements may beestablished that could delay or prevent regulatory approval of our productsunder 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 

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authorization,the disputed points are eventually referred to the European Commission, whosedecision is binding 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 the reimbursementstatus of newly approved healthcare product candidates. We may need to conductexpensive 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. In addition, an increasing emphasis on managed care in theUnited States has increased and will continue to increase the pressure onpharmaceutical 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 31,2005, we employed 18 people of which there are 7 in research and 11 inadministration. Our employees are not represented by any collective bargainingagreements and we believe our employee relations are good.

**Available Information**

Copiesof our Annual Report 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 

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with, or furnish it to, the Securities and ExchangeCommission at 450 Fifth Street, N.W., Washington DC 20549.

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

**Risks Related to Our Industry and Business**

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

We have not received FDAapproval for any of our product candidates. Any compounds that we discover orin-license will require extensive and costly development, preclinical testingand/or clinical trials prior to seeking regulatory approval for commercialsales. Our most advanced product candidate, cethromycin, and any othercompounds we discover, develop or in-license, may never be approved forcommercial sale. The time required to attain product sales and profitability islengthy and highly uncertain, and we cannot assure you that we will be able toachieve 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$46.7 million as of December 31, 2005. Our operating losses are due inlarge part to the significant research and development costs required toidentify, validate and license potential product candidates, conductpreclinical studies and conduct clinical trials of our more advanced productcandidates. To date, we have generated only limited revenues, consisting ofmanagement fees and one-time or limited payments associated with ourcollaborations or grants, and we do not anticipate generating any significantrevenues for at least the next several years, if ever. We expect to increaseour operating expenses over the next several years as we plan to:

·       expand the clinical trialprogram for cethromycin;

·       continue the preclinicaldevelopment and commence the clinical development of our other productcandidates, such as ALS-886 and ALS-357;

·       expand our research and developmentactivities;

·       acquire or in-license newtechnologies and product candidates; and

·       increase our requiredcorporate infrastructure and overhead.

As a result, we expect tocontinue to incur significant and increasing operating losses for the foreseeablefuture. Because of the numerous risks and uncertainties associated with ourresearch and product development efforts, we are unable to predict the extentof any future losses or when we will become profitable, if ever. Even if we doachieve profitability, we may not be able to sustain or increase profitabilityon an ongoing 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.

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To the extent we raiseadditional capital by issuing equity securities, our stockholders couldexperience substantial dilution. Any additional equity securities we issue mayhave rights, preferences or privileges senior to those of existing holders ofstock, including purchasers of our common stock in the offerings. To the extentthat we raise additional funds through collaboration and licensingarrangements, we may be required to relinquish some rights to our technologiesor product candidates, or grant licenses on terms that are not favorable to us.

***Our business would be materially harmed if our twopivotal Phase 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 have commenced two pivotal Phase III clinical trials, thefirst of which was begun in December 2005, of cethromycin for thetreatment of mild-to-moderate community acquired pneumonia. Prior to licensingthe compound to us, Abbott Laboratories conducted an initial Phase III clinicaltrial of cethromycin for the treatment of community acquired pneumonia.Although the results of this study met the primary endpoints for efficacy, thisis no assurance that our pivotal Phase III clinical trials will be successful.

The Abbott study used cethromycin dosing levels of 150mg once-daily and 150 mg twice-daily. Our proposed pivotal Phase III protocoluses a dosing level of 300 mg once-daily, even though Abbott was able todemonstrate efficacy at 150 mg once-daily. We do not expect that the differentdosing regimen will reduce the effectiveness of cethromycin in our pivotalPhase III clinical trials, but we could be incorrect. Clinical trials at thehigher dosage level are also likely to increase the frequency of adverse sideeffects. The Abbott study did not include a standard of care comparator arm.Antibiotic products currently in the marketplace are generally effective and,for this reason, the required threshold to demonstrate non-inferiority for newantibiotic compounds is often very high. There can be no assurance that ourpivotal Phase III clinical trials of cethromycin will establish non-inferioritywhen a comparator arm is applied.

The success of our pivotalPhase III clinical trials in treating mild-to-moderate community acquired pneumoniamay depend on many factors that are beyond our control and unrelated to thesafety or efficacy of cethromycin. For instance, clinical studies maydemonstrate lower than expected cure rates because of the lack of patientcompliance with prescribed dosing regimens. Cethromycin is our most advancedproduct candidate, and, as a company, we do not have any prior experience inconducting Phase III clinical trials. If we are unable to complete these trialssuccessfully or ultimately receive FDA marketing approval for cethromycin, ourability to generate revenues and our business will be materially harmed.

***Prior clinical trials of cethromycin have shownevidence of side effects that may diminish its prospects for commercializationand wide market acceptance.***

The gastrointestinaladverse events reported in prior clinical trials of cethromycin were generallyat frequencies consistent with Ketek and other antibiotic treatments. Thesegastrointestinal side effects included nausea, diarrhea, vomiting and abdominalpain. Taste perversion was the adverse event most frequently observed in priorclinical trials of cethromycin, occurring in 17% of subjects across once-dailydosing regimens of 150 mg, 300 mg and 600 mg. According to available data,taste perversion has not occurred at any significant level for other antibiotictreatments. We do not believe that, by itself, taste perversion presents asafety risk for patients. However, taste perversion may lead to higher levelsof patient non-compliance, which could have the effect of reducing overall curerates in our planned pivotal Phase III clinical trials of cethromycin. Ifoverall cure rates in our pivotal Phase III clinical trials are not sufficientto establish non-inferiority, we may not receive FDA approval for cethromycinand our business will be materially harmed.

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***Prior pivotal Phase III comparator trials ofcethromycin in the treatment of bronchitis and pharyngitis failed to establishnon-inferiority, and our inability to expand cethromycin into these indicationswould harm our ability to generate additional revenues in the future.***

Abbott Laboratoriesconducted four pivotal Phase III comparator trials for cethromycin in treatingbronchitis and pharyngitis at a dosing level of 150 mg once-daily. Each ofthese trials failed to establish non-inferiority against comparatorantibiotics. While we believe that the negative outcomes of the Abbottcomparator trials were related to dosing levels, we may be incorrect. Thefailure to meet primary endpoints in the Abbott trials may not have been doserelated, as we believe, but rather a result of the compound’s lack ofsufficient clinical efficacy. Clinical trials using a 300 mg once-daily regimenare also likely to increase the occurrence of adverse side effects. Even if wereceive FDA approval to market cethromycin for the treatment of communityacquired pneumonia, our failure to expand cethromycin into other indicationswould harm our ability to generate additional revenues in the future.

***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 byfactors beyond 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 National Institutes ofHealth, the University of Illinois at Chicago, Argonne National Laboratory andBaxter International. A description of our agreements with collaborators can befound under the headings ‘‘Business—Abbott Laboratories Collaboration’’ and ‘‘Business—OtherCollaborations and License Agreements.’’ Our collaborations generally presentadditional risks to our business, such as the risk that our collaboratorsencounter conflicts of interest to their arrangements with us, inadequatelydefend our intellectual property rights or develop other products that competewith us. Our ability to generate any significant product revenues in the nearfuture will depend solely on the successful commercialization of cethromycin.If for any reason we are unable to realize the expected benefits of our licenseagreement with Abbott, or under any of our other collaborations, then ourbusiness and financial condition may be materially harmed.

***If we are unable to restructure the debt and jointventure relationship with the State Government of Sarawak, Malaysia, then ourdevelopment program for Calanolide A may be delayed or abandoned.***

The intellectual property for Calanolide A is held bySarawak MediChem Pharmaceuticals, Inc., our 50/50 joint venture with theState Government of Sarawak, Malaysia. The original intent of our businessrelationship was that we would contribute intellectual property and managementto the joint venture and our partner would provide funding. To advanceCalanolide A, the Sarawak Government funded $9.0 million by purchasing its 50%equity position and loaned an additional $12.0 million to the joint venture.According to the terms of the loan agreement with the Sarawak Government, $12.0million of this debt is past due. As a resultof this default in payment by the joint venture, the Sarawak Governmenthas the option under the loan agreement to take over the control and managementof the Calanolide A project or the affairs of the joint venture until such timeas the loan is repaid in full. In July 2005, the Sarawak Governmentasserted its rights to assume control of the management of the joint venture.In December 2005, the Sarawak Government nominated and the Board ofDirectors of SMP approved the appointment of Mr. Jumastapha bin Lamat asthe controlling officer of SMP. Since that time we have been transitioningaccess to the joint venture’s accounting, financial and corporate records torepresentatives of Mr. Lamat. The Sarawak Government also expresslyreserved all contractual and legal remedies available in light of the defaultand indicated its intent to fully exercise its rights as a creditor of thejoint venture. 

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Ultimately, we believethat in order for the joint venture to continue, the terms of the debt must beamended to extend its maturity to a date after commercialization of CalanolideA.

Further development will require that we and theSarawak Government agree to restructure and extend the debt and determine thesource of financing for Phase IIa clinical trials of Calanolide A. No agreementhas yet been reached, and we do not intend to expend any meaningful fundsadvancing the development of Calanolide A unless and until we restructure thejoint venture’s debt and reach a satisfactory agreement with the SarawakGovernment to amend our joint venture relationship and establish our respectiveobligations regarding the future funding of the next phase of developingCalanolide A. As a result, we are unable to predict when, or if at all, we willproceed with our plans to commence Phase IIa clinical trials for Calanolide A.

Further,our joint venture agreement with the Sarawak Government provides that, upon terminationof the joint venture, any liabilities of the joint venture will be settled bythe parties equallyand all patents orlicenses of the joint venture shall be reassigned back to us, including rightsto clinical trials. If we and the SarawakGovernment are unable to restructure the debt of the joint venture or if anydispute arises with the Sarawak Government, then our ability to continue thedevelopment of Calanolide A may be adversely affected, and we may cease futureparticipation in the program. See ‘‘Business—Other Collaborations andLicense Agreements—Sarawak MediChem Pharmaceuticals, Inc.’’

***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.***

Onlytwo product candidates in our development pipeline, cethromycin and CalanolideA, have been tested in clinical trials. Our other product candidateshave only been through preclinical studies.Positiveresults from preclinical studies, particularly*in vitro*studies, are no assurance thatlater clinicaltrials will succeed.Preclinical trials are not designed to establish the clinical efficacy of ourpreclinical productcandidates. Wewill be required to demonstrate through clinical trials that these productcandidates are safe and effective for use before we can seek regulatoryapprovals for their commercial sale. There is typically an extremely high rateof failure as product candidates proceed through clinical trials. If ourproduct candidates fail to demonstrate sufficient safety and efficacy in anyclinical trial, we would experience potentially significant delays in, or berequired to abandon, development of that product candidate. This wouldadversely affect our ability to generate revenues and may damage our reputationin 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 planned clinicaltrials will begin on time, if at all. Delays in the commencement of clinicaltesting could significantly increase our product development costs and delayproduct commercialization. In addition, many of the factors that may cause, orlead to, a delay in the commencement of clinical trials may also ultimatelylead to denial of regulatory approval of a product candidate. Each of theseresults would adversely affect our ability to generate revenues.

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

·       demonstrating sufficientsafety to obtain regulatory approval to commence a clinical trial;

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·       reaching agreement onacceptable terms with prospective contract research organizations and trialsites;

·       manufacturing sufficientquantities of a product candidate; and

·       obtaining institutionalreview board approvals to conduct clinical trials at prospective sites.

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 theprotocol, the proximity of patients to clinical sites, the availability ofeffective treatments for the relevant disease, and the eligibility criteria forthe clinical trial. Because community acquired pneumonia is generally seasonalin nature, achieving sufficient patient enrollment for our pivotal Phase IIIclinical trials of cethromycin may be particularly difficult.

The FDA required one ofour competitors, Aventis Pharmaceuticals, to undertake a 24,000 patient safetystudy prior to approving Ketek® forcommercialization. We do not expect the FDA to require a similarly sized trialfor cethromycin because Ketek was the first ketolide introduced and no previoussafety testing had been conducted for this class of antibiotics. Abbott’sstudies to date and our ongoing clinical program will include monitoring ofcardiac and hepatic safety. Since that time, Ketek has been administered toover ten million patients and, to our knowledge, has not demonstrated any severesafety risks with the exception of one recent article that reported the casehistory of three patients who experienced liver toxicity. The FDA, through abulletin on their website, recommended physicians watch for potential livertoxicity issues of patients prescribed Ketek.  If the FDA does require a large safety trialfor cethromycin, however, it would significantly increase our costs and extendthe time required to receive regulatory approval.

***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 intend to engagecontract research organizations to perform data collection and analysis andother aspects of our clinical trials of cethromycin and our other productcandidates. We do not have the physical and human resources to conduct ourclinical trials independently. The contract research organizations we engagewill interact with clinical investigators and medical institutions to enrollpatients in our clinical trials. As a result, we will depend on these clinicalinvestigators, medical institutions and contract research organizations toperform the studies and trials properly. If these parties do not successfullycarry out their contractual duties or obligations or meet expected deadlines,or if the quality, completeness or accuracy of the clinical data they obtain iscompromised due to the failure to adhere to our clinical protocols or for otherreasons, our clinical trials may be extended, delayed or terminated. Many ofthese factors will be outside of our oversight and beyond our control. We maynot be able to enter into replacement arrangements without undue delays orconsiderable expenditures. If there are delays in testing or regulatoryapprovals as a result of the failure to perform by third parties, our drugdiscovery and development costs will increase, and we may not be able to obtainregulatory approval for our product candidates. In addition, we may not be ableto establish or maintain relationships with these parties on favorable terms,if at all.

 

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***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 NDA we submit. If we are unable to submit an NDA for cethromycin or anyother product candidate, or if any NDA we submit is not approved by the FDA, wewill be unable to commercialize that product in the United States. The FDA canand does reject NDAs, and often requires additional clinical trials, even whenproduct candidates performed well or achieved favorable results in large-scalePhase III clinical trials. The FDA imposes substantial requirements on theintroduction of pharmaceutical products through lengthy and detailed laboratoryand clinical testing procedures, sampling activities and other costly andtime-consuming procedures. Satisfaction of these requirements typically takesseveral years and may vary substantially based upon the type and complexity ofthe pharmaceutical product. A number of our product candidates are novelcompounds, which may further increase the period of time required forsatisfactory 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 of governmentregulation may be to delay or prevent the commencement of clinical trials ormarketing of our product candidates for a considerable period of time, toimpose costly procedures upon our activities and to provide an advantage to ourcompetitors that have greater financial resources or are more experienced inregulatory affairs. The FDA may not approve our product candidates for clinicaltrials or marketing on a timely basis or at all. Delays in obtaining or failureto obtain such approvals would adversely affect the marketing of our productcandidates and our liquidity and capital resources.

Drug products and theirmanufacturers are subject to continual regulatory review after the productreceives FDA approval. Later discovery of previously unknown problems with aproduct or manufacturer may result in additional clinical testing requirementsor restrictions on such product or manufacturer, including withdrawal of theproduct from the market. Failure to comply with applicable regulatoryrequirements can, among other things, result in fines, injunctions and civilpenalties, suspensions or withdrawals of regulatory approvals, product recalls,operating restrictions or shutdown and criminal prosecution. We may lacksufficient resources and expertise to address these and other regulatory issuesas they arise.

***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 ourproducts outside of the United States, we must comply with numerous and varyingregulatory requirements of other countries. Approval procedures vary amongcountries and can involve additional product testing and additionaladministrative review periods. The time required to obtain approval in othercountries might differ from that required to obtain FDA approval in the UnitedStates. Regulatory approval in one country does not ensure regulatory approvalin another, but a failure or delay in obtaining regulatory approval in onecountry may negatively impact the regulatory process in others. The risksinvolved in the non-U.S. regulatory approval process, as well as theconsequences for failing to comply with applicable regulatory requirements,generally include the same considerations as in the United States. Adescription of U.S. regulatory considerations can be found under the sectionentitled ‘‘—Even if we successfully complete clinical trials of cethromycin orany other product candidate, we may fail to obtain FDA approval of a new drugapplication.’’

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***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:

·       our ability to provideacceptable evidence of safety and efficacy;

·       relative convenience andease of administration;

·       the prevalence and severityof any adverse side effects;

·       the availability ofalternative treatments;

·       the details of FDA labelingrequirements, including the scope of approved indications and any safetywarnings;

·       pricing and costeffectiveness;

·       the effectiveness of our orour collaborators’ sales and marketing strategy;

·       our ability to obtainsufficient third-party insurance coverage or reimbursement; and

·       our ability to have theproduct 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 or are more cost effective. Complicationsmay also arise, such as antibiotic or viral resistance, that render ourproducts obsolete. We rely on the favorable resistance profile of cethromycinexhibited in clinical trials to be a potential competitive distinction fromcurrently marketed compounds. Even if we receive FDA approval to marketcethromycin, antibiotic resistance may emerge that will substantially harm ourability to generate revenues from its sale.

