UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 Form 10-K
 þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
 For the fiscal year ended December 31, 2008
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
 For the transition period from            to
 Commission File Number: 001-32629
 AVALON PHARMACEUTICALS, INC.
 (Exact name of Registrant as specified in its charter)
 Delaware
    
    52-2209310(State or other jurisdiction of 
incorporation or organization)
    
    (I.R.S. Employer
Identification No.)20358 Seneca Meadows Parkway,
    
    20876Germantown, Maryland(Address of principal executive offices)
    
    (Zip Code)
 Registrants telephone number, including area code:
(301) 556-9900
 Securities registered pursuant to Section 12 (b) of the Act:
 Title of Each Class
    
    Name of Each Exchange on Which RegisteredCommon Stock, par value $0.01 per share
    
    The NASDAQ Stock Market
 Securities registered pursuant to Section 12 (g) of the Act:
None
 o þ
 o þ
 þ o
 o
  Large accelerated filer oAccelerated filer oNon-accelerated filer o(Do not check if a smaller reporting company)Smaller reporting company þ o þ
   Class
    
    Outstanding on March 24, 2009Common Stock, par value $0.01 per share
    
    20,428,475 shares
 DOCUMENTS INCORPORATED BY REFERENCE
 None




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TABLE OF CONTENTS
 Part
    
    ItemNo.
    
    No.
    
    Description
    
    Page No.I
    
    1
    
    BUSINESS
    
    
    11A
    
    RISK
FACTORS
    
    
    151B
    
    UNRESOLVED STAFF
COMMENTS
    
    
    252
    
    PROPERTIES
    
    
    263
    
    LEGAL PROCEEDINGS
    
    
    264
    
    SUBMISSION OF
MATTERS TO A VOTE OF SECURITY HOLDERS
    
    
    26II
    
    5
    
    MARKET FOR THE
REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
    
    
    266
    
    SELECTED FINANCIAL
DATA
    
    
    277
    
    MANAGEMENTS
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
    
    
    287A
    
    QUANTITATIVE AND
QUALITATIVE DISCLOSURES ABOUT MARKET RISK
    
    
    358
    
    FINANCIAL STATEMENTS
AND SUPPLEMENTARY DATA
    
    
    369
    
    CHANGES IN AND
DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
    
    
    609A(T)
    
    CONTROLS AND
PROCEDURES
    
    
    609B
    
    OTHER INFORMATION
    
    
    60III
    
    10
    
    DIRECTORS AND
EXECUTIVE OFFICERS OF THE REGISTRANT
    
    
    6111
    
    EXECUTIVE
COMPENSATION
    
    
    6312
    
    SECURITY OWNERSHIP
OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
    
    
    7113
    
    CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS
    
    
    7314
    
    PRINCIPAL ACCOUNTANT
FEES AND SERVICES
    
    
    75IV
    
    15
    
    EXHIBITS AND
FINANCIAL STATEMENT SCHEDULES
    
    
    76
  i




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Cautionary Advice Regarding Forward-Looking Statements
   
    
    risks relating to our pending merger with a subsidiary of Clinical Data,
Inc.;
    
    risks relating to the early stage of product candidates under development;
    
    risks relating to our ability to secure and maintain relationships with
collaborators;
    
    uncertainties with, and unexpected results and related analyses relating to
clinical trials of our product candidates;
    
    the timing and content of future U.S. Food and Drug Administration regulatory
actions;
    
    dependence on efforts of third parties;
    
    dependence on intellectual property;
    
    risks that we may lack the financial resources and access to capital to fund
our operations; and
    
    risks relating to the commercialization, if any, of our product candidates
(such as marketing, regulatory, patent, product liability, supply, competition
and other risks).
  ii




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PART I
 
 ITEM 1. BUSINESS
 Overview
 ®
     ® ® ®
 ® ®
 ®
 ®
 Pending Acquisition by Clinical Data
 1




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Merger Agreement.
 1 2
  Private Placement.
  2




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License Agreement. ® ®
 Secured Loan.
 Status of
Merger Transaction.
 Important Information for Investors and Stockholders
 As discussed above,
Avalon and Clinical Data have filed a joint preliminary proxy statement/prospectus with the SEC in
connection with the proposed merger. Investors and stockholders are urged to read the joint
definitive proxy statement/prospectus when it becomes available and any other relevant documents
filed by either party with the SEC because they will contain important information.
 Investors
and stockholders will be able to obtain the joint definitive proxy statement/prospectus and other
documents filed with the SEC free of charge at the website maintained by the SEC at www.sec.gov.
In addition, documents filed with the SEC by Avalon will be available free of charge on the portion
of the Avalon website titled Investors at www.avalonrx.com. Documents filed with the SEC by
Clinical Data will be available free of charge on the portion of the Clinical Data website titled Investors
at www.clda.com.
 Clinical
Data, Avalon and their directors and executive officers may be deemed to be participants in the
solicitation of proxies from Avalon stockholders. Information regarding Clinical Datas participants
is available in Clinical Data's Annual Report on Form 10-K for the year ended March 31, 2008 and
its proxy statement for its 2008 Annual Meeting of stockholders, which are filed with the SEC.
Information regarding Avalon's participants is available elsewhere in this Annual Report  on Form
10-K.  Additional information regarding interests of such participants will be included in the
joint definitive proxy statement/prospectus that will be filed with the SEC. You can obtain
free copies of these documents from Clinical Data and Avalon as indicated above.
 Pending Nasdaq Delisting
   Our Drug Discovery and Development Programs
  3




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AVN944 Program
  ®
  Beta-Catenin Program
 ®
  Aurora/Centrosome Pathway Program
 ®
 4




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Survivin Program
  Myc Program
  Therapeutic Antibodies
 ®
 Hsp90 Program
  Our Technologies
 ® ®
 ®
 ®
 ®
 5




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®
 Our Strategy
  
    
    Advance our anti-cancer therapeutic programs.We plan to advance the
development of our lead candidates in both the beta-catenin and the
Aurora/Centrosome pathway programs to select and optimize pre-clinical candidates
for both programs and to advance those candidates to clinical trials. We will
continue to utilize AvalonRx® to discover and develop new therapeutic
candidates against proprietary Avalon cancer targets and well-known cancer
pathways proven to be difficult for conventional technologies to address.
    
    Continue to deliver value for Avalons partners.We have formed
collaborations with Merck & Co., Inc., AstraZeneca PLC (through the acquisition
of MedImmune, Inc.), Novartis Institutes for Biomedical Research, Inc., Medarex,
Inc. and ChemDiv, Inc. We will continue to deliver value to our partners by
using AvalonRx® to discover and develop compounds together with our
partners.
    
    Leverage AvalonRx in the advancement of AVN944.We began conducting a U.S.
Phase I trial for AVN944 in hematological cancer patients in January 2006. We
initiated Phase IIa clinical trials in pancreatic cancer during 2007. During the
clinical development of AVN944 and the development of all of our subsequent drug
candidates, we intend to leverage AvalonRx® to accelerate
decision-making by: (1) selecting biomarkers of responsive cancers, (2)
identifying responsive patient populations for improved clinical trial design and
outcome, (3) determining appropriate drug combinations more quickly than with
conventional methods, and (4) developing genetic biomarker diagnostics.
  Collaborative Relationships
 Merck & Co., Inc.
  ®
 6




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AstraZeneca PLC
      ChemDiv, Inc.
 ® tm
 ®
 7




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Medarex, Inc.
 ® ®
 Novartis Institutes for Biomedical Research, Inc.
 ®
  ® ® ®
  Patents, Licenses and Proprietary Rights
  Vertex license
 8




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Clinical Data license
 ® ®
 Patent
rights and licenses
    
    
    obtain patents to protect our own products;
    
    obtain licenses to use the technologies of third parties, which may be
protected by patents;
    
    protect our trade secrets and know-how; and
    
    operate without infringing the intellectual property and proprietary rights of
others.
 9




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Trade secrets
 ®
 Competition
    Manufacturing and Supply
   Marketing and Sales
  10




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Government Regulation
  Pharmaceutical Product Regulation
   
    
    Preclinical Phase.The preclinical phase involves the discovery,
characterization, product formulation and animal testing necessary to prepare an
IND for submission to the FDA. The IND must be accepted by the FDA before the
drug can be tested in humans. The review period for an IND submission is 30 days,
after which, if no comments are made by the FDA, the product candidate can be
studied in Phase I clinical trials. Certain preclinical tests must be conducted
in compliance with the FDAs good laboratory practice regulations and the United
States Department of Agricultures Animal Welfare Act.
    
    Clinical Phase.The clinical phase of development follows a successful IND
submission and involves the activities necessary to demonstrate the safety,
tolerability, efficacy, and dosage of the drug in humans, as well as the ability
to produce the drug in accordance with cGMP requirements. Clinical trials are
conducted under protocols detailing, among other things, the objectives of the
study and the parameters to be used in assessing the safety and the efficacy of
the drug. Each protocol must be submitted to the FDA as part of the IND prior to
beginning the trial. Each trial must be reviewed, approved, and conducted under
the auspices of an Institutional Review Board, or IRB, and each trial, with
limited exceptions, must include the patients informed consent. Typically,
clinical evaluation involves the following time-consuming and costly three-phase
sequential process:
 Phase I.
 Phase II.
 Phase III.
  11




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New Drug Application
     Post Approval Phase
  12




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Hatch  Waxman Act
   Pediatric Exclusivity
  Pediatric Assessment
  Orphan Drug Designation and Exclusivity
  13




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Foreign Regulation
  Other Regulations
   Employees
  Organization; Principal Executive Offices
  Available Information
  14




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ITEM 1A. RISK FACTORS
 Risks Related to the Acquisition by Clinical Data
 The number of shares and the value of Clinical Data common stock that Avalon stockholders
will receive in connection with the merger will fluctuate.
   The issuance of Clinical Data common stock under the CVRs is subject to a number of
uncertainties; because of the delay in time before any shares of Clinical Data common stock
could be issuable under the CVRs, the value of such stock will fluctuate.
   
    
    Under the Merck Agreement, Avalon is entitled to a payment of $4 million upon
the achievement of biological proof of concept of a lead compound as an inhibitor
of the target which is the subject of the collaboration. Avalon also is entitled
to an additional payment of $4 million upon the achievement of preclinical proof
of concept of such compound following achievement of biological proof of concept.
In addition, if Merck terminates the agreement, Avalon is entitled to a
termination fee of up to potentially $7 million, depending on the status of the
collaboration at the time of termination of the agreement. With respect to the
$4 million payment upon achievement of biological proof of concept, although
Avalons
management believes that the lead compound that it has identified under this
collaboration has satisfied the criteria for achievement of biological proof of
concept, based on recent discussions with Merck, it appears that Merck may
intend to dispute Avalons achievement of this milestone. We are currently in
discussions with Merck regarding the achievement of this milestone. In addition,
we are in discussions with Merck regarding the termination of the collaboration
by Merck and the payment by Merck to Avalon of a
 15




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termination fee under the terms
of the agreement, as described above. There is no guarantee that these matters
will be resolved favorably for Avalon, and pending the resolution of these
matters, it is unlikely that further progress will be made with respect to the
preclinical proof of concept milestone or any other milestones under the Merck
Agreement. In the event that the collaboration with Merck is terminated, we may
receive all or part of the termination payment described above, but no further
progress will be made towards the attainment of any other milestone under the
Merck Agreement. Moreover, resolution of these matters
could take extensive time to achieve, which could potentially prevent a payment
from Merck that would otherwise constitute a milestone payment under the terms
of the CVR agreement from being received prior to June 30, 2010, the milestone
payment deadline under the CVR agreement. Consequently, there can be no
assurance when, or if, any payments will be received from Merck, and
accordingly, whether any milestone payments will be achieved under the CVR
agreement based on our collaboration with Merck.
 
    
    Under the Novartis Agreement, Avalon is entitled to receive a $500,000
milestone payment if Novartis identifies a validated hit compound and another
$500,000 milestone payment if Novartis identifies a lead compound under the
collaboration. The determination of whether to pursue a validated hit compound or
lead compound under the collaboration is at the sole discretion of Novartis.
Accordingly, there can be no assurance that Novartis will determine to continue
with the collaboration through the identification of a validated hit compound or
of a lead compound. If Novartis determines not to continue with the collaboration
through these milestone events, no further payments will be due to Avalon under
the Novartis Agreement.
    Uncertainty regarding the merger and the effects of the merger could cause our
licensors, collaborators, suppliers or other strategic partners to delay or defer decisions,
which could increase costs of the on-going business for us.
  16




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The merger is subject to closing conditions that could result in the completion of the
merger being delayed or not consummated, which could negatively impact our stock price and
future business and operations.
  Failure to complete the merger could negatively impact the market price of our common
stock and the future business and financial results of Avalon, and the merger agreement
limits our ability to pursue alternatives to the merger.
  
    
    We may be required, under some circumstances, to pay
Clinical Data a termination fee of $300,000 and reimburse
Clinical Data for up to $100,000 of merger-related expenses;
    
    We may be required to repay to Clinical Data the outstanding principal
and accrued interest under the terms of a note purchase agreement between
the parties and related term notes;
    
    The diversion of managements attention, the reduction in capital
spending and acquisitions, the suspension of planned hiring and other
affirmative and negative covenants in the merger agreement restricting the
companies businesses;
    
    Failure to pursue other beneficial opportunities as a result of the
focus of management on the merger, without realizing any of the anticipated
benefits of the merger;
    
    the market price of our common stock may decline to the extent that the
current market price reflects a market assumption that the merger will be
completed;
    
    We may experience negative reactions to the termination of the merger
from licensors, collaborators, suppliers, or other strategic partners;
    
    Our costs incurred related to the merger, such as legal and accounting
fees, must be paid even if the merger are not completed;
    
    Our common stock may be subject to delisting from the Nasdaq Global
Market; and
    
    Clinical Datas royalty-free, fully-paid, worldwide, perpetual,
irrevocable, sublicensable and exclusive license to
AvalonRx®, our proprietary drug-development platform, will
not terminate, thereby restricting our operations and potentially
negatively impacting the value of Avalons common stock.
   17




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During the pendency of the merger, we may not be able to enter into certain business
arrangements with other parties because of restrictions in the merger agreement.
  Risks Related to Our Business
 We have an immediate need for capital and will need to raise additional capital
in the future to continue our business, and our independent registered public
accounting firm has expressed substantial doubt as to our ability to continue as a
going concern.
   We have a history of losses, we expect to continue to incur losses for the
foreseeable future, and we may never achieve or sustain profitability.
  18




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Our stock price is volatile.
   Our common stock may be delisted from the Nasdaq Global Market prior to the
closing of the merger, which could reduce the value of your investment and make your
shares of our stock more difficult to sell.
    We have no products approved for commercial sale and do not expect to have any
products approved for commercial sale for the next several years.
 19




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The drug discovery methods we employ through AvalonRx ® are new and unproven and may not
lead to the development of commercially viable drugs.
 ®
 If we fail to enter into new strategic collaborations, or if existing collaborations are
terminated, we will not grow our revenue and our ability to exploit AvalonRx ® to discover
drugs for diseases other than cancer will be limited; our rights to AvalonRx ® are limited.
  ® ® ®
 We face intense competition in the development and commercialization of our drug
candidates.
   20




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
    
    attract qualified personnel;
    
    attract parties for acquisitions, joint ventures or other collaborations; and
    
    license technology that is competitive with our technology.
 We may face liability claims related to the use or misuse of our drug candidates
in clinical trials. If our insurance coverage is not sufficient, a product liability
claim against us could adversely affect our business.
   Our operating results may vary significantly from period to period, which may result
in a decrease in the price of our common stock.
  
    
    the introduction of new anticancer drugs by us or our competitors;
    
    costs and expenses associated with delays in or changes to preclinical
testing and clinical trials;
    
    the timing of regulatory approvals;
    
    sales and marketing expenses; and
    
    the amount and timing of operating costs and capital expenditures relating to
the expansion of our business operations and facilities.
  Risks Related to Our Intellectual Property
 If we are unable to obtain and enforce patent protection for our drug candidates, our
business could be materially harmed.
  21




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Third parties may challenge the validity of our potential patents or other intellectual
property rights and could deprive us of valuable rights. If we infringe patents or other
proprietary rights of third parties, we could incur substantial liability.
     Our drug discovery technology is not patented, and the value of our technology and
drug candidates could be adversely affected if we are unable to protect the
confidentiality of our proprietary information, know-how and trade secrets.
   22




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Risks Related to Regulatory Matters
 Preclinical and clinical testing are time consuming, expensive, and uncertain
processes.
   
    
    a limited number of, and competition for, suitable patients with particular
types of cancer for enrollment in clinical trials;
    
    delays or failures in obtaining regulatory clearance to commence a clinical
trial;
    
    delays or failures in obtaining sufficient clinical materials;
    
    delays or failures in reaching agreement on acceptable clinical trial
agreement terms or clinical trial protocols with prospective sites; and
    
    delays or failures in obtaining Institutional Review Board, or IRB, approval
to conduct a clinical trial at a prospective site.
  
    
    slower than expected rates of patient recruitment and enrollment;
    
    failure of patients to complete the clinical trial;
    
    unforeseen safety issues;
    
    lack of efficacy during clinical trials;
    
    inability or unwillingness of patients or medical investigators to follow our
clinical trial protocols;
    
    inability to monitor patients adequately during or after treatment; and
    
    regulatory action by the FDA for failure to comply with regulatory
requirements.
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
    
    failing to demonstrate clinical effectiveness or having significantly lower
efficacy than existing therapies;
    
    producing harmful side effects;
    
    denial of regulatory approvals by the FDA or other regulators;
    
    failing to acquire, on reasonable terms, intellectual property rights
necessary for commercialization; and
    
    loss of market to competing drugs which are more effective or economical.
   Even if our drug candidates obtain regulatory approval, we will be subject to ongoing
government regulation.
   24




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We have only limited experience in regulatory affairs which may affect our ability or
the time we require to obtain necessary regulatory approvals.
  Third parties engaged to produce our drug candidates for clinical use may fail to
comply with regulatory requirements, which could delay clinical trials.
  Our operations involve hazardous materials and medical waste and are subject to
environmental, health and safety controls and regulations. Any claim relating to our
improper handing, storage or disposal of biological and hazardous materials could be
time-consuming and costly, and may exceed our resources.
  Our business involves animal testing and changes in laws, regulations or accepted clinical
procedures or social pressures could restrict our use of animals in testing and adversely
affect our research and development efforts.
   
 ITEM 1B. UNRESOLVED STAFF COMMENTS
  25




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ITEM 2. PROPERTIES
  
 ITEM 3. LEGAL PROCEEDINGS
  
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
  
 PART II
 
 ITEM 5. MARKET FOR THE REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES
 Market Information
   High
    
    Low2008:First Quarter(January 1  March 31)
    
    $
    3.44
    
    
    $
    1.90Second Quarter(April 1  June 30)
    
    $
    2.65
    
    
    $
    1.00Third Quarter(July 1  September 30)
    
    $
    1.30
    
    
    $
    0.27Fourth Quarter(October 1  December 31)
    
    $
    0.64
    
    
    $
    0.07
 High
    
    Low2007:First Quarter(January 1  March 31)
    
    $
    5.85
    
    
    $
    3.08Second Quarter(April 1  June 30)
    
    $
    6.38
    
    
    $
    4.25Third Quarter(July 1  September 30)
    
    $
    6.25
    
    
    $
    4.10Fourth Quarter(October 1  December 31)
    
    $
    5.75
    
    
    $
    2.90
  Stockholders
  26




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Dividends
  Securities Authorized for Issuance under Equity Compensation Plans
  
 ITEM 6. SELECTED FINANCIAL DATA
  For the Year Ended December 31,2008
    
    
    2007
    
    
    2006
    
    
    2005
    
    
    2004(In thousands, except per share data)SUMMARY STATEMENTS OF OPERATIONS:Revenue
    
    $
    311
    
    
    $
    809
    
    
    $
    2,724
    
    
    $
    1,544
    
    
    $
    1,900Operating expenses:Research and development
    
    
    15,465
    
    
    
    15,322
    
    
    
    13,269
    
    
    
    15,789
    
    
    
    10,680General and administrative
    
    
    5,266
    
    
    
    8,240
    
    
    
    7,661
    
    
    
    5,066
    
    
    
    4,325Restructuring and merger-
related costs
    
    
    1,570
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total operating expenses
    
    
    22,301
    
    
    
    23,562
    
    
    
    20,930
    
    
    
    20,855
    
    
    
    15,005Loss from operations
    
    
    (21,990
    )
    
    
    (22,753
    )
    
    
    (18,206
    )
    
    
    (19,311
    )
    
    
    (13,105
    )Other income (expense):Interest income
    
    
    584
    
    
    