We are initially seekingFDA approval for cethromycin as a 7 day treatment regimen. There are currentlya number of antibiotic products that are marketed as 5-day therapies. Inthe event that the marketplace considers this to be a significant competitivedistinction, it is uncertain whether we will be able to make cethromycinavailable for a lower dosing period. In addition, we expect that cethromycin,if approved for sale, would be used primarily in the outpatient setting.

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

Initially, we planto conduct pivotal Phase III clinical trials of cethromycin for the treatmentof mild-to-moderate community acquired pneumonia. We also intend to pursueopportunities for cethromycin in the treatment of other respiratory tractinfections such as bronchitis, sinusitis and pharyngitis. There are severalclasses of antibiotics that are primary competitors for the treatment of one ormore of these indications, including:

·       macrolides such as Biaxin®(clarithromycin), a product of Abbott Laboratories; and Zithromax®(azithromycin), a product of Pfizer Inc.;

·       one other ketolideantibiotic, Ketek® (telithromycin), recently launched in the United Statesand Europe by Aventis Pharmaceuticals;

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·       semi-synthetic penicillinssuch as Augmentin® (amoxicillin and clavulanate potassium), a product ofGlaxoSmithKline; and

·       fluoroquinolones such asLevaquin®(levofloxacin), a product of Ortho-McNeil Pharmaceutical, Inc.; Tequin®(gatifloxacin), a product of Bristol-Myers Squibb Company; FACTIVE®(gemifloxacin mesylate) tablets, a product of Oscient Pharmaceuticals; and Cipro®(ciprofloxacin) and Avelox® (moxifloxacin), both products of Bayer Corporation.

If cethromycin is approvedby the FDA, it will not be the first ketolide antibiotic introduced to themarketplace. Ketek has been available for sale in Europe since 2002 and in theUnited States since August 2004. There are several additional ketolideproduct candidates in preclinical development or entering clinical development,including ABT-210, a second-generation ketolide antibiotic productcandidate that we transferred back to Abbott Laboratories in July 2005. Ifultimately approved by the FDA, these product candidates may have improvedefficacy, ease of administration or side effect profiles when compared tocethromycin. The availability of additional ketolide antibiotics may have anadverse affect on our ability to generate product revenues and achieveprofitability.

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

Many generic antibioticsare currently prescribed to treat respiratory tract infections. As competitiveproducts lose patent protection, makers of generic drugs will likely begin tomarket additional competing products. Companies that produce genericequivalents are generally able to offer their products at lower prices. Ketekmay lose patent protection as early as 2015, which would enable generic drugmanufacturers to sell generic ketolide antibiotics at a lower cost thancethromycin. Generic equivalents of Biaxin and Zithromax, two macrolideantibiotic products are available. Cethromycin, if approved for commercialsale, may be at a competitive disadvantage because of its higher cost relativeto generic products. This may have an adverse effect on our ability to generateproduct revenues from cethromycin.

***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 18 employees.Many of our competitors, such as Pfizer, GlaxoSmithKline and Bayer, are largepharmaceutical companies with substantially greater financial, technical andhuman resources than we have. The biotechnology and pharmaceutical industriesare intensely 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 nothave any prior experience in conducting Phase III clinical trials. Ourcompetitors may succeed in obtaining FDA or other regulatory approvals forproduct candidates more rapidly than us. Companies that complete clinicaltrials, obtain required regulatory agency approvals and commence commercialsale of their drugs before we do may achieve a significant competitiveadvantage, including certain FDA marketing exclusivity rights that would delayor prevent our ability to market certain products. Any approved drugs resultingfrom our research and development efforts, or from our 

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jointefforts with our existing or future collaborative partners, might not be ableto compete successfully with our competitors’ existing or future products.

***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 ourproduct candidates has been manufactured in small quantities by ourcollaborators and third party manufacturers for preclinical and clinicaltrials. We do not currently have any agreements with third party manufacturers.If any of our product candidates is approved by the FDA or other regulatoryagencies for commercial sale, we will need to enter into agreements with thirdparties to manufacture the product in larger quantities. Due to factors beyondour control, our collaborators and third party manufacturers may not be able toincrease their manufacturing capacity for any of our product candidates in atimely or economic manner, or at all. Significant scale-up of manufacturing mayrequire additional validation studies, which the FDA must review and approve.If we are unable to increase the manufacturing capacity for a product candidatesuccessfully, the regulatory approval or commercial launch of that productcandidate may be delayed or there may be a shortage in the supply of theproduct candidate. Our product candidates require precise, high-qualitymanufacturing. The failure of our collaborators and third party manufacturersto achieve and maintain these high manufacturing standards, including theincidence of manufacturing errors, could result in patient injury or death,product recalls or withdrawals, delays or failures in product testing ordelivery, 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 currentlyhave product sales and marketing capabilities. If we receive regulatoryapproval to commence commercial sales of any of our product candidates, we willhave to establish a sales and marketing organization with appropriate technicalexpertise and distribution capabilities or make arrangements with third partiesto perform these services. If we receive approval to commercialize cethromycinfor the treatment of community acquired pneumonia, we intend to market theproduct directly in the United States. Our ability to generate any significantrevenues in the near-term is dependent entirely on the successfulcommercialization and market acceptance of cethromycin. Factors that mayinhibit our efforts to commercialize cethromycin or other product candidateswithout strategic partners or licensees include:

·       difficulty recruiting andretaining adequate numbers of effective sales and marketing personnel;

·       the inability of salespersonnel to obtain access to, or persuade adequate numbers of, physicians toprescribe our products;

·       the lack of complementaryproducts to be offered by sales personnel, which may put us at a competitivedisadvantage against companies with broader product lines; and

·       unforeseen costs associatedwith creating an independent sales and marketing organization.

As an alternative toestablishing our own sales and marketing organization, we may 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.

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

If any of our productcandidates receives marketing approval, we will only be permitted to promotethe product for the uses indicated on the label cleared by the FDA. Our pivotalPhase III clinical trials of cethromycin are for the treatment ofmild-to-moderate community acquired pneumonia,although we believe that cethromycin may have other applications in bronchitis,pharyngitisand sinusitis. If werequest additional label indications for cethromycin or our other productcandidates, the FDA may deny those requests outright, require extensiveclinical data to support any additional indications or impose limitations onthe intended 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:

·       we may be unable topurchase or license products or product candidates on terms that would allow usto make an appropriate return from resulting products;

·       competitors may beunwilling to assign or license product or product candidate rights to us;

·       we may not have access tothe capital necessary to purchase or license products or product candidates; or

·       we may be unable to locatesuitable products or product candidates within, or complementary to, our areasof interest.

If we are unable to obtainrights to new products or product candidates from third parties, our ability togenerate product revenues and achieve profitability may suffer.

***Because our product candidates and development andcollaboration efforts depend on our intellectual property rights, adverseevents affecting our intellectual property rights will harm our ability tocommercialize products.***

Our success will depend to a large degree on our own,our licensees’ and our licensors’ ability toobtain and defend patents for each party’s respective technologies and thecompounds and other products, if any, resulting from the application ofsuch technologies. 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.

The degree offuture protection for our proprietary rights is uncertain, and we cannot ensurethat:

·       we were the first to makethe inventions covered by each of our pending patent applications;

·       we were the first to filepatent applications for these inventions;

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·       others will notindependently develop similar or alternative technologies or duplicate any ofour technologies;

·       any of our pending patentapplications will result in issued patents;

·       any patents issued to us orour collaborators will provide a basis for commercially viable products, willprovide us with any competitive advantages or will not be challenged by thirdparties;

·       we will develop additionalproprietary technologies that are patentable; or

·       the patents of others willnot have a negative effect on our ability to do business.

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.

***Confidentiality agreements with employees and othersmay not adequately prevent disclosure of trade secrets and other proprietaryinformation and may not adequately protect our intellectual property.***

We rely on trade secretsto protect our technology, particularly when we do not believe patent protection is appropriate or obtainable. However,trade secrets are difficult to protect. In order to protect ourproprietary technology and processes, we rely in part on confidentiality andintellectual property assignment agreementswith our corporate partners, employees, consultants, outside scientificcollaboratorsand sponsoredresearchers and other advisors. These agreements may not effectively preventdisclosure ofconfidential informationnor result in the effective assignment to us of intellectual property, and maynot provide an adequate remedy in the event of unauthorized disclosureof confidential information or other breaches of the agreements. In addition,others may independently discover our trade secrets and proprietaryinformation, and in such case we could not assert any trade secret rightsagainst such party. Enforcing a claim that a party illegally obtained and isusing our trade secrets is difficult, expensive and time consuming, and theoutcome is unpredictable. In addition, courts outside the United States may beless willing to protect trade secrets. Costly and time-consuming litigationcould be necessary to seek to enforce and determine the scope of ourproprietary rights, and failure to obtain or maintain trade secret protectioncould adversely affect our competitive business position.

***Market acceptance and sales of our product candidateswill be severely limited if we cannot arrange for favorable reimbursementpolicies.***

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 the pricescharged for medical products and services. Also, the trend toward managedhealthcare in the United States, as well as legislative proposals to reformhealthcare, control pharmaceutical prices or reduce government insuranceprograms, may also result in exclusion of our product candidates from reimbursementprograms. Because many generic antibiotics are available for the treatment ofrespiratory tract infections, our ability to list cethromycin on insurancecompany formularies will depend on its 

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effectivenesscompared to lower-cost products. The cost containment measures that health carepayors and providers are instituting, and the effect of any health care reform,could materially and adversely affect ourability to earn revenues from the sales of cethromycin and our otherproduct candidates.

***The recent Medicare prescription drug coveragelegislation and future legislative or regulatory reform of the healthcaresystem could limit future revenues from our product candidates.***

In the United States, there have been a number oflegislative and regulatory proposals to change the healthcare system in waysthat could affect our ability to market and sell our product candidatesprofitably. In particular, in December 2003, President Bush signed intolaw new Medicare prescription drug coverage legislation. Under thislegislation, the Centers for Medicare and Medicaid Services, or CMS, the agencywithin the Department of Health and Human Services that administers Medicareand 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, which became law in December 2003,requires the Secretary of the U.S. Department of Health and Human Services topromulgate regulations allowing drug reimportation from Canada into the United States under certain circumstances. Theseprovisions 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 under circumstances beyond those anticipated undercurrent law. If legislation is enacted, or regulations issued, allowingthe reimportation of drugs, it could decrease the reimbursement we receive forany products that we may commercialize, negatively affecting our anticipatedrevenues and prospects for profitability.

***We will need to increase the size of our organization,and we may encounter difficulties managing our growth, which could adverselyaffect our results of operations.***

We are currently adevelopment stage company with 18 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 andprocedures and to attract and retain sufficient numbers of talented employees.We may be unable to successfully manage theexpansion of our operations or operate on a larger scale and, accordingly, maynot achieve our research, development and commercialization goals.

***If we are unable to attract and retain qualifiedscientific, technical and key management personnel, or if any of our keyexecutives, Michael T. Flavin, Ph.D., Ze-Qi Xu, Ph.D., or John L. Flavin,discontinues his employment with us, it may delay our research and developmentefforts.***

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, or John L. Flavin, our President. We do not currently haveany key man life insurance 

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policies.We have entered into employment agreements with members of our seniormanagement team, but this does not ensure that we will retain their servicesfor any period of time in the future. Our research and drug discovery programsalso depend on our ability to attract and retain highly skilled chemists,biologists and preclinical and clinical personnel. We may not be able toattract or retain qualified scientific personnel in the future due to intensecompetition among biotechnology and pharmaceutical businesses, particularly inthe Chicago area. If we are not able to attract and retain the necessarypersonnel to accomplish our business objectives, we may experience constraintsthat will significantly impede the achievement of our research and developmentobjectives and our ability to meet the demands of our collaborators in a timelyfashion.

***Our business will expose us to potential productliability risks and there can be no assurance that we will be able to acquireand maintain sufficient insurance to provide adequate coverage againstpotential 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 largejudgments in class action lawsuits based on drugs that had unanticipated sideeffects. A successful product liability claim or series of claims broughtagainst us would decrease our cash reserves and could cause our stock price tofall significantly.

***We face regulation and risks related to hazardousmaterials and environmental laws, violations of which may subject us to claimsfor damages or fines that could materially affect our business, financialcondition 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 futureenvironmental laws and regulations. We do not currently have a pollution andremediation insurance 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, warand telecommunication and electrical failures. Our drug discovery andpreclinical testing systems are highly technical and proprietary. Any systemfailure, accident or security breach that causes interruptions in ouroperations could result in a material disruption of our drug discoveryprograms. To the extent that any disruption or security breach results in aloss or damage to our data or applications, or inappropriate disclosure ofconfidential or proprietary information, we may incur liability as a result,our drug discovery programs may be adversely affected and the furtherdevelopment of our product candidates may be 

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delayed.In addition, we may incur additional costs to remedy the damages caused bythese disruptions or security breaches.

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

None.

**Item 2.**                        *Properties.*

In September of 2003,we relocated our operations to our new Advanced Life Sciences ProductDevelopment Center in Woodridge, Illinois, which houses our corporate officesand chemistry and biology laboratories. TheProduct Development Center consists of approximately 15,000 square feet oflaboratory and office space. We believe that our current facilities areadequate to meet our needs for the foreseeable future. Our facilities areleased and our current lease expires in September 2008. We believe thatsuitable additional or alternative space will be available in the future oncommercially 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 securityholders during the quarter ended December 31, 2005.

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**PART II**

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

**OnAugust 4, 2005, we sold 6,400,000 shares of our common stock as part ofour initial public offering. In addition, through a concurrent offering, weissued Abbott Laboratories 600,000 shares of common stock in exchange for a$3.0 million reduction of a milestone payment under our license agreement.The Company’s Common Stock is listed on the Nasdaq National Market under thesymbol ADLS. The following table provides the high and low sales prices asreported for the periods indicated.**

| ** **                                                  | ** ** | **High** | ** ** | **Low** | ** ** |
|-------------------------------------------------------------|------------|----------|------------|---------|------------|
| Period from  August 4, 2005 to September 30, 2005 |       | $        | 5.81       |    | $          | 4.61 |   |
| Quarter ended  December 31, 2005                       |       | $        | 5.06       |    | $          | 3.00 |   |

 

As of March 13, 2006, there were approximately 44shareholders of record of our common stock.

As of March 13, 2006,the 250,000 shares of Advanced Life Sciences, Inc.’s preferred stock washeld by deCODE Genetics.

**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 the Company’s financial condition,capital requirements, result of operations, contractual limitations and otherfactors deemed relevant by the Board of Directors. As of December 31,2005, cumulative accrued undeclared dividends on our subsidiary’s  preferred stock totaled approximately $1.1 million.

**EquityCompensation Plan Information**

The following table sets forth information regardingall securities that could be issued through the exercise of stock options andwarrants:

| ** **                                                        | ** ** | **Number of securities to be** | ** ** | ** **                                       | ** ** | **Number of securites remaining available for** | ** ** |
|-------------------------------------------------------------------|------------|----------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------------------------------|------------|
| ** **                                                        | ** ** | **issued upon exercise of**         | ** ** | **Weighted-average exercise**               | ** ** | **future issuance under equity compensation**        | ** ** |
| ** **                                                        | ** ** | **outstanding options,**                      | ** ** | **price of outstanding options,** | ** ** | **plans (excluding securities reflected in**         | ** ** |
| **Plan Category**                                            | ** ** | ** **                                         | ** ** | **warrants and rights**                | ** ** | **warrants and rights**                                        | ** ** | **column a)** | ** ** |
| ** **                                                        | ** ** | **(a)**                                            | ** ** | **(b)**                                          | ** ** | **(c)**                                                                  | ** ** |
| Equity compensation plans approved by security  holders           |       |                                               | 950,721    |                                             |       |                                                                     | $          | 5.54 |   |   |   | 1,031,012 |   |   |
| Equity compensation plans not approved by security  holders  |       |                                               | —     |                                             |       |                                                                     | —     |   |   |   | — |   |   |
| Total                                                             |       |                                               | 950,721    |                                             |       |                                                                     | $          | 5.54 |   |   |   | 1,031,012 |   |   |
|                                                                   |            |                                                    |            |                                                  |            |                                                                          |            |  |  |  |  |  |  |  |  |  |

 

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**RecentSales of Unregistered Securities**

The following listsets forth information regarding all securities sold by us since January 1,2003:

(1)          On December 13,2004, in connection with our recapitalization, we issued (i) 7,852,330shares of common stock to Flavin Ventures, LLC at a purchase price of $1.46 pershare, giving effect to unallocated contributions of capital made by FlavinVentures, LLC; (ii) 1,588,000 shares of common stock to the Michael T.Flavin Revocable Trust, in exchange for 1,588,000 shares of common stock ofAdvanced Life Sciences, Inc., our current operating subsidiary and (iii) 41,685shares of common stock to Karen Stec, in exchange for 41,685 shares of commonstock of Advanced Life Sciences, Inc.

(2)          On December 13,2004, in connection with and as consideration for our license of cethromycinand ABT-210 from Abbott Laboratories, we issued 1,122,569 shares of ourcommon stock to Abbott Laboratories.