    1,603
    
    
    
    1,288
    
    
    
    503
    
    
    
    327Interest expense
    
    
    (568
    )
    
    
    (633
    )
    
    
    (808
    )
    
    
    (1,147
    )
    
    
    (890
    )Other
    
    
    147
    
    
    
    110
    
    
    
    624
    
    
    
    663
    
    
    
    8Other income (expense), net
    
    
    163
    
    
    
    1,080
    
    
    
    1,104
    
    
    
    19
    
    
    
    (555
    )Net loss
    
    
    (21,827
    )
    
    
    (21,673
    )
    
    
    (17,102
    )
    
    
    (19,292
    )
    
    
    (13,660
    )Dividends on and accretion of
convertible preferred stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,111
    )
    
    
    (1,449
    )Net loss attributed to common
shareholders
    
    $
    (21,827
    )
    
    $
    (21,673
    )
    
    $
    (17,102
    )
    
    $
    (20,403
    )
    
    $
    (15,109
    )Net loss per share  basic and
diluted
    
    $
    (1.24
    )
    
    $
    (1.42
    )
    
    $
    (1.74
    )
    
    $
    (9.58
    )
    
    $
    (117.65
    )Weighted average number of shares
of Common Stock outstanding
    
    
    17,628
    
    
    
    15,299
    
    
    
    9,841
    
    
    
    2,129
    
    
    
    128
 27




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As of December 31,2008
    
    2007
    
    2006
    
    2005
    
    2004(In thousands)SUMMARY BALANCE SHEET
DATA:Cash, cash equivalents
and marketable
securities(1)
    
    $
    5,790
    
    
    $
    28,525
    
    
    $
    20,430
    
    
    $
    27,748
    
    
    $
    14,309Working capital
    
    
    (702
    )
    
    
    18,384
    
    
    
    8,629
    
    
    
    17,070
    
    
    
    5,545Total assets
    
    
    12,144
    
    
    
    37,305
    
    
    
    31,391
    
    
    
    41,282
    
    
    
    29,292Total debt
    
    
    3,000
    
    
    
    7,211
    
    
    
    8,725
    
    
    
    10,944
    
    
    
    13,631Accumulated deficit
    
    
    (146,204
    )
    
    
    (124,377
    )
    
    
    (102,704
    )
    
    
    (85,602
    )
    
    
    (65,949
    )Total stockholders equity
    
    
    4,844
    
    
    
    26,174
    
    
    
    17,874
    
    
    
    25,883
    
    
    
    (65,971
    )
 
 (1)
    
    Includes restricted cash of zero, $5.3 million, $6.0 million, $6.3
million and $6.1 million at December 31, 2008, 2007, 2006, 2005 and
2004, respectively. 
 ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
 Overview
 ®
 ®
   28




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Pending Acquisition by Clinical Data
 ®
 Pending Nasdaq Delisting
  Recent Developments
   Financial Operations Overview
 Revenue
  29




---



##### 



Collaboration Revenue
 Research and Development Expense
    General and Administrative
  Quarterly Results May Fluctuate
  
    
    the timing and extent of our development activities and clinical trials for
AVN944 and any other biopharmaceutical drug candidates that we may develop in the
future;
    
    the timing and outcome of our applications for regulatory approval for our
drug candidates;
    
    the timing and extent of our adding new employees and infrastructure; and
    
    the timing of any milestone payments, license fees, or royalty payments that
we may be required to make or that we may receive from collaborations.
 30




---



##### 



Critical Accounting Policies and Significant Judgments and Estimates
   Revenue Recognition
  Accrued Expenses
  Stock-Based Compensation
   31




---



##### 



Results of Operations
 Year Ended December 31, 2008 Compared to Year Ended December 31, 2007
 Revenue.
 Research and Development.
  General and Administrative.
 Restructuring and merger-related costs.
 Interest Income.
 Interest Expense.
 32




---



##### 



Other Income.
 Year Ended December 31, 2007 Compared to Year Ended December 31, 2006
 Revenue.
 Research and Development.
  General and Administrative.
 Interest Income.
 Interest Expense.
 Other Income.
 Liquidity and Capital Resources
 Overview
  
    
    fund our research, development and clinical programs;
    
    obtain regulatory approvals;
    
    prosecute, defend and enforce any patent claims and other intellectual
property rights;
    
    fund general corporate overhead; and
    
    support our debt service requirements and contractual obligations.
 33




---



##### 



®
 Sources and Uses of Cash
 Operating Activities.
 Investing Activities.
 Financing Activities.
 Credit Arrangements
   34




---



##### 



Recent Accounting Pronouncements
  Off-Balance Sheet Arrangements
  
 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
  35




---



##### 



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
      
 36




---



##### 



Avalon Pharmaceuticals, Inc.
 Balance Sheets
 December 31,2008
    
    
    2007(In thousands, except share and per share data)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    4,890
    
    
    $
    6,276Short-term marketable securities
    
    
    900
    
    
    
    15,558Accounts receivable
    
    
    13
    
    
    
    200Interest receivable
    
    
    11
    
    
    
    190Prepaid expenses
    
    
    358
    
    
    
    743Deposits & Other Current Assets
    
    
    22
    
    
    
    102Total current assets
    
    
    6,194
    
    
    
    23,069Restricted cash and marketable securities
    
    
    
    
    
    
    5,275Property and equipment, net
    
    
    5,950
    
    
    
    7,325Long-term marketable securities
    
    
    
    
    
    
    1,416Deferred financing costs
    
    
    
    
    
    
    220Total assets
    
    $
    12,144
    
    
    $
    37,305LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Short-term note payable
    
    $
    3,000
    
    
    $
    Accounts payable
    
    
    1,627
    
    
    
    1,063Accrued expenses and other current liabilities
    
    
    385
    
    
    
    1,207Deferred revenue and customer advances
    
    
    1,884
    
    
    
    1,204Current portion of long-term debt
    
    
    
    
    
    
    1,211Total current liabilities
    
    
    6,896
    
    
    
    4,685Deferred rent
    
    
    404
    
    
    
    446Long-term debt, net of current portion
    
    
    
    
    
    
    6,000Total liabilities
    
    
    7,300
    
    
    
    11,131Stockholders equity:Series C Junior Participating Preferred
stock, $0.01 par value; 300,000 shares
authorized; no shares issued and outstanding
    
    
    
    
    
    
    Common stock, $0.01 par value; 60,000,000
shares authorized; 20,428,475 and 17,026,462
shares issued and outstanding at December 31,
2008 and 2007, respectively
    
    
    204
    
    
    
    170Additional paid-in capital
    
    
    150,844
    
    
    
    150,331Other comprehensive income
    
    
    
    
    
    
    50Accumulated deficit
    
    
    (146,204
    )
    
    
    (124,377
    )Total stockholders equity
    
    
    4,844
    
    
    
    26,174Total liabilities and stockholders equity
    
    $
    12,144
    
    
    $
    37,305
  37




---



##### 



Avalon Pharmaceuticals, Inc.
 Statements of Operations
 Year Ended December 31,2008
    
    
    2007
    
    
    2006(In thousands, except per share data)Revenues
    
    $
    311
    
    
    $
    809
    
    
    $
    2,724Costs and expenses:Research and development
    
    
    15,465
    
    
    
    15,322
    
    
    
    13,269General and administrative
    
    
    5,266
    
    
    
    8,240
    
    
    
    7,661Restructuring and merger-related costs
    
    
    1,570
    
    
    
    
    
    
    
    Total costs and expenses
    
    
    22,301
    
    
    
    23,562
    
    
    
    20,930Loss from operations
    
    
    (21,990
    )
    
    
    (22,753
    )
    
    
    (18,206
    )Other income (expense):Interest income
    
    
    584
    
    
    
    1,603
    
    
    
    1,288Interest expense
    
    
    (568
    )
    
    
    (633
    )
    
    
    (808
    )Other
    
    
    147
    
    
    
    110
    
    
    
    624Total other income
    
    
    163
    
    
    
    1,080
    
    
    
    1,104Net loss
    
    $
    (21,827
    )
    
    $
    (21,673
    )
    
    $
    (17,102
    )Net loss per common share  basic and diluted
    
    $
    (1.24
    )
    
    $
    (1.42
    )
    
    $
    (1.74
    )Weighted average number of common shares 
basic and diluted
    
    
    17,628
    
    
    
    15,299
    
    
    
    9,841
  38




---



##### 



Avalon Pharmaceuticals, Inc.
 Statements of Stockholders Equity
 Additional
    
    Deferred
    
    Other
    
    
    
    
    
    TotalCommon Stock
    
    Paid-in
    
    Stock
    
    Comprehensive
    
    Accumulated
    
    StockholdersShares
    
    Amount
    
    Capital
    
    Compensation
    
    Income
    
    Deficit
    
    Equity(In thousands, except share data)Balance at December 31, 2005
    
    
    8,407,376
    
    
    $
    84
    
    
    $
    111,677
    
    
    $
    (250
    )
    
    $
    (26
    )
    
    $
    (85,602
    )
    
    $
    25,883Issuance of common stock to employees upon exercise
of stock options
    
    
    35,152
    
    
    
    
    
    
    
    93
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    93Issuance of common stock to board of directors as
compensation
    
    
    28,146
    
    
    
    
    
    
    
    103
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    104Issuance of common stock, net of offering costs
    
    
    1,666,666
    
    
    
    17
    
    
    
    7,180
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,197Expense fair value of options per FAS123R
    
    
    
    
    
    
    
    
    
    
    1,674
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,674Deferred stock compensation
    
    
    
    
    
    
    
    
    
    
    (250
    )
    
    
    250
    
    
    
    
    
    
    
    
    
    
    
    Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (17,102
    )
    
    
    (17,102
    )Net unrealized gain on available for sale securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    26
    
    
    
    
    
    
    
    26Net comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (17,076
    )Balance at December 31, 2006
    
    
    10,137,340
    
    
    $
    101
    
    
    $
    120,477
    
    
    $
    
    
    
    $
    
    
    
    $
    (102,704
    )
    
    $
    17,874Issuance of common stock to employees upon exercise
of stock options
    
    
    27,140
    
    
    
    
    
    
    
    80
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    80Issuance of common stock to board of directors as
compensation
    
    
    23,210
    
    
    
    
    
    
    
    103
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    103Issuance of common stock and warrants, net of
offering costs
    
    
    6,838,772
    
    
    
    69
    
    
    
    28,178
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    28,247Expense fair value of options per FAS123R
    
    
    
    
    
    
    
    
    
    
    1,493
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,493Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (21,673
    )
    
    
    (21,673
    )Net unrealized gain on available for sale securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    50
    
    
    
    
    
    
    
    50Net comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (21,623
    )Balance at December 31, 2007
    
    
    17,026,462
    
    
    $
    170
    
    
    $
    150,331
    
    
    $
    
    
    
    $
    50
    
    
    $
    (124,377
    )
    
    $
    26,174Issuance of common stock to board of directors as
compensation
    
    
    11,466
    
    
    
    
    
    
    
    27
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    27Issuance of common stock and warrants
    
    
    3,390,547
    
    
    
    34
    
    
    
    203
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    237Expense fair value of options per FAS123R
    
    
    
    
    
    
    
    
    
    
    283
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    283Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (21,827
    )
    
    
    (21,827
    )Net realized loss on available for sale securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (50
    )
    
    
    
    
    
    
    (50
    )Net comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (21,877
    )Balance at December 31, 2008
    
    
    20,428,475
    
    
    $
    204
    
    
    $
    150,844
    
    
    $
    
    
    
    $
    
    
    
    $
    (146,204
    )
    
    $
    4,844
  39




---



##### 



Avalon Pharmaceuticals, Inc.
 Statements of Cash Flows
 Year Ended December 31,2008
    
    
    2007
    
    
    2006(In thousands)Operating activitiesNet loss
    
    $
    (21,827
    )
    
    $
    (21,673
    )
    
    $
    (17,102
    )Adjustments to reconcile net loss to net cash used in
operating activities:Depreciation
    
    
    1,645
    
    
    
    2,025
    
    
    
    2,425Non cash interest expense
    
    
    371
    
    
    
    217
    
    
    
    282Compensation expense related to stock and stock options
    
    
    310
    
    
    
    1,596
    
    
    
    1,778Amortization of premium on investments
    
    
    (146
    )
    
    
    (709
    )
    
    
    (37
    )Changes in operating assets and liabilities:Accounts and interest receivable
    
    
    366
    
    
    
    509
    
    
    
    196Prepaid expenses and other assets
    
    
    465
    
    
    
    4
    
    
    
    190Accounts payable
    
    
    564
    
    
    
    (794
    )
    
    
    758Accrued liabilities
    
    
    (822
    )
    
    
    (25
    )
    
    
    266Deferred revenue
    
    
    680
    
    
    
    (30
    )
    
    
    (689
    )Deferred rent
    
    
    (42
    )
    
    
    (23
    )
    
    
    1Net cash used in operating activities
    
    
    (18,436
    )
    
    
    (18,903
    )
    
    
    (11,932
    )Investing activitiesPurchases of marketable securities
    
    
    (7,106
    )
    
    
    (43,406
    )
    
    
    (19,974
    )Proceeds from sale of marketable securities
    
    
    28,551
    
    
    
    39,247
    
    
    
    20,723Purchases of property and equipment
    
    
    (270
    )
    
    
    (427
    )
    
    
    (351
    )Net cash provided by (used in) investing activities
    
    
    21,175
    
    
    
    (4,586
    )
    
    
    398Financing activitiesProceeds from note payable
    
    
    3,000
    
    
    
    
    
    
    
    Principal payments on debt, line of credit
    
    
    (11
    )
    
    
    (314
    )
    
    
    (1,018
    )Proceeds from issuance of common stock and warrants, net
    
    
    237
    
    
    
    28,327
    
    
    
    7,290Principal payments on bond payable
    
    
    (7,200
    )
    
    
    (1,200
    )
    
    
    (1,200
    )Deferred financing costs
    
    
    (151
    )
    
    
    (148
    )
    
    
    (171
    )Net cash provided by (used in) financing activities
    
    
    (4,125
    )
    
    
    26,665
    
    
    
    4,901Net increase (decrease) in cash and cash equivalents
    
    
    (1,386
    )
    
    
    3,176
    
    
    
    (6,633
    )Cash and cash equivalents at beginning of year
    
    
    6,276
    
    
    
    3,099
    
    
    
    9,732Cash and cash equivalents at end of year
    
    $
    4,890
    
    
    $
    6,276
    
    
    $
    3,099Supplemental informationCash paid for interest
    
    $
    181
    
    
    $
    415
    
    
    $
    515
  40




---



##### 



AVALON PHARMACEUTICALS, INC.
 NOTES TO FINANCIAL STATEMENTS
 1. Organization
 ®
  2. Liquidity Risks and Managements Plans
     3. Clinical Data Merger
  41




---



##### 



AVALON PHARMACEUTICALS, INC.
 NOTES TO FINANCIAL STATEMENTS  (Continued)
  Merger Agreement
  1 2
  Rights Plan Amendment
  Private Placement
   42




---



##### 



AVALON PHARMACEUTICALS, INC.
 NOTES TO FINANCIAL STATEMENTS  (Continued)
  License Agreement
 ® ®
 Secured Loan
  Loan Default
  4. Restructuring and Merger-Related Costs
  43




---



##### 



AVALON PHARMACEUTICALS, INC.
 NOTES TO FINANCIAL STATEMENTS  (Continued)
  Year Ended 12/31/08
    
    
    As of 12/31/08Restructuring
    
    
    
    
    
    
    RestructuringCharges
    
    
    Amount Paid
    
    
    Accrual(Amounts in thousands)Severance
    
    $
    830
    
    
    
    ($784
    )
    
    $
    46Benefits
    
    
    55
    
    
    
    (30
    )
    
    
    25Taxes & Other
    
    
    43
    
    
    
    (26
    )
    
    
    17$
    928
    
    
    
    ($840
    )
    
    $
    88
  Year Ended 12/31/08
    
    
    As of 12/31/08Merger Charges
    
    
    Amount Paid
    
    
    Merger Accrual(Amounts in thousands)Legal Fees
    
    $
    347
    
    
    
    ($296
    )
    
    $
    51Fairness Opinion
    
    
    250
    
    
    
    (250
    )
    
    
    0All Other
    
    
    45
    
    
    
    (11
    )
    
    
    34$
    642
    
    
    
    ($557
    )
    
    $
    85
  5. Summary of Significant Accounting Policies
 Use of Estimates
  Cash and Cash Equivalents
  44




---



##### 



AVALON PHARMACEUTICALS, INC.
 NOTES TO FINANCIAL STATEMENTS  (Continued)
 Marketable Securities
  Property and Equipment
   December 31,2008
    
    
    2007Scientific equipment
    
    $
    7,258
    
    
    $
    7,115Computer equipment
    
    
    1,372
    
    
    
    1,379Leasehold improvements
    
    
    12,100
    
    
    
    12,093Furniture and fixtures
    
    
    467
    
    
    
    46321,197
    
    
    
    21,050Less accumulated depreciation
    
    
    15,247
    
    
    
    13,725Property and equipment, net
    
    $
    5,950
    
    
    $
    7,325
  Deferred Financing Costs
  Revenue Recognition
  45




---



##### 



AVALON PHARMACEUTICALS, INC.
 NOTES TO FINANCIAL STATEMENTS  (Continued)
  Research and Development Costs
  Income Taxes
  Restricted Cash and Investments
  Stock-Based Compensation
  Basic and Diluted Net Loss Per Common Share
  46




---



##### 



AVALON PHARMACEUTICALS, INC.
 NOTES TO FINANCIAL STATEMENTS  (Continued)
 Comprehensive Loss
 Reporting Comprehensive Income
 Fair Value of Financial Instruments and Concentration of Credit Risk
  Segment Information
 Disclosure about Segments
of an Enterprise and Related Information.
 Reclassification
  Recently Issued Accounting Pronouncements
 Fair Value Measurements
 
    
    Level 1, defined as observable inputs such as quoted prices in active
markets for identical assets;
    
    Level 2, defined as observable inputs other than level 1 prices such
as quoted prices for similar assets; quoted prices in markets that are
not active; or other inputs that are observable or can be corroborated by
observable market data for substantially the full term of the assets or
liabilities; and
    
    Level 3, defined as unobservable inputs in which little or no market
data exists, therefore requiring an entity to develop its own
assumptions.
 47




---



##### 



AVALON PHARMACEUTICALS, INC.
 NOTES TO FINANCIAL STATEMENTS  (Continued)
   6. Marketable Investments
  2008
    
    
    2007Amortized
    
    
    Gains
    
    
    
    
    
    
    Amortized
    
    
    GainsAvailable for Sale
    
    Cost
    
    
    (Losses)
    
    
    Fair Value
    
    
    Cost
    
    
    (Losses)
    
    
    Fair ValueInvestmentsU.S. Treasury and agencies
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    202
    
    
    $
    5
    
    
    $
    207Corporate debt securities
    
    
    900
    
    
    
    
    
    
    
    900
    
    
    
    16,722
    
    
    
    45
    
    
    
    16,767900
    
    
    
    
    
    
    
    900
    
    
    
    16,924
    
    
    
    50
    
    
    
    16,974Restricted investmentsCash and cash equivalents
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,506
    
    
    
    
    
    
    
    1,506U.S. Treasury and agencies
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,769
    
    
    
    
    
    
    
    3,769Corporate debt securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,275
    
    
    
    
    
    
    
    5,275$
    900
    
    
    $
    
    
    
    $
    900
    
    
    $
    22,199
    
    
    $
    50
    
    
    $
    22,249
  2008
    
    
    2007Maturity
    
    Amortized Cost
    
    
    Fair Value
    
    
    Amortized Cost
    
    
    Fair ValueLess than one year
    
    $
    900
    
    
    $
    900
    
    
    $
    20,790
    
    
    $
    20,833Due in one to two years
    
    
    
    
    
    
    
    
    
    
    1,409
    
    
    
    1,416Total
    
    $
    900
    
    
    $
    900
    
    
    $
    22,199
    
    
    $
    22,249
 7. Debt
  48




---



##### 



AVALON PHARMACEUTICALS, INC.
 NOTES TO FINANCIAL STATEMENTS  (Continued)
   December 31,2008
    
    
    2007Clinical Data Term Note
    
    $
    3,000
    
    
    $
    MIDFA Taxable Variable Rate Demand Revenue Bond
    
    
    
    
    
    
    7,200Equipment financing
    
    
    
    
    
    
    113,000
    
    
    
    7,211Less current portion
    
    
    (3,000
    )
    
    
    (1,211
    )Long-term debt
    
    $
    
    
    
    $
    6,000
 Maryland Industrial Development Financing Authority (MIDFA) Taxable Variable Rate
Demand Revenue Bond
    8. Rights Plan
  49