(3)          On December 13,2004, we issued a warrant to purchase up to 14,887 shares of our common stockat an exercise price of $8.02 per share to Leaders Bank, in connection withentering our bank line of credit with Leaders Bank.

(4)          On February 8,2005, we issued 151,534 shares of common stock to Flavin Ventures, LLC at a purchaseprice of $8.02 per share, giving effect to unallocated contributions of capitalmade by Flavin Ventures, LLC.

(5)          On February 8,2005, we issued 70,284 shares of common stock to accredited investors at apurchase price of $8.02 per share.

(6)          Since the adoption ofour 1999 and 2005 Stock Incentive Plans, we have granted options to purchase1,048,158 shares of common stock to employees, directors and consultants atexercise prices ranging from $0.157 to $8.02 per share. Of the 1,048,158options granted, 935,834 remain outstanding, 6,715 were terminated and 105,609shares of common stock have been purchased pursuant to the exercises of stockoptions for the aggregate consideration of $21,424.

(7)          On March 3, 2006,we issued 10,233,464 shares of common stock to institutional investors for apurchase price of $3.53 per share and warrants to purchase an additional5,116,732 shares of common stock for an exercise price of $3.81 per share.

The offers, sales, andissuances of the securities described in paragraphs 1, 2, 3, 4, 5 and 7 weredeemed to be exempt from registration under the Securities Act in reliance on Section 4(2) ofthe Securities Act in that the issuance of securities to the recipients did notinvolve a public offering. The offers, sales and issuances of the options andcommon stock described in paragraph 6 were deemed to be exempt fromregistration under the Securities Act in reliance on Rule 701 in that thetransactions were under compensatory benefit plans and contracts relating tocompensation as provided under such rule. The recipients of such options andcommon stock were our employees, directors or bona fide consultants andreceived the securities under our 1999 Stock Incentive Plan. Appropriatelegends were affixed to the securities issued in these transactions. Each ofthe recipients of securities in these transactions had adequate access, throughemployment, business or other relationships, to information about us.

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

The followingselected consolidated financial data should be read in conjunction with ourconsolidated 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**      | ** ** |
| **Statement of Operations Data:**      | ** ** | **2005**                                    | ** ** | **2004**    | ** ** | **2003**    | ** ** | **2002**   | ** ** | **2001**   | ** ** | **December 31, 2005** | ** **  |
| Revenue                                               |       | $                                           | 121,451    |        | $          | 319,780     |       | $          | 180,427    |       | $          | 496,207                         |        | $ | 225,218 |   |   | $ | 2,202,201 |   |   |
| Operating expenses                                    |       |                                        |       |        |       |        |       |       |       |       |       |                            |        |   |   |
| Research and development(1)                           |       | 3,121,616                                   |       | 25,661,868  |       | 1,362,255   |       | 924,799    |       | 2,771,517  |       |                            | 39,913,535  |   |   |
| General and administrative                            |       | 3,237,997                                   |       | 1,649,953   |       | 1,198,722   |       | 668,622    |       | 461,001    |       |                            | 7,635,118   |   |   |
| Loss from  operations                                 |       | (6,238,162                                  | )          | (26,992,041 | )          | (2,380,550  | )          | (1,097,214 | )          | (3,007,300 | )          |                            | (45,346,452 | ) |   |
| Interest income                                       |       | (272,216                                    | )          | —      |       | —      |       | —     |       | —     |       |                            | (272,216    | ) |   |
| Interest expense                                      |       | 478,300                                     |       | 194,877     |       | 170,938     |       | 164,337    |       | 377,029    |       |                            | 1,644,303   |   |   |
| Net other (income)  expense                           |       | 206,084                                     |       | 194,877     |       | 170,938     |       | 164,337    |       | 377,029    |       |                            | 1,372,087   |   |   |
| Net loss                                              |       | (6,444,246                                  | )          | (27,186,918 | )          | (2,551,488  | )          | (1,261,551 | )          | (3,384,329 | )          |                            | (46,718,539 | ) |   |
| Less accumulating  preferred dividends for the period |       | 175,000                                     |       | 175,000     |       | 175,000     |       | 175,000    |       | 175,000    |       |                            | 1,144,792   |   |   |
| Net loss allocable  to common shareholders            |       | $                                           | (6,619,246 | )           | $          | (27,361,918 | )          | $          | (2,726,488 | )          | $          | (1,436,551                      | )           | $ | (3,559,329 | ) |   | $ | (47,863,331 | ) |   |
| Basic and diluted  loss per common share(3)           |       | $                                           | (0.49      | )           | $          | (13.27      | )          | $          | (1.72      | )          | $          | (0.90                           | )           | $ | (2.24 | ) |   |   |   |   |
| Weighted average shares  outstanding(3)               |       | 13,610,694                                  |       | 2,062,351   |       | 1,588,000   |       | 1,588,000  |       | 1,588,000  |       |                            |        |   |   |

 

| **Consolidated Balance Sheet Data:** | ** ** | **2005**    | ** ** | **2004**    | ** ** | **2003**    | ** ** | **2002**    | ** ** | **2001**   | ** ** | ** ** | ** ** |
|-----------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|-------------|------------|------------|------------|------------|------------|
| Cash, Cash equivalents and investments              |       | 15,224,932  |       | 194,555     |       | 61,203      |       | 18,739      |       | 7,846      |       |       |       |   |   |
| Total assets                                        |       | 16,021,910  |       | 1,015,932   |       | 255,127     |       | 146,917     |       | 160,467    |       |       |       |   |   |
| Long-term debt, less current portion                |       | 5,905,634   |       | 2,027,279   |       | 2,000,000   |       | 2,000,000   |       | 2,000,000  |       |       |       |   |   |
| Total liabilities(2)                                |       | 7,726,173   |       | 19,289,733  |       | 2,661,806   |       | 2,339,836   |       | 2,252,835  |       |       |       |   |   |
| Deficit accumulated during development stage        |       | (46,718,539 | )          | (40,274,293 | )          | (13,087,375 | )          | (10,535,887 | )          | (9,274,336 | )          |       |       |   |   |
| Total stockholders  equity (deficit)                |       | 8,295,737   |       | (18,273,801 | )          | (2,406,679  | )          | (2,192,919  | )          | (2,092,368 | )          |       |       |   |   |

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(1)          Amount for 2004 includesapproximately $24.5 million of in-process research and development expenserelated to compounds licensed from Abbott Laboratories in December 2004.See Note 11 to the consolidated financial statements.

(2)          Amount for 2004 includes$14.0 million in payments due in 2005 under our license agreement withAbbott Laboratories executed in December 2004. See Note 11 to theconsolidated financial statements.

(3)          Amounts for 2001 through2004 have been restated to give effect to a 3.97-to-1 stock splitauthorized in June of 2005. See Note 1 to the consolidated financialstatements.

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**Item 7.**                        *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, inflammation and oncology. 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 novel ketolideantibiotic in Phase III clinical development for the treatment of respiratorytract infections. We also have product candidates in earlier stages ofdevelopment for the treatment of indications including HIV,inflammation-related tissue 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 years ended December 31, 2005 and 2004 were$6.4 million and $27.2 million, respectively. As of December 31,2005, we had an accumulated deficit of $46.7 million. Our operations todate have been funded principally through proceeds from our initial publicoffering (“the IPO”), debt and capital contributions made by our founder andcontrolling stockholder and borrowings under our bank line of credit.

We completed our IPO in August of this year,selling 6.5 million shares of our common stock at $5.00 per share,including the exercise of the underwriters over-allotment option. Cash proceedsfrom the offering totaled $28.7 million, net of underwriting commissionsand offering costs. In addition, we completed a concurrent offering of 600,000shares of our common stock at $5.00 per share with Abbott Laboratories, inexchange for a $3.0 million reduction of a $5.0 million milestoneobligation. The remaining $2.0 million milestone obligation wassubsequently paid October 2005.

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.

Since the completion of our offerings, we havemanufactured cethromycin and purchased comparator tablets to be used in Phase III clinical trials. Our PhaseIII trials will compare cethromycin with standard of care therapies forcommunity acquired pneumonia in the U.S., Canada, Europe, Central and SouthAmerica, Australia and New Zealand. The objective will be to establishstatistical non-inferiority against comparators.  The trials will be designed to demonstrate aclinical cure rate non-inferiority endpoint using a 95% confidence interval. Weexpect to have data from these trials in the fourth quarter of 2006.

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.

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**Results of Operations**

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

*Revenueand Income.*   Total revenue and income decreasedby 62% to $121,000 for the twelve months ended December 31, 2005 from$320,000 for the twelve months ended December 31, 2004. Revenue earned in2005 was partly derived through our management agreement with Flavin Ventureswherein we provided management and administrative services to a series ofcompanies jointly owned by Flavin Ventures. The decline in revenue isattributable to a reduction in management fees earned from our managementagreement with Flavin Ventures. We were notified in December 2005 byFlavin Ventures that these management services would no longer be needed. As aresult, we do not expect to derive any revenue from this agreement during 2006.

Management fee revenue derived from our 50/50 jointventure, Sarawak MediChem Pharmaceuticals (“SMP”), is recognized on a cashbasis. Billed and unrecognized revenue was approximately $99,000 and $160,000for the years ended December 31, 2005 and 2004, respectively. Cumulativebilled and unpaid revenue totaled $615,000 for the year ended December 31,2005.

Revenue derived through SBIR grants was $60,000 forthe twelve months ended December 31, 2005 compared to $38,000 for the sameperiod last year. We regularly submit grants to the National Institutes ofHealth and received approval for a Phase I grant in August 2005. Weinitiated work on this $100,000 grant in the fourth quarter of 2005 and expectthat it will be completed during the first quarter of 2006.

Royalties from a related party were $0 and $10,000 forthe years ended December 31, 2005 and 2004, respectively. Royalty revenueis derived through a license with deCODE genetics and is based upon deCODE’ssales 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 $25.7 millionfor the twelve months ended December 31, 2004. The total expense realizedin 2004 of $25.7 million includes an in-process research and developmentcharge totaling approximately $24.5 million related to the license withAbbott Laboratories. Excluding this non-recurring 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 clinicalsupplies and 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, approximately $1.9 million is related to our development ofcethromycin. The remainder of our research and development expenditures in2005, totaling approximately $1.2 million, was expended under our otherearlier-stage development programs.

*Generaland administrative expense.*   General andadministrative expense increased 96% to approximately $3.2 million for theyear ended 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 one-time bonus and stock option compensationcharges paid in connection with the completion of our IPO. In addition, weincurred incremental payroll, benefit and payroll related costs ofapproximately $480,000 related to professional staff hired in 2005 primarily inour finance and investor relations functions.  The remainder of the 2005 increase,approximately $300,000, is attributable to incremental administrative andregulatory costs incurred as we operate as a public company.

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*Interestincome.**  *Interestincome totaled approximately $272,000 for the twelve months ended December 31,2005 compared to $0 for the same period last year and was derived throughinvestments made from our IPO proceeds.

*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 Dr. Flavin were approximately $3.9 million and $2.8 million,respectively, as of December 31, 2005.

***Fiscal year ended December 31, 2004 compared tofiscal year ended December 31, 2003***

*Revenueand Income.**  *Totalrevenue and income increased 77% to $320,000 in 2004 from $180,000 in 2003.Management fees, the largest component of revenue, increased 129% in 2004 to$272,000 from $119,000 in 2003. During 2004 we entered into a managementagreement with Flavin Ventures, a company controlled by our founder and controlling stockholder, to provide administrative andmanagement services to a series of companies jointly owned by FlavinVentures.

Management revenue from our 50/50 joint venture,Sarawak MediChem Pharmaceuticals, is recorded on a cash basis and totaled $0and $119,000 in 2004 and 2003, respectively.Billed and unrecognized management fee revenue totaled $160,000 and $185,000for the years ended December 31, 2004 and 2003, respectively.

Grant revenue decreased by 38% in 2004 to $38,000 from$62,000 in 2003, resulting from the completed funding of a Small BusinessInnovation Research (SBIR) grant. We regularly submit grant applications to theNational Institutes of Health. SBIR grants have a budget of $100,000 and lastbetween six months and one year. Royalties from a related party were $10,000 in2004 compared to $0 in 2003. Royalty revenue is derived through a license withdeCODE genetics and is based upon deCODE’s sales of licensed technology.

*Researchand development expense.**  *Research and development expenses increased $24.3 millionfrom $1.4 million in 2003 to $25.7 million in 2004. Approximately$24.5 million of the 2004 expense incurred relates to our purchase ofin-process research and development for cethromycin from Abbott Laboratories. Cethromycin-related expensesrecognized in 2004 represent $1.5 million of payments and$9.0 million of our common stock issued toAbbott by December 31, 2004 and $14 million in payments thatwere due in 2005 under the terms of the contract. The remainder of our researchand development expenditures in 2004,totaling approximately $1.2 million, was expended under a variety ofearly-stage discovery programs.

*Selling,general and administrative expense.**  *General and administrative expensesincreased 38% to $1.6 million in 2004from $1.2 million in 2003. The increase in general and administrativeexpenses was the result of higher legal, audit and travel expensesassociated with our financing activities and increasedbusiness development efforts in connection with the negotiation and conclusionof our license agreement with Abbott Laboratories. General and administrativeexpense consists primarily of compensation for employees in executive andoperational functions, facilities costs and professional fees for accountingand legal services.

*Interest expense—net.**  *Interest expense—net increased 14%to $195,000 in 2004 from $171,000 in 2003. The increase in interest expense isattributable to the $3.0 million note issued to Leaders Bank in December of2004, which bears interest at the prime rate plus 0.75% per annum. Inconnection with this note, we issued warrants to purchase 14,887 shares of ourcommon shares at a price of $8.02 per share. These warrants were determined tohave a fair value at the time of issuance of approximately $12,000, which isbeing amortized ratably over the two-year life of the note. Approximately$185,000 and $171,000 of interest expense incurred in 2004 and 2003,respectively, related to the $2.0 million loan that 

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Dr. Michael T.Flavin provided to us in September 2001. The loan accrues interest at therate of 7.75% per year, compounded annually. The loan is due and payable in December 2007.

**Liquidity and Capital 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 $46.7 million and$40.3 million as of December 31, 2005 and December 31, 2004,respectively, and we expect to incur significant and increasing operatinglosses for the foreseeable future. Our working capital as of December 31,2005 amounted to $15.2 million. Cash, cash equivalents and investments was$15.2 million as of December 31, 2005. Since our inception in 1999 toAugust 2005, we financed our operations primarily through debt and capitalcontributions from our founder and controlling stockholder and borrowings underour bank line of credit. In August 2005 we completed our initial publicoffering in which we raised $28.7 million, net of underwriters discountand offering costs.

In September 2001, Dr. Michael T. Flavinmade a $2.0 million loan to us. The loan accrues interest at the rate of7.75%, compounded annually, and is due and payable in December, 2007.  The balance of Dr. Flavin’s loan wasapproximately $2.8 million as of December 31, 2005.

In December 2004, we entered into a $3.0 millionline of credit with a local financial institution. Interest is based upon theprime rate plus 0.75% and is payable monthly. The principal balance is due on December 31,2007. The line of credit is secured by substantially all of our assets and isguaranteed by Flavin Ventures, Dr. Flavin and his wife and John L.Flavin. Flavin Ventures secured its guaranty by issuing a mortgage on ourprincipal facilities and pledging the shares it owns in us. In May 2005,we increased our line of credit to $4.0 million. In connection with thisincrease, Dr. Flavin entered into a subordination agreement with the bankunder which he agreed to subordinate his loan to us to the line of credit.

During the twelve months ended December 31, 2005,cash used in operating activities totaled $16.3 million, primarily due to$11.0 million in payments made to Abbott under our license agreement, $4.7 millionfor general operations and $500,000 for directors and officers insurance. Cashused in investing activities was $10.6 million and $91,000 during thetwelve months ended December 31, 2005 and 2004, respectively.  Cash provided from financing activitiestotaled approximately $31.4 million during the twelve months ended December 31,2005 and consisted of $29.3 million related to the sale of our commonstock, $1.6 million drawn from our line of credit and a $500,000 grantfrom the State of Illinois.

In March 2006, weraised approximately $33.6 million, net of underwriting discounts, fromthe private placement of common stock to institutional investors.