---



##### 



AVALON PHARMACEUTICALS, INC.
 NOTES TO FINANCIAL STATEMENTS  (Continued)
       9. Stockholders Equity
 Preferred Stock
  Common Stock
  50




---



##### 



AVALON PHARMACEUTICALS, INC.
 NOTES TO FINANCIAL STATEMENTS  (Continued)
      Stock Options
      December 31,2008
    
    
    2007(In thousands)Research and development
    
    $
    109
    
    
    $
    245General and administrative
    
    
    201
    
    
    
    1,351Total stock  based compensation expense
    
    $
    310
    
    
    $
    1,596
  51




---



##### 



AVALON PHARMACEUTICALS, INC.
 NOTES TO FINANCIAL STATEMENTS  (Continued)
 Weighted-Weighted-
    
    
    AverageAverage
    
    
    Remaining
    
    
    AggregateExercise
    
    
    Contractual
    
    
    IntrinsicShares
    
    
    Price
    
    
    Term
    
    
    Value(In thousands)Balance at December 31, 2007
    
    
    2,082,670
    
    
    $
    4.12Granted
    
    
    563,500
    
    
    $
    1.21Exercised
    
    
    
    
    
    
    Cancelled or expired
    
    
    (414,213
    )
    
    $
    3.87Balance at December 31, 2008
    
    
    2,231,957
    
    
    $
    3.44Outstanding at December 31, 2008
    
    
    2,231,957
    
    
    $
    3.44
    
    
    
    7.2262
    
    
    $
    Vested and expected to vest at
December 31, 2008
    
    
    2,167,598
    
    
    $
    4.13
    
    
    
    6.3777
    
    
    $
    Exercisable at December 31, 2008
    
    
    1,516,860
    
    
    $
    4.13
    
    
    
    6.3777
    
    
    $
    
  2008
    
    2007
    
    2006Option pricing model
    
    Black-Scholes
    
    Black-Scholes
    
    Black-ScholesExpected stock price volatility
    
    
    66.46
    %
    
    
    69.81
    %
    
    
    69.26
    %Expected dividend yield
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %Risk-free interest rate
    
    
    3.48
    %
    
    
    4.95
    %
    
    
    4.60
    %Expected life of option (years)
    
    
    6.9
    
    
    
    6.0
    
    
    
    6.0
 Expected Stock Price Volatility
 Dividend Yield
 Risk-Free Interest Rate 
 Expected Life of the Option Term
  52




---



##### 



AVALON PHARMACEUTICALS, INC.
 NOTES TO FINANCIAL STATEMENTS  (Continued)
      Stock Warrants
     53




---



##### 



AVALON PHARMACEUTICALS, INC.
 NOTES TO FINANCIAL STATEMENTS  (Continued)
   10. Income Taxes
  December 31,2008
    
    
    2007(In thousands)Deferred tax assets:Net operating loss carryforwards
    
    $
    47,083
    
    
    $
    36,246Capitalized research and development expenses
    
    
    5,759
    
    
    
    7,383Start-up costs
    
    
    
    
    
    
    1,096Deferred revenue
    
    
    242
    
    
    
    365Deferred rent expense
    
    
    160
    
    
    
    177Accrued payroll
    
    
    49
    
    
    
    101Depreciation
    
    
    1,455
    
    
    
    1,140R&D credit
    
    
    2,891
    
    
    
    2,382Other
    
    
    787
    
    
    
    805Valuation allowance
    
    
    (58,426
    )
    
    
    (49,695
    )Net deferred tax assets
    
    $
    
    
    
    $
    
  54




---



##### 



AVALON PHARMACEUTICALS, INC.
 NOTES TO FINANCIAL STATEMENTS  (Continued)
    2008
    
    
    2007
    
    
    2006Federal tax at statutory rates
    
    $
    (7,421
    )
    
    $
    (7,369
    )
    
    $
    (5,815
    )State taxes, net of federal benefit
    
    
    (1,141
    )
    
    
    (970
    )
    
    
    (758
    )Change in valuation allowance
    
    
    8,265
    
    
    
    8,111
    
    
    
    6,339Permanent differences
    
    
    297
    
    
    
    228
    
    
    
    234Provision for income taxes
    
    $
    
    
    
    $
    
    
    
    $
    
 11. Related Party Transactions
  12. Commitments and Contingencies
   Operating2009
    
    $
    7622010
    
    
    7852011
    
    
    808
 55




---



##### 



AVALON PHARMACEUTICALS, INC.
 NOTES TO FINANCIAL STATEMENTS  (Continued)
 Operating2012
    
    
    8322013
    
    
    70Thereafter
    
    
    Total
    
    $
    3,257
   13. Collaborations and Licenses
  56




---



##### 



AVALON PHARMACEUTICALS, INC.
 NOTES TO FINANCIAL STATEMENTS  (Continued)
          57




---



##### 



AVALON PHARMACEUTICALS, INC.
 NOTES TO FINANCIAL STATEMENTS  (Continued)
  tm
     14 Employee Benefit Plan
  58




---



##### 



AVALON PHARMACEUTICALS, INC.
 NOTES TO FINANCIAL STATEMENTS  (Continued)
  15. Quarterly Financial Information (unaudited)
 Quarter EndedMarch 31
    
    June 30
    
    September 30
    
    December 31(In thousands, except per share data)2008 Summary Statement of OperationsTotal Revenues
    
    $
    50
    
    
    $
    137
    
    
    $
    124
    
    
    $
    Loss from Operations
    
    
    (6,443
    )
    
    
    (5,653
    )
    
    
    (6,023
    )
    
    
    (3,871
    )Net Loss
    
    
    (6,249
    )
    
    
    (5,578
    )
    
    
    (5,959
    )
    
    
    (4,041
    )Net Loss per common
share  basic and
diluted
    
    
    (0.37
    )
    
    
    (0.33
    )
    
    
    (0.35
    )
    
    
    (0.21
    )2007 Summary Statement of OperationsTotal Revenues
    
    $
    731
    
    
    $
    78
    
    
    $
    
    
    
    $
    Loss from Operations
    
    
    (5,608
    )
    
    
    (6,031
    )
    
    
    (5,728
    )
    
    
    (5,386
    )Net Loss
    
    
    (5,345
    )
    
    
    (5,809
    )
    
    
    (5,405
    )
    
    
    (5,114
    )Net Loss per common
share  basic and
diluted
    
    
    (0.43
    )
    
    
    (0.40
    )
    
    
    (0.32
    )
    
    
    (0.30
    )
 16. Subsequent Events
  59




---



##### 



ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
  
 ITEM 9A(T). CONTROLS AND PROCEDURES
 Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
  Changes in Internal Control over Financial Reporting
  Managements Report on Internal Control Over Financial Reporting
 Internal Control
 Integrated Framework
 Internal Control  Integrated
Framework
  
 ITEM 9B. OTHER INFORMATION
  60




---



##### 



PART III
 
 ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
 Directors and Executive Officers
  Year of Election orName
    
    Age
    
    Position Held
    
    AppointmentBradley G. Lorimier
    
    63
    
    Chairman of the Board
    
    1999Kenneth C. Carter, Ph.D.
    
    49
    
    Director, President and Chief Executive Officer
    
    1999Philip Frost, M.D., Ph.D.
    
    68
    
    Director
    
    2008David S. Kabakoff, Ph.D.
    
    61
    
    Director
    
    2006Michael R. Kurman, M.D.
    
    57
    
    Director
    
    2002William H. Washecka
    
    61
    
    Director
    
    2006J. Michael Hamilton
    
    60
    
    Chief Medical Officer
    
    2006Stephen K. Horrigan
    
    47
    
    Vice President of Research
    
    2007C. Eric Winzer
    
    52
    
    EVP and Chief Financial Officer
    
    2007
     61




---



##### 



62




---



##### 



Procedures by which Security Holders May Recommend Nominees to Our Board of Directors
  Audit Committee
  Code of Ethics for Senior Financial Officers
 http://www.avalonrx.com
 Section 16(a) Beneficial Ownership Reporting Compliance
   
 ITEM 11. EXECUTIVE COMPENSATION
 Executive Compensation Discussion
  Compensation Philosophy
  63




---



##### 




    
    Competitive Compensation:The Committee believes in positioning executive
compensation at levels that are competitive with other similar biotechnology
companies in order to attract and retain exceptional leadership talent needed
to achieve success in a small life sciences company such as Avalon.
    
    Performance-based pay:The Committee advocates executive compensation
programs that balance annual and long-term corporate objectives. These programs
are structured to specifically measure the achievement of individual and
corporate goals and operational objectives, with the intent of fostering
stockholder value in the short and long term. Both individual and corporate
level performance affect an executives total compensation, including any
increase to salary, and all annual awards, including cash bonuses and ongoing
equity grants.
    
    Ownership:The Committee believes that using compensation to build an
ownership culture effectively aligns the interest of management and our
stockholders. To this end, the Committee utilizes equity based compensation for
our Chief Executive Officer and our other executive officers, including
performance-contingent stock option grants, to provide incentives to enhance
stockholder value.
    
    Holistic view of compensation:The Committee views all components of
compensation together in making compensation decisions. These components include
base salary, annual incentives, long-term incentives, and fringe benefits and
perquisites.
   Corporate Goals and Objectives.
   64




---



##### 



Elements of Compensation
 Compensation Mix.
 Base Salary.
   Annual Cash Bonus.
  Long-Term Incentives.
 
    
    company results;
    
    individual performance;
    
    individual potential contribution to our success;
    
    competitor and market data; and
    
    total equity already awarded and reserved for awards to executives and
employees.
 65




---



##### 




    
    each officers performance and contribution during the fiscal year;
    
    the potential value delivered from all existing stock option awards; and
    
    competitive practices.
  Personal Benefits and Perquisites
  Change of Control and Severance Benefits
  Executive Compensation Tables
  Summary Compensation Table.
 66




---



##### 



Change inPension ValueNon-Equity
    
    and NonqualifiedStock
    
    Option
    
    Incentive Plan
    
    Deferred
    
    All OtherSalary
    
    Bonus
    
    Awards
    
    Awards
    
    Compensation
    
    Compensation
    
    Compensation
    
    TotalName and Principal Position
    
    Year
    
    ($)
    
    ($)
    
    ($)
    
    ($)(1)
    
    ($)
    
    Earnings
    
    ($)
    
    ($)Kenneth C. Carter, Ph.D.
    