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*ContractualObligations*

As of December 31,2005, 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,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------|------------|------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                     | ** ** | **2006**                                             | ** ** | **2007**   | ** ** | **2008**   | ** ** | **2009** | ** ** | **2010** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
| Long-term debt                 |       | $                                                    | —     |       | $          | 5,915,000  |       | $ | — |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | — |   |   | $ | 5,915,000 |   |
| Interest                       |       | 313,200                                              |       | 1,523,979  |       | —     |       |   | — |   |   |   | — |   |   |   | — |   |   | 1,837,179 |   |
| Abbott license  payments       |       | —                                               |       | 10,000,000 |       | 30,000,000 |       |   | — |   |   |   | — |   |   |   | — |   |   | 40,000,000 |   |
| Cethromycin  development costs |       | 2,165,000                                            |       | 51,000     |       | 8,000      |       |   | — |   |   |   | — |   |   |   | — |   |   | 2,224,000 |   |
| Operating leases               |       | 225,759                                              |       | 234,789    |       | 160,645    |       |   | — |   |   |   | — |   |   |   | — |   |   | 621,193 |   |
| Capital leases                 |       | 17,421                                               |       | 14,110     |       | —     |       |   | — |   |   |   | — |   |   |   | — |   |   | 31,531 |   |
| Total                          |       | $                                                    | 2,721,380  |       | $          | 17,738,878 |       | $ | 30,168,645 |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | — |   |   | $ | 50,628,903 |   |

 

Under our license agreement with Abbott Laboratories,we paid $11.0 million to Abbott in the twelve months ended December 31,2005. We will also owe Abbott $10.0 million if we submit an NDA forcethromycin 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 inaggregate net sales of cethromycin and $5.0 million upon reaching $400 millionin aggregate net sales. The periods in which milestone obligations becomepayable are only estimates due to uncertainties in the regulatory approvalprocess.

Our long-term commitments under operating leases shownabove consist of payments relating to our facility lease in Woodridge,Illinois, which expires in September of 2008.

In February of 2006 we executed contractstotaling approximately $790,000 related to our Phase III pivotal clinical trialsfor cethromycin. Of this amount, $600,000 represents an authority to proceedwith initial project administration efforts related to the clinical trial. Theremaining contracts, totaling approximately $190,000, relate to the manufactureand analysis of clinical supplies for the trials. Payments due under thesecontracts occur primarily over the next twelve months.

In addition to the authority to proceed issued to ourclinical trial provider in February, we expect to execute contracts in thesecond quarter totaling approximately $18.4 million related to thedevelopment of cethromycin. Of this amount, approximately $17.4 millionrepresents the costs we will incur to complete the Phase III pivotal clinicaltrials. The remainder, approximately $980,000, relates to cardiac safetystudies and clinical laboratory support for the trials. Payments due underthese contracts will occur over the next twenty-four months.

To fund these contracts and our existing developmentcommitments, indebtedness and general operating expenses we completed a privateplacement of 10,233,464 shares of our common stock at price of $3.53 per sharein March of 2006. Proceeds from the offering, net of underwritersdiscount, were approximately $33.6 million. Under the terms of thetransaction, 5,116,732 warrants to purchase our common stock were issued at anexercise price of $3.81 per warrant. We believe that our cash on hand at December 31,2005 together with the proceeds from our private placement offering will besufficient to fund our cash requirements at least through the completion of ourPhase III clinical trials of Cethromycin under the current protocol.

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

·       progress in our clinicaldevelopment programs, as well as the magnitude of these programs;

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·       the timing, receipt andamount of milestone and other payments, if any, from present and futurecollaborators;

·       our ability to establishand maintain additional collaborative arrangements;

·       the resources, time andcosts required to successfully initiate and complete our preclinical andclinical trials, obtain regulatory approvals, protect our intellectual propertyand obtain and maintain licenses to third-party intellectual property;

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

·       the timing, receipt andamount of sales and royalties, if any, from our potential products.

If, at any time, ourprospects for financing our clinical development programs are limited, we maydecide to reduce research and development expenses by delaying, discontinuingor reducing ourfunding.

*Calanolide A JointVenture*

Our Calanolide A product candidate is held by our50/50 joint venture with the Sarawak government. To date, the SarawakGovernment has funded substantially all of the joint venture’s activitiesthrough a $9 million equity investment and $12 million in loans.According to the terms of the debt instruments, $12 million of this debtis past due. We are currently in discussions with the Sarawak Government torestructure and extend the joint venture’s debt and determine the source offinancing for the next stage of clinical trials for Calanolide A. We do notintend to expend any meaningful funds advancing the development of Calanolide Auntil we restructure the joint venture’s debt and reach a satisfactoryagreement with the the Sarawak Government to amend our joint venturerelationship and establish our respective obligations regarding future funding.

Our joint venture could besubject to termination if we are unable to successfully negotiate arestructuring with the Sarawak Government. Under our joint venture agreement,upon termination any liabilities of the joint venture will be settled by theparties equally and all patents or licenses of the joint venture would bereassigned back to us. We believe that this equal settlement of liabilities provision was intended to recognize the 50/50equity ownership relationship and does not constitute our guaranty ofthe joint venture’s indebtedness to the Sarawak Government. Consequently, ifthe joint venture is terminated, the joint venture partners would work togetherto monetize the joint venture’s assets for the purpose of satisfying itsliabilities. In the event the joint venture’s assets are insufficient to settle its liabilities, we do not believe thatthe equal settlement of liabilities provision obligates us to contributefunds to the joint venture.

**Off-Balance Sheet Arrangements**

Under the definitioncontained in Item 303 (a)(4)(ii) of Regulation S-K, we do not have anyoff-balance sheet arrangements, except for our joint venture with the SarawakGovernment.

**CriticalAccounting Policies 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. The preparation of thesefinancial statements requires us to make estimatesand judgments that affect the reported amounts of assets, liabilities andexpenses and related disclosure of contingent assets and liabilities. Wereview our estimates on an ongoing basis. We base our estimates on historicalexperience and on various other assumptions that we believe to be reasonableunder the circumstances. Actual results may differ from these estimates underdifferent assumptions or conditions. Whileour significant accounting policies are described in more detail in thenotes to our 

39

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financialstatements included in this annual report, we believe the following accountingpolicies to be critical to the judgments and estimates used in the preparationof our financial statements.

*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 Technical Practice Aid, *Assets Acquired in a Business Combination to be used in Research andDevelopment Activities:  A Focus onSoftware, 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 the Company’s proprietaryproduct portfolio. All such costs are expensed as incurred. Clinical trialcosts incurred by third parties are expensed as the contracted work isperformed. The Company estimates both the total cost and time period of thetrials and the percent completed as of that accounting date.  The Company believes that the estimates madeas of December 31, 2005 are reflective of the actual expenses incurred asof that date.

*Variable InterestEntities*

We determine consolidationof variable interest entities in accordance with FASB Interpretation 46(R),*Consolidation of VariableInterest Entities*. Our 50/50 joint venture, Sarawak MediChem Pharmaceuticals,has not been included in our consolidatedfinancial statements because the majority of its financial support in the form of contributed capital and debt hasbeen funded by our joint venture partner.

*Stock-basedCompensation*

Effective January 2004,we adopted the fair value method as contained in Statement of FinancialAccounting Standards No. 123 *Accounting for Stock-BasedCompensation*. Effective December 2004, we adopted SFAS No. 123(R) *Share-Based Payment.*As prescribed in SFAS No. 123(R) we elected to use the ‘‘prospectivemethod.’’ The prospective method requires expense to be recognized forall awards granted, modified or settled in the year of adoption. Historically,we applied the intrinsic method as provided in Accounting Principles BoardOpinion No. 25 ‘‘Accounting for Stock Issued to Employees’’ and relatedinterpretations and accordingly, no compensation cost had been recognized forstock options issued to employees in prior years. As a result of adopting thefair value method for stock compensation, 

40

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allfuture awards will be expensed over the stock options vesting period. Weutilized the Black-Scholes option pricing model to estimate the fair value ofoptions granted in 2004. The adoption did not have a significant effect in 2004.

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

Our exposure to market risk is currently confined toour cash and cash equivalents and investments that have maturities of less thanone year. We currently do not hedge interest rate exposure. We have not usedderivative financial instruments for speculation or trading purposes. Becauseof the short-term maturities of our cash, cash equivalents and investments, wedo not believe that an increase in market rates would have any significantimpact on the realized value of our investments, but may increase the interestexpense associated with our debt.

Our most liquid assets arecash, cash equivalents and investments. Because of their liquidity, theseassets are not directly affected by inflation. We also believe that we haveintangible assets in the value of our intellectual property. In accordance withgenerally accepted accounting principles, we have not capitalized the value ofthis intellectual property on our balance sheet. Due to the nature of thisintellectual property, we believe that these intangible assets are not affectedby inflation. Because we intend to retain and continue to use our equipment,furniture and fixtures and leasehold improvements, we believe that theincremental 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 OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

To the Board of Directorsand 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 itssubsidiary (the “Company”) as of December 31, 2005 and 2004, and therelated consolidated statements of operations, stockholders’ equity, and cashflows for each of the three years in the period ended December 31, 2005and for the period from January 1, 1999 (inception) through December 31,2005. These financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on the financialstatements based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards 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. An auditincludes 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 31,2005 and 2004, and the results of their operations and their cash flows foreach of the three years in the period ended December 31, 2005, and for theperiod from January 1, 1999 (inception) through December 31, 2005, inconformity with accounting principles generally accepted in the United Statesof America.

The Company is indevelopment stage at December 31, 2005. As discussed in Note 1 to theconsolidated financial statements, the Company’s principal business activity isto conduct new drug research and development and has not yet derivedsignificant revenues from its principal business activity.

*DELOITTE &TOUCHE LLP*

Chicago, IllinoisMarch 14, 2006

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**ADVANCEDLIFE SCIENCES HOLDINGS, INC. AND SUBSIDIARY(A Development Stage Company)**

**CONSOLIDATED BALANCE SHEETS**

| ** **                                                                                                                                                                                      | ** ** | **Year ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                                                                                                      | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
| **ASSETS**                                                                                                                                                                                      | ** ** | ** **                                 | ** ** | ** ** | ** ** |
| CURRENT ASSETS:                                                                                                                                                                                 |       |                                       |       |   |   |
| Cash & cash equivalents                                                                                                                                                                |       | $                                          | 4,749,932  |   | $ | 194,555 |   |
| Investments - available for sale                                                                                                                                                                |       | 10,475,000                                 |       | — |   |
| Accounts receivable - related party                                                                                                                                                             |       | 6,160                                      |       | 24,868 |   |
| Clinical trials supplies                                                                                                                                                                        |       | —                                     |       | 533,333 |   |
| Prepaid insurance                                                                                                                                                                               |       | 362,241                                    |       | — |   |
| Prepaid expenses and other                                                                                                                                                                      |       | 118,263                                    |       | 25,806 |   |
| Total current assets                                                                                                                                                                            |       | 15,711,596                                 |       | 778,562 |   |
| FURNITURE AND EQUIPMENT:                                                                                                                                                                        |       |                                       |       |   |   |
| Furniture and fixtures                                                                                                                                                                          |       | 147,275                                    |       | 139,005 |   |
| Laboratory equipment                                                                                                                                                                            |       | 142,928                                    |       | 142,928 |   |
| Computer equipment                                                                                                                                                                              |       | 111,884                                    |       | 79,146 |   |
| Leasehold improvements                                                                                                                                                                          |       | 40,646                                     |       | 40,646 |   |
| Construction in-progress                                                                                                                                                                        |       | 75,887                                     |       | — |   |
| Total furniture and equipment—at cost                                                                                                                                                      |       | 518,620                                    |       | 401,725 |   |
| Less accumulated depreciation                                                                                                                                                                   |       | (267,372                                   | )          | (180,807 | ) |
| Furniture and equipment—net                                                                                                                                                                |       | 251,248                                    |       | 220,918 |   |
| OTHER LONG-TERM ASSETS:                                                                                                                                                                         |       |                                       |       |   |   |
| Deferred financing costs                                                                                                                                                                        |       | 53,004                                     |       | 15,000 |   |
| Other assets                                                                                                                                                                                    |       | 6,062                                      |       | 1,452 |   |
| Total other long-term assets                                                                                                                                                                    |       | 59,066                                     |       | 16,452 |   |
| TOTAL ASSETS                                                                                                                                                                                    |       | $                                          | 16,021,910 |   | $ | 1,015,932 |   |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                                                  | ** ** | ** **                                 | ** ** | ** ** | ** ** |
| CURRENT LIABILITIES:                                                                                                                                                                            |       |                                       |       |   |   |
| Accounts payable                                                                                                                                                                                |       | $                                          | 294,816    |   | $ | 255,880 |   |
| Accrued expenses                                                                                                                                                                                |       | 240,761                                    |       | 185,348 |   |
| Accrued interest payable                                                                                                                                                                        |       | 5,334                                      |       | 4,319 |   |
| Licenses payable                                                                                                                                                                                |       | —                                     |       | 14,000,000 |   |
| Notes payable, net of $11,766 debt discount                                                                                                                                                     |       | —                                     |       | 2,238,234 |   |
| Short-term lease payable                                                                                                                                                                        |       | 14,114                                     |       | 12,070 |   |
| Total current liabilities                                                                                                                                                                       |       | 555,025                                    |       | 16,695,851 |   |
| Long-term lease payable                                                                                                                                                                         |       | 13,166                                     |       | 27,279 |   |
| Accrued interest payable - related party                                                                                                                                                        |       | 765,514                                    |       | 566,603 |   |
| Grant payable                                                                                                                                                                                   |       | 500,000                                    |       | — |   |
| Notes payable - net of $22,532 debt discount                                                                                                                                                    |       | 3,892,468                                  |       | — |   |
| Notes payable - related party                                                                                                                                                                   |       | 2,000,000                                  |       | 2,000,000 |   |
| Total liabilities                                                                                                                                                                               |       | 7,726,173                                  |       | 19,289,733 |   |
| STOCKHOLDERS’ EQUITY:                                                                                                                                                                      |       |                                       |       |   |   |
| Common stock, $0.01 par value—December 31, 2005:  60,000,000 shares authorized; 17,990,322 issued and outstanding;  December 31, 2004: 10,604,584 shares issued and outstanding; |       | 179,903                                    |       | 106,046 |   |
| Series A  preferred stock of Advanced Life Sciences Inc., no par value—250,000 shares  authorized, issued and outstanding                                                        |       | —                                     |       | — |   |
| Additional paid-in capital                                                                                                                                                                      |       | 54,834,373                                 |       | 21,894,446 |   |
| Deficit accumulated during the development stage                                                                                                                                                |       | (46,718,539                                | )          | (40,274,293 | ) |
| Total stockholders’ equity (deficit)                                                                                                                                                       |       | 8,295,737                                  |       | (18,273,801 | ) |
| TOTAL LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                                                |       | $                                          | 16,021,910 |   | $ | 1,015,932 |   |

 

See notes to consolidated financial statements.

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

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

| ** **                                                                   | ** ** | **Year ended December 31,** | ** ** | **Period From  Inception  (January 1, 1999)  Through** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2005**                                   | ** ** | **2004**                                                              | ** ** | **2003** | ** ** | **December 31, 2005** | ** ** |
| Revenue and Other Income:                                                    |       |                                       |       |                                                                  |       |   |   |   |   |   |   |
| Management fees                                                              |       | $                                          | 61,239     |                                                                  | $          | 271,644 |   | $ | 118,563 |   |   | $ | 1,161,180 |   |   |
| Grant                                                                        |       | 60,212                                     |       | 38,136                                                                |       | 61,864 |   |   | 995,783 |   |   |
| Royalty—related party                                                   |       | —                                     |       | 10,000                                                                |       | — |   |   | 45,238 |   |   |
| Total revenue and other income                                               |       | 121,451                                    |       | 319,780                                                               |       | 180,427 |   |   | 2,202,201 |   |   |
| Expenses:                                                                    |       |                                       |       |                                                                  |       |   |   |   |   |   |   |
| Research and development                                                     |       | 3,121,616                                  |       | 25,661,868                                                            |       | 1,362,255 |   |   | 31,933,236 |   |   |
| Contracted research and development— related party                      |       | —                                     |       | —                                                                |       | — |   |   | 7,980,299 |   |   |
| Selling, general and administrative                                          |       | 3,237,997                                  |       | 1,649,953                                                             |       | 1,198,722 |   |   | 7,635,118 |   |   |
| Total expenses                                                               |       | 6,359,613                                  |       | 27,311,821                                                            |       | 2,560,977 |   |   | 47,548,653 |   |   |
| Loss from  operations                                                        |       | (6,238,162                                 | )          | (26,992,041                                                           | )          | (2,380,550 | ) |   | (45,346,452 | ) |   |
| Interest income                                                              |       | (272,216                                   | )          | —                                                                |       | — |   |   | (272,216 | ) |   |
| Interest expense                                                             |       | 478,300                                    |       | 194,877                                                               |       | 170,938 |   |   | 1,644,303 |   |   |
| Net other  (income) expense                                                  |       | 206,084                                    |       | 194,877                                                               |       | 170,938 |   |   | 1,372,087 |   |   |
| Net loss                                                                     |       | (6,444,246                                 | )          | (27,186,918                                                           | )          | (2,551,488 | ) |   | (46,718,539 | ) |   |
| Less accumulated  preferred dividends for the period                         |       | 175,000                                    |       | 175,000                                                               |       | 175,000 |   |   | 1,144,792 |   |   |
| Net loss available  to common shareholders                                   |       | $                                          | (6,619,246 | )                                                                     | $          | (27,361,918 | ) | $ | (2,726,488 | ) |   | $ | (47,863,331 | ) |   |
| Basic net loss  per share available to common shareholders                   |       | $                                          | (0.49      | )                                                                     | $          | (13.27 | ) | $ | (1.72 | ) |   |   |   |   |
| Weighted average  number common shares outstanding - basic and diluted  |       | 13,610,694                                 |       | 2,062,351                                                             |       | 1,588,000 |   |   |   |   |   |

 

See notes to consolidated financial statements.