    
    2008
    
    
    
    397,848
    
    
    
    
    
    
    
    
    
    
    
    (60,500
    ) (2)
    
    
    
    
    
    
    
    
    
    
    27,893
    (3)
    
    
    365,391President, Chief
Executive Officer and
Director
    
    
    2007
    
    
    
    385,510
    
    
    
    
    
    
    
    
    
    
    
    453,534
    
    
    
    131,978
    
    
    
    
    
    
    
    17,677
    
    
    
    988,699Thomas G. David (4)
    
    
    2008
    
    
    
    187,134
    
    
    
    
    
    
    
    
    
    
    
    (19,664
    ) (5)
    
    
    
    
    
    
    
    
    
    
    284,811
    (6)
    
    
    452,281Senior VP of Operations
and General Counsel
    
    
    2007
    
    
    
    241,516
    
    
    
    
    
    
    
    
    
    
    
    75,090
    
    
    
    70,467
    
    
    
    
    
    
    
    16,635
    
    
    
    403,707C. Eric Winzer
    
    
    2008
    
    
    
    285,600
    
    
    
    
    
    
    
    
    
    
    
    124,471
    
    
    
    
    
    
    
    
    
    
    
    20,939
    (7)
    
    
    431,010EVP and Chief Financial
Officer
    
    
    2007
    
    
    
    137,666
    
    
    
    
    
    
    
    
    
    
    
    127,619
    
    
    
    37,236
    
    
    
    
    
    
    
    7,678
    
    
    
    310,199J. Michael Hamilton, M.D.
    
    
    2008
    
    
    
    291,200
    
    
    
    
    
    
    
    
    
    
    
    21,962
    
    
    
    
    
    
    
    
    
    
    
    28,202
    (8)
    
    
    341,364Chief Medical Officer
    
    
    2007
    
    
    
    279,057
    
    
    
    
    
    
    
    
    
    
    
    39,331
    
    
    
    69,188
    
    
    
    
    
    
    
    22,420
    
    
    
    409,996
 
 (1)
    
    Amounts reflected in this column represent the compensation cost
recognized by Avalon during 2008 and 2007 for stock option awards made
in the reporting year and in prior years, are calculated in accordance
with the provisions of SFAS 123(R). See Note 9 of the Companys
consolidated financial statements contained in Item 8 of this Annual
Report on Form 10-K regarding assumptions underlying the valuation of
equity.(2)
    
    Includes a cumulative reduction in compensation expense of $140,555 in
2008 under SFAS 123(R) for performance based options that were awarded
in December 2006 and determined unlikely to be earned in June 2008.(3)
    
    Consists of (i) $19,462 in 2008 and $15,536 in 2007 for group health,
dental, and life insurance premiums and (ii) other benefits paid for Dr.
Carter.(4)
    
    Mr. Davids employment with the Company terminated on September 15, 2008.(5)
    
    Includes a cumulative reduction in compensation expense of $25,298 in
2008 under SFAS 123(R) for performance based options that were awarded
in December 2006 and determined unlikely to be earned in June 2008 and a
cumulative reduction in compensation expense of $5,276 in 2008 under
SFAS 123(R) for options forfeited upon termination.(6)
    
    Consists of (i) $257,232 in 2008 for salary continuation after
termination, (ii) $19,462 in 2008 and $15,536 in 2007 for group health,
dental, and life insurance premiums and (iii) other benefits paid for
Mr. David.(7)
    
    Consists of (i) $19,462 in 2008 and $7,678 in 2007 for group health,
dental, and life insurance premiums and (ii) other benefits paid for Mr.
Winzer.(8)
    
    Consists of (i) $14,388 in 2008 and $15,356 in 2007 for group health,
dental, and life insurance premiums and (ii) other benefits paid for Dr.
Hamilton. Outstanding Equity Awards At Fiscal Year-End.
 67




---



##### 



Option Awards
    
    Stock AwardsEquityIncentiveEquity
    
    PlanIncentive
    
    Awards:Equity
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Plan
    
    Market orIncentive
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Awards:
    
    PayoutPlan
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Number of
    
    Value ofAwards:
    
    
    
    
    
    
    
    
    
    
    
    
    
    Market
    
    Unearned
    
    UnearnedNumber of
    
    Number of
    
    Number of
    
    
    
    
    
    
    
    
    
    
    
    
    
    Value of
    
    Shares,
    
    Shares,Securities
    
    Securities
    
    Securities
    
    
    
    
    
    
    
    
    
    Number of
    
    Shares or
    
    Units or
    
    Units orUnderlying
    
    Underlying
    
    Underlying
    
    
    
    
    
    
    
    
    
    Shares or
    
    Units of
    
    Other
    
    OtherUnexercised
    
    Unexercised
    
    Unexercised
    
    Option
    
    Option
    
    Units of Stock
    
    Stock That
    
    Rights That
    
    RightsOptions (#)
    
    Options (#)
    
    Unearned
    
    Exercise
    
    Expiration
    
    That Have Not
    
    Have Not
    
    Have Not
    
    That HaveName
    
    Exercisable
    
    Unexercisable
    
    Options (#)
    
    Price ($)
    
    Date

    

    Vested (#)

    

    Vested ($)

    

    Vested

    
    Not VestedKenneth Carter, Ph.D.
    
    
    15,625
    
    
    
    
    
    
    
    
    
    
    
    1.60
    
    
    
    04/04/10
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    President, Chief
    
    
    25,000
    
    
    
    
    
    
    
    
    
    
    
    1.60
    
    
    
    12/06/10
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Executive Officer
    
    
    159,375
    
    
    
    
    
    
    
    
    
    
    
    3.20
    
    
    
    05/03/12
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    and Director
    
    
    146,670
    
    
    
    
    
    
    
    
    
    
    
    6.00
    
    
    
    10/26/15
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    83,572
    
    
    
    24,849
    (1)
    
    
    
    
    
    
    5.50
    
    
    
    11/30/15
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    168,751
    
    
    
    
    
    
    
    
    
    
    
    3.80
    
    
    
    12/06/16
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    200,000
    (2)
    
    
    0.80
    
    
    
    02/22/09
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Thomas G. David(3)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Senior VP of Operations
and General CounselC. Eric Winzer
    
    
    42,499
    
    
    
    77,501
    (4)
    
    
    
    
    
    
    4.24
    
    
    
    07/02/17
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Executive Vice
President and
Chief Financial
Officer
    
    
    
    
    
    
    
    
    
    
    150,000
    (2)
    
    
    0.80
    
    
    
    02/22/09
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    J. Michael Hamilton,
M.D.
    
    
    28,000
    
    
    
    32,000
    (5)
    
    
    
    
    
    
    2.84
    
    
    
    08/01/16
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Chief Medical
Officer
 
 (1)
    
    Remaining unvested options vest in equal monthly installments of 2,259 shares through November 30, 2009.(2)
    
    Remaining unvested options vest upon achievement of performance criteria. These options expired,
unvested, on February 22, 2009.(3)
    
    Mr. Davids employment with the Company terminated on September 15, 2008.(4)
    
    Remaining unvested options vest in equal monthly installments of 2,500 shares through July 2, 2011(5)
    
    Remaining unvested options vest in equal monthly installments of 1,000 shares through August 1, 2011. Employment Agreements
  Kenneth C. Carter, Ph.D.
 68




---



##### 



Good reason
 C. Eric Winzer
 Good reason
 J. Michael Hamilton, M.D.
 Good reason
  69




---



##### 



Confidentiality, Assignment of Inventions and Non-Competition.
 Retention Agreements with Clinical Data.
 Kenneth
Carter.
 J. Michael
Hamilton.
 C. Eric Winzer.
 Compensation of Directors
  Fees
    
    
    
    
    
    
    
    
    
    
    
    
    
    NonqualifiedEarned or
    
    
    
    
    
    
    
    
    
    Non-Equity
    
    DeferredPaid in
    
    Stock
    
    Option
    
    Incentive Plan
    
    Compensation
    
    All OtherCash
    
    Awards
    
    Awards
    
    Compensation
    
    Earnings
    
    Compensation
    
    TotalName
    
    ($)
    
    ($)(1)(2)
    
    ($)(1)
    
    ($)
    
    ($)
    
    ($)
    
    ($)Bradley G. Lorimier
    
    
    62,500
    
    
    
    0
    
    
    
    20,939
    
    
    
    0
    
    
    
    0
    
    
    
    55,000
    (3)
    
    
    176,356Philip Frost, M.D., Ph.D.
    
    
    16,875
    
    
    
    0
    
    
    
    11,063
    
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    27,938David S. Kabakoff, Ph.D.
    
    
    37,500
    
    
    
    0
    
    
    
    4,641
    
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    42,141Michael R. Kurman, M.D.
    
    
    35,625
    
    
    
    0
    
    
    
    2,868
    
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    38,493Ivor Royston, M.D. (4)
    
    
    0
    
    
    
    23,333
    
    
    
    637
    
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    23,970William A. Scott,
Ph.D.(5)
    
    
    21,667
    
    
    
    0
    
    
    
    1,617
    
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    23,284William H. Washecka
    
    
    42,500
    
    
    
    0
    
    
    
    3,037
    
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    45,537
 
 (1)
    
    Amounts reflected in these columns represent the compensation cost
recognized by Avalon during 2008 for stock option awards and awards of
unrestricted shares of our common stock made in 2008 and in prior years,
are calculated in accordance with the provisions of Statement of
Financial Accounting Standards No. 123R Share-Based Payment (SFAS
123(R)). See Note 9 of the Companys consolidated financial statements
contained in Item 8 of this Annual Report on Form 10-K regarding
assumptions underlying the valuation of equity awards.(2)
    
    Represents the directors election to receive all of their annual cash
retainer fees in awards of unrestricted shares of our common stock under
the Incentive Plan (defined below).(3)
    
    Represents consulting fees paid to Mr. Lorimier for services rendered to
us in support of our business development efforts.(4)
    
    Dr. Royston did not stand for re-election at Avalons 2008 annual meeting.(5)
    
    Dr. Scott did not stand for re-election at Avalons 2008 annual meeting.  70




---



##### 



ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS
 Security Ownership of Certain Beneficial Owners and Management
   Number of SharesBeneficially Owned
    
    Percentage of SharesName
    
    as of March 24, 2009
    
    Beneficially Owned(1)(2)Kenneth C. Carter, Ph.D.(3)
    
    
    635,653
    
    
    
    3.0
    %Thomas G. David(4)
    
    
    1,000
    
    
    
    *C. Eric Winzer(5)
    
    
    54,999
    
    
    
    *J. Michael Hamilton, M.D.(6)
    
    
    35,700
    
    
    
    *Bradley G. Lorimier(7)
    
    
    56,374
    
    
    
    *Philip Frost, Ph.D., M.D.(8)
    
    
    8,124
    
    
    
    *David S. Kabakoff, Ph.D.(9)
    
    
    16,277
    
    
    
    *Michael R. Kurman, M.D.(10)
    
    
    23,777
    
    
    
    *William H. Washecka(11)
    
    
    16,277
    
    
    
    *Clinical Data, Inc.(12)
    
    
    4,238,063
    
    
    
    20.7
    %Entities affiliated with Biotechnology Value Fund, L.P.(13)
    
    
    1,682,444
    
    
    
    8.2
    %Entities affiliated with Henry Investment Trust, L.P.(14)
    
    
    1,225,000
    
    
    
    6.0
    %Merlin BioMed Private Equity Advisors, LLC(15)
    
    
    1,049,846
    
    
    
    5.1
    %All directors and officers as a group (9 persons)(16)
    
    
    877,329
    
    
    
    4.1
    %
 
 *
    
    Less than one percent 71




---



##### 



(1)
    
    Beneficial ownership is determined in accordance with the rules of the SEC
and generally includes shares of common stock to which the person has sole
or shared voting or investment power with respect to shares of common stock
including those shares that the person has the right to acquire within 60
days after March 24, 2009, through the exercise of any stock option or
other right. Shares of common stock subject to options or rights currently
exercisable or exercisable within 60 days of March 24, 2009 are deemed
outstanding for purposes of computing the percentage ownership of the
person holding such option or right but are not deemed outstanding for
purposes of computing the percentage ownership of any other person.(2)
    
    20,428,475 shares of Avalon common stock were outstanding on March 24, 2009.(3)
    
    Includes 608,028 shares of common stock underlying options currently
exercisable or exercisable within 60 days of March 24, 2009 and 3,750
shares of common stock held in trust for the benefit of Dr. Carters minor
child for which Dr. Carter disclaims beneficial ownership.(4)
    
    Mr. Davids employment with Avalon terminated on September 15, 2008.(5)
    
    Consists of 54,999 shares of common stock underlying options currently
exercisable or exercisable within 60 days of March 24, 2009.(6)
    
    Consists of 33,000 shares of common stock underlying options currently
exercisable or exercisable within 60 days of March 24, 2009, and (ii) 2,700
shares of common stock held by Dr. Hamiltons spouse.(7)
    
    Includes 47,494 shares of common stock underlying options currently
exercisable or exercisable within 60 days of March 24, 2009.(8)
    
    Consists of 8,124 shares of common stock underlying options currently
exercisable or exercisable within 60 days of March 24, 2009.(9)
    
    Consists of 16,277 shares of common stock underlying options currently
exercisable or exercisable within 60 days of March 24, 2009.(10)
    
    Consists of 23,777 shares of common stock underlying options currently
exercisable or exercisable within 60 days of March 24, 2009.(11)
    
    Consists of 16,277 shares of common stock underlying options currently
exercisable or exercisable within 60 days of March 24, 2009.(12)
    
    Based solely on a Schedule 13D filed by Clinical Data, Inc. on November 5,
2008. Includes 847,516 shares of Avalon common stock that are subject to
separate voting agreements, each dated as of October 27, 2008, by and among
Clinical Data, Inc. and each of J. Michael Hamilton, Stephen K. Horrigan,
Kenneth C. Carter, David S. Kabakoff, Bradley G. Lorimier, Philip Frost, C.
Eric Winzer, Michael R. Kurman, and William Washecka. The address for
Clinical Data, Inc. is One Gateway Center, Suite 702, Newton, Massachusetts
02458.(13)
    
    Based solely on a periodic report on Form 13F filed by BVF Inc. for the
period ended September 30, 2008 and an amendment to Schedule 13G filed by
Biotechnology Value Fund, L.P., Biotechnology Value Fund II, L.P., BVF
Investments, L.L.C., Investment 10, L.L.C., BVF Partners L.P. and BVF Inc.
on January 21, 2009. BVF Partners L.P. and BVF, Inc. share voting and
investment power over shares of the common stock beneficially owned by
Biotechnology Value Fund, LP, Biotechnology Value Fund II, LP, BVF
Investments, LLC and Investment 10, LLC, on whose behalf BVF Partners L.P.
acts as an investment manager and, accordingly, BVF Partners L.P. and BVF,
Inc. have beneficial ownership of all the shares of the common stock and
warrants for common stock owned by such parties. The address for entities
affiliated with Biotechnology Value Fund, L.P. is 900 North Michigan
Avenue, Suite 1100, Chicago, Illinois 60611.(14)
    
    Based solely on a Schedule 13G filed by Henry Investment Trust, L.P., Henry
Partners, L.P. and Matthew Partners, L.P. on February 10, 2009. Includes
725,000 shares of common stock held by Henry Partners, L.P. and 500,000
shares of common stock held by Matthew Partners, L.P. Henry Investment
Trust, L.P. is the sole general partner of each of Henry Partners, L.P. and
Matthew Partners, L.P. and possesses both voting and investment power with
respect to the shares held by each of them. The address for entities
affiliated with Henry Investment Trust, L.P. is 255 South 17th
Street, Suite 2608, Philadelphia, Pennsylvania 19103. 72




---



##### 



(14)
    
    Based solely on an amendment to Schedule 13G filed by Merlin BioMed Private
Equity Advisors, LLC and Dominique Sémon on January 30, 2009. Consists of
shares of common stock held by Merlin BioMed Private Equity Advisors, LLC.
Merlin BioMed Private Equity Advisors, LLC and Dominique Sémon share voting
and investment power with respect to all shares of Avalon common stock held
by Merlin BioMed Private Equity Advisors, LLC. The address for Merlin
BioMed Private Equity Advisors, LLC is 230 Park Avenue, Suite 928, New
York, New York 10169.(15)
    
    Includes 838,124 shares of common stock underlying options currently
exercisable or exercisable within 60 days of March 24, 2009. Changes in Control
  Securities Authorized for Issuance under Equity Compensation Plans
  (c)Number of Securities(a)
    
    
    
    
    
    Remaining Available forNumber of Securities
    
    (b)
    
    Future Issuance Underto be Issued Upon
    
    Weighted-Average
    
    Equity CompensationExercise of
    
    Exercise Price of
    
    Plans ExcludingPlan
    
    Outstanding Options,
    
    Outstanding Options,
    
    Securities Reflected inCategory
    
    Warrants and Rights
    
    Warrants and Rights
    
    Column(a)Equity compensation
plans approved by
security holders(1)
    
    
    2,231,957
    
    
    $
    3.44
    
    
    
    647,247Equity compensation
plans not approved
by security holders
    
    
    0
    
    
    
    N/A
    
    
    
    0Total
    
    
    2,231,957
    
    
    $
    3.44
    
    
    
    647,247
 
 (1)
    
    Consists of shares of common stock to be issued upon exercise of
outstanding options granted under our 1999 Stock Incentive Plan and
our Incentive Plan. Of these plans, the only plan under which options
may be granted in the future is the Incentive Plan. 
 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
 Transactions with Related Persons
  73




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##### 



Related Party Transaction Policy and Procedures
   Director Independence
  74




---



##### 



ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
 Principal Accountant Fees and Services
   Fee Category
    
    2008
    
    
    2007Audit Fees
    
    $
    306,876
    
    
    $
    240,424Audit-Related Fees
    
    
    
    
    
    
    Tax Fees
    
    
    13,000
    
    
    
    13,536All Other Fees
    
    
    
    
    
    
    Total Fees
    
    $
    319,876
    
    
    $
    253,960
 Audit Fees
  Audit-Related Fees
  Tax Fees
  All Other Fees
  Pre-Approval of Services
  75




---



##### 



PART IV
 
 ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
      76




---



##### 



SIGNATURES
  AVALON PHARMACEUTICALS, INCBy:
    /s/   Kenneth C. Carter, Ph.D.Kenneth C. Carter, Ph.D.President and Chief Executive Officer  POWER OF ATTORNEY
   Signature
    
    Title
    
    Date/s/ Kenneth C. Carter, Ph.D.Kenneth C. Carter, Ph.D.
    
    President,
Chief Executive
Officer and Director
(Principal Executive Officer)
    
    March 31, 2009/s/ C. Eric WinzerC. Eric Winzer
    
    Executive
Vice President and
Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)
    
    March 31, 2009/s/ Bradley G. LorimierBradley G. Lorimier
    
    Chairman
of the Board of Directors
    
    March 31, 2009/s/ Philip Frost, M.D., Ph.D.Philip Frost, M.D., Ph.D.
    
    Director
    
    March 31, 2009
 77




---



##### 



Signature
    
    Title
    
    Date/s/ David S. Kabakoff, Ph.D.David S. Kabakoff, Ph.D.
    
    Director
    
    March 31, 2009/s/ Michael R. KurmanMichael R. Kurman
    
    Director
    
    March 31, 2009/s/ William H. WasheckaWilliam H. Washecka
    
    Director
    
    March 31, 2009
 78




---



##### 



INDEX TO EXHIBITS
 ExhibitNumber
    
    Exhibit Title2.1(15)
    
    Agreement and Plan of Merger and Reorganization dated as of October 27, 2008, by and among Avalon
Pharmaceuticals, Inc., Clinical Data, Inc. and API Acquisition Sub II, LLC2.2(15)
    
    Form of Contingent Value Rights Agreement by and between Clinical Data, Inc. and American Stock Transfer
and Trust Co.3.1A(1)
    
    Amended and Restated Certificate of Incorporation of Avalon Pharmaceuticals, Inc., as amended3.1B(8)
    
    Certificate of Designation, Preferences and Rights of Series C Junior Participating Preferred Stock3.1C(8)
    
    Certificate of Elimination of Series A Convertible Preferred Stock and Series B Convertible Preferred Stock3.2(1)
    
    Amended and Restated Bylaws4.1(1)
    
    Specimen Common Stock Certificate4.2(A)(8)
    
    Rights Agreement, dated as of April 26, 2007, between the Company and American Stock Transfer & Trust
Company, as Rights Agent4.2(B)(15)
    
    Amendment No. 1 to Rights Agreement dated as of October 27, 2008, between Avalon Pharmaceuticals, Inc. and
American Stock Transfer & Trust Company10.1*(1)
    
    License Development and Commercialization Agreement, dated February 14, 2005, between Avalon
Pharmaceuticals, Inc. and Vertex Pharmaceuticals Incorporated10.2*(1)
    