 

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**ADVANCED LIFE SCIENCES HOLDINGS, INC. AND SUBSIDIARY(A Development Stage Company)CONSOLIDATED STATEMENTS OF STOCKHOLDERS’EQUITYFOR THE PERIOD FROM INCEPTION (JANUARY 1, 1999) THROUGH December 31, 2005**

| ** **                                                                                                                           | ** ** | **Common Stock** | ** ** | **Preferred Stock** | ** ** | **Additional  Paid-in** | ** ** | **Deficit  Accumulated  During the  Development** | ** ** | ** **  | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|--------------------------|------------|-------------------------|------------|--------------------------------------------------------|------------|-------------|------------|
| ** **                                                                                                                           | ** ** | **Shares**            | ** ** | **Amount**               | ** ** | **Shares**              | ** ** | **Amount**                                             | ** ** | **Capital** | ** ** | **Stage** | ** ** | **Total** | ** ** |
| BALANCE—January 1, 1999 (inception)                                                                                   |       | —                |       | $                        | —     |                    | —     |                                                   |       | $           | —     |   |   | $ | — |   |   | $ | — |   |   | $ | — |   |
| Issuance of common stock in exchange for contributed  intellectual property in January 1999                                |       | 1,588,000             |       | —                   |       | —                  |       |                                                   | —     |        |       | — |   |   | —  |   |   | — |   |
| Exchange of shares under recapitalization and spin-off  from MediChem Life Sciences, Inc. in June 1999, at historical cost |       | (1,588,000            | )          | —                   |       | 250,000                 |       |                                                   | —     |        |       | — |   |   | —  |   |   | — |   |
| Issuance of common stock in June 1999, at $0.157  per share                                                                     |       | 1,588,000             |       | 250,000                  |       | —                  |       |                                                   | —     |        |       | — |   |   | —  |   |   | 250,000 |   |
| Compensation expense related to stock options since  inception                                                                       |       | —                |       | —                   |       | —                  |       |                                                   | —     |        |       | 15,097 |   |   | —  |   |   | 15,097 |   |
| Conversion of loans to stockholder into equity,  August 2001                                                                    |       | —                |       | —                   |       | —                  |       |                                                   | —     |        |       | 5,751,753 |   |   | — |   |   | 5,751,753 |   |
| Capital contributions                                                                                                                |       | —                |       | —                   |       | —                  |       |                                                   | —     |        |       | 1,165,118 |   |   | — |   |   | 1,165,118 |   |
| Net loss since inception                                                                                                             |       | —                |       | —                   |       | —                  |       |                                                   | —     |        |       | — |   |   | (9,274,336 | ) |   | (9,274,336 | ) |
| BALANCE—December 31, 2001                                                                                                  |       | 1,588,000             |       | 250,000                  |       | 250,000                 |       |                                                   | —     |        |       | 6,931,968 |   |   | (9,274,336 | ) |   | (2,092,368 | ) |
| Capital contributions                                                                                                                |       | —                |       | —                   |       | —                  |       |                                                   | —     |        |       | 1,161,000 |   |   | — |   |   | 1,161,000 |   |
| Net loss                                                                                                                             |       | —                |       | —                   |       | —                  |       |                                                   | —     |        |       | — |   |   | (1,261,551 | ) |   | (1,261,551 | ) |
| BALANCE—December 31, 2002                                                                                                  |       | 1,588,000             |       | 250,000                  |       | 250,000                 |       |                                                   | —     |        |       | 8,092,968 |   |   | (10,535,887 | ) |   | (2,192,919 | ) |
| Capital contributions                                                                                                                |       | —                |       | —                   |       | —                  |       |                                                   | —     |        |       | 2,337,728 |   |   | — |   |   | 2,337,728 |   |
| Net loss                                                                                                                             |       | —                |       | —                   |       | —                  |       |                                                   | —     |        |       | — |   |   | (2,551,488 | ) |   | (2,551,488 | ) |
| BALANCE—December 31, 2003                                                                                                  |       | 1,588,000             |       | 250,000                  |       | 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                  |       | 250,000                 |       |                                                   | —     |        |       | 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                  |       | 250,000                 |       |                                                   | —     |        |       | 54,834,373 |   |   | (46,718,539 | ) |   | 8,295,737 |   |
|                                                                                                                                      |            |                       |            |                          |            |                         |            |                                                        |            |             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

See notes to consolidated financial statements.

 

45

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**ADVANCED LIFE SCIENCES HOLDINGS, INC. AND SUBSIDIARY(A Development Stage Company)CONSOLIDATED STATEMENTSOF CASH FLOWS**

| ** **                                                                         | ** ** | **Year ended December 31,** | ** ** | **Period From  Inception  (January 1, 1999)  Through** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2005**                                   | ** ** | **2004**                                                              | ** ** | **2003** | ** ** | **December 31, 2005** | ** ** |
| CASH FLOWS FROM OPERATING  ACTIVITIES:                                             |       |                                       |       |                                                                  |       |   |   |   |   |   |   |
| Net loss                                                                           |       | $                                          | (6,444,246 | )                                                                     | $          | (27,186,918 | ) | $ | (2,551,488 | ) |   | $ | (46,718,539 | ) |   |
| Adjustments to reconcile  net loss to net cash flows used in operating activities: |       |                                       |       |                                                                  |       |   |   |   |   |   |   |
| Depreciation and amortization                                                      |       | 86,565                                     |       | 68,334                                                                |       | 49,620 |   |   | 284,905 |   |   |
| Non-cash interest expense                                                          |       | 25,155                                     |       | 132                                                                   |       | — |   |   | 25,287 |   |   |
| Amortization of deferred compensation                                              |       | 696,204                                    |       | 5,604                                                                 |       | — |   |   | 716,905 |   |   |
| Non-cash research and development                                                  |       | —                                     |       | 24,466,667                                                            |       | — |   |   | 24,466,667 |   |   |
| Settlement of milestone payment                                                    |       | 6,000                                      |       | —                                                                |       | — |   |   | 6,000 |   |   |
| Loss on disposal                                                                   |       | —                                     |       | —                                                                |       | 11,533 |   |   | 11,533 |   |   |
| Changes  in operating assets and liabilities:                                      |       |                                       |       |                                                                  |       |   |   |   |   |   |   |
| Clinical supplies                                                                  |       | 533,333                                    |       | —                                                                |       | — |   |   | 533,333 |   |   |
| Accounts receivable                                                                |       | 18,708                                     |       | (24,868                                                               | )          | — |   |   | (6,160 | ) |   |
| Prepaid expenses                                                                   |       | (454,698                                   | )          | 4,027                                                                 |       | (29,833 | ) |   | (480,504 | ) |   |
| Other assets                                                                       |       | (4,610                                     | )          | 5,602                                                                 |       | 8,343 |   |   | (6,062 | ) |   |
| Accounts payable                                                                   |       | 9,693                                      |       | 45,309                                                                |       | 149,131 |   |   | 265,573 |   |   |
| Accrued expenses                                                                   |       | 55,413                                     |       | 111,797                                                               |       | 1,822 |   |   | 240,761 |   |   |
| Licenses payable                                                                   |       | (11,000,000                                | )          | —                                                                |       | — |   |   | (11,000,000 | ) |   |
| Accrued interest on debt                                                           |       | 199,926                                    |       | 193,239                                                               |       | 171,017 |   |   | 1,348,911 |   |   |
| Net cash flows used in operating activities                                        |       | (16,272,557                                | )          | (2,311,075                                                            | )          | (2,189,855 | ) |   | (30,311,390 | ) |   |
| CASH FLOWS FROM INVESTING  ACTIVITIES:                                             |       |                                       |       |                                                                  |       |   |   |   |   |   |   |
| Capital expenditures                                                               |       | (87,652                                    | )          | (90,777                                                               | )          | (105,409 | ) |   | (383,885 | ) |   |
| Proceeds from the sales of securities                                              |       | 16,750,000                                 |       | —                                                                |       | — |   |   | 16,750,000 |   |   |
| Purchase of securities                                                             |       | (27,225,000                                | )          | —                                                                |       | — |   |   | (27,225,000 | ) |   |
| Net cash flows used in investing activities                                        |       | (10,562,652                                | )          | (90,777                                                               | )          | (105,409 | ) |   | (10,858,885 | ) |   |
| CASH FLOWS FROM FINANCING  ACTIVITIES:                                             |       |                                       |       |                                                                  |       |   |   |   |   |   |   |
| Proceeds from issuance of common stock and capital  contributions                  |       | 29,277,776                                 |       | 2,295,731                                                             |       | 2,337,728 |   |   | 36,487,351 |   |   |
| Proceeds from issuance of notes payable                                            |       | 1,610,000                                  |       | 235,000                                                               |       | — |   |   | 9,018,691 |   |   |
| Proceeds from grants                                                               |       | 500,000                                    |       | —                                                                |       | — |   |   | 500,000 |   |   |
| Proceeds from stock options exercised                                              |       | 14,879                                     |       | 6,563                                                                 |       | — |   |   | 21,442 |   |   |
| Payments on capital leases                                                         |       | (12,069                                    | )          | (2,090                                                                | )          | — |   |   | (107,277 | ) |   |
| Net cash flows provided by financing activities                                    |       | 31,390,586                                 |       | 2,535,204                                                             |       | 2,337,728 |   |   | 45,920,207 |   |   |
| NET INCREASE IN CASH                                                               |       | 4,555,377                                  |       | 133,352                                                               |       | 42,464 |   |   | 4,749,932 |   |   |
| CASH—Beginning of period                                                      |       | 194,555                                    |       | 61,203                                                                |       | 18,739 |   |   | — |   |   |
| CASH—End of period                                                            |       | $                                          | 4,749,932  |                                                                  | $          | 194,555 |   | $ | 61,203 |   |   | $ | 4,749,932 |   |   |
| SUPPLEMENTAL  DISCLOSURE OF CASH FLOW INFORMATION:                                 |       |                                       |       |                                                                  |       |   |   |   |   |   |   |
| Cash paid during the period for interest                                           |       | $                                          | 247,341    |                                                                  | $          | 1,511 |   | $ | 3,958 |   |   | $ | 263,572 |   |   |
| SUPPLEMENTAL DISCLOSURE  OF NONCASH TRANSACTIONS:                                  |       |                                       |       |                                                                  |       |   |   |   |   |   |   |
| Noncash investment activity—purchases of fixed assets  under capital leases   |       | $                                          | —     |                                                                  | $          | 41,438 |   | $ | — |   |   | $ | 134,556 |   |   |
| Capital expenses included in accounts payable                                      |       | 29,243                                     |       | —                                                                |       | — |   |   | 29,243 |   |   |
| Noncash financing activity—issuance of common stock  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.

 

46

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**ADVANCED LIFE SCIENCES HOLDINGS, INC. AND SUBSIDIARY (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**1.**   Nature of Business

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 nonvotingpreferred stock issued by ALS Inc. affecting a spin-off of ALS Inc.

Prior to the spin-off, Dr. Michael Flavin, thesole stockholder, owned 100% of MediChem and ALS Inc., then a wholly-ownedsubsidiary of MediChem. As a result of the spin-off, Dr. Flavin became thesole common stockholder of ALS Inc. MediChem holds 100% of the preferred stockof ALS Inc., which was issued in exchange for common stock held at the June 1999spin-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. ALS Ventures is not included in theconsolidated financial statements of Advanced Life Sciences Holdings, Inc.(“the Company”).

In March of 2002, MediChem was acquired by deCODEgenetics, Inc. (“deCODE”). As a result of the merger, Dr. Flavin’sownership in the merged entity was reduced to a noncontrolling interest with Dr. Flavinholding approximately 1% of the common shares of deCODE genetics, Inc. Afterthe merger was complete, Dr. Flavin resigned his position as chief executiveofficer of MediChem to focus on his role as chief executive officer of ALS Inc.

In December 2004, ALS Inc. executed a plan ofreorganization. The Company, a Delaware corporation, was formed with Dr. Flavinas its chief executive officer. Common shareholders of ALS, Inc. exchangedtheir 1,629,685 common shares for 1,629,685 common stock of the Company. Underthe terms of the reorganization, Flavin Ventures exchanged their 40% ownershipof ALS GP for 7,852,330 shares of the Company’s common stock. After theexchange was completed, ALS GP was dissolved, its assets and liabilitiesassumed by ALS Inc.

In December 2004, according to the plan ofreorganization, ALS Ventures, LLC (“Ventures”), a Delaware Limited LiabilityCompany was formed. After its formation, Dr. Flavin and Flavin Venturessimultaneously contributed all of their common shares, 1,588,000 and 7,852,330,respectively, to Ventures.

In April 2005, the Board of Directors of theCompany (“the Board”) authorized the Company to file 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 to 

47

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**ADVANCED LIFE SCIENCES HOLDINGS, INC. AND SUBSIDIARY (A Development Stage Company) (Continued) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**1.**   Nature of Business (Continued)

reflect this stock split.In August 2005, the Company completed the initial public offering of itscommon stock in which the Company sold 6,400,000 shares of common stock to thepublic at $5.00 per share, resulting in gross proceeds of $32.0 million. TheCompany also completed a concurrent offering of 600,000 shares to an existingstockholder in exchange for a $3.0 million reduction of a milestonepayment obligation under its license agreement with the stockholder. In September 2005,the Company’s underwriters exercised their option to purchase 100,000 shares tocover over-allotments resulting in additional gross proceeds of $500,000. Inconnection with these offerings, the Company paid approximately $2.3 millionin underwriting 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$33.6 million, net of underwriting discounts, in connection with theissuance of 10,233,464 shares of its common stock and warrants to purchase anadditional 5,116,732 shares of its common stock at an exercise price of $3.81per share.

The Company’sprincipal business activity is to conduct new drug research and development inthe fields of infectious disease, oncology and inflammation. Since inception,the Company has devoted substantially all of its efforts to activities such asfinancial planning, capital raising and product development, and has notderived significant revenues from its primary business activity. Accordingly,the Company is in the development stage, as defined by Statement of FinancialAccounting Standards (“SFAS”) No. 7, *Accountingand Reporting by Development Stage Enterprises*.

***Business and Credit Risks***—TheCompany is subject to risks and uncertainties common to drug discoverycompanies, including technological change, potential infringement onintellectual property of third parties, new product development, regulatoryapproval and market acceptance of its products, activities of competitors andits 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 controlling stockholder, and in 2005, fromthe proceeds of the IPO. The Company will not be generating revenues orrealizing cash flows from operations in the near term, and will requireadditional equity or debt financing to meet working capital needs, to fundoperating losses associated with research and development and to fund clinicaltrials. In order to address our working capital shortfall we intend to raiseadditional financing during 2006 through the issuance of equity securities (seeNote 14). Beyond the expected requirement for additional capital in 2006, weexpect that we will need to raise additional capital or incur additionalindebtedness to continue to fund our operations for a longer period. Althoughmanagement believes the Company could obtain such financing, there can be noassurances that such financing will be available in the future at termsacceptable to the Company, if at all. If we cannot raise additional funds, wemay be required to reduce our capital expenditures, scale back productdevelopment or programs, reduce our workforce and license to others products ortechnologies that we may otherwise be able to commercialize. To the extent weraise additional capital by issuing equity securities, our stockholders couldexperience substantial dilution. The accompanying financial statements do notinclude any adjustments that might result from the outcome of theseuncertainties.

48

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**ADVANCED LIFE SCIENCES HOLDINGS, INC. AND SUBSIDIARY (A Development Stage Company) (Continued) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**2.   Summary of Significant Accounting Policies**

***Basis of Presentation***—Theconsolidated financial statements include the accounts of the Company and itswholly-owned subsidiary ALS Inc. All significant intercompany balances andtransactions have been eliminated.

***Cash and Cash Equivalents***—TheCompany considers all highly liquid investments with original maturities of threemonths or less when purchased to be cash equivalents.

***Investments—***TheCompany has marketable debt and equity securities which are classified asavailable-for-sale, the fair value of which is determined using currentlyavailable market prices. The Company reviews the carrying value of investmentseach quarter to determine whether an other than temporary decline in marketvalue exists. If such a decline is deemed to have occured, the investment iswritten-down with a charge to other income (expense), net. Available-for-salesecurities are carried at fair value, with the unrealized gains and losses, netof tax, reported as a component of stockholders’ equity in accumulated othercomprehensive loss. Marketable securities available for current operations areclassified in the balance sheet as current assets; marketable securities heldfor long-term purposes are classified as noncurrent assets. Interest income andrealized gains and losses on securities are included in “Interest income” inthe statements of operations. At December 31, 2005, the Company’sinvestments consist of auction rate debt securities. As of December 31,2005 no unrealized holding gains or losses were recognized in the statements ofoperations and stockholders equity.

***Furniture and Equipment***—Furnitureand 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 the capitallease amounted to $41,000 as of December 31, 2005 and 2004, net ofaccumulated depreciation of $16,000 and $2,300, as of December 31, 2005and 2004, respectively.