    Collaboration Agreement, effective as of October 15, 2003, between Avalon Pharmaceuticals, Inc. and
Medarex, Inc. on behalf of itself and its wholly-owned subsidiary, GenPharm International, Inc.10.3*(1)
    
    Collaboration and License Agreement, dated June 17, 2005, between Avalon Pharmaceuticals, Inc. and
MedImmune, Inc.10.4*(1)
    
    Pilot Study Agreement, dated September 9, 2005, between Avalon Pharmaceuticals, Inc. and Novartis
Institutes for Biomedical Research, Inc.10.5A*(6)
    
    Collaboration Agreement between Avalon Pharmaceuticals, Inc. and ChemDiv, Inc., dated July 25, 200610.5B*(6)
    
    First Amendment, dated September 21, 2006, to Collaboration Agreement between Avalon Pharmaceuticals, Inc.
and ChemDiv, Inc.10.6*(10)
    
    Exclusive License and Research Collaboration Agreement, dated March 5, 2007 by and between Merck & Co.,
Inc., and Avalon Pharmaceuticals, Inc.10.7A(1)
    
    Amended and Restated Employment Agreement, dated April 21, 2005 by and between Avalon Pharmaceuticals, Inc.
and Kenneth C. Carter, Ph.D.10.7B(7)
    
    Amendment No. 1, dated December 26, 2006, to Amended and Restated Employment Agreement, dated April 21,
2005 by and between Avalon Pharmaceuticals, Inc. and Kenneth C. Carter, Ph.D.10.8A(1)
    
    Amended and Restated Employment Agreement, dated April 21, 2005 by and between Avalon Pharmaceuticals, Inc.
and Thomas G. David10.8B(7)
    
    Amendment No. 1, dated December 26, 2006, to Amended and Restated Employment Agreement, dated April 21,
2005 by and between Avalon Pharmaceuticals, Inc. and Thomas G. David10.9A(1)
    
    Amended and Restated Employment Agreement, dated April 21, 2005 by and between Avalon Pharmaceuticals, Inc.
and David Bol, Ph.D.10.9B(7)
    
    Amendment No. 1, dated December 26, 2006, Amended and Restated Employment Agreement, dated April 21, 2005
by and between Avalon Pharmaceuticals, Inc. and David Bol, Ph.D10.10(A)(5)
    
    Employment letter between Avalon Pharmaceuticals, Inc. and J. Michael Hamilton, dated April 20, 2006.10.10(B)(7)
    
    Amendment No. 1, dated December 26, 2006, to Employment Agreement between Avalon Pharmaceuticals, Inc. and
J. Michael Hamilton, dated April 20, 200610.11(9) 
    
    Employment Letter, dated May 2, 2007, between Avalon Pharmaceuticals, Inc. and C. Eric Winzer10.13A(1)
    
    Consulting Agreement, dated February 1, 2000, by and between Avalon Pharmaceuticals, Inc. and Bradley G.
Lorimier10.13B(1)
    
    Addendum to Consulting Agreement10.13C(1)
    
    Second Addendum to Consulting Agreement, dated March 30, 2003
 79




---



##### 



ExhibitNumber
    
    Exhibit Title10.13D(1)
    
    Third Addendum to Consulting Agreement, dated October 25, 200410.13E(13)
    
    Fourth Addendum to Consulting Agreement, dated January 6, 200610.13F(13)
    
    Fifth Addendum to Consulting Agreement, dated January 5, 200710.13G(13)
    
    Sixth Addendum to Consulting Agreement, dated August 1, 200710.14(1)
    
    Avalon Pharmaceuticals, Inc. Amended and Restated 1999 Stock Plan, as of October 15, 2001, as amended10.15(1)
    
    Avalon Pharmaceuticals, Inc. Amended and Restated 1999 Stock Plan  Form of Non-qualified Stock Option
Agreement  $.20 per share10.16(1)
    
    Avalon Pharmaceuticals, Inc. Amended and Restated 1999 Stock Plan  Form of Non-qualified Stock Option
Agreement  $.40 per share10.17(1)
    
    Avalon Pharmaceuticals, Inc. Amended and Restated 1999 Stock Plan  Form of Incentive Stock Option
Agreement  $.20 per share10.18(1)
    
    Avalon Pharmaceuticals, Inc. Amended and Restated 1999 Stock Plan  Form of Incentive Stock Option
Agreement  $.40 per share10.19A(1)
    
    Avalon Pharmaceuticals, Inc. Amended and Restated 1999 Stock Plan  First Amendment to Form of Incentive
Stock Option Agreement10.19B(1)
    
    Avalon Pharmaceuticals, Inc. Amended and Restated 1999 Stock Plan  Second Amendment to Form of Incentive
Stock Option Agreement10.20(12)
    
    Avalon Pharmaceuticals, Inc. 2005 Omnibus Long-Term Incentive Plan, as amended10.21(2)
    
    Avalon Pharmaceuticals, Inc. 2005 Omnibus Long-Term Incentive Plan  Form of Incentive Stock Option
Agreement10.22(2)
    
    Avalon Pharmaceuticals, Inc. 2005 Omnibus Long-Term Incentive Plan  Form of Nonqualified Stock Option
Agreement10.23(3)
    
    Stock Election Policy for Non-Employee Director Fees10.24(1)
    
    Form of Avalon Pharmaceuticals, Inc. Director and Officer Indemnification Agreement10.25(11)
    
    Purchase Agreement, dated May 24, 200710.26(11)
    
    Registration Rights Agreement, dated May 24, 200710.27(11)
    
    Form of Common Stock Purchase Warrant, dated May 25, 200710.28(10)
    
    Purchase Agreement, dated January 19, 200710.29(10)
    
    Registration Rights Agreement, dated January 19, 200710.30*(4)
    
    Purchase Agreement, dated February 27, 200610.31(4)
    
    Registration Rights Agreement, dated February 27, 200610.32(1)
    
    Registration Rights Agreement, dated October 26, 2001, by and between Avalon Pharmaceuticals, Inc. and the
Investors listed on Schedule I thereto10.33(1)
    
    Common Stock Warrant Agreement, dated August 11, 2000, by and between Avalon Pharmaceuticals, Inc. and
Alexandria Real Estate Equities, L.P.10.34A(1)
    
    Series B Convertible Preferred Stock Warrant, dated May 14, 2001, granted to GATX Ventures, Inc.10.34B(1)
    
    Letter Amendment to Series B Convertible Preferred Stock Warrant, dated October 11, 2001, by and between
Avalon Pharmaceuticals, Inc. and GATX Ventures, Inc.10.35(1)
    
    Series B Convertible Preferred Stock Warrant Agreement, dated August 20, 2002, by and between Avalon
Pharmaceuticals, Inc. and General Electric Capital Corporation10.36(1)
    
    Series B Convertible Preferred Stock Warrant Agreement, dated December 23, 2002, by and between Avalon
Pharmaceuticals, Inc. and General Electric Capital Corporation10.37(1)
    
    Series B Convertible Preferred Stock Warrant Agreement, dated June 18, 2003, by and between Avalon
Pharmaceuticals, Inc. and General Electric Capital Corporation10.38(1)
    
    Series B Convertible Preferred Stock Warrant Agreement, dated December 23, 2003, by and between Avalon
Pharmaceuticals, Inc. and General Electric Capital Corporation10.39(1)
    
    Lease Agreement, dated July 15, 2002, by and between Westphalia Center II Limited Partnership and Avalon
Pharmaceuticals, Inc.10.40(15)
    
    Securities Purchase Agreement dated as of October 27, 2008, by and between Avalon Pharmaceuticals, Inc. and
Clinical Data, Inc.10.41(15)
    
    Common Stock Purchase Warrant dated as of October 27, 2008, issued to Clinical Data, Inc.10.42(15)
    
    Registration Rights Agreement dated as of October 27, 2008, by and between Avalon Pharmaceuticals, Inc. and
Clinical Data, Inc.10.43(15)
    
    AvalonRx® License Agreement dated as of October 27, 2008, by and between Avalon Pharmaceuticals, Inc. and
Clinical Data, Inc.10.44(15)
    
    Note Purchase Agreement dated as of October 27, 2008, by and between Avalon Pharmaceuticals, Inc. and
 80




---



##### 



ExhibitNumber
    
    Exhibit TitleClinical Data, Inc.10.45(15)
    
    Form of Term Note, dated as of October 27, 2008, issued to Clinical Data, Inc.10.46(15)
    
    Intellectual Property Security Agreement dated as of October 27, 2008, by and between Avalon
Pharmaceuticals, Inc. and Clinical Data, Inc.21.1
    
    List of Subsidiaries (filed herewith)23.1
    
    Consent of Ernst & Young LLP (filed herewith)31.1
    
    Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of
1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith)31.2
    
    Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of
1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith)32.1
    
    Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith)
 
 *
    
    Confidential treatment has been granted for portions of this exhibit. These confidential
portions have been omitted and were filed separately with the SEC.
    
    Denotes management contract or compensatory plan or arrangement.(1)
    
    Incorporated by reference to our Registration Statement on Form S-1 (File No. 333-124565).(2)
    
    Incorporated by reference to our Current Report on Form 8-K filed on November 1, 2005.(3)
    
    Incorporated by reference to our Current Report on Form 8-K filed on December 5, 2005.(4)
    
    Incorporated by reference to our Current Report on Form 8-K filed on March 3, 2006.(5)
    
    Incorporated by reference to our Current Report on Form 8-K filed on August 2, 2006.(6)
    
    Incorporated by reference to our Quarterly Report on Form 10-Q filed on November 8, 2006.(7)
    
    Incorporated by reference to our Annual Report on Form 10-K filed on March 30, 2007.(8)
    
    Incorporated by reference to our Current Report on Form 8-K filed on April 30, 2007.(9)
    
    Incorporated by reference to our Current Report on Form 8-K filed on May 4, 2007.(10)
    
    Incorporated by reference to our Quarterly Report on Form 10-Q filed on May 14, 2007.(11)
    
    Incorporated by reference to our Current Report on form 8-K filed on May 29, 2007.(12)
    
    Incorporated by reference to our Current Report on form 8-K filed on June 7, 2007.(13)
    
    Incorporated by reference to our Annual Report on Form 10-K filed on March 31, 2008.(14)
    
    Incorporated by reference to our Quarterly Report on Form 10-Q filed on May 8, 2008.(15)
    
    Incorporated by reference to our Current Report on form 8-K filed on October 30, 2008. 81