***Research and Development Expenses***—Researchand development expenses consist of internal research costs and fees paid forcontract research in conjunction with the research and development of theCompany’s proprietary product portfolio. All such costs are expensed asincurred including in-process research and development. Clinical trial costsincurred by third parties are expensed as the contracted work is performed. TheCompany estimates both the total cost and time period of the trials and thepercent completed as of that accounting date. The Company believes that theestimates made as of December 31, 2005 are reflective of the actualexpenses incurred as of that date.

***Clinical Supplies***—Clinicalsupplies consist of clinical trial raw material purchased from AbbottLaboratories and is valued at the lower of cost or market. Such supplies wereexpensed to research and development expense as manufactured into tablets foruse 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 

49

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**ADVANCED LIFE SCIENCES HOLDINGS, INC. AND SUBSIDIARY (A Development Stage Company) (Continued) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**2.**   Summary of Significant Accounting Policies(Continued)

the licensed technology(see Note 4). Revenue earned through our management agreement with FlavinVentures is recorded as expenses are incurred and services performed. Managementfees, which are generated from a shared services agreement with SMP, arerecognized on the cash basis as the collectibility of such fees is notreasonably assured.

***Fair Value of FinancialInstruments***—The carrying amount of the Company’sfinancial instruments, which include cash equivalents, investments, accountspayable, accrued expenses and long-term obligations, approximate their fairvalues.

***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.

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

***Stock-Based Compensation***—InDecember 2004, the FASB issued Statement 123(R) that will requirecompensation cost related to share-based payment transactions to be recognizedin the financial statements. Compensation cost will be measured based on thegrant-date fair value of the equity or liability instruments issued. Compensationexpense will be recognized over the period that an employee provides service inexchange for the award.

Effective January 2004, the Company adopted thefair value method as contained in Statement of Financial Accounting Standards No. 123*Accounting for Stock-Based Compensation*.Effective December 2004, the Company adopted SFAS No. 123(R) *Share-Based Payment.*As prescribed in SFAS No. 123(R) the Company elected touse the ‘‘prospective method.’’ The prospective method requires expenseto be recognized for all awards granted, modified or settled in the year ofadoption. Historically, the Company applied the intrinsic method as provided inAccounting Principles Board Opinion No. 25 ‘‘Accounting for Stock Issuedto Employees’’ and related interpretations and accordingly, no compensationcost had been recognized for stock options issued to employees in prior years.As a result of adopting the fair value method for stock compensation, allfuture awards will be expensed over the stock options vesting period. TheCompany utilized the Black-Scholes option pricing model to estimate the fairvalue of options.

50

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**ADVANCED LIFE SCIENCES HOLDINGS, INC. AND SUBSIDIARY (A Development Stage Company) (Continued) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**2.**   Summary of Significant Accounting Policies (Continued)

The following illustratesthe pro forma effect on net loss and loss per share as if the Company hadapplied the fair value recognition provisions of SFAS No. 123(R) toall awards unvested in each period:

| ** **                          | ** ** | **Pro Forma** | ** ** |
|-------------------------------------|------------|--------------------|------------|
| ** **                          | ** ** | **2005**           | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net Income as  reported             |       | $                  | (6,619,246 | ) | $ | (27,361,918 | ) | $ | (2,726,488 | ) |
| Stock-based employee  compensation: |       |               |       |   |   |   |   |
| Less fair value-based expense       |       | —             |       | — |   | 16,750 |   |
| Pro Forma net  loss                 |       | (6,619,246         | )          | (27,361,918 | ) | (2,743,238 | ) |
| Loss per share:                     |       |               |       |   |   |   |   |
| Basic—as reported              |       | (0.49              | )          | (13.27 | ) | (1.72 | ) |
| Basic—pro forma                |       | $                  | (0.49      | ) | $ | (13.27 | ) | $ | (1.73 | ) |

 

***Disclosure Amount Segments of anEnterprise***—Operating segments are identified ascomponents of an enterprise about which separate discrete financial informationis available for evaluation by the chief operating decision-maker, ordecision-making group, in making decisions regarding resource allocation andassessing performance. To date, the Company has viewed its operations andmanages its business as principally one segment.

***Useof Estimates***—The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesof America requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosure of contingentassets and liabilities at the date of the financial statements. Estimates alsoaffect the reported amounts of revenues and expenses during the reportingperiod. Actual results could differ from those estimates.

**3.   Joint Venture**

Sarawak MediChem Pharmaceuticals (“SMP”) is a jointventure between the State Government of Sarawak, Malaysia (“Sarawak Government”)and the Company. Sarawak, through Craun Sdn Bhd, and ALS Inc. each maintain a50% share in SMP.

Under the joint venture agreement (the “Agreement”),Sarawak Government has contributed $9.0 million to SMP through stocksubscription payments based on the attainment of certain milestone achievementsoutlined in the Agreement. The Company has contributed certain intellectualproperty and has committed to make scientists available to undertake theresearch and clinical trials, to train scientists nominated by the SarawakGovernment and to permit such scientists to participate in the clinical trials,manufacture, marketing and distribution of any commercial product resultingfrom the research and development effort. Additionally, the Sarawak Governmenthas provided long-term loans to SMP of $12.0 million through December 31,2005. Additionally, the Sarawak Government provided approximately $22,000 inshort-term loans during 2005 that was used for patent protection and clinicaltrial insurance expenses. Accrued interest on such loans was approximately $6.0 millionand $4.7 million as of December 31, 2005 and 2004, respectively.

51

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**ADVANCED LIFE SCIENCES HOLDINGS, INC. AND SUBSIDIARY (A Development Stage Company) (Continued) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**3.**   Joint Venture (Continued)

The Company accounts for its investment in SMP underthe modified equity method of accounting, which provides that the Companyrecord its proportional share of earnings once the accumulated deficit incurredby SMP has been recovered. Accordingly, as of December 31, 2005 and 2004,the Company’s investment in SMP had a carrying value of zero.

According to the terms of the loan agreement with theSarawak Government, $12.0 million of SMP’s debt is past due. As a resultof this default in payment by SMP, the Sarawak Government has the option underthe loan agreement to take over the control and management of theCalanolide A project or the affairs of the joint venture until such timeas the loan is repaid in full. To date, the Sarawak Government has not pursuedcollection of this debt or sought to control or manage the Calanolide A project.In July 2005, the Sarawak Government exercised certain of its contractualrights by notifying SMP of its intention to appoint its representative as anofficer of SMP for purposes of assuming control of the affairs and managementof SMP effective immediately. In December 2005, the Sarawak Governmentnominated and the Board of Directors of SMP approved the appointment of Mr. Jumastaphabin Lamat as the controlling officer of SMP. Since that time we have beentransitioning access to the joint venture’s accounting, financial and corporaterecords to representatives of Mr. Lamat. The Sarawak Government alsoexpressly reserved all contractual and legal remedies available in light of thedefault and indicated its intent to fully exercise its rights as a creditor ofthe joint venture. Ultimately, the Company believes that in order for the jointventure to continue, the terms of the debt must be amended to extend itsmaturity to a date after commercialization of Calanolide A.

The Company previously commenced discussions with theSarawak Government to restructure and extend the $12.0 million debt anddetermine the source of financing for Phase IIa clinical trials ofCalanolide A. The Company does not intend to expend any meaningful fundsadvancing the development of Calanolide A unless and until the jointventure’s debt is restructured and the Company reaches a satisfactory agreementwith the Sarawak Government to amend the joint venture relationship andestablish the parties’ respective obligations regarding the future funding ofthe next phase of developing Calanolide A. As a result, the Company isunable to predict when, or if at all, the Company will proceed with its plansto commence Phase IIa clinical trials for Calanolide A.

If the Company is able to restructure our jointventure relationship and determine to proceed with the Phase IIa clinical trialfor Calanolide A, upon completion of this trial the Company will evaluate itsstrategic alternatives for the joint venture relationship and the futureadvancement of Calanolide A. The Company may determine to continue the programthrough our joint venture, independently or under a new joint venturearrangement. It is also possible that the Company will elect to transfer ourrights in the compound to our current jointventure partner or an independent third party. Factors that the Company willconsider in making this decision include the success of the Phase IIaclinical trial, the relative financial obligations of the Company and our jointventure partner and the Company’s capabilities at such time to continuedevelopment independently.

The term of the joint venture agreement continuesindefinitely unless terminated by the written agreement of both parties not toproceed further with the development of Calanolide A. In the event only one ofthe parties wishes to discontinue development of Calanolide A, the other partyhas the right, but 

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**ADVANCED LIFE SCIENCES HOLDINGS, INC. AND SUBSIDIARY (A Development Stage Company) (Continued) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**3.**   Joint Venture (Continued)

not the obligation, topurchase the discontinuing party’s equity interest in the joint venture for$9.0 million. If the other party does not choose to exercise its purchaseright within six months of receiving written notice from the discontinuingparty, then the joint venture is deemed mutually terminated. Upon such mutualtermination, the joint venture agreement provides that any liabilities of thejoint venture will be settled by the parties equally and all patents orlicenses of the joint venture shall be reassigned back to the Company,including rights to clinical trials. We believe that the equal settlement ofliabilities provision in the joint venture agreement was intended to recognizethe 50/50 equity ownership of the joint venture and does not constitute theCompany’s guaranty of the joint venture’s indebtedness to the SarawakGovernment. Consequently, if the joint venture is mutually terminated, thejoint venture partners would work together to monetize the joint venture’sassets for the purpose of satisfying its liabilities, which currently aresolely comprised of indebtedness to a 50% partner, the Sarawak Government. Inthe event the joint venture’s assets are insufficient to settle itsliabilities, the Company does not believe that the equal settlement ofliabilities provision obligates it to contribute funds to the joint venture.

Asummary of financial information for SMP as of December 31, 2005 and 2004,and for the years then ended follows:

| ** **                                       | ** ** | **2005**        | ** ** | **2004**    | ** ** |
|--------------------------------------------------|------------|-----------------|------------|-------------|------------|
| ** **                                       | ** ** | **(Unaudited)** | ** ** |
| Balance sheet  information:                      |       |            |       |        |       |
| Total assets                                     |       | $               | 10,454     |        | $          | 11,006 |   |
| Total liabilities                                |       | 19,384,497      |       | 17,822,053  |       |
| Accumulated deficit                              |       | (28,496,820     | )          | (26,933,824 | )          |
| Stockholders’ deficit                       |       | (19,374,043     | )          | (17,811,047 | )          |
| Results of operations  information—net loss |       | $               | (1,562,996 | )           | $          | (1,577,174 | ) |

 

**4.   Related PartyTransactions**

Subsequent to the spin-off from MediChem in June 1999,the Company and MediChem entered into a master laboratory services agreementunder which the Company is provided services. The Company incurred costs of $0for these services in 2005 and 2004 which are recorded as contracted researchand development expenses in the accompanying consolidated statements of operations.

The Company did not make any payments in 2005 and 2004to MediChem for its achievement of certain milestones in accordance with theterms of research contracts between MediChem and the Company. From inception,the Company has paid $2.4 million in milestone payments to MediChem. Inaddition, the Company paid MediChem $400,000 for the purchase of a patent in1999. These expenses are recorded as research and development expenses in theaccompanying consolidated statements of operations.

In March 2002, the existing license agreementsbetween the Company and MediChem were renegotiated at the time of MediChem’smerger with deCODE. All of the terms and obligations under the previouslicenses were terminated, and a new agreement was formed between the Companyand deCODE/MediChem. Under the new agreement, the Company assigned andrelinquished all of its rights, 

53

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**ADVANCED LIFE SCIENCES HOLDINGS, INC. AND SUBSIDIARY (A Development Stage Company) (Continued) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**4.**   Related Party Transactions(Continued)

title and interest incertain patented technologies in exchange for a 50% royalty on any and allincome received by deCODE/MediChem resulting from the licensing, crosslicensing or sale to a third party of the patented technologies. In 2005, 2004and 2003, the Company received $0, $10,000 and $0, respectively, in royaltypayments relating to these technologies. With the exception of the masterlaboratory services agreement, all other agreements between the Company andMediChem were terminated at the time of MediChem’s merger with deCODE.

In 2001, the Company initiated a management servicesagreement with SMP whereby the Company provides administrative managementservices to SMP. In return, SMP pays a flat monthly service fee to the Company.Management fees recognized as revenue under this agreement totaled $0, $0 and $119,000in 2005, 2004 and 2003, respectively. During 2003, management deemed that thecollectibility of the monthly management fee was not reasonably assured. Consequently,management concluded that fee revenue will be recognized on the cash basis. Asonly three months of fees were paid, only three months of revenue wererecognized during 2003. The remaining nine months have been billed, and theCompany continues to provide management services to SMP. Billed andunrecognized revenue in 2005, 2004 and 2003 totaled approximately $99,000,$160,000 and $185,000, respectively or $615,000 on a cumulative basis.

In January 2004, the Company initiated amanagement services agreement with Flavin Ventures whereby the Company providesadministrative management services to Flavin Ventures and its wholly-ownedsubsidiaries Shamrock Structures, BioStart Property Group and MolecularFormulations. The agreement also requires Flavin Ventures and its relatedsubsidiaries to reimburse the Company for rent and related facility costs basedupon the actual square footage occupied by each of the companies. Fee incomerecognized related to this agreement for the year ended December 31, 2005and 2004 totaled approximately $61,000 and $272,000, respectively. In December 2005,the Company was notified that the management services provided under thisagreement would no longer be required.

The Company’s controlling stockholder, Michael T.Flavin, has loaned to the Company $2.0 million (see Note 5).

The Company’s line of credit has been guaranteed byFlavin Ventures, the controlling stockholder and his wife and the Company’sPresident (see Note 5).

The Company leases facilities from a subsidiary ofFlavin Ventures. Lease payments totaled approximately $286,000, $243,000 and$75,000 for the years ended December 31, 2005, 2004 and 2003, respectively(see Note 10).

The Series Apreferred stock of the Company’s wholly-owned subsidiary, ALS, Inc., isheld by deCODE Genetics (“deCODE”) as a result of ALS Inc.’s spin-off fromMediChem Life Sciences in January 1999, and MediChem’s subsequentacquisition by deCODE Genetics in March 2002. deCODE provides analyticalservices to The Company on an as needed basis. Analytical related chargestotaled approximately $10,000, $6,000 and $1,000 for the years ended December 31,2005, 2004 and 2003, respectively.

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**ADVANCED LIFE SCIENCES HOLDINGS, INC. AND SUBSIDIARY (A Development Stage Company) (Continued) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**5.   Long TermObligations**

In September 2001, the Company entered into a$2.0 million promissory note with the controlling stockholder of theCompany which bears interest at 7.75%. Accrued but unpaid interest is added tothe outstanding principal annually. Principal plus accrued interest was due ina lump sum on September 1, 2006. In August 2005, in conjunctionwith our initial public offering, the stockholder extended the term of the noteto December 31, 2007. No other terms were modified. As of December 31,2005 and 2004, the Company had $2.8 million and $2.6 million,respectively, outstanding under the note.

In December 2004, theCompany entered into a line of credit with a local financial institution for $3.0 million.Interest is based upon the Prime rate plus 0.75% and is payable monthly. Theprincipal balance was due upon demand or by December 21, 2006 if no demandis made. The financial institution also received a warrant to purchase 14,887of the Company’s common stock at an exercise price of $8.02 per share, subjectto certain adjustments. The warrant was exercisable at the time the note wasissued and will terminate, if not exercised, on December 21, 2009. Thewarrant was valued, using the Black-Scholes option pricing model, atapproximately $11,900. The amount was recorded as a discount to long-termobligations and will be amortized to interest expense over the term of the note.The note is secured by the assets of the Company and guaranteed by FlavinVentures. In May 2005, the line of credit was increased to $4.0 million.No other terms were modified. In August 2005, in conjunction with theCompany’s initial public offering, the maturity of the line of credit wasextended to December 31, 2007 and the call feature was removed. No otherterms were modified. In addition, the exercise price of the warrantsautomatically reduced to $5.00 per share in accordance to the terms of thewarrant agreement. As a result of the change in exercise price, the warrant wasrevalued using the Black-Scholes option pricing model at approximately $27,000.The difference between the carrying value and fair value was recorded as adiscount to long-term obligations and is being amortized to interest expenseover the remaining term of the note.

**6.   Stockholders’Deficit**

***Authorized Capital***—Asof December 31, 2005, the authorized capital stock of the Company consistsof 60,000,000 shares of voting common stock authorized for issuance with a parvalue of $0.01 and 5,000,000 shares of undesignated preferred stock which maybe issued from time to time in one or more series. The Company has 17,990,322and 10,604,584 common shares issued and outstanding as of December 31,2005 and 2004, respectively. The Company has not issued any preferred stock asof December 31, 2005.

As of December 31, 2005, ALS Inc. has 250,000shares of Series A Cumulative Preferred Stock (“Series A PreferredStock”) authorized, issued and outstanding to deCODE Genetics. The Series APreferred Stock is nonvoting except as to certain matters including theissuance of any class of stock ranking prior to the shares of Series APreferred Stock, or the merger or consolidation of the Company if such mergerwould adversely affect the powers, preferences or rights of the Series APreferred Stock. The Series A Preferred stockholder is entitled to receivedividends payable in cash at the rate of 7.0% per annum per share on the amountof liquidation preference of the shares.

***Liquidation Preferences***—Upondissolution or winding up of the Company, whether voluntary or involuntary, theholders of the shares of the Series A Preferred Stock are entitled toreceive a liquidation preference of $10 per share, plus all accrued and unpaiddividends.

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**ADVANCED LIFE SCIENCES HOLDINGS, INC. AND SUBSIDIARY (A Development Stage Company) (Continued) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**6.**   Stockholders’ Deficit (Continued)

The total liquidation preference values as of December 31,2005 and 2004 are approximately $3.6 million and $3.5 millionrespectively, including approximately $1.1 million and $1.0 millionof unpaid dividends.

In August 2001, in connection with the formationof ALS GP, the controlling stockholder converted approximately $5.8 millionfrom debt to equity. The conversion was accounted for as a capitalcontribution, and no common or preferred shares were issued as a result of theconversion.

**7.   Incentive StockPlan**

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 of the shares granted vest at the end of eachmonth following the date of grant. Awards of restricted stock are subject tocertain terms, conditions, restrictions and limitations as determined by theboard of directors.

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, 2005, 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 2,072,455. 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 2005 ranged from immediate vesting to 3 years.

The compensation cost that has been charged againstincome for the Company’s Plan was approximately $700,000, $6,000 and $0 for2005, 2004 and 2003, respectively. In August 2005, concurrent to theclosing of the IPO, all outstanding unvested options became fully vestedaccording to the terms of the Plan.

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**ADVANCED LIFE SCIENCES HOLDINGS, INC. AND SUBSIDIARY (A Development Stage Company) (Continued) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**7.**   IncentiveStock Plan (Continued)

The following schedule details the grants under theCompany’s Plan for the years ended December 31, 2005, 2004 and 2003:

| ** **                                     | ** ** | ** ** | ** ** | **Weighted** | ** ** | **Weighted**  | ** ** | ** **    | ** ** |
|------------------------------------------------|------------|------------|------------|--------------|------------|---------------|------------|---------------|------------|
| ** **                                     | ** ** | ** ** | ** ** | **Average**  | ** ** | **Average**   | ** ** | **Aggregate** | ** ** |
| ** **                                     | ** ** | ** ** | ** ** | **Exercise** | ** ** | **Remaining** | ** ** | **Intrinsic** | ** ** |
| **Options**                                    | ** ** | ** ** | ** ** | **Shares**   | ** ** | **Price**     | ** ** | **Term**      | ** ** | **Value** | ** ** |
| Outstanding at  January 1, 2003           |       | 489,402    |       |         |       |          |       |          |       |   |   |   |   |
| Granted                                        |       | 66,497     |       |         | $          | 0.16          |       |          |       |   |   |   |   |   |
| Exercised                                      |       | —     |       |         | —     |          |       |          |       |   |   |   |   |
| Forefeited                                     |       | 1,599      |       |         | 0.16       |          |       |          |       |   |   |   |   |
| Outstanding at December 31, 2003          |       | 554,300    |       |         | $          | 0.16          |       |          |       | 7.2 |   |   | $ | — |   |
| Granted                                        |       | 110,366    |       |         | 0.16       |          |       |          |       |   |   |   |   |
| Exercised                                      |       | 41,685     |       |         | 0.16       |          |       |          |       |   |   |   |   |
| Forefeited                                     |       | 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       |          |       |          |       |   |   |   |   |
| Forefeited                                     |       | —     |       |         | —     |          |       |          |       |   |   |   |   |
| Outstanding at December 31, 2005          |       | 935,834    |       |         | $          | 4.94          |       |          |       | 7.3 |   |   | $ | 1,998,525 |   |
| Options  exercisable at December 31, 2005 |       | 780,612    |       |         | $          | 5.57          |       |          |       | 6.8 |   |   | $ | (1,287,229 | ) |
|                                                |            |            |            |              |            |               |            |               |            |  |  |  |  |  |  |  |  |

 

The weighted-average grant-date fair value of optionsgranted during the years 2005, 2004 and 2003 was approximately $314,000,$30,000 and $16,000, respectively. The total intrinsic value of optionsexercised during the years ended December 31, 2005, 2004 and 2003 wasapproximately $336,000, $60,000 and $0, respectively.

As of December 31, 2005, there was approximately$360,000 of total unrecognized compensation cost related to unvested stockoptions granted under the plan; that cost is expected to be recognized over aperiod of 3 years.

Cash received from optionsexercises under the Plan for the years ended December 31, 2005, 2004 and2003 was approximately $15,000, $7,000 and $0, respectively. The Company issuesnew shares of common stock as a result of stock option exercises.

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**ADVANCED LIFE SCIENCES HOLDINGS, INC. AND SUBSIDIARY (A Development Stage Company) (Continued) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**7.**   Incentive Stock Plan (Continued)

The Company estimates thefair value of each option award on the date of grant using the Black-Scholesmodel that uses assumptions noted in the table below:

| ** **                   | ** ** | **2005**   | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------|------------|------------|------------|----------|------------|----------|------------|
| Expected  volatility         |       | 54 - 64    | %          | 54.0     | %          |     | —     |   |   |
| Weighted-average  volatility |       | 61.0       | %          | 54.0     | %          |     | —     |   |   |
| Expected  dividends          |       | 0.0        | %          | 0.0      | %          |     | —     |   |   |
| Expected term (in  years)    |       | 5.0 - 6.5  |       | 3        |       |     | 10         |   |   |
| Risk-free rate               |       | 3.7% - 4.9 | %          | 3.5      | %          |     | 4.0        | % |   |

 

Due to the limited dataavailable of the Company’s historical stock price volatility, expectedvolatility is computed based upon historical volatilities of pier companieswith similar product portfolios. The expected term of options granted isderived from the average of the vesting period and the life as defined in thePlan.

**8.   Income Taxes**

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 $16.4 million forincome tax purposes are available to offset future taxable income. If notutilized, these carryforwards will expire in varying amounts beginning in theyear 2019.

Thefollowing is a summary of the significant components of the Company’s deferredtax assets as of December 31, 2005 and 2004:

| ** **                          | ** ** | **Years ended December 31,** | ** ** |
|-------------------------------------|------------|---------------------------------------------|------------|
| ** **                          | ** ** | **2005**                                    | ** ** | **2004** | ** ** |
| Deferred tax  assets:               |       |                                        |       |   |   |
| Net operating losses                |       | $                                           | 6,411,965  |   | $ | 3,463,980 |   |
| Stock based compensation            |       | 145,616                                     |       | — |   |
| Depreciation                        |       | 13,456                                      |       | — |   |
| In-process research and development |       | 8,686,399                                   |       | 9,503,130 |   |
| Other accruals and reserves         |       | 544,274                                     |       | — |   |
| Less valuation allowance            |       | (15,801,710                                 | )          | (12,967,110 | ) |
| Deferred tax  asset—net        |       | $                                           | —     |   | $ | — |   |

 

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**ADVANCED LIFE SCIENCES HOLDINGS, INC. AND SUBSIDIARY (A Development Stage Company) (Continued) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**8.**   Income Taxes (Continued)

The reconciliation of thefederal statutory rate to the Company’s effective tax rate is as follows:

| ** **                                             | ** ** | **Years ended December 31,** | ** ** |
|--------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                             | ** ** | **2005**                                    | ** ** | **2004** | ** ** |
| 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 | % |   |

 

**9.   Employee BenefitPlan**

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 after the first year of service hasbeen completed. Approximately $38,000, $32,000 and $32,000 was recognized asexpense in 2005, 2004 and 2003, respectively.

**10.   Commitments**

***Lease Obligations***—TheCompany leases facilities under an operating lease with 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 $18,000 with an additional amount based onthe Company’s proportionate share of the variable building costs. Additionally,the Company leases capital equipment of approximately $41,000 under a capitallease.

Minimumannual payments under operating leases and the present value of minimum capitallease payments as of December 31, 2005 are as follows:

| ** **                               | ** ** | **Operating** | ** ** | **Capital lease** | ** ** |
|------------------------------------------|------------|---------------|------------|------------------------|------------|
| ** **                               | ** ** | **Leases**    | ** ** | **Obligations**        | ** ** |
| Year ending December 31,            |       |          |       |                   |       |   |   |
| 2006                                     |       | $             | 225,759    |                   |       | $ | 17,421 |   |   |
| 2007                                     |       | 234,789       |       |                   | 14,110     |   |   |
| 2008                                     |       | 160,645       |       |                   | —     |   |   |
| 2009                                     |       | —        |       |                   | —     |   |   |
| 2010                                     |       | —        |       |                   | —     |   |   |
| Total                                    |       | $             | 621,193    |                   |       | 31,531 |   |   |
| Less amout representing interest         |       |          |       |                   | 4,251      |   |   |
| Present value of minimum  lease payments |       |          |       |                   | $          | 27,280 |   |   |

 

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**ADVANCED LIFE SCIENCES HOLDINGS, INC. AND SUBSIDIARY (A Development Stage Company) (Continued) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**10.**   Commitments (Continued)

Rental expense relating to the Flavin Ventures leasetotaled approximately $224,000, $224,000 and $75,000 in 2005, 2004 and 2003,respectively.

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

***Employment Contracts***—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.

***Vendor Contracts***—InJuly and October 2005, the Company entered into contracts for themanufacturing and related analytical support for tablets to be consumed in itsupcoming clinical trials. The contracts, in aggregate, totaled approximately$900,000. As of December 31, 2005, approximately $600,000 of expensesrelated to these contracts has been incurred.

In the fourth quarter of 2005, the Company providedauthorizations to proceed, in advance of contract execution, for clinicaltrials, randomization, cardiac safety and clinical lab studies. Theauthorizations, in aggregate, totaled approximately $2.1 million. As of December 31,2005, approximately $200,000 of expenses related to these authorizations hadbeen incurred.

**11.   Research andDevelopment Alliances**

***Abbott Laboratories***—InOctober 2004, the Company executed an option to acquire two antibioticcompounds from Abbott Laboratories (“Abbott”). Under the terms of the optionagreement, the Company paid Abbott a nonrefundable $1 million option fee inexchange for the right to acquire an exclusive world-wide license, with theexception of Japan, to develop, manufacture and commercialize each of thecompounds.

In December 2004, the Company exercised itsoption to acquire the rights for both antibiotic compounds. The licenseagreement required payments totaling $9.0 million and issuance of stock with anestimated value of $9.0 million in exchange for an exclusive world-wide licenseto develop the compounds, with the exception of Japan, and purchase Abbott’sexisting supply of the compounds. Non-milestone based payments and stockissuances under the contract total $25 million, of which $24.5 and $0.5 millionwere classified as in-process research and development expense and clinicaltrials supplies, respectively.

In August 2005, the Company modified the terms ofits license agreement with Abbott for the development and commercialization oftwo antibiotic compounds, cethromycin and ABT-210. In exchange forterminating the Company’s license of ABT-210, Abbott reduced its royaltyrights for cethromycin. Under the new terms, the royalty rate due on aggregatenet sales of cethromycin is 19% on the first $100 million, 18% once aggregatesales exceed $100 million, but are less than $200 million, and 17% on all netsales once aggregate net sales exceed $200 million. Additionally, the Companywill pay a $2.5 million milestone once net aggregate sales of cethromycin reach$200 million and a $5.0 million milestone once net aggregate sales reach $400million.

Concurrent with the initial public offering, theCompany issued 600,000 shares of common stock to Abbott in exchange for a $3.0million reduction of a $5.0 million milestone due upon the earlier of thecommencement of clinical trials or October 31, 2005. The Companysubsequently paid $8.0 million and 

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**ADVANCED LIFE SCIENCES HOLDINGS, INC. AND SUBSIDIARY (A Development Stage Company) (Continued) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**11.**   Research and Development Alliances (Continued)

$2.0 million in August andOctober 2005, respectively. No further milestone payments are due underthe license until a New Drug Application has been filed with the FDA.

In November 2005, clinical supplies weremanufactured in tablet form in 150mg doses to be used in the Company’s clinicaltrials. As a result of the tableting process, the Company charged $500,000 ofclinical supplies to research and development expenses.

***Universityof Illinois at Chicago***—On December 2, 1999 theCompany entered into a license agreement with the University of Illinois atChicago (“UIC”) to license an anti-melanoma compound. Under the terms of theagreement, the Company was granted an exclusive world-wide license in exchangefor certain upfront, milestone and royalty payments. Upon execution, theCompany paid UIC a $15,000 non-refundable license fee and $10,000 patentreimbursement fee both of which were charged to research and developmentexpense. The Company was obligated under the contract to make four additionalannual payments of $10,000 in reimbursement of previous incurred patentprotection costs, which were made as of December 31, 2003. The Company isresponsible for reimbursing UIC for all patent costs incurred subsequent to thelicense date. Patent reimbursement costs totaled approximately $47,000, $72,000and $91,000 in 2005, 2004 and 2003, respectively. In December 2004, theCompany filed an IND with the FDA for the anti-melanoma compound whichtriggered a $10,000 milestone payment to UIC. The milestone was classified as aresearch and development expense.

**12.   Earnings PerShare**

Basic earnings per shareare computed by dividing net income by the number of weighted average commonshares outstanding during the reporting period. Diluted earnings per share arecalculated to give effect to all potentially dilutive common shares that wereoutstanding during the reporting period. The computation of weighted averagecommon shares outstanding for year ended December 31, 2004 gives effect toa 3.97-for-one stock split authorized by the Board in June 2005. Thecomputation of diluted shares outstanding for the periods ended December 31,2005, 2004 and 2003 excludes incremental shares of 950,721, 634,835 and 554,300related to employee stock options and warrants. These shares are excluded dueto their anti-dilutive effect as a result of the Company’s losses for theperiods ended December 31, 2005, 2004 and 2003.

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**ADVANCED LIFE SCIENCES HOLDINGS, INC. AND SUBSIDIARY (A Development Stage Company) (Continued) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**13.   UnauditedQuarterly Financial Data**

Selectedquarterly data for 2005 and 2004 is as follows:

| ** **                                           | ** ** | **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 commons shareholders          |       | (792,076  | )          | (959,802 | ) | (2,251,948 | ) | (2,615,420 | ) |
| Loss per share available  to common shareholders(1): |       |      |       |   |   |   |   |   |   |
| Basic and Diluted                                    |       | $         | (0.07      | ) | $ | (0.09 | ) | $ | (0.15 | ) | $ | (0.15 | ) |

 

| ** **                                           | ** ** | **2004**  | ** ** |
|------------------------------------------------------|------------|-----------|------------|
| ** **                                           | ** ** | **First** | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** |
| Revenue                                              |       | $         | 109,678    |   | $ | 73,295 |   | $ | 74,983 |   | $ | 61,824 |   |
| Research and development  expenses(2)                |       | 300,373   |       | 270,613 |   | 302,133 |   | 24,788,749 |   |
| Selling, general  and administrative expenses        |       | 305,564   |       | 333,521 |   | 559,829 |   | 451,039 |   |
| Operating loss                                       |       | (496,259  | )          | (530,839 | ) | (786,979 | ) | (25,177,964 | ) |
| Net loss  available to common shareholders           |       | (588,217  | )          | (622,770 | ) | (876,863 | ) | (25,274,068 | ) |
| Loss per share available  to common shareholders(1): |       |      |       |   |   |   |   |   |   |
| Basic and Diluted                                    |       | $         | (0.37      | ) | $ | (0.39 | ) | $ | (0.55 | ) | $ | (7.29 | ) |

----

(1)          Amounts for 2004 throughJune of 2005 have been restated to give effect to a 3.97-to-1stock split authorized in June of 2005

(2)          Amountfor 2004 includes approximately $24.5 million of in-process research anddevelopment expense related to compounds licensed from Abbott Laboratories inDecember 2004. See Note 11 to consolidated financial statements.

**14.   SubsequentEvents**

In February of 2006, the Company executedcontracts totaling approximately $790,000 related to its Phase III pivotalclinical trials for cethromycin. Of this amount, $600,000 represents anauthority to proceed with initiation of the clinical trial. The remainingcontracts, totaling approximately $190,000, relate to the manufacture andanalysis of clinical supplies. Payments due under these contracts primarily occurover the next twelve months.

In addition to the authority to proceed issued to theclinical trial provider in February, the Company expects to execute contractsin the second quarter totaling approximately $18.4 million related to thedevelopment of cethromycin. Of this amount, approximately $17.4 millionrepresent the costs expected to be incurred to complete the Phase III pivotalclinical trials. The 

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**ADVANCED LIFE SCIENCES HOLDINGS, INC. AND SUBSIDIARY (A Development Stage Company) (Continued) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**14.**   Subsequent Events (Continued)

remainder, approximately$980,000, relates to cardiac safety studies and clinical laboratory support. Paymentsdue under these contracts will occur over the next twenty-four months.

In March of 2006, the Company sold approximately10.2 million shares of its common stock. In conjunction with the offering,warrants to purchase approximately 5.1 million shares were also issued at a pershare price of $3.81. The warrants can be exercised 180 days following theclosing and expire five years subsequent to the date of issuance. Proceeds fromthe offering, net of underwriting discounts, were approximately $33.6 million.

******

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**ADVANCED LIFESCIENCES HOLDINGS, INC. AND SUBSIDIARY(A Development Stage Company) (Continued)NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

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

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 iscommunicated to management, including the CEO and CFO, as appropriate to allowtimely decisions regarding required disclosure and is recorded, processed,summarized and reported within the time periods specified in the SEC’s rules andforms.

**Changes in Internal Control**

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.*

On March 10, 2006 our Board of Directors modifiedthe compensation plans of our Chief Executive and Financial Officers, Dr. Flavinand Mr. Wieland, respectively. Under the terms of the modified agreements,Dr. Flavin’s annual base salary will increase to $260,000 with a maximumpotential fiscal 2006 bonus of $88,000. Mr. Wieland’s annual base salary willincrease to $190,000 with a maximum potential fiscal 2006 bonus of $48,000.

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**ADVANCED LIFESCIENCES HOLDINGS, INC. AND SUBSIDIARY(A Development Stage Company) (Continued)NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

Inaddition, our Board of Directors granted 233,500 stock options under the 2005Stock Incentive Plan to certain of our named executive officers, employees andscientific advisory board members. The options were granted at an exerciseprice of $3.19 per share and will vest ratably over 36 months. The followingtable summarizes options granted to our executive officers.

|                                                | ** ** | **Options** | ** ** |
|------------------------------------------------|------------|-------------|------------|
| **Name and Principal Position** | ** ** | ** **  | ** ** | **Granted** | ** ** |
| Michael T. Flavin, Ph.D.                       |       |        | 60,000     |   |   |
| *Chairman & CEO*                      |       |        |       |   |   |
| John L. Flavin                                 |       |        | 40,000     |   |   |
| *President*                                    |       |        |       |   |   |
| R. Richard Wieland II                          |       |        | 28,000     |   |   |
| *Executive Vice President*                     |       |        |       |   |   |
| *and Chief Financial Officer*                  |       |        |       |   |   |
| Suseelan Pookote,  Ph.D.                       |       |        | 28,000     |   |   |
| *Executive Vice President*                     |       |        |       |   |   |
| *Corporate Development*                        |       |        |       |   |   |
|                                                |            |             |            |  |  |  |  |

 

**PART III**

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

Weincorporate herein by reference the information concerning directors andexecutive officers in our Notice of Annual Stockholders’ Meeting and ProxyStatement to be filed within 120 days after the end of our fiscal year (the “2006Proxy Statement”).

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

Weincorporate herein by reference the relevant information concerning executivecompensation contained within the 2006 Proxy Statement.

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

Weincorporate herein by reference the relevant information concerning security ownershipof certain beneficial owners and management contained in the 2006 ProxyStatement.

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

Weincorporate herein by reference the relevant information concerning principalaccountant fees and services contained in the 2006 Proxy Statement.

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

We incorporate herein byreference the information concerning certain relationships and relatedtransactions to be contained in the 2006 Proxy Statement.

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**PART IV**

**Item 15.**                 *Exhibits and Financial Statement Schedules.*
| **(a)**    | ** ** | **(1) Financial Statements**                                                                                                                                                                                                                                      |
|------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       | The following consolidated financial statements of  Advanced Life Sciences Holdings, Inc. are included in Part II, Item  8 of this report:                                                                                                                   |
|       |       | Report of Independent Registered Public Accounting  Firm                                                                                                                                                                                                               |
|       |       | Consolidated Balance Sheets at December 31,  2005 and 2004                                                                                                                                                                                                        |
|       |       | Consolidated Statements of Income for the Years  Ended December 31, 2005, 2004, 2003 and period from inception  (January 1, 1999) through December 31, 2005                                                                                             |
|       |       | Consolidated Statements of Stockholders’ Equity for  the Years ended December 31, 2005, 2004 and 2003                                                                                                                                                        |
|       |       | Consolidated Statements of Cash Flows for the Years  Ended December 31, 2005, 2004, 2003 and period from inception (January 1,  1999) through December 31, 2005                                                                                         |
|       |       | Notes to the Consolidated Financial Statements                                                                                                                                                                                                                         |
| ** ** | ** ** | **(2) Financial Statement Schedule**                                                                                                                                                                                                                              |
|       |       | All schedules are  omitted because the required information is not present or is not present in  amounts sufficient to require submission of the schedule or because the  information required is provided in the consolidated financial statements or  notes thereto. |
| ** ** | ** ** | **(3) Exhibits**                                                                                                                                                                                                                                                  |
|       |       | Exhibits required to be attached by Item 601 of  Regulation S-K are listed in the Exhibit Index attached hereto, which in  incorporated herein by this reference.                                                                                                 |
| **(b)**    | ** ** | **Exhibits:**                                                                                                                                                                                                                                                          |
|       |       | See Item 15(a)(3) above.                                                                                                                                                                                                                                          |

 

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized, in the City of Chicago, State ofIllinois, on the 15th day of March, 2006.

|   | ADVANCED LIFE SCIENCES  HOLDINGS, INC. |
|--------|----------------------------------------|
|   | By:                                    |   | /s/  MICHAEL T. FLAVIN |
|   |                                   |   | Michael T. Flavin |
|   |                                   |   | *Chairman  and Chief Executive Officer* |
|   | By:                                    |   | /s/  R. RICHARD WIELAND II |
|   |                                   |   | R. Richard  Wieland II |
|   |                                   |   | *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 15, 2006 |      |
| D. Michael T. Flavin,  Ph. D. |          | (Principal Executive  Officer)                                        |       |                |      |
| /s/ JOHN L. FLAVIN            |          | President and  Director                                               |       | March 15, 2006 |      |
| John L. Flavin                |          |                                                                  |       |                |      |
| /s/ R. RICHARD WIELAND II     |          | Executive Vice  President and                                         |       | March 15, 2006 |      |
| R. Richard Wieland II         |          | Chief Financial Officer  (Principal Financial and Accounting Officer) |       |                |      |
| /s/ SCOTT F. MEADOW           |          | Director                                                              |       | March 15, 2006 |      |
| Scott F. Meadow               |          |                                                                  |       |                |      |
| /s/ TERRY W. OSBORN, PH.D.    |          | Director                                                              |       | March 15, 2006 |      |
| Terry W. Osborn, Ph. D.       |          |                                                                  |       |                |      |
| /s/ RICHARD A. RECK           |          | Director                                                              |       | March 15, 2006 |      |
| Richard A. Reck               |          |                                                                  |       |                |      |

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| /s/ ISRAEL RUBINSTEIN, M.D.     |   | Director |   | March 15, 2006 |   |
|---------------------------------|--------|----------|--------|---------------------|--------|
| Israel Rubinstein, M.D.         |   |     |   |                |   |
| /s/ ROSALIE SAGRAVES, PHARM. D. |   | Director |   | March 15, 2006 |   |
| Rosalie Sagraves, Pharm.  D.    |   |     |   |                |   |
| /s/ THOMAS V. THORNTON          |   | Director |   | March 15, 2006 |   |
| Thomas V. Thornton              |   |     |   |                |   |

 

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**EXHIBIT INDEX**

| 3.1   |   | Amended and Restated Certificate of Incorporation of  Advanced Life Sciences Holdings, Inc. (as filed in our Amended  Registration Statement on Form S-1/A as exhibit 3.1 on  June 3, 2005, as amended and filed in Amended 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   |   | Specimen Common Stock  Certificate. (as filed in our Registration Statement on Form S-1  as exhibit 4.1 on April 28, 2005)                                                                                                                                                                                            |
| 4.2   |   | Warrant to Purchase  3,750 Shares of Common Stock of Advanced Life Sciences Holdings, Inc.,  dated December 21, 2004, issued to Leaders Bank. (as filed in our  Registration Statement on Form S-1 as exhibit 4.2 on  April 28, 2005)                                                                       |
| 4.3   |   | Registration Rights  Agreement, dated December 13, 2004, by and between Abbott Laboratories  and Advanced Life Sciences Holdings, Inc. (as filed in our Registration  Statement on Form S-1 as exhibit 4.3 on April 28, 2005)                                                                               |
| 4.4   |   | Stock Purchase  Agreement, dated December 13, 2004, by and between Abbott Laboratories  and Advanced Life Sciences Holdings, Inc. (as filed in our Registration  Statement on Form S-1 as exhibit 4.4 on April 28, 2005)                                                                                    |
| 4.5   |   | Partnership Exchange  Agreement, dated December 13, 2004, by and between Advanced Life  Sciences Holdings, Inc. and Flavin Ventures, LLC. (as filed in our  Registration Statement on Form S-1 as exhibit 4.5 on  April 28, 2005)                                                                           |
| 4.6   |   | ALS Exchange Agreement,  dated December 13, 2004, by and between Advanced Life Sciences  Holdings, Inc., the Michael T. Flavin Revocable Trust and Karen  Stec. (as filed in our Registration Statement on Form S-1 as exhibit 4.6  on April 28, 2005)                                                 |
| 4.7   |   | Partnership Dissolution  Agreement, dated December 13, 2004 by and between Advanced Life Sciences  Holdings, Inc. and Advanced Life Sciences, Inc. (as filed in our  Registration Statement on Form S-1 as exhibit 4.7 on  April 28, 2005)                                                             |
| 4.8   |   | Contribution Agreement,  dated as of December 13, 2004, by and between Flavin Ventures, LLC and  the Michael T. Flavin Revocable Trust. (as filed in our Registration  Statement on Form S-1 as exhibit 4.8 on April 28, 2005)                                                                              |
| 4.9   |   | Ventures Contribution  Agreement, dated as of December 13, 2004, by and between ALS  Ventures, LLC and Flavin Ventures, LLC. (as filed in our Registration  Statement on Form S-1 as exhibit 4.9 on April 28, 2005)                                                                                         |
| 10.1  |   | Stock Incentive Plan  Assignment, Assumption and Amendment Agreement, dated December 13, 2004,  by and between Advanced Life Sciences, Inc. and Advanced Life Sciences  Holdings, Inc. (as filed in our Registration Statement on Form S-1  as exhibit 10.1 on April 28, 2005)                         |
| 10.2* |   | Amended and Restated  Employment Agreement, dated March 10, 2006, by and between Advanced Life  Sciences, Inc. and Michael T. Flavin.                                                                                                                                                                                      |

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| 10.3   |   | Employment Agreement,  dated April 11, 2005, by and between Advanced Life Sciences, Inc.  and John L. Flavin. (as filed in our Amended Registration Statement on  Form S-1/A as exhibit 10.3 on June 3, 2005, as amended  by the employment agreement amendment, dated January 6, 2006, as filed  in our Current Report on Form 8-K as exhibit 10.1 on  January 6, 2006)    |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.4*  |   | Employment Agreement,  dated April 11, 2005, by and between Advanced Life Sciences, Inc.  and R. Richard Wieland II as amended by the employment agreement amendment  dated March 10, 2006.                                                                                                                                                                                                               |
| 10.5   |   | Employment Agreement,  dated April 11, 2005, by and between Advanced Life Sciences, Inc.  and Suseelan Pookote. (as filed in our Amended Registration Statement on  Form S-1/A as exhibit 10.4 on June 3, 2005, as amended  by the employment agreement amendment, dated January 6, 2006, as filed  in our Current Report on Form 8-K as exhibit 10.2 on  January 6, 2006)  |
| 10.6   |   | Employment Agreement,  dated April 11, 2005, by and between Advanced Life Sciences, Inc.  and Ze-Qi Xu. (as filed in our Amended Registration Statement on Form S-1/A  as exhibit 10.6 on June 3, 2005, as amended by the employment  agreement amendment, dated November 18, 2005,as filed on our Current  Report on Form 8-K as exhibit 10.5 on November 23, 2005)        |
| 10.7   |   | Loan Agreements, dated  between November 25, 1999 and October 29, 2001, between the  Government of the State of Sarawak and Sarawak MediChem Pharmaceuticals Inc.  (as filed in our Registration Statement on Form S-1 as exhibit 10.7  on April 28, 2005)                                                                                                                                      |
| 10.8   |   | Promissory Note, dated  September 1, 2001, from Advanced Life Sciences, Inc. in favor of  Michael T. Flavin. (as filed in our Registration Statement on  Form S-1 as exhibit 10.8 on April 28, 2005.) as amended  by the Letter of Commitment, dated July 28, 2005. (as filed in our  Amended Registration Statement on Form S-1/A as exhibit 10.22  on July 28, 2005) |
| 10.9   |   | Business Loan Agreement,  dated December 21, 2004, between Advanced Life Sciences  Holdings, Inc. and Leaders Bank. (as filed in our Registration Statement  on Form S-1 as exhibit 10.9 on June 3, 2005.)                                                                                                                                                                                      |
| 10.10* |   | Promissory Note, dated  May 31, 2005, between Advanced Life Sciences Holdings, Inc. and  Leaders Bank.                                                                                                                                                                                                                                                                                                         |
| 10.11  |   | License Agreement, dated  December 13, 2004, by and between Abbott Laboratories and Advanced Life  Sciences Holdings, Inc. (as filed in our Current Report on Form 8-K  as exhibit 10.10 on August 12, 2005.)                                                                                                                                                                                   |
| 10.12  |   | License Agreement, dated  April 28, 2003, by and between The University of Chicago, as Operator of  Argonne National Laboratory, and Advanced Life Sciences, Inc. (as filed  in our Registration Statement on Form S-1 as exhibit 10.11 on  April 28, 2005)                                                                                                                                     |
| 10.13  |   | Exclusive License  Agreement, dated December 2, 1999, by and between the Board of Trustees  of the University of Illinois and Advanced Life Sciences, Inc. (as filed  in our Registration Statement on Form S-1 as exhibit 10.12 on  April 28, 2005)                                                                                                                                            |
| 10.14  |   | Patent Assignment and  License Agreement, dated January 24, 1989, Baxter International Inc. and  Michael T. Flavin. (as filed in our Registration Statement on Form S-1  as exhibit 10.13 on April 28, 2005)                                                                                                                                                                                         |
| 10.15  |   | Joint Venture Agreement,  dated December 21, 1996, between Craun Research Sdn. Bhd, for and on  behalf of the Government of the State of Sarawak, Malaysia, and MediChem  Research Inc. (as filed in our Registration Statement on Form S-1  as exhibit 10.14 on April 28, 2005)                                                                                                                     |
| 10.16  |   | Patent License  Agreement, dated May 18, 1995, between the National Institutes of Health  or the Centers for Disease Control and MediChem Research, Inc. (as filed  in our Registration Statement on Form S-1 as exhibit 10.15 on  April 28, 2005)                                                                                                                                              |

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| 10.17 |   | License Agreement, dated  December 27, 1995, between MediChem Research, Inc. and the  Government of Sarawak. (as filed in our Registration Statement on Form S-1  as exhibit 10.16 on April 28, 2005)                         |
|-------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.18 |   | Management Services  Agreement, dated January 1, 2004, by and between Advanced Life  Sciences, Inc. and Flavin Ventures, LLC. (as filed in our Registration  Statement on Form S-1 as exhibit 10.17 on April 28,  2005)       |
| 10.19 |   | Advanced Life  Sciences, Inc. Annual Bonus Plan. (as filed in our Registration  Statement on Form S-1 as exhibit 10.18 on April 28,  2005)                                                                                         |
| 10.20 |   | Advanced Life Sciences  Holdings, Inc. 2005 Stock Incentive Plan. (as filed in our Registration  Statement on Form S-1 as exhibit 10.19 on April 28,  2005)                                                                        |
| 10.21 |   | Assignment of Lease by  Lessor with Consent of Lessee, dated November 1, 2004, by Flavin  Ventures, LLC to Biostart Property Group, LLC (as filed in our Registration  Statement on Form S-1 as exhibit 10.20 on April 28,  2005)  |
| 10.22 |   | Master Service  Agreement, dated November 21, 2005, between Advanced Life  Sciences, Inc. and Quintiles, Inc. (as filed in our Current Report  on Form 8-K as exhibit 10.1 on November 23, 2005)                         |
| 10.23 |   | Authorization to Proceed  with Protocol CL05-001, dated November 21, 2005, between Advanced  Life Sciences, Inc. and Quintiles, Inc. (as filed in our Current  Report on Form 8-K as exhibit 10.2 on November 23, 2005)  |
| 10.24 |   | Laboratory Service  Agreement, dated November 22, 2005, between Advanced Life  Sciences, Inc. and Covance Central Laboratory Services LP. (as filed in  our Current Report on Form 8-K as exhibit 10.3 on  November 23, 2005) |
| 10.25 |   | ECG Service Agreement, dated  November 22, 2005, between Advanced Life Sciences, Inc. and Covance  Cardiac Safety Services, Inc. (as filed in our Current Report on  Form 8-K as exhibit 10.4 on November 23, 2005)      |
| 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.)                                                                                               |
| 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.

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